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THIS FILING IS MADE PURSUANT TO RULE 424(b)(3) UNDER THE SECURITIES ACT OF 1933
IN CONNECTION WITH REGISTRATION NO. 333-59393.
PROSPECTUS CONFIDENTIAL
[LOGO]
RHYTHMS NETCONNECTIONS INC.
OFFER TO EXCHANGE ITS
13 1/2% SENIOR DISCOUNT NOTES DUE 2008, SERIES B
WHICH HAVE BEEN REGISTERED UNDER THE SECURITIES ACT
FOR ANY AND ALL OF ITS OUTSTANDING
13 1/2% SENIOR DISCOUNT NOTES DUE 2008, SERIES A
THE EXCHANGE OFFER AND WITHDRAWAL RIGHTS
WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME
ON NOVEMBER 20, 1998, UNLESS EXTENDED.
--------------------------
Rhythms NetConnections Inc. (the "Company") hereby offers, upon the terms
and subject to the conditions set forth in this Prospectus (as the same may be
amended or supplemented from time to time, the "Prospectus") and the
accompanying Letter of Transmittal (the "Letter of Transmittal" and together
with this Prospectus, the "Exchange Offer"), to exchange $1,000 principal amount
at maturity of its 13 1/2% Senior Discount Notes due 2008, Series B (the "New
Notes"), which have been registered under the Securities Act of 1933, as amended
(the "Securities Act"), pursuant to a Registration Statement (as defined) of
which this Prospectus is a part, for each $1,000 principal amount at maturity of
its outstanding 13 1/2% Senior Discount Notes due 2008, Series A (the "Old
Notes"), of which $290,000,000 principal amount at maturity is outstanding as of
the date hereof. The Old Notes and the New Notes are sometimes herein referred
to collectively as the "Notes."
The Company will accept for exchange any and all validly tendered Old Notes
prior to 5:00 P.M., New York City time, on November 20, 1998, unless extended
(the "Expiration Date"). Old Notes may be tendered only in integral multiples of
$1,000 principal amount at maturity. Tenders of Old Notes may be withdrawn at
any time prior to 5:00 P.M., New York City time, on the Expiration Date. The
Exchange Offer is not conditioned upon any minimum amount of Old Notes being
tendered for exchange. However, the Exchange Offer is subject to certain
customary conditions. In the event the Company terminates the Exchange Offer and
does not accept for exchange any Old Notes, the Company will promptly return the
Old Notes to the Holders (as defined) thereof. The Company will not receive any
proceeds from the Exchange Offer. See "The Exchange Offer."
The terms of the New Notes will be identical in all material respects to
those of the Old Notes, except that the New Notes (i) shall accrue interest from
the last date on which interest was paid on the Old Notes, (ii) will have been
registered under the Securities Act and therefore will not be subject to certain
restrictions on transfer applicable to the Old Notes, and (iii) will not be
entitled to certain registration or other rights under the Registration Rights
Agreement (as defined), including the provision in the Registration Rights
Agreement for additional interest on the Old Notes upon failure by the Company
to consummate the Exchange Offer. See "Description of the Notes--Registration
Rights; Additional Interest." The New Notes will be entitled to the benefits of
the Indenture (as defined) governing the Old Notes. See "Description of the
Notes" and "The Exchange Offer."
THIS PROSPECTUS AND THE LETTER OF TRANSMITTAL ARE FIRST BEING MAILED TO
HOLDERS ON OCTOBER 21, 1998.
SEE "RISK FACTORS" ON PAGE 11 FOR INFORMATION THAT SHOULD BE CONSIDERED IN
CONNECTION WITH THIS OFFERING.
--------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
--------------------------
THE DATE OF THIS PROSPECTUS IS OCTOBER 21, 1998
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NOTICE TO INVESTORS
The New Notes are being offered hereunder in order to satisfy certain
obligations of the Company under the Notes Registration Rights Agreement dated
as of May 5, 1998 (the "Registration Rights Agreement") by and among the Company
and Merrill Lynch, Pierce, Fenner & Smith Incorporated and Donaldson, Lufkin &
Jenrette Securities Corporation (the "Initial Purchasers"), a copy of which has
been filed as an exhibit to the Registration Statement of which this Prospectus
is a part. The Exchange Offer is intended to satisfy the Company's obligations
under the Registration Rights Agreement to register the Old Notes under the
Securities Act.
The Old Notes were initially represented (i) in the case of Old Notes
initially purchased by "qualified institutional buyers" (as such term is defined
in Rule 144A under the Securities Act), by one global Old Note in fully
registered form, registered in the name of a nominee of The Depository Trust
Company ("DTC"), and (ii) in the case of Old Notes initially purchased by
persons other than U.S. persons in reliance upon Regulation S under the
Securities Act, by one global Regulation S Old Note in fully registered form,
registered in the name of a nominee of DTC for the accounts of Euroclear System
("Euroclear") and Cedel Bank, societe anonyme ("Cedel Bank"). The New Notes
exchanged for the Old Notes represented by the global Old Note and global
Regulation S Old Note will be represented (a) in the case of "qualified
institutional buyers", by one global New Note in fully registered form,
registered in the name of the nominee of DTC, and (ii) one global Regulation S
New Note in fully registered form registered in the name of the nominee of DTC
for the accounts of Euroclear and Cedel Bank. The global New Note and global
Regulation S New Note will be exchangeable for definitive New Notes in
registered form, in denominations of $1,000 principal amount at maturity and
integral multiples thereof. The New Notes in global form will trade in The
Depository Trust Company's Same-Day Funds Settlement System, and secondary
market trading activity in such New Notes will therefore settle in immediately
available funds. See "The Exchange Offer--Book-Entry Transfer; Delivery and
Form."
Cash interest on the New Notes will not accrue prior to May 15, 2003, from
which time cash interest on the New Notes will accrue at a rate of 13 1/2% per
annum and will be payable semiannually in arrears on May 15 and November 15 of
each year, commencing November 15, 2003. The New Notes will mature on May 15,
2008. The New Notes will be redeemable for cash at any time on or after May 15,
2003 at the option of the Company, in whole or in part, at the redemption prices
set forth herein, together with accrued and unpaid interest, if any, and
liquidated damages, if any, to the date of redemption. In addition, at any time
on or prior to May 15, 2001, the Company may redeem up to 35% of the
originally-issued aggregate principal amount at maturity of New Notes with the
net proceeds of one or more Public Equity Offerings (as defined herein) and/or
the sale of Capital Stock (as defined herein) (other than Disqualified Stock (as
defined herein)) in one or more transactions to Strategic Equity Investors (as
defined herein) resulting in gross cash proceeds to the Company of at least
$25.0 million in the aggregate at a redemption price equal to 113 1/2% of the
Accreted Value (as defined herein) thereof; provided that not less than 65% of
the originally-issued aggregate principal amount at maturity of New Notes remain
outstanding immediately after such redemption. Upon the occurrence of a Change
of Control, or following an Asset Sale (as defined herein) in certain
circumstances, the Company must offer to repurchase all or a portion of the
outstanding New Notes at a purchase price in cash equal to 101% (or, in the case
of an Asset Sale, 100%) of the Accreted Value thereof, together with accrued and
unpaid interest, if any, and liquidated damages, if any, to the date of
repurchase. See "Description of the Notes" and "Federal Income Tax
Considerations."
The New Notes will be general unsecured obligations of the Company and, as
such, will rank PARI PASSU in right of payment with all existing and future
unsecured and unsubordinated Indebtedness (as defined herein) of the Company.
There currently is no debt subordinate to the Notes. The New Notes will be
effectively subordinated in right of payment to all secured Indebtedness of the
Company to the extent of the value of the assets securing such Indebtedness and
to all Indebtedness of any subsidiary of the Company. As of June 30, 1998, the
Company had outstanding Indebtedness of approximately $149.9
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million of which approximately $3.0 million was secured Indebtedness, which
effectively ranks senior in right of payment to the New Notes. See "Description
of the Notes."
The Company is making the Exchange Offer in reliance on the position of the
Staff of the Division of Corporation Finance of the Securities Exchange
Commission (the "SEC" or "Commission") as set forth in the Staff's Exxon Capital
Holdings Corp. SEC No-Action Letter (available April 13, 1989), Morgan Stanley &
Co., Inc. SEC No-Action Letter (available June 5, 1991), Shearman & Sterling SEC
No-Action Letter (available July 7, 1993), and other interpretive letters
addressed to third parties in other transactions. However, the Company has not
sought its own interpretive letter and there can be no assurance that the Staff
of the Division of Corporation Finance of the SEC would make a similar
determination with respect to the Exchange Offer as it has in such interpretive
letters to third parties. Based on these interpretations by the Staff of the
Division of Corporation Finance, and subject to the two immediately following
sentences, the Company believes that New Notes issued pursuant to this Exchange
Offer in exchange for Old Notes may be offered for resale, resold and otherwise
transferred by a Holder thereof (other than a Holder who is a broker-dealer)
without further compliance with the registration and prospectus delivery
requirements of the Securities Act, provided that such New Notes are acquired in
the ordinary course of such Holder's business and that such Holder is not
participating, and has no arrangement or understanding with any person to
participate, in a distribution (within the meaning of the Securities Act) of
such New Notes. However, any Holder of Old Notes who is an "affiliate" of the
Company or who intends to participate in the Exchange Offer for the purpose of
distributing New Notes, or any broker-dealer who purchased Old Notes from the
Company to resell pursuant to Rule 144A under the Securities Act ("Rule 144A")
or any other available exemption under the Securities Act, (a) will not be able
to rely on the interpretations of the Staff of the Division of Corporation
Finance of the SEC set forth in the above-mentioned interpretive letters, (b)
will not be permitted or entitled to tender such Old Notes in the Exchange Offer
and (c) must comply with the registration and prospectus delivery requirements
of the Securities Act in connection with any sale or other transfer of such Old
Notes unless such sale is made pursuant to an exemption from such requirements.
See "Risk Factors--Consequences to Non-Tendering Holders of Old Notes. In
addition, as described below, any broker-dealer who holds Old Notes acquired for
its own account as a result of market-making activities or other trading
activities (a "Participating Broker-Dealer"), and who receives New Notes for Old
Notes pursuant to the Exchange Offer, may be a statutory underwriter and must
deliver a prospectus meeting the requirements of the Securities Act in
connection with any resale of such New Notes.
Each Holder of Old Notes who wishes to exchange Old Notes for New Notes in
the Exchange Offer will be required to represent that (i) it is not an
"affiliate" (as defined in Rule 405 of the Securities Act) of the Company, or,
if it is such an affiliate, it will comply with the registration and prospectus
delivery requirements of the Securities Act to the extent applicable, (ii) any
New Notes to be received by it are being acquired in the ordinary course of its
business, (iii) it has no arrangement with any person to participate in a
distribution (within the meaning of the Securities Act) of such New Notes, and
(iv) if such Holder is not a broker-dealer, such Holder is not engaged in, and
does not intend to engage in, a distribution (within the meaning of the
Securities Act) of such New Notes. Each Participating Broker-Dealer that
receives New Notes for its own account pursuant to the Exchange Offer must
acknowledge that it acquired the Old Notes for its own account as a result of
market-making activities or other trading activities and must agree that it will
deliver a prospectus meeting the requirements of the Securities Act in
connection with any resale of such New Notes. The Letter of Transmittal states
that by so acknowledging and by delivering a prospectus, a Participating
Broker-Dealer will not be deemed to admit that it is an "underwriter" within the
meaning of the Securities Act. Based on the position taken by the Staff of the
Division of Corporation Finance of the SEC in the interpretive letters referred
to above, the Company believes that Participating Broker-Dealers may fulfill
their prospectus delivery requirements with respect to the New Notes received
upon exchange of such Old Notes (other than Old Notes which represent an unsold
allotment from the original sale of the Old Notes) with a prospectus meeting the
requirements of the Securities Act, which may be the prospectus prepared for an
exchange offer so long as it contains a
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description of the plan of distribution with respect to the resale of such New
Notes. Accordingly, this Prospectus may be used by a Participating Broker-Dealer
during the period referred to below in connection with resales of New Notes
received in exchange for Old Notes where such Old Notes were acquired by such
Participating Broker-Dealer for its own account as a result of market-making or
other trading activities. Subject to certain provisions set forth in the
Registration Rights Agreement, the Company has agreed that this Prospectus may
be used by a Participating Broker-Dealer in connection with resales of such New
Notes for a period ending 180 days after the effective date of the Registration
Statement (subject to extension under certain limited circumstances described
below) or, if earlier, when such Participating Broker-Dealer is no longer
required to deliver a prospectus in connection with market-making or other
trading activities. See "Plan of Distribution."
Any Participating Broker-Dealer who is an "affiliate" of the Company may not
rely on such interpretive letters and must comply with the registration and
prospectus delivery requirements of the Securities Act in connection with any
resale transaction.
In that regard, each Participating Broker-Dealer who surrenders Old Notes
pursuant to the Exchange Offer will be deemed to have agreed, by execution of
the Letter of Transmittal, that upon receipt of notice from the Company of the
occurrence of any event or the discovery of any fact which makes any statement
contained or incorporated by reference in this Prospectus untrue in any material
respect or which causes this Prospectus to omit to state a material fact
necessary in order to make the statements contained or incorporated by reference
herein, in light of the circumstances under which they were made, not misleading
or of the occurrence of certain other events specified in the Registration
Rights Agreement, such Participating Broker-Dealer will suspend the sale of New
Notes pursuant to this Prospectus until the Company has amended or supplemented
this Prospectus to correct such misstatement or omission and has furnished
copies of the amended or supplemented Prospectus to such Participating
Broker-Dealer or the Company has given notice that the sale of the New Notes may
be resumed, as the case may be. If the Company gives such notice to suspend the
sale of the New Notes, it shall extend the 180-day period referred to above
during which Participating Broker-Dealers are entitled to use this Prospectus in
connection with the resale of New Notes by the number of days during the period
from and including the date of the giving of such notice to and including the
date when Participating Broker-Dealers shall have received copies of the amended
or supplemented Prospectus necessary to permit resales of the New Notes or to
and including the date on which the Company has given notice that the sale of
New Notes may be resumed, as the case may be.
Any Old Notes not tendered and accepted in the Exchange Offer will remain
outstanding and will be entitled to all the same rights and will be subject to
the same limitations applicable thereto under the Indenture and the Registration
Rights Agreement (except for those rights which terminate upon consummation of
the Exchange Offer). Following consummation of the Exchange Offer, the Holders
of Old Notes will continue to be subject to the existing restrictions upon
transfer thereof and the Company will have fulfilled certain obligations under
the terms of the Old Notes and the Registration Rights Agreement and,
accordingly, the holders will have no further registration or other rights under
the Registration Rights Agreement, except under certain limited circumstances.
To the extent that Old Notes are tendered and accepted in the Exchange Offer, a
Holder's ability to sell untendered Old Notes could be adversely affected. See
"Summary--Certain Consequences of a Failure to Exchange Old Notes."
THIS PROSPECTUS AND THE RELATED LETTER OF TRANSMITTAL CONTAIN IMPORTANT
INFORMATION. HOLDERS OF OLD NOTES ARE URGED TO READ THIS PROSPECTUS AND THE
RELATED LETTER OF TRANSMITTAL CAREFULLY BEFORE DECIDING WHETHER TO TENDER THEIR
OLD NOTES PURSUANT TO THE EXCHANGE OFFER.
Prior to this Exchange Offer, there has been no public market for the Old
Notes or New Notes. The Company does not intend to list the New Notes on a
national securities exchange or to seek approval for quotation through any
automated quotation system. As the Old Notes were issued and the New Notes are
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being issued to a limited number of institutions who typically hold similar
securities for investments, the Company does not expect that an active public
market for the New Notes will develop. In addition, resales by certain Holders
of any outstanding Old Notes and the New Notes of a substantial percentage of
the aggregate principal amount at maturity of such New Notes could constrain the
ability of any market maker to develop or maintain a market for the New Notes.
To the extent that a market for the New Notes should develop, the market value
of the New Notes will depend on prevailing interest rates, the market for
similar securities and other factors, including the financial condition,
performance and prospects of the Company. Such factors might cause the New Notes
to trade at a discount from face value. See "Risk Factors-- Absence of Public
Market for the New Notes; Restrictions on Transfer." The Company has agreed to
pay the expenses of the Exchange Offer.
The Company will not receive any cash proceeds from the issuance of the New
Notes offered hereby. No dealer-manager is being used in connection with the
Exchange Offer. See "Use of Proceeds" and "Plan of Distribution."
FORWARD-LOOKING STATEMENTS
THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS, WHICH GENERALLY CAN BE
IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS "BELIEVES,"
"EXPECTS," "MAY," "WILL," "SHOULD" OR "ANTICIPATES" OR THE NEGATIVE THEREOF OR
OTHER VARIATIONS THEREON OR COMPARABLE TERMINOLOGY, OR BY DISCUSSION OF STRATEGY
THAT INVOLVES RISKS AND UNCERTAINTIES. MANAGEMENT WISHES TO CAUTION THE READER
THAT THESE FORWARD-LOOKING STATEMENTS, SUCH AS WITH RESPECT TO THE COMPANY'S
ROLL-OUT PLANS AND STRATEGIES, AND STATEMENTS REGARDING THE DEVELOPMENT OF THE
COMPANY'S BUSINESS, THE MARKETS FOR THE COMPANY'S SERVICES AND PRODUCTS, THE
COMPANY'S ANTICIPATED CAPITAL EXPENDITURES, POSSIBLE CHANGES IN REGULATORY
REQUIREMENTS AND OTHER STATEMENTS CONTAINED HEREIN REGARDING MATTERS THAT ARE
NOT HISTORICAL FACTS, ARE ONLY PREDICTIONS AND ESTIMATES REGARDING FUTURE EVENTS
AND CIRCUMSTANCES. ANY FORWARD-LOOKING STATEMENTS CONTAINED HEREIN ARE SUBJECT
TO MATERIAL RISKS AND UNCERTAINTIES, MANY OF WHICH ARE BEYOND THE CONTROL OF THE
COMPANY. MARKET CONDITIONS AND THE COMPANY'S ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM THE MARKET CONDITIONS AND RESULTS DISCUSSED IN THESE STATEMENTS.
FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE, WITHOUT LIMITATION, THOSE
DISCUSSED IN "RISK FACTORS," "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS" AND THOSE DISCUSSED ELSEWHERE IN THIS
PROSPECTUS.
------------------------
Market data and certain industry forecasts used throughout this Prospectus
were obtained from internal surveys, market research, publicly available
information and industry publications. Industry publications generally state
that the information contained therein has been obtained from sources believed
to be reliable, but that the accuracy and completeness of such information is
not guaranteed. Similarly, internal surveys and market research, while believed
to be reliable, have not been independently verified, and none of the Company or
the Initial Purchasers makes any representation as to the accuracy of such
information.
ACI-TM-, ACCELERATED CONNECTIONS-TM-, HOME.RHYTHMS-TM-, LOOP.RHYTHMS-TM-,
NET.RHYTHMS-TM-, NETRHYTHMS-TM-, RHYTHM WORKS-TM-, RHYTHMS-TM-, RHYTHMS
COGNITIVE NETWORK-TM-, RHYTHMS NETCONNECTIONS-TM-, RING.RHYTHMS-TM- and
WORK.RHYTHMS-TM- are trademarks of the Company. The Company has filed
applications for federal
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registration of these trademarks. This Prospectus also makes reference to trade
names and trademarks of other companies which are the property of their
respective holders.
AVAILABLE INFORMATION
The Company is not currently subject to the periodic reporting and other
informational requirements of the Securities Exchange Act of 1934, as amended
(the "Exchange Act"). The Company has agreed that, whether or not it is required
to do so by the rules and regulations of the SEC, for so long as any of the Old
Notes and New Notes remain outstanding, it will furnish to the Holders of the
Old Notes and New Notes and file with the Trustee and file with the SEC audited
financial statements of the Company, including (if permitted by SEC practice and
applicable law and regulations) (i) all quarterly and annual financial
information that would be required to be contained in a filing with the SEC on
Forms 10-Q and 10-K if the Company were required to file such forms, including a
"Management's Discussion and Analysis of Results of Operations and Financial
Condition" and, with respect to the annual information only, a report thereon by
the Company's independent auditors and (ii) all reports that would be required
to be filed with the SEC on Form 8-K if the Company were required to file such
reports, in each case, within the time periods set forth in the rules and
regulations of the SEC. In addition, for so long as any of the Old Notes and New
Notes remain outstanding, the Company has agreed to make available to the
Holders of the Old Notes and New Notes, securities analysts, prospective
purchasers of the Old Notes and New Notes or beneficial owners of the Old Notes
and New Notes in connection with any sale thereof, the information required by
Rule 144A(d)(4) under the Securities Act.
ADDITIONAL INFORMATION
This Prospectus constitutes a part of a registration statement on Form S-4
(together with all amendments thereto, the "Registration Statement") filed by
the Company with the SEC under the Securities Act. This Prospectus, which forms
a part of the Registration Statement, does not contain all the information set
forth in the Registration Statement, certain parts of which have been omitted in
accordance with the rules and regulations of the SEC. Reference is hereby made
to the Registration Statement and related exhibits and schedules filed therewith
for further information with respect to the Company and the New Notes offered
hereby. Statements contained herein concerning the provisions of any document
are not necessarily complete and, in each instance, reference is made to the
copy of such document filed as an exhibit to the Registration Statement or
otherwise filed by the Company with the SEC and each such statement is qualified
in its entirety by such reference. The Registration Statement and the exhibits
and schedules thereto may be inspected and copied at the public reference
facilities maintained by the SEC: New York Regional Office, Seven World Trade
Center, New York, New York 10048, and Chicago Regional Office, 500 West Madison
Street, Chicago, Illinois 60661. The SEC maintains a Web site that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the SEC. Copies of the Registration
Statement may be obtained from the SEC's Internet address at http://www.sec.gov.
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PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION, INCLUDING THE COMPANY'S FINANCIAL STATEMENTS AND NOTES THERETO,
APPEARING ELSEWHERE IN THIS PROSPECTUS. REFERENCES HEREIN TO "RHYTHMS" OR THE
"COMPANY" ARE TO RHYTHMS NETCONNECTIONS INC. (A DELAWARE CORPORATION) AND ITS
WHOLLY OWNED SUBSIDIARIES, ACI CORP. (A DELAWARE CORPORATION) AND ACI CORP. -
VIRGINIA (A VIRGINIA PUBLIC SERVICE CORPORATION), EXCEPT AS OTHERWISE DESCRIBED
IN "DESCRIPTION OF THE NOTES" AND WHERE THE CONTEXT OTHERWISE REQUIRES.
CAPITALIZED TERMS USED IN THIS PROSPECTUS, WHICH ARE NOT OTHERWISE DEFINED
HEREIN, HAVE THE RESPECTIVE MEANINGS ASCRIBED TO THEM IN "GLOSSARY OF TERMS"
BEGINNING ON PAGE A-1.
THE COMPANY
Rhythms is a comprehensive networking solutions company that provides
high-speed data communications services on an end-to-end basis to Service
Providers (as defined herein) and end users. Rhythms combines high-speed local
access through the deployment of digital subscriber line ("DSL") technology with
capacity balanced local and wide area networks to provide low cost networking
solutions (the "Rhythms Network"). The Rhythms Network is intended to be
national in scope and to provide national and regional ISPs, IXCs, CLECs,
network and systems integrators, value-added resellers (collectively, "Service
Providers") and end users with a secure, reliable, high throughput solution to
the key shortcomings of today's networks. Rhythms will offer turnkey end-to-end
data communications solutions that can be integrated with Service Providers'
existing service offerings to provide a comprehensive package to end users. The
Company believes the Rhythms solution will be attractive due to the Company's
ability to provide a complete networking solutions platform including (i) low
cost, high-speed local access; (ii) local and wide area balanced capacity; and
(iii) end-to-end network management.
Rhythms is positioned to capitalize on the increasing importance and rapid
growth in data networking. Rhythms' initial target markets include private line
replacement, remote LAN connectivity and Internet access. According to industry
sources, the total U.S. private line market (low-speed analog and digital
private lines and frame relay DS-0 circuits) was approximately $11.3 billion in
1997 and is expected to grow to $22.7 billion by 2000. In addition, the remote
Internet and LAN access market was approximately $5.9 billion in 1997, and is
expected to grow to $11.7 billion by 2000, representing a projected compound
annual growth rate of 26%. Based on industry sources regarding the number of
LANs in the United States, the Company believes it will be able to address 28%
of all LANs in the United States with the buildout of its initial 11 markets,
expected to be completed by the first half of 1999. The Company intends to
expand into a total of 30 markets across the country by the end of the year
2000; accordingly, it has signed interconnection agreements with four ILECs, has
obtained CLEC authority in ten states, and expects to receive authority in an
additional 14 states by December 31, 1998. While facilitating this expansion,
the Company expects its operating losses and capital expenditures to increase
substantially.
Since its inception in February 1997, Rhythms has made substantial progress
in developing a scalable platform designed to be rapidly rolled out on a
nationwide basis. The Company has signed interconnection agreements with Pacific
Bell, Bell Atlantic, U S WEST and Ameritech, has obtained CLEC authority in
California, Florida, Illinois, Maryland, Massachusetts, Michigan, New Jersey,
New York, Oregon, Virginia, Washington and Wisconsin, is permitted to operate as
a CLEC in Pennsylvania, and is currently in negotiations to interconnect with
five other ILECs. The Company began service trials in the greater San Diego
metropolitan area in December 1997 and began offering commercial services in San
Diego on April 1, 1998 and in San Francisco on June 1, 1998. The Company
believes that the net proceeds from the issuance of the Old Notes ("Old Note
Issuance"), together with its existing cash, lease line proceeds and future
revenue generated from operations, will be sufficient to fund the Company's
operating losses, capital expenditures and working capital requirements for the
next 24 months associated with the rollout and subsequent operation of its
initial 11 markets. The Company intends to subsequently build out in other
markets across the country, as discussed above.
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The Company has assembled a management team with substantial experience in
the development, growth and operation of data networking businesses. The
Company's Chief Executive Officer and President, Catherine Hapka, previously
served as President and Chief Operating Officer of !NTERPRISE Networking
Services, U S WEST's data networking business. Under her leadership, !NTERPRISE
grew from a start-up to $500 million in annual contract sales. James Greenberg,
the Company's Chief Network Officer, directed the design, planning, operation
and construction of Sprint's data networks, during which time Sprint's data
networking business grew from a multi-million to a multi-billion dollar
business. Rhythms' sponsors have invested $30.4 million in equity to date, and
include Kleiner Perkins Caufield & Byers, a leading investor in technology and
telecommunications companies, and Enron Communications Group, Inc., a subsidiary
of Enron Corporation, one of the world's largest energy producers, distributors
and marketers. Other investors include Brentwood Venture Capital, The Sprout
Group and Enterprise Partners.
------------------------
The Company's principal executive office is located at 7337 South Revere
Parkway, Englewood, Colorado 80112-3931, and its telephone number is (303)
476-4200.
RISK FACTORS
Prospective investors should carefully consider the matters set forth under
"Risk Factors," beginning on page 11, in evaluating an investment in the New
Notes. These risks include without limitation the Company's limited operating
history and early stage of development, its unproven business strategy and
uncertainty of market acceptance, its historical and anticipated future losses,
the high leverage of the Company and its ability to service indebtedness, the
Company's significant capital requirements, the Company's dependence on ILECs,
government regulation, competition and the Company's dependence on key
personnel.
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THE EXCHANGE OFFER
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<S> <C>
The Exchange Offer................ $1,000 principal amount at maturity of the New Notes in
exchange for each $1,000 principal amount at maturity of
the Old Notes. As of June 30, 1998, $290,000,000 in
aggregate principal amount at maturity of Old Notes were
outstanding. The Company will issue the New Notes to
Holders on or promptly after the Expiration Date.
Based on an interpretation by the Staff of the SEC set
forth in the Staff's Exxon Capital Holdings Corp. SEC
No-Action Letter (available April 13, 1989), Morgan
Stanley & Co., Inc. SEC No-Action Letter (available June
5, 1991), Shearman & Sterling SEC No-Action Letter
(available July 7, 1993), and other no-action letters
issued to third parties, the Company believes that New
Notes issued pursuant to the Exchange Offer in exchange
for Old Notes may be offered for resale, resold and
otherwise transferred by Holders thereof without
compliance with the registration and prospectus delivery
provisions of the Securities Act. However, any Holder
who is an "affiliate" of the Company or who intends to
participate in the Exchange Offer for the purpose of
distributing the New Notes, or any broker-dealer who
purchased Old Notes from the Company to resell pursuant
to Rule 144A or any other available exemption under the
Securities Act (i) cannot rely on the interpretation by
the Staff of the SEC set forth in the above referenced
no-action letters, (ii) cannot tender its Old Notes in
the Exchange Offer and (iii) must comply with the
registration and prospectus delivery requirements of the
Securities Act in connection with any sale or transfer
of the Old Notes, unless such sale or transfer is made
pursuant to an exemption from such requirements. See
"Risk Factors--Consequences to Non-Tendering Holders of
Old Notes."
Each Participating Broker-Dealer that receives New Notes
for its own account pursuant to the Exchange Offer must
acknowledge that it will deliver a prospectus in
connection with any resale of such New Notes. The Letter
of Transmittal states that by so acknowledging and by
delivering a prospectus, a Participating Broker-Dealer
will not be deemed to admit that it is an "underwriter"
within the meaning of the Securities Act. This
Prospectus may be used by a Participating Broker-Dealer
in connection with resales of New Notes received in
exchange for Old Notes where such Old Notes were
acquired by such Participating Broker-Dealer as a result
of market-making activities or other trading activities
and not acquired directly from the Company. The Company
has agreed that for a period of 180 days after the
effective date of the Registration Statement, it will
make this Prospectus available to any Participating
Broker-Dealer for use in connection with any such
resale. See "Plan of Distribution."
</TABLE>
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Expiration Date................... November 20, 1998, unless the Exchange Offer is
extended, in which case the term "Expiration Date" means
the latest date and time to which the Exchange Offer is
extended.
Accretion of the New Notes and the
Old Notes....................... No cash interest will accrue or be payable in respect of
the New Notes prior to May 15, 2003. Thereafter,
interest will accrue at the rate of 13.5% per annum,
payable semiannually in arrears on each May 15 and
November 15, commencing November 15, 2003. The Old Notes
accepted for exchange will continue to accrete in
principal amount at the rate of 13.5% per annum to, but
excluding, the issuance date of the New Notes and will
cease to accrete in principal amount upon cancellation
of the Old Notes and issuance of the New Notes. Any Old
Notes not tendered or accepted for exchange will
continue to accrete in principal amount at the rate of
13.5% per annum in accordance with its terms. The
Accreted Value of the New Notes upon issuance will equal
the Accreted Value of the Old Notes accepted for
exchange immediately prior to issuance of the New Notes.
Conditions to the Exchange
Offer........................... The Exchange Offer is subject to certain customary
conditions. The conditions are limited and relate in
general to proceedings which have been instituted or
laws which have been adopted that might impair the
ability of the Company to proceed with the Exchange
Offer. As of the date hereof, none of these events had
occurred, and the Company believes their occurrence to
be unlikely. If any such conditions do exist prior to
the Expiration Date, the Company may (i) refuse to
accept any Old Notes and return all previously tendered
Old Notes, (ii) extend the Exchange Offer or (iii) waive
such conditions. See "The Exchange Offer--Conditions."
Procedures for Tendering Old
Notes........................... Each beneficial owner owning interests in Old Notes
("Beneficial Owner") through a DTC Participant (as
defined) must instruct such DTC Participant to cause Old
Notes to be tendered in accordance with the procedures
set forth in this Prospectus and in the applicable
Letter of Transmittal. See "The Exchange
Offer--Book-Entry Transfer; Delivery and Form."
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Each participant (a "DTC Participant") in the Depository
Trust Company ("DTC") holding Old Notes through DTC must
(i) electronically transmit its acceptance to DTC
through the DTC Automated Tender Offer Program ("ATOP"),
for which the transaction will be eligible, and DTC will
then verify the acceptance, execute a book-entry
delivery to the Exchange Agent's (as defined herein)
account at DTC and send an Agent's Message (as defined
herein) to the Exchange Agent for its acceptance, or
(ii) comply with the guaranteed delivery procedures set
forth in this Prospectus and in the Letter of
Transmittal. By tendering through ATOP, DTC Participants
will expressly acknowledge receipt of the accompanying
Letter of Transmittal and agree to be bound by its terms
and the Company will be able to enforce such agreement
against such DTC Participants. See "The Exchange
Offer--Procedures for Tendering--Book-Entry Transfer;
Delivery and Form" and "-- Guaranteed Delivery
Procedures--Old Notes held through DTC."
Each Holder of Old Notes wishing to accept the Exchange
Offer must complete, sign and date the Letter of
Transmittal, or a facsimile thereof, in accordance with
the instructions contained herein and therein, and mail
or otherwise deliver such Letter of Transmittal, or such
facsimile, together with such Old Notes to be exchanged
and any other required documentation to State Street
Bank and Trust Company of California, N.A., as Exchange
Agent (the "Exchange Agent"), at the address set forth
herein and therein or effect a tender of such Old Notes
pursuant to the procedures for book-entry transfer as
provided for herein. By executing the Letter of
Transmittal or effecting a book-entry transfer, each
Holder will represent to the Company that, among other
things, the New Notes acquired pursuant to the Exchange
Offer are being obtained in the ordinary course of
business of the person receiving such New Notes, whether
or not such person is the Holder, that neither the
Holder nor any such other person has an arrangement or
understanding with any person to participate in the
distribution of such New Notes and that neither the
Holder nor any such person is an "affiliate," as defined
in Rule 405 under the Securities Act, of the Company.
Each Participating Broker-Dealer that receives New Notes
not acquired directly from the Company must acknowledge
that it will deliver a copy of this Prospectus in
connection with any resale of such New Notes. See "The
Exchange Offer-- Procedures for Tendering" and "Plan of
Distribution."
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Special Procedures for Beneficial
Owners.......................... Any beneficial owner whose Old Notes are registered in
the name of a broker, dealer, commercial bank, trust
company or other nominee and who wishes to tender such
Old Notes in the Exchange Offer should contact such
registered Holder promptly and instruct such registered
Holder to tender such Old Notes on such beneficial
owner's behalf. If such beneficial owner wishes to
tender on such beneficial owner's own behalf, such owner
must, prior to completing and executing the Letter of
Transmittal and delivering its Old Notes, either make
appropriate arrangements to register ownership of the
Old Notes in such beneficial owner's name or obtain a
properly completed bond power from the registered
Holder. The transfer of registered ownership may take
considerable time and may not be able to be completed
prior to the Expiration Date. See "The Exchange Offer--
Procedures for Tendering."
Guaranteed Delivery Procedures.... Holders of Old Notes who wish to tender their Old Notes
and whose Old Notes are not immediately available or who
cannot deliver their Old Notes, the Letter of
Transmittal or any other documents required by the
Letter of Transmittal to the Exchange Agent, or cannot
complete the procedure for book-entry transfer, prior to
the Expiration Date must tender their Old Notes
according to the guaranteed delivery procedures set
forth in "The Exchange Offer--Guaranteed Delivery
Procedures."
Withdrawal Rights................. Tenders may be withdrawn at any time prior to 5:00 p.m.,
New York City time, on the Expiration Date by delivering
a written notice of such withdrawal to the Exchange
Agent in conformity with certain procedures set forth
under "The Exchange Offer-- Withdrawal of Tenders."
Acceptance of Old Notes and
Delivery of New Notes........... The Company will accept for exchange any and all Old
Notes which are properly tendered in the Exchange Offer
prior to 5:00 p.m., New York City time, on the
Expiration Date. The New Notes issued pursuant to the
Exchange Offer will be delivered promptly following the
Expiration Date. Any Old Notes not accepted for exchange
will be returned without expense to the tendering Holder
thereof as promptly as practicable after the expiration
or termination of the Exchange Offer. See "The Exchange
Offer--Terms of the Exchange Offer."
Certain Tax Considerations........ The exchange pursuant to the Exchange Offer should not
be a taxable event for federal income tax purposes. See
"Federal Income Tax Considerations."
Exchange Agent.................... State Street Bank and Trust Company of California, N.A.
</TABLE>
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TERMS OF NEW NOTES
The Exchange Offer applies to up to $290,000,000 aggregate principal amount
at maturity of the Company's Old Notes. The New Notes will be obligations of the
Company evidencing the same indebtedness as the Old Notes and will be entitled
to the benefits of the same Indenture. See "Description of the New Notes." The
form and terms of the New Notes are the same as the form and terms of the Old
Notes in all material respects except that the New Notes have been registered
under the Securities Act and hence do not include certain rights to registration
thereunder, do not contain transfer restrictions or terms with respect to
additional interest payments applicable to the Old Notes and interest on the New
Notes shall accrue from the last date on which interest was paid on the Old
Notes. See "Description of the New Notes."
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New Notes Offered................. $290,000,000 aggregate principal amount at maturity of
13 1/2% Senior Discount Notes due 2008, Series B.
Maturity May 15, 2008.
Yield and Interest................ 13 1/2% per annum (computed on a semiannual bond
equivalent basis calculated from May 5, 1998). Cash
interest will not accrue on the New Notes prior to May
15, 2003. Thereafter, cash interest on the New Notes
will accrue at a rate of 13 1/2% per annum and will be
payable semi-annually in arrears on May 15 and November
15 of each year, commencing November 15, 2003.
Original Issue Discount........... Each New Note is being offered with original issue
discount for United States Federal income tax purposes.
Thus, although cash interest will not begin to accrue on
the New Notes until May 15, 2003, and there will be no
periodic payments of interest on the New Notes prior to
November 15, 2003, the total amount of original issue
discount (i.e., the difference between the stated
redemption price at maturity of the New Notes and the
amount of the issue price of the Units allocated to the
New Notes) will start to accrue from the issue date and
will be includible as interest income periodically in a
holder's gross income for federal income tax purposes in
advance of receipt of the cash payments to which the
income is attributable. See "Federal Income Tax
Considerations."
Optional Redemption............... The New Notes will be redeemable at the option of the
Company, in whole or in part, at any time on or after
May 15, 2003 at the redemption prices set forth herein,
plus accrued and unpaid interest, if any, and liquidated
damages, if any, to the date of redemption.
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In addition, on or prior to May 15, 2001, the Company
may redeem up to 35% of the originally-issued aggregate
principal amount at maturity of the New Notes, other
than in any circumstance resulting in a Change of
Control, at a redemption price equal to 113 1/2% of the
Accreted Value of the New Notes so redeemed, plus
liquidated damages, if any, as of the date of
redemption, with the net cash proceeds of (a) one or
more Public Equity Offerings and/or (b) the sale of
Capital Stock (other than Disqualified Stock) in one or
more transactions to Strategic Equity Investors,
resulting in gross cash proceeds to the Company of at
least $25.0 million in the aggregate; PROVIDED that not
less than 65% of the originally-issued aggregate
principal amount at maturity of New Notes is outstanding
immediately following such redemption. See "Description
of the Notes--Redemption--OPTIONAL REDEMPTION."
Change of Control................. Upon the occurrence of a Change of Control, the Company
shall make an offer to purchase all outstanding New
Notes at a purchase price equal to 101% of the Accreted
Value thereof, plus accrued and unpaid interest, if any,
and liquidated damages, if any, to the date of purchase.
See "Description of the Notes-- Certain
Covenants--CHANGE OF CONTROL."
Ranking........................... The New Notes will be general unsecured obligations of
the Company and, as such, will rank PARI PASSU in right
of payment with all existing and future unsecured and
unsubordinated Indebtedness of the Company. The New
Notes will be effectively subordinated to all secured
Indebtedness of the Company to the extent of the value
of the assets securing such Indebtedness and will be
structurally subordinated to all existing and future
Indebtedness of any subsidiary of the Company. As of
June 30, 1998, the Company had outstanding Indebtedness
of approximately $149.9 million of which approximately
$3.0 million is secured Indebtedness (consisting of bank
and lease line Indebtedness), which effectively ranks
senior in right of payment to the New Notes. As of June
30, 1998, after giving effect to the creation and
capitalization of the Company's existing subsidiaries,
such subsidiaries had no outstanding Indebtedness.
Although the Indenture (as defined herein) contains
limitations on the amount of additional Indebtedness
that the Company and its Restricted Subsidiaries may
incur, under certain circumstances the amount of such
Indebtedness could be substantial. See "Description of
the Notes--Ranking."
Asset Sale Offer.................. The Company, subject to certain conditions, will be
obligated to make an offer to purchase New Notes with
the net cash proceeds of certain Asset Sales at a
purchase price equal to 100% of the Accreted Value
thereof, plus accrued and unpaid interest thereon, if
any, and liquidated damages, if any, to the date of
purchase. See "Description of the Notes--Certain
Covenants--DISPOSITION OF PROCEEDS OF ASSET SALES."
</TABLE>
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Certain Covenants................. The Indenture contains certain covenants, including,
among others, covenants with respect to the following
matters: (i) limitation on additional Indebtedness; (ii)
limitation on restricted payments; (iii) limitation on
liens securing certain Indebtedness; (iv) Change of
Control; (v) limitation on dividends and other payment
restrictions affecting Restricted Subsidiaries; (vi)
disposition of proceeds of Asset Sales; (vii) limitation
on issuances and sales of capital stock of Restricted
Subsidiaries; (viii) limitation on transactions with
affiliates; (ix) business activities; (x) limitation on
issuances of guarantees by Restricted Subsidiaries; (xi)
limitation on sale/leaseback transactions; (xii)
reports; (xiii) limitation on designations of
Unrestricted Subsidiaries; (xiv) limitation on status as
investment company; and (xv) consolidation, merger, sale
of assets, etc. These covenants are subject to important
exceptions and qualifications. See "Description of the
Notes--Certain Covenants" and "--Consolidation, Merger,
Sale of Assets, Etc."
Exchange Rights................... Holders of New Notes will not be entitled to any
exchange or registration rights with respect to the New
Notes. Holders of Old Notes are entitled to certain
exchange rights pursuant to the Registration Rights
Agreement. Under the Registration Rights Agreement, the
Company is required to offer to exchange the Old Notes
for New Notes having substantially identical terms which
have been registered under the Securities Act. This
Exchange Offer is intended to satisfy such obligation.
Once the Exchange Offer is consummated, the Company will
have no further obligations to register any Old Notes
not tendered by the Holders thereof for exchange. See
"Risk Factors-- Consequences to Non-Tendering Holders of
Old Notes."
Form of New Notes................. The New Notes will be represented by one or more
permanent global Notes in definitive, fully registered
form, to be deposited with State Street Bank and Trust
Company of California, N.A., as the Trustee (the
"Trustee") under the Indenture, as custodian for, and
registered in the name of, a nominee of DTC. The New
Notes sold in offshore transactions in reliance on
Regulation S under the Securities Act will be
represented by one or more permanent global Notes in
definitive, fully registered form deposited with the
Trustee as custodian for, and registered in the name of,
a nominee of DTC for the accounts of Cedel Bank and
Morgan Guaranty Trust Company of New York, Brussels
office, as operator of Euroclear. See "The Exchange
Offer--Book-Entry Transfer; Delivery and Form."
Use of Proceeds................... The Company will not receive any proceeds from, and the
Company has agreed to bear the expenses of, the Exchange
Offer.
</TABLE>
CERTAIN CONSEQUENCES OF A FAILURE TO EXCHANGE OLD NOTES
The Old Notes have not been registered under the Securities Act or any state
securities laws and therefore may not be offered, sold or otherwise transferred
except in compliance with the registration
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requirements of the Securities Act and any other applicable securities laws, or
pursuant to an exemption therefrom or in a transaction not subject thereto, and
in each case in compliance with certain other conditions and restrictions,
including the Company's and the Trustee's right in certain cases to require the
delivery of opinions of counsel, certifications and other information prior to
any such transfer. Old Notes which remain outstanding after consummation of the
Exchange Offer will continue to bear a legend reflecting such restrictions on
transfer. In addition, upon consummation of the Exchange Offer, Holders of Old
Notes which remain outstanding will not be entitled to any rights to have such
Old Notes registered under the Securities Act or to any similar rights under the
Registration Rights Agreement. The Company currently does not intend to register
under the Securities Act any Old Notes which remain outstanding after
consummation of the Exchange Offer (subject to such limited exceptions, if
applicable).
To the extent that Old Notes are tendered and accepted in the Exchange Offer
any trading market for Old Notes which remain outstanding after the Exchange
Offer could be adversely affected.
The New Notes and any Old Notes which remain outstanding after consummation
of the Exchange Offer will vote together as a single class for purposes of
determining whether Holders of the requisite percentage in outstanding principal
amount at maturity thereof have taken certain actions or exercised certain
rights under the Indenture. See "Description of the Notes."
The Registration Rights Agreement provides that, if the Exchange Offer were
not consummated within the time period specified therein, additional interest
will accrue on the Old Notes at a rate of 0.50% per annum over the rate at which
interest is then accruing or, as applicable, principal is then accreting, during
the 90-day period immediately following the occurrence of any Registration
Default (as defined) and shall increase by 0.50% per annum at the end of each
subsequent 90-day period until such Registration Default has been cured, but in
no event would such additional interest exceed 1.5% per annum. See "Description
of the Old Notes--Registration Rights; Additional Interest." Following
consummation of the Exchange Offer, neither the Old Notes nor the New Notes will
be entitled to any such additional interest.
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RISK FACTORS
PRIOR TO TENDERING THEIR OLD NOTES FOR NEW NOTES, PROSPECTIVE INVESTORS
SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS IN ADDITION TO THE OTHER
INFORMATION CONTAINED IN THIS PROSPECTUS.
LIMITED OPERATING HISTORY; EARLY STAGE OF DEVELOPMENT
The Company was incorporated in February 1997, entered into its first
interconnection agreement with an ILEC in July 1997, began to offer trial
services in San Diego, California in December 1997 and began offering commercial
services in San Diego on April 1, 1998 and in San Francisco on June 1, 1998. The
Company has a limited operating history, has limited commercial operations and
its primary activities to date have consisted of the procurement of required
governmental authorizations, the negotiation and execution of interconnection
agreements with four ILECs, the identification of collocation space and
locations for the Company's Connection Points, Metro Service Centers and
business offices, the acquisition and deployment of equipment and facilities,
the hiring of management and other personnel, the raising of capital and the
development and integration of its operational support system ("OSS") and other
back office systems. As of June 30, 1998, the Company had recognized
insignificant revenues. As a result of its limited operating history, the
Company does not have historical financial data for any period other than 1997
or operations upon which an evaluation of the Company or its prospects can be
based. In addition, the Company's senior management team and other employees of
the Company have worked together at the Company for less than one year.
The Company's prospects must be considered in light of the risks, expenses
and difficulties encountered by new companies competing in rapidly evolving
markets. To address these risks, the Company must, among other things, rapidly
expand the geographic coverage of its network services; enter into
interconnection agreements with additional ILECs, some of which are competitors
or potential competitors of the Company; deploy network infrastructure; attract
and retain customers; accurately assess potential markets; continue to develop
and integrate its OSS and other back office systems; obtain any required
governmental authorizations; comply with evolving governmental regulatory
requirements; raise additional capital; increase awareness of the Company's
services; respond to competitive developments; continue to attract, retain and
motivate qualified personnel and continue to upgrade its technologies and
commercialize its network services incorporating such technologies. There can be
no assurance that the Company will be successful in addressing these and other
risks, and failure to do so would have a material adverse effect on the
Company's business, prospects, operating results, financial condition and its
ability to make principal and interest payments on its indebtedness, including
the New Notes.
UNPROVEN BUSINESS STRATEGY; UNCERTAINTY OF MARKET ACCEPTANCE
The Company's business strategy is unproven and, to be successful, the
Company must, among other things, develop and market network services that are
widely accepted by businesses and its Channel Partners at prices that will yield
a profit. The Company began to offer trial services in San Diego, California in
December 1997 and began offering commercial services in San Diego on April 1,
1998 and in San Francisco on June 1, 1998. There can be no assurance that the
services offered in San Diego, San Francisco or in any other geographic markets
in the future will achieve commercial acceptance. The prices the Company charges
for its services are in some cases higher than those charged for some competing
services, and there can be no assurance that sufficient numbers of customers
will be willing to pay the prices charged by the Company for its services.
Accordingly, the Company cannot predict whether its prices will prove to be
commercially acceptable, whether demand for the Company's services will
materialize at the prices it desires to charge or whether current or future
pricing levels will be sustainable. Because of the foregoing factors, among
others, the Company cannot forecast its revenues or the rate at which it will
add new customers with any degree of accuracy. There can be no assurance that
the Company will ever achieve favorable operating results or profitability, or
generate sufficient positive cash flow to service or repay its indebtedness,
including the New Notes. The failure to achieve or sustain desired pricing
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levels or to achieve or sustain broad market acceptance would result in a
material adverse effect on the Company's business, prospects, operating results,
financial condition and its ability to make principal and interest payments on
its indebtedness, including the New Notes.
HISTORICAL LOSSES AND ANTICIPATED FUTURE LOSSES; FLUCTUATIONS IN OPERATING
RESULTS
The Company has incurred net losses and experienced negative operating cash
flow each month since its inception (February 1997). As of June 30, 1998, the
Company had an accumulated deficit of approximately $11.6 million. The Company
currently intends to rapidly and substantially increase its capital expenditures
and operating expenses in an effort to expand its network services and to
increase sales, marketing and general and administrative activities. As a
result, the Company expects to incur substantial additional operating and net
losses and substantial negative cash flow for at least the next several years.
To the extent that increased expenses are not accompanied by significant
revenues, the Company would experience a material adverse effect on its
business, prospects, operating results, financial condition and its ability to
make principal and interest payments on its indebtedness, including the New
Notes. There can be no assurance that the Company's services will ever provide a
revenue base adequate to achieve or sustain profitability or to generate
positive cash flow.
The Company's annual and quarterly operating results may fluctuate
significantly in the future as a result of numerous factors, many of which are
outside the Company's control. Factors that may affect the Company's operating
results include the rate at which customers subscribe to the Company's services
and the prices the customers are willing to pay for such services, the amount
and timing of capital expenditures and other costs relating to the expansion of
the Company's services and infrastructure, the introduction of new services by
the Company or its competitors, price competition by competitors, technical
difficulties or network downtime, general economic conditions and economic
conditions specific to the telecommunications services industry. In addition,
the Company believes its financial performance will depend to a great extent on
attracting and retaining customers and reducing levels of customer churn, which
can result from a variety of sources, including employee turnover within the
Company's customers. Many providers of telecommunications services experience
high rates of customer churn, and there can be no assurance that Rhythms will
not experience substantial customer churn.
SUBSTANTIAL LEVERAGE; ABILITY TO SERVICE INDEBTEDNESS
As a result of the Old Note Issuance, the Company is highly leveraged. As of
June 30, 1998, on an as adjusted basis after giving effect to the Old Notes
Issuance, the Company had approximately $147.9 million of outstanding
indebtedness, the Company's total debt as a percentage of capitalization was 88%
and the Company had a deficiency of earnings to fixed charges of $9.1 million
for the six months ended June 30, 1998. See "Capitalization." In addition, the
Indenture permits, and the Company seeks to structure its future credit
facilities, lease facilities and vendor credit facilities so that they are
expected to permit, the incurrence of certain additional indebtedness. In
addition, in May 1998, the Company entered into a financing arrangement with Sun
Financial Group, Inc. for up to $24.5 million of additional equipment lease
financing. In that regard, the Company intends to seek substantial additional
indebtedness (including secured indebtedness as permitted under the Indenture)
following this Offering for, among other things, the construction and expansion
of its network infrastructure, including the purchase and leasing of equipment,
the introduction of new service offerings, to obtain access to collocation space
in ILEC central offices ("COs"), the development and implementation of its OSS
and the funding of its operating losses. See "--Significant Capital
Requirements; Need for and Uncertainty of Additional Financing."
The degree to which the Company is leveraged could have important
consequences to the holders of the New Notes, including, but not limited to, the
following: (i) the ability of the Company to pay interest and liquidated
damages, if any, on, and the redemption price of or the principal amount at
maturity of, the Notes when due may be materially limited or impaired; (ii) the
Company's ability to obtain additional financing or refinancing in the future
for capital expenditures, repayment of outstanding indebtedness,
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working capital, acquisitions, general corporate or other purposes may be
materially limited or impaired; (iii) the Company's cash flow, if any, may be
unavailable for building the Company's business, as a substantial portion of
such cash flow may be dedicated to the payment of principal and interest on its
indebtedness, including the Notes, and the failure of the Company to generate
sufficient cash flow to service such indebtedness could result in a default
under such indebtedness; (iv) the terms of future permitted indebtedness may
limit the Company's ability to redeem the Notes in the event of a Change of
Control; (v) the Company's high degree of leverage may make it more vulnerable
to economic downturns, may limit its ability to withstand competitive pressures
and may reduce its flexibility in responding to changing business and economic
conditions; and (vi) the Company may be more highly leveraged than many of its
competitors, which may place it at a competitive disadvantage.
The Company's ability to make principal and interest payments on the New
Notes will depend upon, among other things, (i) the Company's ability to achieve
significant and sustained growth in cash flow; (ii) the rate of and successful
commercial deployment of its network services; (iii) the market acceptance,
customer demand, rate of utilization and pricing of the Company's services; (iv)
the future operating performance of the Company; (v) the Company's ability to
successfully complete development, upgrades and enhancements of its network
services; (vi) the level of Company expenses; (vii) the Company's ability to
secure additional financings, as necessary; (viii) the Company's ability to
complete the rollout of its network services on a timely basis; and (ix)
economic, financial, competitive and regulatory conditions and other factors.
Many of the foregoing matters are beyond the Company's control. There can be no
assurance that the Company will have adequate sources of liquidity to make
required payments of principal and interest on its indebtedness (including the
New Notes), whether at or prior to maturity, to finance anticipated capital
expenditures or to fund working capital requirements. If the Company does not
have sufficient available resources to repay its outstanding indebtedness when
it becomes due and payable, the Company may find it necessary to reduce the
scope of and/or delay the rollout of its network services, and/or attempt to
restructure or refinance its indebtedness. There can be no assurance that such
refinancing will be available, or available on reasonable terms, in light of the
Company's high leverage following the Old Notes Issuance and other factors. If
the Company were unable to obtain refinancing on satisfactory terms in order to
meet its debt service obligations, it would have to consider various other
options, such as the sale of equity or other options available to it under law,
and there can be no assurance that the Company will be able to sell equity or
take advantage of other options in a manner sufficient to meet its debt service
obligations.
RESTRICTIVE COVENANTS
The Indenture imposes and will impose significant operating and financial
restrictions on the Company and any future subsidiaries. These restrictions
affect, and in certain cases significantly limit or prohibit, among other
things, the ability of the Company to incur certain additional indebtedness, pay
dividends and make certain other restricted payments, create liens securing
certain Indebtedness, to permit Restricted Subsidiaries to pay dividends or make
other payments, dispose of proceeds of Asset Sales, issue and sell capital stock
of Restricted Subsidiaries, enter into transactions with affiliates, engage in
certain business activities, permit any Restricted Subsidiary to guarantee the
payment of any other Indebtedness of the Company, engage in certain
sale/leaseback transactions or consolidate, merge or transfer all or
substantially all of its assets. There can be no assurance that such covenants
will not adversely affect the Company's ability to finance its future operations
or capital needs or to engage in other business activities. Further, there can
be no assurance that the Company will have available, or will be able acquire
from alternative sources of financing, funds sufficient to repurchase the Notes
in the event of a Change of Control. See "Description of the Notes."
In addition, any future senior indebtedness incurred by the Company is
likely to impose similar restrictions on the Company. Failure by the Company or
its subsidiaries to comply with these restrictions could lead to a default under
the terms of such indebtedness and the Notes notwithstanding the ability of
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the Company to meet its debt service obligations. In the event of such a
default, the holders of such indebtedness could elect to declare all such
indebtedness to be due and payable, together with accrued and unpaid interest.
In such event, a significant portion of the Company's indebtedness (including
the Notes) may become immediately due and payable, and there can be no assurance
that the Company would be able to make such payments or borrow sufficient funds
from alternative sources to make any such payment. Even if additional financing
could be obtained, there can be no assurance that it would be on terms that are
acceptable to the Company.
SIGNIFICANT CAPITAL REQUIREMENTS; NEED FOR AND UNCERTAINTY OF ADDITIONAL
FINANCING
The expansion and development of the Company's business will require
significant capital to fund its capital expenditures, working capital and
operating losses. The Company's principal capital expenditures and lease
payments include the purchase, lease and installation of network equipment such
as routers and multiplexers, collocation space and customer premise equipment
("CPE") such as digital "modems." The Company's working capital is primarily
comprised of accounts receivable, accounts payable and accrued expenses. The
Company will need to secure additional financing beyond the net proceeds of the
Old Notes Issuance to enter markets beyond those included in its initial rollout
plan. In addition, there can be no assurance that the Company will be able to
finance the rollout strategy in a timely fashion, or at all. If demand for the
Company's services or its cash flow from operations is less than expected,
however, the Company may require additional financing prior to the completion of
its initial rollout. The actual amount and timing of the Company's future
capital requirements may differ materially from its estimates as a result of
regulatory, technological, competitive (including additional market developments
and new opportunities) and other developments in its industry. The Company also
expects that it will require additional financing (or require financing sooner
than anticipated) if the Company's development plans or projections change or
prove to be inaccurate. Due to the uncertainty of these factors, actual revenues
and costs may vary from expected amounts, possibly to a material degree, and
such variations are likely to affect the Company's future capital requirements.
There can be no assurance that any future equity or debt financing will be
available to the Company on favorable terms or at all. In addition, the
Indenture contains certain covenants restricting the Company's ability to incur
further indebtedness, and future borrowing instruments such as credit facilities
and lease agreements are likely to contain similar or more restrictive covenants
and will likely require the Company to pledge assets as security for borrowings
thereunder. In the event that the Company is unable to obtain such additional
capital or is required to obtain it on unsatisfactory terms, the Company will be
required to delay the deployment of its network services or take or forego
actions that could materially adversely affect the Company's business,
prospects, operating results, financial condition and its ability to make
principal and interest payments on its indebtedness, including the New Notes. In
the event that the Company is unable to generate sufficient cash flow and is
otherwise unable to obtain funds necessary to meet required payments on its
indebtedness, the Company would be in default under the terms of the agreements
governing its indebtedness, including the New Notes. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Liquidity and Capital Resources."
EXPANSION RISKS; POSSIBLE INABILITY TO MANAGE GROWTH
The Company's planned rapid expansion of its operations will place a
significant strain on its management, financial controls, operations systems,
personnel and other resources. The Company's ability to manage future growth,
should it occur, will depend in large part upon its ability to monitor its
operations, control costs, maintain regulatory compliance, maintain effective
quality controls, significantly expand its internal management and financial
control systems, streamline its customer qualification and provisioning
functions, acquire a significant amount of equipment to support its network
systems and attract, assimilate and retain qualified personnel. If the Company
is successful in implementing its marketing strategy, the Company also expects
the demands on its network infrastructure and the need for
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technical support resources to grow rapidly, and it may experience difficulties
responding to customer demand for its services and providing technical support
in a timely manner and in accordance with its customers' expectations. These
demands are expected to require not only the addition of new management
personnel, but also the development of additional expertise by existing
management personnel and the establishment of long term relationships with
third-party service vendors. There can be no assurance that the Company will be
able to keep pace with any growth, successfully implement and maintain its
operational and financial systems or successfully obtain, integrate and utilize
the employees, facilities, third-party vendors and equipment, and management,
operational and financial resources necessary to manage a developing and
expanding business in an evolving, highly regulated and increasingly competitive
industry. If the Company is unable to manage growth effectively, its business,
prospects, operating results, financial condition and its ability to make
principal and interest payments on its indebtedness, including the New Notes,
will be materially adversely affected. Failure of the Company to manage its
future growth effectively could also adversely affect the expansion of the
Company's customer base and service offerings.
TECHNOLOGICAL CHANGE; UNPROVEN NETWORK PERFORMANCE AND SCALABILITY
The telecommunications industry is subject to rapid and significant changes
in technology, and the effect of technological changes on the business of the
Company, such as continuing developments in DSL technology and alternative
technologies for providing high speed data communications, cannot be predicted.
The Company will be relying in part on third parties (including certain of its
competitors and potential competitors) for the development of and access to
communications and networking technology. The effect of technological changes on
the business of the Company cannot be predicted. The Company believes its future
success will depend, in part, on its ability to anticipate or adapt to such
changes and to offer, on a timely basis, services that meet customer demands and
evolving industry standards. There can be no assurance that the Company will
obtain access to new technology on a timely basis or on satisfactory terms or
that the Company will be able to adapt to such technological changes, offer such
services on a timely basis or establish or maintain a competitive position. Any
technological change, obsolescence or failure to obtain access to important
technologies could have a material adverse effect on the Company's business,
prospects, operating results, financial condition and its ability to make
principal and interest payments on its indebtedness, including the New Notes.
The Company expects that new products and technologies will emerge in the future
that will be applicable to the market in which the Company competes. Such new
products and technologies may be superior to and/or render obsolete the products
and technologies used by the Company. In addition, there can be no assurance
that these various products and technologies will interoperate successfully or
in a manner sufficient for the Company to execute its business plan in a timely
fashion. The Company believes that it will be important for industry standards
to be set in its markets in order to allow for the compatibility of the various
products and technologies. There can be no assurance that standards will be set
on a timely basis or at all.
Many of the products and technologies that the Company intends to use in its
network services are relatively new and unproven. There can be no assurance that
those products and technologies will be reliable on a consistent basis. In
addition, due to the limited deployment of the Company's services, the ability
of the Company's network to connect and manage a substantial number of end users
at high transmission speeds is still unknown, and the Company faces risks
related to its ability to scale its network to service significant end users
while achieving high performance. There can be no assurance that the Company's
network will be able to achieve and maintain competitive digital transmission
speeds. The Company's failure to achieve or maintain high speed reliable digital
transmissions would significantly reduce demand for its services and have a
material adverse effect on its business, prospects, operating results, financial
condition and its ability to make principal and interest payments on its
indebtedness, including the New Notes.
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DEPENDENCE ON ILECS
The Company is dependent on the ILECs for (i) the provision of DSL-capable
copper loops; (ii) collocation space in ILEC COs; and (iii) in many cases the
provision of other ILEC services, such as facilities to connect the Rhythms
Connection Points with the Rhythms Metro Service Centers. In each of these
areas, the Company faces risks that the ILECs will not have sufficient inventory
to supply the Company's needs, that the ILECs will delay provisioning or that
the prices paid by the Company will exceed the ILECs' costs of providing the
elements and services.
In order to provide DSL connections to customers, the Company must use
copper loops controlled by the ILECs. In some ILEC COs, there may be an actual
shortage of DSL-capable copper loops, or the ILECs may claim such a shortage. In
some cases, the Company may not have alternative means of providing service to
end users. The Company will also be dependent on the ILECs to maintain on an
ongoing basis the quality of the copper loops the Company uses for its DSL-based
services. There can be no assurance that the Company will be able to
successfully address these issues through business and regulatory processes or
otherwise. The prices paid by the Company to ILECs for DSL-capable copper loops
will vary by ILEC and may vary by state. Those rates are established by state
regulatory commissions in ongoing public hearings, based on rate proposals and
cost studies submitted by the ILECs and, in some cases, by other parties as well
and until now, they have been based on FCC pricing rules which have been
overturned by the federal appeals court for the Eighth Circuit and will be
reviewed by the U.S. Supreme Court. See "--Government Regulation." ILECs may
from time to time propose new rates, which will also be decided by the state
commissions in public hearings. Participating in such hearings is expected to
involve significant management time and expense. The outcomes of such hearings
and rulings may have a material adverse effect on the Company. In addition, the
Company has not established a history of ordering and obtaining the provisioning
and repair of large volumes of DSL-capable copper loops from ILECs. There can be
no assurance that either the Company's or the ILECs' OSS will be capable of
handling a large volume of orders, or that the Company will be successful in
ordering and provisioning on a large scale.
The Company is dependent on the ILECs to make space available in their COs
so that the Company can physically collocate its own equipment which connects to
the ILEC copper loops and is used in providing the Company's DSL services. In
some COs, there may be an actual shortage of such collocation space, or the
ILECs may claim such a shortage. In some of these cases, the Company may not
have alternative means of connecting its DSL equipment with the ILECs' copper
loops. In some COs, the Company's applications for physical collocation have
been rejected on the grounds that no such space is available. There can be no
assurance that additional applications will not be rejected in the future. The
availability of physical collocation space will also be affected by the number
of other CLECs requesting collocation. To the extent the Company is unable to
obtain physical collocation in its targeted ILEC COs, the Company may face
delays and additional cost in serving certain users, or may not be able to offer
services in certain locations.
The price, terms and conditions under which collocation space is made
available are determined, depending on the state in which the collocation space
is located, by state tariffs, State Public Utility Commission, and/or
interconnection agreements with the ILEC. Interconnection agreements also
determine the terms and conditions of access to unbundled copper loops (and
other UNEs), although many of those terms and conditions, including price, have
been or may be established by the state public utility commissions. There can be
no assurance that the terms and conditions of interconnection agreements that
can be negotiated, or that are determined by state commissions, will be
satisfactory to the Company. The interconnection agreements are generally short
term, and there can be no assurance that the agreements will be renewed on
favorable terms or at all. In addition, interconnection arrangements and
agreements are subject to varying degrees of oversight by the state commissions,
the FCC and the courts. There can be no assurance that these government entities
will not modify the terms or prices of the Company's interconnection
arrangements in ways that would have a material adverse effect on the Company.
Delays
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in obtaining interconnection agreements would delay the Company's entry into
certain markets, which could have a material adverse effect on the Company.
The Company will also seek to purchase additional services from ILECs, such
as transport services, although these services are generally also available from
other providers. There can be no assurance that the Company will be able to
obtain the services it requires from the ILECs, or to do so at rates, terms and
conditions, including timelines, that are satisfactory to the Company. An
inability to obtain access to copper loops, collocation space or services from
ILECs could have a material adverse effect on the Company's business, prospects,
operating results, financial condition, and its ability to make principal and
interest payments on its indebtedness, including the New Notes. There can be no
assurance that disputes will not arise between the Company and the ILECs with
respect to interconnection agreements or that any such disputes will be resolved
in favor of the Company.
UNCERTAIN QUALITY AND AVAILABILITY OF COPPER LOOPS
In order to provide service to its customers, the Company must interconnect
its network with the copper telecommunications loops within the control of the
ILEC that connect to the end user. In order for DSL connections to function
properly, these copper loops must be within certain physical parameters,
including length, minimization of loading coils, minimum numbers of bridge taps
and general physical condition. The Company's ability to provide DSL-based
service to potential customers is highly dependent upon the quality, physical
condition and availability of these copper loops, as well as the maintenance by
the ILECs of the copper loops. The Company believes that the current condition
of copper loops in many cases will be inadequate to permit the Company to fully
implement its network services. See "--Government Regulation." There can be no
assurance that the copper loops will be of sufficient quality, or that the
copper loops will always be maintained in such a condition, to allow the Company
to fully implement its network services. The inability of the Company to
implement its network effectively or broadly due to the availability, quality or
physical condition of copper loops would have a material adverse effect on the
Company's business, prospects, operating results, financial condition and its
ability to make principal and interest payments on its indebtedness, including
the New Notes. See "--Competition."
GOVERNMENT REGULATION
Some of the services offered by the Company, particularly by its
wholly-owned ACI Corp. and ACI Corp. - Virginia subsidiaries, may be subject to
regulation at the federal, state, and/or local levels. There can be no assurance
that current or future federal or state regulations or legislation would not be
less favorable to the Company than current regulation and legislation and
therefore have a material adverse impact on the Company's business prospects,
operating results, financial condition, and ability to make payments on its
indebtedness, including the New Notes. In addition, participation in proceedings
setting rules at either the federal or state level could consume significant
financial and managerial resources, with no assurance of an outcome favorable to
the Company.
The Federal Communications Commission ("FCC") prescribes rules applicable to
interstate communications, including rules implementing the 1996
Telecommunications Act (the "1996 Act"), a responsibility it shares with the
state regulatory commissions. The 1996 Act removed many of the remaining
barriers to local competition, and the FCC's initial rules interpreting the Act
(the "FCC Order") were generally encouraging to increased local competition. A
federal appeals court for the 8th Circuit reviewed the FCC Order, and overruled
some of its provisions, including some rules on pricing and nondiscrimination.
That ruling is itself to be reviewed by the U.S. Supreme Court. In December,
1997 a federal court in Texas ruled unconstitutional the 1996 Act's requirement
that former Bell System ILECs cannot provide interLATA services until they meet
certain requirements. This could reduce the incentives of those ILECs to
cooperate in opening their markets to competition. The FCC and other parties
have asked the U.S. Supreme Court to review this ruling. In May, 1998 a federal
court in Washington, D.C. ruled that other 1996 Act limitations on Bell System
ILECs are not unconstitutional. These contrasting rulings may be
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resolved by the U.S. Supreme Court at some point. There can be no assurance that
the final outcome of these reviews will not have a material adverse impact on
the Company. In addition, four of the Regional Bell Companies have petitioned
the FCC to be relieved of certain regulatory requirements in connection with
their own DSL services, including obligations to unbundle DSL-equipped loops
(but not the obligation to unbundle the loops Rhythms purchases for its DSL
services). There can be no assurance that the final outcome of these petitions
or other proceedings interpreting the requirements of the 1996 Act will not have
a material adverse impact on the Company.
State regulatory commissions prescribe rules applicable to intrastate
communications, and also set prices for wholesale services and unbundled network
elements, as well as for other terms and conditions under the 1996 Act. Rules
and prices vary from state to state, and there can be no assurance that the
rules in the states in which the Company operates will not have a material
adverse impact on the Company's business. Municipalities and other local
entities have the authority, where appropriate, to impose zoning and franchise
requirements, which would become applicable only if and when the Company
constructs its own facilities in public rights of way. In such an event, there
could be no assurance that the requirement would not have a materially adverse
effect on the Company. See "Business--Government Regulation."
DEPENDENCE ON CHANNEL PARTNERS
The Company's strategy relies, in large part, upon the distribution of its
products and services through Channel Partners. Accordingly, the performance of
the Company depends substantially on the ability of the Company to establish
favorable relationships with a large number of key Channel Partners, and the
performance of the Company's Channel Partners. To date, the Company has
established relationships with only a limited number of Channel Partners. There
can be no assurance that the Company will be able to establish favorable
relationships with Channel Partners or that the performance of its Channel
Partners will be satisfactory to the Company and its customers. The performance
of its Channel Partners will be beyond the control of the Company. The failure
of the Company to establish favorable relationships with a large number of key
Channel Partners or the unsatisfactory performance of its Channel Partners would
have a material adverse effect on the Company's business, prospects, operating
results, financial condition and its ability to make principal and interest
payments on its indebtedness, including the New Notes.
COMPETITION
Rhythms will face competition from many competitors with significantly
greater financial resources, well-established brand names, and large, existing
installed customer bases. Moreover, the Company expects the level of competition
to intensify in the future. The Company expects significant competition from
ILECs, traditional and new IXCs, CAPs, CLECs, cable modem service providers,
ISPs and wireless and satellite data service providers. ILECs have existing
metropolitan area networks and circuit switched local access networks. In
addition, most ILECs are establishing their own ISP businesses and are in some
stage of market trials of DSL-based access services. Many of the leading
traditional IXCs, including MCI Telecommunications Corporation (with WorldCom,
Inc./MFS Communications Company, Inc./UUNet Technologies, Inc.), AT&T
Corporation (with Teleport Internet Services/TCG CERFnet, Inc. and its announced
TCI merger) and Sprint Corporation (with EarthLink Network Inc.) are expanding
their capabilities to support high-speed, end-to-end networking services. The
newer IXCs, including Williams Companies Inc. ("Williams"), Qwest Communications
International, Inc. ("Qwest") and Level 3 Communications, Inc., are building and
managing high bandwidth, nationwide IP-based packet networks and partnering with
ISPs to offer services directly to the public (Williams/Concentric; IXC
Communications, Inc./PSINet Inc.; Qwest/Supernet, Inc.). Cable modem service
providers, like @Home (with its cable partners) are offering or preparing to
offer high speed Internet access over hybrid fiber networks to consumers, and
@Work is positioned to do the same for businesses. Several new companies,
including WinStar Communications, Inc., Teligent, Inc., Teledesic LLC, Hughes
Space Communications and Iridium
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World Communications Ltd. are emerging as wireless, including satellite-based,
data service providers over a variety of frequency allocations ranging from 2
GHz to 38 GHz. ISPs, including some with significant and even nationwide
presences, such as Concentric Network Corporation ("Concentric"), Mindspring
Enterprises, Inc. and PSINet Inc. provide Internet access to residential and
business customers, generally over the ILECs' circuit switched networks,
although some, including HarvardNet, Inc. in Massachusetts, have begun offering
DSL-based access. Certain CLECs, including Covad Communications Company
("Covad") and NorthPoint Communications, Inc. ("NorthPoint"), have begun
offering DSL-based access services, and others are likely to do so in the
future.
Many of these competitors are offering (or may soon offer) technologies and
services that will directly compete with some or all of the Company's service
offerings. Such technologies include ISDN, DSL, wireless data and cable modems.
Some of the competitive factors in the Company's markets include transmission
speed, reliability of service, breadth of service availability, price
performance, network security, ease of access and use, content bundling,
customer support, brand recognition, operating experience, capital availability
and exclusive contracts. The Company believes that it compares unfavorably with
its competitors with regard to, among other things, brand recognition, existing
relationships with end users, available pricing discounts, ILEC CO access,
capital availability and exclusive contracts. Substantially all of the Company's
competitors and potential competitors have substantially greater resources than
the Company. There can be no assurance that the Company will be able to compete
effectively in its target markets. A failure by the Company to compete
effectively would have a material adverse effect on the Company's business,
prospects, operating results, financial condition and its ability to make
principal and interest payments on its indebtedness, including the New Notes.
See "Business--Competition."
UNCERTAIN FEDERAL AND STATE TAX AND OTHER SURCHARGES ON THE COMPANY'S SERVICES
Telecommunications providers are subject to a variety of federal and state
surcharges and fees on their gross revenues from interstate and intrastate
services, including regulatory fees, and surcharges related to the support of
universal service. These surcharges and fees are revised from time to time. To
the extent that the Company is subject to these surcharges and fees, there can
be no assurance that such revisions would not have a material adverse effect on
the Company.
DIGITAL COMMUNICATIONS SIGNAL COMPATIBILITY AND POTENTIAL NETWORK INTERFERENCE
Digital services provided over copper loops can, under some circumstances,
pose the potential for interference with each other, including communications
services provided by ILECs and CLECs. Interference, if present, could cause
degradation of performance of the Company's services or render the Company
unable to offer its services on selected copper loops. Interference can be
difficult to detect. The procedures to resolve interference issues between CLECs
and ILECs are still being developed, and there is no assurance that these
procedures will be effective. There can be no assurance that the Company will
successfully negotiate interference resolution procedures with ILECs, or that
ILECs will not make claims regarding interference nor unilaterally take action
to resolve interference issues to the detriment of the Company's services.
Further, interference, if widespread, would have a material adverse effect on
the Company's reputation, brand image, service quality and customer satisfaction
and retention, which would have a material adverse effect on the Company's
business, prospects, operating results, financial condition and its ability to
make principal and interest payments on its indebtedness, including the New
Notes.
DEPENDENCE ON KEY PERSONNEL
The Company's performance is dependent on the performance of its officers
and key employees, especially its Chief Executive Officer. Members of the
Company's senior management team have worked together for only a short period of
time. The Company does not have "key person" life insurance policies on any of
its employees. The Company does not have employment agreements for fixed terms
with any of its employees. Any of the Company's employees, including its senior
management team members, may
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terminate his or her employment with the Company at any time. Given the
Company's early stage of development, the Company is dependent upon its ability
to retain and motivate high quality personnel, especially its management. The
Company's future success also depends on its continuing ability to identify,
hire, train and retain highly qualified technical, sales, marketing and customer
service personnel. Moreover, the industry in which the Company competes is
characterized by a high level of employee mobility and aggressive recruiting of
skilled personnel. There can be no assurance that key personnel will continue to
be employed by the Company or that the Company will be able to attract and
retain qualified personnel in the future. Competition for such qualified
personnel is intense, particularly in software development, network engineering
and product management. The inability to attract and retain key managerial,
technical, sales, marketing and managerial personnel would have a material
adverse effect upon the Company's business, prospects, operating results,
financial condition and its ability to make principal and interest payments on
its indebtedness, including the New Notes. See "Business--Employees" and
"Management."
DEPENDENCE ON EQUIPMENT SUPPLIERS, INSTALLERS AND FIELD SERVICE PROVIDERS
The Company currently plans to purchase all of its equipment from many
different vendors and outsource the installation and field service of its
networks to third parties. Any reduction or interruption in supply from any of
its suppliers or interruption in service from any significant installer or field
service provider could have a disruptive effect on the Company. Although
multiple manufacturers currently produce or are developing equipment that will
meet the Company's current and anticipated requirements, there can be no
assurance that the Company's suppliers will be able to manufacture and deliver
the amount of equipment ordered or that such supply will be sufficient to meet
demand. In addition, the pricing of the equipment purchased by the Company may
substantially increase over time (increasing the costs paid in the future by the
Company) or decrease over time (providing later market entrants with a cost
advantage over the Company). The availability and pricing of the equipment
purchased and technology licensed by the Company may be adversely affected if
its suppliers or licensors enter into competition with it, or if its competitors
enter into exclusive or restrictive arrangements with the suppliers or
licensors. Any shortages in supply of equipment or personnel, or quality issues
relating to any of these third parties would have a material adverse effect on
the Company's business, prospects, operating results, financial condition and
its ability to make principal and interest payments on its indebtedness,
including the New Notes.
DEPENDENCE ON LEASED TRANSPORT FACILITIES
The Company seeks to lease from third parties transport capacity to connect
its network facilities, and is dependent upon the availability of fiber optic
transmission facilities owned by IXCs, ILECs, CLECs and other fiber optic
transport providers who lease their fiber optic networks to service providers,
such as the Company. Many of these entities are, or may become, competitors of
the Company. See "--Competition." The risks inherent in this approach include,
but are not limited to, the possible inability to negotiate and renew favorable
supply agreements and dependence on the timeliness of the IXCs, ILECs, CLECs or
other fiber optic transport providers in processing the Company's orders for
customers who seek to use the Company's services. Moreover, there can be no
assurance that fiber optic transport providers whose networks are being leased
by the Company will be able to maintain existing permits and rights-of-way or to
obtain and maintain the other permits and rights-of-way needed to develop and
operate existing and future networks.
INTELLECTUAL PROPERTY PROTECTION
The Company relies upon a combination of licenses, confidentiality
agreements and other contractual covenants to establish and protect its
technology and other intellectual property rights. The Company has applied for
trademarks and servicemarks on certain terms and symbols that it believes are
important for its business. The Company currently has no patents or patent
applications pending. There can be no
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assurance that the steps taken by the Company will be adequate to prevent
misappropriation of its technology or other intellectual property, or that the
Company's competitors will not independently develop technologies that are
substantially equivalent or superior to the Company's technology. There can be
no assurance that third parties will not assert infringement claims against the
Company and that, in the event of an unfavorable ruling on any such claim, a
license or similar agreement to utilize technology relied upon by the Company in
the conduct of its business will be available to the Company on reasonable terms
or at all. The loss of such rights or failure to obtain any necessary licenses
or agreements may have a material adverse effect on the Company's business,
prospects, financial condition and results of operations and its ability to make
principal and interest payments on its indebtedness, including the New Notes.
The Company also relies on unpatented trade secrets and know-how to maintain its
competitive positions, which it seeks to protect, in part, by confidentiality
agreements with employees, consultants and others. There can be no assurance
that these agreements will not be breached or terminated, that the Company will
have adequate remedies for any breach, or that the Company's trade secrets will
not otherwise become known or be independently discovered by competitors. The
Company's management personnel were previously employed by other
telecommunications companies. In many cases, these individuals are conducting
activities for the Company in areas similar to those in which they were involved
prior to joining the Company. As a result, the Company, as well as these
individuals, could be subject to allegations of violation of trade secrets and
other similar claims.
CONCENTRATION OF OWNERSHIP; VOTING AGREEMENT; POTENTIAL CONFLICTS OF INTEREST
The Company's executive officers and directors, together with the Brentwood
Entities, the KPCB Entities, the Enterprise Entities, the Sprout Entities and
Enron together beneficially own over 97.6% of the outstanding Common Stock of
the Company (assuming conversion of all outstanding Preferred Stock into Common
Stock and without giving effect to the exercise of the Warrants). Accordingly,
these stockholders are able to determine the composition of the Company's Board
of Directors, retain the voting power to approve all matters requiring
stockholder approval and continue to have significant influence over the affairs
of the Company. This concentration of ownership could have the effect of
delaying or preventing a change in control of the Company. See "Management,"
"Principal Stockholders" and "Description of Capital Stock."
Certain decisions concerning the operations or financial structure of the
Company may present conflicts of interest between these investors and the
holders of the New Notes. For example, if the Company encounters financial
difficulties or is unable to pay its debts as they mature, the interest of these
investors may conflict with those of the holders of New Notes. In addition,
these investors may have an interest in pursuing acquisitions, divestitures,
financings or other transactions and business strategies that, in their
judgment, could enhance their equity investment in the Company, even though such
transactions might involve increased risk to the holders of the New Notes.
EFFECTIVE SUBORDINATION OF NEW NOTES TO SECURED INDEBTEDNESS AND INDEBTEDNESS OF
THE COMPANY'S SUBSIDIARIES
The New Notes will be unsecured, senior obligations of the Company and will
rank pari passu in right of payment with all other existing and future senior
unsecured indebtedness of the Company and senior in right of payment to any
existing and future subordinated indebtedness of the Company. The New Notes will
not be secured by any assets of the Company, its current subsidiaries or any
future subsidiaries. The Indenture permits the Company and its subsidiaries to
incur certain secured indebtedness in the future, and such secured indebtedness
would have a prior claim over the New Notes to the extent of the assets that
secure such indebtedness. In the event that a default were to occur with respect
to any of the Company's or its subsidiaries' current or future secured
indebtedness and were the holders thereof to foreclose on the collateral
securing such indebtedness, or in the event of a bankruptcy, liquidation or
reorganization of the Company or its current or future subsidiaries, the holders
of such indebtedness would be entitled to
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payment out of the proceeds of their collateral prior to any payout to the
holders of general unsecured indebtedness, including the New Notes,
notwithstanding the existence of an event of default with respect to the New
Notes. Moreover, the New Notes will not be guaranteed by the Company's current
subsidiaries or any future subsidiaries, and, consequently, the New Notes will
be structurally subordinated in right of payment to all indebtedness and other
liabilities of the Company's subsidiaries, including subordinated indebtedness
and trade payables. See "Description of Notes--Certain Covenants--LIMITATIONS ON
LIENS SECURING CERTAIN INDEBTEDNESS." The Indenture will permit the Company's
subsidiaries to incur additional indebtedness, subject to certain limitations.
See "Description of the Notes-- Certain Covenants--LIMITATION ON ADDITIONAL
INDEBTEDNESS."
RISK OF SYSTEM FAILURE; NETWORK SECURITY RISK
The Company's operations are dependent upon its ability to avoid damages
from fires, earthquakes, floods, power losses, telecommunications failures,
network software flaws, transmission cable cuts and similar events. The
occurrence of a natural disaster or other unanticipated problem at the Company's
owned or leased facilities could cause interruptions in the services provided by
the Company. Additionally, failure of an ILEC or other service provider, such as
a CLEC, to provide communications capacity required by the Company, as a result
of a natural disaster, operational disruption or any other reason, could cause
interruptions in the services provided by the Company. Any damage or failure
that causes interruptions in the Company's operations could have a material
adverse effect on the Company's business, prospects, operating results,
financial condition and its ability to make principal and interest payments on
its indebtedness, including the New Notes.
Despite the implementation of security measures, the Company's network may
be vulnerable to unauthorized access, computer viruses and other disruptive
problems. Corporate networks and ISPs have in the past experienced, and may in
the future experience, interruptions in service as a result of accidental or
intentional actions of Internet users, current and former employees and others.
Unauthorized access could also potentially jeopardize the security of
confidential information stored in the computer systems of the Company's
customers, which might result in liability of the Company to its customers, and
also might deter potential customers. Although the Company intends to implement
security measures that are standard within the telecommunications industry,
there can be no assurance that it will implement such measures in a timely
manner or to the degree that may be compatible with its customers' expectations,
or that, if and when implemented, such measures will not be circumvented.
Eliminating computer viruses and alleviating other security problems may require
interruptions, delays or cessation of service to the Company's customers and
such customers' end users. Any of the foregoing factors relating to network
security could have a material adverse effect on the Company's business,
prospects, operating results, financial condition and its ability to make
principal and interest payments on its indebtedness, including the New Notes.
CONSEQUENCES TO NON-TENDERING HOLDERS OF OLD NOTES
Upon consummation of the Exchange Offer, the Company will have no further
obligation to register the Old Notes. Thereafter, any Holder of Old Notes who
does not tender its Old Notes in the Exchange Offer, including any Holder which
is an "affiliate" (as that term is defined in Rule 405 of the Securities Act) of
the Company which cannot tender its Old Notes in the Exchange Offer, will
continue to hold restricted securities which may not be offered, sold or
otherwise transferred, pledged or hypothecated except pursuant to Rule 144 and
Rule 144A under the Securities Act or pursuant to any other exemption from
registration under the Securities Act relating to the disposition of securities,
provided that an opinion of counsel is furnished to the Company that such an
exemption is available. These restrictions may limit the trading market and
price for the Old Notes.
22
<PAGE>
ABSENCE OF A PUBLIC MARKET FOR THE NEW NOTES; RESTRICTIONS ON TRANSFER
The New Notes are being offered to the Holders of the Old Notes. Prior to
this Exchange Offer, there was no existing trading market for the Old Notes and
there were no existing New Notes. The Company does not intend to apply for
listing of the New Notes on any securities exchange or on the Nasdaq National
Market. Although the New Notes will be eligible for trading in the PORTAL
Market, the New Notes may trade at a discount from their initial offering price,
depending upon prevailing interest rates, the market for similar securities, the
Company's performance and other factors. In connection with the Old Note
Issuance, the Company was advised by the Initial Purchasers that they intended
to make a market in the Old Notes following the Old Note Issuance; however, the
Initial Purchasers are not obligated to do so and any such market-making
activities may be discontinued at any time without notice. Therefore, there can
be no assurance that an active market for the New Notes will develop, either
prior to or after performance of the Company's obligations under the
Registration Rights Agreements. See "Description of the Notes-- Note
Registration Rights" and "Plan of Distribution."
FRAUDULENT CONVEYANCE CONSIDERATIONS
Under applicable provisions of federal bankruptcy law or comparable
provisions of state fraudulent transfer laws, if, among other things, the
Company at the time it incurred the indebtedness evidenced by the New Notes (i)
(a) was or is insolvent or rendered insolvent by reason of such occurrence or
(b) was or is engaged in a business or transaction for which the assets
remaining with the Company constituted unreasonably small capital or (c)
intended or intends to incur, or believed or believes that it would incur, debts
beyond its ability to pay such debts as they mature; and (ii) the Company
received or receives less than reasonably equivalent value or fair consideration
for the incurrence of such indebtedness, then the New Notes could be voided or,
under applicable case law, claims in respect of the New Notes could be
subordinated to all other debts of the Company, as the case may be. In addition,
the payment of interest and principal by the Company pursuant to the New Notes
could be voided and required to be returned to or on behalf of the Company. The
measures of insolvency for purposes of the foregoing considerations will vary
depending upon the law applied in any proceeding with respect to the foregoing.
Generally, however, the Company would be considered insolvent if (i) the sums of
its debts, including contingent liabilities, were greater than the value of all
of its assets at a fair valuation; (ii) the present fair saleable value of its
assets were less than the amount that would be required to pay its probable
liabilities on its existing debts, including contingent liabilities, as they
become absolute and mature; or (iii) it generally is not paying its debts as
they become due. The Company believes that it (i) is solvent and will continue
to be solvent after issuing the New Notes, because the Company believes the fair
value of the Company's assets exceeds and will exceed its probable liabilities;
(ii) will have sufficient capital for carrying on the business it intends to
conduct after such issuance; and (iii) will be able to pay its debts as they
mature. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources." There can be no
assurance, however, that a court would concur with such beliefs and positions.
In rendering its opinion on the validity of the Notes, counsel for each of the
Company and the Initial Purchasers will express no opinion as to federal or
state laws relating to fraudulent transfers.
PAYMENT UPON A CHANGE OF CONTROL
The Indenture provides that, upon the occurrence of a Change of Control, the
Company will be required to make an offer to repurchase all of the New Notes
issued and then outstanding under the Indenture at a purchase price in cash
equal to 101% of the Accreted Value thereof plus accrued and unpaid interest and
Liquidated Damages, if any, thereon to the date of repurchase. See "Description
of the Notes--Certain Covenants--Change of Control." If a Change of Control were
to occur, there can be no assurance that the Company would be able to repay all
of its obligations under the New Notes and any other indebtedness that may
become payable in such event. In addition, the ability of the Company to
repurchase New Notes upon a Change of Control may be restricted by the terms of
other indebtedness of
23
<PAGE>
the Company. There can be no assurance that the Company would be able to
refinance on commercially reasonable terms, if at all, any of such obligations,
and consequently no assurance can be given that the Company would be able to
repurchase any of the New Notes upon a Change of Control.
The Warrant Agreement provides that, upon the occurrence of a "Repurchase
Event" (as defined in the Warrant Agreement), the Company must make an offer to
repurchase for cash all outstanding Warrants (a "Repurchase Offer"). In such
event, properly surrendered Warrants are to be repurchased by the Company at a
price in cash equal to the value on the Valuation Date (as defined in the
Warrant Agreement) relating thereto of the Warrant Shares (and other securities
issuable upon exercise of the Warrants), had the Warrants then been exercised,
less the Exercise Price therefor. See "Description of the Warrants--Certain
Terms--REPURCHASE." The requirement that the Company make a Repurchase Offer
will, unless appropriate consents or waivers are obtained, require the Company
to repay all indebtedness of the Company then outstanding which by its terms
would prohibit such Repurchase Offer. There can be no assurance that the Company
will have sufficient funds available at the time of any Repurchase Event to
repurchase the Warrants and repay any such indebtedness, as well as to
repurchase any other securities of the Company that by their terms require the
Company to repurchase such securities upon the occurrence of such an event. The
triggering of such payment requirements by the Company upon the occurrence of a
Repurchase Event could have a material adverse effect on the Company's ability
to make principal and interest payments on its indebtedness, including the New
Notes.
INVESTMENT COMPANY ACT CONSIDERATIONS
After giving effect to the Old Notes Issuance, the Company has substantial
cash, cash equivalents and short-term investments. The Company intends to invest
the proceeds of the Old Notes Issuance so as to preserve capital (for use in the
rollout of the Company's network) by investing it in short-term instruments
consistent with prudent cash management and not primarily for the purpose of
achieving investment returns. See "Use of Proceeds." Investment in securities
primarily for the purpose of achieving investment returns could result in the
Company being treated as an "investment company" under the Investment Company
Act of 1940, as amended (the "1940 Act"). The 1940 Act requires the registration
of, and imposes various substantive restrictions on, certain companies that are,
or hold themselves out as being, engaged primarily, or propose to engage
primarily, in the business of investing, reinvesting or trading in securities,
or that fail certain statistical tests regarding composition of assets and
sources of income and are not primarily engaged in businesses other than
investing, reinvesting, owning, holding or trading securities.
The Company believes that it is primarily engaged in a business other than
investing, reinvesting, owning, holding or trading securities and, therefore, is
not an investment company within the meaning of the 1940 Act. If the Company
were required to register as an investment company under the 1940 Act, it would
become subject to substantial regulation with respect to its capital structure,
management, operations, transactions with affiliated persons (as defined in the
1940 Act) and other matters. Application of the provisions of the 1940 Act to
the Company would have a material adverse effect on the Company's business,
prospects, financial condition, results of operations and its ability to make
principal and interest payments on its indebtedness, including the New Notes.
RISK REGARDING FORWARD-LOOKING STATEMENTS
This Prospectus contains "forward-looking statements" within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act. Such
forward-looking statements generally can be identified by the use of
forward-looking terminology such as "believes," "expects," "may," "will,"
"should" or "anticipates" or the negative thereof or other variations thereon or
comparable terminology, or by discussion of strategy, that involve risks and
uncertainties. Management wishes to caution the reader that these
forward-looking statements, such as the Company's network rollout plans and
strategies and statements regarding the development of the Company's business,
the markets for the Company's services and products, the Company's anticipated
capital expenditures, possible changes in regulatory requirements
24
<PAGE>
and other statements contained herein regarding matters that are not historical
facts, are only predictions and estimates regarding future events and
circumstances. Any forward-looking statements contained herein are subject to
material risks and uncertainties, many of which are beyond the control of the
Company. Market conditions and the Company's actual results may differ
materially from the market conditions and results discussed in these statements.
Factors that might cause such a difference include, without limitation, those
discussed in "Risk Factors," "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and those discussed elsewhere in this
Prospectus.
ORIGINAL ISSUE DISCOUNT
The New Notes will be issued with substantial original issue discount for
U.S. federal income tax purposes. Consequently, purchasers of the New Notes
generally will be required to include amounts in gross income for U.S. federal
income tax purposes in advance of receipt of the cash payments to which the
income is attributable. Furthermore, the New Notes may be subject to the high
yield discount obligation rules, which will defer and may, in part, eliminate
the Company's ability to deduct for U.S. federal income tax purposes the
original issue discount attributable to the New Notes. Accordingly, the
Company's after-tax cash flow might be less than if the original issue discount
on the New Notes was deductible when it accrued. See "Federal Income Tax
Considerations" for a more detailed discussion of the U.S. federal income tax
consequences for the Company and the beneficial owners of the New Notes
resulting from their purchase, ownership and disposition of the New Notes. If a
bankruptcy case were commenced by or against the Company under the Bankruptcy
Code of 1978, as amended (the "Bankruptcy Code"), after the issuance of the New
Notes, the claim of a holder with respect to the principal amount thereof may be
limited to an amount equal the sum of (i) the initial offering price and (ii)
that portion of the original issue discount that is not deemed to constitute
"unmatured interest" for purposes of the Bankruptcy Code. Any original issue
discount that was not amortized as of the date of any such bankruptcy filing
would constitute "unmatured interest."
BROAD DISCRETION IN USE OF PROCEEDS BY MANAGEMENT
The net proceeds raised in the Old Notes Issuance are anticipated to be used
to fund the Company's capital expenditures, working capital requirements and
operating losses expected to be incurred in connection with its initial market
rollout. The Company's management will have broad discretion over the use of
such proceeds, and holders of the New Notes must rely on the judgment of
management in the application of such proceeds. See "Use of Proceeds."
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 ("Y2K") issue is the result of computer programs that were
written using two digits, rather than four, to define the applicable year. Any
computer programs that contain date-sensitive software may recognize a date
using "00" as the year 1900 rather than the year 2000, which could result in
system failures or miscalculations causing disruptions of operations, including,
among other things, the Company's ability to process customer orders, monitor
its network, complete and record financial transactions, produce invoices, pay
vendors, or engage in similar normal business activities, which could have a
material adverse effect on the Company.
The Company's detailed plan (the "Y2K Plan") to address possible Y2K
compliance issues takes into consideration internally developed and externally
developed software, as well as products, systems and services of the Company's
vendors and other business relations. The Company is currently in the process of
implementing its Y2K Plan and expects to be Y2K compliant by December 31, 1998,
or, if not compliant, expects to identify any areas of non-compliance and to
develop appropriate solutions. Solutions to non-compliance may include
reselection of vendors or changes in products or services used.
25
<PAGE>
Due to the progress to date in implementing its Y2K Plan, including the
selection of business partners and relationships that have represented to be Y2K
compliant, and the fact that the Company's short length of time in business
precludes it from having legacy systems, the cost impact of becoming Y2K
compliant is expected to be minimal.
USE OF PROCEEDS
This Exchange Offer is intended to satisfy certain of the Company's
obligations under the Registration Rights Agreement. The Company will not
receive any cash proceeds from the issuance of the New Notes offered in the
Exchange Offer. In consideration for issuing the New Notes as contemplated in
this Prospectus, the Company will receive in exchange Old Notes in like
principal amount at maturity, the form and terms of which are the same in all
material respects as the form and terms of the New Notes except that the New
Notes (i) will have been registered under the Securities Act and therefore will
not be subject to certain restrictions on transfer applicable to the Old Notes
and (ii) will not be entitled to certain registration or other rights under the
Registration Rights Agreement, including the provision in the Registration
Rights Agreement for additional interest of up to 1.5% per annum upon failure by
the Company to consummate the Exchange Offer. The Old Notes surrendered in
exchange for New Notes will be retired and canceled and cannot be reissued.
Accordingly, issuance of the New Notes will not result in any increase in the
indebtedness of the Company.
The net proceeds to the Company from the Old Note Issuance were
approximately $144.3 million, net of the Initial Purchasers' discount and other
estimated Old Note Issuance expenses payable by the Company. The net proceeds
from the Old Note Issuance, together with existing cash, lease line proceeds and
future revenue generated from operations, are expected to be used by the Company
to fund the capital expenditures, working capital and operating losses expected
to be incurred in connection with the Company's initial market rollout. The
amounts actually expended by the Company for these purposes will vary
significantly depending upon a number of factors, however, including future
revenue growth, if any, volume pricing discounts, competition, regulatory
factors, the amount of cash generated by the Company's operations and other
factors, many of which are beyond the Company's control. Additionally, if the
Company determines it would be in its best interest, the Company may modify the
number, selection and timing of its entry of any or all of the targeted markets.
Accordingly, the Company's management will retain broad discretion in the
allocation of such net proceeds. Although the Company may use a portion of the
net proceeds to pursue possible acquisitions of, or enter into joint ventures
with respect to, complementary businesses, technologies or products in the
future, there are no present understandings, commitments or agreements with
respect to any such acquisitions or joint ventures. Pending use of such net
proceeds for the above purposes, the Company intends to invest such funds in
short-term, investment grade securities to the extent permitted by the Indenture
and any statistical asset tests imposed by the 1940 Act. See "Risk Factors--
Limited Operating History; Early Stage of Development," "--Unproven Business
Strategy; Uncertainty of Market Acceptance," "--Historical Losses and
Anticipated Future Losses; Fluctuations in Operating Results," "--Significant
Capital Requirements; Need for and Uncertainty of Additional Financing" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
DIVIDENDS
The Company has not paid any dividends since its inception and does not
intend to pay cash dividends on its capital stock in the foreseeable future. The
Company anticipates that it will retain all future earnings, if any, for use in
its operations and expansion of its business. In addition, the terms of the
Indenture restrict the Company's ability to pay dividends on, or make
distributions in respect of, its capital stock. See "Description of the Notes
Certain Covenants."
26
<PAGE>
CAPITALIZATION
The following unaudited table sets forth the capitalization of the Company
as of June 30, 1998. This table should be read in conjunction with the Company's
Financial Statements and the related Notes thereto and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included
elsewhere in this Prospectus.
<TABLE>
<CAPTION>
AS OF JUNE
30, 1998
-------------
<S> <C>
(DOLLARS IN
THOUSANDS)
Cash and cash equivalents...................................................... $ 163,368
-------------
-------------
Debt:
Bank Note................................................................ $ 944
Senior Discount Notes (1)................................................ 146,940
-------------
Total debt............................................................. 147,884
-------------
Warrants offered in Old Notes Issuance (1)(2).................................. 6,567
-------------
Stockholders' equity:
Series A Convertible Preferred Stock, $0.001 par value; 12,900,000 shares
authorized; 12,855,094 shares issued and outstanding................... 13
Series B Convertible Preferred Stock, $0.001 par value; 4,044,943 shares
authorized; 4,044,943 shares issued and outstanding.................... 4
Common Stock, $0.001 par value; 24,881,650 shares authorized; 3,322,804
shares issued (3) and outstanding...................................... 3
Additional paid-in capital..................................................... 33,590
Deferred compensation.......................................................... (2,083)
Accumulated deficit............................................................ (11,571)
-------------
Total stockholders' equity................................................... 19,956
-------------
Total capitalization....................................................... $ 174,407
-------------
-------------
</TABLE>
- ------------------------
(1) Reflects the issuance of the Old Notes and accompanying Warrants. The net
proceeds from the issuance was allocated between the Notes and the Warrants.
The Notes will accrete in value through May 15, 2003 at a rate of 13.5% per
annum, compounded semi-annually. No cash interest will be payable on the
Notes prior to that date. The value ascribed to the Warrants results in
additional debt discount, which is amortized to interest expense using the
effective interest method over the period that the Notes are outstanding.
(2) The Warrants may be required to be repurchased by the Company for cash upon
the occurrence of a Repurchase Event, as defined in the provisions of the
Warrant Agreement.
(3) Excludes 438,300 shares of Common Stock reserved for issuance upon exercise
of outstanding options as of June 30, 1998.
27
<PAGE>
SELECTED FINANCIAL DATA
The following statement of operations data for the periods from February 27,
1997 (inception) to December 31, 1997 (audited), February 27, 1997 (inception)
to June 30, 1997 (unaudited), and for the six months ended June 30, 1998
(unaudited), and the balance sheet data as of December 31, 1997 (audited) and
June 30, 1998 (unaudited), have been derived from the Company's Financial
Statements and the related Notes thereto. The following selected financial data
should be read in conjunction with the Company's Financial Statements and the
related Notes thereto and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included elsewhere herein.
<TABLE>
<CAPTION>
FEBRUARY 27, 1997 FEBRUARY 27, 1997 SIX MONTHS
(INCEPTION) TO (INCEPTION) TO ENDED
DECEMBER 31, 1997 JUNE 30, 1997 JUNE 30, 1998
------------------- ------------------- -------------
<S> <C> <C> <C>
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS:
Revenue................................................................ $ -- $ -- $ 82
Operating expenses:
Network and service costs............................................ -- -- 668
Selling, general and administrative.................................. 2,534 104 6,981
Depreciation and amortization........................................ 1 -- 35
------- ------ -------------
Total operating expenses........................................... 2,535 104 7,684
------- ------ -------------
Loss from operations................................................... (2,535) (104) (7,602)
------- ------ -------------
Interest income (expense):
Interest income...................................................... 114 -- 1,674
Interest expense (including amortized debt discount and costs)....... (1) -- (3,221)
------- ------ -------------
Net interest........................................................... 113 -- (1,547)
------- ------ -------------
Net loss............................................................... $ (2,422) $ (104) $ (9,149)
------- ------ -------------
------- ------ -------------
Net loss per share (basic and diluted)................................... $ (2.69) $ (0.12) $ (9.66)
------- ------ -------------
------- ------ -------------
</TABLE>
<TABLE>
<CAPTION>
AS OF AS OF JUNE
DECEMBER 31, 1997 30, 1998
------------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.................................................................. $ 10,166 $ 163,368
Net equipment and furniture................................................................ 1,621 5,639
Total assets............................................................................... 12,241 178,869
Total debt (3)............................................................................. 568 147,884
Mandatorily redeemable Common Stock warrants (3)(4)........................................ -- 6,567
Total stockholders' equity................................................................. 10,346 19,956
</TABLE>
<TABLE>
<CAPTION>
FEBRUARY 27, 1997 FEBRUARY 27, 1997 SIX MONTHS
(INCEPTION) TO (INCEPTION) TO ENDED
DECEMBER 31, 1997 JUNE 30, 1997 JUNE 30, 1998
------------------- ------------------- -------------
<S> <C> <C> <C>
(DOLLARS IN THOUSANDS)
OTHER DATA:
EBITDA (1)............................................................. $ (2,342) $ (85) $ (7,329)
Net cash used for operating activities................................. (1,560) (71) (5,529)
Net cash used for investing activities................................. (1,345) -- (6,485)
Net cash provided by financing activities.............................. 13,071 300 165,216
Deficiency of earnings to cover fixed charges (2)...................... (2,422) (104) (9,149)
</TABLE>
- ------------------------
(1) EBITDA consists of net loss excluding net interest and depreciation and
amortization of capital assets and deferred compensation. EBITDA is
presented to enhance an understanding of the Company's operating results and
is not intended to represent cash flow or results of operations in
accordance with generally accepted accounting principles for the period
indicated and may be calculated differently than EBITDA for other companies.
(2) The deficiency of earnings to cover fixed charges represents the dollar
amount of earnings required to attain a one-to-one ratio to fixed charges,
which includes interest on debt and the interest component of operating
leases.
(3) Reflects the issuance of the Old Notes and accompanying Warrants. The net
proceeds from the issuance was allocated between the Notes and the Warrants.
The Notes will accrete in value through May 15, 2003 at a rate of 13.5% per
annum, compounded semi-annually. No cash interest will be payable on the
Notes prior to that date. The value ascribed to the Warrants results in
additional debt discount, which is amortized to interest expense using the
effective interest method over the period that the Notes are outstanding.
(4) The Warrants may be required to be repurchased by the Company for cash upon
the occurrence of a Repurchase Event, as defined in the provisions of the
Warrant Agreement.
28
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS IS BASED ON THE FINANCIAL STATEMENTS
OF THE COMPANY AND THE NOTES THERETO AND SHOULD BE READ IN CONJUNCTION WITH THE
FINANCIAL STATEMENTS AND THE RELATED NOTES THERETO INCLUDED ELSEWHERE IN THIS
PROSPECTUS. CERTAIN STATEMENTS SET FORTH BELOW CONSTITUTE "FORWARD-LOOKING
STATEMENTS." SUCH FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS,
UNCERTAINTIES AND OTHER FACTORS THAT MAY CAUSE THE ACTUAL RESULTS, PERFORMANCE
OR ACHIEVEMENTS OF THE COMPANY, OR INDUSTRY RESULTS TO BE MATERIALLY DIFFERENT
FROM ANY FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR IMPLIED BY
SUCH FORWARD-LOOKING STATEMENTS. GIVEN THESE UNCERTAINTIES, PROSPECTIVE
INVESTORS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON SUCH FORWARD-LOOKING
STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE,
BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN "RISK FACTORS" AND "BUSINESS." THE
COMPANY DISCLAIMS ANY OBLIGATION TO UPDATE INFORMATION CONTAINED IN ANY
FORWARD-LOOKING STATEMENT.
OVERVIEW
Rhythms believes it is well positioned to capitalize on the explosive demand
for data communications services. The Rhythms Network is intended to be
nationwide and to provide Service Providers and other end users with a secure,
reliable, high-speed solution to the inherent shortcomings of today's legacy
networks. Rhythms will offer a turnkey solution that can be integrated with
Service Providers' existing service offerings in order to provide a
comprehensive package to end users. The Company believes its solution will be
attractive due to the Company's ability to provide (i) low cost, high-speed
local access; (ii) local and wide area balanced capacity; and (iii) end-to-end
network management. The Company is led by a management team with extensive
experience in data communications from such companies as !NTERPRISE, Sprint and
CompuServe.
Since inception in February 1997, the Company's primary activities have
consisted of the procurement of required governmental authorizations, the
negotiation and execution of interconnection agreements with four ILECs, the
identification of collocation space and locations for the Company's Connection
Points, Metro Service Centers and business offices, the acquisition and
deployment of equipment and facilities, the launching of service trials, the
hiring of management and other personnel, the raising of capital and the
development and integration of its OSS and other back office systems. The
Company has signed interconnection agreements with Ameritech, Bell Atlantic,
Pacific Bell and U S WEST, has obtained CLEC authority in 12 states, and expects
to receive authority in an additional 11 states by December 31, 1998. The
Company began service trials in the greater San Diego metropolitan area in
December 1997, and began offering commercial services in the area on April 1,
1998 and in San Francisco on June 1, 1998. Rhythms launched its services in the
East Bay and San Jose in July 1998 and in Los Angeles and Orange County in
September 1998. Rhythms is also currently in active negotiations to interconnect
with five other ILECs. The Company's initial rollout of 11 markets is expected
to be completed by the first half of 1999, with expansion into 30 markets
expected to be completed by the end of year 2000.
The Company has incurred operating losses, net losses and negative operating
cash flow each month since its inception. As of June 30, 1998, the Company had
an accumulated deficit of $11.6 million. The Company currently intends to
substantially increase its operating expenses and capital expenditures in order
to rapidly expand its infrastructure and network services to achieve the
expansion into the 30 markets and to support additional expected customers in
the new markets. The Company expects to incur substantial operating losses, net
losses and negative cash flow during the network build out and initial
penetration of each new market it enters. These losses are expected to continue
for at least the next several years, until the Company's installed base of
customers and resulting operating profits are large enough to absorb losses from
new or recently entered markets. The Company believes that the net proceeds from
the Old Notes Issuance, together with its existing cash, lease line proceeds and
future revenue generated from operations, will be sufficient to fund the
Company's capital expenditures, working capital requirements and
29
<PAGE>
operating losses associated with the rollout and subsequent operation of its
initial 11 markets. The Company expects additional financing will be needed to
build out in other markets across the country.
FACTORS AFFECTING FUTURE OPERATIONS
NET REVENUES
SERVICE OFFERING. Rhythms initially intends to derive the majority of its
revenues from DSL and other high-speed access services and WAN connectivity,
including corporate and ISP connections to the Rhythms Network.
TARGET MARKET AND PENETRATION. The Company's target market consists of the
LANs in each market, which the Company believes is the best indication of data
intensive business density, as well as related remote users. According to a
leading data communications industry source, the total number of business LANs
in the United States is approximately 1.5 million, with an average of 40 users
per LAN. The Company believes that it will be able to address 28% of all LANs in
the United States with the build out of its initial 11 markets. The Company's
goal is to address 50% of the LANs in the United States, which it believes is
achievable by building out a total of 30 markets. Based on other market data,
the Company estimates that 20% of LAN users require remote access. Accordingly,
the Company's total market opportunity in its target markets includes 431,000
LANs and 3.5 million remote users. The Company's addressable market opportunity
may then be derived by taking into consideration the estimated reach of DSL and
the Company's estimated coverage of the businesses and residences served from
ILEC COs. Initially, DSL is expected to reach over 65% of the businesses and
residences served from the ILEC COs. Within each metropolitan area, the Company
expects to collocate in the appropriate number of ILEC COs to cover 75% of the
total market opportunity.
PRICING. For both local access and WAN connectivity, the Company intends to
bill its end users for monthly recurring charges based on the bit rate chosen
for networking services, ranging from 384 Kbps to 7.0 Mbps downstream and 384
Kbps to 1.0 Mbps upstream. The Company plans to offer both flat rate plans and
usage-based plans for its services. In addition to monthly service fees, the
Company plans to bill users for nonrecurring service activation and installation
charges. The Company also intends to charge both monthly and nonrecurring
charges to ISPs for the high-speed egress connection between the Rhythms Metro
Service Center and the ISP router.
To encourage business customers to adopt the Company's services, the Company
may offer the first month(s) of DSL local service at a reduced price. The
Company believes that its services are competitively priced versus alternative
services at comparable bit rates. In order to preserve its price performance for
customers, the Company expects to offer higher bit rates without necessarily
increasing its prices. The Company expects that as a result of competitive
forces, its prices will decline over time.
CHURN. Similar to other telecommunications providers, the Company expects
to encounter customer churn as its customer base grows. The Company expects to
maintain a monthly churn rate not higher than 2% as a result of (i) the
complexity and inconvenience associated with switching data communications
service providers; (ii) the switching costs associated with disconnecting
service; and (iii) the economic impact of paying a new service activation and
installation charge.
UNBILLABLES AND BAD DEBTS. Based on historical industry experience,
approximately 4.5% of gross revenue is expected by the Company to be either
unbillable or uncollectible.
NETWORK AND SERVICE COSTS
The Company's network and service costs are comprised of the following:
installation, monthly recurring and nonrecurring line and service charges,
network facilities operating expenses, the cost of
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transport and backbone circuits, the cost of CPE, equipment operating lease
expenses, line repair and support costs. Over time, the Company's network and
service costs are expected to be predominantly variable with the number of
subscribers.
INSTALLATION. In each market, the Company will require a number of field
service technicians to install CPE at end user locations. The Company currently
outsources most of this function.
MONTHLY RECURRING AND NONRECURRING LINE AND SERVICE CHARGES. The Company
pays ILECs a one-time
installation and activation fee and a monthly service fee for each copper loop.
The Company also pays IXCs a one-time installation and activation fee and a
monthly service fee for WAN connections over a frame relay or ATM network.
Initially, the Company leases these services from IXCs. Over time, as traffic
volume grows, the Company expects its WAN costs to improve through discounts
based on volume commitments and migration towards a partial facilities oriented
approach (potentially including long-term indefeasible rights of use).
NETWORK FACILITIES OPERATING EXPENSES. The Company will incur various
recurring costs at its network and business locations.
TRANSPORT AND BACKBONE CHARGES. The Company incurs charges for transport
between the Company's Connection Points and its Metro Service Centers and incurs
charges for the backbone circuits connecting the Metro Service Centers to the
Rhythms Network Operating Center ("RNOC") in Denver.
COST OF CPE. As part of its DSL local access plans, the Company will
provide the CPE and will expense the cost of CPE for each customer line.
EQUIPMENT LEASING. The Company is initially taking advantage of short-term
operating leases to finance the acquisition of most of its network equipment,
including DSL multiplexers, ATM switches, routers and network "modems."
Depending on its tax position, the Company may decide to purchase and to
capitalize a portion or all of this equipment in the future.
LINE REPAIR AND SUPPORT COSTS. Similar to other telecommunications
providers, the Company estimates that a small percentage of its lines may
require repair or support. Such costs will be comprised of field dispatch labor
and a portion of RNOC costs.
SELLING, GENERAL AND ADMINISTRATIVE COSTS
The Company incurs selling, general and administrative expenses common to
all telecommunications providers, including customer service and technical
support, information systems, billing and collections, general management and
overhead, and administrative functions. Headcount in functional areas, such as
customer service, engineering and operations, is expected to increase gradually
as the number of customers and network locations increases. Other areas,
particularly information and billing systems, may require significant upfront
capital expenditures to the extent that the Company purchases or builds its own
infrastructure. Since the Company does not have any legacy systems, it believes
it has an opportunity to develop systems that provide greater functionality and
flexibility than many existing systems.
GENERAL AND ADMINISTRATIVE COSTS. The Company's experienced management team
has demonstrated past success in building and managing operational functions.
The Company's management is currently hiring and developing the necessary staff
for all of its departments. As the Company commercializes its markets and its
customer base grows, the number of market-specific employees is expected to
grow. Management anticipates that certain functions, such as customer service,
network operations, billing and site planning, are likely to remain centralized
in order to achieve economies of scale; as such, these components will decrease
as a percentage of the Company's overall operating expenses over time.
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SALES AND MARKETING COSTS. Rhythms' sales efforts are focused on attracting
and retaining Channel Partners, including national and regional ISPs, national
and regional systems and network integrators, VARs, CLECs and IXCs. The Company
utilizes a direct sales organization to acquire enterprise customers. The
Company also has a group of employees focused on product development of network
services and network applications.
DEPRECIATION AND AMORTIZATION
Depreciation expense arising from the network equipment will be minimal
since leased equipment expenses will reflect most of the cost and financing of
this equipment. Collocation fees are capitalized and amortized over an estimated
useful life of 10 years.
CAPITAL EXPENDITURES
The development and expansion of the Company's business requires significant
capital expenditures. The principal capital expenditure incurred during the
buildout phase of any market involves the procurement, design and construction
of the Company's Connection Points and expenditures for other elements of the
Company's network design, which include a Metro Service Center in each market.
The Company is also in the process of building an RNOC in San Diego to
supplement the RNOC which is currently operational in Denver. The number of
targeted COs in a market varies, as does the average capital cost to build the
Company's Connection Points in a given market.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 ("Y2K") issue is the result of computer programs that were
written using two digits, rather than four, to define the applicable year. Any
computer programs that contain date-sensitive software may recognize a date
using "00" as the year 1900 rather than the year 2000, which could result in
system failures or miscalculations causing disruptions of operations, including,
among other things, the Company's ability to process customer orders, monitor
its network, complete and record financial transactions, produce invoices, pay
vendors, or engage in similar normal business activities, which could have a
material adverse effect on the Company.
The Company's detailed plan (the "Y2K Plan") to address possible Y2K
compliance issues takes into consideration internally developed and externally
developed software, as well as products, systems and services of the Company's
vendors and other business relations. The Company is currently in the process of
implementing its Y2K Plan and expects to be Y2K compliant by December 31, 1998,
or, if not compliant, expects to identify any areas of non-compliance and to
develop appropriate solutions. Solutions to non-compliance may include
reselection of vendors or changes in products or services used.
Due to the progress to date in implementing its Y2K Plan, including the
selection of business partners and relationships that have represented to be Y2K
compliant, and the fact that the Company's short length of time in business
precludes it from having legacy systems, the cost impact of becoming Y2K
compliant is expected to be minimal.
RESULTS OF OPERATIONS
Since its inception in February 1997, the Company has engaged principally in
the development of its business operations. Accordingly, the Company's
historical results of operations are not indicative of, and should not be relied
upon as an indicator of, the future performance of the Company.
PERIOD ENDED DECEMBER 31, 1997
REVENUES AND NETWORK AND SERVICE COSTS. The Company did not offer
commercial service in 1997 and, as a result, no revenues or network and service
costs were recorded in 1997. Revenues and network and
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service costs are expected to be recorded in 1998 as the Company introduces
commercial services under its initial market rollout.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Total selling, general and
administrative expenses for the period were approximately $2.5 million and
consisted primarily of salaries and legal and consulting fees incurred to
establish a management team and develop the Company's business. Selling, general
and administrative expenses are expected to significantly increase as the
Company expands its business.
INTEREST INCOME AND EXPENSE. Interest income in 1997 of $114,000 consisted
of interest earned on the Company's invested cash balances, principally the
proceeds raised in the Company's Series A Preferred Stock financing. Interest
expense in 1997 totaled $1,000 since borrowings under its note payable were not
drawn until December 30, 1997. Interest income in the future will consist of
interest earned from investing current cash balances and the proceeds from this
Offering in short-term instruments, consistent with any statistical asset tests
imposed by the 1940 Act, until such funds are used for operating expenses and
capital expenditures. Because of restrictions imposed by the 1940 Act on the
Company's short-term investments, the Company may earn less interest income than
it might have earned in the absence of these restrictions. As a result of
completing this Offering, future interest expense will increase significantly
and will consist primarily of interest on the Company's debt and accretion of
the original issue discount.
INCOME TAXES. The Company recognized no provision for income taxes in 1997.
As of December 31, 1997, the Company had generated net operating loss ("NOL")
carryforwards of approximately $2.1 million, which are available to offset
future taxable income through 2016 for federal taxes and 2005 for state taxes,
subject to the limitations of Internal Revenue Code Section 382 relating to
changes in ownership of the Company. The net deferred tax asset arising from the
NOL carryforwards has been fully offset by a valuation allowance since it is
more likely than not that it will not be realized. The Company expects to
generate significant tax losses for the foreseeable future, which would create
additional NOL carryforwards that may be subject to Section 382 use limitations.
In addition, income taxes may be payable during this time due to generation of
taxable income in certain tax jurisdictions. Once the Company achieves operating
profits and its NOL carryforwards have been exhausted or have expired, the
Company may experience significant tax expense.
SIX MONTHS ENDED JUNE 30, 1998
During the first half of fiscal year 1998, the Company continued the
development of its business operations. Commercial service commenced April 1,
1998 in the San Diego market and June 1, 1998 in San Francisco. Build-outs and
development of additional markets continued in accordance with the Company's
intial rollout of 11 markets expected to be completed during the first half of
1999.
Insignificant revenues and network and service costs were recorded during
the first quarter of fiscal year 1998 as a result of alpha and beta customer
tests, while second quarter revenues and network and service costs reflect
penetration of the San Diego and San Francisco markets. Results of the first
quarter tests were positive and allowed the Company to determine, among other
things, that its platform worked, its service performed as expected, its systems
to perform billing and customer service functioned adequately and that the
Company could commence to commercial service on April 1, 1998 as planned.
Revenues comprise primarily DSL service and installation charges, net of
discounts given to customers upon service establishment. Network and service
costs include customer installation costs, line and backbone expenses, the cost
of customer premise equipment, equipment operating leases, and repair and
support costs.
Selling, general and administrative expenses for the first half were $7.0
million and reflect a continued increase in staffing levels, increased marketing
efforts coinciding with the launch of commercial services, and increased legal
fees associated with development of additional markets.
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Interest income of $1.7 million through June 30, 1998 was generated from the
Company's invested cash balances, which included the proceeds from the issuance
of debt and warrants on May 5, 1998 in the net amount of $144.3 million. The
Company recorded $3.2 million in amortized debt discount and costs during the
quarter, a direct result of the debt issuance. The debt issuance discount of
$139.6 million is being amortized using the effective interest method through
May 15, 2003. The value ascribed to warrants of $6.6 million and debt issuance
costs of approximately $6.1 million are being amortized using the effective
interest method over the period the Notes are outstanding (ten years).
The Company continues to be in a NOL tax position through June 30, 1998;
consequently, no provision for income taxes was recorded in the first half of
1998.
LIQUIDITY AND CAPITAL RESOURCES
On May 5, 1998, the Company issued 13.5% senior discount notes due 2008 in
the principal amount of $290.0 million at maturity, combined with warrants to
purchase an aggregate 1,972,000 shares of Common Stock, for net proceeds of
$144.3 million (after issuance costs). Also during May 1998, the Company entered
into a 36-month lease line that provides for $24.5 million in equipment. Prior
to May 1998, the Company financed its operations primarily through private
placements of equity totaling $30.5 million, utilization of operating equipment
leases totaling $2.0 million and borrowings under a note payable from its
primary bank, Silicon Valley Bank, of $1.0 million, which is being repaid over a
36-month period beginning June 1, 1998. As of June 30, 1998, the Company had an
accumulated deficit of $11.6 million and cash and cash equivalents of $163.4
million.
During the first half of 1998, the net cash used in the Company's operating
activities of approximately $5.5 million primarily related to selling, general
and administrative expenses. Cash used by the Company for collocation fees was
$2.7 million. Net cash provided by financing activities, including the senior
discount notes issuance, was $165.2 million. The cash provided by financing
activities also included $18.3 million from the issuance of Preferred Stock in
March 1998 and payment of $6.1 million in debt issuance costs.
The 13.5% senior notes were issued at a discount; cash proceeds from the
issuance were $150.4 million and the Company incurred approximately $6.1 million
in debt issue costs for net proceeds of $144.3 million. The notes accrete in
value through May 15, 2003 at a rate of 13.5% per annum, compounded semi-
annually; no cash interest will be payable prior to that date. The debt issue
costs are being amortized using the effective interest method over the ten-year
life of the Notes.
The Warrants issued in connection with the Notes become exercisable upon
certain events, which will occur no later than November 1, 1998, at an exercise
price of $0.01 per share. The Warrants expire May 15, 2008. The Warrants may be
required to be repurchased by the Company for cash upon the occurrence of a
Repurchase Event, such as a consolidation, merger or sale of assets to another
entity, as defined in the provisions of the Warrant Agreement, at a price to be
determined by an independent financial expert selected by the Company. The value
ascribed to the Warrants of $6.6 million results in additional debt discount,
which is being amortized using the effective interest method over the ten-year
life of the Notes.
Through December 31, 1997, the Company had issued $12.6 million in Common
and Series A Preferred Stock. During the first quarter of 1998, the Company
received proceeds of $18.0 million upon the issuance of Series B Preferred
Stock, and received approximately $0.5 million from other Common and Series A
Preferred Stock issuances.
In November 1997, the Company entered into a 36-month Master Equipment Lease
with Sun Financial Group, Inc. ("SFG") to finance $2.0 million of the Company's
network equipment and network installation and deployment. All related tax
benefits will accrue to the account of SFG. The Company utilized the full $2.0
million in leasing and in May 1998, entered into another financing arrangement
with
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SFG for up to $24.5 million of additional lease financing. In connection with
this additional financing, the Company issued 239,325 warrants to SFG to
purchase Common Stock at a price of $4.45 per share.
The Note payable to Silicon Valley Bank bears interest at the bank's prime
rate plus 0.25%, is secured by assets of the Company, and is being amortized
over a 36-month repayment period.
ACI Corp. ("ACI") and ACI Corp.-Virginia ("ACI-Virginia"), the Company's
wholly-owned subsidiaries formed in 1998, each operate as a CLEC. ACI and ACI-
Virginia each procure, construct and operate network facilities and provide the
underlying DSL connections for Rhythms services. A portion of the network
equipment held under operating leases is for the benefit of ACI or ACI-Virginia
as lessee, as applicable.
The Company believes that the net proceeds from the Old Notes Issuance,
together with its existing cash, lease line proceeds and future revenue
generated from operations will be sufficient to fund the Company's operating
losses, capital expenditures, lease payments and working capital requirements
for the next 24 months associated with the operation of its initial 11 markets.
The Company intends to expand into 30 markets across the country by the end of
year 2000; accordingly, it has signed interconnection agreements with four
ILECs, has obtained CLEC authority in ten states, and expects to receive
authority in an additional 14 states by December 31, 1998. To facilitate this
expansion, the Company expects its operating losses and capital expenditures to
increase substantially. The Company expects that additional financing will be
required following the initial 11 market rollout; this may include commercial
bank borrowings, leasing, vendor financing or the private or public sale of
equity or debt securities. Actual capital requirements may vary based upon the
timing and success of the Company's rollout. The Company's capital requirements
may change as a result of regulatory, technological and competitive developments
or if (i) demand for the Company's services or its anticipated cash flow from
operations is less or more than expected; (ii) the Company's development plans
or projections change or prove to be inaccurate; (iii) the Company engages in
any acquisitions; or (iv) the Company accelerates deployment of its network
services or otherwise alters the schedule or targets of its rollout plan. Other
than the lease financing, the Company has no present commitments or arrangements
assuring it of any future equity or debt financing, and there can be no
assurance that any such equity or debt financing will be available to the
Company on favorable terms or at all. In the event other additional financing
alternatives are not completed, the Company believes that its existing cash
resources are adequate to continue expansion of its operations on a reduced
scale. See "Risk Factors--Significant Capital Requirements; Need For and
Uncertainty of Additional Financing."
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BUSINESS
THE COMPANY
Rhythms is a comprehensive networking solutions company that provides
high-speed data communications services on an end-to-end basis to Service
Providers (as defined herein) and end users. Rhythms combines high-speed local
access through the deployment of DSL technology with capacity balanced local and
wide area networks to provide low cost networking solutions (the "Rhythms
Network"). The Rhythms Network is intended to be national in scope and to
provide national and regional ISPs, IXCs, CLECs, network and systems
integrators, value-added resellers (collectively, "Service Providers") and end
users with a secure, reliable, high throughput solution to the key shortcomings
of today's networks. Rhythms will offer turnkey end-to-end data communications
solutions that can be integrated with Service Providers' existing service
offerings to provide a comprehensive package to end users. The Company believes
the Rhythms solution will be attractive due to the Company's ability to provide
a complete networking solutions platform including (i) low cost, high-speed
local access; (ii) local and wide area balanced capacity; and (iii) end-to-end
network management.
Rhythms is positioned to capitalize on the increasing importance and rapid
growth in data networking. Rhythms' initial target markets include private line
replacement, remote LAN connectivity and Internet access. According to industry
sources, the total U.S. private line market (low-speed analog and digital
private lines and frame relay DS-0 circuits) was approximately $11.3 billion in
1997 and is expected to grow to $22.7 billion by 2000. In addition, the remote
Internet and LAN access market was approximately $5.9 billion in 1997, and is
expected to grow to $11.7 billion by 2000, representing a projected compound
annual growth rate of 26%. Based on industry sources regarding the number of
LANs in the United States, the Company believes it will be able to address 28%
of all LANs in the United States with the buildout of its initial 11 markets,
expected to be completed by the first half of 1999. The Company intends to
expand into a total of 30 markets across the country by the end of the year
2000; accordingly, it has signed interconnection agreements with four ILECs, has
obtained CLEC authority in ten states, and expects to receive authority in an
additional 14 states by December 31, 1998. While facilitating this expansion,
the Company expects its operating losses and capital expenditures to increase
substantially.
Since its inception in February 1997, Rhythms has made substantial progress
in developing a scalable platform designed to be rapidly rolled out on a
nationwide basis. The Company has signed interconnection agreements with Pacific
Bell, Bell Atlantic, U S WEST and Ameritech, has obtained CLEC authority in
California, Florida, Illinois, Maryland, Massachusetts, Michigan, New Jersey,
New York, Oregon, Virginia, Washington and Wisconsin, is permitted to operate as
a CLEC in Pennsylvania, and is currently in negotiations to interconnect with
five other ILECs. The Company began service trials in the greater San Diego
metropolitan area in December 1997 and began offering commercial services in San
Diego on April 1, 1998 and in San Francisco on June 1, 1998. The Company
believes that the net proceeds from the Old Notes Issuance, together with its
existing cash, lease line proceeds and future revenue generated from operations,
will be sufficient to fund the Company's operating losses, capital expenditures
and working capital requirements for the next 24 months associated with the
rollout and subsequent operation of its initial 11 markets. The Company intends
to subsequently build out in other markets across the country, as discussed
above.
The Company has assembled a management team with substantial experience in
the development, growth and operation of data networking businesses. The
Company's Chief Executive Officer and President, Catherine Hapka, previously
served as President and Chief Operating Officer of !NTERPRISE Networking
Services, U S WEST's data networking business. Under her leadership, !NTERPRISE
grew from a start-up to $500 million in annual contract sales. James Greenberg,
the Company's Chief Network Officer, directed the design, planning, operation
and construction of Sprint's data networks, during which time Sprint's data
networking business grew from a multi-million to a multi-billion dollar
business. Rhythms' sponsors have invested $30.4 million in equity to date, and
include Kleiner Perkins Caufield &
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Byers, a leading investor in technology and telecommunications companies, and
Enron Communications Group, Inc., a subsidiary of Enron Corporation, one of the
world's largest energy producers, distributors and marketers. Other investors
include Brentwood Venture Capital, The Sprout Group and Enterprise Partners.
MARKET OPPORTUNITY
Data communications is the fastest growing segment of the telecommunications
industry. Industry sources indicate that data traffic is growing seven times
faster than voice traffic, and that by the end of 2000 data communications will
represent nearly 77% of enterprise network traffic. Much of the growth in data
traffic will be driven by the widespread adoption of bandwidth intensive data
networking applications, such as intranets, collaborative workflow, e-commerce
and data warehousing. The growing use of such bandwidth-intensive applications
is creating a number of challenges for the existing Public Switched Telephone
Network ("PSTN"), public data networks and private networks. These challenges
affect the entire architecture of the existing telecommunications network and
limit the ability of business users to optimally leverage the benefits of new
information technologies. The Company believes that the key shortcomings of
today's networks include:
LOW-SPEED, UNRELIABLE LOCAL ACCESS. The current local access network
represents the greatest bottleneck to high performance data networking. In the
vast majority of cases, distributed workers and remote business locations must
rely on low-speed, unreliable dial-up modems or ISDN connections over the
traditional circuit-switched telephone network to gain access to their corporate
LAN or the public Internet. Industry sources predict that the number of
teleworkers/employees who spend some portion of their workday at other than
company locations will grow to approximately 66 million by 2002. Industry
sources also estimate that over 95% of teleworkers currently gain access to
their corporate LAN or the public Internet through dial-up modems, which
generally provide sub-optimal performance due to lowspeed, dropped connections
and busy signals. In addition, industry sources indicate that 88% of businesses
with intracompany networks currently use dial-up connections for site-to-site
connectivity.
INEFFICIENT NETWORK ARCHITECTURE. Current network architecture is a result
of regulatory restrictions and outdated network design. For example, prior to
deregulation brought about by the passage of the Telecommunications Act of 1996,
local and long distance networks remained separate and distinct. This
architecture results in a number of network inefficiencies, including local
traffic often traversing the long distance network to reach the same local
destination, wasting increasingly valuable wide area backbone bandwidth and
reducing overall network reliability and speed.
INCREASING NETWORK CONGESTION. Networks are becoming increasingly congested
due to the rapid growth in data traffic and the imbalance in capacity between
local and wide area networks. While high-speed local access technologies such as
DSL will be deployed to help solve the local access bottleneck, other
bottlenecks throughout the existing networks, including the PSTN, will likely
become exposed, making it necessary to redesign the existing networks.
LIMITED DISTRIBUTED STORAGE CAPACITY. Little if any distributed storage
capacity currently exists in either private or public networks. As a result,
when user volume exceeds network capacity, data transmission is either slowed or
information is lost. Today, each time a user accesses a high usage company
database or web site, the data must traverse the entire local and wide area
network, wasting capacity and decreasing user performance.
LACK OF AN INTEGRATED SOLUTION. Today, Service Providers and end users are
forced to integrate telecommunications services with offerings from multiple
vendors to create a complete network solution. This requires frequent
interactions with many representatives within the ILECs and other suppliers
resulting in a complex, time-consuming process and limited ability to
proactively monitor and manage the overall performance of customer networks.
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THE RHYTHMS NETWORK SOLUTION
The Rhythms Network has been designed to meet the requirements of broadband,
highly reliable end-to-end data communications and solve the performance
problems of today's networks. The Company's solution offers business customers
an affordable network with the performance, reliability and security of high
performance private networks. The Rhythms Network solution consists of:
HIGH-SPEED, DEDICATED LOCAL ACCESS. Rhythms has constructed a high-speed,
"always on" (i.e., dedicated) local access network in the greater San Diego
metropolitan area using DSL technology over standard copper telephone lines to
give users access speeds of up to 7.0 Mbps downstream and 1.0 Mbps
upstream--substantially greater speeds than a standard 56 Kbps (0.056 Mbps)
modem. The Company believes this technology will offer substantially greater
price performance as compared to conventional network alternatives.
OPTIMIZED LOCAL AND WIDE AREA TRAFFIC MANAGEMENT. Rhythms' network
architecture is designed to switch and route traffic within each metropolitan
area, keeping local traffic local and sending only remote traffic over the wide
area network, thereby increasing overall network capacity and reliability.
END-TO-END BALANCED CAPACITY. In order to provide balanced local and wide
area networks, Rhythms plans to connect its high-speed local access networks to
leased backbone facilities at equivalent or greater speeds to provide uniform
throughput.
PACKAGED NETWORKING SOLUTIONS. Rhythms believes that its solutions can
offer its Channel Partners and end users national, fully integrated, local and
wide area business networking and proactive network management and monitoring.
DISTRIBUTED STORAGE. The Company plans to build storage capacity in the
network to improve network performance. This distributed storage capacity is
designed to (i) increase overall network performance by placing dense content,
software and applications close to the end user; (ii) reduce network volume by
sending high usage content over the wide area network only once, thereby
reducing the number of times that data is transmitted; and (iii) increase
overall throughput by reducing traffic levels across the wide area network.
SECURITY. The Rhythms Network is designed to provide secure communications
on an end-to-end basis by implementing both IP virtual private networks and ATM
permanent virtual circuits (PVCs) to ensure a single, secure path among customer
endpoints.
BUSINESS STRATEGY
The key elements of the Company's business strategy are as follows:
LEVERAGE EXPERIENCED MANAGEMENT TEAM. The Company believes that its ability
to combine and draw upon the diverse and extensive talent of its senior
management gives it a competitive advantage in providing data networking
solutions. The senior management team has come from industry leaders such as
Sprint, U S WEST and CompuServe. On average, each member of the senior
management team has over 15 years of experience in the data networking and
telecommunications industries.
LEAD WITH DSL LOCAL ACCESS NETWORKS. Rhythms intends to capitalize on the
attractive economic, performance and deployment characteristics of DSL to offer
users local access at speeds many times faster than conventional dial-up modems
and with a favorable performance to price ratio relative to existing
alternatives. High-speed local access bandwidth will improve the ability of
customers to better utilize bandwidth intensive applications. Over time, Rhythms
plans to offer a portfolio of high-speed local access technologies to meet
customer needs.
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RAPIDLY ESTABLISH A NATIONAL FOOTPRINT. Rhythms' initial goal is to rapidly
establish a nationwide footprint capable of serving 50% of all LANs in the
United States. As part of its initial deployment in California, Rhythms has
developed a scalable implementation plan which it believes can be replicated in
metropolitan areas nationwide. The Company believes this rollout plan will allow
it to establish early brand awareness, gain valuable market share and achieve
economies of scale.
PROVIDE BROAD MARKET COVERAGE. Rhythms intends to provide widespread,
broadband local access in each of its markets. The Rhythms Network will achieve
this coverage through collocation in ILEC central offices, which allows the
Company to offer high-speed local access to a majority of businesses and their
distributed locations and workers within a given target market. This broad
collocation strategy will enable Rhythms to significantly increase the reach of
its customers' data networks. Rhythms believes that broad deployment of its
local access services is critical in serving its Channel Partners' connectivity
needs by providing complete coverage of their customers' communities of
interest.
MINIMIZE UPFRONT CAPITAL INVESTMENT. The Company believes that the Rhythms
DSL network architecture requires lower initial and incremental capital
investment than many other currently available local access architectures, such
as cable modems and wireless alternatives. Rhythms has designed a business model
in which a significant portion of the capital deployed will be directly linked
to the success of acquiring customers.
CREATE STRATEGIC PARTNERSHIPS WITH SERVICE PROVIDERS. Rhythms intends to
develop strategic relationships with Service Providers in order to accelerate
the distribution of its service offerings. By selling its services through these
Channel Partners, Rhythms believes it will minimize its direct sales costs, gain
access to a wide audience of business customers, accelerate subscriber
penetration and, over time, speed the acceptance of new services. Rhythms
believes that its solution significantly enhances the competitiveness of its
Channel Partners by enabling them to quickly offer a national, integrated
networking services solution, without the time, expense and effort required to
integrate telecommunications services and hardware components.
TARGET MARKET OVERVIEW
Rhythms has identified three primary market segments as the focus of its
initial marketing activities: Edge Networks, Reach Networks and Legacy Networks.
In each of these segments, the Company believes that the Rhythms Network will be
capable of capturing as well as creating new demand as a result of its
attractive price performance and ease of implementation.
EDGE NETWORKS: CONNECTING DISTRIBUTED WORKERS. The number of distributed
workers is large and growing rapidly. According to industry sources, distributed
workers (teleworkers, at-home workers and self-employed professionals) account
for approximately one-third of all workers in the United States. Based on
industry sources, the Company estimates that the number of teleworkers alone
will exceed 66 million by 2002. Industry sources indicate that 90% of all
businesses have employees who work from home at least some of the time. In the
vast majority of cases, these distributed workers must rely on low-speed,
unreliable dial-up modems or ISDN connections over the traditional
circuit-switched telephone network to gain access to their private network or to
the public Internet.
REACH NETWORKS: CONNECTING INTRACOMPANY AND INTERCOMPANY SITES. The large
and growing need for reliable, secure, high-speed connections to a business'
remote offices, customers and business partners is a significant opportunity.
Industry sources indicate that 88% of intracompany communications (e.g.,
business site-to-site connections) currently depend on dial-up access either to
a private network or to the Internet. In addition, businesses have an increasing
need to be electronically linked to each other to collaborate. Intercompany
communication is largely based on dial-up connections to the Internet. Industry
sources indicate that intercompany communication is projected to grow at a much
faster rate than intracompany communication, and that by 2000 intercompany
traffic will approximately equal intracompany traffic.
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LEGACY NETWORKS: REPLACING AND UPGRADING CORPORATE NETWORKS. Upgrading and
replacing slow, expensive circuits in legacy enterprise networks represents an
additional opportunity. Over the years, large businesses have built enterprise
networks to connect multiple intracompany sites through some combination of
low-speed, dial-up, private line and frame relay connections. In many cases,
these conventional networks provide lower relative price performance than DSL
networks. According to industry sources, the total U.S. private line market
(low-speed analog and digital private lines and frame relay DS-0 circuits) was
approximately $11.3 billion in 1997 and is expected to grow to $22.7 billion by
2000, representing a projected compound annual growth rate of 26%.
PRODUCTS AND SERVICES
Rhythms' initial products and services will consist of (i) Power-Internet
solutions for high-speed Internet access; (ii) MetroLAN solutions for secure
intranets and extranets; (iii) Enterprise Telework solutions for remote access
to corporate applications; (iv) Legacy Network Integration solutions for private
line and frame relay networks; and (v) Distributed Storage solutions for access
to corporate software and applications. Many of these services will be sold to
or marketed through Channel Partners under co-marketing or resale types of
arrangements pursuant to which such Channel Partners will package the Company's
services with products and/or services of their own to provide end-users an
integrated solution.
POWER-INTERNET SOLUTIONS. Together with its ISP Channel Partners, Rhythms
offers Internet access at speeds ranging from 384 Kbps to 7.0 Mbps. The Company
intends to offer its customers a choice of speeds depending on the length and
quality of the copper loop. Unlike dial-up access or ISDN, this high bandwidth
Internet solution is always on, significantly reducing latency. The
Power-Internet solution is designed to serve customers' throughput needs with
scalable bandwidth and to protect their sites with ISP or campus firewalls.
Rhythms' existing ISP Channel Partners integrate the Rhythms Network with their
own Internet services (e.g., DNS registration, e-mail, FTP and Usenet) and
consulting/help desk services to create fully functional turnkey Internet
solutions for small, medium and large business customers. The Company intends to
sell the Power-Internet solution into the Edge and Reach Network markets. See
"-- Target Market Overview."
METROLAN SOLUTIONS. The Company's MetroLAN solution offers dedicated
network connectivity for intranets and extranets. The MetroLAN solution can be
connected to existing private networks, leveraging the investment in existing
network access devices and routers. MetroLAN is designed to provide secure
private local connectivity and access to the Internet through a secure gateway.
The Rhythms Network enables firewall capabilities, including source address
routing, packet filtering and physical address binding to ensure traffic is
delivered to subscriber destinations. The Company intends to sell the MetroLAN
solution into the Edge, Reach and Legacy Network markets.
ENTERPRISE TELEWORK SOLUTIONS. Rhythms intends to work with network and
systems integrators to configure corporate teleworker access to the Internet and
the corporate backbone, and to provide high-speed web access, e-mail and file
transfer protocol ("FTP") connectivity. This solution is designed to deliver
highly effective distributed networking, for example, for high-tech
professionals such as corporate systems administrators or network managers or
for groups of remote customer service agents located in a home office setting.
In certain cases, Rhythms will work with information technology departments to
integrate applications at the teleworker's home desktop, or in other cases, host
the end-user's corporate applications on the Rhythms Network. The Company
intends to sell the Enterprise Telework solution into the Edge Network market.
LEGACY NETWORK INTEGRATION SOLUTIONS. Rhythms intends to offer a
comprehensive network solution to upgrade or replace legacy private line
networks and low-speed frame relay networks. For businesses with legacy private
line networks supporting systems network architecture ("SNA") traffic or delay
sensitive traffic, Rhythms intends to provide a more reliable, cost effective
data network. For existing low-speed frame relay networks, Rhythms plans to
re-engineer multi-carrier interfaces to enable frame relay over
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DSL and private connections to end user sites, improving network carrying
capacity and security. The Company intends to sell the Legacy Network
Integration solution into the Legacy Network market.
DISTRIBUTED STORAGE SOLUTIONS. The Distributed Storage solution is designed
to provide cost effective, reliable and secure distributed storage of content
rich data files (e.g., software upgrades, catalogs and customer databases) for
remote business locations and distributed workers. Businesses can store their
data intensive files on servers that reside in each Rhythms Metro Service
Center, giving users more rapid response to their requests for downloads by
reducing the distance the data must travel. In addition, contention among users
simultaneously attempting to access a single host computer will be reduced by
distributing the access load among multiple hosts, each located in a Rhythms
Metro Service Center. The Company intends to sell the Distributed Storage
solution into the Edge and Reach Network markets.
SALES AND MARKETING
As of June 1998, the Company employed a sales and technical support force of
approximately 15 persons in California. The Company will increase the size of
its sales and technical support force to recruit and support new Channel
Partners and to sell and support end users as it enters new markets.
Rhythms' sales strategy will focus on entering into partner relationships
with a variety of indirect channels, including Service Providers, to sell its
solutions to end users. The Company believes that distribution arrangements with
such Service Providers will give it access to their large customer bases.
Rhythms intends to strategically partner with those companies that offer
services to information-intensive businesses with multiple locations and
distributed workers and that provide superior customer service. These Channel
Partners relationships will include distribution and resale arrangements
pursuant to which Rhythms' services will be sold to Service Providers who will
then package Rhythms' services with services and/or products of their own to
provide end-users an integrated solution.
Marketing support services include training, proposal development, channel
support materials, web promotion, joint participation in national and regional
customer events, trade shows and press announcements. Rhythms intends to bring
to its Channel Partners a fully integrated network solution. The Company intends
to relieve its Channel Partners of the burden of acting as a network integrator
by qualifying potential customers, ordering connections, installing and turning
up network services, installing equipment on the customer premises, monitoring
the network, trouble shooting, making repairs and providing a single bill.
To date, the Company has primarily offered its services through ISPs in San
Diego. Rhythms has entered into commercial arrangements with 10 ISPs in San
Diego and five ISPs in San Francisco. The Company is also seeking to sell its
solutions directly to select enterprise customers that have large numbers of
distributed locations and workers currently using hundreds or thousands of ISDN
or dial-up connections. Rhythms has entered into a trial agreement with Cisco
Systems, Inc. and a commercial agreement with QUALCOMM.
The Company began service trials in San Diego in December 1997 and began
offering commercial services in the San Diego area on April 1, 1998 and in San
Francisco on June 1, 1998. Rhythms launched its services in San Jose and East
Bay in July 1998 and Los Angeles and Orange County in September 1998.
CUSTOMER SERVICE
Rhythms intends to offer both its Channel Partners and end users a single
point of contact for implementation, maintenance and billing. The Rhythms
Customer Service Center ("RCSC"), located in Englewood, Colorado, is available
at 1.800.RHYTHMS, from 8 a.m. to 6 p.m., mountain standard time, five days a
week. The Rhythms Network Operations Center ("RNOC"), working in tandem with the
RCSC, will provide both proactive and customer initiated maintenance services
and operates 24 hours a
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day, seven days a week. The Company intends to develop web-based systems to
support customer transactions electronically.
IMPLEMENTATION. Working with a Channel Partner, a Rhythms customer service
technician and a sales engineer will develop a project implementation plan for
each customer. The plan will include qualifying the customer (i.e., for
DSL-based services, determining the availability of an appropriate copper loop
for the customer) for the Company's service offerings, placing orders for the
connection facilities, coordinating the delivery of the connection, turn up and
final installation. In the San Diego and San Francisco markets, Rhythms has
entered into an arrangement with Genicom, Inc. ("Genicom"), under which Genicom
will provide field services for the Company 24 hours a day, seven days a week.
The Company intends to use third parties for field services in other markets.
MAINTENANCE. The RNOC provides network surveillance through standard Simple
Network Management Protocol ("SNMP") tools for each element in the Rhythms
network. Because the Company has complete visibility of the customer's network,
Rhythms believes it will be able to proactively detect and correct the majority
of the customer's maintenance problems remotely. The Company's goal is to
proactively detect and repair 90% of the customer's maintenance problems before
the customer is aware of a problem. The Company believes that customer initiated
maintenance and repair requests will be managed and resolved primarily through
the RCSC. The Company will utilize a trouble ticket management system to
communicate customer maintenance problems from the RCSC to the RNOC engineers
and the field services providers.
BILLING. Customer bills are currently issued on a monthly basis through the
Company's internal systems. Customer billing inquiries are managed by the RCSC.
The Company has entered into an arrangement with Federal Trans Tel, Inc. ("FTT")
under which, beginning October, 1998, FTT has agreed to provide all of the
Company's billing requirements, including service rating, invoicing, bill
creation, mailing, lock box receipts, remittance processing and tax reporting.
The RCSC will continue to be the single point of contact for billing inquiries.
CUSTOMER SUPPORT SYSTEMS. The Company's system architecture is designed to
facilitate rapid service responsiveness and reduce the cost of customer support.
An integrated set of standard, off-the-shelf systems is used to support the
Company's business processes. All business functions, including sales, ordering,
provisioning, maintenance and repair, billing, accounting and decision support,
are designed to use a single database repository, ensuring that every function
has accurate, up-to-date information. Automation within and between processes is
enabled through the use of client/server tools and scalable Unix and Microsoft
NT servers.
SERVICE DEPLOYMENT
To rapidly rollout services in new markets, Rhythms has developed a
structured methodology and process for selecting target cities, deploying its
high performance network services and identifying potential Channel Partners.
The Company developed a prototype rapid deployment process in San Diego and in
San Francisco and is currently replicating this model in East Bay and San Jose
and Los Angeles and Orange County. The Company believes that the rapid
deployment process will significantly reduce time to market and can be refined
and replicated in its other targeted markets.
The target cities were selected based on high volumes and concentrations of
LANs, both of which the Company believes are the best indicators of data
intensive business density. Network deployment locations within a metropolitan
market are selected using proprietary demographic algorithms applied to third
party databases of businesses and households. These concentrations of businesses
and high income households are plotted using sophisticated mapping software that
also overlays ILEC CO boundaries with street level detail.
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Rhythms' rapid deployment process includes an integrated operations buildout
and market development plan to achieve multiple objectives in parallel. The
network related processes include identifying space facilities; designing the
metropolitan network; ordering, staging and installing equipment; and turning up
the network and the support infrastructure. Concurrently, the sales, business
development and marketing teams staff the sales and technical support positions,
attempt to identify and engage the best Channel Partners and launch a marketing
and public relations campaign.
THE RHYTHMS NETWORK ARCHITECTURE
The Rhythms Network Architecture consists of endpoints, transport, Rhythms
Connection Points ("RCPs"), Rhythms Metro Service Centers ("RMSCs") and the
Rhythms Backbone, all centrally managed by the RNOC. These components are
integrated into local, metropolitan and wide area networks that combine speed
and balanced capacity in a manner designed to deliver a high performance
networking experience for the Company's customers.
ENDPOINT. The Rhythms Network begins with the integration of the Rhythms
endpoint device into the customer's personal computer, local area network or
enterprise router. The Company currently offers DSL and private line DS-1 level
and higher connectivity but is not limited to these technologies. For DSL
access, the Company will provide a DSL modem at the customer premises. For DS-1
level and higher access, the Company intends to provide a channel/digital
service unit on the customer premise.
TRANSPORT. Rhythms transport connects customer endpoints to the Rhythms
Network. For subscriber loop access, the transport is a DSL-capable copper loop
ordered by Rhythms from an ILEC. For DS-1 level and higher access, the transport
is leased copper or fiber trunks provided by the ILEC or a CAP. The Company will
act as a single point of contact between its customers and the transport vendors
and will manage the ordering, engineering and implementation processes
associated with connecting the customer endpoint and transport to the Rhythms
Network.
RHYTHMS CONNECTION POINT. An RCP is a physical point of presence within a
market that will connect the DSL equipped copper loop to the Company's DSL
multiplexing equipment. The Company expects that RCPs will typically be
collocated within an ILEC CO, at multiple points throughout a metropolitan area.
RHYTHMS METRO SERVICE CENTER. An RMSC is a physical point of presence
within a market that will accept high speed connectivity over SONET rings from
the RCPs. The Company expects to have one RMSC for each of its markets. The RMSC
houses the Company's ATM switches, IP routers and application servers to connect
traffic to and from a customer endpoint within a region or across the Rhythms
Backbone.
RHYTHMS BACKBONE. The Rhythms Backbone will interconnect RMSCs so that data
traffic can be transported between customer endpoints located in different
regions. Initially, the Company intends to lease high speed ATM, frame relay and
IP technologies from third parties to create the Rhythms Backbone.
COMPETITION
Rhythms will face competition from many competitors with significantly
greater financial resources, well-established brand names, and large, existing
installed customer bases. Moreover, the Company expects the level of competition
to intensify in the future. The Company expects significant competition from
ILECs, traditional and new IXCs, CAPs, CLECs, cable modem service providers,
ISPs and wireless and satellite data service providers.
Many of these competitors are offering (or may soon offer) technologies and
services that will directly compete with some or all of the Company's service
offerings. Such technologies include ISDN, DSL, wireless data and cable modems.
Some of the competitive factors in the Company's markets include
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transmission speed, reliability of service, breadth of service availability,
price performance, network security, ease of access and use, content bundling,
customer support, brand recognition, operating experience, capital availability
and exclusive contracts. The Company believes that it compares unfavorably with
its competitors with regard to, among other things, brand recognition, existing
relationships with end-users, available pricing discounts, ILEC CO access,
capital availability and exclusive contracts. Substantially all of the Company's
competitors and potential competitors have substantially greater resources than
the Company. There can be no assurance that the Company will be able to compete
effectively in its target markets.
INCUMBENT LOCAL EXCHANGE CARRIERS. ILECs, such as GTE and U S WEST, are
leasing wide area connectivity from IXCs, have existing metropolitan area
networks and have circuit-switched local access networks. In addition, most
ILECs are establishing their own ISP businesses and are presently conducting
technical and/or market trials of DSL-based services. Most ILECs have announced
commercial DSL services in certain areas. The Company believes that ILECs have
the potential to quickly overcome many of the issues that have delayed
widespread deployment of DSL services in the past; if and when they do so, the
ILECs will represent strong competition in all of the Company's target markets.
The ILECs have an established brand name in their service areas, possess
sufficient capital to deploy DSL services rapidly and are in a position to offer
service from central offices where the Company may be unable to secure
collocation space.
TRADITIONAL INTER-EXCHANGE CARRIERS, FIBER BASED CAPS AND COMBINATIONS OF
THE TWO. Long distance companies such as WorldCom and AT&T already have, or are
rapidly acquiring, all of the network functionality needed to support
high-speed, end-to-end networking services. This functionality includes wide
area networking (e.g., WorldCom and MCI); metropolitan area networking (e.g.,
WorldCom's acquisition of MFS Communications Company, Inc. and Brooks Fiber
Properties, Inc.; Qwest/LCI; and AT&T's acquisition of Teleport Internet
Services and its announced TCI merger); distributed local access (e.g.,
WorldCom's alliance with MFS); and basic ISP services (e.g., WorldCom's
ownership of UUNET Technologies, Inc., ANS Communications, Inc. and CompuServe;
AT&T's association with TCG CERFnet, Inc.; and Sprint's partnership with
EarthLink Network, Inc.). These carriers have deployed large scale networks,
have large numbers of existing business and residential customers and enjoy
strong brand recognition. For instance, these companies have extensive fiber
networks in many metropolitan areas that primarily provide high speed digital
and voice elements to large companies. These companies could deploy high speed
off-net services using DSL in combination with their current fiber networks.
They also have interconnection agreements with many of the ILECs and have
secured collocation spaces from which they could begin to offer competitive DSL
services. Sprint made an announcement in May 1998 of its intent to create a
high-speed end-to-end data network.
NEW INTER-EXCHANGE CARRIERS. Long-haul backbone providers, such as
Williams, Qwest and Level 3 Communications, Inc., are building and managing high
bandwidth, nationwide IP-based packet technology networks for the wide area
network. These same providers are acquiring or partnering with ISPs to provide
gateways to the public Internet and basic ISP services (e.g.,
Williams/Concentric, IXC/PSINet, Qwest/ Supernet, Inc.). These companies could
extend their existing networks to include fiber metropolitan area networks and
high speed, off-net services using DSL, either alone, or in partnership with
others.
CABLE MODEM SERVICE PROVIDERS. Cable modem service providers such as @Home
Networks (and their respective cable partners) are deploying high-speed Internet
access services over hybrid fiber coaxial cable networks. Where deployed, these
networks provide local access services similar to the Company's services, and in
some cases at higher speed. They also offer these services at lower price points
than the Company's services and target both residential and business customers.
They achieve these lower price points in part by sharing the bandwidth available
on the cable network among multiple end users. Actual or prospective cable modem
service provider competition may have a significant negative effect on the
ability of the
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Company to secure customers and may create downward pressure on the prices the
Company can charge for its services.
WIRELESS AND SATELLITE DATA SERVICE PROVIDERS. Wireless and satellite data
service providers are developing wireless and satellite-based Internet
connectivity. The Company may face competition from terrestrial wireless
services, including 2 GHz and 28 GHz wireless cable systems (Multi-channel
Multi-point Distribution System ("MMDS") and Local Multi-channel Distribution
System ("LMDS")), and 18 GHz and 38 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
LMDS licenses in all markets which can be used for high-speed data services and
Internet access. In addition, companies such as Teligent, Inc., Advanced Radio
Telecom Corp. and WinStar Communications, Inc. hold point-to-point and
point-to-multi-point microwave licenses to provide fixed wireless services such
as voice, data, Internet access and video. The Company also may face competition
from satellite-based systems. Motorola Satellite Systems, Inc., Hughes Space
Communications (a subsidiary of Hughes Electronic Corporation), Teledesic,
Iridium World Communications, Ltd., Globalstar and others are planning or are in
the process of building global satellite networks which can be used to provide
broadband voice and data services. In January 1997, the FCC allocated 300 MHz of
spectrum in the 5 GHz band for unlicensed devices to provide short-range,
high-speed wireless digital communications. These frequencies must be shared
with incumbent users without causing interference. Although the allocation is
designed to facilitate the creation of new wireless LANs, it is too early to
predict what kind of equipment might ultimately be manufactured and for what
purposes it might be utilized.
INTERNET SERVICE PROVIDERS. Independent ISPs such as Concentric Network
Corporation and Mindspring Enterprises provide Internet access to residential
and business customers, generally using the existing PSTN at ISDN speeds or
below. Some ISPs, such as HarvardNet, Inc. in Massachusetts, InterAccess in
Illinois and Vitts Network in New Hampshire, have begun offering DSL-based
services. To the extent the Company is not able to partner with ISPs to provide
its services, ISPs could become DSL service providers competitive with the
Company.
OTHER CLECS. Other companies have plans to enter the market and offer
high-speed data services using a business strategy similar to that of the
Company. The 1996 Act specifically grants CLECs the right to negotiate
interconnection agreements with ILECs. Furthermore, the 1996 Act allows CLECs to
enter into interconnection agreements which are identical in all respects to
that of the Company. Certain CLECs, including Covad and NorthPoint, have begun
offering DSL-based access services, and others are likely to do so in the
future.
GOVERNMENT REGULATIONS
Some of the services offered by the Company, particularly by its
wholly-owned ACI Corp. and ACI Corp. - Virginia subsidiaries may be subject to
regulation at the federal, state and/or local levels. There can be no assurance
that current or future federal or state regulations or legislation and therefore
have a material adverse impact on the Company's business prospects, operating
results, financing condition, and ability to make payments on its indebtedness,
including the New Notes. In addition, participation in proceedings setting rules
at either the federal or state level could consume significant financial and
managerial resources, with no assurance of an outcome favorable to the Company.
FEDERAL LEGISLATION AND REGULATION
THE 1996 ACT. The 1996 Act, enacted on February 8, 1996, substantially
departs from prior legislation in the telecommunications industry by
establishing local exchange competition as a national policy through the removal
of state regulatory barriers to competition and the preemption of laws
restricting competition in the local exchange market.
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The 1996 Act in some sections is self-executing, but in most cases the FCC
must issue regulations that identify specific requirements before the Company
and its competitors can proceed to implement the changes the 1996 Act
prescribes. The outcome of these various ongoing FCC rulemaking proceedings or
judicial appeals of such proceedings could materially affect the Company's
business prospects, operating results, financial condition and its ability to
make principal and interest payments on its indebtedness, including the New
Notes.
The Federal Communications Commission ("FCC") prescribes rules applicable to
interstate communications, including rules implementing the 1996
Telecommunications Act (the "1996 Act"), a responsibility it shares with the
state regulatory commissions. The 1996 Act removed many of the remaining
barriers to local competition, and the FCC's initial rules interpreting the Act
(the "FCC Order") were generally encouraging to increased local competition. A
federal appeals court for the 8th Circuit reviewed the FCC Order, and overruled
some of its provisions, including some rules on pricing and nondiscrimination.
That ruling is itself to be reviewed by the U.S. Supreme Court. In December,
1997 a federal court in Texas ruled unconstitutional the 1996 Act's requirement
that former Bell System ILECs cannot provide interLATA services until they meet
certain requirements. This could reduce the incentives of those ILECs to
cooperate in opening their markets to competition. The FCC and other parties
have asked the U.S. Supreme Court to review this ruling. In May, 1998 a federal
court in Washington, D.C. ruled that other 1996 Act limitations on Bell System
ILECs are not unconstitutional. These contrasting rulings may be resolved by the
U.S. Supreme Court at some point. There can be no assurance that the final
outcome of these reviews will not have a material adverse impact on the Company.
In addition, four of the Regional Bell Companies have petitioned the FCC to be
relieved of certain regulatory requirements in connection with their own DSL
services, including obligations to unbundle DSL-equipped loops (but not the
obligation to unbundle the loops Rhythms purchases for its DSL services). There
can be no assurance that the final outcome of these petitions or other
proceedings interpreting the requirements of the 1996 Act will not have a
material adverse impact on the Company.
STATE REGULATION
Some of the Company's services, particularly those of ACI Corp. and ACI
Corp. -Virginia, may be classified as intrastate services subject to state
regulation. All of the states where the Company operates, or will operate,
require some degree of state regulatory commission approval to provide certain
intrastate services. In most states, intrastate tariffs are also required for
various intrastate services, although the Company is not typically subject to
price or rate of return regulation for tariffed intrastate services. Actions by
state public utility commissions could cause the Company to incur substantial
legal and administrative expenses.
Under the 1996 Act, if a request is made by the Company, ILECs have a
statutory duty to negotiate in good faith with the Company for agreements for
interconnection and access to unbundled network elements. These negotiations are
conducted on a region-wide basis, and individual agreements are then signed for
each of the states in the region for which a request has been made. The Company
has completed interconnection negotiations with Bell Atlantic, Pacific Bell, U S
West and Ameritech. The Company and Ameritech have signed an agreement for
Illinois and currently are negotiating an interconnection agreement for
Michigan. The Company and Bell Atlantic have signed agreements for Pennsylvania,
New Jersey, Maryland and Virginia, and are currently negotiating agreements for
Massachusetts and New York. The Company and Pacific Bell have signed an
agreement for California. The Company and U S West have signed an agreement for
Washington, and are currently negotiating agreements for Colorado, Arizona and
Oregon. In addition, the Company is currently negotiating with SNET for
Connecticut, with GTE for Washington, Oregon, California and Florida, with SBC
for Texas, Missouri and Kansas, and with BellSouth for Georgia and Florida.
There can be no assurance that these interconnection agreements will be on terms
that are entirely satisfactory to the Company.
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During these negotiations, the Company or the ILEC may submit disputes to
the state regulatory commissions for mediation and, after the expiration of the
statutory negotiation period set forth in the 1996 Act, the parties may submit
outstanding disputes to the states for arbitration. To date, the Company has not
submitted any disputes to the states for mediation or arbitration.
Under the 1996 Act, states have begun and, in a number of cases, completed
regulatory proceedings to determine the pricing of UNEs and services, and the
results of these proceedings will determine whether it is economically
attractive to use these elements.
LOCAL GOVERNMENT REGULATION
Should the Company in the future decide to operate its own transport
facilities over public rights-of-way, it may be required to obtain various
permits and authorizations from municipalities in which it operates such
facilities. Some municipalities may seek to impose similar requirements on users
of transmission facilities, even though they do not own such facilities. The
actions of municipal governments in imposing conditions on the grant of permits
or other authorizations or their failure to act in granting such permits or
other authorizations could have a material adverse effect on the Company's
business.
EMPLOYEES
As of September 1998, the Company had approximately 125 employees. The
Company believes that its future success will depend in part on its continued
ability to attract, hire and retain qualified personnel. Competition for such
personnel is intense, and there can be no assurance that the Company will be
able to identify, attract and retain such personnel in the future. None of the
Company's employees are represented by a labor union or are the subject of a
collective bargaining agreement. The Company has never experienced a work
stoppage and believes that its employee relations are good.
PROPERTIES
The Company's headquarters are located in facilities consisting of
approximately 34,000 square feet in Englewood, Colorado, which the Company
occupies under a lease that expires in October 1999. The Company also leases
space in a number of other locations for network equipment installations.
LEGAL PROCEEDINGS
The Company is not currently a party to any legal proceedings. The Company
is, however, subject to state commission, FCC and court decisions as they relate
to the interpretation and implementation of the 1996 Act, the interpretation of
CLEC interconnection agreements in general and the Company's interconnection
agreements in particular. In some cases, the Company may be deemed to be bound
by the results of ongoing proceedings of these bodies. The Company therefore may
participate in proceedings before these regulatory agencies or judicial bodies
that affect, and allow the Company to advance, the Company's business plans.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth the names and ages of the executive officers
and the directors of the Company as of the date of this Prospectus.
<TABLE>
<CAPTION>
NAME AGE POSITION(S)
- ---------------------------------------------- --- ------------------------------------------------------------
<S> <C> <C>
Catherine M. Hapka............................ 44 President, Chief Executive Officer and Director
James A. Greenberg............................ 37 Chief Network Officer
Jeffrey Blumenfeld............................ 50 Vice President and General Counsel
Scott C. Chandler............................. 37 Chief Financial Officer
Joseph R. D'Angelo............................ 32 Vice President and General Manager, Eastern Region
Gloria A. Farler.............................. 51 Vice President, Marketing Support
Eric H. Geis.................................. 52 Vice President and General Manager, Western Region
Rand A. Kennedy............................... 40 Vice President and Chief Network Architect
Robert T. Masitti............................. 36 Vice President, Operations and Information Systems
James J. Masterson............................ 42 Vice President, Business Development
Fredrick H. Smith............................. 40 Vice President, National Sales
Kevin R. Compton.............................. 40 Director
Keith B. Geeslin.............................. 45 Director
Ken L. Harrison............................... 55 Director
William R. Stensrud........................... 48 Director
John L. Walecka............................... 38 Director
</TABLE>
All the officers identified above serve at the discretion of the Board of
Directors of the Company. There are no family relationships between any persons
identified above. The following are brief biographies of the persons identified
above.
CATHERINE M. HAPKA has been President, Chief Executive Officer and a
Director of the Company since June 1997. Prior to joining Rhythms, Ms. Hapka
served as President of NETS, Inc., an electronic commerce software company, from
March 1997 to May 1997. Prior to joining NETS, Inc., Ms. Hapka served as
Executive Vice President, Markets, for U S WEST Communications, Inc. ("U S
WEST") from January 1995 to October 1996. In this capacity, Ms. Hapka led
business and consumer telecommunications units responsible for the voice, data,
wireless, video and long distance businesses. From 1991 to 1994, Ms. Hapka
served as President and Chief Operating Officer of the !NTERPRISE Networking
Services Unit of U S WEST ("!NTERPRISE"). Prior to joining U S WEST, Ms. Hapka
held general management positions with General Electric and McKinsey & Co., Inc.
JAMES A. GREENBERG has been the Chief Network Officer of the Company since
July 1997. From January 1990 to July 1997, Mr. Greenberg served in various
positions at Sprint Communications, most recently as Senior Director and interim
Vice President of the Data Operation and Engineering Group. In that capacity,
Mr. Greenberg directed the design, planning, operation and construction of
Sprint's data networks.
JEFFREY BLUMENFELD has been Vice President and General Counsel of the
Company since August 1997, and has been a partner in the Washington, D.C. law
firm of Blumenfeld & Cohen since 1984, which specializes in pro-competition
advocacy for technology-intensive companies. Since 1995, Mr. Blumenfeld has
served as senior trial counsel to the Antitrust Division of the U.S. Department
of Justice in several matters. Before starting Blumenfeld & Cohen in 1984, Mr.
Blumenfeld held positions with the U.S. Department of Justice from 1973 to 1984,
most recently as Chief of the U.S. v. AT&T staff of the Antitrust
48
<PAGE>
Division. Mr. Blumenfeld is an adjunct professor of communications law at the
Georgetown University Law Center. Pursuant to his employment agreement, Mr.
Blumenfeld has agreed to expend approximately 24 hours a week in his capacity as
an officer of the Company. See "--Employment Agreements and Change in Control
Arrangements."
SCOTT C. CHANDLER has served as the Company's Chief Financial Officer since
April 1998. From August 1996 to April 1998, Mr. Chandler served as President and
Chief Executive Officer of C-Cor Electronics, Inc., a manufacturer of broadband
telecommunications equipment. From June 1990 to August 1996, Mr. Chandler served
in various positions at U S WEST and its subsidiaries, most recently as Vice
President-General Manager of U S WEST Cable & Multimedia from September 1995 to
August 1996. While at U S WEST, Mr. Chandler also served as Vice President and
General Manager of the U S WEST subsidiary, !NTERPRISE AMERICA, from January
1994 to August 1995 and as Director of Vendor Relations/Channel Support of
!NTERPRISE Networking Services from January 1992 to December 1993.
JOSEPH R. D'ANGELO has served as Vice President and General Manager, Eastern
Region, of the Company since August 1997 and also served as its Acting Chief
Financial Officer from August 1997 to April 1998. Prior to joining the Company,
Mr. D'Angelo served in a variety of positions from August 1992 through August
1997 in marketing, sales, business development and general management at Sprint
Communications. Most recently, Mr. D'Angelo served as a Project Director in the
Sprint Business Division of Sprint Long Distance.
GLORIA A. FARLER has been Vice President, Marketing Support of the Company
since October 1997. From January 1993 until she joined Rhythms, Ms. Farler was
employed by U S WEST, most recently as Executive Director, Market Intelligence
and Decision Support. Ms. Farler also led multi-disciplinary marketing strategy
teams serving all of U S WEST's business and operating units and provided
counsel on new business ventures, customer loyalty programs and competitive
response strategy.
ERIC H. GEIS has been Vice President and General Manager, Western Region of
the Company since June 1997 and was a consultant to the Company from April 1997
to June 1997. From November 1995 to December 1996, Mr. Geis served as National
Sales Director at GRC International, a producer and seller of wide area data
network design and optimization software applications. Between July 1991 and
November 1995, Mr. Geis served as President and Chief Executive Officer of
Quintessential Solutions Inc., a provider of WAN design, pricing and
optimization software applications for IXCs, RBOCs, ILECs, ISPs and major
corporate accounts. Mr. Geis was also Founder, President and Chief Executive
Officer of TeleQuest, Inc., a telecommunications products company from May 1983
to December 1990.
RAND A. KENNEDY has served as Vice President and Chief Network Architect of
the Company since August 1997. Prior to joining Rhythms, Mr. Kennedy held
various positions at CompuServe Incorporated ("CompuServe") between 1976 and
1997, most recently in the position of Principal Network Architect. In that
capacity, Mr. Kennedy directed the engineering of CompuServe's global 500+ POP
network. While at CompuServe, Mr. Kennedy was awarded a United States Patent for
communications technology involving financial card authorization. In addition,
Mr. Kennedy holds lead committee positions within the ATM Forum and the DSL
Forum.
ROBERT T. MASITTI has served as Vice President, Operations and Information
Systems of the Company since August 1997. From January 1996 until he joined the
Company, Mr. Masitti served as Manager of Operations at Sprint's Internet
Service Center, where he supervised a team of 54 engineers. Previously, Mr.
Masitti served as Manager of Data Systems for Sprint Long Distance from February
1993 to December 1995. While at Sprint, Mr. Masitti received both Sprint's Quest
for Excellence and Impact awards for outstanding contributions in customer
service and cost improvement, and the Sprint Diamond Award, the Business
Division's highest technical award.
JAMES J. MASTERSON has been Vice President, Business Development of the
Company since October 1997. Prior to joining Rhythms, Mr. Masterson was a
founding member of !NTERPRISE. From
49
<PAGE>
January 1993 to October 1997, Mr. Masterson held a variety of management
positions at !NTERPRISE, most recently as Vice President of Sales Channels,
where he was responsible for sales and channel management for data products.
From January 1995 to April 1996, as Director of Data Integration at !NTERPRISE,
Mr. Masterson crafted that company's strategic partnership strategy.
FREDRICK H. SMITH has been Vice President, National Sales of the Company
since July 1997. From October 1994 until he joined Rhythms, Mr. Smith served as
Vice President and General Partner at Bolder Heuristics, Inc., an advanced
software applications integrator. Previously, Mr. Smith served as Vice President
of Sales and Marketing for Supernet, Inc., an ISP recently acquired by Qwest
from February 1994 to October 1994. From November 1992 to February 1994, Mr.
Smith also served as Director of Sales Support of !NTERPRISE, where he was
responsible for market development, merchandising and sales channel development.
KEVIN R. COMPTON has been a Director of Rhythms since July 1997. Since 1990,
Mr. Compton has served as a general partner of Kleiner Perkins Caufield & Byers,
a venture capital investment firm ("KPCB"). Mr. Compton is a director of Citrix
Systems, Inc., Digital Generation Systems, Inc., Global Village Communication,
Inc. and Corsair Communications, Inc., and is also a director of several
privately held companies. Mr. Compton was elected to the position of Director of
the Company as the nominee of KPCB, pursuant to the terms of a voting agreement.
See "Description of Capital Stock--Board Representation Rights and Voting."
KEITH B. GEESLIN has been a Director of Rhythms since July 1997. Since 1988,
Mr. Geeslin has served as a general partner of The Sprout Group, a venture
capital investment firm. Mr. Geeslin is a director of Actel Corp. and SDL, Inc.,
and is also a director of several privately held companies, including Paradyne
Corporation, a DSL equipment manufacturer and supplier to the Company. Mr.
Geeslin was elected to the position of Director of the Company as the nominee of
The Sprout Group, pursuant to the terms of a voting agreement. See "Description
of Capital Stock--Board Representation Rights and Voting."
KEN L. HARRISON has been a Director of Rhythms since March 1998. Since 1975,
Mr. Harrison has held various management positions at Portland General Electric
Company, where he currently serves as its Chairman and Chief Executive Officer,
a position he has held since December 1988. In addition, Mr. Harrison currently
serves as Vice Chairman and is a Director of Enron Corporation, a position he
has held since July 1997. Mr. Harrison has also served as Chairman of Enron
Communications Group, Inc. since September 1997, and as a Director of Enron Oil
and Gas Corporation since October 1997. Mr. Harrison was elected to the position
of Director of the Company as the nominee of Enron, pursuant to the terms of a
voting agreement. See "Description of Capital Stock--Board Representation Rights
and Voting."
WILLIAM R. STENSRUD has been a Director of Rhythms since its inception in
February 1997 and also served as its President and Chief Executive Officer of
the Company from February 1997 to June 1997. Mr. Stensrud has been a general
partner at the venture capital investment firm of Enterprise Partners since
January 1997. From June 1996 through December 1996, Mr. Stensrud served as
President of Paradyne Corporation. Previously, from February 1992 to March 1996,
Mr. Stensrud served as President and Chief Executive Officer of Primary Access
Corporation. Mr. Stensrud is a director of several privately held companies,
including Paradyne Corporation. Mr. Stensrud was elected to the position of
Director of the Company as the nominee of Enterprise Partners, pursuant to the
terms of a voting agreement. See "Description of Capital Stock--Board
Representation Rights and Voting."
JOHN L. WALECKA has been a Director of Rhythms since July 1997. Since 1984,
Mr. Walecka has served as a general partner of Brentwood Venture Capital, a
venture capital investment firm. Mr. Walecka is a director of Documentum, Inc.
and Xylan Corporation, and is also a director of several privately held
companies. Mr. Walecka was elected to the position of Director of the Company as
the nominee of Brentwood Venture Capital, pursuant to the terms of a voting
agreement. See "Description of Capital Stock Board Representation Rights and
Voting."
50
<PAGE>
DIRECTOR COMPENSATION
Directors of the Company do not receive compensation for services provided
as a Director or for participation on any committee of the Board of Directors.
All Board members are reimbursed for their out-of-pocket expenses in serving on
the Board of Directors or any committee thereof.
EXECUTIVE COMPENSATION
The following table sets forth, for 1997, the compensation earned by the
Company's Chief Executive Officer, its former President and Chief Executive
Officer who resigned in June 1997 and its two other most highly compensated
executive officers (the "Named Executive Officers") whose total compensation for
1997 exceeded $100,000 for services rendered to the Company in all capacities
during that year. No executive who would otherwise have been includable in such
table on the basis of salary and bonus earned for 1997 has resigned or otherwise
terminated employment during 1997.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION AWARDS
------------------------
ANNUAL COMPENSATION RESTRICTED SECURITIES
-------------------------------- STOCK UNDERLYING
NAME AND PRINCIPAL POSITION(S) YEAR SALARY BONUS AWARD(S) OPTIONS (#)
- ------------------------------------------------------------ --------- ---------- --------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Catherine M. Hapka (1)...................................... 1997 $ 163,654 $ 50,000 $ -- 1,460,377(2)
President, Chief Executive Officer and Director 365,094(3)
William R. Stensrud (4)..................................... 1997 -- -- -- --
President, Chief Executive Officer and Director
James A. Greenberg (5)...................................... 1997 63,205 16,615 -- 228,184(2)
Chief Network Officer
Eric H. Geis (7)............................................ 1997 96,519 18,417 -- 55,000(2)
Vice President and General Manager
<CAPTION>
ALL OTHER
NAME AND PRINCIPAL POSITION(S) COMPENSATION
- ------------------------------------------------------------ -------------
<S> <C>
Catherine M. Hapka (1)...................................... $ --
President, Chief Executive Officer and Director
William R. Stensrud (4)..................................... --
President, Chief Executive Officer and Director
James A. Greenberg (5)...................................... 50,000(6)
Chief Network Officer
Eric H. Geis (7)............................................ --
Vice President and General Manager
</TABLE>
- ------------------------
(1) Ms. Hapka has been employed by the Company since June 1997 and the amount
listed sets forth her compensation since such date.
(2) Represents the number of shares of Common Stock that may be purchased upon
the exercise of options.
(3) Represents the number of shares of Series A Preferred Stock that may be
purchased in accordance with Ms. Hapka's employment agreement. See
Employment Agreements and Change in Control Arrangements.
(4) Mr. Stensrud served as the Company's President and Chief Executive Officer
from its inception in February 1997 to June 1997. He received no
compensation for his services.
(5) Mr. Greenberg has been employed by the Company since July 1997 and the
amount listed sets forth his compensation since such date.
(6) Represents a flat fee relocation payment made by the Company.
(7) Mr. Geis has been employed by the Company since April 1997 and the amount
listed sets forth his compensation since such date.
51
<PAGE>
The following table sets forth information with respect to stock options
granted by the Company to the Named Executive Officers during 1997 pursuant to
the 1997 Stock Option/Stock Issuance Plan. No stock appreciation rights were
granted to the Named Executive Officers during 1997.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZABLE
-------------------------- VALUE AT ASSUMED
NUMBER OF % OF TOTAL ANNUAL RATES OF STOCK
SECURITIES OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OPTION TERM(3)
OPTIONS EMPLOYEES PRICE PER ---------------------
NAME GRANTED IN 1997(2) SHARE EXPIRATION DATE 0% 5%
- --------------------------------------- ---------- ------------- ----------- --------------------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Common Stock:
Catherine M. Hapka................... 1,460,377 52.5% $ 0.10 August 14, 2007 -- $ 91,842
William R. Stensrud.................. -- -- -- -- -- --
James A. Greenberg................... 228,184 8.2 0.10 August 14, 2007 -- 14,350
Eric H. Geis......................... 55,000 2.0 0.10 October 29, 2007 -- 3,459
Series A Preferred Stock:
Catherine M. Hapka................... 365,094 13.1 0.80 December 31, 1998 $ 73,019 103,032
<CAPTION>
NAME 10%
- --------------------------------------- ----------
<S> <C>
Common Stock:
Catherine M. Hapka................... $ 232,746
William R. Stensrud.................. --
James A. Greenberg................... 36,367
Eric H. Geis......................... 8,766
Series A Preferred Stock:
Catherine M. Hapka................... 135,373
</TABLE>
- ------------------------
(1) Option grants are immediately exercisable for all the option shares, but any
shares purchased under such option will be subject to repurchase by the
Company, at the option of the Company, at the option exercise price paid per
share with respect to unvested shares. See--1997 Stock Option/Stock Issuance
Plan.
(2) The Company granted options to purchase 2,417,381 shares of Common Stock and
365,094 shares of Series A Preferred Stock during 1997.
(3) Represents potential realizable value of option grants, assuming the initial
fair market value of the Common Stock to equal the option exercise price and
assuming the initial fair market value of the Series A Preferred Stock to
equal $1.00, at the assumed levels of appreciation indicated. There can be
no assurance provided to any executive officer or other holder of the
Company's securities that the actual stock price appreciation over the
ten-year option term will be at the assumed 5% and 10% levels or at any
other defined level. Unless the market price of the Common Stock appreciates
over the option term, no value will be realized from those option grants
which were made to the Named Executive Officers.
The following table provides information, with respect to each of the Named
Executive Officers, concerning the exercise of options during 1997 and
unexercised options held by them at the end of 1997. None of the Named Executive
Officers exercised any options during 1997.
FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT DECEMBER 31, IN-THE-MONEY OPTIONS AT
1997 DECEMBER 31, 1997(1)
--------------------------- --------------------------
<S> <C> <C> <C> <C>
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ------------------------------------------------------------- ------------ ------------- ----------- -------------
Common Stock:
Catherine M. Hapka......................................... 1,460,377(2) -- $ -- $ --
William R. Stensrud........................................ -- -- -- --
James A. Greenberg......................................... 228,184(3) -- -- --
Eric H. Geis............................................... 55,000(4) -- -- --
Series A Preferred Stock:
Catherine M. Hapka......................................... 365,094(2) -- 73,019(2) --
</TABLE>
- ------------------------------
(1) Based on the fair market value of the Company's Common Stock and Series A
Preferred Stock at fiscal year end, $0.10 per share and $1.00 per share,
respectively (in each case as determined by the Company's Board of
Directors), less the exercise price payable for such shares.
(2) Ms. Hapka exercised all of these options in February 1998 for a net purchase
price of $146,038 for Common Stock and $292,075 for Series A Preferred
Stock. These shares of Common Stock were deposited in escrow with the
corporate secretary of the Company where they continue to vest in accordance
with the applicable vesting provisions. See "--1997 Stock Option/Stock
Issuance Plan." Ms. Hapka purchased the shares of Series A Preferred Stock
at a $0.20 per share discount from market value, for an aggregate discount
of $73,019.
(3) Mr. Greenberg exercised all of these options in January 1998 for a net
purchase price of $22,818. These shares were deposited in escrow with the
corporate secretary of the Company where they continue to vest in accordance
with the applicable vesting provisions. See "--1997 Stock Option/Stock
Issuance Plan."
(4) Mr. Geis exercised all of these options in January 1998 for a net purchase
price of $5,500. These shares were deposited in escrow with the corporate
secretary of the Company where they continue to vest in accordance with the
applicable vesting provisions. See "--1997 Stock Option/Stock Issuance
Plan."
52
<PAGE>
EMPLOYMENT AGREEMENTS AND CHANGE IN CONTROL ARRANGEMENTS
No Rhythms employees are employed for a specified term, and each employee's
employment with Rhythms is subject to termination at any time by either party
for any reason, with or without cause.
Pursuant to the terms of a written employment agreement with Ms. Hapka,
Rhythms has agreed to employ Ms. Hapka as President and Chief Executive Officer
at a salary of $350,000 per year, subject to periodic increases by the Board of
Directors at its discretion. In addition, Rhythms has agreed to pay Ms. Hapka a
guaranteed bonus of $100,000, payable in quarterly installments, for her first
year of employment (ending in June 1998) and a bonus potential of 50% of her
base salary for her second year of employment (ending in June 1999), payable
upon achievement of certain milestones to be proposed by Ms. Hapka and agreed to
by the Board of Directors. In connection with her employment in June 1997, Ms.
Hapka was granted an option to purchase 1,460,377 shares of Common Stock at an
exercise price of $0.10 per share under the 1997 Stock Plan. See "--1997 Stock
Option/Stock Issuance Plan." Ms. Hapka exercised such options in February 1998,
subject to a right of repurchase by the Company with respect to the unvested
shares. The Company's right to repurchase these shares lapses in accordance with
the vesting schedule to which the options were subject. See "--1997 Stock
Option/Stock Issuance Plan." In connection with her employment, Ms. Hapka was
also given the right to purchase up to 365,094 shares of Series A Preferred
Stock at $0.80 per share. In February 1998, Ms. Hapka purchased these shares for
an aggregate purchase price of $292,075. The Company does not hold a right to
repurchase these shares of Series A Preferred Stock. In the event Ms. Hapka's
employment is terminated involuntarily and without cause, Ms. Hapka will be
entitled to receive a lump sum payment in an amount equal to her then-current
annual salary.
Pursuant to the terms of a written employment agreement with Mr. Greenberg,
Rhythms has agreed to employ Mr. Greenberg as Chief Network Officer at an annual
salary of $145,000, subject to periodic increases by the Board of Directors at
its discretion. In addition, Rhythms has a severance agreement with Mr.
Greenberg that provides for payment equal to one year's base salary payable in
12 monthly installments in the event of termination without cause during the
first year of employment, which period expires in July 1998.
Pursuant to the terms of a written employment agreement with Mr. Kennedy,
Rhythms has agreed to employ Mr. Kennedy as Vice President and Chief Network
Architect at an annual salary of $132,000, subject to periodic increases by the
Board of Directors at its discretion. In addition, Rhythms has a severance
agreement with Mr. Kennedy that provides for payment equal to one year's base
salary payable in 12 monthly installments in the event of termination without
cause during the first year of employment, which period expires in August 1998.
Pursuant to the terms of a written employment agreement with Mr. Blumenfeld,
Rhythms has agreed to employ Mr. Blumenfeld as Vice President and General
Counsel at an annual salary of $110,000 for a minimum time commitment by Mr.
Blumenfeld of 24 hours a week. Under the terms of such agreement, Mr.
Blumenfeld's law firm, Blumenfeld & Cohen, has agreed to charge Rhythms at a
discount from its regular rates for legal services, including Mr. Blumenfeld's
time in excess of his minimum time commitment. See "Certain Transactions--Legal
Services."
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Company's Board of Directors currently has a Compensation Committee that
reviews and approves the compensation and benefits to be provided to the
executive officers and other key employees of the Company. In addition, the
Compensation Committee administers the Company's 1997 Stock Option/Stock
Issuance Plan. The Compensation Committee currently consists of Messrs. Compton
and Walecka.
1997 STOCK OPTION/STOCK ISSUANCE PLAN
As of June 30, 1998, the Company had reserved 4,863,971 shares of Common
Stock for issuance pursuant to its 1997 Stock Option/Stock Issuance Plan (the
"1997 Stock Plan"), which has been approved by the Company's Board of Directors
and stockholders. The 1997 Stock Plan provides for the granting to
53
<PAGE>
employees (including officers) of qualified "incentive stock options" within the
meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the
"Code"), and for the granting to employees (including officers and directors)
and consultants of nonqualified stock options. The 1997 Stock Plan also provides
for the granting of restricted stock. As of June 30, 1998, options to purchase
an aggregate of 2,875,681 shares of Common Stock had been granted and 1,988,290
shares of Common Stock remained available for future grants. From January 1,
1998 through June 30, 1998, 2,288,545 options to purchase Common Stock were
exercised, of which an aggregate of 1,743,561 were exercised by the Named
Executive Officers as a group, an aggregate of 333,048 were exercised by the
other officers of the Company as a group, and an aggregate of 211,936 were
exercised by non-officer employees of the Company. On two occasions, the Company
has made loans to employees to allow them to exercise options, one in the amount
of $4,500 to Robert T. Masitti and one in the amount of $2,500 to Fredrick H.
Smith.
The 1997 Stock Plan is administered by the Compensation Committee of the
Board of Directors. Options granted generally vest at a rate of 25% of the
shares at the end of the first year and 2.083% of the shares at the end of each
month thereafter and generally expire ten years from the date of grant. All
options granted are immediately exercisable, subject to a repurchase right held
by the Company that lapses in accordance with the vesting schedule of the
options. In the event an optionee exercises his or her option to purchase shares
of the Company's Common Stock (the "Purchased Shares") in which such optionee
has not acquired a vested interest in accordance with the applicable vesting
provisions, such shares are deposited in escrow with the corporate secretary of
the Company where they continue to vest in accordance with the applicable
vesting provisions (the "Unvested Shares"). The Company holds a right,
exercisable by the Company at any time during the sixty (60)-day period
following the date an optionee ceases for any reason to remain in service to the
Company, to repurchase at the exercise price for such options all or (at the
discretion of the Company and with the consent of the optionee) any portion of
such Unvested Shares.
In the event of a merger of the Company with or into another corporation or
the sale of all or substantially all of the assets of the Company (a "Corporate
Transaction"), all outstanding options shall be assumed or an equivalent option
substituted by the successor corporation. In the event a successor corporation
refuses to assume or substitute for the options, a portion of each outstanding
option shall be accelerated so that such portion shall become fully exercisable
for vested shares of Common Stock. The portion of the option which shall so
accelerate shall be a number of shares equal to the number of unvested shares
immediately prior to the Corporate Transaction available under the option
multiplied by a fraction, the numerator of which is the number of complete
months of which elapsed after the vesting commencement date under the option and
the date of the Corporate Transaction, and the DENOMINATOR of which is the
number of months required under the option agreement for the rights of the
optionee to become fully vested. See "--Employment Agreements and Change in
Control Arrangements."
The exercise price of incentive stock options granted under the 1997 Stock
Plan must be at least equal to the fair value of the Company's Common Stock on
the date of grant. The exercise price of options to an optionee who owns more
than 10% of the Company's outstanding voting securities must equal at least 110%
of the fair value of the Common Stock on the date of grant, and the option term
shall not exceed five years measured from the option grant date.
LIMITATION ON LIABILITY AND INDEMNIFICATION MATTERS
The Company's Certificate of Incorporation limits the liability of Directors
to the maximum extent permitted by Delaware law, and the Company's Bylaws
provide that the Company shall indemnify its Directors and officers and may
indemnify its other employees and agents to the fullest extent permitted by law.
The Company has also entered into agreements to indemnify its Directors and
certain executive officers. The Company believes that these provisions and
agreements are necessary to attract and retain qualified Directors and executive
officers. At present, there is no pending litigation or proceeding involving any
Director, officer, employee or agent of the Company where indemnification will
be required or permitted. The Company is not aware of any threatened litigation
or proceeding that might result in a claim for such indemnification. Insofar as
indemnification for liabilities arising under the Securities Act may be
permitted to Directors, officers or persons controlling the Company pursuant to
the foregoing provisions, the Company has been informed that, in the opinion of
the Commission, such indemnification is against public policy as expressed in
the Securities Act and is therefore unenforceable.
54
<PAGE>
CERTAIN TRANSACTIONS
SERIES A PURCHASE AGREEMENT
Pursuant to the Series A Preferred Stock Purchase Agreement by and among
Enterprise Partners, Brentwood Venture Capital, KPCB, The Sprout Group and
certain other investors (together, the "Series A Purchasers") and Rhythms, dated
as of July 3, 1997 (the "Series A Purchase Agreement"), the Series A Purchasers,
in a series of three closings, purchased in the aggregate 12,280,000 shares of
Series A Preferred Stock of the Company for an aggregate purchase price of
$12,280,000. Pursuant to a Subsequent Closing Purchase Agreement dated as of
December 23, 1997 (the "Subsequent Closing Agreement"), the Company sold an
additional 210,000 shares of its Series A Preferred Stock to certain other
investors (the "Additional Series A Purchasers") for an aggregate purchase price
of $210,000. In connection with the Series A Purchase Agreement and Subsequent
Closing Agreement, the Company, Enterprise Partners, as holder of 900,735 shares
of Common Stock (the "Common Holder"), the Series A Purchasers and the
Additional Series A Purchasers entered into an Investors' Rights Agreement and
Addendum thereto, dated as of July 3, 1997 and December 23, 1997, respectively
(the "Series A Rights Agreement"), which provides the Series A Purchasers,
Additional Series A Purchasers and the Common Holder with certain demand and
piggyback registration rights, and certain rights of first offer in the event
the Company proposes to offer for sale certain of its securities. The Series A
Rights Agreement was superseded by the Amended and Restated Investors' Rights
Agreement. See "--Series B Purchase Agreement" and "-- Investors' Rights
Agreement," "Description of Capital Stock--Registration Rights;" and "--Right of
First Offer."
In connection with the Series A Purchase Agreement, the Subsequent Closing
Agreement and an employment agreement between the Company and Catherine Hapka,
the Company issued an aggregate of 12,855,094 shares of Series A Preferred
Stock, 12,490,000 shares of which were issued at a purchase price of $1.00 per
share to the Series A Purchasers and the Additional Series A Purchasers and
365,094 shares of which were issued at a purchase price of $0.80 per share to
Ms. Hapka. See "Management--Employment Agreements and Change in Control
Arrangements."
SERIES B PURCHASE AGREEMENT
Certain of the Series A Purchasers and Enron (together, the "Series B
Purchasers") and Rhythms entered into a Series B Preferred Stock Purchase
Agreement, dated as of March 12, 1998 (the "Series B Purchase Agreement"),
pursuant to which the Series B Purchasers acquired, in the aggregate, 4,044,943
shares of Series B Preferred Stock for an aggregate purchase price of $18.0
million. In connection with the Series B Purchase Agreement, the Company, the
Common Holder, the Series A Purchasers, the Additional Series A Purchasers and
the Series B Purchasers entered into an Amended and Restated Investors' Rights
Agreement, dated as of March 12, 1998 (the "Investors' Rights Agreement"). The
Investors' Rights Agreement replaced the Series A Rights Agreement. See "--
Investors' Rights Agreement."
INVESTORS' RIGHTS AGREEMENT
Pursuant to the terms of the Investors' Rights Agreement, the Common Holder,
the holders of Series A Preferred Stock and the holders of Series B Preferred
Stock (together, the "Investors") acquired certain registration rights with
respect to the Common Stock of Company. At any time after the earlier of (i)
March 11, 2002, or (ii) six months after the effective date of the first
registration statement filed by the Company under the Securities Act, holders of
60% or more of the Registrable Securities (as defined in the Investors' Rights
Agreement) or Enron may require the Issuer to effect registration under the
Securities Act covering at least 20% of the Registrable Securities then
outstanding, or, if initiated by Enron, covering at least 20% of the Registrable
Securities then held by Enron, subject in either case to the Board of Directors'
right to defer such registration for a period up to 120 days; provided, however,
that Rhythms is obligated to effect only (A) two such registrations pursuant to
the request of holders of 60% or more of the
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<PAGE>
Registrable Securities, and (B) one such registration pursuant to the request of
Enron. In addition, if Rhythms proposes to register securities under the
Securities Act (other than a registration relating either to the sale of
securities to employees pursuant to a stock option, stock purchase or similar
plan or a registration on any form which does not include substantially the same
information as would be required to be included in a registration statement
covering the sale of the Registrable Securities), then any of the Investors has
a right (subject to quantity limitations determined by underwriters if the
offering involves an underwriting) to request that the Company register such
holder's Registrable Securities. All registration expenses incurred in
connection with the registrations described in (A) and (B) above and all
piggyback registrations will be borne by the Issuer. The participating Investors
will pay for underwriting discounts and commissions incurred in connection with
any such registrations. Rhythms has agreed to indemnify the Investors against
certain liabilities in connection with any registration effected pursuant to the
foregoing Investors' Rights Agreement, including Securities Act liabilities.
Subject to certain conditions and limitations, each Major Investor (as
defined in the Investors' Rights Agreement) has the right of first refusal to
purchase its pro rata portion each time the Company proposes to offer any shares
of, or securities convertible into or exercisable for any shares of, any class
of its capital stock, on the same terms and conditions as the Company offers
such securities to other investors. If any Major Investor declines to exercise
such right in full, the remaining electing Major Investors are entitled to
purchase such Major Investor's unpurchased portion of the offered securities on
a pro rata basis.
In connection with the issuance of Warrants pursuant to this Offering, the
Major Investors have agreed to waive their rights of first offer under the
Investors' Rights Agreement.
DIRECTOR RELATIONSHIPS
Mr. Stensrud, a director of the Company, also served as President and Chief
Executive Officer of the Company from February 1997 through June 1997. Mr.
Stensrud and Mr. Geeslin, directors of the Company, each also serve as directors
for Paradyne Corporation, a vendor to the Company. Mr. Walecka, a director of
the Company, also serves as a director for Xylan Corporation, an indirect vendor
to the Company. As of December 31, 1997, the Company made purchases totaling
approximately $419,000 from Paradyne; during the first half of fiscal 1998, the
Company purchased approximately $2,334,000 from Paradyne. The Company does not
purchase any products directly from Xylan; rather, the Company's purchase of
Xylan products is sourced through Paradyne. The Company believes that its
transactions with Paradyne and Xylan were completed at rates similar to those
available from alternative vendors.
RELATIONSHIP WITH INITIAL PURCHASER
Certain associates of Donaldson, Lufkin & Jenrette Securities Corporation
("DLJSC"), an Initial Purchaser, beneficially own an aggregate of 3,000,000
shares of Series A Preferred Stock and 449,438 shares of Series B Preferred
Stock of the Company, which represent in the aggregate approximately 17.1% of
the outstanding equity of the Company. Of these, Sprout Capital beneficially
owns 2,609,686 shares of Series A Preferred Stock and 390,966 shares of Series B
Preferred Stock, which represent in the aggregate approximately 14.9% of the
outstanding equity of the Company. All of the shares of the Company beneficially
owned by Sprout Capital are subject to the Sprout Voting Trust and are held by
the Sprout Trustee, an independent third party. The Sprout Trustee will vote
such shares in its sole and absolute discretion as advised by an independent
adviser who is not affiliated with Sprout Capital and DLJSC and subject to the
Voting Agreement. Also, pursuant to the Voting Agreement, Sprout Capital VII,
L.P., The Sprout CEO Fund, L.P., DLJ Capital Corporation and DLJ First ESC
L.L.C. (all of which are affiliates of DLJSC) collectively have the right to
designate one member of the Board of Directors. Their current designee is Keith
B. Geeslin. Mr. Geeslin is a Divisional Senior Vice President of DLJ Capital
Corporation, a wholly owned subsidiary of Donaldson, Lufkin & Jenrette, Inc.,
the parent of DLJSC. Mr. Geeslin is also one of several individuals who serve as
general partners of DLJ Associates VII, L.P., which is a general
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<PAGE>
partner of Sprout Capital VII, L.P. DLJ Capital Corporation is the managing
general partner of each of Sprout Capital VII, L.P. and the Sprout CEO Fund,
L.P. See "Description of Capital Stock--Board Representation Rights and
Voting--SPROUT VOTING TRUST."
LEGAL SERVICES
Jeffrey Blumenfeld, Vice President and General Counsel of Rhythms, also
serves as a partner of Blumenfeld & Cohen, which performs legal services for the
Company. In connection with Mr. Blumenfeld's employment with the Company,
Rhythms sold to certain partners of Blumenfeld & Cohen (including Mr.
Blumenfeld) and to Mr. Blumenfeld 85,000 shares and 55,000 shares, respectively,
of Series A Preferred Stock at $1.00 per share, and Blumenfeld & Cohen agreed to
permanently discount its rates for legal services provided to Rhythms. The
Company incurred expenses for legal fees to Blumenfeld & Cohen through December
31, 1997 of approximately $92,000 and for the first half of 1998 of
approximately $546,000.
LOANS TO EMPLOYEES
The Company has entered into three loan agreements with Robert T. Masitti,
the Vice President, Operations and Information Systems of the Company. To assist
Mr. Masitti in relocating to Colorado, the Company loaned Mr. Masitti an
aggregate of $197,000 pursuant to two promissory notes, each dated January 15,
1998. The first of these notes, in the principal amount of $190,000, bearing
interest at the rate of 5.7%, is secured by a first deed of trust on Mr.
Masitti's personal residence in Colorado and is payable in a lump sum upon the
earlier to occur of the sale of Mr. Masitti's personal residence or January 15,
1999. The second of these notes, in the principal amount of $7,000, bearing
interest at the rate of 5.56%, is unsecured and is payable in equal monthly
installments over a 24 month period ending January 15, 2000. In addition,
pursuant to a promissory note secured by stock pledge agreement dated January 7,
1998, the Company loaned $4,500 to Mr. Masitti to assist him in exercising stock
options.
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PRINCIPAL STOCKHOLDERS
The following table sets forth certain information as of June 30, 1998 with
respect to the beneficial ownership of the Company's Common Stock, Series A
Preferred Stock and Series B Preferred Stock by (i) each person known by the
Company to own beneficially more than five percent, in the aggregate, of the
outstanding shares of the Company's Common Stock, Series A Preferred Stock and
Series B Preferred Stock, on a fully diluted basis, (ii) the directors and Named
Executive Officers of the Company who hold securities of the Company and (iii)
all executive officers and directors as a group. All shares of the Preferred
Stock vote with the Common Stock, have class votes with respect to certain
matters and are convertible into Common Stock. Certain of the outstanding shares
of capital stock of the Company are subject to a voting agreement. See
"Description of Capital Stock Board Representation Rights and Voting." Unless
otherwise indicated, the address for each stockholder is c/o Rhythms
NetConnections Inc., 7337 South Revere Parkway, Englewood, Colorado 80112-3931.
<TABLE>
<CAPTION>
SERIES A PREFERRED SERIES B PREFERRED
COMMON STOCK(2) STOCK (3) STOCK (4)
-------------------- ----------------------------- -----------------------------
BENEFICIAL OWNER(1) NUMBER PERCENT NUMBER PERCENT NUMBER PERCENT
- ---------------------------------------- --------- ------- --------- ------------ --------- ------------
<S> <C> <C> <C> <C> <C> <C>
Brentwood Venture Capital(6)............ -- -- 3,000,000(20) 23.3% 449,438(20) 11.1%
Enterprise Partners(7).................. 900,735(20) 27.1% 3,000,000(20) 23.3% 449,438(20) 11.1%
Kleiner Perkins Caufield & Byers(8)..... -- -- 3,000,000(20) 23.3% 449,438(20) 11.1%
The Sprout Group(9)..................... -- -- 3,000,000(20)(21) 23.3% 449,438(20)(21) 11.1%
Enron Communications Group(10).......... -- -- -- -- 2,247,191(20)(21) 55.6%
Catherine M. Hapka(11).................. 1,460,377 44.0% 365,094 2.8% -- --
James A. Greenberg(12).................. 228,184 6.9% -- -- -- --
Eric H. Geis(13)........................ 55,000 1.7% -- -- -- --
Kevin R. Compton(14).................... -- -- -- -- -- --
Keith B. Geeslin(15).................... -- -- -- -- -- --
Ken Harrison(16)........................ -- -- -- -- -- --
William R. Stensrud(17)................. -- -- -- -- -- --
John L. Walecka(18)..................... -- -- -- -- -- --
All directors and effective officers as
a group (16 persons)(19).............. 2,374,883(22) 67.4% 420,094 3.3% -- --
<CAPTION>
BENEFICIAL OWNERSHIP
OF COMMON STOCK (5)
----------------------
BENEFICIAL OWNER(1) TOTAL SHARES PERCENT
- ---------------------------------------- ------------ -------
<S> <C> <C> <C>
Brentwood Venture Capital(6)............ 3,449,438 17.1%
Enterprise Partners(7).................. 4,350,173 21.5%
Kleiner Perkins Caufield & Byers(8)..... 3,449,438 17.1%
The Sprout Group(9)..................... 3,449,438 17.1%
Enron Communications Group(10).......... 2,247,191 11.1%
Catherine M. Hapka(11).................. 1,825,471 9.0%
James A. Greenberg(12).................. 228,184 1.1%
Eric H. Geis(13)........................ 55,000 0.3%
Kevin R. Compton(14).................... -- --
Keith B. Geeslin(15).................... -- --
Ken Harrison(16)........................ -- --
William R. Stensrud(17)................. -- --
John L. Walecka(18)..................... -- --
All directors and effective officers as
a group (16 persons)(19).............. 2,794,977 13.7%
</TABLE>
- ------------------------
(1) Except as indicated by footnote, the Company understands that the persons
named in the table above have sole voting and investment power with respect
to all shares shown as beneficially owned by them, subject to community
property laws where applicable.
(2) Shares of Common Stock subject to options, which are currently exercisable
or exercisable within 60 days of June 30, 1998, are deemed outstanding for
computing the percentages of the person holding such options but are not
deemed outstanding for computing the percentages of any other person.
Percentage ownership is based on shares of Common Stock outstanding as of
June 30, 1998.
(3) The number of shares reflects the number of shares of Common Stock in the
aggregate issuable upon the conversion of the Series A Preferred Stock. Each
share of Series A Preferred Stock is currently convertible into one share of
Common Stock. See Description of Capital Stock--Preferred Stock.
(4) The number of shares reflects the number of shares of Common Stock in the
aggregate issuable upon the conversion of the Series B Preferred Stock. Each
share of Series B Preferred Stock is currently convertible into one share of
Common Stock. See Description of Capital Stock--Preferred Stock.
(5) Reflects the beneficial ownership of the Company's Common Stock, assuming
the conversion of the Series A Preferred Stock and Series B Preferred Stock.
Shares of Common Stock subject to options, which are currently exercisable
or exercisable within 60 days of June 30, 1998, are deemed outstanding for
computing the percentage of the person holding such options but are not
deemed outstanding for computing the percentage of any other person.
(6) Consists of shares held directly by Brentwood Affiliates Fund, L.P. and
Brentwood Associates VII, L.P. (collectively, the Brentwood Entities). The
address for the Brentwood Entities is 3000 Sand Hill Road, Building 1, Suite
260, Menlo Park, California 94025.
(7) Consists of shares held directly by Enterprise Partners III Associates,
L.P., Enterprise Partners III, L.P. and Enterprise Partners IV, L.P.
(collectively, the Enterprise Entities). The address for each of the
Enterprise Entities is 7979 Ivanhoe, Suite 550, La Jolla, California 92037.
(8) Consists of shares held directly by Kleiner Perkins Caufield & Byers VIII,
KPCB VIII Founders Fund and KPCB VIII Information Sciences Zaibatsu Fund II
(collectively, the KPCB Entities). The address for each of the KPCB Entities
is 2750 Sand Hill Road, Menlo Park, California 94025.
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<PAGE>
(9) Consists of shares beneficially owned by DLJ Capital Corporation, DLJ First
ESC L.L.C., Sprout Capital VII, L.P. and The Sprout CEO Fund, L.P.
(collectively, the Sprout Entities), each of which are affiliates of
Donaldson Lufkin & Jenrette Securities Corporation ("DLJSC"), an Initial
Purchaser. See Certain Transactions--Relationship with Initial Purchaser.
DLJSC and certain other affiliates of The Sprout Entities may be deemed to
be beneficial owners of these securities. Of these, Sprout Capital VII, L.P.
beneficially owns 2,609,686 shares of Series A Preferred Stock and 390,966
shares of Series B Preferred Stock. All of the shares beneficially owned by
Sprout Capital VII, L.P. are subject to a voting trust agreement and are
held and voted by an independent third party, First Union Trust Company,
National Association (First Union), as voting trustee. See Description of
Capital Stock--Board Representation Rights and Voting--SPROUT VOTING TRUST.
The address for each of the Sprout Entities is 3000 Sand Hill Road, Building
3, Suite 170, Menlo Park, California 94025.
(10) The address for Enron Communications Group, Inc. (Enron) is 210 Southwest
Morrison Street, Suite 400, Portland, Oregon 97204.
(11) Includes 1,460,377 shares of Common Stock that are subject to a right of
repurchase in favor of the Company. The repurchase right as to 25% of these
shares expired in June 1998, and thereafter expires in equal monthly
installments over the next 36 months.
(12) Includes 228,184 shares of Common Stock that are subject to a right of
repurchase in favor of the Company. The repurchase right as to 25% of these
shares expired in July 1998, and thereafter expires in equal monthly
installments over the next 36 months.
(13) Includes 55,000 shares of Common Stock that are subject to a right of
repurchase in favor of the Company. The repurchase right as to 25% of these
shares expired in June 1998, and thereafter expires in equal monthly
installments over the next 36 months.
(14) Excludes shares held by the KPCB Entities. Mr. Compton, as a General
Partner of KPCB, may be deemed to have voting and investment power over the
shares held by the KPCB Entities. Mr. Compton disclaims beneficial interest
in such shares, except to the extent of his interest in the KPCB Entities.
(15) Excludes shares held by The Sprout Entities. Mr. Geeslin, as a General
Partner of The Sprout Group, may be deemed to have voting and investment
power over the shares held by the Sprout Entities. Mr. Geeslin disclaims
beneficial interest in such shares, except to the extent of his interest in
the Sprout Entities.
(16) Excludes shares held by Enron. Mr. Harrison, as Chairman of Enron, may be
deemed to have voting and investment power over the shares held by Enron.
Mr. Harrison disclaims beneficial interest in such shares, except to the
extent of his interest in Enron.
(17) Excludes shares held by Enterprise Entities. Mr. Stensrud, as a General
Partner of Enterprise Partners, may be deemed to have voting and investment
power over the shares held by the Enterprise Entities. Mr. Stensrud
disclaims beneficial interest in such shares, except to the extent of his
interest in the Enterprise Entities.
(18) Excludes shares held by the Brentwood Entities. Mr. Walecka, as a General
Partner of Brentwood Venture Capital, may be deemed to have voting and
investment power over the shares held by the Brentwood Entities. Mr. Walecka
disclaims beneficial interest in such shares, except to the extent of his
interest in the Brentwood Entities.
(19) Excludes shares held by the Brentwood Entities, the Enterprise Entities,
the KPCB Entities, the Sprout Entities and Enron. See Notes 6, 7, 8, 9, 10,
14, 15, 16, 17 and 18 above.
(20) These shares are subject to a voting agreement. See Description of Capital
Stock--Board Representation Rights and Voting.
(21) A portion or all of these shares are subject to a voting trust agreement.
See Description of Capital Stock--Board Representation Rights and Voting.
(22) See Notes 11, 12 and 13. Includes options exercisable for 200,000 shares of
Common Stock under the 1997 Stock Plan, and 2,174,883 shares of Common Stock
that are subject to a right of repurchase in favor of the Company that
expires, as to each individual, in accordance with the vesting schedule
under the 1997 Stock Plan.
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<PAGE>
THE EXCHANGE OFFER
PURPOSES OF THE EXCHANGE OFFER
The Old Notes were sold by the Company to the Initial Purchasers, who
subsequently resold the Old Notes to "qualified institutional buyers" (as
defined in Rule 144A under the Securities Act) and non-U.S. persons pursuant to
offers and rates that occurred outside the U. S. pursuant to Regulation S. In
connection with the issuance of the Old Notes, the Company agreed to use its
reasonable best efforts to cause to become effective within the time period
specified in the Registration Rights Agreement, a registration statement with
respect to the Exchange Offer (the "Exchange Offer Registration Statement").
However, if (i) the Company is not required to file the Exchange Offer
Registration Statement or permitted to consummate the Exchange Offer because the
Exchange Offer is not permitted by applicable law or SEC policy or (ii) any
Holder of Old Notes notifies the Company prior to the 20th day following
consummation of the Exchange Offer that (a) it is prohibited by law or SEC
policy from participating in the Exchange Offer or (b) that it may not resell
the Exchange Notes acquired by it in the Exchange Offer to the public without
delivering a prospectus and the prospectus contained in the Exchange Offer
Registration Statement is not appropriate or available for such resales or (c)
that it is a broker-dealer and owns Old Notes acquired directly from the Company
or an affiliate of the Company, the Company will file with the SEC a shelf
registration statement (the "Shelf Registration Statement") to cover resales of
the Old Notes by the Holders thereof who satisfy certain conditions relating to
the provision of information in connection with the Shelf Registration
Statement.
The Exchange Offer is being made by the Company to satisfy its obligations
pursuant to the Registration Rights Agreement. Once the Exchange Offer is
consummated, the Company will have no further obligation to register any of the
Old Notes not tendered by the Holders for exchange. See "Risk Factors--
Consequences to Non-Tendering Holders of Old Notes." A copy of the Registration
Rights Agreement has been filed as an exhibit to the Registration Statement of
which this Prospectus is a part.
Based on an interpretation by the Staff of the SEC set forth in the Staff's
Exxon Capital Holdings Corp. SEC No-Action Letter (available April 13, 1989),
Morgan Stanley & Co., Inc. SEC No-Action Letter (available June 5, 1991),
Shearman & Sterling SEC No-Action Letter (available July 7, 1993), and other
no-action letters issued to third parties, the Company believes that New Notes
issued pursuant to the Exchange Offer in exchange for Old Notes may be offered
for resale, resold and otherwise transferred by Holders thereof without
compliance with the registration and prospectus delivery provisions of the
Securities Act. However, any Holder who is an "affiliate" of the Company or who
intends to participate in the Exchange Offer for the purpose of distributing the
New Notes (i) cannot rely on the interpretation by the staff of the SEC set
forth in the above referenced no-action letters, (ii) cannot tender its Old
Notes in the Exchange Offer, and (iii) must comply with the registration and
prospectus delivery requirements of the Securities Act in connection with any
sale or transfer of the Old Notes, unless such sale or transfer is made pursuant
to an exemption from such requirements. See "Risk Factors--Consequences to Non-
Tendering Holders of Old Notes."
In addition, each Participating Broker-Dealer that receives New Notes for
its own account in exchange for Old Notes not acquired directly from the Company
must acknowledge that it will deliver a prospectus in connection with any resale
of such New Notes. See "Plan of Distribution."
Except as aforesaid, this Prospectus may not be used for an offer to resell,
resale or other transfer of New Notes.
TERMS OF THE EXCHANGE OFFER
GENERAL. Upon the terms and subject to the conditions of the Exchange Offer
set forth in this Prospectus and the Letter of Transmittal, the Company will
accept any and all Old Notes validly tendered and not withdrawn prior to 5:00
p.m., New York City time, on the Expiration Date. The Company will issue
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<PAGE>
$1,000 principal amount at maturity of New Notes in exchange for each $1,000
principal amount at maturity of outstanding Old Notes accepted in the Exchange
Offer. Holders may tender some or all of their Old Notes pursuant to the
Exchange Offer; provided, that Old Notes may be tendered only in integral
multiples of $1,000 principal amount at maturity.
As of June 30, 1998, there was $290,000,000 of aggregate principal amount at
maturity of the Old Notes outstanding. This Prospectus, together with the Letter
of Transmittal, is being sent to such registered Holder(s) as of October 21,
1998.
In connection with the issuance of the Old Notes, the Company arranged for
the Old Notes to be issued and transferable in book-entry form through the
facilities of DTC, acting as depositary. The New Notes will be issued and
transferable in book-entry form through DTC. See "--Book-Entry Transfer;
Delivery and Form."
The Company shall be deemed to have accepted validly tendered Old Notes
when, as and if the Company has given oral or written notice thereof to the
Exchange Agent. The Exchange Agent will act as agent for the tendering Holders
of Old Notes for the purpose of receiving the New Notes from the Company. If any
tendered Old Notes are not accepted for exchange because of an invalid tender,
the occurrence of certain other events set forth herein or otherwise, the
certificates for any such unaccepted Old Notes will be returned, without
expense, to the tendering Holder thereof or the appropriate book-entry transfer
will be made, in each case, as promptly as practicable after the Expiration
Date.
Holders of Old Notes who tender in the Exchange Offer will not be required
to pay brokerage commissions or fees or, subject to the instructions in the
Letter of Transmittal, transfer taxes with respect to the exchange of Old Notes
pursuant to the Exchange Offer. The Company will pay the expenses, other than
certain applicable taxes, of the Exchange Offer. See "--Fees and Expenses.
NEITHER THE BOARD OF DIRECTORS OF THE COMPANY NOR THE COMPANY MAKES ANY
RECOMMENDATION TO HOLDERS OF OLD NOTES AS TO WHETHER TO TENDER OR REFRAIN FROM
TENDERING ALL OR ANY PORTION OF THEIR OLD NOTES PURSUANT TO THE EXCHANGE OFFER.
IN ADDITION, NO ONE HAS BEEN AUTHORIZED TO MAKE ANY SUCH RECOMMENDATION. HOLDERS
OF OLD NOTES MUST MAKE THEIR OWN DECISION WHETHER TO TENDER PURSUANT TO THE
EXCHANGE OFFER AND, IF SO, THE AGGREGATE AMOUNT OF OLD NOTES TO TENDER AFTER
READING THIS PROSPECTUS AND THE LETTER OF TRANSMITTAL AND CONSULTING WITH THEIR
ADVISERS, IF ANY, BASED ON THEIR OWN FINANCIAL POSITION AND REQUIREMENTS.
EXPIRATION DATE; EXTENSIONS; AMENDMENTS. The term "Expiration Date" shall
mean November 20, 1998, unless the Company in its sole discretion, extends the
Exchange Offer, in which case the term "Expiration Date" shall mean the latest
date to which the Exchange Offer is extended.
In order to extend the Expiration Date, the Company will notify the Exchange
Agent and the record Holders of Old Notes of any extension by oral (followed by
written) notice, each prior to 9:00 a.m., New York City time, on the business
day following the previously scheduled Expiration Date. Such notice may state
that the Company is extending the Exchange Offer for a specified period of time
or on a daily basis until 5:00 p.m., New York City time, on the date on which a
specified percentage of Old Notes are tendered.
The Company reserves the right to delay accepting any Old Notes, to extend
the Exchange Offer, to amend the Exchange Offer or to terminate the Exchange
Offer and not accept Old Notes not previously accepted if any of the conditions
set forth herein under "--Conditions" shall have occurred and shall not have
been waived by the Company by giving oral or written notice of such delay,
extension, amendment or termination to the Exchange Agent as promptly as
practicable. If the Exchange Offer is amended in a manner determined by the
Company to constitute a material change, the Company will promptly disclose such
amendment in a manner reasonably calculated to inform the Holders of such
amendment and the
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Company will extend the Exchange Offer for a period of five to ten business
days, depending upon the significance of the amendment and the manner of
disclosure to Holders of the Old Notes, if the Exchange Offer would otherwise
expire during such five to ten business day period.
Without limiting the manner in which the Company may choose to make public
announcement of any delay, extension, amendment or termination of the Exchange
Offer, the Company shall have no obligation to publish, advertise, or otherwise
communicate any such public announcement, other than by making a timely release
to the Dow Jones News Service.
ACCRETION OF THE NEW NOTES AND THE OLD NOTES; INTEREST
The Old Notes will continue to accrete in principal amount through (but not
including) the date of issuance of the New Notes. Any Old Notes not tendered or
accepted for exchange will continue to accrete in principal amount at the rate
of 13.5% per annum in accordance with its terms. From and after the date of
issuance of the New Notes, the New Notes shall accrete in principal amount at
the rate of 13.5% per annum, but no cash interest will accrue or be payable in
respect of the New Notes prior to May 15, 2003. Thereafter, the New Notes will
bear interest at a rate equal to 13.5% per annum. Interest on the New Notes will
be payable semi-annually in arrears on May 15 and November 15 of each year,
commencing on November 15, 2003.
PROCEDURES FOR TENDERING
To tender in the Exchange Offer, a Holder of certificated Old Notes must
complete, sign and date the Letter of Transmittal, or a facsimile thereof, have
the signatures thereon guaranteed if required by Instruction 3 of the Letter of
Transmittal, and mail or otherwise deliver such Letter of Transmittal or such
facsimile, together with the Old Notes and any other required documents, to the
Exchange Agent prior to 5:00 p.m., New York City time, on the Expiration Date.
If delivery of the Old Notes is to be made through book-entry transfer into the
Exchange Agent's account at DTC, tenders of the Old Notes must be effected in
accordance with DTC's Automated Tender Offer Program ("ATOP") procedures. See
"--Book-Entry Transfer; Delivery and Form."
The tender by a Holder of Old Notes will constitute an agreement between
such Holder and the Company in accordance with the terms and subject to the
conditions set forth herein and in the Letter of Transmittal.
Delivery of all documents must be made to the Exchange Agent at its address
set forth below. Holders of Old Notes may also request their respective brokers,
dealers, commercial banks, trust companies or nominees to effect the above
transactions for such Holders.
THE METHOD OF DELIVERY OF CERTIFICATES, THE LETTER OF TRANSMITTAL AND ALL
OTHER REQUIRED DOCUMENTS, IS AT THE OPTION AND SOLE RISK OF THE TENDERING
HOLDER, AND DELIVERY WILL BE DEEMED MADE ONLY WHEN ACTUALLY RECEIVED BY THE
EXCHANGE AGENT. IF DELIVERY IS BY MAIL, REGISTERED MAIL, RETURN RECEIPT
REQUESTED, PROPERLY INSURED, OR AN OVERNIGHT DELIVERY SERVICE IS RECOMMENDED. IN
ALL CASES, SUFFICIENT TIME SHOULD BE ALLOWED TO INSURE TIMELY DELIVERY.
Only a Holder of Old Notes may tender such Old Notes in the Exchange Offer.
The term "Holder" with respect to the Exchange Offer means any person in whose
name Old Notes are registered on the books of the Company or any other person
who has obtained a properly completed bond power from the registered Holder.
Any beneficial Holder whose Old Notes are registered in the name of its
broker, dealer, commercial bank, trust company or other nominee and who wishes
to tender should contact such registered Holder promptly and instruct such
registered Holder to tender on its behalf. If such beneficial Holder wishes to
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tender on its own behalf, such beneficial Holder must, prior to completing and
executing the Letter of Transmittal and delivering its Old Notes, either make
appropriate arrangements to register ownership of the Old Notes in such Holder's
name or obtain a properly completed bond power from the registered Holder. The
transfer of record ownership may take considerable time.
Signatures on a Letter of Transmittal or notice of withdrawal, as the case
may be, must be guaranteed by an Eligible Institution (as defined) unless the
Old Notes tendered pursuant thereto are tendered (i) by a registered Holder who
has not completed the box entitled "Special Payment Instructions" or "Special
Delivery Instructions" on the Letter of Transmittal or (ii) for the account of
an Eligible Institution. In the event that signatures on a Letter of Transmittal
or a notice of withdrawal, as the case may be, are required to be guaranteed,
such guarantee must be by a member firm of a registered national securities
exchange or of the National Association of Securities Dealers, Inc., or a
commercial bank or trust company having an office or correspondent in the U.S.
(an "Eligible Institution").
If the Letter of Transmittal is signed by a person other than the registered
Holder of any Old Notes listed therein, such Old Notes must be endorsed or
accompanied by appropriate bond powers signed as the name of the registered
Holder or Holders appears on the Old Notes.
If the Letter of Transmittal or any Old Notes or bond powers are signed by
trustees, executors, administrators, guardians, attorneys-in-fact, officers of
corporations or others acting in a fiduciary or representative capacity, such
persons shall so indicate when signing and, unless waived by the Company,
evidence satisfactory to the Company of their authority to so act must be
submitted with the Letter of Transmittal.
All questions as to the validity, form, eligibility (including time of
receipt) and acceptance of tendered Old Notes and withdrawal of tendered Old
Notes will be determined by the Company in its sole discretion, which
determination will be final and binding. The Company reserves the absolute right
to reject any and all Old Notes not properly tendered or any Old Notes the
Company's acceptance of which would, in the opinion of counsel for the Company,
be unlawful. The Company also reserves the right to waive any defects,
irregularities or conditions of tender as to particular Old Notes. The Company's
interpretation of the terms and conditions of the Exchange Offer (including the
instructions in the Letter of Transmittal) will be final and binding on all
parties. Unless waived, any defects or irregularities in connection with tenders
of Old Notes must be cured within such time as the Company shall determine.
Neither the Company, the Exchange Agent nor any other person shall be under any
duty to give notification of defects or irregularities with respect to tenders
of Old Notes, nor shall any of them incur any liability for failure to give such
notification. Tenders of Old Notes will not be deemed to have been made until
such irregularities have been cured or waived. Any Old Notes received by the
Exchange Agent that are not properly tendered and as to which the defects or
irregularities have not been cured or waived will be returned by the Exchange
Agent to the tendering Holders of Old Notes, unless otherwise provided in the
Letter of Transmittal, as soon as practicable following the Expiration Date.
In addition, the Company reserves the right in its sole discretion to
purchase or make offers for any Old Notes that remain outstanding subsequent to
the Expiration Date or, as set forth under "--Conditions," to terminate the
Exchange Offer and, to the extent permitted by applicable law, purchase Old
Notes in the open market, in privately negotiated transactions or otherwise. The
terms of any such purchases or offers could differ from the terms of the
Exchange Offer.
By tendering, each Holder will represent to the Company that, among other
things, the New Notes acquired pursuant to the Exchange Offer are being obtained
in the ordinary course of such Holder's business, that such Holder has no
arrangement with any person to participate in the distribution of such New
Notes, and that such Holder is not an "affiliate," as defined under Rule 405 of
the Securities Act, of the Company. If the Holder is a Participating
Broker-Dealer that will receive New Notes for its own account in exchange for
Old Notes that were not acquired directly from the Company, such Holder by
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tendering will acknowledge that it will deliver a prospectus in connection with
any resale of such New Notes. See "Plan of Distribution."
BOOK-ENTRY TRANSFER; DELIVERY AND FORM
The Old Notes were initially represented (i) in the case of Old Notes
initially purchased by "qualified institutional buyers" (as such term is defined
in Rule 144A under the Securities Act), by one global Old Note in fully
registered form, all registered in the name of a nominee of the DTC, and (ii) in
the case of Old Notes initially purchased by persons other than U.S. persons in
reliance upon Regulation S under the Securities Act, by one global Regulation S
Old Note in fully registered form, all registered in the name of a nominee of
DTC for the accounts of Euroclear and Cedel Bank. The New Notes exchanged for
the Old Notes represented by the global Old Notes and global Regulation S Old
Note will be represented (a) in the case of "qualified institutional buyers", by
one global New Note in fully registered form, registered in the name of the
nominee of DTC, and (b) in the case of persons outside of the U. S., by one
global Regulation S New Note in fully registered form, registered in the name of
the nominee of DTC for the accounts of Euroclear and Cedel Bank. The global New
Note and global Regulation S New Note will be exchangeable for definitive New
Notes in registered form, in denominations of $1,000 principal amount at
maturity and integral multiples thereof. The New Notes in global form will trade
in The Depository Trust Company's Same-Day Funds Settlement System, and
secondary market trading activity in such New Notes will therefore settle in
immediately available funds.
The Company understands that the Exchange Agent will make a request promptly
after the date of this Prospectus to establish an account with respect to the
Old Notes at DTC for the purpose of facilitating the Exchange Offer, and subject
to the establishment thereof, any financial institution that is a participant in
DTC's system may make book-entry delivery of Old Notes by causing DTC to
transfer such Old Notes into the Exchange Agent's account with respect to the
Old Notes in accordance with DTC's ATOP procedures for such book-entry
transfers. Although delivery of the Old Notes may be effected through book-entry
transfer into the Exchange Agent's account at DTC, the exchange for Old Notes so
tendered will only be made after timely confirmation (a "Book-Entry
Confirmation") of such book-entry transfer of the Old Notes into the Exchange
Agent's account, and timely receipt by the Exchange Agent of a Book-Entry
Confirmation with an Agent's Message (as defined). The term "Agent's Message"
means a message, transmitted by DTC and received by the Exchange Agent and
forming part of the Book-Entry Confirmation, which states that DTC has received
express acknowledgment from a participant tendering Old Notes that such
participant has received and agrees to be bound by the terms of the Letter of
Transmittal, and that such agreement may be enforced against such participant.
GUARANTEED DELIVERY PROCEDURES
OLD NOTES HELD THROUGH DTC. DTC Participants holding Old Notes through DTC
who wish to cause their Old Notes to be tendered, but who cannot transmit their
acceptances through ATOP prior to the Expiration Date, may cause a tender to be
effected if:
(a) guaranteed delivery is made by or through an Eligible Institution;
(b) prior to 5:00 p.m., New York City time on the Expiration Date, the
Exchange Agent receives from such Eligible Institution a properly completed and
duly executed Notice of Guaranteed Delivery (by mail, hand delivery, facsimile
transmission or overnight courier) substantially in the form provided by the
Company herewith; and
(c) Book-Entry Confirmation and an Agent's Message in connection therewith
(as described above) are received by the Exchange Agent within three New York
Stock Exchange trading days after the date of the execution of the Notice of
Guaranteed Delivery.
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OLD NOTES HELD BY HOLDERS. Holders who wish to tender their Old Notes and
(i) whose Old Notes are not immediately available, (ii) who cannot deliver their
Old Notes, the Letter of Transmittal or any other required documents to the
Exchange Agent or (iii) who cannot complete the procedures for book-entry
transfer prior to the Expiration Date, may effect a tender if:
(a) The tender is made through an Eligible Institution;
(b) Prior to the Expiration Date, the Exchange Agent receives from such
Eligible Institution a properly completed and duly executed Notice of Guaranteed
Delivery (by facsimile transmission, mail or hand delivery) setting forth the
name and address of the Holder of the Old Notes, the certificate number or
numbers of such Old Notes and the principal amount at maturity of Old Notes
tendered, stating that the tender is being made thereby and guaranteeing that,
within three New York Stock Exchange trading days after the Expiration Date, the
Letter of Transmittal (or facsimile thereof) together with the certificate(s)
representing the Old Notes to be tendered in proper form for transfer and any
other documents required by the Letter of Transmittal, or a Book-Entry
Confirmation, as the case may be, will be delivered by the Eligible Institution
to the Exchange Agent; and
(c) Such properly completed and executed Letter of Transmittal (or facsimile
thereof), as well as the certificate(s) representing all tendered Old Notes in
proper form for transfer and all other documents required by the Letter of
Transmittal, or a Book-Entry Confirmation, as the case may be, are received by
the Exchange Agent within three New York Stock Exchange trading days after the
Expiration Date.
Upon request of the Exchange Agent, a Notice of Guaranteed Delivery will be
sent to Holders who wish to tender their Old Notes according to the guaranteed
delivery procedures set forth above.
WITHDRAWAL OF TENDERS
Except as otherwise provided herein, tenders of Old Notes may be withdrawn
at any time prior to 5:00 p.m., New York City time, on the Expiration Date.
OLD NOTES HELD THROUGH DTC. DTC Participants holding Old Notes who have
transmitted their acceptances through ATOP may, prior to 5:00 p.m., New York
City time, on the Expiration Date, withdraw the instruction given thereby by
delivering to the Exchange Agent, at its address set forth under "--Exchange
Agent," a written or facsimile notice of withdrawal of such instruction. Such
notice of withdrawal must contain the name and number of the DTC Participant,
the principal amount due at the maturity date of the Old Notes to which such
withdrawal is related and the signature of the DTC Participant. Withdrawal of
such an instruction will be effective upon receipt of such written notice of
withdrawal by the Exchange Agent.
OLD NOTES HELD BY HOLDERS. Holders may withdraw a tender of Old Notes in
the Exchange Offer, by a written or facsimile notice of withdrawal received by
the Exchange Agent at its address set forth herein prior to 5:00 p.m., New York
City time, on the Expiration Date. Any such notice of withdrawal must (i)
specify the name of the person having deposited the Old Notes to be withdrawn
(the "Depositor"), (ii) identify the Old Notes to be withdrawn (including the
certificate number or numbers and principal amount at maturity of such Old
Notes), (iii) be signed by the Holder in the same manner as the original
signature on the Letter of Transmittal by which such Old Notes were tendered
(including any required signature guarantees) or be accompanied by documents of
transfer sufficient to have the Trustee with respect to the Old Notes register
the transfer of such Old Notes into the name of the person withdrawing the
tender, and (iv) specify the name in which any such Old Notes are to be
registered, if different from that of the Depositor. All questions as to the
validity, form and eligibility (including time of receipt) of such notices will
be determined by the Company, whose determination shall be final and binding on
all parties. Any Old Notes so withdrawn will be deemed not to have been validly
tendered for purposes of the Exchange Offer and no New Notes will be issued with
respect thereto unless the Old Notes so withdrawn are validly retendered. Any
Old Notes which have been tendered but which are not accepted for exchange
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will be returned to the Holder thereof without cost to such Holder as soon as
practicable after withdrawal, rejection of tender or termination of the Exchange
Offer. Properly withdrawn Old Notes may be retendered by following one of the
procedures, described above under "--Procedures for Tendering" at any time prior
to the Expiration Date.
CONDITIONS
Notwithstanding any other term of the Exchange Offer, the Company will not
be required to accept for exchange, or exchange New Notes for, any Old Notes not
theretofore accepted for exchange, and may terminate or amend the Exchange Offer
as provided herein before the acceptance of such Old Notes, if any of the
following conditions exist:
(a) the Exchange Offer, or the making of any exchange by a Holder, violates
applicable law or any applicable interpretation of the SEC;
(b) any action or proceeding is instituted or threatened in any court or by
or before any governmental agency with respect to the Exchange Offer which, in
the sole judgment of the Company, might impair the ability of the Company to
proceed with the Exchange Offer;
(c) any law, statute, rule or regulation is adopted or enacted which, in the
sole judgment of the Company, might materially impair the ability of the Company
to proceed with the Exchange Offer;
(d) a banking moratorium is declared by U.S. federal or California or New
York state authorities which, in the Company's judgment, would reasonably be
expected to impair the ability of the Company to proceed with the Exchange
Offer;
(e) trading on the New York Stock Exchange or generally in the U.S.
over-the-counter market is suspended by order of the SEC or any other
governmental authority which, in the Company's judgment, would reasonably be
expected to impair the ability of the Company to proceed with the Exchange
Offer; or
(f) a stop order is issued by the SEC or any state securities authority
suspending the effectiveness of the Registration Statement or proceedings are
initiated or, to the knowledge of the Company, threatened for that purpose.
If any such conditions exist, the Company may (i) refuse to accept any Old
Notes and return all tendered Old Notes to exchanging Holders, (ii) extend the
Exchange Offer and retain all Old Notes tendered prior to the expiration of the
Exchange Offer, subject, however, to the rights of Holders to withdraw such Old
Notes (see"--Withdrawal of Tenders") or (iii) waive certain of such conditions
with respect to the Exchange Offer and accept all properly tendered Old Notes
which have not been withdrawn or revoked. If such waiver constitutes a material
change to the Exchange Offer, the Company will promptly disclose such waiver in
a manner reasonably calculated to inform Holders of Old Notes of such waiver.
The foregoing conditions are for the sole benefit of the Company and may be
asserted by the Company regardless of the circumstances giving rise to any such
condition or may be waived by the Company in whole or in part at any time and
from time to time in its sole discretion; provided, however, that the Company
shall use reasonable judgement in determining whether any of the foregoing
conditions are satisfied. The failure by the Company at any time to exercise any
of the foregoing rights shall not be deemed a waiver of any such right and each
such right shall be deemed an ongoing right which may be asserted at any time
and from time to time.
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EXCHANGE AGENT
State Street Bank and Trust Company of California, N.A. has been appointed
as Exchange Agent for the Exchange Offer. Letters of Transmittal and Notices of
Guaranteed Delivery should be directed to the Exchange Agent addressed as
follows:
<TABLE>
<S> <C>
By Registered or Certified Mail: By Overnight Courier:
Attention: Kellie Mullen Attention: Kellie Mullen
State Street Bank and Trust Company State Street Bank and Trust Company
of California, N.A. of California, N.A.
c/o State Street Bank and Trust c/o State Street Bank and Trust
Company Company
2 International Place 2 International Place
Boston, MA 02110 Boston, MA 02110
Phone: (617) 664-5587 Phone: (617) 664-5587
By Hand: By Facsimile:
Attention: Kellie Mullen Attention: Kellie Mullen
State Street Bank and Trust Company (617) 664-5290
of California, N.A.
c/o State Street Bank and Trust Confirm by telephone:
Company (617) 664-5587
2 International Place
Boston, MA 02110
Phone: (617) 664-5587
</TABLE>
FEES AND EXPENSES
The expenses of soliciting tenders will be borne by the Company. The
principal solicitation is being made by mail; however, additional solicitation
may be made by telegraph, telephone or in person by officers and regular
employees of the Company and its affiliates.
The Company will not make any payments to brokers, dealers or others
soliciting acceptances of the Exchange Offer. The Company, however, will pay the
Exchange Agent reasonable and customary fees for its services and will reimburse
it for its reasonable out-of-pocket expenses in connection therewith. The
Company may also pay brokerage houses and other custodians, nominees and
fiduciaries the reasonable out-of-pocket expenses incurred by them in forwarding
copies of this Prospectus and related documents to the beneficial owners of the
Old Notes, and in handling or forwarding tenders for exchange.
The cash expenses to be incurred in connection with the Exchange Offer will
be paid by the Company and will include fees and expenses of the Exchange Agent
and the Trustee under the Indenture and accounting and legal fees.
The Company will pay all transfer taxes, if any, applicable to the exchange
of Old Notes pursuant to the Exchange Offer. If, however, certificates
representing New Notes or Old Notes for principal amounts at maturity not
tendered or accepted for exchange are to be delivered to, or are to be
registered or issued in the name of, any person other than the registered Holder
of the Old Notes tendered, or if tendered Old Notes are registered in the name
of any person other than the person signing the Letter of Transmittal, or if a
transfer tax is imposed for any reason other than the exchange of Old Notes
pursuant to the Exchange Offer, then the amount of any such transfer taxes
(whether imposed on the registered Holder or any other persons) will be payable
by the tendering Holder. If satisfactory evidence of payment of such taxes or
exception therefrom is not submitted with the Letter of Transmittal, the amount
of such transfer taxes will be billed directly to such tendering Holder.
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ACCOUNTING TREATMENT
The New Notes will be recorded at the same carrying value as the Old Notes,
which is face value less original issue discount plus accretion to date as
reflected in the Company's accounting records on the date of the Exchange Offer.
Accordingly, no gain or loss for accounting purposes will be recognized upon
consummation of the Exchange Offer. The issuance costs incurred in connection
with the Exchange Offer will be capitalized and amortized over the term of the
New Notes.
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DESCRIPTION OF THE NOTES
The Old Notes were issued under an Indenture (the "Indenture") dated as of
May 5, 1998, between Rhythms NetConnections Inc. (the "Company") and State
Street Bank and Trust Company of California, N.A., as Trustee, a copy of the
form of which will be made available to prospective purchasers upon request, in
a private transaction that was not subject to the registration requirements of
the Securities Act. The terms of the Old Notes include those stated in the
Indenture and those made part of the Indenture by reference to the Trust
Indenture Act of 1939, as amended (the "Trust Indenture Act"). The Old Notes are
subject to all such terms, and Holders of Old Notes are referred to the
Indenture and the Trust Indenture Act for a statement thereof. The following
summary of the material provisions of the Indenture and the Registration Rights
Agreement does not purport to be complete and is qualified in its entirety by
reference to such agreements, including the definitions therein of certain terms
used below. Copies of such agreements have been filed as exhibits to the
Registration Statement of which this Prospectus is a part and are available from
the SEC or as set forth below under "Additional Information." The following
summary of certain provisions of the Indenture does not purport to be complete
and is subject to, and is qualified in its entirety by reference to, the Trust
Indenture Act and to all of the provisions of the Indenture, including the
definitions of certain terms therein and those terms made a part of the
Indenture by reference to the Trust Indenture Act, as in effect on the date of
the Indenture. The definitions of certain capitalized terms used in the
following summary are set forth below under "--Certain Definitions."
GENERAL
The Notes were issued only in fully registered form without coupons, in
denominations of $1,000 principal amount and integral multiples thereof.
Principal of, premium on, if any, and interest on the Notes are payable, and the
Notes are exchangeable and transferable, at the office or agency of the Company
in the City of New York maintained for such purposes (which initially will be
the corporate trust office of the Trustee). See "Exchange Offer--Book-Entry
Transfer; Delivery and Form." No service charge will be made for any
registration of transfer, exchange or redemption of the Notes, except in certain
circumstances for any tax or other governmental charge that may be imposed in
connection therewith.
MATURITY, INTEREST AND PRINCIPAL
The Notes are general unsecured obligations of the Company, limited to
$290,000,000 aggregate principal amount at maturity, and will mature on May 15,
2008. Cash interest will not accrue on the Notes prior to May 15, 2003. See
"Federal Income Tax Considerations." Thereafter, cash interest on the Notes will
accrue at a rate of 13 1/2% per annum and will be payable semi-annually in
arrears on each May 15 and November 15 to registered holders of Notes on the May
1 or November 1, as the case may be, immediately preceding such interest payment
date, commencing November 15, 2003. Interest on the Notes will accrue from the
most recent interest payment date to which interest has been paid or duly
provided for or, if no interest has been paid or duly provided for, from May 15,
2003. Based on the foregoing, the yield to maturity of each Note will be 13 1/2%
per annum (computed on a semiannual bond equivalent basis calculated from May 5,
1998). Interest will be computed on the basis of a 360-day year of twelve 30-day
months. If the Company defaults on any payment of principal (whether at
maturity, upon redemption or otherwise), cash interest will continue to accrue
and, to the extent permitted by law, cash interest will accrue on overdue
installments of interest at the rate of interest borne by the Notes.
REDEMPTION
OPTIONAL REDEMPTION. The Notes will be redeemable, at the option of the
Company, in whole or in part, at any time on or after May 15, 2003, upon not
less than 30 nor more than 60 days' written notice at the redemption prices
(expressed as percentages of principal amount at maturity) set forth below, plus
accrued and unpaid interest thereon, if any, and liquidated damages, if any, to
the applicable redemption
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date, if redeemed during the twelve-month period beginning on May 15 of each of
the years indicated below:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
- --------------------------------------------------------------------------------- -----------
<S> <C>
2003............................................................................. 106.750%
2004............................................................................. 104.500%
2005............................................................................. 102.250%
2006 and thereafter.............................................................. 100.000%
</TABLE>
In addition, at any time on or prior to May 15, 2001, the Company may, other
than in any circumstances resulting in a Change of Control, redeem, at its
option, up to a maximum of 35% of the originally-issued aggregate principal
amount at maturity of Notes at a redemption price (determined at the applicable
redemption date) equal to 113 1/2% of the Accreted Value of the Notes so
redeemed plus liquidated damages, if any, with the net cash proceeds of (a) one
or more Public Equity Offerings and/or (b) the sale, subsequent to the Issue
Date, of Capital Stock (other than Disqualified Stock) in one or more
transactions to Strategic Equity Investors, resulting in gross cash proceeds to
the Company of at least $25.0 million in the aggregate; provided that not less
than 65% of the originally-issued aggregate principal amount at maturity of
Notes is outstanding immediately following such redemption. Any such redemption
must be effected upon not less than 30 nor more than 60 days' notice given
within 30 days after the consummation of a Public Equity Offering or sale to one
or more Strategic Equity Investors the net proceeds from which, together with
any net proceeds from any prior Public Equity Offerings or sales to Strategic
Equity Investors, are to be used to effect an optional redemption in accordance
with this paragraph.
MANDATORY REDEMPTION. The Company will not be required to repurchase the
Notes or make any mandatory redemption or sinking fund payments in respect of
the Notes. However, (i) following the occurrence of a Change of Control, the
Company will be required to make an offer to purchase all outstanding Notes at a
price equal to 101% of the Accreted Value thereof as of the date of purchase,
and (ii) following the occurrence of an Asset Sale, the Company may be obligated
to make an offer to purchase all or a portion of the outstanding Notes at a
price equal to 100% of the Accreted Value thereof as of the date of purchase, in
each case plus accrued and unpaid interest, if any, and liquidated damages, if
any, to the date of purchase. See "--Certain Covenants--Change of Control" and
"--Disposition of Proceeds of Asset Sales," respectively.
SELECTION; EFFECT OF REDEMPTION NOTICE. In the case of a partial
redemption, selection of the Notes for redemption will be made pro rata, by lot
or such other method as the Trustee in its sole discretion deems appropriate and
just; provided that any redemption pursuant to the provisions relating to
redemptions from the proceeds of one or more Public Equity Offerings or sales to
one or more Strategic Equity Investors shall be made on a pro rata basis or on
as nearly a pro rata basis as practicable (subject to DTC procedures). No Notes
of a principal amount at maturity of $1,000 or less shall be redeemed in part.
Notice of redemption shall be mailed by first-class mail at least 30 but not
more than 60 days before the redemption date to each holder of Notes to be
redeemed at its registered address. If any Note is to be redeemed in part only,
the notice of redemption that relates to such Note shall state the portion of
the principal amount thereof to be redeemed. A new Note in a principal amount at
maturity equal to the unredeemed portion thereof will be issued in the name of
the holder thereof upon surrender for cancellation of the original Note. Upon
giving of a redemption notice, interest on Notes called for redemption will
cease to accrue from and after the date fixed for redemption (unless the Company
defaults in providing the funds for such redemption) and such Notes will cease
to be outstanding.
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RANKING
The New Notes will be general unsecured obligations of the Company and, as
such, will rank PARI PASSU in right of payment with all existing and future
unsecured and unsubordinated Indebtedness of the Company. The New Notes will be
effectively subordinated to all secured Indebtedness of the Company to the
extent of the value of the assets securing such Indebtedness and will be
structurally subordinated to all existing and future Indebtedness of any
subsidiary of the Company. As of June 30, 1998, the Company had outstanding
Indebtedness of approximately $149.9 million of which approximately $3.0 million
is secured Indebtedness (consisting of bank and lease line Indebtedness), which
effectively ranks senior in right of payment to the New Notes. As of June 30,
1998, after giving effect to the creation and capitalization of the Company's
existing subsidiaries, such subsidiaries had no outstanding Indebtedness.
Although the Indenture contains limitations on the amount of additional
Indebtedness that the Company or its Restricted Subsidiaries may incur, under
certain circumstances the amount of such Indebtedness could be substantial. See
"--Certain Covenants--LIMITATION ON ADDITIONAL INDEBTEDNESS" below. If the
Company becomes insolvent or is liquidated, or if payment under any secured
Indebtedness is accelerated, the lenders under such Indebtedness would be
entitled to exercise the remedies available to a secured lender under applicable
law pursuant to the terms of the applicable financing agreements. Accordingly,
any claims of such lenders with respect to assets secured in their favor will be
prior to any claims of the holders of the Notes with respect to such assets.
CERTAIN COVENANTS
Set forth below are certain covenants that are contained in the Indenture.
LIMITATION ON ADDITIONAL INDEBTEDNESS. The Indenture provides that the
Company will not, and will not permit any Restricted Subsidiary to, directly or
indirectly, create, incur, assume, issue, Guarantee or in any manner become
directly or indirectly liable for or with respect to, contingently or otherwise,
the payment of (collectively, to "incur") any Indebtedness (including any
Acquired Indebtedness), except for Permitted Indebtedness (including Acquired
Indebtedness to the extent it would constitute Permitted Indebtedness); provided
(i) the Company will be permitted to incur Indebtedness (including Acquired
Indebtedness) and (ii) a Restricted Subsidiary will be permitted to incur
Acquired Indebtedness, if, in either case, after giving pro forma effect to such
incurrence (including the application of the net proceeds therefrom), the
Indebtedness to EBITDA Ratio would be less than or equal to 6 to 1, in the case
of any such incurrence on or before June 30, 2001, or less than or equal to 5 to
1, in the case of any such incurrence thereafter.
Indebtedness of any Person or any of its Subsidiaries existing at the time
such Person becomes a Restricted Subsidiary (or is merged into or consolidated
with the Company or any Restricted Subsidiary), whether or not such Indebtedness
was incurred in connection with, or in contemplation of, such Person becoming a
Restricted Subsidiary (or being merged into or consolidated with the Company or
any Restricted Subsidiary) shall be deemed incurred at the time such Person
becomes a Restricted Subsidiary or merges into or consolidates with the Company
or any Restricted Subsidiary. In addition, pursuant to the purchase agreement
entered into among the Company and each of Merrill Lynch and Donaldson, Lufkin &
Jenrette Securities Corporation, the Company has agreed that for a period of 180
days from April 28, 1998, it will not, without the prior written consent of
Merrill Lynch, directly or indirectly, offer, sell, grant any option to
purchase, or otherwise dispose of, any debt security of the Company or security
of the Company that is convertible into, or exchangeable for, any debt security
of the Company (other than the New Notes). See "Plan of Distribution."
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LIMITATION ON RESTRICTED PAYMENTS. The Indenture provides that the Company
will not, and will not permit any of the Restricted Subsidiaries to, make,
directly or indirectly, any Restricted Payment unless:
(i) no Default shall have occurred and be continuing at the time of or
upon giving effect to such Restricted Payment;
(ii) immediately after giving effect to such Restricted Payment, the
Company would be able to incur $1.00 of Indebtedness under the proviso of
the covenant "--Limitation on Additional Indebtedness"; and
(iii) immediately after giving effect to such Restricted Payment, the
aggregate amount of all Restricted Payments declared or made on or after the
Issue Date does not exceed an amount equal to the sum of, without
duplication, (a) 50% of the Consolidated Net Income accrued on a cumulative
basis during the period beginning on the first day of the first fiscal
quarter immediately subsequent to the Issue Date and ending on the last day
of the fiscal quarter of the Company immediately preceding the date of such
proposed Restricted Payment (or, if such cumulative Consolidated Net Income
of the Company for such period is a deficit, minus 100% of such deficit) for
which financial statements are available, in any event determined by
excluding income resulting from transfers of assets by the Company or a
Restricted Subsidiary to an Unrestricted Subsidiary, PLUS (b) the aggregate
net cash proceeds received by the Company either (x) as capital
contributions to the Company after the Issue Date or (y) from the issuance
and sale of its Capital Stock (other than Disqualified Stock) or options,
warrants or other rights to acquire its Capital Stock (other than
Disqualified Stock), in each case on or after the Issue Date to a Person who
is not a Subsidiary of the Company, PLUS (c) the aggregate net proceeds
received by the Company from the issuance (other than to a Subsidiary of the
Company) on or after the Issue Date of its Capital Stock (other than
Disqualified Stock) upon the conversion of, or in exchange for, Indebtedness
of the Company or upon the exercise of options, warrants or other rights of
the Company, PLUS (d) in the case of the disposition or repayment (in whole
or in part) of any Investment constituting a Restricted Payment made after
the Issue Date, an amount equal to the lesser of the return of capital with
respect to the applicable portion of such Investment and the cost of the
applicable portion of such Investment, in either case, less the cost of the
disposition of such Investment, PLUS (e) in the case of any Revocation with
respect to a Subsidiary of the Company that was made subject to a
Designation after the Issue Date, an amount equal to the lesser of the
Designation Amount with respect to such Subsidiary or the Fair Market Value
of the Investment of the Company and the Restricted Subsidiaries in such
Subsidiary at the time of Revocation, MINUS (f) 50% of the principal amount
of any Indebtedness incurred pursuant to clause (g) of the definition of
"Permitted Indebtedness." For purposes of the preceding clause (b), there
shall be excluded in all cases any issuance and sale of Capital Stock in one
or more Public Equity Offerings or to Strategic Equity Investors to the
extent the net cash proceeds are used, prior to May 15, 2001, to redeem
Notes as described under "--Redemption--OPTIONAL REDEMPTION." The Company
may not redeem Notes as described under "--Redemption--OPTIONAL REDEMPTION"
from net cash proceeds received by the Company from the issuance on or after
the Issue Date of its Capital Stock if such net cash proceeds have ever been
included in a determination of the amount of Restricted Payments that may be
made by the Company pursuant to this covenant, unless the Company would have
been able to make such Restricted Payment without including such net cash
proceeds in such determination.
For purposes of determining the amount expended for Restricted Payments,
cash distributed shall be valued at the face amount thereof and property other
than cash shall be valued at its Fair Market Value.
The provisions of this covenant shall not prohibit the following (each of
which shall be given independent effect): (1) the payment of any dividend or
other distribution within 60 days after the date of declaration thereof if at
such date of declaration such payment would be permitted by the provisions of
the Indenture; (2) the purchase, redemption, retirement or other acquisition of
any shares of Capital Stock of the Company in exchange for, or out of the net
cash proceeds of the substantially concurrent issue and sale
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(other than to a Subsidiary of the Company) of, shares of Capital Stock of the
Company (other than Disqualified Stock); PROVIDED that any such net cash
proceeds are excluded from clause (iii) (b) of the second preceding paragraph;
(3) so long as no Default shall have occurred and be continuing, the purchase,
redemption, retirement, defeasance or other acquisition of Subordinated
Indebtedness (A) made by exchange for, or out of the net cash proceeds of, a
substantially concurrent issue and sale (other than to a Subsidiary of the
Company) of (x) Capital Stock (other than Disqualified Stock) of the Company
PROVIDED that any such net cash proceeds are excluded from clause(iii)(b) of the
second preceding paragraph; or (y) other Subordinated Indebtedness to the extent
that (I) its stated maturity for the payment of principal thereof is not prior
to the 91st day after the final stated maturity of the Notes, (II) its principal
amount does not exceed the principal amount (or, if such Subordinated
Indebtedness being refinanced provides for an amount less than the principal
amount thereof to be due and payable upon an acceleration thereof, such lesser
amount) of the Subordinated Indebtedness being refinanced, PLUS any premium
required to be paid in connection with such refinancing pursuant to the terms of
such Subordinated Indebtedness being refinanced, plus the amount of expenses of
the Company incurred in connection with such refinancing, and (III) such new
Subordinated Indebtedness is subordinated to the Notes to the same extent as the
Subordinated Indebtedness being refinanced, or (B) with Unutilized Cash Proceeds
remaining after completion of an Asset Sale pursuant to the fifth paragraph of
the covenant described under "--DISPOSITION OF PROCEEDS OF ASSET SALES"; (4) so
long as no Default shall have occurred and be continuing, purchases or
redemptions of Capital Stock (including cash settlements of stock options) held
by employees, officers or directors upon or following termination (whether by
reason of death, disability or otherwise) of their employment with the Company
or one of its Subsidiaries; PROVIDED that payments shall not exceed $500,000 in
any fiscal year in the aggregate; (5) payments or distributions to dissenting
stockholders pursuant to applicable law, pursuant to or in contemplation of
merger, consolidation or transfer of assets that complies with the provisions of
the Indenture relating to mergers, consolidations or transfers of substantially
all of the assets of the Company; (6) any purchase of any fractional share of
Common Stock of the Company in connection with an exercise of the Warrants and
any repurchase of Warrants pursuant to a Repurchase Offer (as defined in
"Description of Warrants"); and (7) Restricted Payments in addition to those
otherwise permitted pursuant to this covenant in an aggregate amount not to
exceed $2.0 million.
In determining the amount of Restricted Payments permissible under this
covenant, amounts expended pursuant to clauses (1), (4) and (7) above shall be
included, without duplication, as Restricted Payments.
LIMITATION ON LIENS SECURING CERTAIN INDEBTEDNESS. The Indenture will
provide that the Company will not, and will not permit any Restricted Subsidiary
to, create, incur, assume or suffer to exist any Liens of any kind against or
upon any of the property or assets of the Company or any Restricted Subsidiary,
whether now owned or hereafter acquired, or any proceeds therefrom, which secure
either (x) Subordinated Indebtedness, unless the Notes are secured by a Lien on
such property, assets or proceeds that is senior in priority to the Liens
securing such Subordinated Indebtedness or (y) Indebtedness of (A) the Company
that is not Subordinated Indebtedness or (B) any Restricted Subsidiary, unless
in each case the Notes are equally and ratably secured with the Liens securing
such other Indebtedness, except, in the case of this clause (y), Permitted
Liens.
CHANGE OF CONTROL. Upon the occurrence of a Change of Control (the date of
such occurrence being the "Change of Control Date"), the Company shall make an
offer to purchase (the "Change of Control Offer"), on a business day (the
"Change of Control Payment Date") not later than 60 days following the Change of
Control Date, all Notes then outstanding at a purchase price equal to 101% of
the Accreted Value thereof as of any Change of Control Payment Date, plus
accrued and unpaid interest thereon, if any, and liquidated damages, if any, to
such Change of Control Payment Date. Notice of a Change of Control Offer shall
be given to holders of Notes, not less than 30 days nor more than 60 days before
the Change of
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Control Payment Date. The Change of Control Offer is required to remain open for
at least 20 business days and until the close of business on the Change of
Control Payment Date.
Except as described above with respect to a Change of Control, the Indenture
does not contain provisions that permit the holders of the Notes to require that
the Company repurchase or redeem the Notes in the event of a takeover,
recapitalization or similar transaction which may be highly leveraged.
Future Indebtedness of the Company may contain prohibitions on the
occurrence of certain events that would constitute a Change of Control or may
require such Indebtedness to be repurchased upon a change of control (as defined
in the instruments governing such Indebtedness). Moreover, the exercise by the
Holders of their right to require the Company to repurchase the Notes could
cause a default under such Indebtedness, even if the Change of Control itself
does not.
If a Change of Control Offer is made, there can be no assurance that the
Company will have available funds sufficient to pay for all of the Notes that
might be delivered by holders of Notes seeking to accept the Change of Control
Offer. The Company's obligation to make a Change of Control Offer following a
Change of Control shall be satisfied if a third party makes the Change of
Control Offer in the manner, at the times and otherwise in compliance with the
requirements applicable to a Change of Control Offer made by the Company and
purchases all Notes validly tendered and not withdrawn under such Change of
Control Offer. See "Risk Factors--Risks Associated with a Change of Control."
If the Company is required to make a Change of Control Offer, the Company
shall comply with all applicable tender offer laws and regulations, including,
to the extent applicable, Section 14(e) and Rule 14e-1 under the Exchange Act,
and any other applicable securities laws and regulations. To the extent that the
provisions of any such securities laws or regulations conflict with provisions
of this covenant, the Company will comply with the applicable securities laws
and regulations and will not be deemed to have breached its obligations under
this covenant solely by virtue of such compliance.
LIMITATION ON DIVIDENDS AND OTHER PAYMENT RESTRICTIONS AFFECTING RESTRICTED
SUBSIDIARIES. The Indenture provides that the Company will not, and will not
permit any Restricted Subsidiary to, directly or indirectly, create or otherwise
enter into or cause to become effective any encumbrance or restriction of any
kind on the ability of any Restricted Subsidiary to (a) pay dividends, in cash
or otherwise, or make any other distributions on its Capital Stock or any other
interest or participation in, or measured by, its profits to the extent owned by
the Company or any Restricted Subsidiary, (b) pay any Indebtedness owed to the
Company or any Restricted Subsidiary, (c) make any Investment in the Company or
any Restricted Subsidiary or (d) transfer any of its properties or assets to the
Company or to any Restricted Subsidiary, except for (i) any encumbrance or
restriction in existence on the Issue Date, (ii) customary non-assignment
provisions, (iii) any encumbrances or restriction pertaining to an asset subject
to a Lien to the extent set forth in the security documentation governing such
Lien, (iv) any encumbrance or restriction applicable to a Restricted Subsidiary
at the time that it becomes a Restricted Subsidiary that is not created in
contemplation thereof, (v) any encumbrance or restriction existing under any
agreement that refinances or replaces an agreement containing a restriction
permitted by clause (iv) above; PROVIDED that the terms and conditions of any
such encumbrance or restriction are not materially less favorable to the holders
of Notes than those under or pursuant to the agreement being replaced or the
agreement evidencing the Indebtedness refinanced, (vi) any encumbrance or
restriction imposed upon a Restricted Subsidiary pursuant to an agreement which
has been entered into for the sale or disposition of all or substantially all of
the Capital Stock or assets of such Restricted Subsidiary or any Asset Sale to
the extent limited to the Capital Stock or assets in question, and (vii) any
customary encumbrance or restriction applicable to a Restricted Subsidiary that
is contained in an agreement or instrument governing or relating to Permitted
Indebtedness contained in any Debt Securities or Permitted Credit Facility;
provided that the terms and conditions of any such encumbrance or restriction
contained in any Debt Securities are no more restrictive than those contained in
the Indenture; PROVIDED FURTHER, that the provisions of such agreement or
instrument permit the payment of interest and principal and mandatory
repurchases pursuant to the terms of the Indenture and the Notes
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and other Indebtedness (other than Subordinated Indebtedness) that is solely an
obligation of the Company; and PROVIDED FURTHER that such agreement or
instrument may contain customary covenants regarding the merger of or sale of
all or any substantial part of the assets of the Company or any Restricted
Subsidiary, customary restrictions on transactions with affiliates and customary
subordination provisions governing indebtedness owed to the Company or any
Restricted Subsidiary.
DISPOSITION OF PROCEEDS OF ASSET SALES. The Indenture provides that the
Company will not, and will not permit any Restricted Subsidiary to, make any
Asset Sale unless (a) the Company or such Restricted Subsidiary, as the case may
be, receives consideration at the time of such Asset Sale at least equal to the
Fair Market Value of the shares or assets sold or otherwise disposed of and (b)
at least 75% of such consideration consists of cash or Cash Equivalents;
PROVIDED that the following shall be treated as cash for purposes of this
covenant: (x) the amount of any Indebtedness (other than Subordinated
Indebtedness) of the Company or any Restricted Subsidiary that is actually
assumed by the transferee of assets disposed of in such Asset Sale and from
which Company and the Restricted Subsidiaries are fully released and (y) the
amount of any notes or other obligations that within 30 days of receipt are
converted into cash (to the extent of the cash (after payment of any costs of
disposition) so received). Notwithstanding the preceding sentence, the Company
and its Restricted Subsidiaries may consummate an Asset Sale without complying
with clause (b) of the immediately preceding sentence if at least 75% of the
consideration for such Asset Sale consists of any combination of cash, Cash
Equivalents and Permitted Business Assets (as defined below) (or in Capital
Stock of any Person that will become a Restricted Subsidiary as a result of such
investment if all or substantially all of the properties and assets of such
Person are Permitted Business Assets); provided that any non-cash consideration
(other than Permitted Business Assets received by the Company or any of its
Restricted Subsidiaries in connection with such Asset Sale) that is converted
into or sold or otherwise disposed of for cash or Cash Equivalents within 270
days after such Asset Sale and any Permitted Business Assets constituting cash
or Cash Equivalents received by the Company or any Restricted Subsidiary shall
constitute Net Cash Proceeds subject to the provisions set forth below. The
Company or the applicable Restricted Subsidiary, as the case may be, may (i)
apply the Net Cash Proceeds from such Asset Sale, within 270 days of the receipt
thereof, to the permanent reduction (whether by means of repayment, release
pursuant to clause (x) of the first sentence of this covenant or otherwise) of
(A) Indebtedness of any Restricted Subsidiary and/or (B) Indebtedness of the
Company ranking senior to or PARI PASSU with the Notes, and, in each case,
permanently reduce the amount of the commitments thereunder by the amount of the
Indebtedness so repaid, and/or (ii) apply such Net Cash Proceeds, within 270
days of the receipt thereof, to an investment in properties and assets that will
be used in the same or a related line of business as that being conducted by the
Company or any Restricted Subsidiary at the time of such Asset Sale
(collectively, "Permitted Business Assets") (or in Capital Stock of any Person
that will become a Restricted Subsidiary as a result of such investment if all
or substantially all of the properties and assets of such Person are Permitted
Business Assets).
To the extent all or part of the Net Cash Proceeds of any Asset Sale are not
applied within 270 days of such Asset Sale as described in clause (i) or (ii) of
the preceding paragraph (such Net Cash Proceeds, the "Unutilized Net Cash
Proceeds"), the Company shall, within 20 days after such 270th day, make an
offer to purchase (an "Asset Sale Offer") all outstanding Notes up to a maximum
Accreted Value (expressed as a multiple of $1,000) equal to the Note Pro Rata
Share of Unutilized Net Cash Proceeds, at a purchase price in cash equal to 100%
of the Accreted Value thereof as of any purchase date, plus accrued and unpaid
interest, if any, and liquidated damages, if any, to such purchase date;
provided, however, that an Asset Sale Offer may be deferred by the Company until
there are Unutilized Net Cash Proceeds equal to at least $5.0 million, at which
time the entire amount of such Unutilized Net Cash Proceeds (and not just the
amount in excess of $5.0 million) shall be applied as required pursuant to this
paragraph and the next following paragraph.
If any other Indebtedness of the Company which ranks PARI PASSU with the
Notes (the "Other Indebtedness") requires that an offer to repurchase such
Indebtedness be made upon the consummation
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of an Asset Sale, the Company may apply the Unutilized Net Cash Proceeds
otherwise required to be applied to an Asset Sale Offer to offer to purchase
such Other Indebtedness and to an Asset Sale Offer so long as the amount of such
Unutilized Net Cash Proceeds applied to repurchase the Notes is not less than
the Note Pro Rata Share of Unutilized Net Cash Proceeds. Any offer to purchase
such Other Indebtedness shall be made at the same time as the Asset Sale Offer,
and the purchase date in respect of any such offer to purchase and the Asset
Sale Offer shall occur on the same day.
For purposes of this covenant, "Note Pro Rata Share of Unutilized Net Cash
Proceeds" means the amount of the Unutilized Net Cash Proceeds equal to the
product of (x) the Unutilized Net Cash Proceeds and (y) a fraction, the
numerator of which is the aggregate Accreted Value of, and all accrued interest
thereon to the purchase date on, all Notes (or portions thereof) validly
tendered and not withdrawn pursuant to an Asset Sale Offer related to such
Unutilized Net Cash Proceeds (the "Note Amount") and the denominator of which is
the sum of the Note Amount and the lesser of (i) the aggregate principal face
amount, and all accrued interest thereon to the purchase date, or (ii) the
Accreted Value as of the purchase date of all Other Indebtedness (or portions
thereof) validly tendered and not withdrawn pursuant to a concurrent offer to
purchase such Other Indebtedness made at the time of such Asset Sale Offer.
Each Asset Sale Offer shall remain open for a period of 20 business days or
such longer period as may be required by law. To the extent that the Accreted
Value, plus accrued interest thereon, if any, to the payment date, of Notes
validly tendered and not withdrawn pursuant to an Asset Sale Offer is less than
the Unutilized Net Cash Proceeds or the Note Pro Rata Share of Unutilized Net
Cash Proceeds, as the case may be, the Company or any Restricted Subsidiary may
use such deficiency for general corporate purposes, including the repayment or
repurchase of Indebtedness. If the Accreted Value, plus accrued interest
thereon, if any, to the payment date, of Notes validly tendered and not
withdrawn by holders thereof exceeds the amount of Notes which can be purchased
with the Unutilized Net Cash Proceeds or the Note Pro Rata Share of Unutilized
Net Cash Proceeds, as the case may be, then the Notes to be purchased will be
selected on a pro rata basis. Upon completion of an Asset Sale Offer and offer
for any Other Indebtedness, the amount of Unutilized Net Cash Proceeds shall be
reset to zero.
If the Company is required to make an Asset Sale Offer, the Company shall
comply with all applicable tender offer rules, including, to the extent
applicable, Section 14(e) and Rule 14e-1 under the Exchange Act, and any other
applicable securities laws and regulations. To the extent that the provisions of
any such securities laws or regulations conflict with provisions of this
covenant, the Company will comply with the applicable securities laws and
regulations and will not be deemed to have breached its obligations under this
covenant solely by virtue of such compliance.
LIMITATION ON ISSUANCES AND SALES OF CAPITAL STOCK OF RESTRICTED
SUBSIDIARIES. The Indenture provides that the Company will not sell, and will
not permit any Restricted Subsidiary, directly or indirectly, to issue or sell,
any shares of Capital Stock (or any options, warrants or other rights to
purchase such CapitalStock) of a Restricted Subsidiary, except (i) any sale or
issuance of Capital Stock to the Company or a Wholly Owned Restricted
Subsidiary, (ii) any sale or issuance of Common Stock to directors as director
qualifying shares, but only to the extent required under applicable law, (iii)
any sale or other disposition of all, but not less than all, of the issued and
outstanding Capital Stock of any Restricted Subsidiary owned by the Company and
the Restricted Subsidiaries or (iv) any sale or issuance of Capital Stock of a
Restricted Subsidiary (other than pursuant to clauses (i) or (ii)) if such
Restricted Subsidiary would no longer be a Restricted Subsidiary immediately
after such transaction and any Investment in such Person remaining after giving
effect to such sale or issuance would have been permitted to be made under the
covenant described under "--LIMITATION ON RESTRICTED PAYMENTS," and, in the case
of both (iii) and (iv), in compliance with the covenant described under
"--DISPOSITION OF PROCEEDS OF ASSET SALES."
LIMITATION ON TRANSACTIONS WITH AFFILIATES. The Indenture provides that the
Company shall not, and shall not permit, cause or suffer any Restricted
Subsidiary to, directly or indirectly, conduct any business, sell, lease,
transfer or otherwise dispose of any of its properties or assets to, or purchase
any property or
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assets from, or enter into any contract, agreement, loan, advance or Guarantee
or engage in any other transaction (or series of related transactions which are
similar or part of a common plan) with or for the benefit of any of their
respective Affiliates or any beneficial owner of 10% or more of the Common Stock
of the Company or any officer or director of the Company or any Subsidiary
(each, an "Affiliate Transaction"), unless the terms of the Affiliate
Transaction are set forth in writing and are no less favorable to the Company or
such Restricted Subsidiary, as the case may be, than would be available in a
comparable transaction with an unaffiliated third party. Each Affiliate
Transaction (or series of related Affiliate Transactions) involving aggregate
payments and/or other consideration having Fair Market Value (i) in excess of
$1.0 million shall be approved by a majority of the Board, such approval to be
evidenced by a Board Resolution stating that the Board has determined that such
transaction or transactions comply with the foregoing provisions, (ii) in excess
of $5.0 million shall further require the approval of a majority of the
Disinterested Directors and (iii) in excess of $10.0 million shall further
require that the Company obtain a written opinion from an Independent Financial
Advisor stating that the terms of such Affiliate Transaction (or series of
related Affiliate Transactions) are fair to the Company or the Restricted
Subsidiary, as the case may be, from a financial point of view; PROVIDED that
this clause (iii) shall not apply to purchases of goods and/or services in the
ordinary course of the Company's business, and on terms no less favorable to the
Company than those customarily granted to purchasers of such goods and/or
services, from Paradyne Corporation or Xylan Corporation. For purposes of this
covenant, any Affiliate Transaction approved by a majority of the Disinterested
Directors or as to which a written opinion has been obtained from an Independent
Financial Advisor, on the basis set forth in the preceding sentence, shall be
deemed to be on terms that are no less favorable to the Company or such
Restricted Subsidiary, as the case may be, than would be available in a
comparable transaction with an unaffiliated third party and, therefore, shall be
permitted under this covenant.
Notwithstanding the foregoing, the restrictions set forth in this covenant
shall not apply to (i) transactions with or among, or solely for the benefit of,
the Company and/or any of the Restricted Subsidiaries, provided that in any such
case, no officer, director or beneficial owner of 10% or more of any class of
Capital Stock of the Company shall beneficially own any Capital Stock of any
such Restricted Subsidiary, (ii) transactions pursuant to agreements and
arrangements existing on the Issue Date and specified on a schedule to the
Indenture, (iii) any Restricted Payment made in compliance with the covenant
"--LIMITATION ON RESTRICTED PAYMENTS," (iv) the payment of reasonable and
customary regular fees to directors of the Company or any Restricted Subsidiary
who are not employees of the Company or any Restricted Subsidiary, (v)
employment agreements, stock option agreements and indemnification arrangements
entered into by the Company or any of its Restricted Subsidiaries in the
ordinary course of business and consistent with industry practice, (vi) the
granting and performance of registration rights for securities of the Company,
(vii) loans and advances to officers, directors and employees of the Company or
any Restricted Subsidiary for travel, entertainment, moving and other relocation
expenses, in each case made in the ordinary course of business and consistent
with industry practice, and (viii) any Permitted Investment.
BUSINESS ACTIVITIES. Pursuant to the Indenture, the Company will not, and
will not permit any Restricted Subsidiary to, engage in any business other than
the Permitted Business.
LIMITATION ON ISSUANCES OF GUARANTEES BY RESTRICTED SUBSIDIARIES. The
Indenture prohibits the Company from permitting any Restricted Subsidiary,
directly or indirectly, to Guarantee the payment of any other Indebtedness of
the Company unless such Restricted Subsidiary simultaneously executes and
delivers a supplemental indenture to the Indenture providing for the Guarantee
of the payment of the Notes by such Restricted Subsidiary, which Guarantee shall
be senior to or PARI PASSU with such Restricted Subsidiary's Guarantee of such
other Indebtedness; provided that this paragraph shall not apply to any
Guarantee of Indebtedness described in clause (h) of the definition of
"Permitted Indebtedness." Notwithstanding the foregoing, any such Guarantee by a
Restricted Subsidiary of the Notes shall provide by its terms that it shall be
automatically and unconditionally released and discharged upon (i) any sale,
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exchange or transfer, to any Person not an Affiliate of the Company, of all of
the Company's stock in, or all or substantially all the assets of, such
Restricted Subsidiary, which sale, exchange or transfer is made in compliance
with the applicable provisions of the Indenture, (ii) the Designation of such
Restricted Subsidiary as an Unrestricted Subsidiary in compliance with the
covenant described under "--LIMITATION ON DESIGNATIONS OF UNRESTRICTED
SUBSIDIARIES" or (iii) the release of such Restricted Subsidiary from all of its
obligations under all of its Guarantees of Indebtedness of the Company. A form
of such Guarantee is attached as an exhibit to the Indenture.
LIMITATION ON SALE/LEASEBACK TRANSACTIONS. The Indenture prohibits the
Company and its Restricted Subsidiaries from, directly or indirectly, entering
into, assuming, Guaranteeing or otherwise becoming liable with respect to any
Sale/Leaseback Transaction. However, the Company or any Restricted Subsidiary
may enter into any such transaction if (i) the Company or such Restricted
Subsidiary would be permitted under the covenants described above under
"--LIMITATION ON ADDITIONAL INDEBTEDNESS" and "--LIMITATION ON LIENS SECURING
CERTAIN INDEBTEDNESS" to incur secured Indebtedness in an amount equal to the
Attributable Debt with respect to such transaction; (ii) the consideration
received by the Company or such Restricted Subsidiary from such transaction is
at least equal to the Fair Market Value of the property being transferred, and
(iii) to the extent that such transaction constitutes an Asset Sale, the Net
Cash Proceeds received by the Company or such Restricted Subsidiary from such
transaction are applied in accordance with the covenant described above under
"--DISPOSITION OF PROCEEDS OF ASSET SALES."
REPORTS. The Indenture provides that, whether or not the Company is subject
to Section 13(a) or 15(d) of the Exchange Act or any successor provision of law,
the Company shall furnish without cost to each holder of Notes and file with the
Trustee (i) within 135 days after the end of each fiscal year of the Company,
financial information that would be required to be contained in an annual report
on Form 10-K for such year filed by the Company with the SEC (whether or not the
Company is then required to file such Form with the SEC), including a
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and audited financial statements of the Company, including a report
thereon by the Company's certified public accountants, (ii) within 60 days after
the end of each of the first three fiscal quarters of each fiscal year of the
Company, financial information that would be required to be contained in a
quarterly report on Form 10-Q filed by the Company with the SEC (whether or not
the Company is then required to file such Form with the SEC), including a
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and (iii) on a timely basis, any information concerning the Company
or any Restricted Subsidiary required to be contained in a current report on
Form 8-K (whether or not the Company is then required to file such Form with the
SEC). Until such time as the Company is otherwise required to file periodic
reports with the SEC under the Exchange Act (or any successor provision of law),
the Company will file with the SEC (if permitted by SEC practice and applicable
law and regulations), for public availability, a copy of the annual and
quarterly financial information and other information prepared by it for
distribution to holders of Notes and filing with the Trustee. In addition, for
so long as any Notes remain outstanding, the Company shall furnish to securities
analysts and prospective investors, upon their request, the information required
to be delivered pursuant to Rule 144A(d)(4) under the Securities Act, and, to
any beneficial holder of Notes, if not obtainable from the SEC, information of
the type that would be filed with the SEC pursuant to the foregoing provisions,
upon the request of any such holder.
LIMITATION ON DESIGNATIONS OF UNRESTRICTED SUBSIDIARIES. The Indenture
provides that the Company will not designate any Subsidiary of the Company
(other than a newly created Subsidiary in which the Company has made an
Investment of $1,000 or less) as an "Unrestricted Subsidiary" under the
Indenture (a "Designation") unless:
(a) no Default shall have occurred and be continuing at the time of or
after giving effect to such Designation; and
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(b) the Company would be permitted under the Indenture to make an
Investment at the time of such Designation (assuming the effectiveness of
such Designation) in an amount (the "Designation Amount") equal to the Fair
Market Value of the interest of the Company and its Restricted Subsidiaries
in such Subsidiary on such date.
In the event of any such Designation, the Company shall be deemed to have
made an Investment constituting a Restricted Payment pursuant to the covenant
"--LIMITATION ON RESTRICTED PAYMENTS" for all purposes of the Indenture in an
amount equal to the Designation Amount. The Indenture will further provide that
neither the Company nor any Restricted Subsidiary shall at any time (x) provide
a Guarantee of, or similar credit support for, or subject any of its properties
or assets (other than the Capital Stock of any Unrestricted Subsidiary) to the
satisfaction of, any Indebtedness of any Unrestricted Subsidiary (including any
undertaking, agreement or instrument evidencing such Indebtedness), (y) be
directly or indirectly liable for any Indebtedness of any Unrestricted
Subsidiary or (z) be directly or indirectly liable for any other Indebtedness
which provides that the holder thereof may (upon notice, lapse of time or both)
declare a default thereon (or cause the payment thereof to be accelerated or
payable prior to its final scheduled maturity) upon the occurrence of a default
with respect to any other Indebtedness that is Indebtedness of an Unrestricted
Subsidiary (including any corresponding right to take enforcement action against
such Unrestricted Subsidiary), except in the case of clause (x) or (y) to the
extent otherwise permitted under the Indenture, including, without limitation,
under the covenant "--LIMITATION ON RESTRICTED PAYMENTS" above.
The Indenture further provides that the Company will not revoke any
Designation of a Subsidiary as an Unrestricted Subsidiary (a "Revocation")
unless:
(a) no Default shall have occurred and be continuing at the time of and
after giving effect to such Revocation; and
(b) all Liens and Indebtedness of such Unrestricted Subsidiary
outstanding immediately following such Revocation would, if incurred at such
time, have been permitted to be incurred for all purposes of the Indenture.
All Designations and Revocations must be evidenced by Board Resolutions and
officers' certificates delivered to the Trustee certifying compliance with the
foregoing provisions.
LIMITATION ON STATUS AS INVESTMENT COMPANY. The Indenture provides that the
Company will not, and will not permit any of its Subsidiaries or Affiliates to,
conduct its business in a fashion that would cause the Company to be required to
register as an "investment company" (as that term is defined in the Investment
Company Act of 1940, as amended (the "Investment Company Act")), or otherwise
become subject to regulation under the Investment Company Act. For purposes of
establishing the Company's compliance with this provision, any exemption that is
or would become available under Section 3(c)(1) or Section 3(c)(7) of the
Investment Company Act will be disregarded.
CONSOLIDATION, MERGER, SALE OF ASSETS, ETC.
The Indenture provides that the Company will not (i) consolidate or combine
with or merge with or into or, directly or indirectly, sell, assign, convey,
lease, transfer or otherwise dispose of all or substantially all of its
properties and assets to any Person or Persons in a single transaction or
through a series of transactions, or (ii) permit any of the Restricted
Subsidiaries to enter into any such transaction or series of transactions if it
would result in the disposition of all or substantially all of the properties or
assets of the Company and the Restricted Subsidiaries on a consolidated basis,
unless, in the case of either (i) or (ii), (a) the Company shall be the
continuing Person or, if the Company is not the continuing Person, the
resulting, surviving or transferee Person (the "surviving entity") shall be a
company organized and existing under the laws of the United States or any State
or territory thereof; (b) the surviving entity (if other than the Company) shall
expressly assume all of the obligations of the Company under the Notes and the
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Indenture, and shall execute a supplemental indenture to effect such assumption
which supplemental indenture shall be delivered to the Trustee and shall be in
form and substance reasonably satisfactory to the Trustee; (c) immediately after
giving effect to such transaction or series of transactions on a pro forma basis
(including, without limitation, any Indebtedness incurred or anticipated to be
incurred in connection with or in respect of such transaction or series of
transactions), (I) the Company or the surviving entity (assuming such surviving
entity's assumption of the Company's obligations under the Notes and the
Indenture), as the case may be, would be able to incur $1.00 of Indebtedness
(other than Permitted Indebtedness) under the covenant described under
"--Certain Covenants--LIMITATION ON ADDITIONAL INDEBTEDNESS" above, and (II) the
Company or the surviving entity, as the case may be, would have a Consolidated
Net Worth equal to or greater than the Consolidated Net Worth of the Company
immediately prior to such transaction or series of transactions; (d) immediately
after giving effect to such transaction or series of transactions on a pro forma
basis (including, without limitation, any Indebtedness incurred or anticipated
to be incurred in connection with or in respect of such transaction or series of
transactions), no Default shall have occurred and be continuing; and (e) the
Company or the surviving entity, as the case may be, shall have delivered to the
Trustee an Officers' Certificate and an Opinion of Counsel stating that such
transaction or series of transactions and, if a supplemental indenture is
required in connection with such transaction or series of transactions to
effectuate such assumption, such supplemental indenture, complies with this
covenant and that all conditions precedent in the Indenture relating to the
transaction or series of transactions have been satisfied.
Upon any consolidation or merger or any sale, assignment, conveyance, lease,
transfer or other disposition of all or substantially all of the assets of the
Company in accordance with the foregoing in which the Company or the Restricted
Subsidiary, as the case may be, is not the surviving corporation, then the
successor corporation formed by such a consolidation or into which the Company
or such Restricted Subsidiary is merged or to which such transfer is made, will
succeed to, and be substituted for, and may exercise every right and power of,
the Company or such Restricted Subsidiary, as the case may be, under the
Indenture with the same effect as if such successor corporation had been named
as the Company or such Restricted Subsidiary therein; and thereafter, except in
the case of (i) any lease or (ii) any sale, assignment, conveyance, transfer,
lease or other disposition to a Restricted Subsidiary of the Company, the
Company shall be discharged from all obligations and covenants under the
Indenture and the Notes.
The Indenture provides that, for all purposes of the Indenture (including
the provisions of this covenant and the covenants described under "--Certain
Covenants--LIMITATION ON ADDITIONAL INDEBTEDNESS," "--LIMITATION ON RESTRICTED
PAYMENTS" and "--LIMITATION ON LIENS SECURING CERTAIN INDEBTEDNESS") and the
Notes, Subsidiaries of any surviving entity will, upon such transaction or
series of related transactions, become Restricted Subsidiaries or Unrestricted
Subsidiaries as provided pursuant to the covenant "--Certain
Covenants--Limitation on Designations of Unrestricted Subsidiaries," and all
Indebtedness, and all Liens on property or assets, of the surviving entity and
the Restricted Subsidiaries (except Indebtedness, or Liens on property or
assets, of the Company and the Restricted Subsidiaries in existence immediately
prior to such transaction or series of related transactions) will be deemed to
have been incurred upon such transaction or series of related transactions.
The meaning of the phrase "all or substantially all" as used above varies
according to the facts and circumstances of the subject transaction, has no
clearly established meaning under relevant law and is subject to judicial
interpretation. Accordingly, in certain circumstances, there may be a degree of
uncertainty in ascertaining whether a particular transaction would involve a
disposition of "all or substantially all" of the assets of the Company, and
therefore it may be unclear whether the foregoing provisions are applicable.
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EVENTS OF DEFAULT
The following are "Events of Default" under the Indenture:
(i) default in the payment of interest on the Notes when it becomes due
and payable and continuance of such default for a period of 30 days or more;
or
(ii) default in the payment of the principal of, or premium, if any, on
the Notes when due at maturity, upon redemption or otherwise; or
(iii) default in the performance, or breach, of any covenant described
under "--Certain Covenants--CHANGE OF CONTROL," "--DISPOSITION OF PROCEEDS
OF ASSET SALES" OR "--CONSOLIDATION, MERGER, SALE OF ASSETS, ETC."; or
(iv) default in the performance, or breach, of any covenant in the
Indenture (other than defaults specified in clause (i), (ii) or (iii)
above), and continuance of such default or breach for a period of 30 days or
more after written notice to the Company by the Trustee or to the Company
and the Trustee by the holders of at least 25% in aggregate principal amount
at maturity of the outstanding Notes (in each case, when such notice is
deemed given in accordance with the Indenture); or
(v) (a) failure to pay, following any applicable grace period, any
installment of principal due (whether at maturity or otherwise) under one or
more classes or issues of Indebtedness in an aggregate principal amount of
$5.0 million or more under which the Company or any Restricted Subsidiary is
obligated or (b) failure by the Company or any Restricted Subsidiary to
perform any other term, covenant, condition or provision of one or more
classes or issues of Indebtedness in an aggregate principal amount of $5.0
million or more under which the Company or such Restricted Subsidiary is
obligated and, in the case of this clause (b), such failure results in an
acceleration of the maturity thereof; or
(vi) one or more judgments, orders or decrees for the payment of money
of $5.0 million or more, either individually or in the aggregate, shall be
entered against the Company or any Restricted Subsidiary or any of their
respective properties and shall not be paid or discharged and there shall
have been a period of 60 consecutive days or more during which a stay of
enforcement of such judgment or order, by reason of pending appeal or
otherwise, shall not be in effect; or
(vii) certain events of bankruptcy, insolvency, reorganization,
administration or similar proceedings with respect to the Company or any
Restricted Subsidiary shall have occurred; or
(viii) the Indenture or the Registration Rights Agreement ceases to be
in force and effect in all material respects (other than with respect to the
invalidity or alleged invalidity of any provision in the Registration Rights
Agreement regarding indemnification for matters arising under the federal
securities laws) or is declared null and void or the Company denies that it
has any further obligation or liability thereunder or gives notice to that
effect (other than by reason of termination or release in accordance with
the terms thereof).
If an Event of Default (other than an Event of Default specified in clause
(vii) above with respect to the Company or any Restricted Subsidiary) occurs and
is continuing, then the Trustee or the holders of at least 25% in principal
amount at maturity of the outstanding Notes may, by written notice, and the
Trustee upon the request of the holders of not less than 25% in principal amount
at maturity of the outstanding Notes shall, declare the Default Amount of all
outstanding Notes to be immediately due and payable and upon any such
declaration such amount shall become immediately due and payable. If an Event of
Default specified in clause (vii) above with respect to the Company or any
Restricted Subsidiary occurs and is continuing, then the Default Amount of all
outstanding Notes shall ipso facto become and be immediately due and payable
without any declaration or other act on the part of the Trustee or any holder.
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After a declaration of acceleration, the holders of a majority in aggregate
principal amount at maturity of outstanding Notes may, by notice to the Trustee,
rescind such declaration of acceleration if all existing Events of Default,
other than nonpayment of the Default Amount of the Notes that has become due
solely as a result of such acceleration, have been cured or waived and if the
rescission of acceleration would not conflict with any judgment or decree. The
holders of a majority in principal amount at maturity of the outstanding Notes
also have the right to waive past defaults under the Indenture, except a default
in the payment of principal of, or any interest on, any outstanding Note, or in
respect of certain covenants or provisions that cannot be modified or amended
without the consent of all holders of Notes.
No holder of any of the Notes has any right to institute any proceeding with
respect to the Indenture or any remedy thereunder, unless (i) the holders of at
least 25% in principal amount at maturity of the outstanding Notes have made
written request, and offered reasonable security or indemnity, to the Trustee to
institute such proceeding as Trustee, (ii) the Trustee has failed to institute
such proceeding within 60 days after receipt of such notice, and (iii) the
Trustee has not within such 60-day period received directions inconsistent with
such written request by holders of a majority in principal amount at maturity of
the outstanding Notes. Such limitations do not apply, however, to a suit
instituted by a holder of a Note for the enforcement of the payment of the
principal of, or any accrued and unpaid interest on, such Note on or after the
respective due dates expressed in such Note.
During the existence of an Event of Default, the Trustee is required to
exercise such rights and powers vested in it under the Indenture and use the
same degree of care and skill in its exercise thereof as a prudent person would
exercise under the circumstances in the conduct of such person's own affairs.
Subject to the provisions of the Indenture relating to the duties of the
Trustee, if an Event of Default shall occur and be continuing, the Trustee is
not under any obligation to exercise any of its rights or powers under the
Indenture at the request or direction of any of the holders unless such holders
shall have offered to such Trustee reasonable security or indemnity. Subject to
certain provisions concerning the rights of the Trustee, the holders of a
majority in principal amount at maturity of the outstanding Notes have the right
to direct the time, method and place of conducting any proceeding for any remedy
available to the Trustee or exercising any trust or power conferred on the
Trustee.
The Indenture provides that the Trustee will, within 30 days after the
occurrence of any Default, give to the holders of the Notes notice of such
Default known to it, unless such Default shall have been cured or waived;
provided that the Trustee shall be protected in withholding such notice if it
determines in good faith that the withholding of such notice is in the interest
of such holders.
The Company is required to furnish to the Trustee annually a statement as to
its compliance with all conditions and covenants under the Indenture.
DEFEASANCE
The Company may at any time terminate all of its obligations with respect to
the Notes ("defeasance"), except for certain obligations, including those
regarding any trust established for a defeasance and obligations to register the
transfer or exchange of the Notes, to replace mutilated, destroyed, lost or
stolen Notes as required by the Indenture and to maintain agencies in respect of
Notes. The Company may at any time terminate its obligations under certain
covenants set forth in the Indenture, some of which are described under
"--Certain Covenants"above, and any omission to comply with such obligations
shall not constitute a Default or an Event of Default with respect to the Notes
("covenant defeasance"). To exercise either defeasance or covenant defeasance,
the Company must irrevocably deposit in trust, for the benefit of the holders of
the Notes, with the Trustee money (in United States dollars) or U.S. government
obligations (denominated in United States dollars), or a combination thereof, in
such amounts as will be sufficient to pay the Accreted Value of and premium, if
any, and accrued but unpaid interest on the Notes to redemption or maturity and
comply with certain other conditions, including the delivery of a legal opinion
as to certain tax matters. The requirements for defeasance shall not be deemed
satisfied if a
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Default specified in clause (vii) of "--Events of Default" above occurs on or
prior to the 91st calendar day after the date of the deposit of money or
securities in the defeasance trust.
SATISFACTION AND DISCHARGE
The Indenture will be discharged and will cease to be of further effect
(except as to surviving rights or registration of transfer or exchange of Notes)
as to all outstanding Notes when either (a) all such Notes theretofore
authenticated and delivered (except lost, stolen or destroyed Notes that have
been replaced or paid and Notes for whose payment money has theretofore been
deposited in trust or segregated and held in trust by the Company and thereafter
repaid to the Company or discharged from such trust) have been delivered to the
Trustee for cancellation; or (b) (i) all such Notes not theretofore delivered to
the Trustee for cancellation have become due and payable and the Company has
irrevocably deposited or caused to be deposited with the Trustee as trust funds
in trust for the purpose an amount of money sufficient to pay and discharge the
entire indebtedness on the Notes not theretofore delivered to the Trustee for
cancellation, for principal amount, premium, if any, and accrued and unpaid
interest to the date of such deposit; (ii) the Company has paid all sums payable
by it under the Indenture; and (iii) the Company has delivered irrevocable
instructions to the Trustee to apply the deposited money toward the payment of
the Notes at maturity or on the redemption date, as the case may be. In
addition, the Company must deliver an Officers' Certificate and an Opinion of
Counsel stating that all conditions precedent to satisfaction and discharge have
been complied with.
AMENDMENT AND WAIVERS
From time to time, the Company, when authorized by resolutions of the Board,
and the Trustee, without the consent of the holders of the Notes, may amend,
waive or supplement the Indenture or the Notes for certain specified purposes,
including, among other things, curing ambiguities, defects or inconsistencies,
maintaining the qualification of the Indenture under the Trust Indenture Act or
making any change that does not adversely affect the rights of any holder. Other
amendments and modifications of the Indenture and the Notes may be made by the
Company and the Trustee by supplemental indenture with the consent of the
holders of not less than a majority of the aggregate principal amount at
maturity of the outstanding Notes; PROVIDED that no such modification or
amendment may, without the consent of the holder of each outstanding Note
affected thereby, (i) reduce the principal amount at maturity of, change the
fixed maturity of, or alter the redemption provisions of, the Notes or amend or
modify the calculation of the Accreted Value or the Default Amount so as to
reduce the amount of the Accreted Value or the Default Amount, (ii) change the
currency in which any Notes or amounts owing thereon is payable, (iii) reduce
the percentage of the aggregate principal amount at maturity of the outstanding
Notes which must consent to an amendment, supplement or waiver or consent to
take any action under the Indenture or the Notes, (iv) impair the right to
institute suit for the enforcement of any payment on or with respect to the
Notes, (v) waive a default in payment with respect to the Notes, except a
rescission of acceleration of the relevant Notes by the holders thereof as
provided in the Indenture and a waiver of the payment default that resulted from
such acceleration, (vi) reduce the rate or change the time for payment of
interest on the Notes, (vii) alter the Company's obligation to purchase the
Notes following the occurrence of a Change of Control or an Asset Sale in
accordance with the Indenture or waive any default in the performance thereof or
(viii) affect the ranking of the Notes in a manner adverse to the holder of the
Notes.
Holders of a majority in aggregate principal amount at maturity of the
outstanding Notes, on behalf of all holders of Notes, may waive compliance by
the Company with certain restrictive provisions of the Indenture. Subject to
certain rights of the Trustee as provided in the Indenture, the holders of a
majority in aggregate principal amount at maturity of the Notes, on behalf of
all holders, may waive any past Default under the Indenture (including any such
waiver obtained in connection with a tender offer or exchange offer for such
Notes), except a default in the payment of principal or interest or a Default
arising from failure to purchase any Notes tendered pursuant to an offer to
purchase required to be made by any
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provision of the Indenture, or a Default in respect of a provision that under
the Indenture cannot be modified or amended without the consent of the holder of
each Note that is affected.
REGARDING THE TRUSTEE
State Street Bank and Trust Company of California, N.A. will serve as
Trustee under the Indenture.
GOVERNING LAW
The Indenture provides that the Indenture and the Notes, respectively, will
be governed by and construed in accordance with the laws of the State of New
York, without giving effect to principles of conflicts of law.
CERTAIN DEFINITIONS
Set forth below is a summary of certain defined terms used in the Indenture.
Reference is made to the Indenture for the full definition of all such terms, as
well as any other capitalized terms used herein for which no definition is
provided.
"Accreted Value" means, as of any date (the "Specified Date"), with respect
to each $1,000 principal amount at maturity of Notes:
(i) if the Specified Date is one of the following dates (each a
"Semi-Annual Accrual Date"), the amount set forth opposite such date below:
<TABLE>
<CAPTION>
SEMI-ANNUAL ACCRETED
ACCRUAL DATE VALUE
- --------------------------------------------------------------------------------- ----------
<S> <C>
Issue Date....................................................................... $ 518.50
May 15, 1998..................................................................... $ 520.38
November 15, 1998................................................................ $ 555.51
May 15, 1999..................................................................... $ 593.00
November 15, 1999................................................................ $ 633.03
May 15, 2000..................................................................... $ 675.76
November 15, 2000................................................................ $ 721.37
May 15, 2001..................................................................... $ 770.07
November 15, 2001................................................................ $ 822.05
May 15, 2002..................................................................... $ 877.53
November 15, 2002................................................................ $ 936.77
May 15, 2003..................................................................... $ 1,000.00
</TABLE>
(ii) if the Specified Date occurs between two Semi-Annual Accrual Dates,
the sum of (A) the Accreted Value for the Semi-Annual Accrual Date
immediately preceding the Specified Date and (B) an amount equal to the
product of (x) the Accreted Value for the Semi-Annual Accrual Date
immediately following the Specified Date less the Accreted Value for the
Semi-Annual Accrual Date immediately preceding the Specified Date and (y) a
fraction, the numerator of which is the number of days actually elapsed from
the immediately preceding Semi-Annual Accrual Date to the Specified Date,
using a 360-day year of twelve 30-day months, and the denominator of which
is 180; and
(iii) if the Specified Date is on or after May 15, 2003, $1,000.
"Acquired Indebtedness" means Indebtedness of a Person (i) assumed in
connection with an Asset Acquisition from such Person or (ii) existing at the
time such Person is merged or consolidated with or into the Company or any
Restricted Subsidiary or becomes a Restricted Subsidiary, in each case not
incurred in connection with, or in anticipation of, such Asset Acquisition or
merger or consolidation or such Person becoming a Restricted Subsidiary;
PROVIDED that Indebtedness of such Person which is redeemed, defeased,
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retired or otherwise repaid at the time of or immediately upon consummation of
such Asset Acquisition or the transactions by which such Person is merged or
consolidated with or into the Company or any Restricted Subsidiary or becomes a
Restricted Subsidiary shall not constitute Acquired Indebtedness.
"Affiliate" of any specified Person means (i) any other Person which,
directly or indirectly, controls, is controlled by or is under direct or
indirect common control with, the specified Person, (ii) any other Person that
owns, directly or indirectly, 10% or more of the specified Person's Voting Stock
or (iii) any executive officer or director of the specified Person; provided
that Donaldson, Lufkin & Jenrette, Inc. and its Affiliates shall not be deemed
to be Affiliates of the Company solely as a result of such entities holding the
Units, the Notes, the Warrants, the Series A Preferred Stock or the Series B
Preferred Stock (or any security which is convertible into or exchangeable for
any of the foregoing) or having the right to nominate and have elected one
member of the Board. For the purposes of this definition, "control" when used
with respect to any Person means the power to direct the management and policies
of such Person, directly or indirectly, whether through the ownership of voting
securities, by contract or otherwise, and the terms "affiliated," "controlling"
and "controlled" have meanings correlative to the foregoing.
"Asset Acquisition" means (i) any capital contribution (by means of
transfers of cash or other property to others or payments for property or
services for the account or use of others, or otherwise) by the Company or any
Restricted Subsidiary in any other Person, or any acquisition or purchase of
Capital Stock of any other Person by the Company or any Restricted Subsidiary,
in either case pursuant to which such Person shall (a) become a Restricted
Subsidiary or (b) shall be merged or consolidated with or into the Company or
any Restricted Subsidiary or (ii) any acquisition by the Company or any
Restricted Subsidiary of the assets of any Person which constitute substantially
all of an operating unit or line of business of such Person or which is
otherwise outside of the ordinary course of business.
"Asset Sale" means any direct or indirect sale, conveyance, transfer or
lease (that has the effect of a disposition and is not for security purposes) or
other disposition (that is not for security purposes) (including by way of a
Sale/Leaseback Transaction) to any Person other than the Company or a Restricted
Subsidiary, in one transaction or a series of related transactions, of (i) any
Capital Stock of any Restricted Subsidiary, (ii) any assets of the Company or
any Restricted Subsidiary which constitute substantially all of an operating
unit or line of business of the Company and the Restricted Subsidiaries or (iii)
any other property or asset of the Company or any Restricted Subsidiary outside
of the ordinary course of business. For the purposes of this definition, the
term "Asset Sale" shall not include (i) any disposition of properties and assets
of the Company that is governed under "--Consolidation, Merger, Sale of Assets,
Etc." above, (ii) sales of property or equipment that have become worn out,
obsolete or damaged or otherwise unsuitable for use in connection with the
business of the Company or any Restricted Subsidiary, as the case may be, and
(iii) for purposes of the covenant "--Certain Covenants--DISPOSITION OF PROCEEDS
OF ASSET SALES," (a) sales, conveyances, transfers, leases or other dispositions
of property or assets, whether in one transaction or a series of related
transactions occurring within one year, involving assets with a Fair Market
Value not in excess of $500,000 in any 12 month period and (b) any asset of the
Company or a Restricted Subsidiary that is the subject of a Sale/Leaseback
Transaction with a Person (other than the Company or an Affiliate of the
Company) made in accordance with the covenant described under "--Certain
Covenants-- LIMITATION ON SALE/LEASEBACK TRANSACTIONS" and that was acquired by
the Company or such Restricted Subsidiary no more than 120 days prior to the
transfer to a third party in a Sale/Leaseback Transaction.
"Attributable Debt" in respect of a Sale/Leaseback Transaction means, as at
the time of determination, the present value (discounted at the interest rate
implicit in the terms of the lease included in such Sale/Leaseback Transaction)
of the total obligations of the lessee for rental payments during the remaining
term of the lease included in such Sale/Leaseback Transaction (including any
period for which such lease has been extended).
"Average Life to Stated Maturity" means, with respect to any Indebtedness,
as at any date of determination, the quotient obtained by dividing (i) the sum
of the products of (a) the number of years
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from such date to the date or dates of each successive scheduled principal
payment (including, without limitation, any sinking fund requirements) of such
Indebtedness multiplied by (b) the amount of each such principal payment by (ii)
the sum of all such principal payments; provided that, in the case of any
Capitalized Lease Obligation, all calculations hereunder shall give effect to
any applicable options to renew in favor of the Company or any Restricted
Subsidiary.
"Board" means the Board of Directors of the Company.
"Board Resolution" means a copy of a resolution certified by the Secretary
or an Assistant Secretary of the Company to have been duly adopted by the Board
and to be in full force and effect on the date of such certification, and
delivered to the Trustee.
"Capital Stock" means, with respect to any Person, any and all shares,
interests, participations, rights in, or other equivalents (however designated
and whether voting and/or non-voting) of, such Person's capital stock, including
Preferred Stock, whether outstanding on the Issue Date or issued after the Issue
Date, and any and all rights (other than any evidence of Indebtedness), warrants
or options exchangeable for or convertible into such capital stock.
"Capitalized Lease Obligation" means any obligation to pay rent or other
amounts under a lease of (or other agreement conveying the right to use) any
property (whether real, personal or mixed, immovable or movable) that is
required to be classified and accounted for as a capitalized lease obligation
under GAAP, and, for the purpose of the Indenture, the amount of such obligation
at any date shall be the capitalized amount thereof at such date, determined in
accordance with GAAP.
"Cash Equivalents" means (i) any evidence of Indebtedness which matures 365
days or less from the date of purchase or acquisition issued or directly and
fully guaranteed or insured by the United States Government or any agency or
instrumentality thereof (provided that the full faith and credit of the United
States Government is pledged in support thereof or such Indebtedness constitutes
a general obligation of such country); (ii) deposits, certificates of deposit or
acceptances with a maturity of 365 days or less of any financial institution
that is a member of the Federal Reserve System, in each case having combined
capital and surplus and undivided profits (or any similar capital concept) of
not less than $500.0 million and whose senior unsecured debt is rated at least
"A-1" by S&P or "P-1" by Moody's; (iii) commercial paper with a maturity of 365
days or less issued by a corporation (other than an Affiliate of the Company)
organized under the laws of the United States or any State thereof and rated at
least "A-1" by S&P or "P-1" by Moody's; (iv) repurchase agreements and reverse
repurchase agreements relating to marketable direct obligations issued or
unconditionally guaranteed by the United States Government or issued by any
agency thereof and backed by the full faith and credit of the United States
Government maturing within 365 days from the date of acquisition; and (v) money
market funds in the United States which invest substantially all of their assets
in securities of the type described in any of the preceding clauses (i) through
(iv).
"Change of Control" means the occurrence of any of the following events: (a)
any "person" or "group" (as such terms are used in Sections 13(d) or 14(d) of
the Exchange Act, provided that no "group" shall be deemed to result solely from
the Investors' Rights Agreement (as defined herein), the Voting Agreement (as
defined herein) or the Voting Trust Agreement (as defined herein) or the
transactions contemplated thereby), excluding Permitted Holders, is or becomes
the "beneficial owner" (as defined in Rules 13d-3 or 13d-5 under the Exchange
Act, except that a person shall be deemed to have "beneficial ownership" of all
securities that such person has or acquires the right to acquire, whether such
right is exercisable immediately or only after the passage of time), directly or
indirectly, of more than 50% of the total voting power of all Voting Stock of
the Company (except that the person or group shall not be deemed the "beneficial
owner" of shares tendered pursuant to a tender or exchange offer made by that
person or group or any of their Affiliates until the tendered shares are
accepted for purchase or exchange) or has, directly or indirectly, the right to
elect or designate a majority of the Board or (b) the Company consolidates with,
or merges with or into, another person or sells, assigns, conveys, transfers,
leases or otherwise disposes of all or substantially all of its assets to any
person, or any person consolidates with, or
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merges with or into, the Company, in any such event pursuant to a transaction in
which the outstanding Voting Stock of the Company is converted into or exchanged
for cash, securities or other property, other than any such transaction where
(i) the outstanding Voting Stock of the Company is converted into or exchanged
for (1) Voting Stock (other than Disqualified Stock) of the surviving or
transferee corporation or its parent corporation and/or (2) cash, securities and
other property in any amount which could be paid by the Company as a Restricted
Payment under the Indenture, (ii) the "beneficial owners" (as so defined) of the
Voting Stock of the Company immediately before such transaction own, directly or
indirectly, immediately after such transaction, at least a majority of the
voting power of all Voting Stock of the surviving or transferee corporation or
its parent corporation immediately after such transaction, as applicable, or
(iii) immediately after such transaction, no "person" or "group" (as such terms
are defined above), excluding the Permitted Holders, is the "beneficial owner"
(as defined above), directly or indirectly, of more than 50% of the Voting Stock
of such surviving or transferee corporation or its parent corporation, as
applicable, or has, directly or indirectly, the right to elect or designate a
majority of the board of directors of the surviving or transferee corporation or
its parent corporation, as applicable, or (c) during any consecutive two-year
period, individuals who at the beginning of such period constituted the Board
(together with any new directors whose election by the Board or whose nomination
for election by the stockholders of the Company was approved by a vote of a
majority of the directors then still in office who were either directors at the
beginning of such period or whose election or nomination for election was
previously so approved) cease for any reason to constitute a majority of the
Board then in office. The good faith determination by the Board, based upon
advice of outside counsel, of the beneficial ownership of securities of the
Company within the meaning of Rules 13d-3 and 13d-5 under the Exchange Act shall
be conclusive, absent contrary controlling precedent or contrary written
interpretation published by the SEC. No inference shall be created that officers
or employees of the Company are acting as a "person" or "group" (as such terms
are used in Sections 13(d) or 14(d) of the Exchange Act) with the power to
designate a majority of the members of the Board solely because such officers or
employees constitute a majority of the members of the Board.
"Common Stock" means, with respect to any Person, any and all shares,
interests, participations or rights in, or other equivalents (however designated
and whether voting and/or nonvoting) of, such Person's common stock and
includes, without limitation, all series and classes of such common stock.
"Consolidated Income Tax Expense" means, with respect to any period, the
provision for federal, state, local, foreign and other income taxes of the
Company and the Restricted Subsidiaries for such period as determined on a
consolidated basis in accordance with GAAP.
"Consolidated Interest Expense" means, with respect to any period, without
duplication, the sum of (i) the interest expense of the Company and the
Restricted Subsidiaries for such period as determined on a consolidated basis in
accordance with GAAP, including, without limitation, (a) any amortization of
debt discount, (b) the net cost under Interest Rate Obligations (including any
amortization of discounts), (c) the interest portion of any deferred payment
obligation, (d) all commissions, discounts and other fees and charges owed with
respect to letters of credit and bankers' acceptance financing and similar
transactions and (e) all capitalized interest and accrued interest, (ii) the
interest component of Capitalized Lease Obligations paid, accrued and/or
scheduled to be paid or accrued by the Company and the Restricted Subsidiaries
during such period as determined on a consolidated basis in accordance with
GAAP, (iii) the portion of any rental obligation in respect of any
Sale/Leaseback Transaction allocable to interest expense (determined as if such
were treated as a Capital Lease Obligation), and (iv) the amount of dividends
and distributions in respect of Preferred Stock or Disqualified Stock paid by
the Restricted Subsidiaries to a Person other than the Company or a Restricted
Subsidiary or by the Company during such period.
"Consolidated Net Income" means, with respect to any period, the net income
(or loss) of the Company and the Restricted Subsidiaries for such period
determined on a consolidated basis in accordance with GAAP, adjusted, to the
extent included in calculating such consolidated net income (or loss), by
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excluding, without duplication, (i) all extraordinary, unusual or nonrecurring
gains or losses and all gains or losses from sales or other dispositions of
assets (including Asset Sales) out of the ordinary course of business (net of
taxes, fees and expenses relating to the transaction giving rise thereto) for
such period, (ii) that portion of such net income (or loss) derived from or in
respect of Investments in Persons other than Restricted Subsidiaries, except to
the extent of any cash dividends actually received by the Company or any
Restricted Subsidiary (subject, in the case of any Restricted Subsidiary, to the
provisions of clause (vi) of this definition); (iii) any gain or loss, net of
taxes, realized upon the termination of any employee pension benefit plan during
such period, (iv) that portion of such net income (or loss) allocable to
minority interests in any Restricted Subsidiary for such period, (v) net income
(or loss) of any other Person combined with the Company or any Restricted
Subsidiary on a "pooling of interests" basis attributable to any period prior to
the date of combination and (vi) the net income of any Restricted Subsidiary for
such period to the extent that the declaration of dividends or similar
distributions by that Restricted Subsidiary of that income is not at the time
permitted, directly or indirectly, by operation of the terms of its charter or
any agreement, instrument, judgment, decree, order, statute, rule or
governmental regulations applicable to that Restricted Subsidiary or its
stockholders.
"Consolidated Net Worth" means, with respect to any Person, the consolidated
stockholders' or partners' equity of such Person reflected on the most recent
balance sheet of such Person, determined in accordance with GAAP, less any
amounts attributable to redeemable capital stock (as determined under applicable
accounting standards promulgated by the SEC) of such Person.
"Consolidated Operating Cash Flow" means, with respect to any period,
Consolidated Net Income for such period (a) increased (without duplication), to
the extent deducted in arriving at such Consolidated Net Income, by the sum of
(i) Consolidated Income Tax Expense for such period; (ii) Consolidated Interest
Expense for such period; and (iii) depreciation, amortization and any other
non-cash items for such period of the Company and the Restricted Subsidiaries
(other than any non-cash item which requires the accrual of, or a reserve for,
cash charges for any future period), including, without limitation, amortization
of capitalized debt issuance costs for such period, all determined on a
consolidated basis in accordance with GAAP, and (b) decreased by any non-cash
items (including non-recurring gains and non-recurring items of income) to the
extent they increased Consolidated Net Income for such period (including any
partial or complete reversal of reserves taken in a prior period).
"Debt Securities" means any debt securities issued by the Company in a
public offering or in a private placement to institutional "accredited
investors" (as defined in Rule 501(a)(1), (2), (3) or (7) under the Securities
Act).
"Default" means any event that is, or after notice or passage of time or
both would be, an Event of Default.
"Default Amount" means (i) as of any date prior to May 15, 2003, the
Accreted Value of the Notes (and any applicable premium thereon) as of such date
and (ii) as of any date on and after May 15, 2003, the principal amount at
maturity of the Notes (and any applicable premium thereon) and any accrued and
unpaid interest thereon.
"Designation" and "Designation Amount" have the meanings set forth under
"--Certain Covenants--LIMITATION ON DESIGNATIONS OF UNRESTRICTED SUBSIDIARIES."
"Disinterested Director" means, with respect to any transaction or series of
related transactions, a member of the Board other than a director who (i) has
any material direct or indirect financial interest in or with respect to such
transaction or series of related transactions or (ii) is an employee or officer
of the Company or an Affiliate that is itself a party to such transaction or
series of transactions or an Affiliate of a party to such transaction or series
of related transactions.
"Disqualified Stock" means, with respect to any Person, any Capital Stock
which, by its terms (or by the terms of any security into which it is
convertible or for which it is exchangeable), or upon the
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happening of any event, matures or becomes mandatorily redeemable, pursuant to a
sinking fund obligation or otherwise, or becomes exchangeable for Indebtedness
at the option of the holder thereof, or becomes redeemable at the option of the
holder thereof, in whole or in part, on or prior to the final maturity date of
the Notes; PROVIDED that any Capital Stock that would not constitute
Disqualified Stock but for provisions thereof giving holders thereof the right
to require such Person to repurchase or redeem such Capital Stock upon the
occurrence of an "asset sale" or "change of control" occurring prior to the
final maturity date of the Notes will not constitute Disqualified Stock so long
as the "asset sale" or "change of control" provisions applicable to such Capital
Stock are no more favorable to the holders thereof than the provisions described
in "--Certain Covenants--CHANGE OF CONTROL" and "--DISPOSITION OF PROCEEDS OF
ASSET SALES" and such Capital Stock specifically provides that such Person will
not repurchase or redeem any such stock pursuant to such provision prior to the
Company's repurchase of such Notes as are required to be repurchased pursuant to
the provisions described in "-- Certain Covenants--CHANGE OF CONTROL" and
"--DISPOSITION OF PROCEEDS OF ASSET SALES."
"Exchange Act" means the Securities Exchange Act of 1934, as amended,
together with the rules and regulations promulgated thereunder.
"Fair Market Value" means, with respect to any asset or property, the price
(after taking into account any liabilities relating to such asset or property)
that could be negotiated in an arms-length free market transaction, for cash,
between a willing seller and a willing buyer, neither of whom is under pressure
or compulsion to complete the transaction. Unless otherwise specified in the
Indenture, Fair Market Value shall be determined by the Board acting in good
faith and shall be evidenced by a Board Resolution.
"GAAP" means, as of any date of determination, generally accepted accounting
principles set forth in the opinions and pronouncements of the Accounting
Principles Board of the American Institute of Certified Public Accountants and
statements and pronouncements of the Financial Accounting Standards Board, the
SEC or in such other statements by such other entity as may be approved by a
significant segment of the accounting profession of the United States, which are
in effect as of such date of determination and which are consistently applied
for all applicable periods.
"Guarantee" means, as applied to any obligation, (i) a guarantee (other than
by endorsement of negotiable instruments for collection in the ordinary course
of business), direct or indirect, in any manner, of any part or all of such
obligation and (ii) an agreement, direct or indirect, contingent or otherwise,
the practical effect of which is to assure in any way the payment or performance
(or payment of damages in the event of non-performance) of all or any part of
such obligation, including, without limiting the foregoing, any obligation (A)
to pay amounts drawn down by letters of credit, (B) to purchase or pay (or
advance or supply funds for the purchase or payment of) such obligation (whether
arising by virtue of partnership arrangement, agreements to keep-well, to
purchase assets, goods, securities or services, to take-or-pay, or to maintain
financial statement conditions or otherwise) or (C) entered into for purposes of
assuring in any other manner the obligee of such obligation of the payment
thereof or to protect such obligee against loss in respect thereof (in whole or
in part); PROVIDED that the term "Guarantee" shall not include endorsements for
collection or deposit in the ordinary course of business. The term "Guarantee"
used as a verb has a corresponding meaning.
"Indebtedness" means, with respect to any Person, without duplication
(whether or not the recourse of the lender is to the whole of the assets of such
Person or only to a portion thereof), (i) every liability of such Person,
whether or not contingent, (A) for borrowed money, (B) evidenced by notes,
bonds, debenture or other similar instruments (whether or not negotiable), (C)
for reimbursement of amounts expended under letters of credit, bankers'
acceptances or similar facilities issued for the account of such Person, (D)
issued or assumed as the deferred purchase price of property or services, (E)
relating to a Capitalized Lease Obligation and all Attributable Debt in respect
of Sale/Leaseback Transactions of such Person and (F) in respect of an Interest
Rate Obligation of such Person; (ii) every liability of others of the kind
described in the preceding clause (i) which such Person has Guaranteed or which
is otherwise its legal
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liability; or (iii) every obligation secured by a Lien (other than (x) Permitted
Liens of the types described in clauses (b), (d) or (e) of the definition of
Permitted Liens; provided that the obligations secured would not constitute
Indebtedness under clauses (i) or (ii) or (iii) of this definition, and (y)
Liens on Capital Stock or Indebtedness of any Unrestricted Subsidiary) to which
the property or assets of such Person are subject, whether or not the
obligations secured thereby shall have been assumed by or shall otherwise be
such Person's legal liability (the amount of such obligation being deemed to be
the lesser of the Fair Market Value of such property or asset or the amount of
the obligation so secured); (iv) all Disqualified Stock of such Person, valued
at the greater of its voluntary or involuntary maximum fixed repurchase or
redemption price (plus accrued and unpaid dividends to the date of
determination); and (v) any and all deferrals, renewals, extensions and
refundings of, or amendments, modifications or supplements to, any liability of
the kind described in any of the preceding clauses (i), (ii), (iii) or (iv). In
no event shall "Indebtedness" include trade payables and accrued liabilities
that are current liabilities incurred in the ordinary course of business,
excluding the current maturity of any obligation which would otherwise
constitute Indebtedness. For purposes of the covenants described under "--
Certain Covenants--LIMITATION ON ADDITIONAL INDEBTEDNESS" and "LIMITATION ON
RESTRICTED PAYMENTS" and the definition of "Events of Default," in determining
the principal amount of any Indebtedness to be incurred by the Company or a
Restricted Subsidiary or which is outstanding at any date, (i) the principal
amount of any Indebtedness which provides that an amount less than the principal
amount at maturity thereof shall be due upon any declaration of acceleration
thereof shall be the accreted value thereof at the date of determination; (ii)
the principal amount of any Indebtedness shall be reduced by any amount of cash
or Cash Equivalent collateral securing on a perfected basis, and dedicated for
disbursement exclusively to the payment of principal of and interest on, such
Indebtedness; and (iii) the amount of Indebtedness of any Person at any date
shall be the outstanding balance at such date of all unconditional obligations
as described above and the maximum liability of any Guarantees at such date.
"Indebtedness to EBITDA Ratio" means, as at any date of determination (the
"Transaction Date"), the ratio of (i) Total Consolidated Indebtedness (including
all Permitted Indebtedness) as at the Transaction Date to (ii) Consolidated
Operating Cash Flow for the four full fiscal quarters immediately preceding the
Transaction Date for which financial statements are available (such four full
fiscal quarter period being referred to herein as the "Measurement Period"). For
purposes of calculating Consolidated Operating Cash Flow for the relevant
Measurement Period prior to a Transaction Date, (A) any Person that is a
Restricted Subsidiary on the Transaction Date (or would become a Restricted
Subsidiary on such Transaction Date in connection with the transaction that
requires the calculation of such Consolidated Operating Cash Flow) shall be
deemed to have been a Restricted Subsidiary at all times during the Measurement
Period, (B) any Person that is not a Restricted Subsidiary on such Transaction
Date (or would cease to be a Restricted Subsidiary on such Transaction Date in
connection with the transaction that requires the calculation of Consolidated
Operating Cash Flow) will be deemed not to have been a Restricted Subsidiary at
any time during the Measurement Period, and (C) if the Company or any Restricted
Subsidiary shall have in any manner (x) acquired through an Asset Acquisition or
(y) disposed of (including by way of an Asset Sale or the termination or
discontinuance of activities constituting such operating business) any operating
business during such Measurement Period or after the end of such period and on
or prior to the Transaction Date, such calculation will be made on a pro forma
basis in accordance with GAAP as if, in the case of an Asset Acquisition, such
transaction had been consummated on the first day of the Measurement Period and,
in the case of an Asset Sale or other disposition, termination or discontinuance
of activities constituting such an operating business, such transaction had been
consummated prior to the first day of the Measurement Period; PROVIDED, HOWEVER
that such PRO FORMA adjustment shall not give effect to the operating cash flow
of any Person that would become a Restricted Subsidiary on the Transaction Date
in connection with the transaction that requires the calculation of Consolidated
Operating Cash Flow to the extent that such Person's net income would be
excluded from the calculation of Consolidated Net Income pursuant to clause (vi)
of the definition of Consolidated Net Income.
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"Independent Financial Advisor" means a United States investment banking
firm of national or regional standing in the United States (i) which does not,
and whose directors, officers and employees or Affiliates do not have, a direct
or indirect financial interest in the Company and (ii) which, in the judgment of
the Board, is otherwise independent and qualified to perform the task for which
it is to be engaged.
"Interest Rate Obligations" means the obligations of any Person pursuant to
any arrangement with any other Person whereby, directly or indirectly, such
Person is entitled to receive from time to time periodic payments calculated by
applying either a floating or a fixed rate of interest on a stated notional
amount and shall include, without limitation, interest rate swaps, caps, floors,
collars, forward interest rate agreements and similar agreements.
"Investment" means, with respect to any Person, any direct or indirect
advance, loan, account receivable (other than an account receivable arising in
the ordinary course of business), or other extension of credit (including,
without limitation, by means of any Guarantee) or any capital contribution to
(by means of transfers of cash or other property or assets to others, payments
for property or services for the account or use of others, or otherwise), or any
purchase or acquisition of capital stock, bonds, notes, debentures or other
securities or evidences of Indebtedness of any other Person. The amount of any
Investment shall be the original cost of such Investment, PLUS the cost of all
additions thereto, and MINUS the amount of any portion of such Investment repaid
to such Person in cash as a repayment of principal or a return of capital, as
the case may be, but without any other adjustments for increases or decreases in
value, or write-ups, write-downs or write-offs with respect to such Investment.
In determining the amount of any Investment involving a transfer of any property
or assets other than cash, such property shall be valued at its Fair Market
Value at the time of transfer.
"Issue Date" means the original date of issuance of the Old Notes.
"Lien" means any mortgage, charge, pledge, lien (statutory or other),
security interest, hypothecation, assignment for security, claim, or preference
or priority or other encumbrance upon or with respect to any property of any
kind whether or not filed, recorded or otherwise perfected under applicable law
(including any conditional sale or other title retention agreement, any lease in
the nature thereof, any option or other agreement to sell or give a security
interest and any filing of or agreement to give any financing statement under
the Uniform Commercial Code (or equivalent statutes) of any jurisdiction). A
Person shall be deemed to own subject to a Lien any property which such Person
has acquired or holds subject to the interest of a vendor or lessor under any
conditional sale agreement, capital lease or other title retention agreement.
"Market Capitalization" of any Person means, as of any day of determination,
the product of (i) the average Closing Price of a share of such Person's Common
Stock over the 20 consecutive trading days immediately preceding such date and
(ii) the number of shares of such Common Stock issued and outstanding on such
date. "Closing Price" on any trading day with respect to the per share price of
any shares of Common Stock means the last reported sale price regular way or, in
case no such reported sale takes place on such day, the average of the reported
closing bid and asked prices regular way, in either case on the New York Stock
Exchange or, if such shares of Common Stock are not listed or admitted to
trading on such exchange, on the principal national securities exchange on which
such shares are listed or admitted to trading or, if not listed or admitted to
trading on any national securities exchange, on the Nasdaq National Market or,
if such shares are not listed or admitted to trading on any national securities
exchange or quoted on the Nasdaq National Market but such Person is a "Foreign
Issuer" (as defined in Rule 3b-4(b) under the Exchange Act) and the principal
securities exchange on which such shares are listed or admitted to trading is a
"designated offshore securities market" (as defined in Rule 902(b) under the
Securities Act), the average of the reported closing bid and asked prices
regular way on such principal exchange or, if such shares are not listed or
admitted to trading on any national securities exchange or quoted on the Nasdaq
National Market and such Person and any securities markets in which such
Person's Common Stock trades does not meet any of the foregoing such
requirements, the average of the closing
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bid and asked prices in the over-the-counter market as furnished by any New York
Stock Exchange member firm that is selected from time to time by the Company for
the purpose and is reasonably acceptable to the Trustee.
"Maturity Date" means, with respect to any Note, the date specified in such
Note as the fixed date on which the principal of such Note is due and payable.
"Moody's" means Moody's Investors Service, Inc. (and any successor).
"Net Cash Proceeds" means, with respect to any Asset Sale, the proceeds
thereof received by the Company or any Restricted Subsidiary in the form of cash
(including assumed Indebtedness (other than Subordinated Indebtedness) and other
items deemed to be cash under the proviso to the first sentence of the covenant
described under "--Certain Covenants--DISPOSITION OF PROCEEDS OF ASSET SALES")
or Cash Equivalents including payments in respect of deferred payment
obligations when received in the form of cash or Cash Equivalents (except to the
extent that such obligations are financed or sold with recourse to the Company
or any Restricted Subsidiary) net of (i) brokerage commissions and other fees,
costs and expenses (including fees and expenses of legal counsel and investment
bankers) related to such Asset Sale, (ii) provisions for all taxes paid or
payable as a result of such Asset Sale, (iii) amounts required to be paid to any
Person (other than the Company or any Restricted Subsidiary) owning a beneficial
interest in or having a Lien on the assets subject to the Asset Sale, (iv) with
respect to Asset Sales by Restricted Subsidiaries, the portion of such cash and
Cash Equivalents attributable to any Persons holding a minority interest in such
Restricted Subsidiary and (v) appropriate amounts to be provided by the Company
or any Restricted Subsidiary, as the case may be, as a reserve required in
accordance with GAAP against any liabilities associated with such Asset Sale and
retained by the Company or any Restricted Subsidiary, as the case may be, after
such Asset Sale, including, without limitation, pension and other
post-employment benefit liabilities, liabilities related to environmental
matters and liabilities under any indemnification obligations associated with
such Asset Sale, all as reflected in an Officers' Certificate delivered to the
Trustee.
"Permitted Business" means any of the following: (i) transmitting, providing
services relating to or developing network and software applications for the
transmission and management of voice, data, video or other information through
owned or leased wireline or wireless transmission facilities or over the
internet; (ii) creating, developing, constructing, installing, integrating,
repairing, maintaining or marketing communications-related systems, network
equipment and wireless and wireline transmission facilities, software and other
related products; and (iii) evaluating, owning, operating, participating in or
pursuing any other business that is primarily related to those identified in the
foregoing clauses (i) and (ii).
"Permitted Business Assets" has the meaning set forth in the covenant
described under "--Certain Covenants--DISPOSITION OF PROCEEDS OF ASSET SALES."
"Permitted Business Investments" means an Investment in any Person the
primary business of which consists of a Permitted Business.
"Permitted Credit Facility" means any senior secured or unsecured commercial
term loan and/or revolving credit facilities (including any letter of credit
subfacility) entered into principally with commercial banks and/or other
financial institutions.
"Permitted Holders" means Brentwood Venture Capital, Enterprise Partners,
Kleiner Perkins Caulfield & Byers, The Sprout Group and Catherine M. Hapka, and
their respective Affiliates.
"Permitted Indebtedness" means the following Indebtedness (each of which
shall be given independent effect):
(a) Indebtedness under the Notes and the Indenture;
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(b) Indebtedness (including Disqualified Stock) of the Company and/or
any Restricted Subsidiary outstanding, or committed but undrawn, on the
Issue Date and identified on a schedule to the Indenture;
(c) (i) Indebtedness of any Restricted Subsidiary owed to and held by
the Company or a Wholly Owned Restricted Subsidiary and (ii) Indebtedness of
the Company, which is not secured by any Lien and is subordinated to the
Company's obligations with respect to the Notes, owed to and held by any
Restricted Subsidiary; PROVIDED that an incurrence of Indebtedness shall be
deemed to have occurred upon (x) any sale or other disposition of any
Indebtedness of the Company or a Restricted Subsidiary referred to in this
clause (c) to a Person other than the Company or a Restricted Subsidiary,
(y) any sale or other disposition of Capital Stock of a Restricted
Subsidiary which holds Indebtedness of the Company or another Restricted
Subsidiary such that such Restricted Subsidiary ceases to be a Restricted
Subsidiary or (z) the Designation of a Restricted Subsidiary which holds
Indebtedness of the Company or another Restricted Subsidiary as an
Unrestricted Subsidiary;
(d) Interest Rate Obligations of the Company and/or any Restricted
Subsidiary relating to Indebtedness of the Company and/or such Restricted
Subsidiary, as the case may be (which Indebtedness (i) bears interest at
fluctuating interest rates and (ii) is otherwise permitted to be incurred
under the "Limitation on Additional Indebtedness" covenant), but only to the
extent that the notional amount of such Interest Rate Obligations does not
exceed the principal amount of the Indebtedness (and/or Indebtedness subject
to commitments) to which such Interest Rate Obligations relate;
(e) Indebtedness of the Company and/or any Restricted Subsidiary in
respect of performance bonds of the Company or any Restricted Subsidiary or
surety bonds provided by the Company or any Restricted Subsidiary, in each
case incurred in the ordinary course of business;
(f) Indebtedness of the Company and/or any Restricted Subsidiary to the
extent it represents a replacement, renewal, refinancing or extension (a
"refinancing") of the Notes (during the periods for which redemption is
permitted under the terms of the Indenture) or other outstanding
Indebtedness of the Company and/or of any Restricted Subsidiary incurred or
outstanding pursuant to clause (a), (b), (g) or (h) of this definition or
the proviso in the first paragraph of the covenant described under
"--Certain Covenants--LIMITATION ON ADDITIONAL INDEBTEDNESS"; PROVIDED that
(i) no Restricted Subsidiary may incur Indebtedness to refinance
Indebtedness of the Company (except for Guarantees issued in accordance with
the covenant described under "--Certain Covenants--LIMITATION ON ISSUANCES
OF GUARANTEES OF INDEBTEDNESS BY RESTRICTED SUBSIDIARIES"); (ii) if such
Indebtedness being refinanced has an Average Life to Stated Maturity equal
to or longer than the Average Life to Stated Maturity of the Notes, any such
refinancing shall have an Average Life to Stated Maturity longer than the
Average Life to Stated Maturity of the Notes and a final stated maturity for
the payment of principal thereof later than the final stated maturity of the
Notes; (iii) if such Indebtedness being refinanced has an Average Life to
Stated Maturity shorter than the Average Life to Stated Maturity of the
Notes, any such refinancing shall have an Average Life to Stated Maturity
longer than, and a final stated maturity later than, the Indebtedness being
refinanced; (iv) any such refinancing shall not exceed the sum of the
principal amount (or, if such Indebtedness provides for a lesser amount to
be due and payable upon a declaration of acceleration thereof, an amount no
greater than such lesser amount) of the Indebtedness being refinanced, PLUS
the amount of accrued and unpaid interest thereon, PLUS the amount of any
reasonably determined prepayment premium necessary to accomplish such
refinancing and such reasonable fees and expenses incurred in connection
therewith; (v) the Notes and Indebtedness that ranks PARI PASSU with the
Notes may be refinanced only with Indebtedness that is made PARI PASSU with
or subordinate in right of payment to the Notes, and Subordinated
Indebtedness may only be refinanced with Subordinated Indebtedness; and (vi)
the refinancing Indebtedness shall be incurred by the obligor of the
Indebtedness being refinanced or by the Company;
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(g) Indebtedness of the Company such that, after giving effect to the
incurrence thereof, (i) the total aggregate principal amount of Indebtedness
incurred under this clause (g) and any refinancings thereof otherwise
incurred in compliance with the Indenture would not exceed 200% of Total
Incremental Equity, and (ii) such Indebtedness does not mature prior to the
final stated maturity of the Notes and has an Average Life to Stated
Maturity longer than the Notes;
(h) Indebtedness of the Company or any Restricted Subsidiary incurred
under any Permitted Credit Facility and/or Indebtedness of the Company
represented by Debt Securities, and any refinancings of the foregoing
otherwise incurred in compliance with the Indenture, in an aggregate
principal amount not to exceed $40.0 million at any time outstanding;
(i) Indebtedness of the Company or any Restricted Subsidiary that is
Purchase Money Indebtedness;
(j) Indebtedness in respect of (i) letters of credit, bankers'
acceptances or other similar instruments or obligations, issued in
connection with liabilities incurred in the ordinary course of business or
(ii) surety, judgment, appeal, performance and other similar bonds,
instruments or obligations provided in the ordinary course of business; and
(k) in addition to the items referred to in clauses (a) through (j)
above, Indebtedness of the Company having an aggregate principal amount not
to exceed $5.0 million at any time outstanding.
"Permitted Investments" means (a) any Investment in the Company or in a
Wholly Owned Restricted Subsidiary of the Company or in a Person as a result of
which such Person becomes a Wholly Owned Restricted Subsidiary; (b) Investments
constituting Permitted Business Investments, the sum of which does not exceed
$25.0 million at any one time outstanding; (c) Cash Equivalents; (d) Investments
in prepaid expenses, negotiable instruments held for collection and lease,
utility and workers' compensation, performance and other similar deposits; (e)
Interest Rate Obligations incurred in compliance with the covenant described
under "--Certain Covenants--LIMITATION ON ADDITIONAL INDEBTEDNESS"; (f) loans
and advances to employees made in the ordinary course of business not to exceed
$500,000 in the aggregate at any one time outstanding; (g) bonds, notes,
debentures or other securities (other than Capital Stock of any Restricted
Subsidiary that is not a Wholly Owned Restricted Subsidiary) received as a
result of Asset Sales permitted under "--Certain Covenants--DISPOSITION OF
PROCEEDS OF ASSET SALES"; (h) any Investment to the extent that the
consideration therefor consists of Capital Stock (other than Disqualified Stock)
of the Company; and (i) the extension by the Company of (x) trade credit to
Subsidiaries of the Company represented by accounts receivable, extended on
usual and customary terms in the ordinary course of business or (y) Guarantees
of commitments for the purchase of goods or services incurred in the ordinary
course of business so long as such Guarantees, to the extent constituting
Indebtedness, are permitted to be incurred under the covenant described under
"--Certain Covenants--LIMITATION ON ADDITIONAL INDEBTEDNESS."
"Permitted Liens" means (a) Liens on property of a Person existing at the
time such Person is merged into or consolidated with the Company or any
Restricted Subsidiary or becomes a Restricted Subsidiary; PROVIDED that such
Liens were in existence prior to the contemplation of such merger, consolidation
or acquisition and do not secure any property or assets of the Company or any
Restricted Subsidiary other than the property or assets subject to the Liens
prior to such merger or consolidation or acquisition; (b) Liens imposed by law,
such as carriers', warehousemen's and mechanics' Liens and other similar Liens
arising in the ordinary course of business that secure payment of obligations
not more than 60 days past due or that are being contested in good faith and by
appropriate proceedings; (c) Liens existing on the Issue Date (including Liens
securing Indebtedness permitted under clause (b) of the definition of Permitted
Indebtedness); (d) Liens for taxes, assessments or governmental charges or
claims that are not yet delinquent or that are being contested in good faith by
appropriate proceedings promptly instituted and diligently conducted; PROVIDED
that any reserve or other appropriate provision as shall be required in
conformity with GAAP shall have been made therefor; (e) easements, rights of
way, restrictions and other similar easements, licenses, restrictions on the use
of properties, or minor imperfections of title that, in the
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aggregate, are not material in amount and do not in any case materially detract
from the properties subject thereto or interfere with the ordinary conduct of
the business of the Company or the Restricted Subsidiaries; (f) Liens to secure
the performance of statutory obligations, surety or appeal bonds, performance
bonds or other obligations of a like nature incurred in the ordinary course of
business (exclusive of obligations for the payment of borrowed money); (g) Liens
securing Indebtedness incurred under a Permitted Credit Facility; PROVIDED,
HOWEVER, that the incurrence of such Indebtedness is permitted by the covenant
described under "--Certain Covenants--LIMITATION ON ADDITIONAL INDEBTEDNESS"
above; (h) Liens to secure any refinancing of any Indebtedness secured by Liens
permitted by the Indenture, but only to the extent that such Liens do not extend
to any other property or assets (other than improvements thereto); (i) Liens to
secure the Notes and Liens created under the Indenture; (j) Liens securing
Purchase Money Indebtedness; (k) Liens on and pledges of Capital Stock of any
Unrestricted Subsidiary securing any Indebtedness of such Unrestricted
Subsidiary; (l) Liens securing reimbursement obligations with respect to letters
of credit that encumber documents and other property relating to such letters of
credit and the products and proceeds thereof; (m) Liens to secure Capitalized
Lease Obligations permitted to be incurred under the Indenture; (n) Liens that
do not materially detract from the value of the property subject to such Liens,
that do not materially interfere with the ordinary conduct of the business of
the Company or any of its Restricted Subsidiaries, and that are made on
customary and usual terms applicable to similar assets; (o) pledges or deposits
by such Person under workmen's compensation laws, unemployment insurance laws or
similar legislation, or good faith deposits in connection with bids, tenders,
contracts (other than for the payment of Indebtedness) or leases to which such
Person is a party, or deposits to secure public or statutory obligations of such
Person, or deposits or cash or United States government bonds to secure surety
or appeal bonds to which such Person is a party, or deposits as security for
contested taxes or import duties or for the payment of rent, in each case
incurred in the ordinary course of business; (p) Liens customary in the industry
and incurred in the ordinary course of business securing Interest Rate
Obligations so long as the related Indebtedness is, and is permitted to be under
the Indenture, secured by a Lien on the same property securing such Interest
Rate Obligations; and (q) Liens held by the Company on the assets or property of
a Restricted Subsidiary of the Company to secure Indebtedness of such Restricted
Subsidiary owing to and held by the Company.
"Person" means any individual, corporation, limited liability company,
partnership, joint venture, association, joint-stock company, trust,
unincorporated organization, government or any agency or political subdivision
thereof or any other entity.
"Preferred Stock" means, with respect to any Person, any and all shares,
interests, participations or other equivalents (however designated) of such
Person's preferred or preference stock whether now outstanding or issued after
the Issue Date, and including, without limitation, all classes and series of
preferred or preference stock of such Person.
"Public Equity Offering" means an underwritten primary public offering of
Common Stock of the Company for cash pursuant to an effective registration
statement filed under the Securities Act.
"Purchase Money Indebtedness" means Indebtedness of the Company or any
Restricted Subsidiary (including Acquired Indebtedness and Indebtedness
represented by Capitalized Lease Obligations, Attributable Debt in respect of
Sale/Leaseback Transactions, mortgage financings and purchase money obligations)
incurred at any time within 180 days of and for the purpose of financing all or
any part of the cost of, the construction, expansion, installation, acquisition
or improvement by the Company or any Restricted Subsidiary of any Permitted
Business Assets or not less than 66 2/3 percent of the outstanding Voting Stock
of a Person that becomes a Restricted Subsidiary the assets of which consist
primarily of Permitted Business Assets; PROVIDED that the proceeds of such
Indebtedness are expended for such purposes within such 180-day period; and
PROVIDED FURTHER that the amount of such Indebtedness does not exceed, as of the
date of incurrence of such Indebtedness, 100 percent of the lesser of the cost
or the Fair Market Value of such Permitted Business Assets.
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"Refinancing" has the meaning set forth in clause (f) of the definition of
"Permitted Indebtedness."
"Restricted Payment" means any of the following: (i) the declaration or
payment of any dividend or any other distribution on any Capital Stock of the
Company or any Restricted Subsidiary or any other payment made to the direct or
indirect holders (in their capacities as such) of Capital Stock of the Company
or any Restricted Subsidiary (other than any dividends, distributions or
payments made to the Company or any Restricted Subsidiary and dividends or
distributions payable solely in Capital Stock (other than Disqualified Stock) of
the Company or in options, warrants or other rights to purchase Capital Stock
(other than Disqualified Stock) of the Company); (ii) the purchase, redemption
or other acquisition or retirement for value of any Capital Stock of the Company
or any Restricted Subsidiary (other than any such Capital Stock owned by the
Company or a Restricted Subsidiary); (iii) the purchase, redemption, defeasance
or other acquisition or retirement for value, or the making of any principal
payment on, prior to any scheduled repayment, scheduled sinking fund payment or
scheduled maturity, of any Subordinated Indebtedness (other than any
Subordinated Indebtedness held by a Wholly Owned Restricted Subsidiary); or (iv)
the making by the Company or any Restricted Subsidiary of any Investment (other
than a Permitted Investment) in any Person.
"Restricted Subsidiary" means any Subsidiary of the Company that has not
been designated by the Board, by a Board Resolution delivered to the Trustee, as
an Unrestricted Subsidiary pursuant to and in compliance with the covenant
described under "--Certain Covenants--LIMITATION ON DESIGNATIONS OF UNRESTRICTED
SUBSIDIARIES." Any such designation may be revoked by a Board Resolution
delivered to the Trustee, subject to the provisions of such covenant.
"Revocation" has the meaning set forth under "--Certain
Covenants--LIMITATION ON DESIGNATIONS OF UNRESTRICTED SUBSIDIARIES."
"S&P" means Standard & Poor's Rating Services, a division of The McGraw-Hill
Companies (and any successor).
"Sale/Leaseback Transaction" of any Person means an arrangement with any
lender or investor or to which such lender or investor is a party providing for
the leasing by such Person of any property or assets of such Person which has
been or is being sold or transferred by such Person after its acquisition
thereof or the completion of construction or commencement of operations thereof
to such lender or investor or to any other Person to whom funds have been or are
to be advanced by such lender or investor on the security of such property or
asset.
"Strategic Equity Investor" means any Person that, as of the date of
determination, has a Market Capitalization or Consolidated Net Worth of at least
$2.0 billion and that derives a substantial portion of its revenues from a
business related to the Permitted Business.
"Subordinated Indebtedness" means any Indebtedness of the Company which is
expressly subordinated in right of payment to any other Indebtedness of the
Company.
"Subsidiary" means, with respect to any Person, (a) any corporation of which
the outstanding Capital Stock having at least a majority of the votes entitled
to be cast in the election of directors shall at the time be owned, directly or
indirectly, by such Person, or (b) any other Person of which at least a majority
of voting interest is at the time, directly or indirectly, owned by such Person.
"Total Consolidated Indebtedness" means, at any date of determination, an
amount equal to the aggregate amount of all Indebtedness of the Company and the
Restricted Subsidiaries outstanding as of such date of determination.
"Total Incremental Equity" means, at any time of determination, the sum of,
without duplication, (a) the aggregate net cash proceeds received by the Company
from capital contributions in respect of existing Capital Stock (other than
Disqualified Stock) or the issuance and sale of Capital Stock (other than
Disqualified Stock but including Capital Stock issued upon the conversion of
convertible Indebtedness or
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from the exercise of options, warrants or rights to purchase Capital Stock
(other than Disqualified Stock)) subsequent to the Issue Date, other than to a
Subsidiary of the Company, PLUS (b) 80 percent of the Fair Market Value of
property (other than cash and Cash Equivalents) received by the Company after
the Issue Date as a contribution of capital or from the sale of its Capital
Stock (other than Disqualified Stock) to a Person that is not a Subsidiary of
the Company, MINUS (c) any amounts included in clause (a) above to the extent
used to make a Restricted Payment pursuant to clauses (2) or (3)(A)(x) of the
covenant described under "--Certain Covenants--LIMITATION ON RESTRICTED
PAYMENTS."
"Unrestricted Subsidiary" means any Subsidiary of the Company designated as
such pursuant to and in compliance with the covenant described under "--Certain
Covenants--LIMITATION ON DESIGNATIONS OF UNRESTRICTED SUBSIDIARIES." Any such
designation may be revoked by a Board Resolution delivered to the Trustee,
subject to the provisions of such covenant.
"U.S. Government Securities" means securities that are direct obligations of
the United States of America for the payment of which its full faith and credit
is pledged.
"Voting Stock" means, with respect to any Person, the Capital Stock of any
class or kind ordinarily having the power to vote for the election of directors
or other members of the governing body of such Person.
"Voting power" means, with respect to the Capital Stock of any Person,
relative voting power in any general election of directors or other members of
the governing body of such Person.
"Wholly Owned Restricted Subsidiary" means any Restricted Subsidiary of
which 100% of the outstanding Capital Stock is owned by the Company or another
Wholly Owned Restricted Subsidiary. For the purposes of this definition, any
directors' qualifying shares or investments by foreign nationals mandated by
applicable law shall be disregarded in determining the ownership of a Restricted
Subsidiary.
NOTE REGISTRATION RIGHTS
The Company entered into a registration rights agreement with the Initial
Purchasers (the "Registration Rights Agreement"), a copy of the form of which is
available to prospective purchasers upon request, pursuant to which the Company
agreed to file with the Securities and Exchange Commission (the "Commission")
the Exchange Offer Registration Statement on an appropriate form under the
Securities Act with respect to an offer to exchange the Old Notes for the New
Notes. Upon the effectiveness of the Exchange Offer Registration Statement, the
Company will offer to the holders of Notes who are able to make certain
representations the opportunity to exchange their Old Notes for New Notes. If
(i) the Company is not permitted to file the Exchange Offer Registration
Statement or to consummate the Exchange Offer because the Exchange Offer is not
permitted by applicable law or Commission policy, (ii) the Exchange Offer is not
for any other reason consummated within 180 days after the Issue Date, (iii) any
holder of Notes notifies the Company within a specified time period that (a) due
to a change in law or policy it is not entitled to participate in the Exchange
Offer, (b) due to a change in law or policy it may not resell the New Notes
acquired by it in the Exchange Offer to the public without delivering a
prospectus and (x) the prospectus contained in the Exchange Offer Registration
Statement is not appropriate or available for such resales by such holder and
(y) such prospectus is not promptly amended or modified in order to be suitable
for use in connection with such resales for such holder and all similarly
situated holders or (c) it is a broker-dealer and owns Notes acquired directly
from the Company or an affiliate of the Company or (iv) the holders of a
majority of the Notes may not resell the Exchange Notes acquired by them in the
New Offer to the public without restriction under the Securities Act and without
restriction under applicable blue sky or state securities laws, the Company will
file with the Commission the Shelf Registration Statement to cover resales of
the Transfer Restricted Notes (as defined below) by the holders thereof. The
Company will use its best efforts to cause the applicable registration statement
to be declared effective as promptly as possible by the Commission. For purposes
of the foregoing, "Transfer Restricted Notes" means each Note until (i) the date
on which such Note has been exchanged by a person
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other than a broker-dealer for an New Note in the Exchange Offer, (ii) following
the exchange by a broker-dealer in the Exchange Offer of a Note for an New Note,
the date on which such New Note is sold to a purchaser who receives from such
broker-dealer on or prior to the date of such sale a copy of the prospectus
contained in the Exchange Offer Registration Statement, (iii) the date on which
such Note has been effectively registered under the Securities Act and disposed
of in accordance with the Shelf Registration Statement, (iv) the date on which
such Note is distributed to the public pursuant to Rule 144(k) under the
Securities Act (or any similar provision then in force, but not Rule 144A under
the Securities Act), (v) such Note shall have been otherwise transferred by the
holder thereof and a new Note not bearing a legend restricting further transfer
shall have been delivered by the Company and subsequent disposition of such Note
shall not require registration or qualification under the Securities Act or any
similar state law then in force or (vi) such Note ceases to be outstanding.
Under existing Commission interpretations, the New Notes would, in general,
be freely transferable after the Exchange Offer without further registration
under the Securities Act; provided that in the case of broker-dealers
participating in the Exchange Offer, a prospectus meeting the requirements of
the Securities Act must be delivered upon resale by such broker-dealers in
connection with resales of the New Notes. The Company has agreed, for a period
of 180 days after consummation of the Exchange Offer, to make available a
prospectus meeting the requirements of the Securities Act to any such
broker-dealer for use in connection with any resale of any New Notes acquired in
the Exchange Offer. A broker-dealer which delivers such a prospectus to
purchasers in connection with such resales will be subject to certain of the
civil liability provisions under the Securities Act and will be bound by the
provisions of the Registration Rights Agreement (including certain
indemnification rights and obligations).
Each holder of Notes that wishes to exchange such Notes for Exchange Notes
in the New Offer will be required to make certain representations, including
representations that (i) any New Notes to be received by it will be acquired in
the ordinary course of its business, (ii) it has no arrangement with any person
to participate in the distribution of the New Notes and (iii) it is not an
"affiliate," as defined in Rule 405 of the Securities Act, of the Company, or if
it is an affiliate, it will comply with the registration and prospectus delivery
requirements of the Securities Act to the extent applicable.
If the holder is not a broker-dealer, it will be required to represent that
it is not engaged in, and does not intend to engage in, the distribution of the
New Notes. If the holder is a broker-dealer that will receive New Notes for its
own account in exchange for Notes that were acquired as a result of
market-making activities or other trading activities, it will be required to
acknowledge that it will deliver a prospectus in connection with any resale of
such New Notes.
The Company has agreed to pay all expenses incident to the Exchange Offer
and will indemnify the Initial Purchasers against certain liabilities, including
liabilities under the Securities Act.
The Registration Rights Agreement provides that: (i) unless the Exchange
Offer would not be permitted by applicable law or Commission policy, the Company
will file the Exchange Offer Registration Statement with the Commission on or
prior to the 90th day after the Issue Date, (ii) unless the Exchange Offer would
not be permitted by applicable law or Commission policy, the Company will use
its best efforts to have the Exchange Offer Registration Statement declared
effective by the Commission on or prior to the 150th day after the Issue Date
(the "Target Effectiveness Date"), (iii) unless the Exchange Offer would not be
permitted by applicable law or Commission policy, the Company will commence the
Exchange Offer and use its best efforts to issue, on or prior to the date which
is 30 days after the date on which the Exchange Offer Registration Statement was
declared effective by the Commission, New Notes in Exchange for all Notes
tendered prior thereto in the Exchange Offer and (iv) if obligated to file the
Shelf Registration Statement, the Company will use its best efforts to file
prior to the later of (a) the 90th day after the Issue Date or (b) the 30th day
after such filing obligation arises and will use its best efforts to cause the
Shelf Registration Statement to be declared effective by the Commission on or
prior to the 60th day after such obligation arises; provided that if the Company
has not consummated the Exchange Offer
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within the date which is 180 days after the Issue Date, then the Company will
file the Shelf Registration Statement with the Commission on or prior to the
30th day after such date. The Company shall use its best efforts to keep such
Shelf Registration Statement continuously effective, supplemented and amended
until the earlier of (i) the second anniversary of the effective date of the
Shelf Registration Statement and (ii) such time as all of the Transfer
Restricted Notes covered by the Shelf Registration Statement have been sold
thereunder or otherwise cease to be Transfer Restricted Notes.
During any 365-day period, if any event occurs as a result of which the
Board determines in good faith that it is necessary to amend a Shelf
Registration Statement or amend or supplement any prospectus or prospectus
supplement thereunder to ensure that each of those documents does not include
any untrue statement of fact or omit to state a material fact necessary to make
the statements therein not misleading, then the Company will have the ability to
suspend the availability of the Shelf Registration Statement and the use of the
related prospectus for up to 60 consecutive days (except for the consecutive
60-day period immediately prior to maturity of the Notes).
If (i) the Company fails to file any of the registration statements required
by the Registration Rights Agreement on or before the date specified for such
filing, (ii) any of such registration statements is not declared effective by
the Commission on or prior to the Target Effectiveness Date (subject to certain
limited exceptions), (iii) the Company fails to consummate the Exchange Offer
within 30 days of the Target Effectiveness Date with respect to the Exchange
Offer Registration Statement, or (iv) the Shelf Registration Statement or the
Exchange Offer Registration Statement is declared effective but thereafter,
subject to certain limited exceptions, ceases to be effective or usable in
connection with the Exchange Offer or resales of Transfer Restricted Notes, as
the case may be, during the periods specified in the Registration Rights
Agreement (each such event referred to in clauses (i) through (iv) above, a
"Registration Default"), then the Company shall pay as liquidated damages
interest on the Transfer Restricted Notes as to which any Registration Default
exists. If a Registration Default exists with respect to Transfer Restricted
Notes, the Company will, with respect to the first 90-day period (or portion
thereof) while such Registration Default is continuing immediately following the
occurrence of such Registration Default, make cash payments at a rate of .50%
per annum multiplied by the Accreted Value of the Transfer Restricted Notes as
of the date such payment is required to be made. The rate of such cash payment
shall increase by an additional .50% per annum at the beginning of each
subsequent 90-day period (or portion thereof) while such Registration Default is
continuing until such Registration Default is cured, up to a maximum rate of
1.5% per annum. Following the cure of all Registration Defaults, the making of
cash payments with respect to the Notes will cease and the interest rate on the
Notes will revert to zero.
The summary herein of certain provisions of the Registration Rights
Agreement does not purport to be complete and is subject to, and is qualified in
its entirety by reference to, all the provisions of the Registration Rights
Agreement.
DESCRIPTION OF THE NEW NOTES
The terms of the New Notes will be identical in all material respects to
those of the Old Notes, except that the New Notes (i) shall accrue interest from
the last date on which interest was paid on the Old Notes, (ii) will have been
registered under the Securities Act and therefore will not be subject to certain
restrictions on transfer applicable to the Old Notes, and (iii) will not be
entitled to certain registration rights under the Registration Rights Agreement,
including the provision for Additional Interest of up to 1.5% on the Old Notes.
Holders of Old Notes should review the information set forth under "Summary--
Certain Consequences of a Failure to Exchange Old Notes" and "--Terms of New
Notes."
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DESCRIPTION OF THE WARRANTS
In connection with the Old Notes Issuance, the Company issued Warrants to
purchase 1,972,000 shares of Common Stock. Upon the effectiveness of the
Registration Statement of which this Prospectus is a part, the Notes and the
Warrants will be separately transferable, in accordance with any applicable
restrictions on transferability thereof as provided by the respective terms
thereof. The following is a description of the Warrants.
GENERAL
The Warrants were issued pursuant to the Warrant Agreement between the
Company and State Street Bank and Trust Company of California, N.A. (the
"Warrant Agent"). The following summary of certain provisions of the Warrant
Agreement does not purport to be complete and is subject to, and qualified in
its entirety by reference to, the provisions of the Warrant Agreement, including
the definitions of certain terms therein. Wherever particular defined terms of
the Warrant Agreement, not otherwise defined herein, are referred to, such
defined terms have the meanings set forth in the Warrant Agreement, which
definitions are incorporated herein by reference. A copy of the Warrant
Agreement is available upon request from the Company at 7337 South Revere
Parkway, Englewood, Colorado 80112-3931. For purposes of this "Description of
the Warrants" section, the term "Company" refers to Rhythms NetConnections Inc.
only and not its subsidiaries.
Each Warrant is evidenced by a Warrant Certificate which entities the holder
thereof to purchase 1.70 shares of Common Stock from the Company at a price (the
"Exercise Price") of $0.01 per share, subject to adjustment as provided in the
Warrant Agreement. The Warrants may be exercised at any time beginning one year
after the Closing Date and prior to the maturity date of the Notes. Warrants
that are not exercised by such date will expire. The Warrants will become
separately transferable from the Notes on the Separation Date. Notwithstanding
the foregoing, Warrants may not be exercised or transferred, and Warrant Shares
may not be transferred, during the 180-day period commencing on the date of an
initial public offering of the Common Stock (subject to certain exceptions).
The aggregate number of Warrant Shares is equal to approximately 8.0% of the
outstanding shares of Common Stock, on an as converted, fully diluted basis, as
of the date of this Prospectus.
CERTAIN DEFINITIONS
The Warrant Agreement contains, among others, the following definitions:
A "Financial Expert" is one of the persons listed in Appendix A to the
Warrant Agreement, all of which are nationally recognized investment banking
firms.
An "Independent Financial Expert" is a Financial Expert that does not (and
whose directors, executive officers and 5% stockholders do not) have a direct or
indirect financial interest in the Company or any of its subsidiaries or
affiliates, which has not been for at least five years and, at the time that it
is called upon to give independent financial advice to the Company, is not (and
none of its directors, executive officers or 5% stockholders is) a promoter,
director or officer of the Company or any of its subsidiaries or affiliates.
A "Repurchase Event" occurs on any date when the Company (i) consolidates
with or merges into or with another person (but only where the holders of Common
Stock receive consideration in exchange for all or part of such Common Stock),
if the Common Stock (or other securities) thereafter issuable upon exercise of
the Warrants is not registered under the Exchange Act or (ii) sells all or
substantially all of its assets to another person, if the Common Stock (or other
securities) thereafter issuable upon exercise of the Warrants is not registered
under the Exchange Act; provided, that in each case a "Repurchase Event" shall
not be deemed to have occurred if the consideration for such transaction
consists solely of cash.
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CERTAIN TERMS
REPURCHASE. Following the occurrence of a Repurchase Event, the Company
must make an offer to repurchase for cash all outstanding Warrants (a
"Repurchase Offer"). The holders of the Warrants may, until 5:00 p.m. (New York
City time) on the date (the "Final Surrender Time") at least 30 but not more
than 60 days following the date on which the Company gives notice of such
Repurchase Offer to such holders, surrender all or part of their Warrants for
repurchase by the Company. Except as otherwise provided in the Warrant
Agreement, Warrants received by the Warrant Agent in proper form for purchase
during a Repurchase Offer prior to the Final Surrender Time are to be
repurchased by the Company at a price in cash (the "Repurchase Price") equal to
the value (the "Relevant Value") on the Valuation Date (as defined in the
Warrant Agreement) relating thereto of the Warrant Shares (and other securities
issuable upon exercise of the Warrants), had the Warrants then been exercised,
less the Exercise Price therefor. The "Relevant Value" of the Common Stock (or
other securities) shall be determined (without giving effect to any discount for
lack of liquidity, the fact that the Company has no class of equity securities
registered under the Exchange Act, the fact that there may be no public market
for the Common Stock or the fact that the Common Stock (or other securities)
issuable upon exercise of the Warrants represents a minority interest in the
Company) by an Independent Financial Expert.
The Board of Directors of the Company is required to select an Independent
Financial Expert not more than five business days following a Repurchase Event.
Within two days after its selection of the Independent Financial Expert, the
Company must deliver to the Warrant Agent a notice setting forth the name of
such Independent Financial Expert. The Company must use its best efforts
(including by selecting another Independent Financial Expert) to cause the
Independent Financial Expert to deliver to the Company, with a copy to the
Warrant Agent, a value report (a "Value Report") which states the Relevant Value
of the Common Stock (or other securities) as of the Valuation Date and contains
a brief statement as to the nature and scope of the methodologies upon which the
determination was made. The Warrant Agent will have no duty with respect to the
Value Report of any Independent Financial Expert, except to keep it on file and
available for inspection by the holders of the Warrants. The determination of
the Independent Financial Expert as to the Relevant Value in accordance with the
provisions of the Warrant Agreement shall be conclusive on all persons.
The requirement that the Company make a Repurchase Offer will, unless
appropriate consents or waivers are obtained, require the Company to repay all
indebtedness of the Company then outstanding which by its terms would prohibit
such Repurchase Offer. There can be no assurance that the Company will have
sufficient funds available at the time of any Repurchase Event to repurchase the
Warrants and repay any such indebtedness, as well as to repurchase any other
securities of the Company that by their terms require the Company to repurchase
such securities upon the occurrence of such an event.
EXERCISE. In order to exercise all or any of the Warrants represented by a
Warrant Certificate, the holder thereof is required to surrender to the Warrant
Agent the Warrant Certificate, a duly executed copy of the subscription form set
forth in the Warrant Certificate and payment in full of the Exercise Price for
each share of Common Stock or other security issuable upon exercise of such
Warrants, which payment may be made in cash or by certified or official bank or
bank cashier's check payable to the order of the Company or through the
surrender of an appropriate amount of unexercised Warrant Certificates. Upon the
exercise of any Warrant in accordance with the Warrant Agreement, the Warrant
Agent will instruct the Company to transfer promptly to or upon the written
order of the holder of such Warrant Certificate appropriate evidence of
ownership of any shares of Common Stock or other security or property to which
it is entitled as a result of such exercise, registered or otherwise placed in
such name or names as it may direct in writing, and will deliver such evidence
of ownership to the person or persons entitled to receive the same and
fractional shares, if any, or an amount in cash, in lieu of any fractional
shares, if any. All shares of Common Stock or other securities issuable by the
Company upon the exercise of the Warrants must be validly issued, fully paid and
nonassessable. The Warrant Agreement provides that, if the Company conducts an
initial public offering of equity securities other than Common Stock, the
Company
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will give holders of Warrants and Warrant Shares the opportunity to convert such
Warrants into warrants to purchase such equity securities and the opportunity to
convert such Warrant Shares into such equity securities. Such conversion
opportunity will be on terms and conditions determined to be fair and reasonable
by the Company's Board of Directors in its sole discretion.
In the event of a taxable distribution to holders of Common Stock that
results in an adjustment to the number of shares of Common Stock or other
consideration for which a Warrant may be exercised, the holders of the Warrants
may, in certain circumstances, be deemed to have received a distribution subject
to United States federal income tax as a dividend. See "Federal Income Tax
Considerations Warrants."
ANTI-DILUTION PROVISIONS. The Warrant Agreement contains provisions
adjusting the number of shares of Common Stock or other securities issuable upon
exercise of a Warrant in the event of (i) a division, consolidation or
reclassification of the shares of Common Stock, (ii) the issuance of rights,
options, warrants or convertible or exchangeable securities to all holders of
shares of Common Stock entitling such holders to subscribe for or purchase
shares of Common Stock at a price per share which is lower than the then current
value per share of Common Stock, subject to certain exceptions, (iii) the
issuance of shares of Common Stock at a price per share that is lower than the
then current value of such shares, except for issuances in connection with an
acquisition, merger or similar transaction with a third party and (iv) certain
distributions to all holders of shares of Common Stock of evidences of
indebtedness or assets.
NO RIGHTS AS STOCKHOLDERS. The holders of Warrants are not entitled, as
such, to receive dividends or other distributions, receive notice of any meeting
of the stockholders, consent to any action of the stockholders, receive notice
of any other stockholder proceedings or to any other rights as stockholders of
the Company. The holders of Warrants will not be entitled to share in the assets
of the Company in the event of liquidation, dissolution or the winding up of the
Company. In the event a bankruptcy or reorganization is commenced by or against
the Company, a bankruptcy court may hold that unexercised Warrants are executory
contracts which may be subject to rejection by the Company with approval of the
bankruptcy court, and the holders of the Warrants may, even if sufficient funds
are available, receive nothing or a lesser amount as a result of any such
bankruptcy case than they would be entitled to if they had exercised their
Warrants prior to the commencement of any such case.
MERGERS, CONSOLIDATIONS OR SALES OF ASSETS. Except as provided below, in
the event that the Company consolidates with, merges with or into, or sells all
or substantially all of its property and assets to another person, each Warrant
thereafter shall entitle the holder thereof to receive upon exercise thereof the
number of shares of capital stock or other securities or property which the
holder would have been entitled as a result of such consolidation, merger or
sale had the Warrant been exercised immediately prior thereto. If the Company
merges or consolidates with, or sells all or substantially all of the property
and assets of the Company to, another person and, in connection therewith,
consideration to the holders of Common Stock in exchange for their shares is
payable solely in cash, or in the event of the dissolution, liquidation or
winding-up of the Company, then the holders of the Warrants will be entitled to
receive distributions on an equal basis with the holders of Common Stock or
other securities issuable upon exercise of the Warrants assuming the Warrants
had been exercised immediately prior to such event, less the Exercise Price.
Upon receipt of such payment, if any, the Warrants will expire and the rights of
the holders thereof will cease. If the Company has made a Repurchase Offer that
has not expired at the time of such transaction, the holders of the Warrants
will be entitled to receive the higher of (i) the amount payable to the holders
of the Warrants described above and (ii) the Repurchase Price payable to the
holders of the Warrants pursuant to such Repurchase Offer. In case of any such
merger, consolidation or sale of assets, the surviving or acquiring person and,
in the event of any dissolution, liquidation or winding-up of the Company, the
Company must deposit promptly with the Warrant Agent the funds, if any,
necessary to pay to the holders of the Warrants. After such funds and the
surrendered Warrant Certificate are received, the Warrant Agent must make
payment by delivering a check in such amount as is appropriate (or, in the case
of consideration
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other than cash, such other consideration as is appropriate) to such person or
persons as it may be directed in writing by the holders surrendering such
Warrants.
REGISTRATION REQUIREMENTS. The holders of the Warrants are entitled to
piggyback registration rights for the issuance and (if available) resale of
Warrant Shares in connection with (i) an initial public offering of the Common
Stock (or other securities issuable upon exercise of the Warrants) if any
stockholder of the Company participates in such public offering or (ii) certain
public offerings of shares of Common Stock (or other securities issuable upon
exercise of the Warrants) issuable upon exercise of the Warrants conducted
subsequent to the initial public offering of such stock, subject to pro rata
cut-back provisions in the event that the managing underwriter in any
underwritten offering determines that inclusion of the Warrant Shares would
materially and adversely affect the success of the offering. If only the Company
sells shares in the initial public offering or all of the Warrant Shares (or
other securities issuable upon exercise of the Warrants) are not sold in the
initial public offering or any subsequent public offering, the Company will be
required to use its best efforts to cause to be declared effective, no later
than the later of (i) 180 days after the closing date of the initial public
offering (provided that, if a "lock up" or "black out" period is imposed on the
Company pursuant to or in connection with any underwriting or purchase agreement
relating to an underwritten Rule 144A or registered public offering of Common
Stock or securities convertible into or exchangeable or exercisable for Common
Stock, then the Company shall not be required to file such registration
statement until the end of such "lock up" or "black out" period, in which case
the Company shall be required to use its best efforts to be declared effective
no later than 30 days after the end of the "lock up" or "black out" period, but
in no event later than 210 days after the closing date of the initial public
offering) or (ii) the first anniversary of the Closing Date, a shelf
registration statement (the "Warrant Shelf Registration Statement") with respect
to the issuance (if available) of Warrant Shares (or other securities issuable
upon exercise of the Warrants). The Company is required to use reasonable
efforts to maintain the effectiveness of the Warrant Shelf Registration
Statement until the earlier of (i) such time as all Warrants have been exercised
and the Warrant Shares sold and (ii) 120 days after the date of effectiveness of
the Warrant Shelf Registration Statement. During any consecutive 365-day period
while the Warrants are exercisable, the Company will have the ability to
postpone or suspend the filing, effectiveness or use of such registration
statement for up to 60 days (except during the 60 days immediately prior to the
expiration of the Warrants) if the Company's Board of Directors determines in
good faith that there is a valid purpose for the postponement or suspension and
provides notice of such determination to the holders at their addresses
appearing in the register of Warrants maintained by the Warrant Agent. The
holders of Warrants shall have the right (i) in the case of a postponement of
the filing or effectiveness of such registration statement by a majority vote,
to withdraw the request for registration, or (ii) in the case of a suspension of
the right to make sales, to receive an extension of the registration period.
Holders of Warrants will not be named as selling security holders in the Warrant
Shelf Registration Statement. The Warrant Agreement requires the Company to pay
the expenses associated with such registration.
RESTRICTIONS ON EXERCISE. Warrants may not be exercised or transferred, and
Warrant Shares may not be transferred, during the 180-day period commencing on
the date of an initial public offering of the Common Stock (subject to certain
exceptions). Holders of Warrants will be able to exercise their Warrants only if
a registration statement relating to the Common Stock underlying the Warrants is
then effective and available, or the exercise of such Warrants is exempt from
the registration requirements of the Securities Act, and such securities are
qualified for sale or exempt from qualification under the applicable securities
laws of the states or other jurisdictions in which the various holders of the
Warrants reside.
RESERVATION OF SHARES. The Company has authorized and will reserve for
issuance such number of shares of Common Stock as will be issuable upon the
exercise of all outstanding Warrants. Such shares of Common Stock, when issued
and paid for in accordance with the Warrant Agreement, will be duly and validly
issued, fully paid and nonassessable, free of preemptive rights and free from
all taxes, liens, charges and security interests.
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REPORTS. At all times from and after the earlier of (i) the date of
effectiveness of a registration statement with respect to the Notes and (ii) the
date that is one year after the Closing Date, in either case, whether or not the
Company is then required to file reports with the Commission, the Company shall
file with the Commission all such reports and other information as it would be
required to file with the Commission by Sections 13(a) or 15(d) under the
Exchange Act if it were subject thereto. The Company shall supply the Warrant
Agent and each holder of a Warrant or shall supply to the Warrant Agent for
forwarding to each such holder, without cost to such holder, copies of such
reports and other information. In addition, at all times prior to the earlier of
the date that any registration statement related to the Warrants is declared
effective and one year after the Closing Date, the Company shall, at its cost,
deliver to each Warrant holder quarterly and annual reports substantially
equivalent to those which would be required by the Exchange Act if the Company
was subject thereto. In addition, at all times prior to the date that any
registration statement related to the Warrants is declared effective, upon the
request of any Warrant holder or any prospective purchaser of the Warrants
designated by a Warrant holder, the Company shall supply to such holder or such
prospective purchaser the information required under Rule 144A under the
Securities Act.
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DESCRIPTION OF CAPITAL STOCK
The following summary of the terms of the Company's capital stock does not
purport to be complete and is qualified in its entirety by reference to the
actual terms of the capital stock contained in the Company's Amended and
Restated Certificate of Incorporation and other agreements referenced below.
The Company's Restated Certificate of Incorporation (the "Certificate of
Incorporation") authorizes the issuance of 24,881,650 shares of Common Stock and
16,944,943 shares of Preferred Stock, of which 12,900,000 shares are designated
as Series A Preferred Stock and 4,044,943 shares are designated as Series B
Preferred Stock. The Series A Preferred Stock and Series B Preferred Stock are
collectively referred to herein as the "Preferred Stock." As of June 30, 1998,
there were approximately 25 holders of record of Common Stock and approximately
29 holders of record of Preferred Stock. The following table sets forth, with
respect to each series of Preferred Stock and Common stock as of June 30, 1998,
the number of shares designated, the number of shares outstanding, the number of
shares subject to outstanding options and warrants and the total fully diluted
capitalization of the Company (excluding shares of Common Stock issuable upon
exercise of the Warrants):
<TABLE>
<CAPTION>
SHARES
ISSUABLE COMMON STOCK OUTSTANDING
AUTHORIZED OUTSTANDING UNDER OPTIONS ON A FULLY DILUTED, AS
SHARES SHARES AND WARRANTS (#)(1) CONVERTED BASIS (#)(2)
------------ ------------ ------------------- -------------------------
<S> <C> <C> <C> <C>
Preferred Stock
Series A Preferred Stock........... 12,900,000 12,855,094 -- 12,855,094
Series B Preferred Stock........... 4,044,943 4,044,943 -- 4,044,943
------------ ------------ ------------------- -----------
Total Preferred Stock.............. 16,944,943 16,900,037 16,900,037
Common Stock......................... 24,881,650 3,322,804 4,653,227 7,976,031
------------ ------------ ------------------- -----------
Total.............................. 41,826,593 20,222,841 4,653,227 24,876,068
------------ ------------ ------------------- -----------
------------ ------------ ------------------- -----------
</TABLE>
- ------------------------
(1) Includes shares issuable in connection with options outstanding or available
for future grant under the 1997 Stock Plan and shares issuable in connection
with warrants outstanding.
(2) All shares of Preferred Stock are convertible, at any time at the holder's
option, into Common Stock. The ratio for converting Preferred Stock into
Common Stock is currently one to one, subject to anti-dilution protection on
a broad-based weighted-average basis.
COMMON STOCK
Subject to the preferences that may be applicable to any then outstanding
Preferred Stock, the holders of the Company's Common Stock are entitled to
receive dividends, if any, when and if declared by the Board of Directors out of
funds legally available therefor. Upon liquidation, dissolution, merger or sale
of all or substantially all of the assets of the Company (collectively, a
"Liquidation"), after paying in full the preferential amounts due the holders of
Preferred Stock, all remaining assets will be distributed ratably among the
holders of Common Stock based upon the number of shares of Common Stock then
held by each. The holders of Common Stock are entitled to one vote for each
share held of record on all matters submitted to a vote of stockholders. The
Common Stock has no preemptive or other subscription rights, and there are no
redemption or sinking fund provisions applicable to the Common Stock. No Common
Stock has conversion rights. All outstanding shares of Common Stock are fully
paid and non-assessable.
PREFERRED STOCK
The holders of Series A Preferred Stock and Series B Preferred Stock are
entitled to receive dividends in preference to the Common Stock at a rate of
$0.08 and $0.356 per share, respectively, per annum when and if declared by the
Company's Board of Directors. Dividends on the Preferred stock are not
cumulative. Upon a Liquidation, the holders of Series A Preferred Stock and
Series B Preferred Stock are entitled to
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receive in preference to the holders of Common Stock an amount equal to $1.00
and $4.45 per share, respectively, plus any declared but unpaid dividends.
Thereafter, any remaining assets shall be distributed ratably among the holders
of Common Stock based upon the number of shares of Common Stock then held by
each.
The Preferred Stock is convertible by the holder at any time into Common
Stock at the rate of its initial conversion price divided by the conversion
price then in effect. The initial conversion prices of the Series A Preferred
Stock and Series B Preferred Stock are $1.00 and $4.45 per share, respectively.
The conversion price of the Preferred Stock is subject to adjustment for stock
splits, stock dividends, consolidations, combinations, reclassifications and
other like events. The conversion prices of the Series A Preferred Stock and
Series B Preferred Stock may also be subject to adjustment for certain dilutive
issues of stock at a price per share below the applicable conversion price of
such respective series of Preferred Stock, based on the weighted average
dilution to such series. The Series A Preferred Stock and Series B Preferred
Stock are automatically convertible into Common Stock upon the earlier of (i)
the closing of a registered public offering of Common Stock, the public offering
price of which is not less than $20,000,000 in the aggregate or (ii) the date
upon which the Company obtains the consent of the holders of 66 2/3% of the then
outstanding shares of Preferred Stock.
The holders of Preferred Stock are entitled to notice of any stockholders'
meeting in accordance with the Bylaws of the Company and are entitled to vote
together with the holders of Common stock as a class. The holders of Preferred
Stock are entitled to the number of votes equal to the number of shares of
Common Stock into which such shares are convertible. Notwithstanding the general
voting rights described above, (i) so long as any shares of Series A Preferred
Stock are outstanding, the holders of a majority of the then outstanding shares
of Series A Preferred Stock, voting as a separate class on an as-converted
basis, are entitled to elect four directors and the holders of Common Stock and
Series A Preferred Stock, voting as a single class on an as-converted basis, are
entitled to elect one director; (ii) so long as any shares of Series B Preferred
Stock are outstanding, the holders of a majority of the then outstanding shares
of Series B Preferred Stock, voting as a separate class on an as-converted
basis, are entitled to elect one director; and (iii) all remaining directors are
elected by the holders of the Preferred Stock and Common Stock voting together
on an as-converted basis.
So long as any shares of Series B Preferred Stock are outstanding, the
Company may not, without first obtaining the approval of the holders of at least
a majority of the then-outstanding shares of Series B Preferred Stock, voting
together as a separate series on an as-converted basis, (i) take any action that
would materially and adversely alter the rights, preferences or privileges of
the Series B Preferred Stock as a separate series in a manner that is dissimilar
and disproportionate relative to the manner in which the rights, preferences or
privileges of the Series A Preferred Stock are altered; (ii) authorize
additional shares of Series B Preferred Stock; (iii) take any action that would
cause the Company to become a "public utility" or a "holding company" as those
terms are defined under the Public Utility Holding Company Act of 1935; (iv)
take any action that would alter the right of the holders of the then
outstanding shares of Series B Preferred Stock to elect one director of the
Company; or (v) amend certain sections of the Certificate of Incorporation as
set forth more fully therein. So long as any shares of Series A Preferred Stock
and/or Series B Preferred Stock are outstanding, the Company may not, without
first obtaining the approval of the holders of at least 55% or more of the then
outstanding shares of Preferred Stock, voting together as a single class on an
as-converted basis, (i) sell, convey, or otherwise dispose of or encumber all or
substantially all of its property or business or merge into or consolidate with
any other corporation (other than a wholly owned subsidiary corporation) or
effect any transaction or series of related transactions in which more than 50%
of the voting power of the Company is disposed of; (ii) create any new class or
series of stock or any other securities convertible into equity securities of
the Company having a preference over, or being on a parity with, the Series A
Preferred Stock or Series B Preferred Stock with respect to voting, dividends or
upon liquidation; or (iii) authorize additional shares of Series A Preferred
Stock.
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The Certificate of Incorporation does not contain any restriction on the
purchase or redemption of shares by the Company while there is an arrearage in
the payment of dividends. There are no sinking fund provisions applicable to the
Preferred Stock.
In connection with the issuance of Warrants pursuant to this Offering, the
holders of Preferred Stock have agreed to waive their rights to anti-dilution
adjustments under the Certificate of Incorporation.
BOARD REPRESENTATION RIGHTS AND VOTING
CERTIFICATE OF INCORPORATION. In any election of directors, the Certificate
of Incorporation provides that (i) so long as any shares of Series A Preferred
Stock are outstanding, the holders of a majority of the shares of the Series A
Preferred Stock, voting as a separate class on an as-converted basis, shall be
entitled to elect four directors (the "Series A Directors") and the holders of a
majority of the Common Stock and Series A Preferred Stock, voting as a single
class on an as-converted basis, shall be entitled to elect one director (the
"Common/Series A Director"); (ii) so long as any shares of Series B Preferred
Stock are outstanding, the holders of a majority of the shares of the Series B
Preferred Stock, voting as a separate class on an as-converted basis, shall be
entitled to elect one director (the "Series B Director"); and (iii) all
remaining directors will be elected by the holders of Preferred Stock and Common
Stock voting together as one class on an as-converted basis.
At any meeting held for the purpose of electing or nominating directors, the
presence in person or by proxy of the holders of a majority of the Series A
Preferred Stock then outstanding shall constitute a quorum of the Series A
Preferred Stock for the election or nomination of the Series A Directors, the
presence in person or by proxy of the holders of a majority of the shares of
Series B Preferred Stock then outstanding, shall constitute a quorum of the
Series B Preferred Stock for the election or nomination of the Series B
Director, the presence in person or by proxy of the holders of a majority of the
Common Stock and Series A Preferred Stock, on an as-converted basis, then
outstanding shall constitute a quorum of the Common Stock and Series A Preferred
Stock for the election or nomination of the Common/ Series A Director, and the
presence in person or by proxy of the holders of a majority of the Preferred
Stock and Common Stock, on an as-converted basis, then outstanding shall
constitute a quorum of the Preferred Stock and Common Stock for the election or
nomination of all remaining directors.
A vacancy in any directorship elected solely by the holders of Series A
Preferred Stock shall be filled only by vote of the holders of Series A
Preferred Stock, a vacancy in the directorship elected solely by the holders of
the Series B Preferred Stock shall be filled only by vote of the Series B
Preferred Stock, a vacancy in the directorship elected by the holders of the
Common Stock and Series A Preferred Stock shall be filled only by vote of the
Common Stock and Series A Preferred Stock, voting together as one class on an
as-converted basis, and a vacancy in any directorship elected by the holders of
Preferred Stock and Common Stock shall be filled only by the vote of the holders
of Preferred Stock and Common Stock voting together as one class on an
as-converted basis.
Any director elected by the holders of Series A Preferred Stock may be
removed during such director's term of office, either for or without cause, by
and only by the affirmative vote of the holders of a majority of the outstanding
shares of Series A Preferred Stock, any director elected by the holders of
Series B Preferred Stock may be removed during such director's term of office,
either for or without cause, by and only by the affirmative vote of the holders
of a majority of the outstanding shares of Series B Preferred Stock, any
director elected by the holders of Common Stock and Series A Preferred Stock may
be removed during such director's term of office, either for or without cause,
by and only by the affirmative vote of the holders of a majority of the
outstanding shares of Common Stock and Series A Preferred Stock, voting together
as one class on an as-converted basis, and any director elected by the holders
of Preferred Stock and Common Stock may be removed during such director's term
of office, either for or without cause, by and only by the affirmative vote of
the holders of a majority of the outstanding shares of Preferred Stock and
Common Stock, voting together as one class on an as-converted basis.
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VOTING AGREEMENT. Pursuant to an Amended and Restated Voting Agreement (the
"Voting Agreement") among the Company and certain of its stockholders dated
March 12, 1998, the parties thereto agreed to certain provisions with respect to
the voting of their shares. For so long as any of the Brentwood Entities, the
Enterprise Entities, the KPCB Entities or the Sprout Entities own at least
1,000,000 shares of Series A Preferred Stock, each of the holders of Series A
Preferred Stock shall vote all of its shares of Series A Preferred Stock to
elect as Series A Directors one nominee designated by Brentwood, one nominee
designated by Enterprise, one nominee designated by KPCB and one nominee
designated by Sprout. During the term of the Voting Agreement, each of the
holders of Series A Preferred Stock and Series B Preferred Stock shall vote all
of its Series A Preferred Stock or Common Stock to elect as the Common/Series A
Director the Company's Chief Executive Officer, or a replacement nominee as
described more fully therein. Shares held by the Sprout Trustee (as hereinafter
defined) pursuant to the Sprout Voting Trust (as hereinafter defined) are deemed
shares held by the Sprout Entities. For so long as Enron owns at least 750,000
shares of Series B Preferred Stock, each of the holders of Series B Preferred
Stock shall vote all of its shares of Series B Preferred Stock to elect as the
Series B Director a nominee designated by Enron (the "Enron Nominee"). All of
the parties to the Voting Agreement also agreed that in the event the size of
the Board of Directors is increased (the "Board Increase"), then each of the
parties shall vote all of its shares of Preferred Stock or Common Stock to amend
the Certificate of Incorporation and the Voting Agreement such that the number
of directors to be elected by the holders of Series B Preferred Stock and the
number of Enron Nominees shall be increased so that (i) the proportion of the
total number of directors elected by the holders of Series B Preferred Stock and
the number of Enron Nominees to the total size of the Board is approximately
equal (rounding to the nearest whole number of directors) to (ii) the proportion
of shares of Common Stock issued or issuable upon conversion of the Series B
Preferred Stock owned by Enron to the total outstanding capital stock of the
Company as of the time of the applicable Board Increase. At such time as the
number of Enron Nominees is increased as described above (the "Additional Enron
Nominee"), each of the holders of Series B Preferred Stock shall vote all of its
shares of Series B Preferred Stock to elect the Enron Nominees to the Board.
SPROUT VOTING TRUST. Pursuant to a Voting Trust Agreement (the "Sprout
Voting Trust") dated as of May 5, 1998, Sprout Capital VII, L.P. ("Sprout
Capital") transfer its 2,609,686 shares of Series A Preferred Stock and its
390,966 shares of Series B Preferred Stock to First Union Trust Company
Association, as voting trustee (the "Sprout Trustee") in trust for the purpose
of voting on certain stockholder matters. Except as provided below, with respect
to any proposal submitted for a stockholder vote (a "Stockholder Proposal"),
including without limitation any matters on which the Preferred Stock has class
or series voting rights, the Sprout Trustee shall vote the shares held in trust
for or against such Stockholder Proposal in its sole and absolute discretion as
advised by an adviser and subject to the Voting Agreement. The adviser shall be
selected by the Sprout Trustee and shall not be an affiliate of Sprout Capital
or DLJSC (as hereinafter defined). Subject to certain provisions regarding
extending its term, the Sprout Voting Trust terminates on the earlier to occur
of (i) ten years from its date of execution, (ii) the sale of all of the shares
subject to the Sprout Voting Trust, (iii) a merger or sale of the Company or
(iv) the effective date of a liquidation or dissolution of the Company. The
address of the Sprout Trustee is: First Union Trust Company, National
Association, One Rodney Square, First Floor, 920 King Street, Wilmington, DE
19801, Attention: Corporate Trust Administrator.
ENRON VOTING TRUST. Pursuant to a Voting Trust Agreement dated March 12,
1998 (the "Voting Trust Agreement"), Enron transferred its shares of Series B
Preferred Stock to the Company as voting trustee (the "Trustee") in trust for
the purpose of voting on certain stockholder matters. Except as provided below,
with respect to any Stockholder Proposal, including without limitation any
matters on which the Preferred Stock or Series B Preferred Stock has class or
series voting rights, the Trustee shall vote the shares held in trust for or
against such Stockholder Proposal, in the same proportion as a majority of the
then outstanding shares of Series A Preferred Stock, voting as a separate class,
are voted or abstain. Notwithstanding the above, with respect to any proposal
submitted for stockholder vote with respect to the election of the Series B
Director or with respect to the protective provisions of the Series B Preferred
Stock, the
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Trustee shall vote the shares held in trust in the manner directed by Enron.
Subject to certain provisions regarding extending its term, the Voting Trust
terminates on the earlier to occur of (i) March 11, 2008, (ii) the Company's
initial public offering, (iii) a merger or sale of the Company or (iv) the
effective date of a liquidation or dissolution of the Company. The address of
the Company, as Trustee, is Rhythms NetConnections Inc., 7337 South Revere
Parkway, Englewood, Colorado 80112-3931, Attention: Chief Financial Officer.
REGISTRATION RIGHTS
Pursuant to the terms of the Investors' Rights Agreement, the current
holders of Common Stock, Series A Preferred Stock and Series B Preferred Stock
(together, the "Investors") acquired certain registration rights with respect to
the Company. At any time after the earlier of (i) March 11, 2002, or (ii) six
months after the effective date of the first registration statement filed by the
Company under the Securities Act, holders of 60% or more of the Registrable
Securities (as defined in the Investors' Rights Agreement) or Enron may require
the Issuer to effect registration under the Securities Act covering at least 20%
of the Registrable Securities then outstanding, or, if initiated by Enron,
covering at least 20% of the Registrable Securities then held by Enron, subject
in either case to the Board of Directors' right to defer such registration for a
period up to 120 days; provided, however, that Rhythms is obligated to effect
only (A) two such registrations pursuant to the request of holders of 60% or
more of the Registrable Securities, and (B) one such registration pursuant to
the request of Enron. In addition, if Rhythms proposes to register securities
under the Securities Act (other than a registration relating either to the sale
of securities to employees pursuant to a stock option, stock purchase or similar
plan or a registration on any form which does not include substantially the same
information as would be required to be included in a registration statement
covering the sale of the Registrable Securities), then any of the Investors has
a right (subject to quantity limitations determined by underwriters if the
offering involves an underwriting) to request that the Company register such
holder's Registrable Securities. All registration expenses incurred in
connection with the registrations described in (A) and (B) above and all
piggyback registrations will be borne by the Issuer. The participating Investors
will pay for underwriting discounts and commissions incurred in connection with
any such registrations. Further, the holders of 40% or more of the Registrable
Securities may require the Company to register all or a portion of their
Registrable Securities on Form S-3 (a "Form S-3 Registration") when such form
becomes available to the Company, provided that the aggregate proceeds of each
such registration is at least $5,000,000 and subject to certain other conditions
and limitations, including the Company's ability to defer the filing of the Form
S-3 Registration for a period of not more than 120 days in certain
circumstances. All expenses incurred in connection with such a Form S-3
Registration shall be borne pro rata by the Investor or Investors participating
in the Form S-3 Registration. All registration rights will terminate no later
than after five years following the Company's initial public offering. Rhythms
has agreed to indemnify the Investors against certain liabilities in connection
with any registration effected pursuant to the foregoing Investors' Rights
Agreement, including liabilities under the Securities Act.
RIGHT OF FIRST OFFER
Under the Investors' Rights Agreement, each Major Investor (as defined
below) has the right of first refusal to purchase its pro rata portion each time
the Company proposes to offer any shares of, or securities convertible into or
exercisable for any shares of, any class of its capital stock, on the same terms
and conditions as the Company offers such securities to other investors subject
to certain conditions and limitations. For purposes of this right of first
offer, a "Major Investor" is defined as (i) any investor who holds at least 50%
of such investor's originally acquired shares of Series A Preferred Stock or
Series B Preferred Stock issued pursuant to (A) that certain Series A Preferred
Stock Purchase Agreement dated July 3, 1997 (the "Series A Agreement") or (B)
that certain Series B Preferred Stock Purchase Agreement dated March 12, 1998,
(the "Series B Agreement"), as applicable, and (ii) any person who acquires at
least (A) 10% of the Series A Preferred Stock (or the Common Stock issued upon
conversion thereof) issued
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pursuant to the Series A Agreement or (B) 10% of the Series B Preferred Stock
(or the Common Stock issued upon conversion thereof) issued pursuant to the
Series B Agreement.
The right of first offer of all holders terminates upon the closing of a
registered public offering of the Common Stock.
In connection with the issuance of Warrants pursuant to this Offering, the
Major Investors have agreed to waive their rights of first offer under the
Investors' Rights Agreement.
OTHER RIGHTS
Each holder of at least 500,000 Registrable Securities (as defined in the
Investors' Rights Agreement) is entitled to certain annual, quarterly and
monthly financial information from the Company, and also has certain rights of
access and inspection. The information and inspection rights terminate upon the
earlier of (i) a registered public offering of the Company's securities raising
at least $20,000,000 or (ii) when the Company first becomes subject to the
periodic reporting requirements of Sections 12(g) or 15(d) of the 1934 Act.
TRANSFER AGENT
The Company acts as the transfer agent and registrar for its Common and
Preferred Stock.
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FEDERAL INCOME TAX CONSIDERATIONS
The following discussion is a summary of the material United States federal
income tax (and in the case of Non-U.S. Holders, as defined below, estate tax)
considerations relevant to the Exchange Offer and the purchase, ownership and
disposition of the New Notes, but does not purport to be a complete analysis of
all the potential tax effects thereof. Except as specifically discussed below
with regard to Non-U.S. Holders (as defined below), this summary applies only to
initial investors who held the Old Notes and will hold the New Notes as capital
assets and who, for United States federal income tax purposes, are (i)
individual citizens or residents of the United States, (ii) corporations,
partnerships or other entities created or organized in or under the laws of the
United States or of any political subdivision thereof (unless, in the case of a
partnership, Treasury Regulations otherwise provide), (iii) estates, the income
of which are subject to United States federal income taxation regardless of the
source of such income or (iv) trusts subject to the primary supervision of a
United States court and the control of one or more United States persons ("U.S.
Holders"). Persons other than U.S. Holders ("Non-U.S. Holders") are subject to
special United States federal income and estate tax considerations that are
discussed below. There can be no assurance that the Internal Revenue Service
(the "Service") will agree with the following discussion. Further, the
discussion does not address all aspects of taxation that may be relevant to
particular holders in light of their personal circumstances (including the
effect of any foreign, state or local tax laws) or to certain types of holders
(including dealers in securities, insurance companies, foreign persons,
financial institutions, tax-exempt entities and persons holding the Old Notes or
the New Notes as part of a straddle, hedge or conversion transaction) subject to
special treatment under the United States federal income tax laws. Moreover, the
effect of any applicable state, local or foreign tax laws is not discussed.
The discussion of the United States federal income tax (and, in the case of
Non-U.S. Holders, United States federal estate tax) consequences set forth below
is based upon currently existing provisions of the Internal Revenue Code of
1986, as amended (the "Code"), judicial decisions, and administrative
interpretations including, but not limited to, Treasury regulations relating to
original issue discount ("OID Regulations"), all of which are subject to change,
possibly with retroactive effect. BECAUSE INDIVIDUAL CIRCUMSTANCES MAY DIFFER,
EACH PROSPECTIVE PARTICIPANT IN THE EXCHANGE OFFER SHOULD CONSULT HIS OWN TAX
ADVISOR WITH RESPECT TO HIS PARTICULAR TAX SITUATION AND THE PARTICULAR TAX
EFFECTS OF ANY STATE, LOCAL, FOREIGN OR OTHER TAX LAWS AND POSSIBLE CHANGES IN
THE TAX LAWS.
EXCHANGE OF NOTES
The exchange of New Notes for Old Notes pursuant to the Exchange Offer will
not be treated as a significant modification of the Old Notes under applicable
U.S. Treasury Regulations. As a result, the exchange will be treated for U.S.
federal income tax purposes as merely a registration and continuation of the Old
Notes. As a result, no gain or loss will be recognized by any holder of the Old
Notes by reason of their participation in the Exchange Offer (each such holder,
a "Participant"). Each Participant's adjusted basis and holding period in the
New Notes will be the same as such Participant's adjusted basis and holding
period in the Old Notes. Similarly, since the New Notes and the Old Notes are
treated as one and the same for U.S. federal income tax purposes, any original
issue discount, acquisition premium, market discount or other tax attributes
associated with the Old Notes will continue to apply to the New Notes.
SALE OR OTHER DISPOSITION OF NOTES. In general, upon the sale, exchange or
redemption of a New Note, a U.S. Holder will recognize taxable gain or loss
equal to the difference between (i) the amount of cash proceeds and the fair
market value of any property received on the sale, exchange or redemption (not
including any amount attributable to accrued but unpaid interest) and (ii) the
U.S. Holder's adjusted tax basis in the New Note. An initial U.S. Holder's
adjusted tax basis in a New Note generally will be equal to the cost of the Note
to such U.S. Holder (i.e., the portion of the Unit purchase price allocated to
such Old Note), increased by the amount of any market discount or OID previously
included in income by the U.S.
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Holder with respect to such Old Note or the New Note received in exchange
therefor and reduced by the amount of any principal received by the U.S. Holder.
Subject to the market discount rules, gain or loss realized on the sale,
exchange or redemption of a New Note will be capital gain or loss. Capital gain
recognized by individual U.S. Holders generally will be subject to a maximum
United States federal income tax rate of (i) 39.6% if the U.S. Holder held the
New Note for not more than one year, (ii) 28% if the U.S. Holder held the New
Note for more than one year but not more than eighteen months, and (iii) 20% if
the U.S. Holder held the New Note for more than eighteen months. Beginning in
2001, the rate of tax on gains from certain property held more than five years
will be further reduced to 18%. A holder's holding period with respect to the
Old Notes surrendered in the Exchange Offer shall be included in the holder's
holding period with respect to the New Notes received in such exchange. The
characterization of income as capital gain or loss is also relevant for purposes
of, among other things, limitations with respect to the deductibility of capital
losses.
NON-U.S. HOLDERS
In general, subject to the discussion below concerning backup withholding:
a. payments of principal or interest (including OID) on the New Notes by
the Company or any paying agent to a beneficial owner of a New Note that is
a Non-U.S. Holder will not be subject to United States withholding tax,
provided that, in the case of interest or accrued OID, (i) such Non-U.S.
Holder does not own, actually or constructively, 10% or more of the total
combined voting power of all classes of stock of the Company entitled to
vote, within the meaning of Section 871(h)(3) of the Code, (ii) such
Non-U.S. Holder is not a "controlled foreign corporation" (within the
meaning of the Code) that is related, directly or indirectly, to the Company
through stock ownership, (iii) such Non-U.S. Holder is not a bank receiving
interest described in Section 881(c)(3)(A) of the Code, and (iv) the
certification requirements under Section 871(h) or Section 881(c) of the
Code and Treasury Regulations thereunder (summarized below) are satisfied.
b. Non-U.S. Holder of a New Note will not be subject to United States
income tax on gains realized on the sale, exchange or other disposition of
such New Note, unless (i) such Non-U.S. Holder is an individual who is
present in the United States for 183 days or more in the taxable year of
sale, exchange or other disposition, and certain conditions are met, (ii)
such gain is effectively connected with the conduct by the Non-U.S. Holder
of a trade or business in the United States and, if certain tax treaties
apply, is attributable to a United States permanent establishment maintained
by the Non-U.S. Holder, or (iii) the Non-U.S. Holder is subject to Code
provisions applicable to certain United States expatriate.
c. a New Note held by an individual who is not a citizen or resident of
the United States at the time or his death will not be subject to United
States estate tax as a result of such individual's death, provided that, at
the time of such individual's death, the individual does not own, actually
or constructively, 10% or more of the total combined voting power of all
classes of stock of the Company entitled to vote and payments with respect
to such New Note would not have been effectively connected with the conduct
by such individual of a trade or business in the United States.
To satisfy the certification requirements referred to in (a)(iv) above,
Sections 871(h) and 881(c) of the Code and currently effective Treasury
Regulations thereunder require that either (i) the beneficial owner of a New
Note must certify, under penalties of perjury, to the Company or its paying
agent, as the case may be, that such owner is a Non-U.S. Holder and must provide
such owner's name and address, and United States taxpayer identification number
("TIN"), if any, or (ii) a securities clearing organization, bank or other
financial institution that holds customer securities in the ordinary course of
its trade or business (a "Financial Institution") and holds the New Note on
behalf of the beneficial owner thereof must certify, under penalties of perjury,
to the Company or its paying agent, as the case may be, that such certificate
has been received from the beneficial owner and must furnish the payor with a
copy thereof. A certificate
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described in this paragraph is effective only with respect to payments of
interest made to the certifying Non-U.S. Holder after delivery of the
certificate in the calendar year of its delivery and the two immediately
succeeding calendar years. Under temporary Treasury Regulations, such
requirement will be fulfilled if the beneficial owner of a New Note certifies on
IRS Form W-8, under penalties of perjury, that it is a Non-U.S. Holder and
provides its name and address, and any Financial Institution holding the New
Note on behalf of the beneficial owner files a statement with the withholding
agent to the effect that it has received such a statement from the beneficial
owner (and furnishes the withholding agent with a copy thereof).
Treasury Regulations released on October 6, 1997 (the "New Regulations") and
effective for payments made after December 31, 1998, will provide alternative
methods for satisfying the certification requirements described above. The New
Regulations also would require, in the case of New Notes held by a foreign
partnership, that (i) the certification be provided by the partners rather than
by the foreign partnership and (ii) the partnership provide certain information,
including a TIN. A look-through rule would apply in the case of tiered
partnerships.
If a Non-U.S. Holder of a New Note is engaged in a trade or business in the
United States and if interest (including OID) on the New Note, or gain realized
on the sale, exchange or other disposition of the New Note, is effectively
connected with the conduct of such trade or business (and, if certain tax
treaties apply, is attributable to a United States permanent establishment
maintained by the Non-U.S. Holder in the United States), the Non-U.S. Holder,
although exempt from United States withholding tax (provided that the
certification requirements discussed in the next sentence are met), will
generally be subject to regular United States federal income tax on such
interest or gain in the same manner as if it were a U.S. Holder. In lieu of the
certificate described above, such a Non-U.S. Holder will be required, under
currently effective Treasury Regulations, to provide the Company with a properly
executed Internal Revenue Service Form 4224 in order to claim an exemption from
withholding tax. In addition, if such Non-U.S. Holder is a foreign corporation,
it may be subject to a branch profits tax equal to 30% (or such lower rate
provided by an applicable treaty) of its effectively connected earnings and
profits for the taxable year, subject to certain adjustments. For purposes of
the branch profits tax, interest (including OID) on a New Note and any gain
recognized on the sale, exchange or other disposition of a New Note will be
included in the earnings and profits of such Non-U.S. Holder if such interest or
gain is effectively connected with the conduct by a Non-U.S. Holder of a trade
or business in the United States. The New Regulations will change certain of the
withholding reporting and certification requirements described above, effective
for payments made after December 31, 1998, subject to certain grandfathering
provisions.
Compliance with the above discussed certification requirements in respect of
the Old Notes will continue as compliance with such certification requirements
in respect of the New Notes.
Non-U.S. Holders should consult with their tax advisors regarding United
States and foreign tax consequences with respect to the New Notes.
BACKUP WITHHOLDING AND INFORMATION REPORTING
Backup withholding of United States federal income tax at a rate of 31% may
apply to payments made in respect of a New Note to a holder that is not an
"exempt recipient" and that fails to provide certain identifying information
(such as the holder's TIN) in the manner required. Generally, individuals are
not exempt recipients, whereas corporations and certain other entities are
exempt recipients. Payments made in respect of a New Note must be reported to
the Service, unless the holder is an exempt recipient or otherwise establishes
an exemption.
In the case of payments of interest on a New Note to a Non-U.S. Holder,
Treasury Regulations provide that backup withholding and information reporting
will not apply to payments with respect to which either requisite certification
has been received or an exemption has otherwise been established
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(provided that neither the Company nor a paying agent has actual knowledge that
the holder is a U.S. Holder or that the conditions of any other exemption are
not in fact satisfied).
Payments of the proceeds of the sale of a New Note to or through a foreign
office of a broker that is a United States person, a "controlled foreign
corporation" (within the meaning of the Code) or a foreign person, 50% or more
of whose gross income from all sources for the three-year period ending with the
close of its taxable year preceding the payment was effectively connected with
the conduct of a trade or business within the United States, are currently
subject to certain information reporting requirements, unless the payee is an
exempt recipient or such broker has evidence in its records that the payee is a
Non-U.S. Holder and no actual knowledge that such evidence is false and certain
other conditions are met. Temporary Treasury Regulations indicate that such
payments are not currently subject to backup withholding. Under current Treasury
Regulations, payments of the proceeds of a sale of a New Note to or through the
United States office of a broker will be subject to information reporting and
backup withholding unless the payee certifies under penalties of perjury as to
his or her status as a Non-U.S. Holder and satisfies certain other
qualifications (and no agent or broker who is responsible for receiving or
reviewing such statement has actual knowledge that it is incorrect) and provides
his or her name and address or the payee otherwise establishes an exemption.
If in connection with the acquisition and ownership of the Old Notes a
holder provided identifying information (such as the holder's TIN) in the manner
required or otherwise established an exemption from backup withholding, such
compliance with the backup withholding and information reporting rules will
continue in respect of the New Notes.
Any amounts withheld under the backup withholding rules from a payment to a
holder of a New Note will be allowed as a refund or credit against such holder's
United States federal income tax, provided that the required information is
furnished to the Service.
As noted above, the Treasury Department recently issued the New Regulations.
In general, the New Regulations do not significantly alter the substantive
withholding and information reporting requirements but unify current
certification procedures and forms and clarify reliance standards. Under the New
Regulations, special rules apply which permit the shifting of primary
responsibility for withholding to certain financial intermediaries acting on
behalf of beneficial owners. A holder of a New Note should consult with its tax
advisor regarding the application of the backup withholding rules to its
particular situation, the availability of an exemption therefrom, the procedure
for obtaining such an exemption, if available, and the impact of the New
Regulations on payments made with respect to New Notes after December 31, 1998.
THE FOREGOING SUMMARY DOES NOT DISCUSS ALL ASPECTS OF UNITED STATES FEDERAL
INCOME TAXATION THAT MAY BE RELEVANT TO A PARTICULAR HOLDER OF NEW NOTES IN
LIGHT OF ITS PARTICULAR CIRCUMSTANCES AND INCOME TAX SITUATION. PROSPECTIVE
HOLDERS SHOULD CONSULT THEIR OWN TAX ADVISOR AS TO THE SPECIFIC TAX CONSEQUENCES
TO THEM OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF THE NEW NOTES, INCLUDING
THE APPLICATION AND EFFECT OF STATE, LOCAL, FOREIGN AND OTHER TAX LAWS AND THE
POSSIBLE EFFECTS OF CHANGES IN UNITED STATES OR OTHER TAX LAWS.
PLAN OF DISTRIBUTION
Each Participating Broker-Dealer that receives New Notes for its own account
in connection with the Exchange Offer must acknowledge that it will deliver a
prospectus in connection with any resale of such New Notes. This Prospectus may
be used by Participating Broker-Dealers during the period referred to below in
connection with resales of the New Notes received in exchange for Old Notes if
such Old Notes were acquired by such Participating Broker-Dealers for their own
accounts. The Company has agreed that this Prospectus may be used by a
Participating Broker-Dealer in connection with resales of such New Notes
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for a period ending 180 days after the effective date of the Registration
Statement (subject to extension under certain limited circumstances described
herein) or, if earlier, when all such New Notes have been disposed of by such
Participating Broker-Dealer. See "The Exchange Offer--Terms of the Exchange
Offer."
The Company will not receive any cash proceeds from the issuance of the New
Notes offered hereby. New Notes received by Participating Broker-Dealers for
their own accounts in connection with the Exchange Offer may be sold from time
to time in one or more transactions in the over-the-counter market, in
negotiated transactions, through the writing of options on the New Notes or a
combination of such methods of resale, at market prices prevailing at the time
of resale, at prices related to such prevailing market prices or at negotiated
prices. Any such resale may be made directly to purchasers or to or through
brokers or dealers who may receive compensation in the form of commissions or
concessions from any such broker-dealer and/or the purchasers of any such New
Notes. Any Participating Broker-Dealer that resells New Notes that were received
by it for its own account in connection with the Exchange Offer and any broker
or dealer that participates in a distribution of such New Notes may be deemed to
be an "underwriter" within the meaning of the Securities Act, and any profit on
any such resale of New Notes and any commissions or concessions received by any
such persons may be deemed to be underwriting compensation under the Securities
Act. The Letter of Transmittal states that by acknowledging that it will deliver
and by delivering a prospectus, a Participating Broker-Dealer will not be deemed
to admit that it is an "underwriter" within the meaning of the Securities Act.
LEGAL MATTERS
The validity of the New Notes will be passed upon for the Company by
Brobeck, Phleger & Harrison LLP ("BPH"), San Diego, California. The BPH
investment fund and certain BPH attorneys hold in the aggregate 30,000 shares of
Series A Preferred Stock.
EXPERTS
The financial statements of the Company as of December 31, 1997 and for the
period from February 27, 1997 (inception) through December 31, 1997, included in
this Prospectus, have been so included in reliance on the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
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GLOSSARY OF TERMS
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ATM.......................................... ASYNCHRONOUS TRANSFER MODE. High bandwidth,
low- delay, connection-oriented, packet-like
switching and multiplexing technique
requiring 53-byte, fixed- sized cells.
Backbone..................................... An element of the network infrastructure that
provides high-speed, high capacity
connections among the network's physical
points of presence, i.e., RCPs and RMSCs. The
backbone is used to transport end user
traffic across the metropolitan area and
across the United States.
Bandwidth.................................... Refers to the maximum amount of data that can
be transferred through a computer's backbone
or communication channel in a given time. It
is usually measured in Hertz (cycles per
second) for analog communications and bits
per second for digital communications.
CAP.......................................... COMPETITIVE ACCESS PROVIDER. A company that
provides its customers with an alternative to
the local telephone company for local and
interstate transport of private line, special
access and switched access telecommunications
services.
Channel Partners............................. Service Providers with retail customers to
whom Rhythms will co-market its services.
CLEC......................................... COMPETITIVE LOCAL EXCHANGE CARRIER. Category
of telephone service provider (carrier) that
offers local exchange and other services
similar to (and in competition with) those of
the ILEC, as allowed by recent changes in
telecommunications law and regulation. A CLEC
may also provide other types of services such
as long distance telephone, data
communications, Internet access and video.
CO........................................... CENTRAL OFFICE. A building used by ILECs to
connect circuits to communications equipment.
The usual location of a Rhythms Connection
Point.
Collocation.................................. A location where a CLEC network interconnects
with the network of an ILEC inside an ILEC
CO.
Copper Loop.................................. A pair of traditional copper telephone lines
using electric current to carry signals.
CPE.......................................... CUSTOMER PREMISE EQUIPMENT.
Telecommunications equipment, such as
interface equipment and modems, that is
installed on the customer premises.
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DNS Registration............................. DOMAIN NAME SERVICES (DNS) REGISTRATION. The
process of recording domain names so they are
accessible to users of the Internet.
Downstream................................... Refers to the transmission speed of a
connection between the Rhythms Connection
Point and the end user.
DS-0......................................... Standard telecommunications industry digital
signal format, which is distinguishable by
bit rate (the number of binary digits (0 and
1) transmitted per second). DS-0 service has
a bit rate of 64 kilobits per second.
DSL.......................................... DIGITAL SUBSCRIBER LINE. A transmission
technology enabling high-speed access in the
local copper loop, often referred to as the
last mile between the network service
provider (i.e., an ILEC, CLEC or an ISP) and
end user.
E-Commerce................................... ELECTRONIC COMMERCE. An Internet service that
supports electronic transactions between
customers and vendors to purchase goods and
services.
Ethernet..................................... A standard packet protocol used in Local Area
Networks that can work at megabit and gigabit
speeds.
FCC.......................................... FEDERAL COMMUNICATIONS COMMISSION. The United
States federal regulatory agency responsible
for regulating interstate and international
communications, among other things.
Firewall..................................... A computer device that separates a LAN from a
WAN and prevents unauthorized access to the
LAN through the use of electronic security
mechanisms.
Frames....................................... Information represented as bytes grouped
together that exists only on the link between
two communication nodes.
Frame Relay.................................. A form of packet switching with variable
length frames that may be used with a variety
of communications protocols.
FTP.......................................... FILE TRANSFER PROTOCOL. Internet tool for
transferring and accessing files.
GHz.......................................... GIGAHERTZ. Billions of hertz or cycles per
second; a measure used to characterize the
frequency or amount of bandwidth of a radio
frequency signal.
ILEC......................................... INCUMBENT LOCAL EXCHANGE CARRIER. A company
providing local exchange services on the date
of enactment of the Telecommunications Act of
1996. These companies consist of the RBOCs,
GTE, and numerous independent telephone
companies.
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Interconnection Agreement.................... A contract between an ILEC and a CLEC for the
connection of a CLEC network to the PSTN, as
well as CLEC access to ILEC UNEs, e.g.,
copper loops. This agreement sets out the
financial agreement and operational aspects
of such interconnection and access.
Inter-LATA................................... Inter-LATA long distance calls are calls that
pass from one LATA to another. Typically,
these calls are simply referred to as
long-distance calls, although calls within a
single LATA can also be long distance calls.
Internet..................................... An array of interconnected networks using a
common set of protocols defining the
information coding and processing
requirements that can communicate across
hardware platforms and over many links; now
operated by a consortium of
telecommunications service providers and
others.
IP........................................... INTERNET PROTOCOL. A standard for software
that keeps track of the inter-network
addresses for different nodes, routes
outgoing messages and recognizes incoming
messages.
ISDN......................................... INTEGRATED SERVICES DIGITAL NETWORK. A
transmission method that provides
circuit-switched access to the public network
at speeds of 64 Kbps [or Nx64] for voice,
data and video transmission.
ISP.......................................... INTERNET SERVICE PROVIDER. A company who
provides direct access to the Internet.
IXC.......................................... INTEREXCHANGE CARRIER. Usually referred to as
a long-distance service provider. There are
many IXCs, including AT&T, MCI, WorldCom,
Sprint and Qwest.
Kbps......................................... KILOBITS PER SECOND. 1,000 bits per second.
LAN.......................................... LOCAL AREA NETWORK. A privately owned and
administered network for data communications.
Usually provides high bandwidth
communications between attached devices over
a limited geographical area.
LATA......................................... LOCAL ACCESS AND TRANSPORT AREA. A geographic
area inside of which an RBOC can offer
switched telecommunications services,
including long distance (known as toll).
RBOCs are currently not allowed to provide
long distance service between these regions.
There are 196 LATAs in the United States
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LEC.......................................... LOCAL EXCHANGE CARRIER. A company that
provides local exchange services; this term
includes ILECs and CLECs.
LMDS......................................... LOCAL MULTIPOINT DISTRIBUTION SERVICE.
Digital wireless service in the 28-30 GHz
frequency band.
Mbps......................................... MEGABITS PER SECOND. Millions of bits per
second.
MHz.......................................... MEGAHERTZ. Millions of hertz or cycles per
second; a measure used to characterize the
frequency or amount of bandwidth of a radio
frequency signal.
MMDS......................................... MULTICHANNEL MULTIPOINT DISTRIBUTION SERVICE.
Wireless transmission systems licensed by the
FCC originally for wireless cable services,
that may be permitted to offer two-way
services in the future.
Multiplexing................................. An electronic or optical process that
combines several lower speed transmission
signals into one higher speed signal. There
are various techniques for multiplexing,
including frequency division (splitting the
total available frequency bandwidth into
smaller frequency slices), time division
(slicing a channel into timeslots and placing
each signal into its assigned timeslot) and
statistical (combining signals in the same
channel, but allowing each signal to transmit
only when it has data to send).
NAP.......................................... NETWORK ACCESS PROVIDER. A service provider
that connects subscribers to either ILECs,
CLECs or ISPs. The NAP is typically the
network provider that has access to the
copper loops over which DSL-based service
operates.
Node......................................... A node on a network is usually formed by the
presence of a router and user access
equipment (such as a modem or an Ethernet
card). Often, several leased lines are joined
together at a network node.
OSS.......................................... OPERATIONAL SUPPORT SYSTEMS. The
computer-based systems for ordering and
servicing services and facilities between
CLECs and ILECs.
Packets...................................... Information represented as bytes grouped
together through a communication node with a
common destination address and other
attribute information.
Packet/Cell Networks......................... Networks that transport packet protocols such
as X25, frame relay and IP, and cell
technologies such as ATM.
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POP.......................................... POINTS OF PRESENCE. Locations in a service
area where a carrier has installed
transmission equipment that serves as, or
relays calls to, a network switching center
of that carrier.
Protocol..................................... The rules or procedures that control how data
are organized and transmitted from one
computer to another.
PSTN......................................... PUBLIC SWITCHED TELEPHONE NETWORK. The
existing interconnected circuit switched
networks of the ILECs and the IXCs.
RBOC......................................... REGIONAL BELL OPERATING COMPANY. One of the
ILECs created by AT&T's divestiture of its
local exchange business. The current RBOCs
are BellSouth, Bell Atlantic Corporation,
Ameritech Corporation, U S WEST, Inc. and SBC
Communications, Inc.
RCP.......................................... RHYTHMS CONNECTION POINT. A physical point of
presence in the Rhythms Network that connects
a copper line extending from a customer
premises to a DSL multiplexer and utilizes a
broadband and redundant backbone to transport
customer traffic to the Rhythms Metro Service
Center (RMSC).
RMSC......................................... RHYTHMS METRO SERVICE CENTER. The physical
point of presence in a market to which the
RCPs are connected. The RMSCs will be
connected together over a backbone network.
RNOC......................................... RHYTHMS NETWORK OPERATIONS CENTER.
Router....................................... A device that accepts the IP protocol from a
LAN or another WAN device and switches/routes
IP packets across a network backbone.
Router's also provide protocol conversion
services to transfer IP packets over Frame
Relay, ATM, and other backbone network
services.
SNA.......................................... SYSTEMS NETWORK ARCHITECTURE. IBM's
proprietary connection-oriented, virtual
circuit network architecture for
terminal/host communication.
SNMP......................................... SIMPLE NETWORK MANAGEMENT PROTOCOL. The
network management protocol used with
TCP/IP-based Internets.
SONET........................................ SYNCHRONOUS OPTICAL NETWORK TECHNOLOGY. A
technology and network architecture that
enables signals to be transported
simultaneously along two different paths so
that if one pathway is cut, traffic can
continue in the other direction without
interruption to its destination. This is also
referred to as diverse routing.
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TCP/IP....................................... TRANSMISSION CONTROL PROTOCOL/INTERNET
PROTOCOL. A set of network protocols that
allow computers with different architectures
and operating system software to communicate
with other computers on the Internet.
UNE.......................................... UNBUNDLED NETWORK ELEMENTS. The various
components of an ILEC's network that a CLEC
can lease for purposes of building a
facilities-based competitive network,
including copper lines, CO collocation space,
inter-office transport, operational support
systems and local switching.
Upstream..................................... Refers to the transmission speed of a
connection between the end user and the
Rhythms Connection Point.
VARs......................................... VALUE ADDED RESELLERS.
WAN.......................................... WIDE AREA NETWORK. A computer or
communication network that covers a
geographic area that is larger than a city.
</TABLE>
A-6
<PAGE>
RHYTHMS NETCONNECTIONS INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Accountants..................................................... F-2
Financial Statements:
Balance Sheet....................................................................... F-3
Statement of Operations............................................................. F-4
Statement of Cash Flows............................................................. F-5
Statement of Stockholders' Equity................................................... F-6
Notes to Financial Statements....................................................... F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of Rhythms NetConnections Inc.
In our opinion, the accompanying balance sheet and the related statements of
operations, of cash flows, and of stockholders' equity present fairly, in all
material respects, the financial position of Rhythms NetConnections Inc. at
December 31, 1997, and the results of its operations and its cash flows for the
period from February 27, 1997 (inception) through December 31, 1997 in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
generally accepted auditing standards 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 audit provides a reasonable basis for the opinion expressed
above.
As explained in Note 3, the financial statements were restated to record
additional compensation in connection with Common Stock options issued during
the period from February 27, 1997 (inception) to December 31, 1997.
PRICEWATERHOUSECOOPERS LLP
San Diego, California
March 13, 1998, except as to
Note 3 which is as
of October 15, 1998
F-2
<PAGE>
RHYTHMS NETCONNECTIONS INC.
BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31, (UNAUDITED)
1997 JUNE 30,
(RESTATED) 1998
------------- --------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents....................................................... $ 10,166,000 $ 163,368,000
Accounts and loans receivable................................................... -- 260,000
Inventory....................................................................... -- 364,000
Prepaid expenses................................................................ 95,000 133,000
------------- --------------
Total current assets............................................................ 10,261,000 164,125,000
Equipment and furniture, net...................................................... 1,621,000 5,639,000
Collocation fees, net............................................................. 327,000 3,058,000
Deferred debt offering costs...................................................... -- 6,000,000
Other assets...................................................................... 32,000 47,000
------------- --------------
$ 12,241,000 $ 178,869,000
------------- --------------
------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt............................................... $ 126,000 $ 333,000
Accounts payable................................................................ 992,000 3,589,000
Accrued expenses................................................................ 335,000 873,000
------------- --------------
Total current liabilities..................................................... 1,453,000 4,795,000
Long-term debt.................................................................... 442,000 611,000
13.5% senior discount notes, net.................................................. -- 146,940,000
------------- --------------
Total liabilities............................................................. 1,895,000 152,346,000
------------- --------------
Commitments (Note 12)
Mandatorily redeemable Common Stock warrants...................................... -- 6,567,000
------------- --------------
Stockholders' equity:
Series A Convertible Preferred Stock, $0.001 par value; 17,000,000 shares
authorized in 1997, 12,900,000 shares in 1998; 12,490,000 shares issued and
outstanding in 1997, 12,855,094 in 1998....................................... 12,000 13,000
Series B Convertible Preferred Stock, $0.001 par value; no shares authorized in
1997, 4,044,943 shares in 1998; no shares issued and outstanding in 1997,
4,044,943 shares in 1998...................................................... -- 4,000
Common Stock, $0.001 par value; 22,764,706 shares authorized in 1997, 24,881,650
shares in 1998; 1,034,259 shares issued and outstanding in 1997, 3,322,804
shares in 1998................................................................ 1,000 3,000
Additional paid-in capital...................................................... 14,013,000 33,590,000
Deferred compensation........................................................... (1,258,000) (2,083,000)
Accumulated deficit............................................................. (2,422,000) (11,571,000)
------------- --------------
Total stockholders' equity.................................................... 10,346,000 19,956,000
------------- --------------
$ 12,241,000 $ 178,869,000
------------- --------------
------------- --------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
RHYTHMS NETCONNECTIONS INC.
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
(UNAUDITED)
PERIOD FROM PERIOD FROM
FEBRUARY 27, FEBRUARY 27,
1997 1997
(INCEPTION) (INCEPTION) (UNAUDITED)
THROUGH THROUGH SIX MONTHS
DECEMBER 31, JUNE 30, ENDED
1997 1997 JUNE 30,
(RESTATED) (RESTATED) 1998
--------------- --------------- -------------
<S> <C> <C> <C>
REVENUE:
Service and installation....................................... $ -- $ -- $ 82,000
--------------- --------------- -------------
OPERATING EXPENSES:
Network and service costs...................................... -- -- 668,000
Selling, general and administrative............................ 2,534,000 104,000 6,981,000
Depreciation and amortization.................................. 1,000 -- 35,000
--------------- --------------- -------------
Total operating expenses..................................... 2,535,000 104,000 7,684,000
--------------- --------------- -------------
LOSS FROM OPERATIONS............................................. (2,535,000) (104,000) (7,602,000)
--------------- --------------- -------------
OTHER INCOME AND EXPENSE:
Interest Income................................................ 114,000 -- 1,674,000
Interest Expense (including amortized debt discount and
costs)....................................................... (1,000) -- (3,221,000)
--------------- --------------- -------------
NET LOSS......................................................... $ (2,422,000) $ (104,000) $(9,149,000)
--------------- --------------- -------------
--------------- --------------- -------------
NET LOSS PER SHARE:
Basic.......................................................... $ (2.69) $ (0.12) $ (9.66)
--------------- --------------- -------------
--------------- --------------- -------------
Diluted........................................................ $ (2.69) $ (0.12) $ (9.66)
--------------- --------------- -------------
--------------- --------------- -------------
SHARES USED IN COMPUTING NET LOSS PER SHARE:
Basic.......................................................... 900,735 900,735 946,782
--------------- --------------- -------------
--------------- --------------- -------------
Diluted........................................................ 900,735 900,735 946,782
--------------- --------------- -------------
--------------- --------------- -------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
RHYTHMS NETCONNECTIONS INC.
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
(UNAUDITED)
PERIOD FROM PERIOD FROM
FEBRUARY 27, FEBRUARY 27,
1997 1997
(INCEPTION) (INCEPTION) (UNAUDITED)
THROUGH THROUGH SIX MONTHS
DECEMBER 31, JUNE 30, ENDED
1997 1997 JUNE 30,
(RESTATED) (RESTATED) 1998
--------------- --------------- --------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss...................................................... $ (2,422,000) $ (104,000) $ (9,149,000)
Adjustments to reconcile net loss to net cash used for
operating activities:
Depreciation and amortization............................... 1,000 -- 35,000
Amortized debt discount and costs........................... -- -- 3,188,000
Amortized deferred compensation............................. 192,000 19,000 238,000
Compensation expense from stock option issued to employee... 73,000 -- --
Changes in assets and liabilities:
Increase in accounts and loans receivable................. -- -- (260,000)
Increase in inventory..................................... -- -- (364,000)
Increase in prepaid expenses.............................. (95,000) -- (38,000)
Increase in other assets.................................. (32,000) (7,000) (15,000)
Increase in accounts payable.............................. 388,000 21,000 298,000
Increase in accrued expenses.............................. 335,000 -- 538,000
--------------- --------------- --------------
Net cash used for operating activities........................ (1,560,000) (71,000) (5,529,000)
--------------- --------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of equipment and furniture.......................... (1,018,000) -- (3,742,000)
Payment of collocation fees................................... (327,000) -- (2,743,000)
--------------- --------------- --------------
Net cash used for investing activities...................... (1,345,000) -- (6,485,000)
--------------- --------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from leasing company for equipment purchases......... -- -- 2,000,000
Proceeds from issuance of 13.5% senior discount notes......... -- -- 150,365,000
Payment of debt issue costs on 13.5% senior discount notes.... -- -- (6,046,000)
Proceeds from borrowings on long-term debt.................... 568,000 -- 432,000
Repayments on long-term debt.................................. -- -- (56,000)
Proceeds from issuance of Common Stock........................ 13,000 3,000 229,000
Proceeds from issuance of Preferred Stock..................... 12,490,000 297,000 18,292,000
--------------- --------------- --------------
Net cash provided by financing activities................... 13,071,000 300,000 165,216,000
--------------- --------------- --------------
Net increase in cash and cash equivalents....................... 10,166,000 229,000 153,202,000
Cash and cash equivalents at beginning of period................ -- -- 10,166,000
--------------- --------------- --------------
Cash and cash equivalents at end of period...................... $ 10,166,000 $ 229,000 $ 163,368,000
--------------- --------------- --------------
--------------- --------------- --------------
Supplemental schedule of cash flow information:
Cash paid for interest........................................ $ 3,000 $ -- $ 25,000
--------------- --------------- --------------
--------------- --------------- --------------
Supplemental schedule of non-cash financing activities:
Equipment purchases payable, to be financed through operating
leases...................................................... $ 604,000 $ -- $ 2,299,000
--------------- --------------- --------------
--------------- --------------- --------------
Warrants issued in conjunction with senior discount notes..... $ -- $ -- $ 6,567,000
--------------- --------------- --------------
--------------- --------------- --------------
</TABLE>
The accompanying notes are an integral part of these financial statements
F-5
<PAGE>
RHYTHMS NETCONNECTIONS INC.
STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
SERIES A CONVERTIBLE SERIES B CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK COMMON STOCK
$0.001 PAR VALUE $0.001 PAR VALUE $0.001 PAR VALUE ADDITIONAL
---------------------- ------------------------ ------------------------ PAID-IN
# SHARES AMOUNT # SHARES AMOUNT # SHARES AMOUNT CAPITAL
--------- ----------- ----------- ----------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Issuance of Common Stock to Founders (at
inception)............................. -- $ -- -- $ -- 900,735 $ 1,000 $ --
Issuance of Series A Preferred Stock for
cash ($1.00 per share)................. 12,490,000 12,000 -- -- -- -- 12,477,000
Issuance of Common Stock upon exercise of
options ($0.10 per share exercise
price)................................. -- -- -- -- 133,524 -- 13,000
Grant of options to purchase Series A
Preferred Stock ($0.80 per share
exercise price)........................ -- -- -- -- -- -- 73,000
Deferred compensation from grant of
options to purchase Common Stock....... -- -- -- -- -- -- 1,450,000
Amortization of deferred compensation.... -- -- -- -- -- -- --
Net loss for 1997........................ -- -- -- -- -- -- --
--------- ----------- ----------- ----------- ----------- ----------- ----------
Balance at December 31, 1997
(restated)............................. 12,490,000 12,000 -- -- 1,034,259 1,000 14,013,000
Issuance of Common Stock upon exercise of
options ($0.10 per share exercise
price) (unaudited)..................... -- -- -- -- 2,288,545 2,000 227,000
Issuance of Series A Preferred Stock for
cash ($0.80 per share) in February 1998
(unaudited)............................ 365,094 1,000 -- -- -- -- 291,000
Issuance of Series B Preferred Stock for
cash ($4.45 per share) in March 1998
(unaudited)............................ -- -- 4,044,943 4,000 -- -- 17,996,000
Deferred compensation from grant of
options to purchase Common Stock
(unaudited)............................ -- -- -- -- -- -- 1,063,000
Amortization of deferred compensation
(unaudited)............................ -- -- -- -- -- -- --
Net loss for first half 1998
(unaudited)............................ -- -- -- -- -- -- --
--------- ----------- ----------- ----------- ----------- ----------- ----------
Balance at June 30, 1998 (unaudited)..... 12,855,094 $ 13,000 4,044,943 $ 4,000 3,322,804 $ 3,000 $33,590,000
--------- ----------- ----------- ----------- ----------- ----------- ----------
--------- ----------- ----------- ----------- ----------- ----------- ----------
<CAPTION>
TOTAL
DEFERRED ACCUMULATED STOCKHOLDERS'
COMPENSATION DEFICIT EQUITY
------------- ------------ ------------
<S> <C> <C> <C>
Issuance of Common Stock to Founders (at
inception)............................. $ -- $ -- $ 1,000
Issuance of Series A Preferred Stock for
cash ($1.00 per share)................. -- -- 12,489,000
Issuance of Common Stock upon exercise of
options ($0.10 per share exercise
price)................................. -- -- 13,000
Grant of options to purchase Series A
Preferred Stock ($0.80 per share
exercise price)........................ -- -- 73,000
Deferred compensation from grant of
options to purchase Common Stock....... (1,450,000) -- --
Amortization of deferred compensation.... 192,000 -- 192,000
Net loss for 1997........................ -- (2,422,000) (2,422,000)
------------- ------------ ------------
Balance at December 31, 1997
(restated)............................. (1,258,000) (2,422,000) 10,346,000
Issuance of Common Stock upon exercise of
options ($0.10 per share exercise
price) (unaudited)..................... -- -- 229,000
Issuance of Series A Preferred Stock for
cash ($0.80 per share) in February 1998
(unaudited)............................ -- -- 292,000
Issuance of Series B Preferred Stock for
cash ($4.45 per share) in March 1998
(unaudited)............................ -- -- 18,000,000
Deferred compensation from grant of
options to purchase Common Stock
(unaudited)............................ (1,063,000) -- --
Amortization of deferred compensation
(unaudited)............................ 238,000 -- 238,000
Net loss for first half 1998
(unaudited)............................ -- (9,149,000) (9,149,000)
------------- ------------ ------------
Balance at June 30, 1998 (unaudited)..... $(2,083,000) ($11,571,000) $19,956,000
------------- ------------ ------------
------------- ------------ ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
RHYTHMS NETCONNECTIONS INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1--ORGANIZATION AND BASIS OF PRESENTATION
THE COMPANY: Rhythms NetConnections Inc. (the "Company"), a Delaware
corporation, was organized under the name Accelerated Connections Inc. effective
February 27, 1997. The Company's name was changed to Rhythms NetConnections Inc.
as of August 15, 1997. The Company is in the business of providing high-speed
data communications services on an end-to end basis to business customers and
end users. The Company began service trials in the San Diego, California, market
in December 1997 and began commercial operations in San Diego effective April 1,
1998.
The Company's ultimate success depends upon, among other factors, rapidly
expanding the geographic coverage of its network services; entering into
interconnection agreements with incumbent local exchange carriers, some of which
are competitors or potential competitors of the Company; deploying network
infrastructure; attracting and retaining customers; accurately assessing
potential markets; continuing to develop and integrate its operational support
system and other back office systems; obtaining any required governmental
authorizations; responding to competitive developments; continuing to attract,
retain and motivate qualified personnel; and continuing to upgrade its
technologies and commercialize its network services incorporating such
technologies. There can be no assurance that the Company will be successful in
addressing these matters and failure to do so could have a material adverse
effect on the Company's business, prospects, operating results and financial
condition. As the Company continues the development of its business, it will
seek additional sources of financing to fund its development. If unsuccessful in
obtaining such financing, the Company will continue expansion of its operations
on a reduced scale based on its existing capital resources.
INTERIM RESULTS (UNAUDITED): The accompanying balance sheet at June 30,
1998, the related statements of operations and of cash flows for the six months
ended June 30, 1998 and the period from February 27, 1997 through June 30, 1997,
and the related statement of stockholders' equity for the six months ended June
30, 1998 have been prepared in accordance with generally accepted accounting
principles for interim financial information and, therefore, do not include all
the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management,
these statements have been prepared on the same basis as the audited financial
statements and include all adjustments, consisting only of normal recurring
accruals, that are necessary for the fair statement of results for the unaudited
interim periods. The data disclosed in these notes to financial statements at
such date and for such periods are also unaudited. The operating results for the
interim periods are not necessarily indicative of the results to be expected for
a full fiscal year or for any future periods.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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 and the disclosure of contingent assets and liabilities at the
financial statement date, as well as the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
REVENUE RECOGNITION: Revenue is recorded in the period services are
provided to customers.
CASH AND CASH EQUIVALENTS: Cash and cash equivalents includes cash on hand,
money market funds and certificates of deposit with a maturity of 90 days or
less at the time of purchase.
F-7
<PAGE>
RHYTHMS NETCONNECTIONS INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS: The carrying amounts of the Company's
financial instruments as presented are reasonable estimates of those
instruments' fair values because of the short maturity of those instruments or
based on the current rates offered to the Company for debt of the same remaining
maturities.
INVENTORY: Inventory consists of communications equipment that will be
installed at customer locations. Inventory is accounted for on a FIFO basis.
EQUIPMENT AND FURNITURE: Equipment and furniture consists of purchased
equipment, furniture, computer software, and leasehold improvements. Equipment
and furniture is recorded at cost. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets, generally
three to seven years.
COLLOCATION FEES: Collocation fees represent nonrecurring fees paid to
secure Central Office space for location of certain Company equipment. The fees
are amortized over their estimated useful lives of ten years.
IMPAIRMENT OF LONG-LIVED ASSETS: The Company investigates potential
impairments of its long-lived assets on an exception basis when evidence exists
that events or changes in circumstances may have made recovery of an asset's
carrying value unlikely. An impairment loss is recognized when the sum of the
expected undiscounted future net cash flows is less than the carrying amount of
the asset. No such losses have been identified.
CONCENTRATIONS OF CREDIT RISK: Credit risk is primarily concentrated in
cash equivalents. Cash in excess of operating requirements is conservatively
invested in money market funds and certificates of deposit with high-quality
financial institutions to minimize risk.
INCOME TAXES: The Company provides for income taxes utilizing the liability
method. Under the liability method, current income tax expense or benefit
represents income taxes expected to be payable or refundable for the current
period. Deferred income tax assets and liabilities are established for both the
impact of differences between the financial reporting bases and tax bases of
assets and liabilities and for the expected future tax benefit to be derived
from tax credits and tax loss carryforwards. Deferred income tax expense or
benefit represents the change during the reporting period in the net deferred
income tax assets and liabilities. Deferred tax assets are reduced by a
valuation allowance when, in the opinion of management, it is more likely than
not that some portion or all of the deferred tax assets will not be realized.
NET LOSS PER SHARE: The Company has adopted Statement of Financial
Accounting Standard ("SFAS") No. 128, "Earnings Per Share." Basic earnings per
share ("EPS") is calculated by dividing the income or loss available to common
stockholders by the weighted average number of common shares outstanding for the
period, without consideration for common stock equivalents. Diluted EPS is
computed by dividing the income or loss available to common stockholders by the
weighted average number of common shares outstanding for the period in addition
to the weighted average number of common stock equivalents outstanding for the
period. Shares subject to repurchase by the Company are considered common stock
equivalents for purposes of this calculation. Shares issuable upon conversion of
the Series A Preferred Stock, upon the exercise of outstanding stock options and
shares issued subject to repurchase by
F-8
<PAGE>
RHYTHMS NETCONNECTIONS INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
the Company totaling 15,272,475 at December 31, 1997 have been excluded from the
computation since their effect would be antidilutive.
NET LOSS PER SHARE FOR INTERIM PERIODS (UNAUDITED): As of June 30, 1998,
the diluted net loss per share computation excludes 20,915,262 shares subject to
conversion or repurchase by the Company, since the effect of these shares would
be antidilutive.
STOCK-BASED COMPENSATION: The Company measures compensation expense for its
employee stock-based compensation using the intrinsic value method and provides
pro forma disclosures of net loss as if the fair value method had been applied
in measuring compensation expense (Note 7). Under the intrinsic value method of
accounting for stock-based compensation, when the exercise price of options
granted to employees is less than the fair value of the underlying stock on the
date of grant, compensation expense is to be recognized.
NEW ACCOUNTING PRONOUNCEMENTS: In June 1997, SFAS No. 130, "Reporting
Comprehensive Income," was issued. The Company adopted SFAS No. 130 as required
in 1998. This statement establishes standards for reporting and presenting
comprehensive income and its components in the financial statements.
Comprehensive income is defined as "the change in equity (net assets) of a
business enterprise during a period from transactions and other events and
circumstances from non-owner sources. It includes all changes in equity during a
period except those resulting from investments by owners or distributions to
owners." The adoption had no impact on the Company's statement of operations. In
June 1998, SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities" was issued. This statement establishes accounting and reporting
standards for derivative instruments and for hedging activities. The Company
will adopt SFAS No. 133 as required in 2000. The Company expects that adoption
will have no impact on the Company's financial statements.
NOTE 3--RESTATEMENT OF FINANCIAL STATEMENTS
The balance sheet at December 31, 1997 and the related statements of
operations, of cash flows, and of stockholders' equity for the period from
February 27, 1997 (inception) to December 31, 1997 were restated to record
additional compensation in connection with Common Stock options issued during
the period, based on the difference between the estimated fair value of the
underlying Common Stock at the date of grant of the options and the exercise
price of $.10 per share. The additional compensation expense of $192,000
increased the net loss for the period from $2,230,000 to $2,422,000. The related
deferred compensation is being amortized over the vesting period of the options
and the unamortized portion of the deferred compensation at December 31, 1997,
in the amount of $1,258,000, was recorded as an increase to additional paid-in
capital.
F-9
<PAGE>
RHYTHMS NETCONNECTIONS INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--COMPOSITION OF CERTAIN BALANCE SHEET COMPONENTS
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------
<S> <C>
Equipment and furniture, net, consists of the following:
Operating equipment...................................................... $ 1,241,000
Computer software licenses............................................... 173,000
Computer equipment....................................................... 133,000
Office furniture......................................................... 43,000
Leasehold improvements................................................... 32,000
Less accumulated depreciation............................................ (1,000)
-----------------
$ 1,621,000
-----------------
-----------------
</TABLE>
NOTE 5--DEBT
As of December 31, 1997, the Company had borrowed $568,000 from a financial
institution, with an additional $432,000 available to be drawn under the note at
any time through April 29, 1998. Terms of the note payable include an interest
rate of prime plus 0.25 percent (8.75 percent at December 31, 1997). The note is
secured by assets of the Company. Through April 29, 1998, interest only is due
monthly on the outstanding principal. As of April 29, 1998, the outstanding
principal will be amortized over a 36-month repayment period; the outstanding
principal will continue to bear interest. If no additional amounts are drawn by
April 29, 1998, the $568,000 will be repaid during the years 1998 through 2001
in the amounts of $111,000 in 1998, $189,000 each in 1999 and 2000, and $79,000
in 2001.
NOTE 6--DEBT AND WARRANTS (UNAUDITED)
On May 5, 1998, the Company issued 13.5 percent senior discount notes due
2008 in the principal amount of $290,000,000 at maturity, combined with warrants
to purchase 1,972,000 shares of Common Stock. The notes were issued at a
discount; cash proceeds from the issuance of the notes and warrants were
$150,365,000. The Company additionally incurred approximately $6,046,000 in debt
issue costs. The notes will accrete in value through May 15, 2003 at a rate of
13.5 percent per annum, compounded semi-annually; no cash interest will be
payable prior to that date. Upon a change in control or upon certain asset
sales, the Company must offer to repurchase all or a portion of the outstanding
notes.
The warrants are exercisable upon certain events, which will occur no later
than November 1, 1998, at an exercise price of $0.01 per share. The warrants
expire May 15, 2008. The warrants may be required to be repurchased by the
Company for cash upon the occurrence of a repurchase event, such as a
consolidation, merger, or sale of assets to another entity, as defined in the
provisions of the Warrant Agreement, at a price to be determined by an
independent financial expert selected by the Company. In the event a repurchase
event occurs, the difference between the repurchase price and the carrying value
of the warrants would be charged to equity. The value ascribed to the warrants
of $6,567,000 resulted in additional debt discount, which, together with the
debt issue costs are being amortized to interest expense using the effective
interest method over the period that the notes are outstanding.
During May 1998 the Company entered into a 36-month lease line that provides
for $24.5 million in equipment on an operating lease basis. In connection with
this lease agreement, the Company issued 239,325 warrants to purchase Common
Stock at a price of $4.45 per share, exercisable immediately.
F-10
<PAGE>
RHYTHMS NETCONNECTIONS INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--STOCKHOLDERS' EQUITY
The Company was initially capitalized in February 1997 with Common Stock. In
July 1997, the Company was granted authority to issue two classes of stock
consisting of up to 17,000,000 shares of Series A Preferred Stock and 22,764,706
shares of Common Stock, both with a $0.001 par value per share.
The Company's Series A Preferred Stock may be converted, at the option of
the holder, into the Company's Common Stock on a one-for-one basis, subject to
antidilution protection on a broad-based weighted-average basis. The Series A
Preferred Stock will also be automatically converted upon certain closings of
registered public offerings of Common Stock. The holders of the Series A
Preferred Stock are entitled to receive non-cumulative dividends in the amount
equal to $0.08 per share per annum, as and if declared by the Board of
Directors, or an amount equal to that paid on any other outstanding shares of
the Company, payable quarterly, as and if declared by the Board of Directors. In
the event of a liquidation of the Company, the holders of the Series A Preferred
Stock will be entitled, in preference to the holders of Common Stock, to an
amount equal to $1.00 per share, plus all declared and unpaid dividends. The
Preferred shares entitle holders to one vote per share, on an "as-converted"
basis.
NOTE 8--STOCK OPTIONS
The Company has established the 1997 Stock Option/Stock Issuance Plan (the
"Plan"), which provides for the grant of options to employees, directors and
outside consultants for purchase of up to an aggregate of 4,863,971 shares of
Common Stock. The options are immediately exercisable and expire within ten
years after the date of grant. Shares acquired upon exercise are subject to
repurchase by the Company ratably over a four-year period from the date of
grant, at the option of the Company and at the exercise price. The Plan provides
for both incentive option and non-statutory option grants and for accelerated
vesting in the event of a 50 percent or more change in control of the Company.
Through December 31, 1997, plan activity consisted only of incentive options.
Plan activity through December 31, 1997 is as follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE WEIGHTED AVERAGE
NUMBER OF SHARES FAIR VALUE EXERCISE PRICE
---------------- ----------------- -----------------
<S> <C> <C> <C>
Granted.......................................... 2,417,381 $ 0.70 $ 0.10
Exercised........................................ (133,524) $ 0.70 $ 0.10
Canceled......................................... -- -- --
----------------
Outstanding at December 31, 1997................. 2,283,857 $ 0.70 $ 0.10
----------------
----------------
</TABLE>
The following summarizes the outstanding and exercisable options under the
Plan at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------ -----------------------------
NUMBER WEIGHTED AVERAGE WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE
EXERCISE PRICE OUTSTANDING REMAINING LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- --------------- ----------- ---------------- ----------------- ---------- -----------------
<S> <C> <C> <C> <C> <C>
$ 0.10 2,283,857 9.63 years $ 0.10 2,283,857 $ 0.10
</TABLE>
During 1997, options were granted to employees at less than fair value on
the date of grant, resulting in $1,450,000 of deferred compensation recorded as
a reduction of stockholders' equity through December 31, 1997. This amount is
being amortized as a charge to selling, general and administrative expenses
F-11
<PAGE>
RHYTHMS NETCONNECTIONS INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--STOCK OPTIONS (CONTINUED)
over the vesting periods of the applicable options; such amortization totaled
$192,000 for the period ended December 31, 1997.
An option to purchase 365,094 shares of Series A Preferred Stock at $0.80
per share was granted to an employee during 1997. The Company recorded $73,000
in compensation expense during 1997 related to this grant.
Had compensation expense for the Company's 1997 Stock Option/Stock Issuance
Plan and the Preferred Stock option been determined based on the fair value
method of accounting for stock-based compensation, the Company's net loss and
net loss per share for the period ended December 31, 1997 would have been
increased by $11,000 and $0.01 per share, respectively. For purposes of
determining this compensation expense, the fair value of each option grant is
estimated on the grant date using the Black Scholes option pricing model with
the following weighted average assumptions used for grants during the period
ended December 31, 1997: no dividend yield, risk free interest rate of 5.3
percent, expected volatility of nil, and expected term of four years for Common
options and six months for the Preferred option.
NOTE 9--INCOME TAXES
As of December 31, 1997, the Company had net operating loss carryforwards of
approximately $2,117,000, which are available to offset future taxable income
through 2016 for federal taxes and 2005 for state taxes, subject to the
limitations of Internal Revenue Code Section 382 relating to changes in
ownership of the Company. The deferred tax asset arising from the loss
carryforwards has been fully offset by a valuation allowance since it is more
likely than not that it will not be realized.
Components of deferred income taxes are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------
<S> <C>
Deferred tax assets:
Net operating loss carryforwards......................................... $ 908,000
Accrued vacation and other............................................... 89,000
--------
Gross deferred tax asset................................................... 997,000
Valuation allowance........................................................ (997,000)
--------
Net deferred income taxes.................................................. $ --
--------
--------
</TABLE>
The provision for (benefit from) income taxes reconciles to the statutory
federal tax rate as follows:
<TABLE>
<S> <C>
Statutory federal tax rate........................................... 34.0%
State income tax..................................................... 8.4
Other................................................................ (1.2)
Deferred tax asset valuation allowance............................... (41.2)
---------
--%
---------
---------
</TABLE>
F-12
<PAGE>
RHYTHMS NETCONNECTIONS INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--RELATED PARTY TRANSACTIONS
The Company's in-house counsel is also a partner in a law firm used
externally by the Company. During 1997, the Company incurred legal fees and
expenses of approximately $92,000 to the external firm, in addition to the
salary paid to the in-house counsel.
Two members of the Company's Board of Directors serve as directors to a
company that supplies equipment to the Company. The total amount purchased
during 1997 from the equipment supplier was approximately $419,000.
NOTE 11--RELATED PARTY TRANSACTIONS (UNAUDITED)
During the first quarter of 1998, the Company extended three loans to an
employee. These loans total $201,000, bear interest at approximately 5.6
percent, are secured by certain assets, and are generally repayable to the
Company during 1998.
NOTE 12--COMMITMENTS
The Company leases office space and certain office equipment under
non-cancelable operating lease agreements. The leases range in term from 24
months to 60 months and, in certain instances, provide for options to extend.
Rent expense under the operating leases for 1997 totaled $46,000. Future minimum
rental payments under the leases are $270,000 in 1998, $250,000 in 1999,
$110,000 in 2000, $30,000 in 2001, and $30,000 in 2002.
NOTE 13--SUBSEQUENT EVENTS
During January and February 1998, a total of 2,268,545 shares of Common
Stock was issued upon the exercise of stock options; proceeds to the Company
were $227,000. During February 1998, 365,094 shares of Series A Preferred Stock
were issued to an employee for proceeds of $292,000 upon the exercise of an
option.
Effective March 6, 1998, the Company amended its Certificate of
Incorporation to increase the number of authorized Common shares to 22,909,650,
to decrease the number of authorized Preferred shares to 16,944,943, and to
designate 12,900,000 of the Preferred shares as Series A and 4,044,943 shares as
Series B.
During March 1998, the Company issued 4,044,943 shares of its Series B
Preferred Stock to new and existing investors at a price of $4.45 per share.
Proceeds to the Company were $18,000,000. The Company's Series B Preferred Stock
may be converted, at the option of the holder, into the Company's Common Stock
on a one-for-one basis, subject to antidilution protection on a broad-based
weighted-average basis. The Series B Preferred Stock will also be automatically
converted upon certain closings of registered public offerings of Common Stock.
The holders of the Series B Preferred Stock are entitled to receive non-
cumulative dividends in the amount equal to $0.356 per share per annum, as and
if declared by the Board of Directors, or an amount equal to that paid on any
other outstanding shares of the Company, payable quarterly, as and if declared
by the Board of Directors. In the event of a liquidation of the Company, the
holders of the Series B Preferred Stock will be entitled, in preference to the
holders of Common Stock, to an amount equal to $4.45 per share, plus all
declared and unpaid dividends. The Preferred shares entitle holders to one vote
per share, on an "as-converted" basis.
F-13
<PAGE>
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- --------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFERING COVERED BY THIS PROSPECTUS. IF GIVEN
OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY THE COMPANY OR BY THE INITIAL PURCHASERS. THIS PROSPECTUS
DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY, THE
SECURITIES OFFERED HEREBY IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM IT
IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE HEREUNDER SHALL, IN ANY CIRCUMSTANCES, CREATE AN
IMPLICATION THAT THERE HAS NOT BEEN ANY CHANGE IN THE FACTS SET FORTH IN THIS
PROSPECTUS OR IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
NOTICE TO INVESTORS............................. ii
AVAILABLE INFORMATION........................... vi
ADDITIONAL INFORMATION.......................... vi
PROSPECTUS SUMMARY.............................. 1
RISK FACTORS.................................... 11
USE OF PROCEEDS................................. 26
DIVIDENDS....................................... 26
CAPITALIZATION.................................. 27
SELECTED FINANCIAL DATA......................... 28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATION..................................... 29
BUSINESS........................................ 36
MANAGEMENT...................................... 48
CERTAIN TRANSACTIONS............................ 55
PRINCIPAL STOCKHOLDERS.......................... 58
THE EXCHANGE OFFER.............................. 60
DESCRIPTION OF THE NOTES........................ 69
DESCRIPTION OF THE NEW NOTES.................... 99
DESCRIPTION OF THE WARRANTS..................... 100
DESCRIPTION OF CAPITAL STOCK.................... 105
FEDERAL INCOME TAX CONSIDERATIONS............... 111
PLAN OF DISTRIBUTION............................ 114
LEGAL MATTERS................................... 115
EXPERTS......................................... 115
GLOSSARY OF TERMS............................... A-1
INDEX TO FINANCIAL STATEMENTS................... F-1
</TABLE>
--------------------------
UNTIL JANUARY 19, 1999, ALL DEALERS EFFECTING TRANSACTIONS IN THE NEW NOTES,
WHETHER OR NOT PARTICIPATING IN THIS EXCHANGE OFFER, MAY BE REQUIRED TO DELIVER
A PROSPECTUS.
[LOGO]
RHYTHMS
NETCONNECTIONS INC.
OFFER TO EXCHANGE ITS
13 1/2% SERIES B
SENIOR DISCOUNT NOTES DUE 2008
FOR ANY AND ALL OF ITS OUTSTANDING
13 1/2% SERIES A SENIOR
DISCOUNT NOTES DUE 2008
---------------------
PROSPECTUS
---------------------
OCTOBER 21, 1998
- --------------------------------------------------------------------------------
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