<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 8, 1999
REGISTRATION NO. 333-87527
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- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
AMENDMENT NO. 1
TO FORM S-1
ON
FORM S-3
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------------
RHYTHMS NETCONNECTIONS INC.
(Exact name of Registrant as Specified in Its Charter)
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<S> <C>
DELAWARE 33-0747515
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
</TABLE>
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6933 SOUTH REVERE PARKWAY, ENGLEWOOD, COLORADO 80112
(303) 476-4200
(Address, Including Zip Code, and Telephone Number,
Including Area Code, of Registrant's Principal Executive Offices)
--------------------------
CATHERINE HAPKA
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
RHYTHMS NETCONNECTIONS INC.
6933 SOUTH REVERE PARKWAY
ENGLEWOOD, COLORADO 80112
(303) 476-4200
(Name, Address, Including Zip Code, and Telephone Number, Including Area Code,
of Agent for Service)
--------------------------
COPIES TO:
MARTIN C. NICHOLS
ROBERT H. CUTLER
BROBECK, PHLEGER & HARRISON LLP
550 WEST "C" STREET, SUITE 1200
SAN DIEGO, CALIFORNIA 92101
(619) 234-1966
--------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
FROM TIME-TO-TIME AFTER THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT.
--------------------------
If the only securities being registered on this form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box: / /
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box: /X/
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering: / /
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: / /
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box: / /
--------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SEC, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.
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<PAGE>
740,111 SHARES
[LOGO]
RHYTHMS NETCONNECTIONS INC.
COMMON STOCK
------------------
This prospectus relates to the public offering of 740,111 shares of our
common stock by some of our stockholders. This offering is not being
underwritten. The prices at which our stockholders may sell the shares will be
determined by the prevailing market price for the shares or in negotiated
transactions. The selling stockholders will receive all of the proceeds from the
sale of the shares offered by this prospectus.
Our common stock is traded on the Nasdaq National Market under the symbol
"RTHM." On November 4, 1999, the average of the high and low prices for the
common stock was $30.50 per share.
INVESTING IN OUR COMMON STOCK INVOLVES RISKS WHICH ARE DESCRIBED IN THE
"RISK FACTORS" SECTION BEGINNING ON PAGE 5 OF THIS PROSPECTUS.
---------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION, NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES, OR PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
------------------------
THE DATE OF THIS PROSPECTUS IS NOVEMBER 8, 1999
<PAGE>
TABLE OF CONTENTS
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Summary..................................................... 1
The Offering................................................ 4
Risk Factors................................................ 5
Forward-Looking Statements.................................. 19
Use of Proceeds............................................. 19
Business.................................................... 20
Recent Developments......................................... 40
Information Incorporated by Reference....................... 42
Dilution.................................................... 43
Selling Stockholders........................................ 44
Plan of Distribution........................................ 45
Legal Matters............................................... 46
Experts..................................................... 46
Where You Can Find More Information......................... 47
</TABLE>
WE HAVE NOT AUTHORIZED ANY DEALER, SALESPERSON OR OTHER PERSON TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS. IF THEY GIVE YOU SUCH INFORMATION OR MAKE SUCH REPRESENTATIONS, YOU
MUST NOT RELY UPON THEM AS HAVING BEEN AUTHORIZED BY US. THIS PROSPECTUS IS NOT
AN OFFER TO SELL, OR THE SOLICITATION OF AN OFFER TO BUY, ANY SECURITIES OTHER
THAN THESE REGISTERED SECURITIES. IT IS ALSO NOT AN OFFER TO, OR SOLICITATION
OF, ANY PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION WOULD BE
UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY OFFER OR SALE SHALL,
UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT WE HAVE HAD NO CHANGE IN
OUR BUSINESS SINCE THE DATE OF THIS PROSPECTUS OR THAT THE INFORMATION CONTAINED
IN THIS PROSPECTUS IS CORRECT AS OF ANYTIME AFTER THE DATE OF THIS PROSPECTUS.
We use market data and industry forecasts throughout this prospectus, which
we have obtained from internal surveys, market research, publicly available
information and industry publications. Industry publications generally state
that the information they provide has been obtained from sources believed to be
reliable, but that the accuracy and completeness of such information is not
guaranteed. Similarly, we believe that the surveys and market research we or
others have performed are reliable, but we have not independently verified this
information. We do not represent that any such information is accurate.
We own applications for federal registration and claim rights in the
following trademarks: ACI-TM-; ACCELERATED CONNECTIONS-TM-; APPLINET-TM-; CHOICE
ROUTE-TM-; DSL... CAN YOU HANDLE THE SPEED?-TM-; HOME.RHYTHMS-TM-;
LOOP.RHYTHMS-TM-; NET.RHYTHMS-TM-; NETRHYTHMS-TM-; RHYTHM WORKS-TM-;
RHYTHMS-TM-; RHYTHMS COGNITIVE NETWORK-TM-; RHYTHMS.NET-TM-; RHYTHMS
NETCONNECTIONS-TM-; RHYTHMS NETSELECT-TM-; RHYTHMS NETWORKNOW-TM-; RHYTHMS
PBXPRESS-TM-; RHYTHMS TOOLBAR-TM-; RHYTHMS TOTAL ACCESS SOLUTIONS-TM-; RHYTHMS
U.S. LAN-TM-; RING.RHYTHMS-TM- and WORK.RHYTHMS-TM- and
[LOGO]
-TM-. We have filed an application for federal registration and claim rights
in the trademark RHYTHMS LINK.
This prospectus also refers to trade names and trademarks of other
companies.
<PAGE>
SUMMARY
THIS SUMMARY HIGHLIGHTS SOME OF THE SIGNIFICANT ASPECTS OF OUR BUSINESS AND
THIS OFFERING, BUT YOU SHOULD READ THE ENTIRE PROSPECTUS, INCLUDING THE
FINANCIAL DATA AND RELATED NOTES IN THE DOCUMENTS WHICH WE INCORPORATE BY
REFERENCE IN THIS PROSPECTUS, BEFORE MAKING AN INVESTMENT DECISION. WHEN WE
REFER TO OUR COMPANY IN THIS PROSPECTUS, WE REFER TO US AND OUR SUBSIDIARIES, AS
A COMBINED ENTITY, EXCEPT WHERE WE INDICATE OTHERWISE. YOU SHOULD CAREFULLY
CONSIDER THE INFORMATION SET FORTH UNDER "RISK FACTORS."
We are a leading service provider of high-speed local access networking
solutions using DSL technology to businesses. We have designed our network to
give our customers a high-speed "always on" local connection to the Internet and
to private local and wide area networks. We offer a variety of DSL technologies
that deliver data transfer rates ranging from 128 Kbps to 7.1 Mbps. For
customers that subscribe at the 7.1 Mbps rate, our network provides transfer
speeds faster than frame relay and T-1 circuits, and is approximately 125 times
the speed of the fastest dial-up modem and over 55 times the speed of integrated
services digital network (ISDN) lines. Through our packet-based network,
multiple users on a single connection are able to simultaneously access the
Internet and private networks. Beyond high-speed access, we also offer a growing
suite of features and applications that we can individually configure to each
user's needs. We believe our network solutions will increase remote office and
worker productivity and reduce the complexity of communications for businesses.
Since our inception in February 1997, we have made substantial progress in
implementing a scalable nationwide network. We began offering commercial
services in our first market in April 1998, and as of September 30, 1999, we
offer service in a total of 27 markets in 21 states. We intend to continue our
network rollout into an additional 6 markets in 1999 and a further 17 markets by
the end of 2000. Upon completion of this network expansion, we anticipate
providing services in 50 of the nation's largest metropolitan areas, which we
believe contain 60% of the nation's local area networks. We have signed
interconnection agreements with Ameritech, Bell Atlantic, BellSouth, GTE,
Pacific Bell, and U S WEST, and we are currently pursuing interconnection
arrangements with 4 other incumbent carriers. As of September 30, 1999, we
provide service or have installed equipment in over 850 incumbent carrier
central offices. We have obtained competitive carrier authority or have been
permitted to operate as a competitive carrier in 34 states. We intend to
continue to investigate expansion of our network both in the United States and
internationally.
In March 1999, we entered into separate strategic arrangements with MCI
WorldCom, Inc. and Microsoft Corporation. As part of our strategic arrangements,
MCI WorldCom's investment fund and Microsoft each invested $30 million in us.
The MCI WorldCom arrangement also designates us as the first choice in its
alternative carrier access provisioning system for DSL services in certain
circumstances, and provides that MCI WorldCom is committed to sell at least
100,000 of our DSL lines over a period of five years, subject to penalties for
failure to reach target commitments. In turn, we have designated MCI WorldCom as
our preferred provider of network services in certain circumstances. MCI
WorldCom will also work with us to develop voice and data applications over a
single DSL connection. For instance, in June 1999, MCI WorldCom and we, in
conjunction with Cisco Systems, Inc. and Jetstream Communications, successfully
demonstrated toll-quality voice and high-speed data communications over a single
copper line utilizing DSL technology. In our Microsoft arrangement, we will
jointly develop and distribute with Microsoft a co-branded DSL version of the
Microsoft Network (MSN) service focused on our small business customers and on
our customers' teleworkers.
In April 1999, we entered into a customer relationship with Qwest
Communications Corporation, in connection with which Qwest's wholly owned
subsidiary, U.S. Telesource, Inc., invested $15 million in us. Qwest has
committed to purchase from us performance class DSL services for re-sale to its
customers. In return, we have agreed to use Qwest's network and application
hosting services in certain
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situations. The combined DSL line commitment from Qwest and MCI WorldCom totals
200,000 lines over several years.
We also market our services through our direct sales force and through our
partnerships with recognized leaders in the networking industry, including
Microsoft and Cisco. Under our strategic partnership with Cisco, Cisco agreed to
jointly market and sell our networking solutions to its customer base and will
engage in joint development projects with us. As of September 30, 1999 we had
approximately 6,700 lines in service. Our business customers include QUALCOMM
Incorporated, Cisco, Silicon Graphics, Inc., Wind River Systems and Broadcom
Corporation. Our service provider customers include Ingram Micro, Intermedia
Communications Inc., Savvis Communications Corporation, Verio Inc. and Williams
Communications, Inc.
In April 1999, we completed an initial public offering of our common stock,
raising net proceeds of approximately $210.1 million. On April 23, 1999, we
completed the sale and issue of senior notes, raising net proceeds of
approximately $314.5 million, of which approximately $113.2 million was used to
purchase a portfolio of U.S. government securities to secure the payment of the
first six scheduled interest payments on the notes. We also completed a
secondary public offering of our common stock in September 1999, raising net
proceeds of $16.4 million.
Our senior management team has extensive experience in developing
next-generation networking businesses. Our Chairman and Chief Executive Officer,
Catherine Hapka, was previously the founder, President and Chief Operating
Officer of !NTERPRISE Networking Services, U S WEST's data networking business.
Steve Stringer, our President and Chief Operating Officer, was previously the
Global Chief Operating Officer of GE Capital IT Solutions. Scott Chandler, our
Chief Financial Officer, was previously President and Chief Executive Officer of
C-COR Electronics, Inc., a manufacturer of broadband telecommunications
equipment. Our sponsors, which include Microsoft, MCI WorldCom's investment
fund, a subsidiary of Qwest, Kleiner Perkins Caufield & Byers, Enterprise
Partners, Brentwood Venture Capital, the Sprout Group and a subsidiary of Enron
Corp., have to date invested approximately $105.3 million in us.
MARKET OPPORTUNITY
We believe that a substantial market opportunity exists as a result of the
convergence of six factors:
- the growing demand for high-speed access to the Internet and corporate
networks;
- the inherent limitations of dial-up modems as a connection to data
networks;
- the need for large companies to improve the productivity of their remote
offices and workers;
- the need for small and medium businesses to have an integrated
communication solution for their networking requirements;
- the increasing adoption of DSL and widespread use of packet-based
networks; and
- the 1996 Telecommunications Act.
These factors create a dual market opportunity: new carriers can create
efficient high-speed data, voice and video networks using existing
infrastructure, and business customers can better address their local and wide
area networking needs through a single carrier.
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THE RHYTHMS SOLUTIONS
We believe our network solutions effectively address many of the unmet
communications needs of today's businesses by offering an appealing combination
of quality, performance, price and service. Our network consists of:
- HIGH-SPEED, "ALWAYS ON" LOCAL CONNECTIONS. Using DSL technology over
standard telephone lines, our network is capable of delivering data at
speeds ranging from 128 Kbps to 7.1 Mbps.
- METROPOLITAN AND WIDE AREA OVERLAY NETWORK. We have designed our network
architecture so that we can effectively and efficiently manage data
traffic within and among metropolitan areas in which we offer our
services. We manage the network and monitor service levels on a nationwide
basis from our Network Operations Center in Denver.
- PRODUCTIVITY ENHANCING FEATURES AND APPLICATIONS. We offer a growing suite
of network-enabled features and applications that extend the functionality
of corporate communications and networking resources to remote offices and
workers. We also offer high performance Internet access solutions to
remote offices and workers as well as small and medium businesses in
conjunction with our Internet Service Provider customers.
- SERVICE FLEXIBILITY. We have designed our network so that, over a single
DSL connection, we are able to customize the features and applications for
each individual user and local area network user.
- TURNKEY SOLUTION. We offer turnkey network solutions for our customers by
providing each customer with a single point of contact for all of our
services, including network implementation, maintenance and billing.
BUSINESS STRATEGY
Our goal is to become the leading national service provider of high
performance networking solutions for remote offices and workers. We intend to
implement the following strategies to achieve our goal:
- exploit our early market entrance by deploying our network rapidly and
building strong relationships with businesses and service provider
customers;
- focus on businesses that demand high performance networking solutions;
- use our network as a platform for productivity-enhancing features and
applications that we and third parties develop;
- continue to establish strong distribution channels to reach large, medium
and small businesses; and
- provide superior service and customer care.
Our principal executive offices is located at 6933 South Revere Parkway,
Englewood, Colorado 80112, and our telephone number is (303) 476-4200 or
(800) RHYTHMS.
3
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THE OFFERING
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<S> <C>
Common stock offered by the selling
stockholders............................... 740,111 shares
Common stock to be outstanding after this
offering................................... 77,569,463
Use of proceeds.............................. We will not receive any proceeds from the sale of
shares of common stock by the selling stockholders.
Dividend policy.............................. We currently intend to retain any future earnings to
fund the development of our business. Therefore, we
do not currently anticipate paying cash dividends.
Nasdaq National Market symbol................ RTHM
</TABLE>
The shares of our common stock which may be offered by the selling
stockholders under this prospectus represent shares issuable to the selling
stockholders upon their "net exercise" of warrants that were issued in
connection with our 1998 senior discount notes.
The shares of our common stock to be outstanding after this offering include
740,111 shares of common stock issuable upon a "net exercise" of outstanding
warrants that were issued in connection with our 1998 senior discount notes
which are to be sold in this offering by the selling stockholders, and exclude:
- 5,768,333 shares of common stock issuable upon the exercise of stock
options outstanding as of September 30, 1999, with a weighted average
exercise price of $22.05, all of which are exercisable and 111,993 of
which are vested;
- 2,233,996 shares of common stock issuable upon the exercise of outstanding
warrants, with a weighted average price of $7.20 per share; and
- 488,890 shares of treasury stock.
4
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RISK FACTORS
AN INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD
CAREFULLY CONSIDER THE RISKS AND UNCERTAINTIES DESCRIBED BELOW AND THE OTHER
INFORMATION IN THIS PROSPECTUS BEFORE DECIDING TO PURCHASE SHARES OF OUR COMMON
STOCK. THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE ONLY ONES FACING
OUR COMPANY.
WE CANNOT PREDICT OUR SUCCESS BECAUSE WE HAVE A SHORT OPERATING HISTORY
We formed our company in February 1997, and we have a short operating
history for you to review in evaluating our business. We have limited historical
financial and operating data upon which you can evaluate our business and
prospects. We entered into our first interconnection agreement with an incumbent
carrier in July 1997 and began to offer commercial services in our first market
in April 1998. We have limited commercial operations and have recognized limited
revenues since our inception. In addition, our senior management team and our
other employees have worked together at our company for only a short period of
time.
BECAUSE OUR MARKET IS NEW AND EVOLVING, WE CANNOT PREDICT ITS FUTURE GROWTH OR
ULTIMATE SIZE, AND WE MAY BE UNABLE TO COMPETE EFFECTIVELY
The market for packet-based high-speed digital communication services using
telephone lines is in the early stages of development. Since this market is new
and evolving and because our current and future competitors are likely to
introduce competing services, we cannot accurately predict the rate at which
this market will grow, if at all, or whether new or increased competition will
result in market saturation. Various providers of high-speed digital
communication services are testing products from various suppliers for various
applications, and suppliers have not broadly adopted an industry standard.
Certain critical issues concerning commercial use of DSL for Internet and local
area network access, including security, reliability, ease and cost of access
and quality of service, remain unresolved and may impact the growth of these
services. If the markets for our services fail to develop, grow more slowly than
anticipated or become saturated with competitors, these events could materially
and adversely affect our business, prospects, operating results and financial
condition.
Our success will depend on the development of this new and rapidly evolving
market and our ability to compete effectively in this market. To address these
risks, we must, among other things:
- rapidly expand the geographic coverage of our network services;
- raise additional capital;
- enter into interconnection agreements and working arrangements with
additional incumbent carriers, substantially all of which we expect to be
our competitors;
- deploy an effective network infrastructure;
- attract and retain customers;
- successfully develop relationships and activities with our partners and
distributors, including MCI WorldCom, Microsoft, Qwest and Cisco;
- continue to attract, retain and motivate qualified personnel;
- accurately assess potential markets and effectively respond to competitive
developments;
- continue to develop and integrate our operational support system and other
back office systems;
- obtain any required governmental authorizations;
- comply with evolving governmental regulatory requirements;
- increase awareness of our services;
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- continue to upgrade our technologies; and
- effectively manage our expanding operations.
We may not be successful in addressing these and other risks, and our
failure to address risks would materially and adversely affect our business,
prospects, operating results and financial condition.
WE CANNOT PREDICT OUR SUCCESS BECAUSE OUR BUSINESS MODEL IS UNPROVEN
We have not validated our business model and strategy in the market. We
believe that the combination of our unproven business model and the highly
competitive and fast changing market in which we compete makes it impossible to
predict the extent to which our network service will achieve market acceptance
and our overall success. To be successful, we must develop and market network
services that are widely accepted by businesses at profitable prices. We may
never be able to deploy our network as planned, achieve significant market
acceptance, favorable operating results or profitability or generate sufficient
cash flow to repay our debt. Of the approximately 6,700 lines that are in
service, we installed approximately 80% to only five customers. None of our
large business customers has rolled out our services broadly to its employees,
and we cannot be certain when or if these rollouts will occur. We will not
receive significant revenue from our large customers unless these rollouts
occur. Any continued or ongoing failure for any reason of large business
customers to roll out our services, failure to validate our business model in
the market, including failure to build out our network, achieve widespread
market acceptance or sustain desired pricing would materially and adversely
affect our business, prospects, operating results and financial condition.
WE EXPECT OUR LOSSES TO CONTINUE
We have incurred losses and experienced negative operating cash flow for
each month since our formation. As of June 30, 1999, we had an accumulated
deficit of approximately $105.5 million. We intend to rapidly and substantially
increase our expenditures and operating expenses in an effort to expand our
network services. We expect to have annual interest and amortization expense
relating to our 1998 senior discount notes and 1999 senior notes of
approximately $52.2 million in 1999 and increasing to $81.0 million in 2003. In
addition, we may incur more debt in the future. Furthermore, as a result of
recent business relationships arising from preferred stock and warrant issuances
and of previous stock option grants, we anticipate that there will be
significant charges to earnings in future periods. We estimate that these
charges will total approximately $6.2 million per year over each of the next
several years. As a result of these factors, we expect to incur substantial
operating and net losses and negative operating cash flow for the foreseeable
future. We will need to obtain additional financing to pay our expenses and to
make payments on our debt. We cannot give you any assurance about whether or
when we will have sufficient revenues to satisfy our funding requirements or pay
our debt service obligations.
OUR OPERATING RESULTS IN ONE OR MORE FUTURE PERIODS ARE LIKELY TO FLUCTUATE
SIGNIFICANTLY AND MAY FAIL TO MEET OR EXCEED THE EXPECTATIONS OF SECURITIES
ANALYSTS OR INVESTORS
Our annual and quarterly operating results are likely to fluctuate
significantly in the future due to numerous factors, many of which are outside
of our control. These factors include:
- the rate of customer acquisition and turnover;
- the prices our customers are willing to pay;
- the amount and timing of expenditures relating to the expansion of our
services and infrastructure;
- the timing and availability of incumbent carrier central office
collocation facilities and transport facilities;
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- the success of our relationships with our partners and distributors,
including MCI WorldCom, Microsoft, Qwest and Cisco;
- our ability to deploy our network on a timely basis;
- introduction of new services or technologies by our competitors;
- price competition;
- the ability of our equipment and service suppliers to meet our needs;
- regulatory developments, including interpretations of the 1996
Telecommunications Act;
- technical difficulties or network downtime;
- the success of our strategic alliances; and
- the condition of the telecommunication and network service industries and
general economic conditions.
Because of these factors, our operating results in one or more future
periods could fail to meet or exceed the expectations of securities analysts or
investors. In that event, any trading price of our common stock would likely
decline.
IF SALES FORECASTED FOR A PARTICULAR PERIOD ARE NOT REALIZED IN THAT PERIOD DUE
TO THE LENGTHY SALES CYCLE OF OUR SERVICES, OUR OPERATING RESULTS FOR THAT
PERIOD WILL BE HARMED
The sales cycle of our network services can be very lengthy, particularly
for large businesses. The sales cycle for large businesses typically involves:
- a significant technical evaluation;
- an initial trial rollout to a relatively small number of end users;
- a commitment of capital and other resources by the customer;
- delays associated with the customer's internal procedures to approve large
capital expenditures;
- time required to engineer the deployment of our services;
- coordination of the activation of multiple access lines with incumbent
carriers; and
- testing and acceptance of our services.
For these and other reasons, our sales cycle for large businesses lasts at
least six months. During this lengthy sales cycle, we will incur significant
expenses in advance of the receipt of revenues. If sales that we forecast for a
particular period do not occur because of our lengthy sales cycle, this event
could materially and adversely affect our business, prospects, operating results
and financial condition during that period.
WE DEPEND ON INCUMBENT CARRIERS FOR COLLOCATION AND TRANSMISSION FACILITIES
We must use copper telephone lines controlled by the incumbent carriers to
provide DSL connections to customers. We also depend on the incumbent carriers
for collocation and for a substantial portion of the transmission facilities we
use to connect our equipment in incumbent carrier central offices to our Metro
Service Centers. In addition, we depend on the incumbent carriers to test and
maintain the quality of the copper lines that we use. We have not established a
history of obtaining access to collocation and transmission facilities from
incumbent carriers in large volumes. In many cases, we may be unable to obtain
access to collocation and transmission facilities from the incumbent carriers,
or to gain access at acceptable rates, terms and conditions, including
timeliness. We have experienced, and expect to experience in the future, lengthy
periods between our request for and the
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actual provision of the collocation space and telephone lines. An inability to
obtain adequate and timely access to collocation space or transmission
facilities on acceptable terms and conditions from incumbent carriers could have
a material and adverse effect on our business, prospects, operating results and
financial condition.
Because we compete with incumbent carriers in our markets, they may be
reluctant to cooperate with us. The incumbent carriers may experience, or claim
to experience, a shortage of collocation space or transmission capacity. If this
occurs, we may not have alternate means of connecting our DSL equipment with the
copper lines or connecting our equipment in central offices to Metro Service
Centers. We have experienced rejections of some of our collocation applications
on the grounds that no space is available. We may receive additional rejections
in the future. The number of other competitive local exchange carriers that
request collocation space will also affect the availability of collocation space
and transmission capacity. If we are unable to obtain physical collocation space
or transmission capacity from our targeted incumbent carriers, we may face
delays, additional costs or an inability to provide services in certain
locations. In many cases where our application for physical collocation is
rejected, we expect to have the option of adjacent location--where we install
our equipment in a building that is very close to the incumbent carrier central
office--or virtual collocation--where the incumbent carrier manages and operates
our equipment. While we have used adjacent and virtual collocation in our
network, those alternatives reduce our control over our equipment, and therefore
may reduce the level of quality and service we provide to our customers. We are
currently in an arbitration proceeding with SBC Communications Inc. concerning
the availability of DSL-enabled copper lines, as well as other operational
issues. Delays in obtaining access to collocation space and telephone lines or
the rejection of our applications for collocation could result in delays in, and
increased expenses associated with, the rollout of our services, which in turn
could have a material and adverse effect on our business, prospects, operating
results and financial condition.
WE ARE UNABLE TO CONTROL THE TERMS AND CONDITIONS UNDER WHICH WE GAIN ACCESS TO
INCUMBENT CARRIER COLLOCATION AND TRANSMISSION FACILITIES
We cannot control the terms under which we collocate our equipment, connect
to copper lines or gain the use of an incumbent carrier's transmission
facilities. State tariffs, state public utility commissions, the Federal
Communications Commission and interconnection agreements with the incumbent
carriers determine the price, terms and conditions under which collocation space
is made available, and they make these administrative determinations in ongoing
hearings. Interconnection agreements and state public utility commissions also
determine the terms and conditions of access to copper lines and other
components of an incumbent carrier's network. We may be unable to negotiate or
enter into interconnection agreements on acceptable terms or at all. In
addition, we cannot be sure that incumbent carriers will abide by their
obligations under those agreements. Delays in obtaining interconnection
agreements would delay our entry into certain markets. In addition, disputes may
arise between us and the incumbent carriers with respect to interconnection
agreements, and we may be unable to resolve disputes in our favor. If we are
unable to enter into, or experience a delay in obtaining, interconnection
agreements, this inability or delay could adversely affect our business,
prospects, operating results and financial condition. Further, the
interconnection agreements are generally short term, and we may be unable to
renew the interconnection agreements on acceptable terms or at all. The state
commissions, the Federal Communications Commission and the courts oversee, in
varying degrees, interconnection arrangements as well as the terms and
conditions under which we gain access to incumbent carrier copper lines and
transmission facilities. These government entities may modify the terms or
prices of our interconnection agreements and our access to incumbent carrier
copper lines and transmission facilities in ways that would be adverse to our
business. The Federal Communications Commission and state regulatory commissions
establish the rates for DSL-capable copper lines as well as other rates, terms
and conditions of our dealings with the incumbent carriers in ongoing public
hearings. Participation in these hearings will involve significant
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management time and expense. Incumbent carriers may from time to time propose
new rates, and the outcomes of hearings and rulings could have a material and
adverse effect on our business, prospects, operating results and financial
condition.
WE DEPEND ON THIRD PARTIES, PARTICULARLY MCI WORLDCOM, MICROSOFT, QWEST AND
CISCO, FOR THE MARKETING AND SALES OF OUR NETWORK SERVICES
We will rely significantly on indirect sales channels for the marketing and
sales of our network services. We will seek to establish relationships with
numerous service providers, including Internet Service Providers, interexchange
carriers, other competitive carriers and value-added resellers, to gain access
to customers. Our agreements to date with service providers are non-exclusive,
and we anticipate that future agreements will also be on a non-exclusive basis,
allowing service providers to resell services offered by our competitors. These
agreements are generally short term, and can be cancelled by the service
provider without significant financial consequence. We cannot control how these
service providers perform and cannot be certain that their performance will be
satisfactory to us or our customers. Many of these companies also compete with
us. If the number of customers we obtain through indirect sales channels is
significantly lower than our forecast for any reason, or if the service
providers with which we have contracted are unsuccessful in competing in their
own intensely competitive markets, these events would have a material and
adverse effect on our business, prospects, operating results and financial
condition.
We expect to rely particularly on the sales and marketing efforts of our
strategic partners, including MCI WorldCom, Microsoft, Qwest and Cisco. While
our agreements with MCI WorldCom and Qwest call for them to sell an aggregate of
200,000 DSL lines, the agreements also enable MCI WorldCom and Qwest to
terminate their respective agreements under certain circumstances and to receive
offsets and credits under other circumstances. Therefore, MCI WorldCom and Qwest
might sell significantly fewer than 200,000 DSL lines, or we might receive
significantly lower revenues than we otherwise would.
THE MARKET IN WHICH WE OPERATE IS HIGHLY COMPETITIVE, AND WE MAY NOT BE ABLE TO
COMPETE EFFECTIVELY, ESPECIALLY AGAINST ESTABLISHED INDUSTRY COMPETITORS WITH
SIGNIFICANTLY GREATER FINANCIAL RESOURCES
We will face competition from many competitors with significantly greater
financial resources, well-established brand names and large, existing installed
customer bases. We expect the level of competition to intensify in the future.
We expect significant competition from incumbent carriers, traditional and new
long distance carriers, cable modem service providers, Internet Service
Providers, wireless and satellite data service providers and other competitive
carriers. Incumbent carriers have existing metropolitan area networks and
circuit-switched local access networks. In addition, most incumbent carriers are
establishing their own Internet Service Provider businesses and are in some
stage of market trials and retail sales of DSL-based access services. Some
incumbent carriers have announced that they intend to aggressively market these
services to their residential customers at attractive prices. We believe that
incumbent carriers have the potential to quickly overcome many of the issues
that have delayed widespread deployment of DSL services in the past. In
addition, we may experience substantial customer turnover in the future. Many
providers of telecommunications and networking services experience high rates of
customer turnover.
Many of the leading traditional long distance carriers, including AT&T
Corporation, MCI WorldCom and Sprint, are expanding their capabilities to
support high-speed, end-to-end networking services. The newer long distance
carriers, including Williams, Level 3 Communications, Inc. and Qwest, are
building and managing high bandwidth, nationwide packet networks and partnering
with Internet Service Providers to offer services directly to the public. Cable
modem service providers, like @Home Networks, are offering or preparing to offer
high-speed Internet access over hybrid fiber networks to consumers, and @Work
has positioned itself to do the same for businesses. Several new
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companies are emerging as wireless, including satellite-based, data service
providers. Internet Service Providers, including some with significant and even
nationwide presences, provide Internet access to residential and business
customers, generally over the incumbent carriers' circuit switched networks,
although some have begun offering DSL-based access. Certain competitive
carriers, including Covad Communications Group, Inc. and NorthPoint
Communications, Inc., have begun offering DSL-based access services, and, like
us, have attracted strategic equity investors, marketing allies and product
development partners. Others are likely to do the same in the future. In
addition, regional Internet Service Providers and competitive carriers,
including HarvardNet, Inc., Network Access Solutions Corp. and DSL.net, Inc.
have begun offering DSL-based access services that compete with the services we
offer. As a result of increasing competition for our services, we are
experiencing substantial price competition, particularly with respect to sales
generated through our indirect sales channels.
Many of these competitors are offering, or may soon offer, technologies and
services that will directly compete with some or all of our service offerings.
Some of the technologies used by these competitors for local access connections
include integrated services digital network (ISDN), DSL, wireless data and cable
modems. Some of the competitive factors in our 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. We believe that we compare unfavorably with many of our
competitors with regard to, among other things, brand recognition, existing
relationships with end users, available pricing discounts, central office
access, capital availability and exclusive contracts. Substantially all of our
competitors and potential competitors have substantially greater resources than
us. We may not be able to compete effectively in our target markets. Our failure
to compete effectively would have a material and adverse effect on our business,
prospects, operating results and financial condition. For more details about our
competitors, please see "Business--Competition."
OUR NETWORK SERVICES MAY NOT ACHIEVE SIGNIFICANT MARKET ACCEPTANCE BECAUSE OUR
PRICES ARE OFTEN HIGHER THAN THOSE CHARGED FOR COMPETING SERVICES
Our prices are in some cases higher than those that our competitors charge
for some of their services. Prices for digital communications services have
fallen historically, and we expect prices in the industry in general, and for
the services we offer now and plan to offer in the future, to continue to fall.
We may be required to reduce prices periodically to respond to competition and
to generate increased sales volume. Our prices may not permit our network
services to gain a desirable level of commercial acceptance, and we may be
unable to sustain any current or future pricing levels. Due to these factors, we
cannot accurately forecast our revenues or the rate at which we will add new
customers.
WE WILL NEED SIGNIFICANT ADDITIONAL FUNDS, WHICH WE MAY NOT BE ABLE TO OBTAIN
The expansion and development of our business will require significant
additional capital. We intend to seek substantial additional financing in the
future to fund the growth of our operations, including funding the significant
capital expenditures and working capital requirements necessary for us to
provide service in our targeted markets. We believe that our current capital
resources will be sufficient to fund our aggregate capital expenditures and
working capital requirements, including operating losses, through approximately
June 2001. We will not have completed our network rollout by this date and will
need additional capital, whether or not our estimate on how long current capital
resources will last is accurate. In addition, our actual funding requirements
may differ materially if our assumptions underlying this estimate turn out to be
incorrect. Therefore, you should consider our estimate in light of the following
facts:
- we have no meaningful history of operations or revenues;
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- our estimated funding requirements do not reflect any contingency amounts
and may increase, perhaps substantially, if we are unable to generate
revenues in the amount and within the time frame we expect or if we have
unexpected cost increases; and
- we face many challenges and risks, including those discussed elsewhere in
"Risk Factors."
We may be unable to obtain any future equity or debt financing on acceptable
terms or at all. Recently the financial markets have experienced extreme price
fluctuations. A market downturn or general market uncertainty may adversely
affect our ability to secure additional financing. The indentures that govern
the 1998 senior discount notes and the 1999 senior notes restrict our ability to
obtain additional debt financing. Any future borrowing instruments, such as
credit facilities and lease agreements, are likely to contain similar or more
restrictive covenants and could require us to pledge assets as security for the
borrowings. If we are unable to obtain additional capital or are required to
obtain it on terms less satisfactory than what we desire, we will need to delay
deployment of our network services or take other actions that could adversely
affect our business, prospects, operating results and financial condition. If we
are unable to generate sufficient cash flow or obtain funds necessary to meet
required payments of our debt, then we will be in default on our debt
instruments. To date, our cash flow from operations has been insufficient to
cover our expenses and capital needs.
OUR SERVICES ARE SUBJECT TO GOVERNMENT REGULATION, AND CHANGES IN CURRENT OR
FUTURE LAWS OR REGULATIONS COULD RESTRICT THE WAY WE OPERATE OUR BUSINESS
A significant portion of the services that we offer through our subsidiaries
is subject to regulation at the federal, state and/or local levels. Future
federal or state regulations and legislation may be less favorable to us than
current regulation and legislation and therefore have an adverse impact on our
business, prospects, operating results and financial condition. In addition, we
may expend significant financial and managerial resources to participate in
rule-setting proceedings at either the federal or state level, without achieving
a favorable result. The Federal Communications Commission prescribes rules
applicable to interstate communications, including rules implementing the 1996
Telecommunications Act, a responsibility it shares with the state regulatory
commissions. In particular, we believe that incumbent carriers will work
aggressively to modify or restrict the operation of many provisions of the 1996
Telecommunications Act. We expect incumbent carriers will pursue litigation in
courts, institute administrative proceedings with the Federal Communications
Commission and other regulatory agencies and lobby the United States Congress,
all in an effort to affect laws and regulations in a manner favorable to the
incumbent carriers and against the interest of competitive carriers such as us.
If the incumbent carriers succeed in any of their efforts, if these laws and
regulations change or if the administrative implementation of laws develops in
an adverse manner, these events could have a material and adverse effect on our
business, prospects, operating results and financial condition. For more details
about our regulatory situation, please see "Business--Government Regulation."
OUR FAILURE TO MANAGE GROWTH COULD ADVERSELY AFFECT US
We have rapidly and significantly expanded our operations. We anticipate
further significant expansion of our operations in an effort to achieve our
network rollout and deployment objectives. Our expansion to date has strained
our management, financial controls, operations systems, personnel and other
resources. Any future rapid expansion would increase these strains. If our
marketing strategy is successful, we may experience difficulties responding to
customer demand for services and technical support in a timely manner and in
accordance with their expectations. As a result, rapid growth of our business
would make it difficult to implement successfully our strategy to provide
superior customer service. To manage any growth of our operations, we must:
- improve existing and implement new operational, financial and management
information controls, reporting systems and procedures;
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- hire, train and manage additional qualified personnel;
- expand and upgrade our core technologies; and
- effectively manage multiple relationships with our customers, suppliers
and other third parties.
We may not be able to install management information and control systems in
an efficient and timely manner, and our current or planned personnel, systems,
procedures and controls may not be adequate to support our future operations.
Failure to manage our future growth effectively could adversely affect the
expansion of our customer base and service offerings. Any failure to
successfully address these issues could materially and adversely affect our
business, prospects, operating results and financial condition.
OUR SUBSTANTIAL DEBT CREATES FINANCIAL AND OPERATING RISK
We are highly leveraged, and we intend to seek additional debt funding in
the future. As of June 30, 1999, we had approximately $494.3 million of
outstanding debt, and our debt made up 66.8% of our capitalization. We are not
generating any meaningful revenue to fund our operations or to repay our debt.
Our substantial leverage poses the risks that:
- we may be unable to repay our debt due to one or more events discussed in
"Risk Factors;"
- we may be unable to obtain additional financing;
- we must dedicate a substantial portion of our cash flow from operations to
servicing our debt once our debt requires us to make cash interest
payments, and any remaining cash flow may not be adequate to fund our
planned operations; and
- we may be more vulnerable during economic downturns, less able to
withstand competitive pressures and less flexible in responding to
changing business and economic conditions.
THE TELECOMMUNICATIONS INDUSTRY IS UNDERGOING RAPID TECHNOLOGICAL CHANGE, AND
NEW TECHNOLOGIES MAY BE SUPERIOR TO THE TECHNOLOGY WE USE
The telecommunications industry is subject to rapid and significant
technological changes, such as continuing developments in DSL technology and
alternative technologies for providing high-speed data communications. We cannot
predict the effect of technological changes on our business. We will rely in
part on third parties, including certain of our competitors and potential
competitors, for the development of and access to communications and networking
technology. We expect that new products and technologies applicable to our
market will emerge. New products and technologies may be superior and/or render
obsolete the products and technologies that we currently use. Our future success
will depend, in part, on our ability to anticipate and adapt to technological
changes and evolving industry standards. We may be unable to obtain access to
new technology on acceptable terms or at all, and we may be unable to adapt to
new technologies and offer services in a competitive manner. Our joint
development projects with Cisco and MCI WorldCom and our strategic arrangement
with Microsoft may not produce useful technologies or services for us. Further,
new technologies and products may not be compatible with our technologies and
business plan. We believe that the telecommunications industry must set
standards to allow for the compatibility of various products and technologies.
However, the industry may not set standards on a timely basis or at all. In
addition, many of the products and technologies that we intend to use in our
network services are relatively new and unproven and may be unreliable.
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WE MAY BE UNABLE TO EFFECTIVELY EXPAND OUR NETWORK SERVICES AND PROVIDE HIGH
PERFORMANCE TO A SUBSTANTIAL NUMBER OF END USERS
Due to the limited deployment of our network services, we cannot guarantee
that our network will be able to connect and manage a substantial number of end
users at high transmission speeds. We may be unable to scale our network to
service a substantial number of end users while achieving high performance.
Further, our network may be unable to achieve and maintain competitive digital
transmission speeds. While digital transmission speeds of up to 7.1 Mbps are
possible on certain portions of our network, that speed is not available over a
majority of our network. Actual transmission speeds on our network will depend
on a variety of factors and many of these factors are beyond our control,
including the type of DSL technology deployed, the distance an end user is
located from a central office, the quality of the telephone lines, the presence
of interfering transmissions on nearby lines and other factors. As a result, we
may not be able to achieve and maintain digital transmission speeds that are
attractive in the market.
OUR SERVICES MAY SUFFER BECAUSE THE TELEPHONE LINES WE REQUIRE MAY BE
UNAVAILABLE OR IN POOR CONDITION
Our ability to provide DSL-based services to potential customers depends on
the quality, physical condition, availability and maintenance of telephone lines
within the control of the incumbent carriers. We believe that the current
condition of telephone lines in many cases will be inadequate to permit us to
fully implement our network services. In addition, the incumbent carriers may
not maintain the telephone lines in a condition that will allow us to implement
our network effectively. The telephone lines may not be of sufficient quality or
the incumbent carriers may claim they are not of sufficient quality to allow us
to fully implement or operate our network services. Further, some customers use
technologies other than copper lines to provide telephone services, and DSL
might not be available to these customers.
OUR SUCCESS DEPENDS ON OUR RETENTION OF CERTAIN KEY PERSONNEL AND ON THE
PERFORMANCE OF THOSE PERSONNEL
Our success depends on the performance of our officers and key employees,
especially our Chief Executive Officer. Members of our senior management team
have worked together for only a short period of time. We do not have "key
person" life insurance policies on any of our employees nor do we have
employment agreements for fixed terms with any of our employees. Any of our
employees, including any member of our senior management team, may terminate his
or her employment with us at any time. Given our early stage of development, we
depend on our ability to retain and motivate high quality personnel, especially
our management. Our future success also depends on our continuing ability to
identify, hire, train and retain highly qualified technical, sales, marketing
and customer service personnel. Moreover, the industry in which we compete has a
high level of employee mobility and aggressive recruiting of skilled personnel.
We may be unable to continue to employ our key personnel or to attract and
retain qualified personnel in the future. We face intense competition for
qualified personnel, particularly in software development, network engineering
and product management.
WE DEPEND ON THIRD PARTIES FOR EQUIPMENT, INSTALLATION AND PROVISION OF FIELD
SERVICE
We currently plan to purchase all of our equipment from many vendors and
outsource the majority of the installation and field service of our networks to
third parties. Our reliance on third party vendors involves a number of risks,
including the absence of guaranteed capacity and reduced control over delivery
schedules, quality assurance, production yields and costs. If any of our
suppliers reduces or interrupts its supply, or if any significant installer or
field service provider interrupts its service to us, this reduction or
interruption could disrupt our business. Although multiple manufacturers
currently produce or are developing equipment that will meet our current and
anticipated requirements, our
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suppliers may be unable to manufacture and deliver the amount of equipment we
order, or the available supply may be insufficient to meet our demand.
Currently, almost all of the DSL modem and DSL multiplexing equipment we use for
a single connection over a copper line must come from the same vendor since
there are no existing interoperability standards for the equipment used in our
higher speed services. If our suppliers or licensors enter into competition with
us, or if our competitors enter into exclusive or restrictive arrangements with
the suppliers or licensors, then these events may materially and adversely
affect the availability and pricing of the equipment we purchase and the
technology we license.
A SYSTEM FAILURE OR BREACH OF NETWORK SECURITY COULD CAUSE DELAYS OR
INTERRUPTIONS OF SERVICE TO OUR CUSTOMERS
Our operations depend on our ability to avoid damages from fires,
earthquakes, floods, power losses, excessive sustained or peak user demand,
telecommunications failures, network software flaws, transmission cable cuts and
similar events. A natural disaster or other unanticipated problem at our owned
or leased facilities could interrupt our services. Additionally, if an incumbent
carrier, competitive carrier or other service provider fails to provide the
communications capacity we require, as a result of a natural disaster,
operational disruption or any other reason, then this failure could interrupt
our services.
Despite the implementation of security measures, our network may be
vulnerable to unauthorized access, computer viruses and other disruptive
problems. Corporate networks and Internet Service Providers 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 our customers, which might cause us to be liable to our customers,
and also might deter potential customers. Eliminating computer viruses and
alleviating other security problems may require interruptions, delays or
cessation of service to our customers and our customers' end users.
INTERFERENCE OR CLAIMS OF INTERFERENCE COULD DELAY OUR ROLLOUT OR HARM OUR
SERVICES
All transport technologies deployed on copper telephone lines have the
potential to interfere with, or to be interfered with by, other transport
technologies on the copper telephone lines. We believe that our DSL
technologies, like other transport technologies, do not interfere with existing
voice services. We believe that a workable plan that takes into account all
technologies could be implemented in a scalable way across all incumbent
carriers using existing plant engineering principles. There are several
initiatives underway to establish national standards and principles for the
deployment of DSL technologies. We believe that our technologies can be deployed
consistently with these evolving standards. Nevertheless, incumbent carriers may
claim that the potential for interference permits them to restrict or delay our
deployment of DSL services. Interference could degrade the performance of our
services or make us unable to provide service on selected lines. The procedures
to resolve interference issues between competitive carriers and incumbent
carriers are still being developed, and these procedures may not be effective.
We may be unable to successfully negotiate interference resolution procedures
with incumbent carriers. Moreover, incumbent carriers may make claims regarding
interference or unilaterally take action to resolve interference issues to the
detriment of our services. State or federal regulators could also institute
responsive actions. Interference, or claims of interference, if widespread,
would adversely affect our speed of deployment, reputation, brand image, service
quality and customer satisfaction and retention.
WE DEPEND ON THIRD PARTIES FOR FIBER OPTIC TRANSPORT FACILITIES
We depend on the availability of fiber optic transmission facilities from
third parties to connect our equipment within and between metropolitan areas.
These third party fiber optic carriers include long
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distance carriers, incumbent carriers and other competitive carriers. Many of
these entities are, or may become, our competitors. This approach includes a
number of risks. For instance, we may be unable to negotiate and renew favorable
supply agreements. Further, we depend on the timeliness of these companies to
process our orders for customers who seek to use our services. We have in the
past experienced supply problems with certain of our fiber optic suppliers, and
they may not be able to meet our needs on a timely basis in the future.
Moreover, the fiber optic transport providers whose networks we lease may be
unable to obtain or maintain permits and rights-of-way necessary to develop and
operate existing and future networks.
UNCERTAIN FEDERAL AND STATE TAX AND OTHER SURCHARGES ON OUR SERVICES MAY
INCREASE OUR PAYMENT OBLIGATIONS
Telecommunications providers pay a variety of surcharges and fees on their
gross revenues from interstate and intrastate services. The division of our
services between interstate and intrastate services is a matter of
interpretation, and in the future the Federal Communications Commission or
relevant state commission authorities may contest this division. A change in the
characterization of the jurisdiction of our services could cause our payment
obligations to increase. In addition, pursuant to periodic revisions by state
and federal regulators of the applicable surcharges, we may be subject to
increases in the surcharges and fees currently paid.
OUR INTELLECTUAL PROPERTY PROTECTION MAY BE INADEQUATE TO PROTECT OUR
PROPRIETARY RIGHTS, AND WE MAY BE SUBJECT TO INFRINGEMENT CLAIMS
We rely on a combination of licenses, confidentiality agreements and other
contracts to establish and protect our technology and other intellectual
property rights. We have applied for trademarks and servicemarks on certain
terms and symbols that we believe are important for our business. We currently
have no patents or patent applications pending. The steps we have taken may be
inadequate to protect our technology or other intellectual property. Moreover,
our competitors may independently develop technologies that are substantially
equivalent or superior to ours. Third parties may assert infringement claims
against us and, in the event of an unfavorable ruling on any claim, we may be
unable to obtain a license or similar agreement to use technology we rely upon
to conduct our business. We also rely on unpatented trade secrets and know-how
to maintain our competitive positions, which we seek to protect, in part, by
confidentiality agreements with employees, consultants and others. However,
these agreements may be breached or terminated, and we may not have adequate
remedies for any breach. In addition, our competitors may otherwise learn or
discover our trade secrets. Our management personnel were previously employees
of other telecommunications companies. In many cases, these individuals are
conducting activities for us in areas similar to those in which they were
involved prior to joining us. As a result, we or our employees could be subject
to allegations of violation of trade secrets and other similar claims.
RISKS ASSOCIATED WITH POTENTIAL GENERAL ECONOMIC DOWNTURN
In the last few years the general health of the economy, particularly the
economy of California where we have conducted a significant portion of our
operations to date, has been relatively strong and growing, a consequence of
which has been increasing capital spending by individuals and growing companies
to keep pace with rapid technological advances. To the extent the general
economic health of the United States or of California declines from recent
historically high levels, or to the extent individuals or companies fear a
decline is imminent, these individuals and companies may reduce expenditures
such as those for our services. Any decline or concern about an imminent decline
could delay decisions among certain of our customers to roll out our services or
could delay decisions by prospective customers to make initial evaluations of
our services. Any delays would have a material and adverse effect on our
business, prospects, operating results and financial condition.
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WE MAY BE UNABLE TO SATISFY, OR MAY BE ADVERSELY CONSTRAINED BY, THE COVENANTS
IN OUR EXISTING DEBT SECURITIES
The indentures governing our 1998 senior discount notes and 1999 senior
notes impose significant restrictions on how we can conduct our business. For
example, the restrictions prohibit or limit our ability to incur additional
debt, make dividend payments and engage in certain business activities. The
restrictions may materially and adversely affect our ability to finance future
operations or capital needs or conduct additional business activities. Any
future senior debt that we may incur will likely impose additional restrictions
on us. If we fail to comply with any existing or future restrictions, we could
default under the terms of the applicable debt and be unable to meet our debt
obligations. If we default, the holders of the applicable debt could demand that
we repay the debt, including interest, immediately. We may be unable to make the
required payments or raise sufficient funds from alternative sources to make the
payments. Even if additional financing is available in the event that we
default, it may not be on acceptable terms.
OUR PRINCIPAL STOCKHOLDERS AND MANAGEMENT OWN A SIGNIFICANT PERCENTAGE OF OUR
COMPANY AND WILL BE ABLE TO EXERCISE SIGNIFICANT INFLUENCE OVER OUR COMPANY
Following this offering, our executive officers and directors and principal
stockholders together will beneficially own 75.4% of the total voting power of
our company. Accordingly, these stockholders will be able to determine the
composition of our Board of Directors, will retain the voting power to approve
all matters requiring stockholder approval and will continue to have significant
influence over our affairs. This concentration of ownership could have the
effect of delaying or preventing a change in our control or otherwise
discouraging a potential acquirer from attempting to obtain control of us, which
in turn could have a material and adverse effect on the market price of the
common stock or prevent our stockholders from realizing a premium over the
market prices for their shares of common stock.
OUR FAILURE AND THE FAILURE OF THIRD PARTIES TO BE YEAR 2000 COMPLIANT COULD
NEGATIVELY IMPACT OUR BUSINESS
Many computer programs have been written using two digits rather than four
to define the applicable year. This poses a problem at the end of the century
because these computer programs may recognize a date using "00" as the year 1900
rather than the year 2000. This, in turn, could result in major system failures
or miscalculations, and is generally referred to as the "Year 2000 issue." We
have formulated and, to a large extent, effected a plan to address our
Year 2000 issues.
Our Year 2000 plan applies to two areas: internal business systems and
compliance by external customers and providers. We have completed our Year 2000
compliance testing for all of our internal systems and believe that they are
Year 2000 compliant. Because we are a young company, we believe we have been
able to build our business systems with the Year 2000 issue in mind. Therefore,
there have been few Year 2000 changes required to our existing systems and
applications. We have substantially completed a compliance check of our external
customers and providers, except for the incumbent carriers. Based on responses
from these third parties, other than the incumbent carriers, we have no
information or data to suggest that they will not experience Year 2000 problems
that would materially and adversely affect our business. We have not been able
to conduct a compliance check of incumbent carriers nor assess the incumbent
carriers' Year 2000 compliance. To the extent that one or more incumbent
carriers or other third parties experience Year 2000 problems, our network and
services could be adversely affected. Furthermore, the purchasing patterns of
our customers may be affected by Year 2000 issues as companies expend
significant resources to correct their current systems for Year 2000 compliance.
These expenditures may result in reduced funds available for our services. Any
of these developments could have a material and adverse effect on our business,
prospects, operating results and financial condition. We have not fully
determined the risks associated with the
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reasonably worst-case scenario and have not formulated a contingency plan to
address Year 2000 issues. We do not expect to have a specific contingency plan
in place in the future.
IF WE ARE REQUIRED TO REGISTER AS AN INVESTMENT COMPANY, WE WOULD BECOME SUBJECT
TO SUBSTANTIAL REGULATION WHICH WOULD INTERFERE WITH OUR ABILITY TO CONDUCT
OUR BUSINESS ACCORDING TO OUR BUSINESS PLAN
As a result of our previous financings, we have substantial cash, cash
equivalents and short-term investments. We plan to continue investing the excess
proceeds of these financings in short-term instruments consistent with prudent
cash management and not primarily for the purpose of achieving investment
returns. Investment in securities primarily for the purpose of achieving
investment returns could result in our being treated as an "investment company"
under the Investment Company Act of 1940. The Investment Company Act requires
the registration of companies that are primarily in the business of investing,
reinvesting or trading securities or that fail to meet certain statistical tests
regarding their composition of assets and sources of income even though they
consider themselves not to be primarily engaged in investing, reinvesting or
trading securities.
We believe that we are primarily engaged in a business other than investing
in or trading securities and, therefore, are not an investment company within
the meaning of the Investment Company Act. If the Investment Company Act
required us to register as an investment company, we would become subject to
substantial regulation with respect to our capital structure, management,
operations, transactions with affiliated persons and other matters. Application
of the provisions of the Investment Company Act to us would materially and
adversely affect our business, prospects, operating results and financial
condition.
WE EXPECT OUR STOCK PRICE TO BE VOLATILE
The trading price of our common stock has been and is likely to continue to
be highly volatile. Our stock price could fluctuate widely in response to many
factors, including the following:
- our historical and anticipated quarterly and annual operating results;
- announcements of new products or services by us or our competitors or new
competing technologies;
- the addition or loss of business or service provider customers;
- variations between our actual results and analyst and investor
expectations;
- investor perceptions of our company and comparable public companies;
- conditions or trends in the telecommunications industry, including
regulatory developments;
- announcements by us of significant acquisitions, strategic partnerships,
joint ventures or capital commitments;
- additions or departures of key personnel;
- future equity or debt offerings or our announcements of such offerings;
and
- general market and economic conditions.
In addition, in recent years the stock market in general, and the Nasdaq
National Market and the market for Internet and technology companies in
particular, have experienced extreme price and volume fluctuations. These
fluctuations have often been unrelated or disproportionate to the operating
performance of these companies. These market and industry factors may materially
and adversely affect our stock price, regardless of our operating performance.
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WE HAVE NOT PAID AND DO NOT INTEND TO PAY DIVIDENDS
We have not paid any dividends, and we do not intend to pay cash dividends
in the foreseeable future. Our current financing documents contain provisions
which restrict our ability to pay dividends.
ANTI-TAKEOVER PROVISIONS COULD NEGATIVELY IMPACT OUR STOCKHOLDERS
Our Board of Directors has adopted a stockholder rights plan. Our
stockholder rights plan would cause substantial dilution to any person or group
that attempts to acquire our company on terms not approved in advance by our
Board of Directors. In addition, some of the provisions that may be included in
our certificate of incorporation and bylaws may discourage, delay or prevent a
merger or acquisition at a premium price. These provisions include:
- authorizing the issuance of "blank check" preferred stock;
- providing for a classified Board of Directors with staggered, three-year
terms;
- eliminating the ability of stockholders to call a special meeting of
stockholders;
- limiting the removal of directors by the stockholders to removal for
cause; and
- requiring a super-majority stockholder vote to effect certain amendments.
In addition, certain provisions of the Delaware General Corporation Law and
our stockholder rights plan may deter someone from acquiring or merging with us,
including a transaction that results in stockholders receiving a premium over
the market price for the shares of common stock held by them. Section 203 of the
Delaware General Corporation Law also imposes certain restrictions on mergers
and other business combinations between us and any holder of more than 15% and
less than 85% of our common stock.
The indentures governing our 1998 senior discount notes and 1999 senior
notes require us to offer to repurchase all such notes for 101% of their
principal amount or accreted value, as the case may be, plus any accrued
interest and liquidated damages, within 30 days after a change of control. For
more details about these indentures, please see "Description of Certain
Indebtedness." We might not have sufficient funds available at the time of any
change of control to make any required payment, as well as any payment that may
be required pursuant to any other outstanding indebtedness at the time,
including our indebtedness to equipment financing lenders. These covenants may
also deter third parties from entering into a change of control transaction with
us. Furthermore, following the occurrence of certain change-of-control events,
we must offer to repurchase for cash all of the outstanding warrants issued in
connection with the senior discount notes.
THE PRICE OF OUR COMMON STOCK MAY DECLINE DUE TO SHARES ELIGIBLE FOR FUTURE SALE
Sales of substantial amounts of common stock in the public market following
this offering, or the appearance that a large number of shares is available for
sale, could adversely affect the market price for the common stock. The number
of shares of common stock available for sale in the public market is limited by
lock-up agreements that were entered into in connection with our secondary
offering in August 1999. Under such lock-up agreements, the holders of
approximately 76.1% of our outstanding shares of common stock agreed not to sell
or otherwise dispose of any of their shares for a period of 90 days after
August 11, 1999. However, Merrill Lynch and Salomon Smith Barney may, in their
sole discretion and at any time without notice, release all or any portion of
the securities subject to such lock-up agreements. In addition to the adverse
effect a price decline could have on holders of common stock, that decline would
likely impede our ability to raise capital through the issuance of additional
shares of common stock or other equity securities.
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YOU WILL INCUR IMMEDIATE AND SUBSTANTIAL DILUTION
Assuming an offering price of $30.63 per share, which was the closing price
of our common stock on November 4, 1999, the public offering price is
substantially higher than the net tangible book value per share of the
outstanding common stock after this offering. Accordingly, if you purchase
common stock in this offering at the offering price of $30.63 per share, you
will incur immediate and substantial dilution of $27.75 in the net tangible book
value per share of the common stock from the price you pay for the common stock
in this offering.
FORWARD-LOOKING STATEMENTS
In addition to historical information, this prospectus may contain
forward-looking statements. These statements involve risks and uncertainties.
Our actual results could differ materially from those projected in the
forward-looking statements. Factors that could cause or contribute to such
differences include those discussed in the section entitled "Risk Factors," as
well as those discussed elsewhere in this prospectus or in documents
incorporated in this prospectus by reference. We undertake no obligation to
update these forward-looking statements.
USE OF PROCEEDS
We will not receive any of the proceeds from the sale of the shares by the
selling stockholders.
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BUSINESS
OUR BUSINESS
We are a leading service provider of high-speed local access networking
solutions using DSL technology to businesses. We have designed our network to
give our customers a high-speed "always on" local connection to the Internet and
to private local and wide area networks. We offer a variety of DSL technologies
that deliver data transfer rates ranging from 128 Kbps to 7.1 Mbps. For
customers that subscribe at the 7.1 Mbps rate, our network provides transfer
speeds faster than frame relay and T-1 circuits, and is approximately 125 times
the speed of the fastest dial-up modem and over 55 times the speed of integrated
services digital network (ISDN) lines. Through our packet-based network,
multiple users on a single connection are able to simultaneously access the
Internet and private networks. Beyond high-speed access, we also offer a growing
suite of features and applications that we can individually configure to each
user's needs. We believe our network solutions will increase remote office and
worker productivity and reduce the complexity of communications for businesses.
Since our inception in February 1997, we have made substantial progress in
implementing a scalable nationwide network. We began offering commercial
services in our first market in April 1998, and currently offer service in a
total of 27 markets in 21 different states. We intend to continue our network
rollout into an additional 6 markets in 1999 and a further 17 markets by the end
of 2000. Upon completion of this network expansion, we anticipate providing
services in 50 of the nation's largest metropolitan areas, which we believe
contain 60% of the nation's local area networks. We have signed interconnection
agreements with Ameritech, Bell Atlantic, BellSouth, GTE, Pacific Bell, and
U S WEST, and we are currently pursuing interconnection arrangements with 4
other incumbent carriers. As of September 30, 1999, we provide service or have
installed equipment in over 850 incumbent carrier central offices. We have
obtained competitive carrier authority or have been permitted to operate as a
competitive carrier in 34 states. We intend to investigate expansion of our
network both in the United States and internationally.
In March 1999, we entered into separate strategic arrangements with MCI
WorldCom and Microsoft. As part of our strategic arrangements, MCI WorldCom's
investment fund and Microsoft each invested $30 million in us. The MCI WorldCom
arrangement also designates us as the first choice in its alternative carrier
access provisioning system for DSL services in certain circumstances, and
provides that MCI WorldCom is committed to sell at least 100,000 of our DSL
lines over a period of five years, subject to penalties for failure to reach
target commitments. In turn, we have designated MCI WorldCom as our preferred
provider of network services in certain circumstances. MCI WorldCom will also
work with us to develop voice and data applications over a single DSL
connection. For instance, in June 1999, MCI WorldCom and we, in conjunction with
Cisco and Jetstream Communications, successfully demonstrated toll-quality voice
and high-speed data communications over a single copper line utilizing DSL
technology. In our Microsoft arrangement, we will jointly develop and distribute
with Microsoft a co-branded DSL version of the Microsoft Network (MSN) service
focused on our small business customers and on our customers' teleworkers.
In April 1999, we entered into a customer relationship with Qwest, in
connection with which Qwest's wholly owned subsidiary, U.S. Telesource, invested
$15 million in us. Qwest has committed to purchase from us performance class DSL
services for re-sale to its customers. In return, we have agreed to use Qwest's
network and application hosting services in certain situations. The combined DSL
line commitment from Qwest and MCI WorldCom totals 200,000 lines over several
years.
We also market our services through our direct sales force and through our
partnerships with recognized leaders in the networking industry, including
Microsoft and Cisco. Under our strategic partnership with Cisco, Cisco agreed to
jointly market and sell our networking solutions to its customer base and will
engage in joint development projects with us. As of September 30, 1999 we had
approximately 6,700 lines in service. Our business customers include Broadcom,
Cisco, Wind River
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Systems, QUALCOMM, and Silicon Graphics. Our service provider customers include
Ingram Micro, Intermedia Communications, Savvis Communications, Verio and
Williams Communications.
In April 1999, we completed an initial public offering of our common stock,
raising net proceeds of approximately $210.1 million. On April 23, 1999, we
completed the sale and issue of senior notes, raising net proceeds of
approximately $314.5 million, of which approximately $113.2 million was used to
purchase a portfolio of U.S. government securities to secure the payment of the
first six scheduled interest payments on the notes.
In September 1999 we sold 594,279 shares of our common stock in a public
offering for net proceeds of approximately $16.4 million. These shares were sold
by us to several underwriters when they exercised an option to purchase the
shares in connection with an underwriting agreement whereby those underwriters
also agreed to sell up to 3,961,862 of our shares of common stock on behalf of
several of our stockholders in a public offering. We received no net proceeds
from the sale of these stockholder-held shares.
Our senior management team has extensive experience in developing
next-generation networking businesses. Our Chairman and Chief Executive Officer,
Catherine Hapka, was previously the founder, President and Chief Operating
Officer of !NTERPRISE Networking Services, U S WEST's data networking business.
Steve Stringer, our President and Chief Operating Officer, was previously the
Global Chief Operating Officer of GE Capital IT Solutions. Scott Chandler, our
Chief Financial Officer, was previously President and Chief Executive Officer of
C-COR Electronics, Inc., a manufacturer of broadband telecommunications
equipment. Our sponsors, which include Microsoft, MCI WorldCom's investment
fund, a subsidiary of Qwest, Kleiner Perkins Caufield & Byers, Enterprise
Partners, Brentwood Venture Capital, the Sprout Group and a subsidiary of Enron
Corp., have to date invested approximately $105.3 million in us.
MARKET OPPORTUNITY
We believe that a substantial market opportunity exists as a result of the
convergence of six factors:
- the growing demand for high-speed access to the Internet and corporate
networks;
- the inherent limitations of dial-up modems as a connection to data
networks;
- the need for large companies to improve the productivity of their remote
offices and workers;
- the need for small and medium businesses to have an integrated
communication solution for their networking requirements;
- the increasing adoption of DSL and widespread use of packet-based
networks; and
- the 1996 Telecommunications Act.
GROWING DEMAND FOR HIGH-SPEED ACCESS TO THE INTERNET AND CORPORATE NETWORKS
The value of goods and services sold through the Internet will grow from
$2.6 billion in 1996 to $400 billion in 2002, according to analyst projections.
Today, business spending for connecting remote workers, branch offices and
corporate headquarters to each other and to customers, suppliers and
partners--either through the Internet or private networks--is large and growing.
Industry analysts estimate that the U.S. market for remote Internet and local
area network access will grow from $5.9 billion in 1997 to $11.7 billion by
2002. Industry sources estimate that spending in the United States on
distributed networking and network services and applications will grow from
$54.2 billion in 1998 to $173 billion in 2002. Much of that growth is expected
to result from increased demand for e-mail, Web hosting services, e-commerce,
collaboration and real-time video services and applications.
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Industry sources expect spending on distributed networking and network services
and applications to encompass 57% of a company's total annual information
technology spending by 2002.
LIMITATIONS OF DIAL-UP MODEMS AND INTEGRATED SERVICES DIGITAL NETWORK (ISDN)
Because only five percent of buildings in the United States are currently
connected to high-speed fiber rings--typically large buildings in metropolitan
areas or clusters of buildings in regional campus parks--the vast majority of
workers who access data networks do so through slow dial-up modems connected to
the traditional circuit switched public telephone system. These traditional
dial-up modems are creating a bottleneck in data communications because the
data-carrying capacity of the fastest commercially available dial-up modem is
only 56 Kbps. The capacity of another alternative, an integrated services
digital network (ISDN) line, is only 128 Kbps. While integrated services digital
network (ISDN) technology provides improved capacity relative to dial-up modems,
the cost of an integrated services digital network (ISDN) solution is often
prohibitive.
NEEDS OF LARGE BUSINESSES FOR REMOTE OFFICE AND WORKER PRODUCTIVITY
Many large companies are supporting increasing numbers of remote offices and
workers. These companies face the challenge of finding a cost effective way to
make their remote workers as productive as those who have access to all of the
high performance communications and networking resources available to workers
located at corporate headquarters. A high-speed network solution that
encompasses access to the corporate local area network, the corporate telephone
system, the Internet, the corporate video conferencing system, customers,
suppliers and partners would substantially increase remote office and worker
productivity. At present, large businesses are incurring significant capital
expenditures to purchase equipment to support dial-up modems and integrated
services digital network (ISDN) connections, and paying for high cost technical
support personnel only to implement networking solutions that fail to optimize
worker productivity.
NEEDS OF SMALL AND MEDIUM BUSINESSES FOR INTEGRATED COMMUNICATION SOLUTIONS
A significant number of small and medium businesses have no practical
alternative to dial-up modems or integrated services digital network (ISDN) for
their workers to access the Internet and remote local area networks. As a
result, these workers suffer productivity limitations associated with slow
transmission speeds. In addition, these businesses need to contend with the cost
and complexity of retaining multiple vendors for their communication needs:
incumbent carriers for local voice traffic; long distance carriers for long
distance voice traffic; Internet Service Providers for Internet access; and
equipment integrators for on-premises voice and network systems. We believe that
these businesses can benefit from working with a single service provider that
offers integrated communication solutions, using a single connection.
EMERGENCE OF DSL AND PACKET-BASED TECHNOLOGIES
DSL technology dramatically increases the data, voice and video carrying
capacity of standard copper telephone lines. Because DSL technology uses
existing copper telephone lines, a broad network deployment can be implemented
rapidly, and requires a lower initial fixed investment than some existing
alternative technologies, such as fiber, cable modems and satellite
communications systems. A significant portion of the build-out of a DSL-based
network is directly related to the demand of paying subscribers, resulting in a
success-based deployment of capital.
Packet-based networks often are more efficient than traditional
point-to-point networks, and allow end users to connect to any location that can
be assigned an Internet Protocol address. Traditional point-to-point networks,
including the traditional telephone network and private line networks, are less
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efficient because they require a dedicated connection between two locations.
Packet-based networks allow multiple users to share connections between
locations.
1996 TELECOMMUNICATIONS ACT
The 1996 Telecommunications Act allows competitive carriers to leverage the
existing incumbent carrier infrastructure, as opposed to building a competing
infrastructure at significant cost. The 1996 Telecommunications Act requires all
incumbent carriers to allow competitive carriers to collocate their equipment
along with incumbent carrier equipment in incumbent carrier central offices,
which enables competitive carriers to access end users through existing
telephone line connections. The 1996 Telecommunications Act was designed to
create an incentive for incumbent carriers that were formerly part of the Bell
system to cooperate with competitive carriers: these incumbent carriers cannot
provide long distance service until regulators determine that there is
competition in the incumbent carrier's local market.
MARKET IMPACT OF CONVERGENCE
We believe the convergence of these factors has had several fundamental
effects on the communications market. New carriers can:
- leverage the existing network infrastructure by obtaining local network
access connections, and offer efficient high-speed data, voice and video
networks;
- provide large businesses with productivity enhancing remote office and
worker networking solutions;
- offer small and medium businesses integrated voice and data solutions that
reduce the complexity of using multiple vendors for communication
services; and
- build new networks that can provide efficient high-speed access over a
single connection to any Internet Protocol address on the Internet and/or
corporate network, along with features and applications that can be
configured to meet each user's needs.
THE RHYTHMS SOLUTIONS
We believe our network solutions effectively address many of the unmet
communications needs of today's businesses by offering an appealing combination
of quality, performance, price and service. Our network consists of:
- HIGH-SPEED, "ALWAYS ON" LOCAL CONNECTIONS. Our network delivers
high-speed, "always on" local access. Using DSL technology over standard
copper telephone lines, our network is capable of delivering data transfer
rates at speeds ranging from 128 Kbps to 7.1 Mbps. For customers that
subscribe at the 7.1 Mbps rate, the transfer rate is faster than frame
relay and T-1 circuits, and is approximately 125 times the rate of the
fastest dial-up modem and over 55 times the rate of an integrated services
digital network (ISDN) line. Moreover, unlike dial-up modems and
integrated services digital network (ISDN) lines, the DSL solution is
"always-on"--it does not require users to dial-up to connect to the
Internet or their local area network for each use.
- METROPOLITAN AND WIDE AREA OVERLAY NETWORK. We have designed our network
so that we can effectively and efficiently manage data traffic within and
among the metropolitan areas in which we offer our services. We use
transport services provided by other carriers for local access to users,
metropolitan area network connections and for long distance backbone
capacity. This overlay network is designed to route and switch traffic
within each metropolitan area, keeping local traffic local and sending
only long distance traffic over the wide area network, thereby increasing
overall network capacity and reliability and minimizing our backbone
costs. We
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manage the network and monitor service levels on a nationwide basis from
our Network Operations Center in Denver.
- PRODUCTIVITY ENHANCING FEATURES AND APPLICATIONS. We offer a growing suite
of network-enabled features and applications that extend the functionality
of corporate communications and networking resources to remote offices and
workers. We also offer remote offices and workers, as well as small and
medium businesses high performance Internet access solutions in
conjunction with our service provider customers.
- SERVICE FLEXIBILITY. We have designed our network so that we are able,
over a single DSL connection, to individually configure each network
user's features and applications.
- TURNKEY SOLUTION. We offer turnkey network solutions for our customers by
providing each customer with a single point of contact for a complete
package of services, including network implementation, maintenance,
billing and the DSL modem. For large customers, we provide complete
project management, including design, implementation and results
reporting. In some cases, we also seamlessly link our network operations
systems to existing customer information systems to ensure maximum service
efficiency.
BUSINESS STRATEGY
Our goal is to become the leading national service provider of high
performance networking solutions for remote offices and workers. We intend to
implement the following strategies to achieve our goal:
EXPLOIT EARLY MOVER ADVANTAGE
We intend to exploit our early market entrance to deploy our network and
establish strong relationships with business and service provider customers. As
of September 30, 1999, we provide service or had installed our network equipment
in over 850 central offices. Installation on this scale requires significant
time and resources; therefore, we believe our progress to date provides us a
significant time-to-market advantage over would-be competitors. We have gained
significant build-out experience, which we believe will streamline our further
expansion. In addition, we plan to construct our network rapidly and intend to
evaluate the potential acquisition of other companies so that we are an early
mover in our other target markets. We intend to exploit our early mover
advantage to gain significant market share in our target markets.
FOCUS ON PERFORMANCE-DRIVEN BUSINESS CUSTOMERS
We believe that the underserved segment of the business networking market
that demands high performance is currently relying on dial-up modems or
integrated services digital network (ISDN) for network access. Many large
businesses have remote offices and workers that are not able to take advantage
of the full array of communications and networking resources available to
workers at the main office. In addition to offering these businesses high-speed
access to the Internet and corporate networks, we intend to offer them
network-enabled features and applications that increase worker productivity.
Further, we believe that small and medium businesses are looking for an
integrated service provider to reduce their reliance on multiple vendors.
Accordingly, we intend to offer multiple networking services, including voice
and data services over a single DSL connection, to meet the needs of small and
medium businesses. We intend to evaluate offering new or enhanced products and
services to the consumer market.
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EXPAND NETWORK-ENABLED FEATURES AND APPLICATIONS
We seek to have our network become a platform that facilitates the delivery
of productivity-enhancing features and applications to businesses and their
employees. By collaborating with industry leaders such as MCI WorldCom,
Microsoft and Cisco, we intend to jointly develop features and applications that
will meet the needs of our customers. For instance, in June 1999, MCI WorldCom
and we, in conjunction with Cisco and Jetstream Communications, successfully
demonstrated toll-quality voice and high-speed data communications over a single
copper line utilizing DSL technology. In addition, we believe that the
proliferation of high-speed local access networks, such as our own, will
encourage third parties to create more bandwidth-intensive features and
applications. One of our objectives in providing these enhanced features and
applications is to strengthen customer loyalty and increase revenue per network
user.
ESTABLISH STRONG DISTRIBUTION CHANNELS
We intend to build strong distribution channels. For large businesses, we
are building a direct sales force and are entering into strategic joint
marketing alliances. We have entered into strategic alliances with Microsoft,
MCI WorldCom, Qwest and Cisco. Pursuant to our alliance with Microsoft, we will
jointly distribute with Microsoft a co-branded DSL version of the Microsoft
Network service focused on our small business customers and our customers'
teleworkers. Our strategic alliance with MCI WorldCom designates us as its
preferred provider of business DSL connections for large, medium and small
businesses. Under our Qwest alliance, Qwest has committed to purchase from us
performance class DSL services for re-sale to its customers. In return, we have
agreed to use Qwest's network and application hosting services in certain
situations. The combined DSL line commitment from Qwest and MCI WorldCom totals
200,000 lines over several years. In our alliance with Cisco, we have agreed
with Cisco to jointly market and sell our networking solutions to large
businesses. For small and medium businesses, we will distribute our services
through our service provider customers. Over time, we will seek to develop
additional strategic alliances, focusing on partners that can both add value to
our network and give us a meaningful distribution channel.
PROVIDE SUPERIOR CUSTOMER SERVICE
As part of our strategy to obtain and retain business and service provider
customers, we intend to provide superior service and customer care. We will
guarantee high-quality service by providing carrier-class networking solutions
and superior customer service. Our carrier-class networking solutions include
end-to-end proactive network monitoring and management through our Network
Operations Center, 24 hours a day, seven days a week. We also offer multiple
security features and a network that we can scale to meet demand. Our customer
service includes a personal and Web-based single point of contact, a complete
packaged solution including the DSL modem, installation, activation and network
management, and specific customer service objectives against which we measure
our performance. Our objective in providing outstanding customer service is to
provide a high level of customer satisfaction, achieve customer loyalty and
accelerate the adoption rate of our service.
STRATEGIC PARTNERSHIPS
MCI WORLDCOM
In March 1999 (as amended in April, May and July 1999), we entered into a
strategic partnership with MCI WorldCom in which MCI WorldCom invested
$30.0 million in us.
- PROVIDING DSL TO MCI WORLDCOM. We have been designated MCI WorldCom's
first choice in its alternative carrier access provisioning system for DSL
services in areas where we deploy our network for all new DSL services,
except for services to certain subsidiaries and in locations where MCI
WorldCom deploys its own DSL equipment. In addition, MCI WorldCom has
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committed to sell a minimum of 100,000 business quality DSL lines over a
period of five years, subject to penalties for failure to reach target
commitments. MCI WorldCom will have 60 months to place orders for these
lines, starting on the date when we have 1,250 collocations in commercial
service in at least 29 metropolitan statistical areas. As part of our
agreement, we must provide specified service levels and have available
capacity.
- OBTAINING NETWORK SERVICES FROM MCI WORLDCOM. We have designated MCI
WorldCom as our preferred provider of network services, including
metropolitan area network services, long-haul backbone services and
Internet Protocol backbone services. MCI WorldCom has a right of first
refusal to provide all of these services to us at market competitive
terms.
- COLLABORATION. We are jointly developing voice and data applications over
a single DSL connection. For instance, in June 1999, MCI WorldCom and we,
in conjunction with Cisco and Jetstream Communications, successfully
demonstrated toll-quality voice and high-speed data communications over a
single copper line utilizing DSL technology. We have also formed a working
group with MCI WorldCom to develop and implement the systems and
procedures necessary to jointly deploy DSL service nationwide. We will
collaborate with MCI WorldCom in selecting technologies and vendors to
support our network deployments.
MICROSOFT
In March 1999, we entered into a strategic partnership with Microsoft, in
which Microsoft invested $30.0 million in us. Pursuant to this relationship,
among other things, Microsoft has agreed to jointly distribute with us over the
Internet a co-branded DSL version of the Microsoft Network service focused on
our small business customers and on our customers' teleworkers. This agreement
expires in March 2002.
QWEST
In April 1999, we entered into a customer relationship with Qwest, in which
Qwest invested $15.0 million in us. Pursuant to this relationship, among other
things, Qwest has committed to purchase from us performance class DSL services
for re-sale to its customers. In return, we have agreed to use Qwest's network
and application hosting services in certain situations. The combined DSL line
commitment from Qwest and MCI WorldCom totals 200,000 lines over several years.
CISCO SYSTEMS
In October 1998, we entered into a strategic partnership with Cisco, in
which Cisco agreed to work jointly with us to sell our services to its customers
including providing compensation to its sales representatives for selling our
services. In addition, Cisco has committed to a joint marketing program with us
to increase our market recognition among businesses. We are also under contract
with Cisco to manage and upgrade its remote access program for 8,500 teleworkers
nationwide.
RHYTHMS NETWORK SERVICES, FEATURES AND APPLICATIONS
We offer our customers solutions that address many of their high performance
networking needs. Our local connection services use a variety of DSL
technologies to deliver high-speed, "always on" local access. We also aggregate
traffic within metropolitan areas and route or switch the traffic to our service
provider customers, or to a corporate local area network within the same
metropolitan area or another metropolitan area using our inter-network
connections. In addition to local connections and metropolitan and wide area
inter-network connections, we offer a growing suite of network-enabled features
and applications.
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LOCAL CONNECTIONS
Our local connection services connect individual users or multiple users on
a local area network to our metropolitan or national network or to the Internet
using DSL technology over traditional telephone lines. Using DSL technology over
copper lines, our network is capable of data transfer rates ranging from
128 Kbps to 7.1 Mbps. Unlike dial-up modems and integrated services digital
network (ISDN) lines, the DSL solution is "always on"--it does not require users
to dial-up to connect to the Internet or their local area network for each use.
We place DSL equipment both at the customer premises--a residence or
business--and in the central office that services that specific customer
premises. There are typically many incumbent carrier central offices in each
metropolitan area. We connect the DSL equipment in each central office to one of
our Metro Service Centers so that we can route or switch network traffic to
either a local destination, a national destination where we provide service or
the Internet.
For our local connection services, the speed and effectiveness of the DSL
connection will vary based on a number of factors, including the distance of the
end user from the central office and the condition of the copper line that
connects the end user to the central office. However, the specific number of
potential users for higher speeds will vary by central office and by region and
will be affected by line quality. In the future, we intend to examine adding a
variety of high-speed local access technologies as they are developed, including
emerging wireless technologies. The chart below compares the performance and
range for our local connection services as of September 30, 1999. The range
numbers represent the estimated maximum distance from the central office to the
end user. The technologies listed below are more fully described in "--DSL
Technologies" below. Speeds to the end user under the IDSL row are 128 Kbps
under some circumstances.
<TABLE>
<CAPTION>
SPEED TO SPEED FROM RANGE
END USER END USER (FEET) TECHNOLOGY
- -------- ---------- --------- ----------
<S> <C> <C> <C>
144 Kbps 144 Kbps Unlimited IDSL
256 Kbps 256 Kbps 18,000 SDSL
384 Kbps 384 Kbps 15,000 RADSL
512 Kbps 512 Kbps 14,000 RADSL
768 Kbps 768 Kbps 12,000 RADSL
1 Mbps 1 Mbps 12,000 RADSL
1.5 Mbps 1.5 Mbps 8,000 SDSL
3 Mbps 1 Mbps 10,700 RADSL
5 Mbps 1 Mbps 9,000 RADSL
7.1 Mbps 1 Mbps 7,800 RADSL
</TABLE>
METROPOLITAN AREA AND WIDE AREA INTER-NETWORK CONNECTIONS
For our business and service provider customers, we offer high-speed
connections both within and among metropolitan areas. In order to switch and
route traffic aggregated from each central office to its ultimate local or long
distance destination, we offer two interconnection services.
Our 1.544 Mbps service--DS-1--is suitable for small business customers or
service providers. Our 45 Mbps service--DS-3--is intended for large business
customers or service providers. The monthly service charge for both services is
greater if traffic aggregated in one metropolitan area is terminated in another
metropolitan area, and varies based on the speed of the local access connection.
Our wide area network currently operates between each of the metropolitan
areas in which we provide service. We currently lease frame relay backbone and
Asynchronous Transfer Mode backbone capacity from a number of long distance
carriers. We have almost completed upgrading our nationwide network to
Asynchronous Transfer Mode.
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NETWORK-ENABLED SERVICES, FEATURES AND APPLICATIONS
We intend to use our high-speed local access connection to provide multiple
network services, features and applications. Instead of just providing a
high-speed access connection, we intend to offer many network-enabled features
and applications, which we are able to configure to meet each user's needs. We
believe our strategy to provide additional network services, features and
applications for each user on our network allows us to address a larger market
opportunity than the market opportunity represented by connection services
alone. Our strategy is to benefit from additional recurring monthly revenue by
providing multiple network features and applications.
The features and applications that we currently offer are outlined below.
- CORPORATE TELEPHONE SYSTEM EXTENSION. This feature extends the
functionality of the corporate telephone system directly into a
teleworker's home or, in the future, a company's branch office. This
feature supports common corporate telephone functions such as four digit
dialing, conference calling and speed dialing. Benefits to our business
customers include increased worker productivity, reduced second line
expenses for voice service and the ability to aggregate and control long
distance charges.
- COMPUTER BACKUP. The computer backup feature allows end users to
automatically backup data to a secure remote site. Computer backup
leverages our "always on," high-speed local access connection and allows
the backup to be done at the times most convenient for the end user. We
believe this feature is more cost effective than substitutes such as tape
drives and disk cartridge drives, and has the additional protection of
being stored off site. This application is provided by a third party,
@Backup, Inc.
- CONTENT CACHING. We offer content caching for our customers' end users who
access the Internet. This network feature operates in the background,
serving user requests for Web pages locally rather than obtaining the
content from the actual server across the Internet. Caching enables our
customers to retrieve content faster than would otherwise be possible. Our
caching solution requires no configuration setup by our customer. If the
cache fails in any way, it will be automatically bypassed and user
requests will be sent directly to the Internet.
- SERVICE SELECTION. We have implemented a service selection feature within
our network that enables end users to access multiple destinations,
including the corporate local area network, the corporate telephone
system, the Internet, customers, suppliers and partners. Using this
feature, a connection to the Internet and the corporate local area network
can be established simultaneously by different users over the same DSL
access line. This feature alleviates the corporate network from servicing
Internet traffic to a teleworker.
- DYNAMIC HOST CONFIGURATION PROTOCOL FUNCTIONALITY. This feature relieves
network administrators from the burden of notifying each teleworker of
network configuration changes. Through the use of this protocol, once
teleworkers start up their computers, the customer's server automatically
downloads all of his or her network configuration parameters. If any
modifications to the configuration are necessary, they only need to be
modified once by the network administrator, and the network configuration
parameters will be automatically distributed to all of the organization's
teleworkers.
- TURNKEY INTERNET. This application allows small and medium businesses or
large business branch offices the ability to host Internet and intranet
websites. This application includes network equipment on the customer
premises that provides router, Web server, e-mail, file server, firewall
and Web-page caching. This premises-based Internet solution is combined
with our "always on" high-speed network connection and Internet services
from an Internet Service Provider customer.
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In the future, we plan to continue to expand our network features and
applications by working closely with leading hardware, software and networking
companies. We expect to focus on many applications, including combining voice
and data communications, increasing our directory and security capabilities, and
providing businesses with the ability to access their important applications
from remote locations. We have agreed to jointly develop directory and
voice-over Internet Protocol applications with Cisco. In addition, as part of
our strategic agreement with MCI WorldCom, we expect to jointly develop multiple
applications using DSL technology including voice and data applications over a
single DSL connection. For instance, in June 1999, MCI WorldCom and we, in
conjunction with Cisco and Jetstream Communications, successfully demonstrated
toll-quality voice and high-speed data communications over a single copper line
utilizing DSL technology. Our strategic relationship with Microsoft will focus
on delivering co-branded network applications that will facilitate our
customers' access to the Internet and other destinations.
Using these network-enabled features and applications, we can assemble a
broad solution to meet our business customer needs. For example, for a
teleworker, we might combine high-speed access to the corporate network and the
Internet with computer backup and corporate telephone extension. For a small
business, we might offer a turnkey Internet solution by combining high-speed
access to the Internet through our Internet Service Provider customer, with
customer premises equipment that supports Web server, e-mail, file server,
firewall, Web-page caching and network backup.
TURNKEY SOLUTION
We offer a full service solution for the configuration, provisioning, and
installation of the local access connection at the end user location, for which
the customer pays a one-time charge. That charge covers the cost of installing
the DSL line, any required inside wiring, the DSL modem, attaching the DSL modem
to either a single computer, local area network or enterprise server,
installation of a single network interface card if required, and installing the
TCP/IP software if required. For our large business customers, we provide
complete project management, including design, implementation and results
reporting. In some cases we seamlessly link our network operations systems to
existing customer information systems through Web-based interfaces.
CUSTOMERS, SALES AND MARKETING
We offer our services to large, medium and small businesses. As of
September 30, 1999, we served approximately 680 business and 30 service provider
customers. For these business and service provider customers we have
approximately 6,700 lines in service. Selected business customers include
Broadcom, Cisco, Wind River Systems, QUALCOMM and Silicon Graphics. In addition,
our service provider customers include Ingram Micro, Intermedia Communications,
Savvis, Verio, and Williams Communications.
DIRECT SALES CHANNELS
We market our services to large businesses through a direct sales force. Our
target account profile is a large, information-intensive enterprise with
multiple locations and large numbers of distributed workers. Our sales force
seeks to deal directly with the Chief Information Officer and the
telecommunications manager responsible for remote access in the target account.
Sales teams are deployed in each of the metropolitan areas in which we offer our
services. As of September 30, 1999, we had approximately 260 sales and technical
personnel supporting our direct and indirect sales efforts. We intend to
increase the size of our sales and technical support force to sell and support
large businesses as we enter new geographic markets.
Our relationship with large business customers can involve multiple phases.
A customer typically initially agrees to a first phase commitment for a specific
number of connections at a negotiated price
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and one year contract term. Typically, three to six months into the first phase
implementation, the customer agrees to successive phases of implementation that
could include additional connections and upgrades in services, features and
applications. In general, we have experienced a six to nine month sales cycle
prior to receiving significant order volume from a business customer. Please see
"Risk Factors--We cannot predict our success because our business model is
unproven."
INDIRECT SALES CHANNELS
We also market our services to small and medium businesses through indirect
channels, including Internet Service Providers, interexchange carriers,
competitive carriers, value-added resellers, and integrators. We offer each
service provider the ability to select those services that it would like to
bundle with its own service offerings to offer a total solution to its
customers. For example, Internet Service Providers typically combine our
high-speed connections with their Internet access services and resell the
combination to their existing and new customers. We address these markets
through sales and marketing personnel dedicated to each of these indirect
channels.
We supplement our sales effort to certain of these service providers by
offering marketing support services that may include training, proposal
development, lead generation, channel support materials, joint marketing funds,
Web promotion, joint participation in national and regional customer events and
press announcements. We also offer promotions and sales incentives from time to
time to our service providers. Additionally, we support our service providers by
acting as a network integrator by qualifying potential customers for service,
ordering connections, installing equipment on the customer premises, turning up
the service, monitoring the network, troubleshooting, making repairs and
invoicing the customer on a single bill.
Our agreements with our service provider customers vary widely. Generally,
our agreements have a one- to three-year term, and are based on negotiated
prices that decline with increasing levels of volume achievement. In many cases,
service providers have selected one or two, and perhaps three, DSL service
providers as preferred suppliers in each market. Our goal is to be selected as
the preferred supplier or one of the preferred suppliers in each metropolitan
area where we operate. When we are selected as a preferred supplier within a
given market, we may enter into joint marketing arrangements to promote our DSL
services. See "Risk Factors--We depend on third parties, particularly MCI
WorldCom, Microsoft, Qwest and Cisco, for the marketing and sales of our network
services."
CUSTOMER SERVICE
We offer our business and service provider customers a single point of
contact for implementation, maintenance and billing. Our Network Operations
Center provides both proactive and customer initiated maintenance services
24 hours a day, seven days a week. We also provide a broad range of customer
service and Network Operations Center services through our Web interface.
- IMPLEMENTATION. Working with a business or service provider customer, our
customer service technicians and sales engineers will develop an
implementation plan for each customer. The plan will include qualifying
the customer for our service offerings, placing orders for the connection
facilities, coordinating the delivery of the connection, installation and
turn up.
- MAINTENANCE. Our Network Operations Center in Denver provides network
surveillance through standard Simple Network Management Protocol tools for
all equipment in our network. Because we have complete end-to-end
visibility of our network, we are able to proactively detect and correct
the majority of our customer's maintenance problems remotely. Our goal is
to proactively detect and repair 90% of our customer's maintenance
problems before our customer is aware of a problem. Customer initiated
maintenance and repair requests are managed and resolved primarily through
the Customer Service Center. We utilize a trouble ticket management system
to communicate customer maintenance problems from the customer service
center to the
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Network Operations Center engineers and the field services engineers.
Because our Network Operations Center is fully staffed 24 hours a day,
seven days a week, we believe our ability to provide superior proactive
maintenance is significantly enhanced.
- BILLING. Customer bills are currently issued on a monthly basis through an
internal billing system. Customer billing inquiries are managed by our
Customer Service Center. In the future, billing inquiries will also be
supported through our Web interface.
- CUSTOMER SUPPORT SYSTEMS. Our system architecture is designed to
facilitate rapid service responsiveness and reduce the cost of customer
support. We use an integrated set of standard, off-the-shelf systems to
support our business processes. We designed all business functions,
including sales, ordering, provisioning, maintenance and repair, billing,
accounting and decision support to use a single database, ensuring that
every function has accurate, up-to-date information. The use of
client-server tools and scalable Unix and Microsoft NT servers enables
automation within and between processes.
NETWORK ARCHITECTURE
NETWORK TECHNOLOGY
The key design features allowing us to be a business-class network are:
- CARRIER-CLASS NETWORK MANAGEMENT. Our network is designed to be
carrier-class throughout. For example, it has been designed with redundant
network electronics and transmission paths. We have the ability to
electronically view our entire network including the DSL modem located at
the end user's computer or located on our customer's local area network
from our Network Operations Center in Denver. We provide our business and
service provider customers with service level agreements that guarantee
specific levels of network performance. We have found that by offering
service level agreements, we are better able to convince businesses to
move their mission-critical applications onto our network.
- SCALABLE SYSTEMS. We use industry standard, off-the-shelf software to
support preordering, ordering, provisioning, billing, network monitoring
and trouble management. We have implemented these systems using web-based
and distributed client-server systems architecture. This approach allows
us to grow our customer support and network management capabilities as
customer demand increases.
- NETWORK SECURITY. Non-dedicated access, such as dial-up modem or
integrated services digital network (ISDN) lines, or dedicated access to
the public Internet, represents security risks for business networks.
These security risks are mitigated through the use of virtual private
network technologies such as authentication, tunneling, encryption, and
through the use of permanent virtual circuits that define a logical
dedicated connection between the end user and the corporate network. Our
network enables businesses to fully employ these virtual private network
technologies by using their own equipment at the edges of our network, or
optionally purchasing virtual private networking services from us.
NETWORK COMPONENTS
Our network is an overlay network in that we lease existing transport
services from other service providers: local access copper lines from incumbent
carriers, metropolitan fiber from incumbent carriers or competitive carriers and
long-distance backbone fiber from long distance carriers. This overlay network
is designed to switch and route traffic within each metropolitan area, keeping
local traffic local and only sending non-local traffic over the wide area
network, thereby increasing overall network capacity and reliability and
reducing costs. The primary components of our network are customer
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endpoint devices, local transport, our Connection Points, high-speed
metropolitan area network, our Metro Service Centers, our backbone and our
Network Operations Center.
- CUSTOMER ENDPOINT DEVICES. We currently offer DSL and private line local
access connections in our network. For DSL access, we include the customer
endpoint device--the DSL modem--as part of our complete turnkey service
offering. We configure and install these modems with the end user's
computer, or local area network or enterprise router along with any
required on-site wiring needed to connect the modem to the telephone line
leased from the incumbent carrier. Currently, almost all of the DSL modem
and DSL multiplexing equipment we use for a single connection over a
copper line must come from the same vendor since there are no existing
interoperability standards for the equipment used in our higher speed
services.
- LOCAL TRANSPORT. Our local transport connects customer end-point devices
to our network. For digital subscriber line access, the transport is a
DSL-capable copper loop leased by us from the incumbent carrier under
terms specified in our interconnection agreements. In many cases,
DSL-capable lines result from modification of voice grade lines to carry
digital signals, at times involving an additional one-time or monthly
charge relative to voice grade lines. For private line access, the
transport is leased copper or fiber trunks provided by the incumbent
carrier or a competitive carrier.
- CONNECTION POINTS. Through our interconnection agreements with the
incumbent carriers, we secure collocation space in central offices. In
each of these Connection Points, we connect the DSL-equipped copper loop
to our DSL multiplexing equipment. Each of our Connection Points is
designed to offer the same high reliability and availability standards as
the incumbent carrier's own central office space. We expect to place our
equipment in each of 30 to 90 central offices in any metropolitan area
that we enter. As of September 30, 1999, we had Connection Points in over
850 central offices. Although we expect that many Connection Points will
be physically located within the central office, we have placed and will
continue to place our Connection Points in locations immediately adjacent
to central offices, when collocation space within the central office is
not available.
- HIGH-SPEED METROPOLITAN AREA NETWORK. In each of our targeted metropolitan
area markets, we operate a private metropolitan area network. The network
consists of high-speed Asynchronous Transfer Mode communications circuits
that we lease from competitive carriers or incumbent carriers to connect
our Connection Points to the Metro Service Center. The metropolitan area
network operates at 45 Mbps--DS-3--today, and can be upgraded to 150
Mbps--OC-3--and 600 Mbps--OC-12--in the future. We anticipate leasing a
substantial portion of this capacity from MCI WorldCom, as described in
"--Strategic Partnerships."
- METRO SERVICE CENTERS. The Metro Service Center is a physical point of
presence within a metropolitan area where local access traffic is
aggregated from the Connection Points over our high-speed metropolitan
area network. Although we generally expect to have one Metro Service
Center in each of our targeted metropolitan areas, in larger metropolitan
areas, we may have two. The Metro Service Center houses our Asynchronous
Transfer Mode switches and Internet Protocol routers. We also place
applications servers in our Metro Service Centers to support network
enabled feature and applications. We design our Metro Service Centers for
high availability including battery backup power, redundant equipment and
active network monitoring.
- BACKBONE. Our backbone interconnects our Metro Service Centers so that
communications traffic can be transported among different metropolitan
areas. We currently lease frame relay backbone and Asynchronous Transfer
Mode backbone capacity from a number of long distance carriers. We have
almost completed upgrading our nationwide network to Asynchronous Transfer
Mode.
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- NETWORK OPERATIONS CENTER. Our entire network is managed from the Network
Operations Center located in Denver. From these centers, we provide
end-to-end network monitoring and management using advanced network
management tools 24 hours a day, seven days a week. This enhances our
ability to address performance or connection issues before they affect our
end user's experience. From the Network Operations Center, we monitor the
equipment and circuits in each Metro Service Center, each metropolitan
area network, each Connection Point, individual end user lines and modems.
Please see "Risk Factors--A system failure or breach of network security
could cause delays or interruptions of service to our customers."
We are pursuing a program of ongoing network development. Our engineering
efforts focus on the design and development of new technologies and services to
increase the speed, efficiency, reliability and security of our network and to
enable network features and applications developed by us or by third parties.
Please see "Risk Factors--We may be unable to effectively expand our network
services and provide high performance to a substantial number of end users."
DSL TECHNOLOGIES
We utilize various DSL equipment and technologies from different vendors.
The various DSL technologies allow us to offer a range of connection speeds.
Actual speeds are a function of the distance from the end user or local area
network to the central office and the quality of the copper line. We describe
the basic features and the market positioning of our primary DSL technologies
below.
RATE ADAPTIVE DIGITAL SUBSCRIBER LINE (RADSL)
RADSL technology allows each end user or local area network to utilize the
full digital capability of the underlying telephone line. Speeds reach up to 7.1
Mbps downstream and up to 1.1 Mbps upstream if the end user or local area
network is within 7,800 feet from the central office. We use this technology for
end users or local area networks needing very high access speeds. Our target
customers for RADSL connections consist of small and medium businesses and
branch offices of large businesses needing T-1 or higher speeds. We believe that
these businesses often find the cost of dedicated private line or frame relay
services to be prohibitive. Our RADSL connection competes favorably on a price/
performance basis relative to traditional fractional T-1 and frame relay
services. The service also provides the highest speed of any DSL service for
bandwidth intensive applications.
SYMMETRIC DIGITAL SUBSCRIBER LINE (SDSL)
Our SDSL technology allows end users and local area network to achieve up to
1.5 Mbps speeds both downstream and upstream. Depending on the quality of the
copper line, 1.5 Mbps can typically be achieved if the end user or local area
network is within 8,000 feet, or approximately 1.5 miles, from the central
office.
INTEGRATED DIGITAL SUBSCRIBER LINE (IDSL)
IDSL technology allows us to reach all end users or local area networks
within a central office serving area irrespective of the end user or local area
network distance from the central office. Our IDSL service operates at up to 144
Kbps in each direction. This service can use existing integrated services
digital network (ISDN) equipment at the end user site, and is targeted at the
integrated services digital network (ISDN) replacement market. For information
intensive users, we believe that IDSL compares favorably with integrated
services digital network (ISDN) on a price/performance basis when the monthly
flat rate IDSL charge is compared with the per minute integrated services
digital network (ISDN) charge. We also offer IDSL to end users that have lines
that do not consist of continuous copper, such as digital line carrier equipped
lines that are partially copper and partially fiber.
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COMPETITION
We will face competition from many competitors with significantly greater
financial resources, well-established brand names and large, existing installed
customer bases. Moreover, we expect the level of competition to intensify in the
future. We expect significant competition from:
- INCUMBENT CARRIERS. Incumbent carriers, such as GTE and U S WEST, are
leasing wide area connections from long distance carriers, and have
existing metropolitan area networks and circuit switched local access
networks. Most incumbent carriers have announced deployment of commercial
DSL services in certain areas. In addition, most incumbent carriers are
combining their DSL service with their own Internet Service Provider
businesses or entering into cooperative or exclusive relationships with
established Internet Service Providers. We believe that incumbent carriers
have the potential to quickly overcome many of the issues that have
delayed widespread deployment of DSL services in the past. If a Regional
Bell Operating Company is authorized to provide in-region long distance
service in one or more states, by fulfilling the market-opening provisions
of the 1996 Telecommunications Act, the Regional Bell Operating Company
may be able to offer "one stop shopping" that would be competitive with
our offerings. In addition, proposed mergers involving Regional Bell
Operating Companies, including SBC's proposed merger with Ameritech and
Qwest's proposed merger with U S WEST, could ease each combined entity's
ability to provide end-to-end high-speed data offerings. The incumbent
carriers 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 we may be unable to secure
collocation space.
- TRADITIONAL INTEREXCHANGE CARRIERS. Many of the leading traditional
interexchange carriers, such as AT&T, MCI WorldCom and Sprint, are
expanding their capabilities to support high-speed, end-to-end networking
services. Increasingly, their bundled services include high-speed local
access combined with metropolitan and wide area networks, and a full range
of Internet services and applications. For example, AT&T's acquisition of
MediaOne will exploit ubiquitous local cable infrastructure. We expect
them to offer combined data, voice and video services over these networks.
These carriers have deployed large scale networks, have large numbers of
existing business and residential customers and enjoy strong brand
recognition, and as a result represent significant competition. For
instance, they have extensive fiber networks in many metropolitan areas
that primarily provide high-speed data and voice communications to large
companies. They have announced deployment of DSL services in combination
with their current fiber networks. They also have interconnection
agreements with many of the incumbent carriers and have secured
collocation spaces from which they could begin to offer competitive DSL
services.
- NEWER INTEREXCHANGE CARRIERS. The newer interexchange carriers, such as
Williams, Qwest and Level 3 Communications, are building and managing high
bandwidth, packet-based networks nationwide. They are also building direct
sales forces and partnering with Internet Service Providers to offer
services directly to business customers. They 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, like @Home
Networks and its cable partners, are offering or preparing to offer
high-speed Internet access over hybrid fiber coaxial cable networks to
consumers. @Work has positioned itself to do the same for businesses.
Where deployed, these networks provide local access services similar to
our services, and in some cases at higher speeds. They typically offer
these services at lower prices than our services, in part by sharing the
bandwidth available on their cable networks among multiple end users.
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- WIRELESS AND SATELLITE DATA SERVICE PROVIDERS. Several new companies are
emerging as wireless and satellite-based data service providers, over a
variety of frequency allocations. These include:
- WinStar Communications, Inc.,
- Teligent, Inc.,
- Teledesic LLC,
- Hughes Space Communications, and
- Iridium World Communications Ltd.
These companies use a variety of new and emerging technologies, such as
terrestrial wireless services, point-to-point and point-to-multipoint fixed
wireless services, satellite-based networking and high-speed wireless digital
communications.
- INTERNET SERVICE PROVIDERS. Internet Service Providers provide Internet
access to residential and business customers. These companies generally
provide such Internet access over the incumbent carriers' circuit switched
networks at integrated services digital network (ISDN) speeds or below.
However, some Internet Service Providers have begun offering DSL-based
access using their own DSL services, or DSL services offered by the
incumbent carrier or other DSL-based competitive carriers. Some Internet
Service Providers have significant and even nationwide marketing presences
and combine these with strategic or commercial alliances with DSL-based
competitive carriers. Some Internet Service Providers, such as Concentric
Network Corporation, Mindspring Enterprises, Inc., PSINet Inc. and Verio
have significant and even nationwide presences.
- COMPETITIVE CARRIERS. Certain competitive carriers, including Covad
Communications Group, Inc. and NorthPoint Communications, Inc., have begun
offering DSL-based data services. In addition, regional competitive
carriers, including HarvardNet, Inc., Network Access Solutions Corp. and
DSL.net have begun offering DSL-based access services that compete with
the services we offer. Other competitive carriers are likely to do so in
the future. Conditions attached to the proposed merger between SBC and
Ameritech may make entry and operation in affected regions easier for our
competitors. The 1996 Telecommunications Act specifically grants
competitive carriers the right to negotiate interconnection agreements
with incumbent carriers, including interconnection agreements which may be
identical in all respects to our agreements.
Many of these competitors are offering, or may soon offer, technologies and
services that will directly compete with some or all of our service offerings.
Such technologies include integrated services digital network (ISDN), DSL,
wireless data and cable modems. Please see "Risk Factors--The market in which we
operate is highly competitive, and we may not be able to compete effectively,
especially against established industry competitors with significantly greater
financial resources, for more details about this risk." Some of the competitive
factors we face include:
- transmission speed,
- reliability of service,
- breadth of service availability,
- price performance,
- network security,
- ease of access and use,
- content bundling,
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- customer support,
- brand recognition,
- operating experience,
- ability to scale,
- capital availability and
- exclusive contracts.
INTERCONNECTION AGREEMENTS WITH INCUMBENT CARRIERS
Interconnection agreements with incumbent carriers are critical to our
business. These agreements cover a number of aspects of our relationships with
incumbent carriers, including:
- the price we pay to lease and the access we have to the incumbent
carrier's copper lines;
- the removal by the incumbent carrier of equipment or electronics from
lines to enable these lines to transmit DSL signals;
- the price and terms for collocation of our equipment in the incumbent
carrier central offices;
- the price we pay and the access we have to the incumbent carrier's
transport facilities;
- the ability we have to access conduits and other rights of way the
incumbent carrier has to construct its own network facilities;
- the operational support systems and interfaces that we can use to place
orders and report and monitor the incumbent carrier's response to our
requests;
- the dispute resolution process we use with the incumbent carrier to
resolve disagreements on the terms of the interconnection contract; and
- the term of the interconnection agreement, its transferability to
successors, its liability limits and other general aspects of our
relationship with the incumbent carrier.
We have signed interconnection agreements with six different major incumbent
carriers covering 24 states and the District of Columbia. In many cases,
incumbent carriers do not agree to the provisions in interconnection agreements
that we request, and we have not consistently prevailed in obtaining all of the
provisions we desire. We may be unable to continue to sign interconnection
agreements with incumbent carriers. If we are unable to enter into, or
experience delay in obtaining, interconnection agreements, this inability or
delay may materially and adversely affect our business and financial prospects.
The incumbent carriers are also permitting competitive carriers to adopt
previously signed interconnection agreements.
Our interconnection agreements have a maximum term of three years, requiring
us to renegotiate the existing terms in the future. We may be unable to extend
our existing interconnection agreements or renegotiate new agreements on
favorable or any terms. In addition, our interconnection agreements are subject
to state commission, Federal Communications Commission and judicial oversight.
These bodies may modify the terms or prices of our interconnection agreements in
ways that would adversely affect our business and financial prospects.
GOVERNMENT REGULATION
A significant portion of the services that we offer, particularly through
our wholly owned subsidiaries, Rhythms Links Inc., formerly ACI Corp., and
Rhythms Links Inc.-Virginia, formerly ACI Corp.-Virginia, may be subject to
regulation at the federal, state and/or local levels. Future federal or
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state regulations and legislation may be less favorable to us than current
regulation and legislation and therefore have a material and adverse impact on
our business and financial prospects. In addition, we may expend significant
financial and managerial resources to participate in proceedings setting rules
at either the federal or state level, without achieving a favorable result.
FEDERAL LEGISLATION AND REGULATION
The 1996 Telecommunications Act, enacted on February 8, 1996, substantially
departs from prior legislation in the telecommunications industry by
establishing local exchange competition as a national policy. This act removes
state regulatory barriers to competition and preempts laws restricting
competition in the local exchange market.
The 1996 Telecommunications Act in some sections is self-executing, but in
addition, the Federal Communications Commission issues regulations that identify
specific requirements upon which we and our competitors rely in implementing the
changes it prescribes. The outcome of these various ongoing Federal
Communications Commission rulemaking proceedings or judicial appeals of such
proceedings could materially affect our business and financial prospects.
The Federal Communications Commission prescribes rules applicable to
interstate communications, including rules implementing the 1996
Telecommunications Act, a responsibility it shares with the state regulatory
commissions. The 1996 Telecommunications Act, and the Federal Communications
Commission's initial rules interpreting such act, encouraged increased local
competition. A federal appeals court for the Eighth Circuit reviewed some of the
initial rules, and overruled some of its provisions, including some rules on
pricing and nondiscrimination. In January, 1999, the United States Supreme Court
reversed elements of the Eighth Circuit's ruling, finding that the Federal
Communications Commission has broad authority to interpret the 1996
Telecommunications Act and issue rules for its implementation, specifically
including authority over pricing methodology. The Supreme Court upheld the
Federal Communications Commission's orders to the incumbent carriers to combine
unbundled elements for competitors, and to allow competitors to pick and choose
among provisions in existing interconnection agreements. The Supreme Court also
found that the Federal Communications Commission's interpretation of the rules
for establishing unbundled elements was not consistent with the 1996
Telecommunications Act, and required the Federal Communications Commission to
reconsider its delineation of unbundled elements. The Federal Communications
Commission's replacement decision on unbundled elements may adversely affect our
business. In addition, some incumbent carriers may take the position that they
have no obligation to provide unbundled elements, including copper loops, until
the Federal Communications Commission issues new rules, which could adversely
affect our business.
In November, 1998, the Federal Communications Commission ruled that DSL
services provided as dedicated access services in connection with interstate
services such as Internet access are interstate services subject to the Federal
Communications Commission's jurisdiction. This decision is currently subject to
reconsideration and appeal.
In addition, in the spring of 1998, four of the regional bell operating
companies petitioned the Federal Communications Commission, and they and others
have initiated legislative efforts since then, to be relieved of certain
regulatory requirements in connection with their own DSL services, including
obligations to unbundle DSL loops, but not the obligation to unbundle the loops
we purchase for our DSL services, and to resell DSL services. In October 1998,
the Federal Communications Commission ruled that DSL services are
telecommunications services subject to the requirements of the 1996
Telecommunications Act to unbundle such services and offer them for resale. In
October 1998, the Federal Communications Commission also issued a Notice of
Proposed Rulemaking indicating its intention to clarify expanded rights of
competitive carriers for collocation, access to copper loops, and various other
issues of consequence to competitive carriers deploying DSL services. The
Federal
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Communications Commission also indicated its intention to allow incumbent
carriers to create separate affiliates for their DSL businesses that would have
to operate as competitive carriers and would be permitted to operate free of the
resale and unbundling obligations of the 1996 Telecommunications Act. The final
outcome of these decisions, originally scheduled to be announced on January 28,
1999, had been postponed by the Federal Communications Commission while it
considered the impact of the Supreme Court's ruling on the 1996
Telecommunications Act. On March 31, 1999, the Federal Communications Commission
issued a decision on collocation issues which was generally favorable to the
competitive carriers. This decision has been appealed to the D.C. Circuit by U S
WEST and GTE, although it has not been stayed. In the same decision the Federal
Communications Commission established further proceedings to consider issues
related to unbundled network elements. The Federal Communications Commission is
also engaged in a proceeding to define what the incumbent carriers' obligations
are to make available unbundled network elements. The final outcome of these
petitions or other proceedings or initiatives interpreting the requirements of
the 1996 Telecommunications Act may adversely affect our business.
STATE REGULATION
Some of our services, particularly those of our subsidiaries, Rhythms
Links Inc. and Rhythms Links Inc.-Virginia, may be classified as intrastate
services subject to state regulation. All of the states where we operate, 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 we are not typically subject
to price or rate of return regulation for tariffed intrastate services. Actions
by state public utility commissions could cause us to incur substantial legal
and administrative expenses.
Under the 1996 Telecommunications Act, if we so request, incumbent carriers
have a statutory duty to negotiate in good faith with us 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 we have made a request. We have
signed interconnection agreements with Ameritech, Bell Atlantic, BellSouth, GTE,
Pacific Bell and U S WEST. We have signed agreements with Ameritech for Illinois
and Michigan and currently are negotiating interconnection agreements for
Indiana, Ohio and Wisconsin. We have signed agreements with Bell Atlantic for
the District of Columbia, Maryland, Massachusetts, New Jersey, New York,
Pennsylvania and Virginia and are currently negotiating agreements for
Connecticut, Delaware, New Hampshire and Rhode Island. We have signed agreements
with BellSouth for Alabama, Florida, Georgia, Kentucky, Louisiana, Mississippi,
North Carolina, South Carolina and Tennessee. We have signed agreements with GTE
for California, Florida, North Carolina and Washington and are currently
completing agreements for Ohio, Oregon, Texas and Virginia. We have signed an
agreement with Pacific Bell for California. We have signed agreements with U S
WEST for Arizona, Colorado, Minnesota, Oregon, and Washington and are currently
negotiating an agreement for Utah. In addition, we are currently negotiating
with SBC Communications Inc. for Kansas and Missouri and with Sprint for
Florida, Minnesota, Nevada, New Jersey, North Carolina, Ohio, Pennsylvania,
Tennessee and Virginia, with the Southern New England Telephone Company for
Connecticut and with Cincinnati Bell for Ohio and Kentucky. These
interconnection agreements may not be on terms that are entirely satisfactory to
us.
During these negotiations, either the incumbent carrier or we may submit
disputes to the state regulatory commissions for mediation and, after the
expiration of the statutory negotiation period set forth in the 1996
Telecommunications Act, we may submit outstanding disputes to the states for
arbitration. We are currently arbitrating with SBC Communications Inc. in Texas
the terms of our interconnection agreement with Southwestern Bell for Texas. The
outcome of this arbitration may be unfavorable to us.
38
<PAGE>
Under the 1996 Telecommunications Act, states have begun and, in a number of
cases, completed regulatory proceedings to determine the pricing of unbundled
network elements and services, and the results of these proceedings will
determine the price we pay for, and whether it is economically attractive for us
to use, these elements and services.
We are subject to requirements in some states to obtain prior approval for,
or notify the state commission of, any transfers of control, sales of assets,
corporate reorganizations, issuances of stock or debt instruments and related
transactions. Although we believe such authorizations could be obtained, there
can be no assurance that the state commissions would grant us authority to
complete any transactions.
LOCAL GOVERNMENT REGULATION
Should we in the future decide to operate our own transport facilities over
public rights-of-way, we may be required to obtain various permits and
authorizations from municipalities in which we operate such facilities. Some
municipalities may seek to impose similar requirements on users of transmission
facilities, even though they do not own such facilities. If municipal
governments impose conditions on granting permits or other authorizations or if
they fail to act in granting such permits or other authorizations, our business
could be adversely affected.
39
<PAGE>
RECENT DEVELOPMENTS
MANAGEMENT
Since the beginning of our the current fiscal year, we have had several
changes to our management and board of directors as follows:
- Catherine M. Hapka, our Chief Executive Officer, was elected as our
Chairman of the Board in June 1999.
- Steve Stringer was elected as our President and Chief Operating Officer in
May 1999. Prior to joining us, Mr. Stringer served in various positions at
GE Capital from 1991 to May 1999.
- Michael S. Lanier was elected as our Chief Information Officer in
May 1999. Prior to joining us, Mr. Lanier was most recently President and
Chief Executive Officer of the Technology Extension Company from
April 1996 to May 1999.
- Rand Kennedy was elected as our Senior Vice President, Networks, in
October 1999.
- Richard Johnston was elected as our Chief Sales Officer--Channels in
July 1999.
- Susan Mayer and Edward J. Zander were both elected as members of our board
of directors in March 1999.
- James A. Greenburg, our former Chief Network Officer, left our employ in
October 1999.
- Frank Tolve, our former Chief Sales Officer--Enterprise, left our employ
in November 1999.
- Ken Harrision resigned as a director in October 1999.
We entered into an employment agreement with Mr. Stringer in connection with
his employment with us. Mr. Stringer's employment agreement provides for a
salary of $300,000 per year, payable in accordance with our regular pay period
practices, and subject to periodic increases by our Board of Directors at its
discretion. The employment agreement also provides for guaranteed bonus
compensation during the first year of employment of $200,000, payable in
quarterly installments. For any future years of performance, Mr. Stringer's
bonus will be consistent with the bonus plan applicable to other members of our
management team, as approved by our Board of Directors. In connection with his
employment, Mr. Stringer was granted options to purchase 350,000 shares of our
common stock at an exercise price equal to the common stock's fair market value
on the date of the grant. The options will vest over four years in accordance
with the standard vesting schedule under our 1999 Stock Incentive Plan.
Mr. Stringer has yet to exercise these options. In addition, Mr. Stringer was
also granted an option to purchase 70,252 shares of common stock at an exercise
price of $14.23 per share. This second option will vest over a two-year period
in 24 equal monthly installments beginning on his hire date. Mr. Stringer has
yet to exercise these options. If Mr. Stringer's employment is terminated
without cause, he will be eligible to receive monthly payments at his then
applicable monthly base salary for a period of 12 months from the date of
termination of his employment.
We also entered into an employment agreement with Mr. Lanier in connection
with his employment with us. Mr. Lanier's employment agreement provides for a
salary of $250,000 per year, subject to periodic increases by our Board of
Directors at its discretion. In addition, the agreement provides for an annual
bonus of up to 25% of his annual salary. Mr. Lanier also received, as part of
the acceptance of his employment, a hiring bonus of $50,000. In connection with
his employment, Mr. Lanier was granted options to purchase 300,000 shares of our
common stock at an exercise price equal to the fair market price of the common
stock on the date of the grant. The options will vest over four years in
accordance with the standard vesting schedule under our 1999 Stock Incentive
Plan. Mr. Lanier has yet to exercise these options.
40
<PAGE>
LEGAL PROCEEDINGS
On February 18, 1999, we filed a complaint for declaratory relief in San
Diego County Superior Court, North County against Thomas R. Lafleur.
Mr. Lafleur was a former employee who resigned and/or was terminated in 1998.
After he left, we sent him a check for the repurchase or buy-back of his
unvested shares; Mr. Lafleur refused to cash this check. The declaratory relief
action is to determine that his shares were unvested and thus properly
repurchased. On or about March 26, 1999, Mr. Lafleur filed an answer to the
complaint and also filed a cross-complaint against us for fraud, breach of the
covenant of good faith and fair dealing, conspiracy to inflict emotional
distress, intentional infliction of emotional distress, conversion and
declaratory relief. The cross-complaint seeks compensatory and punitive damages
according to proof, and 438,115 shares of common stock. Mr. Lafleur alleges in
his cross-complaint that since we failed to purchase his shares within 60 days
following his termination, the terms of his stock purchase agreement prevent us
from repurchasing his shares. On April 24, 1999, we filed a demurrer and motion
to strike the cross-complaint filed by Mr. Lafleur. In response, Mr. Lafleur
decided to withdraw and amend his cross-complaint rather than oppose the
demurrer, which had been scheduled for hearing on June 24, 1999. On or about
June 23, 1999, Mr. Lafleur filed his first amended cross-complaint wherein he
dropped four of the claims alleged in his original cross-complaint: fraud,
breach of the covenant of good faith and fair dealing, conspiracy to inflict
emotional distress, and intentional infliction of emotional distress.
Mr. Lafleur also added a claim for breach of contract. On July 23, 1999, we
filed a demurrer to the first amended cross-complaint. On September 16, 1999,
the court sustained the demurrer, with 10 days leave to amend the cross-
complaint. On September 27, 1999, Mr. Lafleur, together with his wife Kathleen
Lafleur, filed a second amended cross-complaint for damages for breach of
contract, conversion and declaratory relief, to which we, again demurred. The
demurrer was scheduled to be decided on November 4, 1999; the ruling on this
decision is postponed to November 18, 1999. We filed an amended complaint
against Mr. Lafleur and his wife Kathleen Lafleur on September 21, 1999, for
fraud, breach of employment agreement, breach of covenant not to compete and
proprietary information and inventions agreement, rescission and restitution,
unjust enrichment, interference with prospective economic advantage and
declaratory relief. The Court has scheduled trial on this matter in
January 2000. We intend to vigorously defend against the amended
cross-complaint. We are currently accounting for these 438,115 shares as
treasury stock.
SECONDARY OFFERING
In August 1999, some of our warrant holders exercised their warrants that we
had issued in connection with our 1998 senior discount notes and purchased an
aggregate of 3,961,862 shares of our common stock, which were subsequently sold
in an underwritten public offering that closed on August 11, 1999. As part of
this offering, the underwriters of the offering exercised their option to
purchase 594,279 shares of our common stock on September 14, 1999, resulting in
net proceeds to us of $16.4 million.
EXCHANGE OFFER
On October 13, 1999 we completed an exchange of all outstanding
$325 million in aggregate principal amount of our 12 3/4% Senior Notes due 2009
for newly issued $325 million in aggregate principal amount of 12 3/4% Senior
Notes due 2009. We registered the new notes under the Securities Act of 1933, as
amended, by filing a registration statement on Form S-4 which was declared
effective on September 16, 1999.
OCI COMMUNICATIONS INC. INVESTMENT
On October 22, 1999 we invested approximately $5 million in OCI
Communications Inc., the parent company of Optel Communications Corporation, a
competitive local exchange carrier in
41
<PAGE>
Canada. This investment was made in connection with our establishing a joint
venture company with Optel to develop a pan-Canadian DSL network and offer,
throughout Canada, dedicated high-speed DSL services to enterprise customers and
to wholesale customers, including Internet service providers, carriers and
value-added resellers.
INFORMATION INCORPORATED BY REFERENCE
The SEC allows us to "incorporate by reference" the information we file with
them, which means that we can disclose important information to you by referring
you to those documents. The information incorporated by reference is considered
to be part of this prospectus, and later information filed with the SEC will
update and supersede this information. We incorporate by reference the documents
listed below and any future filings we make with the SEC under Section 13(a),
13(c), 14, or 15(d) of the Securities Exchange Act of 1934 until our offering is
completed.
1. Our Annual Report on Form 10-K for the fiscal year ended December 31,
1998.
2. Our Quarterly Report on Form 10-Q for the quarter ended March 31, 1999.
3. Our Quarterly Report on Form 10-Q for the quarter ended June 30, 1999.
4. The description of our common stock contained in our Registration
Statement on Form 8-A filed on April 8, 1999.
The reports and other documents that we file after the date of this
prospectus will update and supersede the information in this prospectus.
You may request a copy of these filings, at no cost, by writing or
telephoning us at:
Rhythms NetConnections Inc.
6933 South Revere Parkway
Englewood, Colorado 80112
(303) 476-4200
Attn: General Counsel.
YOU SHOULD RELY ONLY ON THE INFORMATION PROVIDED OR INCORPORATED BY
REFERENCE IN THIS PROSPECTUS. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH
DIFFERENT INFORMATION. THE SELLING STOCKHOLDERS ARE NOT AUTHORIZED TO MAKE AN
OFFER OF THESE SECURITIES IN ANY STATE WHERE THE OFFER IS NOT PERMITTED. YOU
SHOULD NOT ASSUME THAT THE INFORMATION IN THIS PROSPECTUS IS ACCURATE AS OF ANY
DATE OTHER THAN THE DATE ON THE FRONT OF THE DOCUMENT.
42
<PAGE>
DILUTION
As of June 30, 1999 we had an as adjusted net tangible book value of
approximately $223.2 million, or $2.88 per share of our common stock, after
giving effect to the exercise of warrants issued in connection with the 1998
senior discount notes to purchase 3,961,862 shares of our common stock prior to
our offering that closed on August 17, 1999 and the exercise of warrants to
purchase 740,111 shares of our common stock prior to the consummation of this
offering and after giving effect to the sale of 594,279 shares of our common
stock on September 14, 1999, divided by the as adjusted number of shares of our
common stock outstanding, excluding treasury stock. We will not receive any
proceeds from the sale of shares of common stock by the selling stockholders in
this offering. As a result, our as adjusted net tangible book value per share
will neither increase nor decrease.
Assuming that the new investors purchase shares at a price of $30.63, which
was the closing price of our common stock on November 4, 1999, such new
investors will have an immediate dilution in net tangible book value of $27.75
per share. Dilution in net tangible book value per share represents the
difference between the amount per share paid by purchasers of shares of our
common stock in this offering and the as adjusted net tangible book value per
share of our common stock as of June 30, 1999. The following table illustrates
this per share dilution:
<TABLE>
<S> <C>
Public offering price per share............................. $30.63
As adjusted net tangible book value per share as of
June 30, 1999............................................. 2.88
------
Dilution per share to new investors......................... $27.75
======
</TABLE>
43
<PAGE>
SELLING STOCKHOLDERS
The following table shows the number of shares owned by each of the selling
stockholders. This registration statement also shall cover any additional shares
of common stock which become issuable in connection with the shares registered
for sale under this prospectus by reason of any stock dividend, stock split,
recapitalization or other similar transaction effected without the receipt of
consideration which results in an increase in the number of our outstanding
shares of common stock.
Donaldson, Lufkin & Jenrette Securities Corporation and Merrill Lynch & Co.,
an affiliated company of Merrill Lynch Pierce Fenner & Smith, Inc., both served
as underwriters in connection with our private placement of units consisting of
$290 million aggregate principal amount at maturity of senior discount notes and
warrants to purchase 4,732,800 shares of our common stock on May 5, 1998.
Merrill Lynch & Co. also served as our managing underwriter in connection with
our initial public offering and a secondary offering that we completed in
August 1999. No other selling stockholder has had a material relationship with
us within the past three years other than as a result of the ownership of our
securities.
Any estimate given regarding the number of shares that will be held by the
selling stockholders after completion of this offering may prove to be
inaccurate because the selling stockholders may offer all or some of the shares
they hold and because there currently are no agreements, arrangements or
understandings with respect to the sale of any of the shares. The shares offered
by this prospectus may be offered from time to time by the selling stockholders
named below. Unless otherwise indicated, each person has sole power to invest
and vote the shares listed in the table, subject to community property laws,
where applicable. For purposes of this table, a person or group of persons is
deemed to have "beneficial ownership" of any shares which that person has the
right to acquire within 60 days. Percentage ownership is based on 76,829,352
shares of our common stock outstanding on September 30, 1999. For purposes of
computing the percentage of outstanding shares held by each person or group of
persons named below, any security which such person or group of persons has the
right to acquire within 60 days is deemed to be outstanding for the purpose of
computing the percentage ownership for such person or persons, but is not deemed
to be outstanding for the purpose of computing the percentage ownership of any
other person.
<TABLE>
<CAPTION>
SHARES SHARES
BENEFICIALLY OWNED BENEFICIALLY OWNED
PRIOR TO THE OFFERING AFTER THE OFFERING
----------------------- SHARES TO ---------------------
NUMBER PERCENTAGE BE SOLD NUMBER PERCENTAGE
---------- ---------- --------- -------- ----------
<S> <C> <C> <C> <C> <C>
Delaware Delchester Fund of Delaware Group
Income Funds, Inc. and Delchester Series of
Delaware Group Premium Fund, Inc............ 293,760 * 293,760 0 0%
Merrill Lynch Pierce Fenner & Smith Inc....... 262,752 * 262,752 0 0%
Deutsche Bank Securities Inc.................. 48,960 * 48,960 0 0%
Millennium Partners, L.P...................... 38,352 * 38,352 0 0%
J.P. Morgan Securities Inc.................... 32,640 * 32,640 0 0%
Donaldson, Lufkin & Jenrette Securities
Corporation................................. 31,008 * 31,008 0 0%
The Canyon Value Realization Fund
(Cayman) Ltd................................ 22,439 * 22,439 0 0%
The Value Realization Fund, L.P............... 9,486 * 9,486 0 0%
Delphi Financial Group, Inc................... 714 * 714 0 0%
------- -- -------
TOTAL..................................... 740,111 1% 740,111
======= == =======
</TABLE>
- ------------------------
* Represents beneficial ownership of less than 1%
44
<PAGE>
PLAN OF DISTRIBUTION
The selling stockholders may sell the shares from time to time. The selling
stockholders will act independently of us in making decisions regarding the
timing, manner and size of each sale. The sales may be made on one or more
exchanges or in the over-the-counter market or otherwise, at prices and at terms
then prevailing or at prices related to the then current market price, or in
negotiated transactions. The selling stockholders may effect such transactions
by selling the shares to or through broker-dealers. The shares may be sold by
one or more of, or a combination of, the following:
- a block trade in which the broker-dealer will attempt to sell the shares
as agent but may position and resell a portion of the block as principal
to facilitate the transaction,
- purchases by a broker-dealer as principal and resale by such broker-dealer
for its account under this prospectus,
- an exchange distribution in accordance with the rules of such exchange,
- ordinary brokerage transactions and transactions in which the broker
solicits purchasers, and
- in privately negotiated transactions.
To the extent required, this prospectus may be amended or supplemented from
time to time to describe a specific plan of distribution. In effecting sales,
broker-dealers engaged by the selling stockholders may arrange for other
broker-dealers to participate in the resales.
The selling stockholders may enter into hedging transactions with
broker-dealers in connection with distributions of the shares or otherwise. In
these transactions, broker-dealers may engage in short sales of the shares in
the course of hedging the positions they assume with selling stockholders. The
selling stockholders also may sell shares short and redeliver the shares to
close out such short positions. The selling stockholders may enter into option
or other transactions with broker-dealers which require the delivery to the
broker-dealer of the shares. The broker-dealer may then resell or otherwise
transfer such shares under this prospectus. The selling stockholders also may
loan or pledge the shares to a broker-dealer. The broker-dealer may sell the
shares so loaned, or upon a default the broker-dealer may sell the pledged
shares under this prospectus.
Broker-dealers or agents may receive compensation in the form of
commissions, discounts or concessions from selling stockholders. Broker-dealers
or agents may also receive compensation from the purchasers of the shares for
whom they act as agents or to whom they sell as principals, or both.
Compensation as to a particular broker-dealer might be in excess of customary
commissions and will be in amounts to be negotiated in connection with the sale.
Broker-dealers or agents and any other participating broker-dealers or the
selling stockholders may be deemed to be "underwriters" within the meaning of
Section 2(11) of the Securities Act of 1933, the Securities Act, in connection
with sales of the shares. Accordingly, any such commission, discount or
concession received by them and any profit on the resale of the shares purchased
by them may be deemed to be underwriting discounts or commissions under the
Securities Act. Because selling stockholders may be deemed to be "underwriters"
within the meaning of Section 2(11) of the Securities Act, the selling
stockholders will be subject to the prospectus delivery requirements of the
Securities Act. In addition, any securities covered by this prospectus which
qualify for sale to comply with Rule 144 promulgated under the Securities Act
may be sold under Rule 144 rather than under this prospectus. The selling
stockholders have advised us that they have not entered into any agreements,
understandings or arrangements with any underwriters or broker-dealers regarding
the sale of their securities. There is no underwriter or coordinating broker
acting in connection with the proposed sale of shares by the selling
stockholders.
The shares will be sold only through registered or licensed brokers or
dealers if required under applicable state securities laws. In addition, in
certain states the shares may not be sold unless they
45
<PAGE>
have been registered or qualified for sale in the applicable state or an
exemption from the registration or qualification requirement is available and is
complied with.
Under applicable rules and regulations under the Exchange Act, any person
engaged in the distribution of the shares may not simultaneously engage in
market making activities with respect to our common stock for a period of two
business days prior to the commencement of such distribution. In addition, each
selling stockholder will be subject to applicable provisions of the Exchange Act
and the associated rules and regulations under the Exchange Act, including
Regulation M, which provisions may limit the timing of purchases and sales of
shares of our common stock by the selling stockholders. We will make copies of
this prospectus available to the selling stockholders and have informed them of
the need to deliver copies of this prospectus to purchasers at or prior to the
time of any sale of the shares.
We will file a supplement to this prospectus, if required, to comply with
Rule 424(b) under the Securities Act upon being notified by a selling
stockholder that any material arrangements have been entered into with a
broker-dealer for the sale of shares through a block trade, special offering,
exchange distribution or secondary distribution or a purchase by a broker or
dealer, such supplement will disclose:
- the name of each such selling stockholder and of the participating
broker-dealer(s),
- the number of shares involved,
- the price at which such shares were sold,
- the commissions paid or discounts or concessions allowed to such
broker-dealer(s), where applicable,
- that such broker-dealer(s) did not conduct any investigation to verify the
information set out or incorporated by reference in this prospectus, and
- other facts material to the transaction.
In addition, upon being notified by a selling stockholder that a donee or
pledgee intends to sell more than 500 shares, we will file a supplement to this
prospectus.
We will bear all costs, expenses and fees in connection with the
registration of the shares. The selling stockholders will bear all commissions
and discounts, if any, attributable to the sales of the shares. The selling
stockholders may agree to indemnify any broker-dealer or agent that participates
in transactions involving sales of the shares against certain liabilities,
including liabilities arising under the Securities Act. The selling stockholders
have agreed to indemnify certain persons, including broker-dealers and agents,
against certain liabilities in connection with the offering of the shares,
including liabilities arising under the Securities Act.
LEGAL MATTERS
For purposes of this offering, Brobeck, Phleger & Harrison LLP, San Diego,
California, is giving its opinion as to the validity of the shares.
EXPERTS
The financial statements incorporated in this prospectus by reference to our
Annual Report on Form 10-K for the year ended December 31, 1998, have been so
incorporated in this prospectus in reliance on the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
that firm as experts in auditing and accounting.
46
<PAGE>
WHERE YOU CAN FIND MORE INFORMATION
We file reports, proxy statements and other information with the SEC. You
may read and copy any document we file at the SEC's public reference rooms in
Washington, D.C., New York, New York and Chicago, Illinois. Please call the SEC
at 1-800-SEC-0330 for further information on the public reference rooms. Our SEC
filings are also available to the public on the SEC's website at
http://www.sec.gov.
47
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
740,111 SHARES
[LOGO]
RHYTHMS NETCONNECTIONS INC.
COMMON STOCK
---------------------
PROSPECTUS
---------------------
NOVEMBER 8, 1999
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth all expenses, other than underwriting
discounts and commissions, payable by the Registrant in connection with the sale
of the common stock being registered. All the amounts shown are estimates,
except for the registration fee and the Nasdaq National Market fee.
<TABLE>
<S> <C>
Registration fee............................................ $ 7,640
Nasdaq National Market fee.................................. 17,500
Blue Sky fees and expenses.................................. 5,000
Printing and engraving expenses............................. 75,000
Legal fees and expenses..................................... 150,000
Accounting fees and expenses................................ 30,000
Transfer Agent and Registrar fees........................... 5,000
Miscellaneous expenses...................................... 9,860
--------
Total................................................... $300,000
========
</TABLE>
INDEMNIFICATION OF OFFICERS AND DIRECTORS
Section 145 of the Delaware General Corporation Law permits indemnification
of the Registrant's officers and directors under certain conditions and subject
to certain limitations. Section 145 of the Delaware General Corporation Law also
provides that a corporation has the power to purchase and maintain insurance on
behalf of its officers and directors against any liability asserted against such
person and incurred by him or her in such capacity, or arising out of his or her
status as such, whether or not the corporation would have the power to indemnify
him or her against such liability under the provisions of Section 145 of the
Delaware General Corporation Law.
Article VII, Section 1 of the Registrant's Restated Bylaws provides that the
Registrant shall indemnify its directors and executive officers to the fullest
extent not prohibited by the Delaware General Corporation Law. The rights to
indemnify thereunder continue as to a person who has ceased to be a director,
officer, employee or agent and inure to the benefit of the heirs, executors and
administrators of the person. In addition, expenses incurred by a director or
executive officer in defending any civil, criminal, administrative or
investigative action, suit or proceeding by reason of the fact that he or she is
or was a director or officer of the Registrant (or was serving at the
Registrant's request as a director of officer of another corporation) shall be
paid by the Registrant in advance of the final disposition of such action, suit
or proceeding upon receipt of an undertaking by or on behalf of such director or
officer to repay such amount if it shall ultimately be determined that he or she
is not entitled to be indemnified by the Registrant as authorized by the
relevant section of the Delaware General Corporation Law.
As permitted by Section 102(b)(7) of the Delaware General Corporation Law,
Article V, Section (A) of the Registrant's Restated Certificate of Incorporation
provides that a director of the Registrant shall not be personally liable for
monetary damages for breach of fiduciary duty as a director, except for
liability (i) for any breach of the director's duty of loyalty to the Registrant
or its stockholders, (ii) for acts or omissions not in good faith or acts or
omissions that involve intentional misconduct or a knowing violation of law,
(iii) under Section 174 of the Delaware General Corporation Law or (iv) for any
transaction from which the director derived any improper personal benefit.
The Registrant has entered into indemnification agreements with each of its
directors and executive officers. Generally, the indemnification agreements
attempt to provide the maximum protection permitted by Delaware law as it may be
amended from time to time. Moreover, the
II-1
<PAGE>
indemnification agreements provide for certain additional indemnification. Under
such additional indemnification provisions, however, an individual will not
receive indemnification for judgments, settlements or expenses if he or she is
found liable to the Registrant (except to the extent the court determines he or
she is fairly and reasonable entitled to indemnity for expenses), for
settlements not approved by the Registrant or for settlements and expenses if
the settlement is not approved by the court. The indemnification agreements
provide for the Registrant to advance to the individual any and all reasonable
expenses (including legal fees and expenses) incurred in investigating or
defending any such action, suit or proceeding. In order to receive an advance of
expenses, the individual must submit to the Registrant copies of invoices
presented to him or her for such expenses. Also, the individual must repay such
advances upon a final judicial decision that he or she is not entitled to
indemnification.
The Registrant has purchased director's and officers' liability insurance.
The Registrant intends to enter into additional indemnification agreements with
each of its directors and executive officers to effectuate these indemnity
provisions.
The Registrant has an insurance policy covering the directors and officers
of the Registrant with respect to certain liabilities, including liabilities
arising under the Securities Act or otherwise.
RECENT SALES OF UNREGISTERED SECURITIES
Since its incorporation in February 1997, the Registrant has issued and sold
unregistered securities as follows (adjusted for subsequent stock splits):
(1) An aggregate of 2,161,764 of common stock was issued in private
placements in February through June 1997 to Enterprise Partners in connection
with the Registrant's initial funding. The consideration received for such
shares was $901.
(2) An aggregate of 6,140,000 shares of Series A preferred stock (which have
converted into 14,736,000 shares of common stock) was issued in a private
placement in July 1997 to Brentwood Venture Capital, Enterprise Partners,
Kleiner Perkins Caufield & Byers, the Sprout Group and certain other purchasers
pursuant to a Series A preferred stock Purchase Agreement. The consideration
received for such shares was $6,138,500.
(3) An aggregate of 6,350,000 shares of Series A preferred stock (which have
converted into 15,240,000 shares of common stock) was issued in a private
placement in December 1997 to Brentwood Venture Capital, Enterprise Partners,
Kleiner Perkins Caufield & Byers, the Sprout Group and certain other purchasers
pursuant to a Series A preferred stock Purchase Agreement and a Subsequent
Closing Purchase Agreement. The consideration received for such shares was
$6,350,000.
(4) An aggregate of 365,094 shares of Series A preferred stock (which have
converted into 876,226 shares of common stock) was issued in a private placement
in February 1998 to Catherine Hapka in connection with the Series A preferred
stock Purchase Agreement, the Subsequent Closing Purchase Agreement and an
employment agreement between the Company and Ms. Hapka. The consideration
received for such shares was $292,075.
(5) An aggregate of 4,044,943 shares of Series B preferred stock (which have
converted into 9,707,863 shares of common stock) was issued in a private
placement in March 1998 to Brentwood Venture Capital, Enterprise Partners,
Kleiner Perkins Caufield & Byers, the Sprout Group and Enron Communications
Group, Inc. The consideration for such shares was $18,000,000.
(6) In May 1998 the Registrant issued 290,000 units consisting of 13 1/2%
senior discount notes due 2008 and warrants to purchase an aggregate of
4,732,800 shares of common stock with exercise prices of $0.004 per share to
Merrill Lynch & Co. and Donaldson, Lufkin & Jenrette Securities Corporation, as
initial purchasers, for resale to qualified institutional buyers. Merrill
Lynch & Co. and Donaldson,
II-2
<PAGE>
Lufkin & Jenrette Securities Corporation received commissions of $5,262,920 for
acting as initial purchasers in connection with this transaction.
(7) In May 1998 the Registrant issued to Sun Financial Group, Inc., now GATX
Capital Corporation, a warrant to purchase 574,380 shares of common stock with
an exercise price of $1.85 per share in connection with an equipment lease
financing.
(8) In March 1999 the Registrant issued to MCI WorldCom Venture Fund, Inc.
and to Microsoft Corporation 3,731,410 and 3,731,409 shares of Series C
preferred stock, respectively, and issued to each of them a warrant to purchase
720,000 shares of common stock for an aggregate purchase price of
$60.0 million. In April 1999, the Registrant issued to MCI WorldCom Venture
Fund, Inc. a warrant to purchase 136,996 shares of common stock at the purchase
price per share sold in this offering.
(9) In March 1999 the Registrant issued to GATX Capital Corporation warrants
to purchase an aggregate of 45,498 shares of common stock with an exercise price
per share of $10.55 in connection with an equipment lease financing.
(10) In April 1999 the Registrant issued to U.S. Telesource, Inc. 932,836
shares of Series C preferred stock, which are convertible into 1,119,403 shares
of common stock, and 441,176 shares of Series D preferred stock, which are
convertible into 441,176 shares of common stock, subject to adjustment if the
price per share in this offering is less than $17.00. The Registrant also issued
to U.S. Telesource, Inc. a warrant to purchase 180,000 shares of common stock at
an exercise price of $6.70 per share. The aggregate consideration received for
this issuance was $15 million.
(11) In April 1999 the Registrant issued to Cisco Systems Capital Corporation
a warrant to purchase 75,000 shares of common stock with an exercise price per
share of $10.55 in connection with an equipment lease financing.
(12) From August 1997 through April 5, 1999, the Registrant granted stock
options to purchase an aggregate of 12,387,070 shares of common stock to
employees and consultants with aggregate exercise prices ranging from $0.04 to
$16.00 per share pursuant to the Registrant's stock option plan. As of April 5,
1999, 8,408,362 shares of common stock have been issued upon exercise of
options.
(13) In April 1999 the Registrant issued 12 3/4% senior notes due 2009 in the
aggregate principal amount of $325.0 million to Merrill Lynch & Co. and Salomon
Smith Barney Inc., as initial purchasers, for resale to qualified institutional
buyers. Merrill Lynch & Co. and Salomon Smith Barney Inc. received commissions
of $9,750,000 for acting as initial purchasers in connection with this
transaction.
(14) In July 1999, the Registrant issued a warrant to GATX Capital
Corporation to purchase up to 10,000 shares of the Registrant's common stock at
an exercise price of $50.00 per share. This warrant is exercisable immediately
and expires on July 30, 2004.
No underwriters were used in connection with these sales and issuances
except for the issuance of the senior discount notes and related warrants in
(6) above and the issuance of senior notes in (13) above. The sales and
issuances of these securities except for those in (6) and (13) above were exempt
from registration under the Securities Act pursuant to Rule 701 promulgated
thereunder on the basis that these securities were offered and sold either
pursuant to a written compensatory benefit plan or pursuant to written contracts
relating to consideration, as provided by Rule 701, or pursuant to Section 4(2)
thereof on the basis that the transactions did not involve a public offering.
The sales and issuances in (6) and (13) above were each exempt from registration
under the Securities Act pursuant to Section 4(2) and, in connection with the
resales by the initial purchasers of the securities described in (6) and
(13) above, Rule 144A thereunder.
II-3
<PAGE>
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibits.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
--------------------- -----------
<C> <S>
4.1** Restated Certificate of Incorporation of the Registrant.
4.2** Certificate of Designation of Series 1 Junior Participating
Preferred Stock of Registrant.
4.3** Restated Bylaws of the Registrant.
4.4** Form of Certificate of common stock.
4.5* Indenture, dated as of May 5, 1998, by and between the
Registrant and State Street Bank and Trust Company of
California, N.A., as trustee, including form of the
Registrant's 13 1/2% Senior Discount Notes due 2008,
Series A and form of Registrant's 13 1/2% Senior Discount
Notes due 2008, Series B.
4.6* Warrant Agreement, dated as of May 5, 1998, by and between
the Registrant and State Street Bank and Trust Company of
California, N.A.
4.7* Warrant Registration Rights Agreement, dated as of May 5,
1998, by and among the Registrant and Merrill Lynch & Co.,
Merrill Lynch, Pierce, Penner & Smith Incorporated, and
Donaldson, Lufkin & Jenrette Securities Corporation.
4.8** Warrant to Purchase Shares of Common Stock, dated May 19,
1998, by and between the Registrant and Sun Financial
Group, Inc.
4.9** Common Stock Purchase Warrant, dated March 3, 1999, by and
between the Registrant and MCI WorldCom Venture
Fund, Inc.
4.10** Common Stock Purchase Warrant, dated March 16, 1999, by and
between the Registrant and Microsoft Corporation.
4.11** Warrant to Purchase Shares of Common Stock, dated March 31,
1999, by and between Registrant and GATX Capital
Corporation.
4.12** Warrant Purchase Agreement, dated as of April 6, 1999, by
and between Registrant and MCI WorldCom Venture
Fund, Inc.
4.13** Common Stock Purchase Warrant, dated April 6, 1999, by and
among the Registrant and MCI WorldCom Venture Fund, Inc.
4.14** Common Stock Purchase Warrant, dated April 6, 1999, by and
among the Registrant and U.S. Telesource, Inc.
4.15** Common Stock Purchase Warrant, dated April 5, 1999, by and
among the Registrant and Cisco Systems Capital
Corporation.
4.16** Rights Agreement, dated April 2, 1999, by and among
Registrant and American Securities Transfer & Trust, Inc.
4.17*** Indenture, dated as of April 23, 1999, by and between the
Registrant and State Street Bank and Trust Company of
California, N.A., as trustee, including form of the
Registrant's 12 3/4% Senior Notes due 2009, Series A and
form of the Registrant's 12 3/4% Senior Notes due 2009,
Series B.
4.18*** Notes Registration Rights Agreement, dated as of April 23,
1999, by and among the Registrant and Merrill Lynch & Co.,
Merrill Lynch, Pierce Fenner & Smith Incorporated, Salomon
Smith Barney Inc. and Chase Securities Inc.
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
--------------------- -----------
<C> <S>
4.19*** Pledge and Escrow Agreement, dated as of April 23, 1999,
from the Registrant as Pledgor to State Street Bank and
Trust Company of California, N.A., as trustee.
4.20**** Amendment No. 1 to Warrant Agreement, dated as of August,
1999 between the Registrant and State Street Bank and
Trust Company of California, N.A.
5.1 Opinion of Brobeck, Phleger & Harrison LLP.
23.1 Consent of PricewaterhouseCoopers LLP, Independent
Accountants.
23.2 Consent of Brobeck, Phleger & Harrison LLP. Reference is
made to Exhibit 5.1.
24.1+ Power of Attorney.
</TABLE>
- ------------------------
+ Previously filed.
* Previously filed with the Commission as an exhibit to the registration
statement on Form S-4 (file No. 333-59393) and incorporated herein by
reference.
** Previously filed with the Commission as an exhibit to the registration
statement on Form S-1 (File No. 333-72409) and incorporated herein by
reference.
*** Previously filed with the Commission as an exhibit to the registration
statement on Form S-4 (File No. 333-82637) and incorporated herein by
reference.
**** Previously filed with the Commission as an exhibit to the registration
statement on Form S-1 (File No. 333-82867) and incorporated herein by
reference.
UNDERTAKINGS
The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act;
(ii) To reflect in the prospectus any facts or events arising after the
effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information set forth in the
registration statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum offering range
may be reflected in the form of prospectus filed with the Commission
pursuant to Rule 424(b) if, in the aggregate, the changes in volume and
price represent no more than a 20% change in the maximum aggregate offering
price set forth in the "Calculation of Registration Fee" table in the
effective registration statement.
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or any
material change to such information in the registration statement.
(2) That, for the purpose of determining any liability under the Securities
Act of 1933, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof;
(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of the
offering.
II-5
<PAGE>
(4) If the registrant is a foreign private issuer, to file a post-effective
amendment to the registration statement to include any financial statements
required by Rule 3-19 of Regulation S-X at the state of any delayed offering or
throughout a continuous offering. Financial statements and information otherwise
required by Section 10(a)(3) of the Act need not be furnished, provided, that
the registrant includes in the prospectus, by means of a post-effective
amendment, financial statements required pursuant to this paragraph (a)(4) and
other information necessary to ensure that all other information in the
prospectus is at least as current as the date of those financial statements.
Notwithstanding the foregoing, with respect to registration statements on
Form F-3, a post-effective amendment need not be filed to include financial
statements and information required by Section 10(a)(3) of the Act or Rule 3-19
of this chapter if such financial statements and information are contained in
periodic reports filed with or furnished to the Commission by the registrant
pursuant to section 13 or section 15(d) of the Securities Exchange Act of 1934
that are incorporated by reference in the Form F-3.
The undersigned Registrant hereby undertakes that, for purposes of
determining any liability under the Act, each filing of the Registrant's annual
report pursuant to Section 13(a) or Section 15(d) of the Securities Exchange Act
of 1934 (and, where applicable, each filing of an employee benefit plan's annual
report pursuant to Section 15(d) of the Securities Exchange Act of 1934) that is
incorporated by reference in the Registration Statement shall be deemed to be a
new registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of
Triangle pursuant to the foregoing provisions, Delaware Corporation law, the
Underwriting Agreement or otherwise, the Registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Act and is, therefor, unenforceable.
In the event that a claim for indemnification against such liabilities (other
than the payment by the Registrant of expenses incurred or paid by a director,
officer, or controlling person of the Registrant in the successful defense of
any action, suit, or proceeding) is asserted by such director, officer, or
controlling person in connection with the securities being registered hereunder,
the Registrant will, unless in the opinion of its counsel the question has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question of whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
II-6
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Denver, State of Colorado, on the 8th day of
November, 1999.
<TABLE>
<S> <C> <C>
RHYTHMS NETCONNECTIONS, INC.
By: /s/ SCOTT C. CHANDLER
-----------------------------------------
Scott C. Chandler
CHIEF FINANCIAL OFFICER
</TABLE>
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S> <C>
* /S/ CATHERINE M. HAPKA Chairman of the Board and
------------------------------------------- Chief Executive Officer November 8, 1999
Catherine M. Hapka (Principal Executive Officer)
/S/ SCOTT C. CHANDLER Chief Financial Officer
------------------------------------------- (Principal Financial and November 8, 1999
Scott C. Chandler Accounting Officer)
* /S/ KEVIN R. COMPTON
------------------------------------------- Director and President November 8, 1999
Kevin R. Compton
* /S/ KEITH B. GEESLIN
------------------------------------------- Director November 8, 1999
Keith B. Geeslin
* /S/ SUSAN MAYER
------------------------------------------- Director November 8, 1999
Susan Mayer
* /S/ WILLIAM R. STENSRUD
------------------------------------------- Director November 8, 1999
William R. Stensrud
* /S/ JOHN L. WALECKA
------------------------------------------- Director November 8, 1999
John L. Walecka
* /S/ EDWARD J. ZANDER
------------------------------------------- Director November 8, 1999
Edward J. Zander
</TABLE>
* by Scott C. Chandler, Attorney-in-fact
II-7
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
--------------------- -----------
<C> <S>
4.1** Restated Certificate of Incorporation of the Registrant.
4.2** Certificate of Designation of Series 1 Junior Participating
Preferred Stock of Registrant.
4.3** Restated Bylaws of the Registrant.
4.4** Form of Certificate of common stock.
4.5* Indenture, dated as of May 5, 1998, by and between the
Registrant and State Street Bank and Trust Company of
California, N.A., as trustee, including form of the
Registrant's 13 1/2% Senior Discount Notes due 2008,
Series A and form of Registrant's 13 1/2% Senior Discount
Notes due 2008, Series B.
4.6* Warrant Agreement, dated as of May 5, 1998, by and between
the Registrant and State Street Bank and Trust Company of
California, N.A.
4.7* Warrant Registration Rights Agreement, dated as of May 5,
1998, by and among the Registrant and Merrill Lynch & Co.,
Merrill Lynch, Pierce, Fenner & Smith Incorporated, and
Donaldson, Lufkin & Jenrette Securities Corporation.
4.8** Warrant to Purchase Shares of Common Stock, dated May 19,
1998, by and between the Registrant and Sun Financial
Group, Inc.
4.9** Common Stock Purchase Warrant, dated March 3, 1999, by and
between the Registrant and MCI WorldCom Venture
Fund, Inc.
4.10** Common Stock Purchase Warrant, dated March 16, 1999, by and
between the Registrant and Microsoft Corporation.
4.11** Warrant to Purchase Shares of Common Stock, dated March 31,
1999, by and between Registrant and GATX Capital
Corporation.
4.12** Warrant Purchase Agreement, dated as of April 6, 1999, by
and between Registrant and MCI WorldCom Venture
Fund, Inc.
4.13** Common Stock Purchase Warrant, dated April 6, 1999, by and
among the Registrant and MCI WorldCom Venture Fund, Inc.
4.14** Common Stock Purchase Warrant, dated April 6, 1999, by and
among the Registrant and U.S. Telesource, Inc.
4.15** Common Stock Purchase Warrant, dated April 5, 1999, by and
among the Registrant and Cisco Systems Capital
Corporation.
4.16** Rights Agreement, dated April 2, 1999, by and among
Registrant and American Securities Transfer & Trust, Inc.
4.17*** Indenture, dated as of April 23, 1999, by and between the
Registrant and State Street Bank and Trust Company of
California, N.A., as trustee, including form of the
Registrant's 12 3/4% Senior Notes due 2009, Series A and
form of the Registrant's 12 3/4% Senior Notes due 2009,
Series B.
4.18*** Notes Registration Rights Agreement, dated as of April 23,
1999, by and among the Registrant and Merrill Lynch & Co.,
Merrill Lynch, Pierce Fenner & Smith Incorporated, Salomon
Smith Barney Inc. and Chase Securities Inc.
4.19*** Pledge and Escrow Agreement, dated as of April 23, 1999,
from the Registrant as Pledgor to State Street Bank and
Trust Company of California, N.A., as trustee.
</TABLE>
II-8
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
--------------------- -----------
<C> <S>
4.20**** Amendment No. 1 to Warrant Agreement, dated as of August,
1999 between the Registrant and State Street Bank and
Trust Company of California, N.A.
5.1 Opinion of Brobeck, Phleger & Harrison LLP.
23.1 Consent of PricewaterhouseCoopers LLP, Independent
Accountants.
23.2 Consent of Brobeck, Phleger & Harrison LLP. Reference is
made to Exhibit 5.1.
24.1+ Power of Attorney.
</TABLE>
- ------------------------
+ Previously filed.
* Previously filed with the Commission as an exhibit to the registration
statement on Form S-4 (file No. 333-59393) and incorporated herein by
reference.
** Previously filed with the Commission as an exhibit to the registration
statement on Form S-1 (File No. 333-72409) and incorporated herein by
reference.
*** Previously filed with the Commission as an exhibit to the registration
statement on Form S-4 (File No. 333-82637) and incorporated herein by
reference.
**** Previously filed with the Commission as an exhibit to the registration
statement on Form S-1 (File No. 333-82867) and incorporated herein by
reference.
II-9
<PAGE>
[Brobeck, Phleger & Harrison LLP Letterhead]
November 8, 1999
Rhythms NetConnections Inc.
6933 South Revere Parkway
Englewood, CO 80112
Re: Rhythms NetConnections Inc. Registration Statement
for resale of up to 740,111 Shares of Common Stock
Ladies and Gentlemen:
We have acted as counsel to Rhythms NetConnections Inc., a Delaware
corporation (the "Company"), in connection with the proposed sale by certain
selling stockholders (the "Selling Stockholders") of up to 740,111 shares of the
Company's Common Stock (the "Shares") issuable upon the exercise of warrants
held by the Selling Stockholders (the "Warrants"), pursuant to the Company's
Registration Statement originally filed on Form S-1, as subsequently amended on
Form S-3 (the "Registration Statement"), filed with the Securities and Exchange
Commission under the Securities Act of 1933, as amended (the "Act").
This opinion is being furnished in accordance with the requirements of
Item 16 of Form S-3 and Item 601(b)(5)(i) of Regulation S-K.
We have reviewed the Company's charter documents and the corporate
proceedings taken by the Company in connection with the issuance and sale of
the Shares. Based on such review, we are of the opinion that the Shares have
been duly authorized and when the Warrants are exercised in accordance with
the terms of the Warrants, the Shares will be legally issued, fully paid and
nonassessable.
We consent to the filing of this opinion letter as Exhibit 5.1 to the
Registration Statement and to the reference to this firm under the caption
"Legal Matters" in the prospectus which is part of the Registration Statement.
In giving this consent, we do not thereby admit that we are within the category
of persons whose consent is required under Section 7 of the Act or the rules and
regulations of the Securities and Exchange Commission promulgated thereunder.
This opinion letter is rendered as of the date first written above and
we disclaim any obligation to advise you of facts, circumstances, events or
developments which hereafter may be brought to our attention and which may
alter, affect or modify the opinion expressed herein. Our opinion is expressly
limited to the matters set forth above and we render no opinion, whether by
implication or otherwise, as to any other matters relating to the Company or the
Shares.
Very truly yours,
BROBECK, PHLEGER & HARRISON LLP
<PAGE>
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in this Registration
Statement on Form S-3 of our report dated March 4, 1999, except for the last
paragraph of Note 11 as to which the date is March 19, 1999 relating to the
financial statements, which appears in Rhythms NetConnections, Inc., Annual
Report on Form 10-K for the year ended December 31, 1998. We also consent to the
reference to us under the heading "Experts" in such Registration Statement.
PricewaterhouseCoopers LLP
Denver, Colorado
November 8, 1999
