<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 16, 1999
REGISTRATION NO. 333-72409
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 3
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
RHYTHMS NETCONNECTIONS INC.
(Exact Name of Registrant as Specified in its Charter)
<TABLE>
<S> <C> <C>
DELAWARE 4813 33-0747515
(State or Other Jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Classification Code Number) Identification
Incorporation or Organization) Number)
</TABLE>
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
PRESIDENT 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:
JOHN A. DENNISTON, ESQ. MALCOLM I. ROSS, ESQ.
MARTIN C. NICHOLS, ESQ. MICHAEL S. NOVINS, ESQ.
BROBECK, PHLEGER & HARRISON LLP BAKER & MCKENZIE
550 WEST "C" STREET, SUITE 1200 805 THIRD AVENUE
SAN DIEGO, CALIFORNIA 92101 NEW YORK, NEW YORK 10022
(619) 234-1966 (212) 751-5700
--------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: AS SOON AS
PRACTICABLE AFTER THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT.
--------------------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. / /
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. / / _________
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / / _________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /
--------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AGGREGATE AMOUNT OF
SECURITIES TO BE REGISTERED OFFERING PRICE(1) REGISTRATION FEE
<S> <C> <C>
Common stock (including the associated Rights to purchase
Series 1 Junior Participating Stock)(2)......................................... $183,281,250 $5,083(3)
</TABLE>
(1) Estimated solely for the purpose of calculating the registration fee in
accordance with Rule 457(o) under the Securities Act of 1933.
(2) The Rights to purchase shares of our Series 1 Junior Participating Preferred
Stock initially are attached to and trade with the shares of our common
stock being registered. Value attributed to such Rights, if any, is
reflected in the market price of our common stock.
(3) Based on a calculated registration fee of $50,953, of which $45,870 was
previously paid.
--------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SUCH SECTION 8(a),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED MARCH 16, 1999
The information in this prospectus is not complete and may be changed. We may
not sell these securities until the registration statement filed with the
Securities and Exchange Commission is
effective. This prospectus is not an offer to sell these securities and it is
not soliciting an offer to buy these securities in any state where the offer or
sale is not permitted.
<PAGE>
P_R_O_S_P_E_C_T_U_S
9,375,000 SHARES
[LOGO]
RHYTHMS NETCONNECTIONS INC.
COMMON STOCK
--------------
This is Rhythms' initial public offering of common stock.
We expect the public offering price to be between $15.00 and $17.00 per
share. Currently, no public
market exists for the shares. After pricing of the offering, we expect that the
common stock will trade on The Nasdaq National Market under the symbol "RTHM".
INVESTING IN THE COMMON STOCK INVOLVES RISKS WHICH ARE DESCRIBED IN THE
"RISK FACTORS" SECTION BEGINNING ON PAGE 8 OF THIS PROSPECTUS.
-----------------
<TABLE>
<CAPTION>
PER SHARE TOTAL
--------------- -----------
<S> <C> <C>
Public Offering Price........................................ $ $
Underwriting Discount........................................ $ $
Proceeds, before expenses, to Rhythms........................ $ $
</TABLE>
The underwriters may also purchase up to an additional 1,406,250 shares at
the public offering price, less the underwriting discount, within 30 days from
the date of this prospectus to cover over-allotments.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The shares of common stock will be ready for delivery in New York, New York
on or about , 1999.
------------------
JOINT BOOK-RUNNING MANAGERS
MERRILL LYNCH & CO. SALOMON SMITH BARNEY
-----------
HAMBRECHT & QUIST THOMAS WEISEL PARTNERS LLC
-----------
The date of this prospectus is , 1999.
<PAGE>
[MAP OF UNITED STATES SHOWING RHYTHMS NATIONAL COVERAGE]
Our goal is to provide service in 50 metropolitan areas which contain
approximately 60% of U.S. LANs.*
*In addition to the 33 metropolitan areas indicated above, our plan is to
launch service in an additional 17 metropolitan areas in 2000.
[MAP OF UNITED STATES SHOWING RHYTHMS NETWORK ARCHITECTURE]
2
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Summary.................................................................................................... 4
Risk Factors............................................................................................... 8
Use of Proceeds............................................................................................ 22
Dividend Policy............................................................................................ 22
Capitalization............................................................................................. 23
Dilution................................................................................................... 24
Selected Consolidated Financial Data....................................................................... 25
Management's Discussion and Analysis of Financial Condition and Results of Operations...................... 26
Description of Certain Indebtedness........................................................................ 32
Business................................................................................................... 33
Management................................................................................................. 52
Certain Relationships and Related Transactions............................................................. 63
Principal Stockholders..................................................................................... 66
Description of Capital Stock............................................................................... 68
Shares Eligible for Future Sale............................................................................ 71
Underwriting............................................................................................... 72
Legal Matters.............................................................................................. 74
Experts.................................................................................................... 74
Where You Can Find More Information........................................................................ 74
Glossary of Terms.......................................................................................... A-1
Index to Financial Statements.............................................................................. F-1
</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 OR THE UNDERWRITERS.
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.
UNTIL , 1999, ALL DEALERS SELLING OR BUYING OUR COMMON STOCK MAY
BE REQUIRED TO DELIVER A PROSPECTUS EVEN IF THEY ARE NOT PARTICIPATING IN THIS
OFFERING. THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS
TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR
UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
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 is reliable, but we have not independently verified this
information. Neither we nor any of the underwriters represents 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 NETCONNECTIONS-TM-; RHYTHMS
PBXPRESS-TM-; RHYTHMS TOOLBAR-TM-; RING.RHYTHMS-TM-; WORK.RHYTHMS-TM- and
[LOGO].
This prospectus also refers to trade names and trademarks of other
companies.
3
<PAGE>
SUMMARY
THIS SUMMARY HIGHLIGHTS CERTAIN SIGNIFICANT ASPECTS OF OUR BUSINESS AND THIS
OFFERING, BUT YOU SHOULD READ THE ENTIRE PROSPECTUS, INCLUDING THE FINANCIAL
DATA AND RELATED NOTES, 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. UNLESS OTHERWISE NOTED, ALL
COMMON STOCK NUMBERS IN THIS PROSPECTUS GIVE RETROACTIVE EFFECT TO A TWO FOR ONE
STOCK SPLIT EFFECTED IN NOVEMBER 1998 AND A SIX FOR FIVE STOCK SPLIT TO BE
EFFECTED IN MARCH 1999 AND ASSUME THE CONVERSION OF ALL OUTSTANDING SHARES OF
PREFERRED STOCK INTO COMMON STOCK UPON COMPLETION OF THIS OFFERING AND THAT THE
UNDERWRITERS WILL NOT EXERCISE THEIR OVER-ALLOTMENT OPTION. WE HAVE PROVIDED A
GLOSSARY OF TERMS FOR YOUR CONVENIENCE BEGINNING ON PAGE A-1. 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 digital subscriber line ("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
Kilobits per second (Kbps) to 7.1 Megabits per second (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 San Diego in April 1998, and have subsequently begun service in nine
additional markets: San Francisco, San Jose, Oakland/East Bay, Chicago, Los
Angeles, Orange County, Boston, Sacramento and New York. We intend to continue
our network rollout into an additional 23 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, Bell South, GTE,
Pacific Bell and U S WEST, and we are currently pursuing interconnection
arrangements with two other incumbent carriers. As of January 31, 1999, we
provide service or have installed equipment in nearly 200 incumbent carrier
central offices. We have obtained competitive carrier authority or have been
permitted to operate as a competitive carrier in 21 states.
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 MCI WorldCom's preferred
provider of business DSL lines 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. In our
Microsoft arrangement, we will jointly 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.
We also market our services through our direct sales force and through our
partnerships with recognized leaders in the networking industry, including
Microsoft, Cisco Systems, Inc. and a contemplated arrangement with Verio Inc.
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
4
<PAGE>
development projects with us. As of January 31, 1999, we had over 650 lines in
service, and we are currently under contract to supply over 9,000 additional DSL
lines to our business and service provider customers, including Cisco, Silicon
Graphics, Inc., QUALCOMM Incorporated, Wind River Systems and Broadcom
Corporation.
Our senior management team has extensive experience in developing
next-generation networking businesses. Our President 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. Scott Chandler, our Chief Financial Officer, was previously President
and Chief Executive Officer of C-COR Electronics, Inc., a manufacturer of
broadband telecommunications equipment. James Greenberg, our Chief Network
Officer, directed the design, planning, operation and construction of Sprint
Corporation's data networks. Frank Tolve, our Chief Sales Officer, previously
served as Vice President, Sales Operations of Bay Networks. Our sponsors, which
include Microsoft, MCI WorldCom's investment fund, Kleiner Perkins Caufield &
Byers, Enterprise Partners, Brentwood Venture Capital, the Sprout Group and a
subsidiary of Enron Corporation, have to date invested approximately $90.3
million.
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.
THE RHYTHMS SOLUTIONS
We believe our network solutions effectively address many of the unmet
communication 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 to extend the functionality
of corporate communications and networking resources for remote offices
and workers. We also offer high performance Internet
5
<PAGE>
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 in an effort 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 office is located at 6933 South Revere Parkway,
Englewood, Colorado 80112, and our telephone number is (303) 476-4200 or (800)
RHYTHMS.
6
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common stock offered......................... 9,375,000 shares
Common stock to be outstanding after this
offering................................... 67,631,896 shares(1)
Use of proceeds.............................. We will use the net proceeds to fund the
continuing deployment of network services in
our existing markets, as well as our planned
rollout in additional markets. We also expect
to use these proceeds for expenses associated
with the continued development of our sales
and marketing activities, to fund operating
losses, to pay our debt obligations and for
general corporate purposes.
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.
Proposed Nasdaq National Market symbol....... RTHM
</TABLE>
- ------------------------
(1) Based on the number of shares outstanding as of March 16, 1999. Includes
49,515,472 shares of common stock to be issued upon conversion of our
preferred stock and 4,728,886 shares of common stock which are currently
subject to repurchase by us. Excludes 3,491,006 shares of common stock
issuable upon the exercise of stock options outstanding as of March 16,
1999, with a weighted average exercise price of $2.27 per share, all of
which are exercisable and 19,716 of which are vested, 6,747,180 shares of
common stock issuable upon the exercise of outstanding warrants, with a
weighted average exercise price of $1.59 per share and 438,115 shares of
treasury stock. See "Capitalization" and "Business--Legal Proceedings."
7
<PAGE>
RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE RISKS AND UNCERTAINTIES DESCRIBED BELOW
AND THE OTHER INFORMATION IN THIS PROSPECTUS BEFORE DECIDING TO INVEST IN US.
YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT. 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 San Diego 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 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;
8
<PAGE>
- 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 9,800 lines that we have committed to
deliver to date, we committed approximately 8,700 to only two 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 December 31, 1998, we had an accumulated
deficit of approximately $38.8 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 senior discount notes of approximately $23.6 million in 1999 and
increasing to $41.5 million in 2003. In addition, we intend to seek additional
debt financing in the future. 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;
- the success of our relationships with our partners and distributors,
including MCI WorldCom, Microsoft and Cisco;
9
<PAGE>
- 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, the 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.
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 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
10
<PAGE>
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 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. State regulatory commissions establish the price 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 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.
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WE DEPEND ON THIRD PARTIES, PARTICULARLY MCI WORLDCOM, MICROSOFT 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 and Cisco. While our
agreement with MCI WorldCom calls for it to sell 100,000 DSL lines, the
agreement also enables MCI WorldCom to terminate the agreement under certain
circumstances and to receive offsets and credits under other circumstances.
Therefore, MCI WorldCom might sell significantly fewer than 100,000 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 Companies Inc., Qwest Communications International,
Inc. and Level 3 Communications, Inc., 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 positioned itself to do the same
for businesses. Several new 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
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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.
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. 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, including the proceeds of this offering, will be sufficient to fund
our aggregate capital expenditures and working capital requirements, including
operating losses, until June 2000. 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;
- 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
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general market uncertainty may adversely affect our ability to secure additional
financing. The indenture that governs our senior discount notes restricts 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. Please see "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and Capital
Resources."
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;
- 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.
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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 December 31, 1998, we had approximately $158.3 million of
outstanding debt, and our debt made up 100% of our capitalization. Please see
"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.
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
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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. Please see "Business--Employees" and "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 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.
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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 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.
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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.
WE MAY BE UNABLE TO SATISFY, OR MAY BE ADVERSELY CONSTRAINED BY, THE COVENANTS
IN OUR EXISTING DEBT SECURITIES
The indenture for our senior discount notes imposes 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
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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 pay 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
Our executive officers and directors and principal stockholders together
will beneficially own 86.7% of the common stock after completion of this
offering, or 84.9% if the over-allotment option is exercised in full.
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. See "Principal Stockholders" for information about
the ownership of common stock by our executive officers, directors and principal
stockholders.
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 in a more
effective manner than many older companies. 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 believe 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 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.
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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 this offering and 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. Please see "Use of Proceeds."
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 price at which our common stock will trade will depend upon many
factors, including our historical and anticipated quarterly and annual operating
results, variations between our actual results and analyst and investor
expectations, announcements by us or others and developments affecting our
business, investor perceptions of our company and comparable public companies,
changes in our industry and general market and economic conditions. Some of
these factors are beyond our control. You should be aware that the stock market
has from time to time experienced extreme price and volume fluctuations.
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.
THERE HAS BEEN NO PRIOR MARKET FOR THE COMMON STOCK
Before this offering, there has not been a public market for the common
stock. We will apply to the Nasdaq National Market System to list our common
stock, but we do not know whether active trading in the common stock will
develop and continue after the offering. We will determine the initial public
offering price for the common stock through negotiations with the underwriters.
You may not be able to resell your shares at or above the initial public
offering price. For a description of the factors that will be taken into account
to determine the offering price, please see "Underwriting."
ANTI-TAKEOVER PROVISIONS COULD NEGATIVELY IMPACT OUR STOCKHOLDERS
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;
20
<PAGE>
- 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. We intend to adopt a stockholder rights plan
prior to the completion of this offering. 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. See
"Description of Capital Stock--Possible Anti-Takeover Matters."
The indenture governing our senior discount notes requires us to offer to
repurchase all senior discount notes for 101% of their principal amount or
accreted value, plus any accrued interest due, within 30 days after a change of
control. 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 will be
limited by lock-up agreements under which the holders of substantially all of
our outstanding shares of common stock and options and warrants to purchase
common stock will agree not to sell or otherwise dispose of any of their shares
for a period of 180 days after the date of this prospectus without the prior
written consent of Merrill Lynch and Salomon Smith Barney. 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 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. See "Description of Capital Stock--Registration Rights" and
"Shares Eligible for Future Sale."
YOU WILL INCUR IMMEDIATE AND SUBSTANTIAL DILUTION OF APPROXIMATELY $13.13 PER
SHARE
The initial public offering price is substantially higher than the net
tangible book value per share of the outstanding common stock immediately after
this offering. Accordingly, if you purchase common stock in this offering, you
will incur immediate and substantial dilution of $13.13 in the net tangible book
value per share of the common stock from the price you pay for the common stock
in this offering.
MANAGEMENT HAS BROAD DISCRETION TO USE THE PROCEEDS FROM THIS OFFERING
Our management will have broad discretion over the use of proceeds we raise
in this offering, and you must rely on the judgment of management in the
application of the proceeds. Please see "Use of Proceeds" for more information
related to our financing plan.
21
<PAGE>
USE OF PROCEEDS
We will use the aggregate net proceeds of this offering, which we estimate
at approximately $138.6 million after deducting the underwriters' discount and
other estimated offering expenses, to fund the expenditures incurred in the
continuing deployment of network services in our existing markets, as well as
our planned rollout in additional markets. Additionally, we plan to use the net
proceeds from this offering for expenses associated with the continued
development of our sales and marketing activities, to fund operating losses, to
pay our debt obligations and for general corporate purposes. Pending use of such
net proceeds, we intend to invest the net proceeds in short-term, investment
grade securities to the extent permitted by the terms of the covenants governing
our existing debt and any statistical asset tests imposed by the Investment
Company Act of 1940.
The actual amounts we spend will vary significantly depending upon a number
of factors, including future revenue growth, if any, capital expenditures, the
amount of cash generated by our operations and other factors, many of which are
beyond our control. Additionally, we may modify the number, selection and timing
of our entry with respect to any or all of our targeted markets. Accordingly,
our management will retain broad discretion in the allocation of the net
proceeds. Please see "Risk Factors--We will need significant additional funds,
which we may not be able to obtain" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
DIVIDEND POLICY
We have never declared or paid dividends on our capital stock, and we do not
anticipate paying any cash dividends in the foreseeable future. Payments of any
future dividends will be at the discretion of our Board of Directors after
taking into account various factors, such as our financial condition, operating
results, current and anticipated cash needs and plans for expansion.
22
<PAGE>
CAPITALIZATION
The following unaudited table sets forth our capitalization as of December
31, 1998:
- on an actual basis;
- pro forma to give effect to the issuance of Series C preferred stock and
warrants to MCI WorldCom's investment fund on March 4, 1999 and to
Microsoft on March 16, 1999; and
- pro forma as adjusted to give effect to this offering, including
conversion of the existing Series A, Series B and Series C preferred stock
into common stock which will occur automatically upon the completion of
this offering.
Please read this table in conjunction with our consolidated financial
statements, the related notes to the financial statements and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this prospectus.
<TABLE>
<CAPTION>
AS OF
DECEMBER 31, 1998
-----------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
--------- ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Cash, cash equivalents and short-term investments............................. $ 136,812 $ 196,812 $ 335,437
--------- ----------- -----------
--------- ----------- -----------
Debt:
Bank note (1)............................................................... $ 805 $ 805 $ 805
13 1/2% senior discount notes due 2008...................................... 157,465 157,465 157,465
--------- ----------- -----------
Total debt................................................................ 158,270 158,270 158,270
--------- ----------- -----------
Mandatorily redeemable common stock warrants.................................. 6,567 6,567 6,567
--------- ----------- -----------
Stockholders' equity:
Series A convertible preferred stock, $0.001 par value; 12,900,000 shares
authorized actual and pro forma and no shares authorized pro forma as
adjusted; 12,855,094 shares issued and outstanding actual and pro forma
and no shares issued and outstanding pro forma as adjusted................ 13 13 --
Series B convertible preferred stock, $0.001 par value; 4,044,943 shares
authorized actual and pro forma and no shares authorized pro forma as
adjusted; 4,044,943 shares issued and outstanding actual and pro forma and
no shares issued and outstanding pro forma as adjusted.................... 4 4 --
Series C convertible preferred stock, $0.001 par value; no shares authorized
actual, 7,462,819 shares authorized pro forma and no shares authorized pro
forma as adjusted; no shares issued and outstanding actual, 7,462,819
shares issued and outstanding pro forma and no shares issued and
outstanding pro forma as adjusted......................................... -- 7 --
Common stock, $0.001 par value; 80,049,892 shares authorized actual,
89,005,274 shares authorized pro forma and 98,380,274 shares authorized
pro forma as adjusted; 8,042,530 shares issued actual and pro forma and
66,933,001 shares issued pro forma as adjusted (2)........................ 8 8 67
Treasury stock, at cost; 438,115 shares....................................... (18) (18) (18)
Additional paid-in capital.................................................... 37,212 101,919 240,509
Warrants...................................................................... -- 2,600 2,600
Deferred compensation......................................................... (5,210) (5,210) (5,210)
Accumulated deficit........................................................... (38,756) (38,756) (38,756)
--------- ----------- -----------
Total stockholders' equity (deficit)...................................... (6,747) 60,567 199,192
--------- ----------- -----------
Total capitalization.................................................... $ 158,090 $ 225,404 $ 364,029
--------- ----------- -----------
--------- ----------- -----------
</TABLE>
- ------------------------------
(1) Consists of a $1.0 million note payable to Silicon Valley Bank which is
being amortized over a 36-month period that ends in April 2001.
(2) Excludes 1,137,010 shares of common stock issued between January 1, 1999 and
March 16, 1999 upon the exercise of options. Also excludes 6,747,180 shares
of common stock issuable upon the exercise of outstanding warrants and
3,491,006 shares of common stock issuable upon the exercise of outstanding
options as of March 16, 1999.
23
<PAGE>
DILUTION
Our pro forma net tangible book value at December 31, 1998 was $0.93 per
share. Pro forma net tangible book value per share represents the amount of our
total tangible assets less total liabilities, divided by the number of shares of
common stock outstanding after giving effect to the issuance of Series C
preferred stock to MCI WorldCom's investment fund and Microsoft and to the
conversion of all outstanding shares of preferred stock into 49,515,472 shares
of common stock upon the completion of this offering. Please see
"Capitalization." After giving effect to the sale of the 9,375,000 shares of
common stock in this offering, assuming a public offering price of $16.00 per
share, the mid-point of the range set forth on the front cover, less estimated
underwriting discounts and commissions and other expenses of this offering, our
as adjusted pro forma net tangible book value as of December 31, 1998 would have
been $2.87 per share. This represents an immediate increase in net tangible book
value per share of $1.94 to existing stockholders and immediate dilution in net
tangible book value of $13.13 per share to new investors in this offering. The
following table illustrates the per share dilution:
<TABLE>
<S> <C> <C>
Assumed public offering price per share...................... $ 16.00
Pro forma net tangible book value per share at December 31,
1998..................................................... $ 0.93
Increase per share attributable to new investors........... 1.94
---------
As adjusted pro forma net tangible book value per share after
this offering.............................................. 2.87
---------
Dilution per share to new investors (1)...................... $ 13.13
---------
---------
</TABLE>
- ------------------------
(1) If the underwriters' over-allotment option is exercised in full, dilution
per share to new investors would be $11.90.
The following table summarizes the number of shares of common stock
purchased from us, assuming conversion of all outstanding shares of preferred
stock into common stock, the total consideration paid and the average price per
share paid by the existing stockholders and by new investors in this offering,
before deduction of estimated underwriting discounts and commissions and other
expenses of this offering. The calculations in this table with respect to the
shares to be purchased by new investors in this offering reflect an assumed
initial public offering price of $16.00 per share, the mid-point of the range
set forth on the front cover.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------------- --------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
-------------- -------- ----------- -------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders....................................... 57,558,001 86.0% $37,237,000 19.9% $ 0.65
New investors............................................... 9,375,000 14.0 150,000,000 80.1 $16.00
-------------- --- ----------- ---
Total................................................... 66,933,001(1) 100% $187,237,000 100%
-------------- --- ----------- ---
-------------- --- ----------- ---
</TABLE>
- ------------------------
(1) Excludes 1,137,010 shares of common stock issued between January 1, 1999 and
March 16, 1999 upon the exercise of options. Also excludes 6,747,180 shares
of common stock issuable upon the exercise of outstanding warrants and
3,491,006 shares of common stock issuable upon the exercise of outstanding
options as of March 16, 1999.
24
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following statement of operations data for the periods from our
inception on February 27, 1997 to December 31, 1997 and for the year ended
December 31, 1998, and the balance sheet data as of December 31, 1997 and 1998
(actual) have been derived from our consolidated financial statements and the
related notes to the financial statements. The following selected consolidated
financial data should be read in conjunction with our consolidated financial
statements and the related notes to the financial statements and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this prospectus.
<TABLE>
<CAPTION>
FEBRUARY 27, 1997
(INCEPTION) TO YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1998
------------------- -----------------
(DOLLARS IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue.................................................................. $ -- $ 528
Operating expenses:
Network and service costs.............................................. -- 4,695
Selling, marketing, general and administrative......................... 2,534 23,153
Depreciation and amortization.......................................... 1 1,081
------- --------
Total operating expenses............................................. 2,535 28,929
------- --------
Loss from operations..................................................... (2,535) (28,401)
Interest and other income (expense), net................................. 113 (7,933)
------- --------
Net loss................................................................. $ (2,422) $ (36,334)
------- --------
------- --------
Net loss per share (basic and diluted)................................... $ (1.12) $ (12.18)
------- --------
------- --------
Unaudited pro forma net loss per share (basic and diluted)(1)............ $ (0.88)
--------
--------
OTHER FINANCIAL DATA:
EBITDA (2)............................................................... $ (2,342) $ (26,628)
Adjusted EBITDA (3)...................................................... (2,342) (25,036)
Net cash used for operating activities................................... (1,560) (19,024)
Net cash used for investing activities................................... (1,345) (139,032)
Net cash provided by financing activities................................ 13,071 169,205
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1998
AS OF -----------------------------------------
DECEMBER 31, 1997 ACTUAL PRO FORMA (4) AS ADJUSTED (5)
------------------- --------- ------------- ---------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments..................................... $ 10,166 $ 136,812 $ 196,812 $ 335,437
Equipment and furniture, net...................... 1,621 11,510 11,510 11,510
Total assets...................................... 12,241 171,726 239,040 377,665
Total debt........................................ 568 158,270 158,270 158,270
Mandatorily redeemable common stock warrants...... -- 6,567 6,567 6,567
Total stockholders' equity (deficit).............. 10,346 (6,747) 60,567 199,192
</TABLE>
- ------------------------------
(1) Unaudited pro forma net loss per share gives effect to conversion of the
Series A and Series B preferred stock into common stock which will occur
upon the closing of this offering.
(2) EBITDA consists of the net loss excluding net interest, depreciation and
amortization of capital assets and deferred compensation expense. EBITDA is
presented to enhance an understanding of our operating results and is not
intended to represent cash flow or results of operations in accordance with
generally accepted accounting principles for the period indicated and may be
calculated differently than EBITDA for other companies.
(3) Total operating expenses for the year ended December 31, 1998 include
$1,592,000 of operating lease expense to GATX Capital Corporation. No
amounts were incurred to GATX for operating leases in 1997. Adjusted EBITDA
reflects EBITDA excluding the GATX operating lease expense.
(4) Gives effect to the issuance of Series C preferred stock and warrants in
March 1999 for $60 million. See "Certain Relationships and Related
Transactions--Series C Purchase Agreement; Other Agreements with MCI
WorldCom and --Series C Purchase Agreement; Other Agreements with
Microsoft."
(5) Adjusts the pro forma information to give effect to this offering.
25
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
We are a leading service provider of high-speed local access networking
solutions using DSL technology to businesses. We began offering commercial
services in San Diego in April 1998, and have subsequently begun service in nine
additional markets: San Francisco, San Jose, Oakland/East Bay, Chicago, Los
Angeles, Orange County, Boston, Sacramento and New York. We intend to continue
our network rollout into an additional 23 markets in 1999 and a further 17
markets by the end of 2000.
Since our inception in February 1997, our primary activities have consisted
of:
- obtaining required governmental authorizations;
- negotiating and executing interconnection agreements with incumbent
carriers;
- entering into strategic alliances;
- identifying collocation space and locations for our Connection Points,
Metro Service Centers and business offices;
- acquiring and deploying equipment and facilities;
- launching service trials;
- hiring management and other personnel;
- raising capital; and
- developing and integrating our operations support system and other back
office systems.
We have incurred operating losses, net losses and negative operating cash
flow for each month since our formation. As of December 31, 1998, we had an
accumulated deficit of $38.8 million. We currently intend to substantially
increase our operating expenses and capital expenditures in an effort to rapidly
expand our infrastructure and network services. We expect to incur substantial
operating losses, net losses and negative cash flow during the network build-out
and initial penetration of each new market we enter. These losses are expected
to continue for at least the next several years.
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 MCI WorldCom's preferred provider of business
DSL lines 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. In our Microsoft arrangement, we will jointly 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.
FACTORS AFFECTING OPERATIONS
REVENUE
The following factors affect our revenue:
- SERVICE OFFERING. We derive a majority of our operating revenue from DSL
access and wide area network services. For both local access and wide area
network connections, we bill our customers for monthly recurring charges
based on the data transfer speeds selected by the customer. We offer flat
rate plans for our services. In addition to monthly service fees, we bill
26
<PAGE>
users for nonrecurring service activation and installation charges. We
also charge both monthly and nonrecurring charges to each customer for the
high-speed connection between our Metro Service Center and the customer's
router. To encourage potential customers to adopt our services, we
sometimes offer reduced prices for an initial period of time. We expect
that, as a result of competitive forces, our prices will decline over
time.
- PENETRATION OF TARGET MARKETS. We base our target market assessment on the
number of local area networks in each market, which we believe is the best
indication of data intensive business density and potential customers for
our services. According to a leading data communications industry source,
the total number of business local area networks in the United States is
approximately 1.5 million, with an average of 40 users per local area
network. We believe that our initial ten markets contain 23% of all local
area networks in the United States. Our goal is to cover 60% of the local
area networks in the United States, which we believe is achievable by
building out a total of 50 markets. Initially, DSL is expected to reach
over 70% of the businesses and residences served from the central offices.
Within each metropolitan area, we expect to collocate in the appropriate
number of central offices to cover 75% of the total market opportunity.
- TURNOVER. To date, our customer turnover has been minimal. We expect this
to increase in the future as competition intensifies.
NETWORK AND SERVICE COSTS
Our network and service costs are generally comprised of the following:
- EQUIPMENT INSTALLATION CHARGES. In each market, we will require a number
of field service technicians to install customer premise equipment at end
user locations. We currently outsource most of this function.
- MONTHLY RECURRING AND NONRECURRING LINE AND SERVICE CHARGES. We pay
incumbent carriers a one-time installation and activation fee and a
monthly service fee for each copper line.
- METROPOLITAN AREA NETWORK TRANSPORT CHARGES. We incur charges for
transport between our Connection Points and our Metro Service Centers.
Currently, these charges are typically for DS-3 services from a
competitive carrier or incumbent carrier. These charges also include
customer connections to our network.
- NETWORK FACILITIES OPERATING EXPENSES. We incur various recurring costs at
our network locations. These costs include facility rent and utility
costs.
- WIDE AREA NETWORK CONNECTION CHARGES. We pay long distance carriers a
one-time installation and activation fee and a monthly service fee for
wide area network connections over a frame relay or Asynchronous Transfer
Mode network. We are currently leasing these services from long distance
carriers.
- COST OF CUSTOMER PREMISE EQUIPMENT. As part of our DSL product offering,
we provide the customer premise equipment and expense the cost of the
customer premise equipment for each customer line.
- EQUIPMENT OPERATING LEASE EXPENSES. We currently take advantage of
short-term operating leases to finance the acquisition of substantially
all of our network equipment, including DSL multiplexers, Asynchronous
Transfer Mode switches and routers. We may decide to purchase and to
capitalize some or all of this equipment in the future.
27
<PAGE>
- LINE REPAIR AND SUPPORT COSTS. Similar to other telecommunications
providers, we estimate that a small percentage of our lines may require
repair or support. These costs will consist of field dispatch labor and a
portion of our Network Operations Center costs.
SELLING, GENERAL AND ADMINISTRATIVE COSTS
Our selling, general and administrative expenses include customer service
and technical support, information systems, billing and collections, general
management and overhead, and administrative functions. Headcount in functional
areas, such as customer service, engineering and operations, will increase as we
expand our network, and if our number of customers increases.
- SALES AND MARKETING COSTS. Our sales and marketing efforts focus on
attracting and retaining service providers, including national and
regional Internet Service Providers, national and regional systems and
network integrators, value-added resellers, competitive carriers and long
distance carriers, as well as large business customers.
- GENERAL AND ADMINISTRATIVE COSTS. As we expand our network, we expect the
number of employees located in specific markets to grow. Certain
functions, such as customer service, network operations, finance, billing
and site planning, are likely to remain centralized in order to achieve
economies of scale.
DEPRECIATION AND AMORTIZATION
Depreciation expense arising from our network equipment will be minimal
since leased equipment expenses will reflect most of the cost and financing of
this equipment. Collocation fees are capitalized and amortized over an estimated
useful life of ten years.
RESULTS OF OPERATIONS
REVENUE
We did not offer commercial services in 1997 and, as a result, did not
record any revenue in 1997. During the year ended December 31, 1998, we
continued the development of our business operations, commencing service in the
San Diego market in April, the San Francisco, the Oakland/East Bay and San Jose
markets in July, the Los Angeles and Orange County markets in September and the
Chicago market in October. We recorded revenue of $528,000 during this period,
which was primarily from DSL service and installation charges, net of discounts
given to customers.
NETWORK AND SERVICE COSTS
Since we did not offer commercial services in 1997, we did not record any
network or service costs in 1997. For the year ended December 31, 1998, we
recorded network and service costs of $4.7 million. We expect network and
service costs to increase significantly in future periods as we expand our
network into additional markets.
SELLING, MARKETING, GENERAL AND ADMINISTRATIVE
From inception through December 31, 1997 selling, marketing, general and
administrative expenses were $2.5 million and consisted primarily of salaries
and legal and consulting fees incurred to establish a management team and
develop our business. For the year ended December 31, 1998, we recorded selling,
marketing, general and administrative expenses of $23.2 million. This increase
is attributable to a continued increase in staffing levels, increased marketing
efforts coinciding with the launch of commercial services and increased legal
fees associated with the development of additional markets. We expect selling,
marketing, general and administrative expenses to continue to increase
significantly as we expand our business.
28
<PAGE>
DEPRECIATION AND AMORTIZATION
Depreciation from network equipment is minimal since substantially all of
this equipment is currently leased. Depreciation and amortization was negligible
for the period from inception through December 31, 1997 and was $1.1 million for
the year ended December 31, 1998. The increase was due to the commencement of
our operations in 1998. We expect depreciation and amortization to increase
significantly in future periods as we increase capital expenditures to expand
our network.
OTHER INCOME AND EXPENSE
Other income and expense consists primarily of interest income from our cash
and short-term investments and interest expense associated with our debt. From
inception through December 31, 1997 net interest income was $113,000, which was
primarily attributable to the interest income earned from the proceeds raised in
our Series A preferred stock financing. For the year ended December 31, 1998, we
recorded net interest expense of $8.0 million, consisting of interest income of
$5.8 million generated from invested cash balances, offset by $13.8 million in
interest expense. The increase in the interest expense is substantially due to
the accretion of interest on the senior discount notes that were issued in May
1998.
INCOME TAXES
We generated net operating loss carryforwards of $2.1 million from inception
to December 31, 1997 and $35.0 million during the year ended December 31, 1998.
We expect significant consolidated losses for the foreseeable future which will
generate additional net operating loss carryforwards. However, our ability to
use net operating losses may be subject to annual limitations. In addition,
income taxes may be payable during this time due to operating income in certain
tax jurisdictions. In the future, if we achieve operating profits and the net
operating losses have been exhausted or have expired, we may experience
significant tax expense. We recognized no provision for taxes because we
operated at a loss throughout 1997 and 1998.
LIQUIDITY AND CAPITAL RESOURCES
The development and expansion of our business requires significant capital
expenditures. The principal capital expenditures incurred during the build-out
phase of any market involve the procurement, design and construction of our
Connection Points, one or two Metro Service Centers and other elements of our
network design.
The number of targeted central offices in a market varies, as does the
average capital cost to build our Connection Points in a given market. Capital
expenditures, including payments for collocation fees, were $23.5 million for
the year ended December 31, 1998. We expect our capital expenditures to be
substantially higher in future periods, arising primarily from payment of
collocation fees and the purchase of infrastructure equipment necessary for the
development and expansion of our network.
Through December 31, 1998, we financed our operations primarily through
private placements of equity totaling $30.8 million, of which we received $30.3
million from our venture capital and institutional sponsors, the use of
operating equipment leases totaling $26.5 million, borrowings under a note
payable from Silicon Valley Bank of $1.0 million, and $144.0 million in net
proceeds raised from the issuance of the senior discount notes. As of December
31, 1998, we had an accumulated deficit of $38.8 million and cash, cash
equivalents and short-term investments of $136.8 million. In March 1999, we
received $60.0 million in separate investments by Microsoft and MCI WorldCom's
investment fund.
For the year ended December 31, 1998, the net cash used in our operating
activities was $19.0 million. This cash was used for a variety of operating
purposes, including salaries, consulting and legal expenses, network operations
and overhead expense. Our net cash used for investing activities for
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the year ended December 31, 1998 was $139.0 million and was used primarily for
purchases of short-term investments and equipment and payments of collocation
fees. Net cash provided by financing activities for the year ended December 31,
1998 was $169.2 million and primarily came from the issuance of the senior
discount notes and from the issuance of preferred stock.
We believe that the net proceeds from this offering, together with our
existing cash and short-term investments, existing and anticipated equipment
lease financings and future revenue generated from operations, will be
sufficient to fund our operating losses, capital expenditures, lease payments
and working capital requirements through June 2000. We expect our operating
losses and capital expenditures to increase substantially primarily due to our
network expansion. We expect that additional financing will be required in the
future. We may attempt to raise financing through some combination of commercial
bank borrowings, leasing, vendor financing or the private or public sale of
equity or debt securities. We have received a financing proposal from GATX
Capital Corporation for up to $30 million of additional lease financing, of
which $24 million is allocated for equipment and $6 million is allocated for
collocation fees. This proposal also contains a provision for another $20
million of available financing, for a total of $50 million, that would be
available upon the occurrence of certain events. Our senior discount notes
contain covenants that restrict the our ability to make certain payments,
including dividend payments, and incur additional debt. See "Dividend Policy."
Our capital requirements may vary based upon the timing and success of our
rollout and as a result of regulatory, technological and competitive
developments or if
- demand for our services or our anticipated cash flow from operations is
less or more than expected;
- our development plans or projections change or prove to be inaccurate;
- we engage in any acquisitions; or
- we accelerate deployment of our network services or otherwise alter the
schedule or targets of our rollout plan.
Equity or debt financing may not be available to us on favorable terms or at
all. See "Risk Factors--We will need significant additional funds, which we may
not be able to obtain."
IMPACT OF THE YEAR 2000 ISSUE
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 in a more
effective manner than many older companies. 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 believe 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
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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 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.
FINANCIAL INFORMATION
The preceding discussion and analysis is based on our consolidated financial
statements and the related notes and should be read in conjunction with the
consolidated financial statements and the related notes included in this
prospectus.
FORWARD-LOOKING STATEMENTS
This prospectus includes forward-looking statements. These forward-looking
statements address, among other things:
- our network rollout plans and strategies;
- development and management of our business;
- our ability to attract, retain and motivate qualified personnel;
- success of our strategic alliances;
- our ability to attract and retain customers;
- the extent of acceptance of our services;
- the market opportunity and trends in the markets for our services;
- our ability to upgrade our technologies;
- prices of telecommunication services;
- the nature of regulatory requirements that apply to us;
- our ability to obtain any required governmental authorizations;
- our future capital expenditures and needs;
- our ability to obtain financing on commercially reasonable terms;
- our ability to implement a Year 2000 readiness program;
- our ability to compete; and
- the extent and nature of competition.
These statements may be found in this section, in the front inside cover of
this prospectus, in the sections of this prospectus entitled "Summary," "Risk
Factors," "Use of Proceeds" and "Business" and in this prospectus generally.
We have based these forward-looking statements on our current expectations
and projections about future events. However, our actual results could differ
materially from those anticipated in these forward-looking statements as a
result of risks facing us, including risks stated in "Risk Factors," or faulty
assumptions on our part. For example, assumptions that could cause actual
results to vary materially from future results include, but are not limited to:
- our ability to successfully market our services to current and new
customers;
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- our ability to generate customer demand for our services in our target
markets;
- the development of our target market and market opportunities;
- market pricing for our services and for competing services;
- the extent of increasing competition;
- our ability to acquire funds to expand our network;
- the ability of our equipment and service suppliers to meet our needs;
- trends in regulatory, legislative and judicial developments;
- our ability to manage growth of our operations; and
- our ability to access regions and enter into suitable interconnection
agreements with incumbent carriers.
We undertake no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
In light of these risks, uncertainties and assumptions, the forward-looking
events discussed in this prospectus might not occur.
DESCRIPTION OF CERTAIN INDEBTEDNESS
In November 1997 and May 1998, we entered into 36-month lease lines for an
aggregate $26.5 million in lease financing with Sun Financial Group, Inc., now
GATX Capital Corporation, pursuant to which we lease office equipment,
telecommunications equipment, network equipment and furniture on an operating
lease basis. In connection with this leasing arrangement, we issued to GATX a
warrant to purchase 574,380 shares of common stock at a price of $1.85 per
share. This warrant is immediately exercisable. During February 1999, we
received a financing proposal from GATX for up to $30 million in additional
lease financing, of which $24 million is allocated for equipment and $6 million
is allocated for collocation fees. This new proposal also contains a provision
for another $20 million of available financing, for a total of $50 million, that
would be available upon the occurrence of certain events.
We also have outstanding senior discount notes, which we issued in May 1998.
These 13 1/2% notes were issued at a discount and raised net proceeds of
approximately $144.0 million. These notes are senior unsecured obligations that
mature with a principal amount of $290 million on May 15, 2008. The discount
amount is being accreted to interest expense for the first five years of the
notes; cash interest on these notes will not accrue prior to May 15, 2003, but
will do so after that date and will be payable semi-annually each year,
commencing November 15, 2003. These notes are redeemable at our option, in whole
or in part, at any time after May 15, 2003 and, prior to May 15, 2001, out of
the proceeds of certain equity offerings, at predetermined redemption prices
together with accrued and unpaid interest through the date of redemption. We
will not use the proceeds of this offering to redeem any of these notes. Upon a
change of control, each holder of these notes may require us to repurchase the
notes at 101% of the principal amount thereof, plus accrued and unpaid interest
to the date of purchase. These notes contain certain restrictive covenants,
including limitations on future indebtedness, restricted payments, transactions
with affiliates, liens, sale of stock of subsidiaries, dividends, mergers and
transfers of assets.
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BUSINESS
THE COMPANY
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 San Diego in April 1998, and have subsequently begun service in nine
additional markets: San Francisco, San Jose, Oakland/East Bay, Chicago, Los
Angeles, Orange County, Boston, Sacramento and New York. We intend to continue
our network rollout into an additional 23 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, Bell South, GTE,
Pacific Bell and U S WEST, and we are currently pursuing interconnection
arrangements with two other incumbent carriers. As of January 31, 1999, we
provide service or have installed equipment in nearly 200 incumbent carrier
central offices. We have obtained competitive carrier authority or have been
permitted to operate as a competitive carrier in 21 states.
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 MCI WorldCom's preferred provider of business
DSL lines 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. In our Microsoft arrangement, we will
jointly 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.
We also market our services through our direct sales force and through our
partnerships with recognized leaders in the networking industry, including
Microsoft, Cisco and a contemplated arrangement with Verio. 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 January 31, 1999, we had over 650 lines in service, and we are
currently under contract to supply over 9,000 additional DSL lines to our
business and service provider customers, including Cisco, Silicon Graphics,
Inc., QUALCOMM Incorporated, Wind River Systems and Broadcom Corporation.
Our senior management team has extensive experience in developing
next-generation networking businesses. Our President 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. Scott Chandler, our Chief Financial Officer, was previously President
and Chief Executive Officer of C-COR Electronics, Inc., a manufacturer of
broadband telecommunications equipment. James Greenberg, our Chief Network
Officer, directed the design, planning, operation and
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construction of Sprint Corporation's data networks. Frank Tolve, our Chief Sales
Officer, previously served as Vice President, Sales Operations of Bay Networks.
Our sponsors, which include Microsoft, MCI WorldCom's investment fund, Kleiner
Perkins Caufield & Byers, Enterprise Partners, Brentwood Venture Capital, the
Sprout Group and a subsidiary of Enron Corporation, have to date invested
approximately $90.3 million.
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. 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
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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
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 creates 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;
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- 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 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.
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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 January 31, 1999, we provide service or had installed our network equipment
in nearly 200 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. We plan to construct our network rapidly 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.
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 example, as part of our strategic
agreement with MCI WorldCom, we have agreed to jointly develop voice and data
applications over a single DSL connection. 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 a strategic alliance with Microsoft in
which 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. We have also entered into a strategic alliance with MCI
WorldCom in which we have been designated its preferred provider of business DSL
connections for large, medium and small businesses. In addition, we entered into
a strategic alliance with Cisco, in which we will 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.
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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, we entered into a strategic partnership with MCI WorldCom,
pursuant to which, among other things:
- MCI WORLDCOM INVESTMENT. MCI WorldCom's investment fund invested $30
million in us, in return for 3,731,410 shares of our Series C preferred
stock, which are convertible into 4,477,692 shares of common stock, and a
warrant to purchase 720,000 shares of our common stock at $6.70 per share.
As the majority holder of Series C preferred stock, the fund has the right
to elect one of our directors.
- PROVIDING DSL TO MCI WORLDCOM. We have been designated MCI WorldCom's
preferred provider of business DSL access services in areas where we deploy
our network, except for services to certain subsidiaries and in locations
where MCI WorldCom deploys its own DSL equipment. We have a right of first
refusal to match offers made to MCI WorldCom by other providers of DSL
services.
MCI WorldCom has committed to sell a minimum of 100,000 business quality
DSL lines, 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.
- COLLABORATION. We will jointly develop voice and data applications over a
single DSL connection. We will also form 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,
pursuant to which, among other things:
- MICROSOFT INVESTMENT. Microsoft invested $30 million in us, in return for
3,731,409 shares of our Series C preferred stock, which are convertible
into 4,477,691 shares of common stock, and a warrant to purchase 720,000
shares of our common stock at $6.70 per share.
- CO-BRANDING FOR SMALL BUSINESSES AND TELEWORKERS. 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.
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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.
OTHER PARTNERS
In October 1998, we entered into a letter of intent contemplating a joint
marketing agreement with Verio to jointly fund an advertising and market
awareness program in the Chicago metropolitan area. In the future we intend to
pursue additional joint marketing relationships to strengthen our distribution
capabilities and enable us to penetrate our target markets more rapidly.
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.
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
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technologies as they are developed, including emerging wireless technologies.
The chart below compares the performance and range for our local connection
services as of February 1999:
<TABLE>
<CAPTION>
SPEED TO SPEED FROM RANGE(1)
END USER END USER (FEET) TECHNOLOGY(2)
- ----------- ----------- ----------- -------------
<C> <S> <C> <C>
144 Kbps 144 Kbps Unlimited IDSL(3)
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>
- ------------------------
(1) Estimated maximum distance from the central office to the end user.
(2) The technologies are described more fully in "--DSL Technologies" below.
(3) Speeds are 128 Kbps under certain circumstances.
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, and is currently a frame relay network which
we lease from a long distance carrier. In the future, we expect to add
Asynchronous Transfer Mode capability.
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.
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- 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
Web sites. 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.
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. 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 premise equipment that supports Web server, e-mail, file server,
firewall, Web-page caching and network backup.
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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 January
31, 1999, we served more than 75 business and 20 service provider customers. For
these business and service provider customers we have over 650 lines in service
and are under contract to supply over 9,000 additional DSL lines. Selected
business customers include Cisco, Silicon Graphics and QUALCOMM. In addition,
our service provider customers include CTSNet, ConnectNet, Verio, Epoch
Networks, Inc. and Ingram Micro.
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 January 31, 1999, we had 40 sales and technical personnel
supporting our direct 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 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. We currently have two large business
customers that have committed to multi-phase implementation programs: Cisco and
Silicon Graphics. Collectively, these two customers account for over 90% of our
commitments to purchase our connections. 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
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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 Microsoft,
MCI WorldCom 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 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.
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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 a
distributed client-server systems architecture that operates using a
single, integrated database. This approach allows us to grow our customer
support and network management capabilities as customer demand increases
by giving our personnel faster, more accurate access to a fully integrated
business information system.
- 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 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
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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 January 31, 1999, we had Connection Points in nearly
200 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. Currently, we lease a frame relay backbone from a long distance
carrier. We anticipate leasing a substantial portion of this capacity from
MCI WorldCom, as described in "--Strategic Partnerships." In the future,
we expect to add Asynchronous Transfer Mode capability.
- 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
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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 15,000 feet, or approximately 2.8 miles, 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.
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. 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.
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.
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- 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. 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 could deploy 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 Communications International 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.
- 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, including HarvardNet, Inc. in
Massachusetts, 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.
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- COMPETITIVE CARRIERS. Certain competitive carriers, including Covad
Communications Group, Inc. and NorthPoint Communications, Inc., have begun
offering DSL-based data services. Other competitive carriers are likely to
do so in the future. 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." 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,
- 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 special conditioning the incumbent carrier provides on certain of
these lines to enable the transmission of 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 23 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
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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, ACI Corp. and ACI Corp.--Virginia, may be 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 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
49
<PAGE>
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 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 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. These decisions are currently subject to reconsideration and appeal. The
final outcome of these decisions, originally scheduled to be announced on
January 28, 1999, has been postponed by the Federal Communications Commission
while it considers the impact of the Supreme Court's ruling on the 1996
Telecommunications Act. The final outcome of these petitions or other
proceedings interpreting the requirements of the 1996 Telecommunications Act may
adversely affect our business.
STATE REGULATION
Some of our services, particularly those of our subsidiaries, ACI Corp. and
ACI Corp.--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, Bell South,
GTE, Pacific Bell and U S WEST. We have signed agreements with Ameritech for
Illinois and Michigan and currently are negotiating interconnection agreements
for Ohio and Wisconsin. We have signed agreements with Bell Atlantic for the
District of Columbia, Maryland, Massachusetts, New Jersey, New York,
Pennsylvania and Virginia. We have signed agreements with Bell South for
Alabama, Arkansas, Florida, Georgia, Kentucky, Louisiana, North Carolina, South
Carolina and Tennessee. We have signed an agreement with GTE for California and
are currently completing agreements for Florida, Minnesota, North
Carolina, Oregon, Texas, Virginia and Washington. 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 several
states. 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.
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<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.
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.
EMPLOYEES
As of January 31, 1999, we had approximately 220 employees. We believe that
our future success will depend in part on our continued ability to attract, hire
and retain qualified personnel. Competition for such personnel is intense, and
we may be unable to identify, attract and retain such personnel in the future.
None of our employees are represented by a labor union or are the subject of a
collective bargaining agreement. We have never experienced a work stoppage and
believe that our employee relations are good.
PROPERTIES
Our headquarters are located in facilities consisting of approximately
80,000 square feet in Englewood, Colorado, which we occupy under leases that
expire in October 1999 and January 2004. These leases may be extended. We also
lease space for network equipment installations in a number of other locations.
LEGAL PROCEEDINGS
We are currently a party to an arbitration proceeding between us and SBC
Communications regarding the terms of interconnection with Southwestern Bell in
Texas. This arbitration, instituted December 11, 1998, is pending before the
Public Utility Commission of Texas. The dispute involves the terms and
conditions of issues related to DSL-based services and loops in connection with
our interconnection agreement with Southwestern Bell. We are seeking to compel
Southwestern Bell to include in our interconnection agreement language
comparable to that in our other interconnection agreements, which gives us the
ability to obtain copper telephone lines on which we provide our chosen variety
of DSL technologies.
We filed a complaint for declaratory relief on February 18, 1999 in San
Diego County Superior Court (North County) versus Mr. Thomas L. Lafleur. Mr.
Lafleur is a former employee who resigned and/or was terminated in 1998. After
he left, we sent him a check for the repurchase of his unvested shares, but he
has not yet cashed this check. This declaratory relief action is to determine
that his shares were unvested and properly repurchased. We are currently
accounting for these 438,115 shares as treasury stock.
In addition, we are subject to state commission, Federal Communications
Commission and court decisions as they relate to the interpretation and
implementation of the 1996 Telecommunications Act, the interpretation of
competitive carrier interconnection agreements in general and our
interconnection agreements in particular. In some cases, we may be deemed to be
bound by the results of ongoing proceedings of these bodies. We therefore may
participate in proceedings before these regulatory agencies or judicial bodies
that affect, and allow us to advance, our business plans.
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<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth, as of March 16, 1999, the names, ages and
positions of our executive officers and directors. Their respective backgrounds
are described below.
<TABLE>
<CAPTION>
NAME AGE POSITION(S)
- ----------------------------------------------------- --- -----------------------------------------------------
<S> <C> <C>
Catherine M. Hapka................................... 44 President, Chief Executive Officer and Director
Jeffrey Blumenfeld................................... 51 Vice President and General Counsel
Michael E. Calabrese................................. 33 Vice President, Sales Engineering
Scott C. Chandler.................................... 37 Chief Financial Officer
Eric H. Geis......................................... 52 Vice President of National Deployment
James A. Greenberg................................... 38 Chief Network Officer
David J. Shimp....................................... 53 Chief Marketing Officer
Frank J. Tolve, Jr................................... 53 Chief Sales Officer
Kevin R. Compton..................................... 40 Director
Keith B. Geeslin..................................... 45 Director
Ken L. Harrison...................................... 56 Director
Susan Mayer.......................................... 48 Director
William R. Stensrud.................................. 48 Director
John L. Walecka...................................... 39 Director
Edward J. Zander..................................... 52 Director
</TABLE>
All the officers identified above serve at the discretion of our Board of
Directors. There are no family relationships between any persons identified
above. The following are brief biographies of the persons identified above.
CATHERINE M. HAPKA has been our President, Chief Executive Officer and a
director since June 1997. Prior to joining us, Ms. Hapka served as President of
NETS, Inc., an electronic commerce software company, from March 1997 to May
1997. Prior to joining NETS, Inc., Ms. Hapka served as Executive Vice President,
Markets, for U S WEST Communications, Inc. from January 1995 to October 1996. In
this capacity, Ms. Hapka led business and consumer telecommunications units
responsible for the voice, data, wireless, video and long distance businesses.
From 1991 to 1994, Ms. Hapka served as President and Chief Operating Officer of
the !NTERPRISE Networking Services Unit of U S WEST. Prior to joining U S WEST,
Ms. Hapka held general management positions with General Electric and McKinsey &
Co., Inc.
JEFFREY BLUMENFELD has been our Vice President and General Counsel since
August 1997, and has been a partner in the Washington, D.C. law firm of
Blumenfeld & Cohen since 1984, which specializes in pro-competition advocacy for
technology-intensive companies. Since 1995, Mr. Blumenfeld has served as senior
trial counsel to the Antitrust Division of the U.S. Department of Justice in
several matters. Before starting Blumenfeld & Cohen in 1984, Mr. Blumenfeld held
positions with the U.S. Department of Justice from 1973 to 1984, most recently
as Chief of the U.S. V. AT&T staff of the Antitrust Division. Mr. Blumenfeld is
an adjunct professor of communications law at the Georgetown University Law
Center. Pursuant to his employment agreement, Mr. Blumenfeld has agreed to
expend approximately 24 hours a week in his capacity as one of our officers. For
more information on
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Mr. Blumenfeld's relationship with us, please see "Certain Relationships and
Related Transactions-- Legal Services."
MICHAEL E. CALABRESE has been our Vice President, Sales Engineering since
August 1998. Prior to joining us, Mr. Calabrese served in various positions at
Cisco Systems, Inc. from August 1995 to August 1998, most recently as Account
Manager of the Data Equipment Group. In that capacity, Mr. Calabrese maintained
primary responsibility for managing Cisco's major accounts. From January 1993 to
August 1995, Mr. Calabrese held management positions at Sprint Communications.
First, as Manager, Project Engineering, Mr. Calabrese led Sprint Communication's
new product rollouts. Subsequently, as Manager, Network Planner, Mr. Calabrese
was responsible for the design and build-out of Sprint Communications Data
Networks.
SCOTT C. CHANDLER has served as our Chief Financial Officer since April
1998. From August 1996 to April 1998, Mr. Chandler served as President and Chief
Executive Officer of C-COR Electronics, Inc., a manufacturer of broadband
telecommunications equipment. From June 1990 to August 1996, Mr. Chandler served
in various positions at U S WEST and its subsidiaries, most recently as Vice
President and General Manager of U S WEST Cable and Multimedia from September
1995 to August 1996. While at U S WEST, Mr. Chandler also served as Vice
President and General Manager of the U S WEST subsidiary, !NTERPRISE AMERICA,
from January 1994 to August 1995 and as Director of Vendor Relations and Channel
Support of !NTERPRISE Networking Services from January 1992 to December 1993.
ERIC H. GEIS has been our Vice President of National Deployment since
January 1, 1999. Prior to that, he served as our Vice President and General
Manager, Western Region beginning June 1997 and was a consultant to us from
April 1997 to June 1997. From November 1995 to December 1996, Mr. Geis served as
National Sales Director at GRC International, a producer and seller of wide area
data network design and optimization software applications. Between July 1990
and November 1995, Mr. Geis served as President and Chief Executive Officer of
Quintessential Solutions Inc., a provider of wide area network design, pricing
and optimization software applications for interexchange carriers, regional bell
operating companies, incumbent carriers, Internet Service Providers and major
corporate accounts. Mr. Geis was also Founder, President and Chief Executive
Officer of TeleQuest, Inc., a telecommunications products company from May 1983
to December 1990.
JAMES A. GREENBERG has been our Chief Network Officer since July 1997. From
January 1990 to July 1997, Mr. Greenberg served in various positions at Sprint
Communications, most recently as Senior Director and interim Vice President of
the Data Operations and Engineering Group. In that capacity, Mr. Greenberg
directed the design, planning, operation and construction of Sprint's data
networks.
DAVID J. SHIMP has served as our Chief Marketing Officer since October 1998.
Prior to joining us, Mr. Shimp was a partner at LAI Ward Howell, Inc., a
professional services firm, where he implemented that firm's first systems group
and was a leader in the technology department during his tenure from January
1991 to October 1998. Previously, Mr. Shimp held management positions at
McKinsey & Co. and the Deerpath Group.
FRANK J. TOLVE, JR. has served as our Chief Sales Officer since December
1998. From November 1994 to September 1998, Mr. Tolve served as Vice President,
Sales Operations at Bay Networks. In that capacity, Mr. Tolve's responsibilities
included sales administration, channel strategy and worldwide
telesales/telemarketing. Mr. Tolve also served as Vice President, Sales
Operations for SynOptics Communications from November 1992 to November 1994.
KEVIN R. COMPTON has been a director since July 1997. Since 1990, Mr.
Compton has served as a general partner of Kleiner Perkins Caufield & Byers, a
venture capital investment firm ("KPCB"). Mr. Compton is a director of Citrix
Systems, Inc., Digital Generation Systems, Inc., Global Village
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<PAGE>
Communication, Inc. and Corsair Communications, Inc., and is also a director of
several privately held companies. Mr. Compton was elected a director as the
nominee of KPCB, pursuant to the terms of a voting agreement.
KEITH B. GEESLIN has been a director since July 1997. Since 1988, Mr.
Geeslin has served as a general partner of The Sprout Group, a venture capital
investment firm. Mr. Geeslin is a director of SDL, Inc., and is also a director
of several privately held companies, including Paradyne Corporation, a DSL
equipment manufacturer and supplier to us. Please see "Certain Relationships and
Related Transactions--Director Relationships." Mr. Geeslin was elected a
director as the nominee of The Sprout Group, pursuant to the terms of a voting
agreement.
KEN L. HARRISON has been a director since March 1998. Since 1975, Mr.
Harrison has held various management positions at Portland General Electric
Company, where he currently serves as its Chairman and Chief Executive Officer,
a position he has held since December 1988. In addition, Mr. Harrison currently
serves as Vice Chairman and is a director of Enron Corporation, a position he
has held since July 1997. Mr. Harrison has also served as Chairman of Enron
Communications Group, Inc. since September 1997, and as a director of Enron Oil
and Gas Corporation since October 1997. Mr. Harrison was elected a director as
the nominee of Enron, pursuant to the terms of a voting agreement.
SUSAN MAYER has been a director since March 1999. Ms. Mayer is the President
of the MCI WorldCom Venture Fund and a Senior Vice President of MCI WorldCom
Inc. Previously, she was Senior Vice President of MCI Communications Corporation
from 1994 to 1998. From 1996 to 1997, Ms. Mayer was also President and Chief
Operating Officer of Sky MCI. From 1993 to 1994, Ms. Mayer was Vice President of
MCI Communications Corporation.
WILLIAM R. STENSRUD has been a director since our inception in February 1997
and also served as our President and Chief Executive Officer from February 1997
to June 1997. Mr. Stensrud has been a general partner at the venture capital
investment firm of Enterprise Partners since January 1997. From June 1996
through December 1996, Mr. Stensrud served as President of Paradyne Corporation.
Previously, from February 1992 to March 1996, Mr. Stensrud served as President
and Chief Executive Officer of Primary Access Corporation. Mr. Stensrud is a
director of several privately held companies, including Paradyne Corporation.
Please see "Certain Relationships and Related Transactions--Director
Relationships." Mr. Stensrud was elected a director as the nominee of Enterprise
Partners, pursuant to the terms of a voting agreement.
JOHN L. WALECKA has been a director since July 1997. Since 1984, Mr. Walecka
has been at Brentwood Venture Capital, a venture capital investment firm, and
has been a general partner since 1990. Mr. Walecka is a director of Documentum,
Inc. and Xylan Corporation, and is also a director of several privately held
companies. Please see "Certain Relationships and Related Transactions--Director
Relationships." Mr. Walecka was elected a director as the nominee of Brentwood
Venture Capital, pursuant to the terms of a voting agreement.
EDWARD J. ZANDER has been a director since March 1999. Since 1987, Mr.
Zander has held various management positions at Sun Microsystems, Inc., where he
currently serves as its Chief Operating Officer, a position he has held since
February 1998. Mr. Zander is a director of Documentum, Inc. and one privately
held company.
Members of the Board of Directors currently hold office and serve until our
next annual meeting of stockholders or until their respective successors have
been elected. The Board of Directors is currently comprised of eight directors
and, prior to the completion of this offering, will be classified into three
classes of directors serving staggered three-year terms, with one class of
directors to be elected at each annual meeting of stockholders. The
classification of directors has the effect of making
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<PAGE>
it more difficult to change the composition of the Board of Directors. See
"Description of Capital Stock--Possible Anti-Takeover Matters."
All of our executive officers are appointed annually by and serve at the
discretion of the Board of Directors. All of our executive officers are at-will
employees.
COMMITTEES OF THE BOARD OF DIRECTORS
We have a standing compensation committee currently composed of Messrs.
Walecka, Harrison and Stensrud. The compensation committee reviews and acts on
matters relating to compensation levels and benefit plans for our executive
officers and key employees, including salary and stock options. The compensation
committee is also responsible for granting stock awards, stock options and stock
appreciation rights and other awards to be made under our existing incentive
compensation plans. We also have a standing audit committee composed of Messrs.
Compton and Geeslin. The audit committee assists in selecting our independent
auditors and in designating services to be performed by, and maintaining
effective communication with, those auditors.
DIRECTOR COMPENSATION
Directors do not receive compensation for services provided as a director or
for participation on any committee of the Board of Directors. All directors are
reimbursed for their out-of-pocket expenses in serving on the Board of Directors
or any committee thereof.
EXECUTIVE COMPENSATION
The following table sets forth certain information with respect to the
compensation awarded to, earned by or paid to our current Chief Executive
Officer and our four other most highly compensated executive officers (the
"Named Executive Officers") during 1998 and 1997.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION AWARDS
--------------------------
ANNUAL COMPENSATION SECURITIES
----------------------- UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION(S) YEAR SALARY BONUS OPTIONS(#) COMPENSATION
- -------------------------------------------------- ---- -------- ------------- -------------- ---------
<S> <C> <C> <C> <C> <C>
Catherine M. Hapka (1)............................ 1998 $339,583 $ 134,584 -- $--
President, Chief Executive Officer and Director 1997 163,654 50,000 3,504,905(2) --
365,094(3)
Michael E. Calabrese (4).......................... 1998 42,417 157,623(5) 360,000(2) --
Vice President, Sales Engineering 1997 -- -- -- --
James A. Greenberg (6)............................ 1998 145,000 31,538 48,000(2) --
Chief Network Officer 1997 63,205 16,615 547,642(2) 50,000 (7)
Gloria A. Farler (8).............................. 1998 137,500 29,906 24,000(2) --
Vice President, Marketing Support 1997 25,781 7,161 48,000(2)
Eric H. Geis (9).................................. 1998 136,000 29,580 -- --
Vice President of National Deployment 1997 96,519 18,417 132,000(2) --
</TABLE>
- ------------------------------
(1) Ms. Hapka has been employed by us since June 1997, and the amount listed
sets forth her compensation since such date.
(2) Represents the number of shares of common stock that may be purchased upon
the exercise of options.
(3) Represents a right to purchase 365,094 shares of Series A preferred stock,
which she purchased in 1998.
(4) Mr. Calabrese has been employed by us since August 1998, and the amount
listed sets forth his compensation since such date.
(5) Includes a cash payment of $150,000 to cover a signing bonus and relocation
expenses.
(6) Mr. Greenberg has been employed by us since July 1997, and the amount listed
sets forth his compensation since such date.
(7) Represents a flat fee relocation payment.
(8) Ms. Farler had been employed by us since October 1997; she resigned her
position in February 1999.
(9) Mr. Geis has been employed by us since April 1997, and the amount listed
sets forth his compensation since such date.
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<PAGE>
OPTION GRANTS IN 1998
The following table sets forth information with respect to stock options
granted to each of the Named Executive Officers during 1998 pursuant to our 1997
Stock Option/Stock Issuance Plan. We did not grant any stock appreciation rights
to the Named Executive Officers during 1998.
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS (1) VALUE AT ASSUMED
------------------------------------------------------------ ANNUAL RATES OF
NUMBER OF % OF TOTAL STOCK
SECURITIES OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OPTION TERM (3)
OPTIONS EMPLOYEES PRICE PER --------------------
NAME GRANTED IN 1998 (2) SHARE EXPIRATION DATE 5% 10%
- ------------------------------------- ----------- --------------- ----------- ----------------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Catherine M. Hapka................... -- -- -- -- -- --
Michael E. Calabrese................. 360,000 10.7% $ 0.25 September 9, 2008 $ 56,601 $ 143,437
James A. Greenberg................... 48,000 1.4% 0.25 September 9, 2008 7,547 19,125
Gloria A. Farler (4)................. 24,000 0.7% 0.25 September 9, 2008 3,773 9,562
Eric H. Geis......................... -- -- -- -- -- --
</TABLE>
- ------------------------------
(1) Options granted are immediately exercisable for all the option shares, but
any shares purchased under such options will be subject to repurchase by us
at such shares' option exercise price until they vest. Please see "--1997
Stock Option/Stock Issuance Plan."
(2) We granted options to purchase 3,364,680 shares of common stock during 1998.
(3) Amount represents potential realizable value of option grants, assuming that
our common stock appreciates at the annual rate shown, compounded annually,
from the date of grant until expiration of the granted options. These
numbers are calculated based on Securities and Exchange Commission
requirements and do not reflect our projection or estimate of future stock
price growth. Actual gains, if any, on stock option exercises are dependent
on the future performance of our common stock.
(4) Ms. Farler resigned her position in February 1999.
FISCAL YEAR-END 1998 OPTION VALUES
The following table provides information with respect to each of the Named
Executive Officers, concerning the exercise of common and preferred stock
options during 1998 and unexercised options held by them at the end of 1998.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING IN-THE-
UNEXERCISED OPTIONS AT MONEY OPTIONS AT
SHARES DECEMBER 31, 1998 DECEMBER 31, 1998(1)
ACQUIRED ON VALUE -------------------------------- --------------------------
NAME EXERCISE(2) REALIZED(3) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ----------------------------- -------------- ------------- ----------- ------------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Catherine M. Hapka........... 3,869,999(4) $ 73,019 -- -- -- --
Michael E. Calabrese......... -- -- 360,000 -- $1,440,000 --
James A. Greenberg........... 547,642(5) -- 48,000 -- 192,000 --
Gloria A. Farler (6)......... 43,200(7) -- 24,000 -- 96,000 --
Eric H. Geis................. 132,000(8) -- -- -- -- --
</TABLE>
- ------------------------------
(1) Amount based on the fair market value of our common stock on December 31,
1998 as determined by our Board of Directors, less the exercise price
payable for such shares.
(2) The shares of common stock were deposited in escrow with our corporate
secretary where they continue to vest in accordance with the applicable
vesting provisions. Please see "--1997 Stock Option/Stock Issuance Plan."
(3) Amount based on the fair market value, as determined by our Board of
Directors, of our common stock and Series A preferred stock on the exercise
date for such shares, less the exercise price paid for such shares.
(4) Ms. Hapka exercised all of these options in February 1998 for a net purchase
price of $146,038 for common stock and $292,075 for Series A preferred
stock. Ms. Hapka purchased the shares of Series A preferred stock at a $0.20
per share discount from market value, for an aggregate discount of $73,019.
(5) Mr. Greenberg exercised all of these options in January 1998 for a net
purchase price of $22,818.
(6) Ms. Farler resigned her position in February 1999.
(7) Ms. Farler exercised all of these options in March 1998 for a net purchase
price of $1,800.
(8) Mr. Geis exercised all of these options in January 1998 for a net purchase
price of $5,500.
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<PAGE>
EMPLOYMENT AGREEMENTS AND CHANGE IN CONTROL ARRANGEMENTS
None of our employees are employed for a specified term, and each employee's
employment with us is subject to termination at any time by either party for any
reason, with or without cause.
Ms. Hapka's employment agreement provides for a salary of $350,000 per year,
subject to periodic increases by the Board of Directors at its discretion. In
addition, it provides for a bonus potential of 50% of her base salary for her
second year of employment, which ends in June 1999, payable upon achievement of
certain milestones to be proposed by Ms. Hapka and agreed to by the Board of
Directors. In connection with her employment in June 1997, Ms. Hapka was granted
an option to purchase 3,504,905 shares of common stock at an exercise price of
$0.04 per share under the 1997 Stock Option/Stock Issuance Plan. Ms. Hapka
exercised such options in February 1998, subject to our right of repurchase
which lapses in accordance with the vesting schedule of the options. Please see
"--1997 Stock Option/Stock Issuance Plan." In connection with her employment,
Ms. Hapka was also given the right to purchase up to 365,094 shares of Series A
preferred stock at $0.80 per share. In February 1998, Ms. Hapka purchased these
shares for an aggregate purchase price of $292,075. We do not hold a right to
repurchase these shares of Series A preferred stock. In the event Ms. Hapka's
employment is terminated involuntarily and without cause, Ms. Hapka will be
entitled to receive a lump sum payment in an amount equal to her then-current
annual salary.
Mr. Calabrese's employment agreement provides for an annual salary of
$130,000, subject to periodic increases by the Board of Directors at its
discretion. It provides for an annual bonus of up to 20% of his annual salary.
In addition, Mr. Calabrese received, as part of the acceptance of his
employment, a cash payment of $150,000, which also covered relocation expenses.
In the event Mr. Calabrese's employment is terminated involuntarily and without
cause during the first year of employment, which ends in August 1999, Mr.
Calabrese will be entitled to receive a payment equal to one year's base salary
payable in 12 monthly installments.
Mr. Greenberg's employment agreement provides for an annual salary of
$145,000, subject to periodic increases by the Board of Directors at its
discretion.
Mr. Geis' employment agreement provides for an annual salary of $136,000,
subject to periodic increases by the Board of Directors at its discretion. It
provides for an annual bonus of up to 25% of his base salary.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Our Board of Directors currently has a compensation committee that reviews
and approves the compensation and benefits to be provided to our executive
officers and other key employees. In addition, the compensation committee
administers the 1997 Stock Option/Stock Issuance Plan. The compensation
committee currently consists of Messrs. Harrison, Stensrud and Walecka.
BENEFIT PLANS
1999 STOCK INCENTIVE PLAN
Our 1999 Stock Incentive Plan is intended to serve as the successor equity
incentive program to the 1997 Stock Option/Stock Issuance Plan. The 1999 Stock
Incentive Plan was adopted by the board on March 16, 1999. Subject to
stockholder approval, the 1999 Stock Incentive Plan will become effective upon
effectiveness of the offering. All outstanding options under the 1997 Stock
Option/Stock Issuance Plan will at that time be incorporated into the 1999 Stock
Incentive Plan, and no further option grants will be made under the 1997 Stock
Option/Stock Issuance Plan. The incorporated options will continue to be
governed by their existing terms, unless the plan administrator elects to extend
one or more features of the 1999 Incentive Plan to those options. Except as
otherwise noted below, the incorporated options have substantially the same
terms as will be in effect for grants made under the Discretionary Option Grant
Program of the 1999 Stock Incentive Plan.
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<PAGE>
An initial reserve of 7,440,000 shares of common stock has been authorized
for issuance under the 1999 Stock Incentive Plan. This share reserve consists of
(i) the number of shares estimated to remain available for issuance under the
1997 Stock Option/Stock Issuance Plan on the effective date of the new 1999
Stock Incentive Plan, including the shares subject to outstanding options
thereunder, plus (ii) an additional increase of approximately 6,000,000 shares.
The number of shares of common stock reserved for issuance under the 1999 Stock
Incentive Plan will automatically increase on the first trading day in January
each calendar year, beginning in calendar year 2000, by an amount equal to two
percent (2%) of the total number of shares of common stock outstanding on the
last trading day in December in the preceding calendar year, but in no event
will this annual increase exceed 1,440,000 shares. In addition, no participant
in the 1999 Stock Incentive Plan may be granted stock options, separately
exercisable stock appreciation rights and direct stock issuances for more than
900,000 shares of common stock in the aggregate per calendar year.
The 1999 Stock Incentive Plan is divided into five separate components:
- the Discretionary Option Grant Program, under which eligible individuals
in our employ or service (including officers, non-employee board members
and consultants) may, at the discretion of the plan administrator, be
granted options to purchase shares of common stock at an exercise price
not less than 100% of the fair market value of those shares on the grant
date;
- the Stock Issuance Program under which eligible individuals may, in the
plan administrator's discretion, be issued shares of common stock
directly, upon the attainment of designated performance milestones or upon
the completion of a specified service requirement or as a bonus for past
services;
- the Salary Investment Option Grant Program, which may, at the plan
administrator's sole discretion, be activated for one or more calendar
years and, if so activated, will allow executive officers and other highly
compensated employees the opportunity to apply a portion of their base
salary each year to the acquisition of special below-market stock option
grants;
- the Automatic Option Grant Program, under which option grants will
automatically be made at periodic intervals to eligible non-employee board
members to purchase shares of common stock at an exercise price equal to
100% of the fair market value of those shares on the grant date; and
- the Director Fee Option Grant Program, which may, in the plan
administrator's sole discretion, be activated for one or more calendar
years and, if so activated, will allow non-employee board members the
opportunity to apply a portion of the annual retainer fee otherwise
payable to them in cash each year to the acquisition of special
below-market option grants.
The Discretionary Option Grant Program and the Stock Issuance Program will
be administered by the compensation committee. The compensation committee as
plan administrator will have complete discretion to determine which eligible
individuals are to receive option grants or stock issuances under those
programs, the time or times when the grants or issuances are to be made, the
number of shares subject to each grant or issuance, the status of any granted
option as either an incentive stock option or a non-statutory stock option under
the Federal tax laws, the vesting schedule to be in effect for the option grant
or stock issuance and the maximum term for which any granted option is to remain
outstanding. However, the board acting by disinterested majority will have the
exclusive authority to make any discretionary option grants or stock issuances
to members of the compensation committee. The compensation committee will also
have the exclusive authority to select the executive officers and other highly
compensated employees who may participate in the Salary Investment Option Grant
Program in the event that program is activated for one or more calendar years.
Neither the compensation committee nor the board will exercise any
administrative discretion with respect to option grants under the Salary
Investment Option Grant Program or under the Automatic Option Grant or Director
Fee Option Grant Program for the non-employee board members. All grants under
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those latter three programs will be made in strict compliance with the express
provisions of each program.
The exercise price for the shares of common stock subject to option grants
made under the 1999 Stock Incentive Plan may be paid in cash or in shares of
common stock valued at fair market value on the exercise date. The option may
also be exercised through a same-day sale program without any cash outlay by the
optionee.
The plan administrator will have the authority to effect the cancellation of
outstanding options under the Discretionary Option Grant Program (including
options incorporated from the 1997 Stock Option/Stock Issuance Plan) in return
for the grant of new options for the same or different number of option shares
with an exercise price per share based upon the fair market value of the common
stock on the new grant date.
Stock appreciation rights are authorized for issuance under the
Discretionary Option Grant Program. These rights will provide the holders with
the election to surrender their outstanding options for an appreciation
distribution from us equal to the excess of (i) the fair market value of the
vested shares of common stock subject to the surrendered option over (ii) the
aggregate exercise price payable for those shares. Such appreciation
distribution may be made in cash or in shares of common stock. None of the
incorporated options from the 1997 Stock Option/Stock Issuance Plan contain any
stock appreciation rights.
In the event that we are acquired by merger or asset sale, each outstanding
option under the Discretionary Option Grant Program which is not to be assumed
by the successor corporation will automatically accelerate in full, and all
unvested shares under the Discretionary Option Grant and Stock Issuance Programs
will immediately vest, except to the extent our repurchase rights with respect
to those shares are to be assigned to the successor corporation. The plan
administrator will have complete discretion to grant one or more options under
the Discretionary Option Grant Program which will vest and become exercisable
for all the option shares in the event those options are assumed in the
acquisition and the optionee's service with us or the acquiring entity is
terminated within a designated period (not to exceed eighteen months) following
that acquisition. The vesting of outstanding shares under the Stock Issuance
Program may be accelerated upon similar terms and conditions.
The plan administrator is also authorized to grant options and structure
repurchase rights so that the shares subject to those options or repurchase
rights will immediately vest in connection with a change in ownership or control
(whether by successful tender offer for more than fifty percent of our
outstanding voting stock or by a change in the majority of our board through one
or more contested elections for board membership). Such accelerated vesting may
occur either at the time of such change or upon the subsequent termination of
the individual's service within a designated period (not to exceed eighteen
months) following the change.
The options to be incorporated from the 1997 Stock Option/Stock Issuance
Plan will immediately vest if we are acquired by merger or asset sale, unless
our repurchase rights with respect to the unvested shares subject to those
options are assigned to the successor entity. There are no other change in
control provisions currently in effect for those options. However, the plan
administrator will have the discretion to extend the acceleration provisions of
the 1999 Stock Incentive Plan to any or all of the options outstanding under the
1997 Stock Option/Stock Issuance Plan.
In the event the plan administrator elects to activate the Salary Investment
Option Grant Program for one or more calendar years, each executive officer and
other highly compensated employee selected for participation may elect, prior to
the start of the calendar year, to reduce his or her base salary for that
calendar year by a specified dollar amount not less than $10,000 nor more than
$50,000. Each selected individual who files this timely election will
automatically be granted, on the first trading day in January of the calendar
year for which that salary reduction is to be in effect, a non-statutory option
to purchase that number of shares of common stock determined by dividing the
salary reduction amount by two-thirds of the fair market value per share of
common stock on the grant date. The
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option will be exercisable at a price per share equal to one-third of the fair
market value of the option shares on the grant date. As a result, the total
spread on the option shares at the time of grant (the fair market value of the
option shares on the grant date less the aggregate exercise price payable for
those shares) will be equal to the amount of salary invested in that option. The
option will vest and become exercisable in a series of twelve equal monthly
installments over the calendar year for which the salary reduction is to be in
effect.
Under the Automatic Option Grant Program, eligible non-employee board
members will receive a series of option grants over their period of board
service. Each individual who first becomes a non-employee board member at any
time at or after the effective date of this offering will receive an option
grant for 24,000 shares of common stock on the date such individual joins the
board, provided such individual has not been in our prior employ. In addition,
on the date of each annual stockholders meeting held after the effective date of
this offering, each non-employee board member who is to continue to serve as a
non-employee board member (including the individuals who are currently serving
as non-employee board members) will automatically be granted an option to
purchase 6,000 shares of common stock, provided such individual has served on
the board for at least six months. There will be no limit on the number of such
6,000 share option grants any one eligible non-employee Board member may receive
over his or her period of continued board service, and non-employee board
members who have previously been in our employ will be eligible to receive one
or more such annual option grants over their period of board service.
Each automatic grant will have an exercise price per share equal to the fair
market value per share of common stock on the grant date and will have a term of
10 years, subject to earlier termination following the optionee's cessation of
board service. Each automatic option will be immediately exercisable for all of
the option shares; however, any unvested shares purchased under the option will
be subject to repurchase by the Company, at the exercise price paid per share,
should the optionee cease to serve on the board service prior to vesting in
those shares. The shares subject to each initial 24,000-share automatic option
grant will vest in a series of six successive equal semi-annual installments
upon the optionee's completion of each six-month period of board service over
the thirty-six-month period measured from the grant date. The shares subject to
each annual 6,000-share automatic grant will vest upon in two successive equal
semi-annual installments upon the optionee's completion of each six-month period
of board service measured from the grant date. However, the shares will
immediately vest in full upon certain changes in control or ownership or upon
the optionee's death or disability while a board member. Following the
optionee's cessation of board service for any reason, each option will remain
exercisable for a 12-month period and may be exercised during that time for any
or all shares in which the optionee is vested at the time of such cessation of
service.
If the Director Fee Option Grant Program is activated in the future, each
non-employee board member will have the opportunity to apply all or a portion of
any annual retainer fee otherwise payable in cash to the acquisition of a
below-market option grant. The option grant will automatically be made on the
first trading day in January in the year for which the retainer fee would
otherwise be payable in cash. The option will have an exercise price per share
equal to one-third of the fair market value of the option shares on the grant
date, and the number of shares subject to the option will be determined by
dividing the amount of the retainer fee applied to the program by two-thirds of
the fair market value per share of common stock on the grant date. As a result,
the total spread on the option (the fair market value of the option shares on
the grant date less the aggregate exercise price payable for those shares) will
be equal to the portion of the retainer fee invested in that option. The option
will vest and become exercisable for the option shares in a series of twelve
equal monthly installments over the calendar year for which the election is to
be in effect. However, the option will become immediately exercisable and vested
for all the option shares upon (i) certain changes in the ownership or control
or (ii) the death or disability of the optionee while serving as a board member.
The shares subject to each option under the Salary Investment Option Grant,
Automatic Option Grant and Director Fee Option Grant Programs will immediately
vest upon (i) an acquisition of us by
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merger or asset sale or (ii) the successful completion of a tender offer for
more than 50% of our outstanding voting stock or a change in the majority of our
board effected through one or more contested elections for board membership.
Limited stock appreciation rights will automatically be included as part of
each grant made under the Automatic Option Grant, Salary Investment Option Grant
and Director Fee Option Grant Programs and may be granted to one or more
officers as part of their option grants under the Discretionary Option Grant
Program. Options with this limited stock appreciation right may be surrendered
to us upon the successful completion of a hostile tender offer for more than 50%
of our outstanding voting stock. In return for the surrendered option, the
optionee will be entitled to a cash distribution from us in an amount per
surrendered option share equal to the excess of (i) the highest price per share
of common stock paid in connection with the tender offer over (ii) the exercise
price payable for such share.
The board may amend or modify the 1999 Stock Incentive Plan at any time,
subject to any required stockholder approval. The 1999 Stock Incentive Plan will
terminate on the earliest of (i) February 28, 2009, (ii) the date on which all
shares available for issuance under the 1999 Stock Incentive Plan have been
issued as fully-vested shares or (iii) the termination of all outstanding
options in connection with certain changes in control or ownership of us.
1999 EMPLOYEE STOCK PURCHASE PLAN
Our 1999 Employee Stock Purchase Plan was adopted by the board on March 16,
1999. Subject to stockholder approval, the 1999 Employee Stock Purchase Plan
will become effective immediately upon the execution of the Underwriting
Agreement for this offering. The plan is designed to allow our eligible
employees and those of our participating subsidiaries to purchase shares of
common stock, at semi-annual intervals, through their periodic payroll
deductions under the plan.
One million two hundred thousand shares of common stock will initially be
reserved for issuance under the plan. The reserve will automatically increase on
the first trading in January each year, beginning with calendar year 2000, by an
amount equal to one percent of the total number of outstanding shares of our
common stock on the last trading day in December in the immediately preceding
calendar year, but in no event will any such annual increase exceed 780,000
shares.
The plan will be implemented in a series of successive offering periods,
each with a maximum duration of 24 months. However, the initial offering period
will begin on the execution date of the Underwriting Agreement and will end on
the last business day in April 2001. The next offering period will commence on
the first business day in May 2001, and subsequent offering periods will
commence as designated by the plan administrator.
Individuals who are eligible employees (scheduled to work more than 20 hours
per week for more than five calendar months per year) on the start date of any
offering period may enter the plan on that start date or on any subsequent
semi-annual entry date (the first business day of May or November each year).
Individuals who become eligible employees after the start date of the offering
period may join the plan on any subsequent semi-annual entry date within that
offering period.
Payroll deductions may not exceed 15% of the participant's cash earnings,
and the accumulated payroll deductions of each participant will be applied to
the purchase of shares on his or her behalf on each semi-annual purchase date
(the last business day in April and October each year) at a purchase price per
share equal to 85% of the lower of (i) the fair market value of the common stock
on the participant's entry date into the offering period or (ii) the fair market
value on the semi-annual purchase date. In no event, however, may any
participant purchase more than 900 shares on any semi-annual purchase date, nor
may all participants in the aggregate purchase more than 300,000 shares on any
semi-annual purchase date.
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If the fair market value per share of our common stock on any purchase date
is less than the fair market value per share on the start date of the two-year
offering period, then that offering period will automatically terminate, and a
new two-year offering period will begin on the next business day, with all
participants in the terminated offering to be automatically transferred to the
new offering period.
Should we be acquired by merger, sale of substantially all its assets or
sale of securities possessing more than fifty percent of the total combined
voting power of our outstanding securities, then all outstanding purchase rights
will automatically be exercised immediately prior to the effective date of an
acquisition. The purchase price will be equal to 85% of the lower of (i) the
fair market value per share of common stock on the participant's entry date into
the offering period in which an acquisition occurs or (ii) the fair market value
per share of common stock immediately prior to an acquisition. The limitation on
the maximum number of shares purchasable in the aggregate on any one purchase
date will not be in effect for any purchase date attributable to such an
acquisition.
The plan will terminate on the earlier of (i) the last business day of April
2009, (ii) the date on which all shares available for issuance under the plan
shall have been sold pursuant to purchase rights exercised thereunder or (iii)
the date on which all purchase rights are exercised in connection with an
acquisition of us by merger or asset sale.
The board may at any time alter, suspend or discontinue the plan. However,
certain amendments may require stockholder approval.
LIMITATION ON LIABILITY AND INDEMNIFICATION MATTERS
Our certificate of incorporation limits the liability of directors to the
maximum extent permitted by Delaware law. In addition, our bylaws require us to
indemnify our directors and officers, and allow us to indemnify our other
employees and agents, to the fullest extent permitted by law. We have also
entered into agreements to indemnify our directors and certain executive
officers. We believe that these provisions and agreements are necessary to
attract and retain qualified directors and executive officers. At present, there
is no pending litigation or proceeding involving any director, officer, employee
or agent where indemnification will be required or permitted. We are not aware
of any threatened litigation or proceeding that might result in a claim for such
indemnification. Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers or persons controlling
our company pursuant to the foregoing provisions, we have been informed that, in
the opinion of the Securities and Exchange Commission, such indemnification is
against public policy as expressed in the Securities Act and is therefore
unenforceable.
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CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
SERIES A PURCHASE AGREEMENT
On July 3, 1997, we entered into a Series A Preferred Stock Purchase
Agreement with Enterprise Partners, Brentwood Venture Capital, Kleiner Perkins
Caufield & Byers, The Sprout Group and certain other investors (together, the
"Series A Purchasers"). In a series of three closings, the Series A Purchasers
purchased in the aggregate 12,280,000 shares of our Series A preferred stock for
an aggregate purchase price of $12.3 million, which will convert into 29,472,000
shares of common stock upon the closing of this offering. Also, pursuant to a
Subsequent Closing Purchase Agreement dated as of December 23, 1997, we sold an
additional 210,000 shares of our Series A preferred stock to certain other
investors (the "Additional Series A Purchasers") for an aggregate purchase price
of $210,000, which will convert into 504,000 shares of common stock upon the
closing of this offering. In connection with these sales, we entered into an
Investors' Rights Agreement and Addendum with the Series A Purchasers and the
Additional Series A Purchasers, which provided the Series A Purchasers and
Additional Series A Purchasers with certain demand and piggyback registration
rights, and certain rights of first offer in the event we propose to offer for
sale certain of our securities. The Investors' Rights Agreement and Addendum was
replaced by the Amended and Restated Investors' Rights Agreement which has been
superseded by the 1999 Investors' Rights Agreement. Please see "--Investors'
Rights Agreement" and "Description of Capital Stock--Registration Rights."
In connection with an employment agreement between us and Catherine Hapka,
we issued 365,094 shares of Series A preferred stock at a purchase price of
$0.80 per share to Ms. Hapka, which will convert into 876,226 shares of common
stock upon the closing of this offering. Please see "Management--Employment
Agreements and Change in Control Arrangements."
SERIES B PURCHASE AGREEMENT
On March 12, 1998, we entered into a Series B Preferred Stock Purchase
Agreement with certain of the Series A Purchasers and Enron Communications
Group, Inc. (together, the "Series B Purchasers"). Under this agreement, the
Series B Purchasers acquired an aggregate of 4,044,943 shares of Series B
preferred stock for an aggregate purchase price of $18.0 million, which will
convert into 9,707,863 shares of common stock upon the closing of this offering.
In connection with the Series B preferred stock Purchase Agreement, we entered
into an Amended and Restated Investors' Rights Agreement with the Series A
Purchasers, the Additional Series A Purchasers and the Series B Purchasers on
March 12, 1998. This agreement replaced the Investors' Rights Agreement and
Addendum from the Series A preferred stock financing and has been superseded by
the 1999 Investors' Rights Agreement. Please see "--Investors' Rights
Agreement."
SERIES C PURCHASE AGREEMENT; OTHER AGREEMENTS WITH MCI WORLDCOM
In March 1999, we entered into a Series C Preferred Stock and Warrant
Purchase Agreement with MCI WorldCom's investment fund, pursuant to which the
fund acquired, in the aggregate 3,731,410 shares of Series C preferred stock,
which are convertible into 4,477,692 shares of common stock, and a warrant to
purchase an aggregate of 720,000 shares of our common stock for an aggregate
purchase price of $30.0 million. In connection with this purchase agreement, we
entered into an Amended and Restated Investors' Rights Agreement, which has been
replaced by the 1999 Investors' Rights Agreement from the Microsoft investment.
Please see "--Investors' Rights Agreement."
The MCI WorldCom investment was part of a broader strategic arrangement
between us and MCI WorldCom. As part of this strategic arrangement, we also
entered into an agreement with MCI WorldCom which designates us as MCI
WorldCom's preferred provider of business DSL lines in certain circumstances,
and which 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. See "Business--Strategic Partnerships."
SERIES C PURCHASE AGREEMENT; OTHER AGREEMENTS WITH MICROSOFT
In March 1999, we entered into a Series C Preferred Stock and Warrant
Purchase Agreement with Microsoft, pursuant to which Microsoft acquired, in the
aggregate 3,731,409 shares of Series C preferred stock, which are convertible
into 4,477,691 shares of common stock, and a warrant to
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purchase an aggregate of 720,000 shares of our common stock for an aggregate
purchase price of $30.0 million. In connection with this purchase agreement, we
entered into an Amended and Restated Investors' Rights Agreement dated March 16,
1999 (the "1999 Investors' Rights Agreement"). The 1999 Investors' Rights
Agreement replaced the investors' rights agreement from the MCI WorldCom
investment. Please see "--Investors' Rights Agreement."
The Microsoft investment was also part of a broader strategic arrangement.
As part of the Microsoft arrangement, we entered into an agreement in which
Microsoft agreed to jointly distribute with us a co-branded DSL version of the
Microsoft Network service focused on our small business customers. See
"Business--Strategic Partnerships."
INVESTORS' RIGHTS AGREEMENT
Pursuant to the terms of the 1999 Investors' Rights Agreement, the holders
of preferred stock acquired certain registration rights with respect to our
common stock. At any time after the earlier of (i) March 11, 2002 or (ii) six
months after the effective date of the first registration statement for a public
offering of our securities we file under the Securities Act:
- holders of 60% or more of the registrable securities, as defined in the
1999 Investors' Rights Agreement, may require us to register for public
sale no less than 20% of their shares then outstanding; or
- Enron may require us to register for public sale no less than 20% of our
shares it then holds; or
- MCI WorldCom's investment fund may require us to register for public sale
no less than 20% of our shares it then holds.
In addition, if certain competitors of MCI WorldCom acquire greater than 5%
of our common stock, then MCI WorldCom's investment fund may require us to
register for public sale all of its shares of our stock (the "Contingent Demand
for Registration"). Our Board of Directors may defer any of the above demands
for registration for a period up to 120 days. We are obligated to effect only:
- two such registrations pursuant to the request of holders of 60% or more
of the registrable securities,
- one such registration pursuant to the request of Enron,
- one such registration pursuant to the request of MCI WorldCom's investment
fund, and
- one Contingent Demand for Registration pursuant to the request of MCI
WorldCom's investment fund.
In addition, if we propose to register securities under the Securities Act
after this offering, with certain exceptions, then any of the parties to the
Amended and Restated Investors' Rights Agreement has a right to request that we
register such holder's registrable securities, subject to quantity limitations
determined by underwriters if the offering involves an underwriting. All
registration expenses incurred in connection with the registrations described
above and all piggyback registrations will be borne by us. The participating
stockholders will pay for underwriting discounts and commissions incurred in
connection with any such registrations. We have agreed to indemnify the parties
to the agreement against certain liabilities in connection with any registration
effected pursuant to the 1999 Investors' Rights Agreement, including Securities
Act liabilities. Further, the holders of 40% or more of the registrable
securities may require us to register all or a portion of our registrable
securities on Form S-3 (a "Form S-3 Registration") when we qualify to file on
such form, provided that the aggregate proceeds of each such registration are at
least $5,000,000 and subject to certain other conditions and limitations,
including our ability to defer the filing of the Form S-3 Registration for a
period of not more than 120 days in certain circumstances. All expenses incurred
in connection with such a Form S-3 Registration shall be borne pro rata by the
stockholders participating in the Form S-3 Registration. All registration rights
will terminate no later than after five years following this offering. We have
agreed to indemnify the stockholders against certain liabilities in connection
with any registration effected pursuant to the 1999 Investors' Rights Agreement,
including liabilities under the Securities Act.
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OFFERING OF NOTES AND WARRANTS
On May 5, 1998, we closed a 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. In October 1998, we
exchanged our senior discount notes for a like principal amount of 1998 Notes
that we registered under the Securities Act. Certain associates of Donaldson,
Lufkin & Jenrette Securities Corporation ("DLJSC"), an initial purchaser in the
May 1998 offering, own an aggregate of 3,000,000 shares of Series A preferred
stock and 449,438 shares of Series B preferred stock, which represent in the
aggregate approximately 14.2% of our outstanding equity.
Of these, Sprout Capital VII, L.P. beneficially owns 2,609,686 shares of
Series A preferred stock and 390,966 shares of Series B preferred stock, which
represent in the aggregate approximately 12.4% of our outstanding equity. All of
the shares owned by Sprout Capital VII, L.P. are subject to a voting trust and
are held by an independent third party as trustee. The trustee will vote such
shares in its sole and absolute discretion as advised by an independent adviser
who is not affiliated with Sprout Capital VII, L.P. and DLJSC and subject to the
Amended and Restated Voting Agreement dated March 12, 1998.
Also, pursuant to the Amended and Restated Voting Agreement, Sprout Capital
VII, L.P., The Sprout CEO Fund, L.P., DLJ Capital Corporation and DLJ First ESC
L.L.C., all of which are affiliates of DLJSC, collectively have the right to
designate one member of the Board of Directors. Their current designee is Keith
B. Geeslin. Mr. Geeslin is a Divisional Senior Vice President of DLJ Capital
Corporation, a wholly owned subsidiary of Donaldson, Lufkin & Jenrette, Inc.,
the parent of DLJSC. Mr. Geeslin is also one of several individuals who serve as
general partners of DLJ Associates VII, L.P., which is a general partner of
Sprout Capital VII, L.P. DLJ Capital Corporation is the managing general partner
of each of Sprout Capital VII, L.P. and The Sprout CEO Fund, L.P.
DIRECTOR RELATIONSHIPS
William R. Stensrud, a member of our Board of Directors, also served as our
President and Chief Executive Officer from February 1997 through June 1997. Mr.
Stensrud and Mr. Geeslin, also a member of our Board of Directors, each also
serve as directors for Paradyne Corporation, one of our vendors. Additionally,
from June 1996 through December 1996, Mr. Stensrud served as President of
Paradyne Corporation. John L. Walecka, a member of our Board of Directors, also
serves as a director for Xylan Corporation, an indirect vendor to us. For the
period ended December 31, 1997 and for the year ended December 31, 1998, we made
purchases totaling approximately $419,000 and $13.0 million, respectively, from
Paradyne Corporation. We do not purchase any products directly from Xylan
Corporation; rather, our purchase of Xylan Corporation products is sourced
through Paradyne Corporation. We believe that our transactions with Paradyne
Corporation and Xylan Corporation were completed at rates similar to those
available from alternative vendors.
Susan Mayer, a member of our Board of Directors, also serves as President of
MCI WorldCom's investment fund and a Senior Vice President of MCI WorldCom, Inc.
In March 1999, we entered into a strategic arrangement with MCI WorldCom, Inc.
As part of this strategic arrangement, MCI WorldCom's investment fund invested
$30.0 million in us. Please see "Business--Strategic Partnerships."
LEGAL SERVICES
Jeffrey Blumenfeld, our Vice President and General Counsel, also serves as a
partner of Blumenfeld & Cohen, a law firm which performs legal services for us.
In connection with Mr. Blumenfeld's employment with us, we issued to him options
to purchase 438,115 shares of common stock at an exercise price of $0.04 per
share, which were exercised in January 1998. In addition, Mr. Blumenfeld and
certain other partners of Blumenfeld & Cohen purchased an aggregate of 140,000
shares of Series A preferred stock at $1.00 per share. For the period ended
December 31, 1997 and for the year ended December 31, 1998, we incurred expenses
for legal fees to Blumenfeld & Cohen of approximately $92,000 and $1.3 million,
respectively.
Pursuant to the terms of a written employment agreement with Mr. Blumenfeld,
we have agreed to employ him as Vice President and General Counsel at an annual
salary of $110,000 for a minimum time commitment by Mr. Blumenfeld of 24 hours a
week. Under the terms of such agreement, Blumenfeld & Cohen has agreed to charge
us at a discount from its regular rates for legal services, including Mr.
Blumenfeld's time in excess of his minimum time commitment.
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PRINCIPAL STOCKHOLDERS
The following table sets forth certain information as of March 16, 1999 with
respect to the beneficial ownership of our common stock and as adjusted to
reflect the sale of shares of common stock in this offering by:
- each person known by us to own beneficially more than five percent, in the
aggregate, of the outstanding shares of our common stock, assuming the
conversion of all preferred stock into common stock,
- our directors and our Named Executive Officers, and
- all executive officers and directors as a group.
Share ownership in each case includes shares issuable upon exercise of
outstanding options and warrants that are exercisable within 60 days of March
16, 1999 as described in the footnotes below. Percentage of ownership is
calculated pursuant to SEC Rule 13d-3(d)(1). Certain of the outstanding shares
of our capital stock are subject to a voting agreement. Unless otherwise
indicated, the address for each stockholder is c/o Rhythms NetConnections Inc.,
6933 South Revere Parkway, Englewood, Colorado 80112.
<TABLE>
<CAPTION>
PERCENTAGE BENEFICIALLY
OWNED
NUMBER OF ------------------------
BENEFICIALLY BEFORE AFTER
BENEFICIAL OWNER (1) OWNED SHARES (1) OFFERING OFFERING
- --------------------------------------------------------------------------- ---------------- ----------- -----------
<S> <C> <C> <C>
Brentwood Venture Capital (2).............................................. 8,278,651 14.2% 12.2%
Enterprise Partners (3).................................................... 10,440,415 17.9% 15.4%
Kleiner Perkins Caufield & Byers (4)....................................... 8,278,651 14.2% 12.2%
MCI WorldCom Investment Fund (5)........................................... 5,197,692 8.8% 7.6%
The Sprout Group (6)....................................................... 8,278,651 14.2% 12.2%
Enron Communications Group (7)............................................. 5,393,258 9.3% 8.0%
Microsoft Corporation (8).................................................. 5,197,691 8.8% 7.6%
Catherine M. Hapka (9)..................................................... 4,621,130 7.9% 6.8%
Michael E. Calabrese (10).................................................. 360,000 * *
Eric H. Geis (11).......................................................... 150,000 * *
James A. Greenberg (12).................................................... 715,642 1.2% 1.1%
Gloria Farler (13)......................................................... 36,000 * *
Kevin R. Compton (14)...................................................... -- -- --
Keith B. Geeslin (15)...................................................... -- -- --
Ken Harrison (16).......................................................... -- -- --
Susan Mayer (17)........................................................... -- -- --
William R. Stensrud (18)................................................... -- -- --
John L. Walecka (19)....................................................... -- -- --
Edward J. Zander........................................................... -- -- --
All directors and executive officers as a group (16 persons) (20).......... 7,582,886 12.8% 11.0%
</TABLE>
- ------------------------------
* Represents beneficial ownership of less than one percent of the outstanding
shares of our common stock.
(1) Except as indicated by footnote, we understand that the persons named in
the table above have sole voting and investment power with respect to all
shares shown as beneficially owned by them, subject to community property
laws where applicable.
(2) Consists of shares beneficially owned by Brentwood Affiliates Fund, L.P.
and Brentwood Associates VII, L.P. (collectively, the "Brentwood
Entities"). The address for the Brentwood Entities is 3000 Sand Hill Road,
Building 1, Suite 260, Menlo Park, California 94025.
(3) Consists of shares beneficially owned by Enterprise Partners III
Associates, L.P., Enterprise Partners III, L.P. and Enterprise Partners IV,
L.P. (collectively, the "Enterprise Entities"). The address for each of the
Enterprise Entities is 7979 Ivanhoe, Suite 550, La Jolla, California 92037.
(4) Consists of shares beneficially owned by Kleiner Perkins Caufield & Byers
VIII, KPCB VIII Founders Fund and KPCB VIII Information Sciences Zaibatsu
Fund II (collectively, the "KPCB Entities"). The address for each of the
KPCB Entities is 2750 Sand Hill Road, Menlo Park, California 94025.
(5) Includes 720,000 shares issuable upon exercise of a warrant exercisable
within 60 days of March 16, 1999.
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<PAGE>
(6) Consists of shares beneficially owned by DLJ Capital Corporation, DLJ First
ESC L.L.C., Sprout Capital VII, L.P. and The Sprout CEO Fund, L.P.
(collectively, the "Sprout Entities"). The address for each of the Sprout
Entities is 3000 Sand Hill Road, Building 3, Suite 170, Menlo Park,
California 94025. Of these, Sprout Capital VII, L.P. beneficially owns
7,201,565 shares. All of the shares beneficially owned by Sprout Capital
VII, L.P. are subject to a voting trust agreement and are held and voted by
an independent third party, First Union Trust Company, National
Association, as voting trustee. Please see "Certain Relationships and
Related Transactions--Offering of Senior Discount Offering Notes and
Warrants."
(7) These shares are subject to a voting trust agreement. See "Description of
Capital Stock--Board Representation Rights and Voting." The address for
Enron Communications Group, Inc. is 210 Southwest Morrison Street, Suite
400, Portland, Oregon 97204.
(8) Includes 720,000 shares issuable upon exercise of a warrant exercisable
within 60 days of March 16, 1999. The address for Microsoft Corporation is
One Microsoft Way, Redmond, Washington 98052.
(9) Includes shares held by Ms. Hapka's children, Christopher H. Safaya and
Catherine A. Safaya, in the amount of 5,333 shares each and shares held by
Christopher H. Safaya 1999 Trust and Catherine A. Safaya 1999 Trust in the
amount of 120,000 shares each.
(10) Includes 180,000 shares issuable upon exercise of options exercisable
within 60 days of March 16, 1999.
(11) Includes 18,000 shares issuable upon exercise of options exercisable
within 60 days of March 16, 1999.
(12) Includes 168,000 shares issuable upon exercise of options exercisable
within 60 days of March 16, 1999.
(13) Ms. Farler resigned in February 1999.
(14) Excludes shares held by the KPCB Entities. Mr. Compton, as a General
Partner of KPCB, may be deemed to have voting and investment power over
the shares held by the KPCB Entities. Mr. Compton disclaims beneficial
interest in such shares, except to the extent of his interest in the KPCB
Entities.
(15) Excludes shares held by the Sprout Entities. Mr. Geeslin, as a General
Partner of The Sprout Group, may be deemed to have voting and investment
power over the shares held by the Sprout Entities. Mr. Geeslin disclaims
beneficial interest in such shares, except to the extent of his interest
in the Sprout Entities.
(16) Excludes shares held by Enron. Mr. Harrison, as Chairman of Enron, may be
deemed to have voting and investment power over the shares held by Enron.
Mr. Harrison disclaims beneficial interest in such shares, except to the
extent of his interest in Enron.
(17) Excludes shares held by MCI WorldCom's investment fund. Ms. Mayer, as
President of MCI WorldCom's investment fund, may be deemed to have voting
and investment power over the shares held by MCI WorldCom's investment
fund. Ms. Mayer disclaims beneficial interest on such shares, except to
the extent of her interest in MCI WorldCom's investment fund.
(18) Excludes shares held by the Enterprise Entities. Mr. Stensrud, as a
General Partner of Enterprise Partners, may be deemed to have voting and
investment power over the shares held by the Enterprise Entities. Mr.
Stensrud disclaims beneficial interest in such shares, except to the
extent of his interest in the Enterprise Entities.
(19) Excludes shares held by the Brentwood Entities. Mr. Walecka, as a General
Partner of Brentwood Venture Capital, may be deemed to have voting and
investment power over the shares held by the Brentwood Entities. Mr.
Walecka disclaims beneficial interest in such shares, except to the extent
of his interest in the Brentwood Entities.
(20) Includes 1,182,000 shares issuable upon exercise of options or warrants
exercisable within 60 days of March 16, 1999 and excludes shares held by
the Brentwood Entities, the Enterprise Entities, the KPCB Entities, MCI
WorldCom, the Sprout Entities and Enron Communications Group.
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DESCRIPTION OF CAPITAL STOCK
After this offering, we will be authorized to issue 100,000,000 shares of
common stock, $0.001 par value per share, of which 67,631,896 shares will be
issued and outstanding, 1,000,000 shares of Series 1 preferred stock, $0.001 par
value per share, of which no shares will be issued and outstanding and 4,000,000
shares of undesignated preferred stock, $0.001 par value per share, of which no
shares will be issued and outstanding.
COMMON STOCK
As of March 16, 1999, there were 8,741,424 shares of common stock
outstanding and held of record by approximately 50 stockholders. The holders of
common stock are entitled to one vote for each share held of record on all
matters submitted to a vote of the stockholders. Subject to preferences that may
be applicable to any outstanding shares of preferred stock, holders of common
stock are entitled to receive ratably such dividends as may be declared by the
Board of Directors out of funds legally available. See "Dividend Policy." All
outstanding shares of common stock are fully paid and nonassessable.
PREFERRED STOCK
After this offering of common stock, the Board of Directors will have the
authority, without further action by the stockholders, to issue up to 1,000,000
shares of Series 1 preferred stock and 4,000,000 additional shares of preferred
stock in one or more series and to fix the rights, priorities, preferences,
qualifications, limitations and restrictions, including dividend rights,
conversion rights, voting rights, terms of redemption, terms of sinking funds,
liquidation preferences and the number of shares constituting any series or the
designation of such series, which could decrease the amount of earnings and
assets available for distribution to holders of common stock or adversely affect
the rights and powers, including voting rights, of the holders of the common
stock. The issuance of preferred stock could have the effect of delaying or
preventing a change in control or make removal of our management more difficult.
Additionally, the issuance of preferred stock may have the effect of decreasing
the market price of the common stock and may adversely affect the voting and
other rights of the holders of common stock. After this offering, there will be
no shares of preferred stock outstanding.
WARRANTS
In connection with the issuance of the senior discount notes in May 1998, we
issued warrants to purchase an aggregate of 4,732,800 shares of common stock
with an exercise price of $0.004 per share. These warrants become exercisable on
May 4, 1999 and automatically expire on May 15, 2008. Following the occurrence
of a "repurchase event" as defined in the warrant agreement governing these
warrants, we must make an offer to repurchase for cash all outstanding warrants
issued in connection with the senior discount notes.
In May 1998, we also 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. This warrant is immediately exercisable and
expires on the later of 10 years from the date of grant or five years after the
closing of this offering.
In connection with its $30 million equity investment in us in March 1999, we
issued to MCI WorldCom's investment fund a warrant to purchase up to 720,000
shares of common stock at an exercise price of $6.70 per share. This warrant is
immediately exercisable and expires on March 2, 2004.
In connection with its $30 million equity investment in us in March 1999, we
issued to Microsoft a warrant to purchase up to 720,000 shares of common stock
at an exercise price of $6.70 per share. This warrant is immediately exercisable
and expires on March 15, 2004.
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REGISTRATION RIGHTS
Pursuant to the terms of the 1999 Investors' Rights Agreement, the holders
of preferred stock acquired certain registration rights with respect to our
common stock. For a description of these rights, see "Certain Relationships and
Related Transactions--Investors' Rights Agreement."
The holders of the warrants issued in connection with the senior discount
notes are entitled to piggyback registration rights similar to those described
above.
POSSIBLE ANTI-TAKEOVER MATTERS
CERTIFICATE OF INCORPORATION AND BYLAWS
Our certificate of incorporation authorizes our Board of Directors to
establish one or more series of undesignated preferred stock, the terms of which
can be determined by the Board of Directors at the time of issuance. See
"--Preferred Stock." Our certificate of incorporation also provides that all
stockholder action must be effected at a duly called meeting of stockholders and
not by a consent in writing. Our bylaws provide that our Board of Directors will
be classified into three classes of directors. Please see "Management--Directors
and Executive Officers." In addition, our bylaws do not permit our stockholders
to call a special meeting of stockholders; only our Chief Executive Officer,
President, Chairman of the Board or a majority of the Board of Directors are
permitted to call a special meeting of stockholders. Our bylaws also require
that stockholders give advance notice to our secretary of any nominations for
director or other business to be brought by stockholders at any stockholders'
meeting and require a supermajority vote of members of our Board of Directors
and/or stockholders to amend certain bylaw provisions. These provisions of the
certificate of incorporation and the bylaws could discourage potential
acquisition proposals and could delay or prevent a change in control of our
company. Such provisions may also have the effect of preventing changes in our
management.
DELAWARE ANTI-TAKEOVER STATUTE
We are subject to Section 203 of the Delaware General Corporation Law
("Section 203") which, subject to certain exceptions, prohibits a Delaware
corporation from engaging in any business combination with any interested
stockholder -- defined as any person or entity that is the beneficial owner of
at least 15% of a corporation's voting stock -- for a period of three years
following the time that such stockholder became an interested stockholder,
unless:
- prior to such time, such corporation's board of directors approved either
the business combination or the transaction that resulted in the
stockholder becoming an interested stockholder;
- upon consummation of the transaction that resulted in the stockholder
becoming an interested stockholder, the interested stockholder owned at
least 85% of such corporation's voting stock outstanding at the time the
transaction commenced, excluding, for purposes of determining the number
of shares outstanding, those shares owned (x) by persons who are directors
and also officers and (y) by employee stock plans in which employee
participants do not have the right to determine confidentially whether
shares held subject to the plan will be tendered in a tender or exchange
offer; or
- at or subsequent to such time, the business combination is approved by
such corporation's board of directors and authorized at an annual or
special meeting of stockholders, and not by written consent, by the
affirmative vote of at least two-thirds of the outstanding voting stock
that is not owned by the interested stockholder.
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Section 203 defines business combination to include:
- any merger or consolidation involving the corporation and the interested
stockholder;
- any sale, lease, exchange, mortgage, transfer, pledge or other disposition
involving the interested stockholder and 10% or more of the assets of the
corporation;
- subject to certain exceptions, any transaction which results in the
issuance or transfer by the corporation of any stock of the corporation to
the interested stockholder;
- any transaction involving the corporation that has the effect of
increasing the proportionate share of the stock of any class or series of
the corporation beneficially owned by the interested stockholder; or
- the receipt by the interested stockholder of the benefit of any loans,
advances, guarantees, pledges or other financial benefits provided by or
through the corporation.
RIGHTS PLAN
Prior to the closing of this offering, it is anticipated that our Board of
Directors will adopt a rights plan (the "Rights Agreement") pursuant to which
one right (a "Right") to purchase one one-thousandth of a share of a series of
preferred stock, par value $0.001 per share (the "Rights Plan preferred stock")
at a specified price, would be issued as a dividend for each outstanding share
of common stock. The Rights would become exercisable ten days after a person or
group acquires 15% or more of the outstanding common stock or commences or
announces a tender or exchange offer which would result in such ownership.
If, after the Rights become exercisable, we were to be acquired through a
merger or other business combination transaction or 50% or more of our assets or
earning power were sold, each Right would permit the holder to purchase, for the
exercise price, common stock of the acquiring company having a market value of
twice the exercise price. In addition, if any person acquires 15% or more of the
outstanding common stock, each Right not owned by such person would permit the
purchase, for the exercise price, of common stock having a market value of twice
the exercise price.
The Rights would expire ten years after the adoption of the Rights
Agreement, unless earlier redeemed by us in accordance with the terms of the
Rights Agreement. The purchase price payable and the shares of Rights Plan
preferred stock issuable upon exercise of the Rights would be subject to
adjustment from time to time as specified in the Rights Agreement. In addition,
our Board of Directors would retain the authority to redeem, at $0.001 per
Right, and replace the Rights with new rights at any time, provided that no such
redemption could occur after a person or group acquires 15% or more of the
outstanding common stock.
Shares of Rights Plan preferred stock, when issued upon exercise of the
Rights, will be nonredeemable and will rank junior to all series of any other
class of preferred stock. Each share of Rights Plan preferred stock will be
entitled to a cumulative preferential quarterly dividend payment equal to the
greater of (1) $10 per share or (2) 1,000 times the dividend declared per share
of common stock. In the event of liquidation, the holders of shares of Rights
Plan preferred stock will be entitled to a preferential liquidation payment
equal to the greater of (a) $1,000 per share or (b) 1,000 times the payment made
per share of common stock. Each share of Rights Plan preferred stock will
entitle the holder to 1,000 votes, voting together with the common stock.
Finally, in the event of any merger, consolidation or other transaction in which
common stock is exchanged, each share of Rights Plan preferred stock will be
entitled to receive 1,000 times the amount received per share of common stock.
The foregoing rights would be subject to antidilution adjustments. The number of
shares constituting the series of Rights Plan preferred stock will be 1,000,000.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the common stock is American Securities
Transfer & Trust, Inc.
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SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, there will be approximately 67.6 million
shares of our common stock outstanding. There were also approximately 19,700
shares covered by vested options outstanding at March 16, 1999, which are not
considered to be outstanding shares. Of the outstanding shares, approximately
12.4 million shares, including the 9.375 million shares of common stock sold in
this offering, will be immediately eligible for resale in the public market
without restriction under the Securities Act, except that any shares purchased
in this offering by our affiliates, as that term is defined in Rule 144 under
the Securities Act ("Rule 144"), may generally only be resold in compliance with
applicable provisions of Rule 144.
Our executive officers and directors and substantially all of our security
holders, have agreed pursuant to certain agreements that they will not, without
the prior written consent of Merrill Lynch and Salomon Smith Barney, offer, sell
or otherwise dispose of the shares of common stock beneficially owned by them
for a period of 180 days from the date of this prospectus. The shares subject to
the lock-up agreements include approximately 65.7 million of the shares of
common stock that would otherwise have become immediately eligible for resale in
the public market upon completion of this offering.
Under Rule 144, a stockholder, including an affiliate, who has beneficially
owned his or her restricted securities (as that term is defined in Rule 144) for
at least one year from the later of the date such securities were acquired from
us or (if applicable) the date they were acquired from an affiliate is entitled
to sell, within any three-month period, a number of such shares that does not
exceed the greater of 1% of the then outstanding shares of common stock
(approximately 676,000 immediately after this offering) or the average weekly
trading volume in the common stock during the four calendar weeks preceding the
date on which notice of such sale was filed under Rule 144, provided certain
requirements concerning availability of public information, manner of sale and
notice of sale are satisfied. In addition, under Rule 144(k), if a period of at
least two years has elapsed between the later of the date restricted securities
were acquired from us or, if applicable, the date they were acquired from our
affiliate, a stockholder who is not our affiliate at the time of sale and has
not been our affiliate for at least three months prior to the sale is entitled
to sell the shares immediately without compliance with the foregoing
requirements under Rule 144.
Securities issued in reliance on Rule 701 (such as shares of common stock
that may be acquired pursuant to the exercise of certain options granted prior
to this offering) are also restricted securities and may be sold by stockholders
other than our affiliate subject only to the manner of sale provisions of Rule
144 and by our affiliate under Rule 144 without compliance with its one-year
holding period requirement.
Prior to this offering, there has been no public market for the common
stock. No prediction can be made as to the effect, if any, that market sales of
shares or the availability of shares for sale will have on the market price of
the common stock prevailing from time to time. We are unable to estimate the
number of shares that may be sold in the public market pursuant to Rule 144,
since this will depend on the market price of the common stock, the personal
circumstances of the sellers and other factors. Nevertheless, sales of
significant amounts of our common stock in the public market could adversely
affect the market price of the common stock and could impair our ability to
raise capital through an offering of our equity securities.
In addition, we have registered a total of 4,061,105 shares of common stock
subject to outstanding options or reserved for issuance under our stock
incentive plans and intend to register an additional 6,000,000 such shares on
the effective date of this offering. Further, upon expiration of such lock-up
agreements, holders of approximately 57.0 million shares of common stock will be
entitled to certain registration rights with respect to such shares. If such
holders, by exercising their registration rights, cause a large number of shares
to be registered and sold in the public market, such sales could have a material
adverse effect on the market price of the common stock.
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UNDERWRITING
Merrill Lynch, Pierce, Fenner & Smith Incorporated, Salomon Smith Barney
Inc., Hambrecht & Quist LLC and Thomas Weisel Partners LLC are acting as
representatives of the underwriters. Subject to the terms and conditions
contained in a purchase agreement, we have agreed to sell to each underwriter,
and each underwriter severally has agreed to purchase from us, the numbers of
shares of common stock set forth opposite its name below. The underwriters are
committed to purchase and pay for all such shares if any are purchased.
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
- ---------------------------------------------------------------- -----------
<S> <C>
Merrill Lynch, Pierce, Fenner & Smith
Incorporated..........................................
Salomon Smith Barney Inc. ......................................
Hambrecht & Quist LLC...........................................
Thomas Weisel Partners LLC......................................
-----------
Total................................................. 9,375,000
-----------
-----------
</TABLE>
The representatives have advised us that the underwriters propose to offer
the common stock to the public at the initial public offering price set forth on
the cover page of this prospectus and to certain dealers at such price less a
concession of not in excess of $ per share. The underwriters may allow, and
such dealers may reallow, a discount not in excess of $ per share to certain
other dealers. After the initial public offering, the public offering price,
concession and discount may be changed. No such change shall reduce the amount
of proceeds to be received by us as set forth on the cover page of this
prospectus.
We have granted to the underwriters an option, exercisable during the 30-day
period after the date of this prospectus, to purchase up to 1,406,250 additional
shares of common stock, at the price set forth on the cover page of this
prospectus, less the underwriting discount. To the extent that the underwriters
exercise such option, each of the underwriters will have a firm commitment to
purchase approximately the same percentage of such additional shares that the
number of shares of common stock to be purchased by it shown in the above table
represents as a percentage of the 9,375,000 shares offered hereby. If purchased,
such additional shares will be sold by the underwriters on the same terms as
those on which the 9,375,000 shares are being sold.
The purchase agreement contains covenants of indemnity among the
underwriters and us against certain civil liabilities, including liabilities
under the Securities Act and liabilities arising from breaches of
representations and warranties contained in the purchase agreement.
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The following table shows the per share and total underwriting discount we
will pay to the underwriters. The amounts are shown assuming both no exercise
and full exercise of the underwriters' option to purchase 1,406,250 additional
shares of common stock.
<TABLE>
<CAPTION>
TOTAL
WITHOUT TOTAL
PER SHARE OPTION WITH OPTION
--------------- ------------- -----------------
<S> <C> <C> <C>
Public Offering Price...................................... $ $ $
Underwriting Discount...................................... $ $ $
Proceeds, before expenses, to Rhythms...................... $ $ $
</TABLE>
We expect to incur expenses of approximately $1,250,000 in connection with
this offering.
The common stock is being offered by the underwriters, subject to prior
sale, when, as and if issued to and accepted by them, subject to approval of
certain conditions by counsel to the underwriters and certain other conditions.
The underwriters reserve the right to withdraw, cancel or modify such offer and
to reject orders in whole or in part.
Each of our officers and directors and substantially all of the holders of
common stock have agreed with the representatives, for a period of 180 days
after the date of this prospectus (the "Lock-Up Period"), subject to certain
exceptions, not to offer to sell, contract to sell, or otherwise sell, dispose
of, loan, pledge or grant any rights with respect to any shares of common stock,
any options or warrants to purchase any shares of common stock, or any
securities convertible into or exchangeable for shares of common stock owned as
of the date of this prospectus or thereafter acquired directly by such holders
or with respect to which they have or hereafter acquire the power of
disposition, without the prior written consent of Merrill Lynch and Salomon
Smith Barney. 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 lock-up agreements. We have agreed that during the Lock-Up
Period, we will not, subject to certain exceptions, without the prior written
consent of Merrill Lynch and Salomon Smith Barney, issue, sell, contract to sell
or otherwise dispose of, any shares of common stock, any options or warrants to
purchase any shares of common stock or any securities convertible into,
exercisable for or exchangeable for shares of common stock, other than the sale
of our shares in this offering, the issuance of common stock upon the exercise
of outstanding options and warrants and our issuance of options and stock under
the 1997 Stock Plan. See "Shares Eligible for Future Sale."
The representatives have advised us that they do not intend to confirm sales
to any accounts over which they exercise discretionary authority.
Prior to this offering, there has been no public market for our common
stock. Consequently, the initial public offering price for the common stock
offered hereby will be determined through negotiations between us and the
representatives. Among the factors to be considered in such negotiations are
prevailing market conditions, our financial information, market valuations of
other companies that we and the representatives believe to be comparable to us,
estimates of our business potential, the present state of our development and
other factors deemed relevant.
Certain persons participating in this offering may engage in transactions,
including syndicate covering transactions or the imposition of penalty bids,
which may involve the purchase of common stock on the Nasdaq National Market or
otherwise. Such transactions may stabilize or maintain the market price of the
common stock at a level above that which might otherwise prevail in the open
market and, if commenced, may be discontinued at any time.
The representatives have advised us that, pursuant to Regulation M under the
Securities Act, certain persons participating in this offering may engage in
transactions, including stabilizing bids, syndicate covering transactions or the
imposition of penalty bids, which may have the effect of
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stabilizing or maintaining the market price of the common stock at a level above
that which might otherwise prevail in the open market. A "stabilizing bid" is a
bid for or the purchase of the common stock on behalf of the underwriters for
the purpose of fixing or maintaining the price of the common stock. A "syndicate
covering transaction" is the bid for or the purchase of the common stock on
behalf of the underwriters to reduce a short position incurred by the
underwriters in connection with the offering. A "penalty bid" is an arrangement
permitting the representatives to reclaim the selling concession otherwise
accruing to an underwriter or syndicate member in connection with this offering
if the common stock originally sold by such underwriter or syndicate member is
purchased by the representatives in a syndicate covering transaction and has
therefore not been effectively placed by such underwriter or syndicate member.
The representatives have advised us that such transactions may be effected on
the Nasdaq National Market or otherwise and, if commenced, may be discontinued
at any time.
Merrill Lynch acted as an initial purchaser of our senior discount notes in
May 1998, for which they received usual and customary fees.
Thomas Weisel Partners LLC was formed in October 1998.
LEGAL MATTERS
Brobeck, Phleger & Harrison LLP ("BPH"), San Diego, California, will pass
upon the validity of the issuance of the shares of common stock offered hereby
for us. Baker & McKenzie, New York, New York, will pass upon certain legal
matters related to the issuance of the shares of common stock offered hereby for
the underwriters. The BPH investment fund and certain BPH attorneys hold in the
aggregate 30,000 shares of Series A preferred stock which will convert into
72,000 shares of common stock upon the closing of this offering.
EXPERTS
The financial statements of the Company as of December 31, 1997 and 1998,
for the period from February 27, 1997 through December 31, 1997 and for the year
ended December 31, 1998, included in this prospectus, have been included herein
in reliance on the report of PricewaterhouseCoopers LLP, independent
accountants, given on the authority of that firm as experts in accounting and
auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the SEC a registration statement on Form S-1 under the
Securities Act with respect to the common stock. This prospectus does not
contain all of the information contained in the registration statement, and the
exhibits and schedules to the registration statement. For further information
with respect to us and our common stock, we refer you to the registration
statement, and the exhibits and schedules filed as part of the registration
statement. Statements in this prospectus concerning the contents of any contract
or any other document are not necessarily complete. If a contract or document
has been filed as an exhibit to the registration statement, we refer you to that
exhibit. Each statement in this prospectus relating to a contract or document
filed as an exhibit to the registration statement is qualified by the filed
exhibits.
IN ADDITION, WE FILE REPORTS, PROXY STATEMENTS AND OTHER INFORMATION WITH
THE SEC. YOU MAY READ AND COPY ANY DOCUMENT WE FILE, INCLUDING THE REGISTRATION
STATEMENT, 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.
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GLOSSARY OF TERMS
<TABLE>
<S> <C>
Asynchronous Transfer Mode... High bandwidth, low-delay, connection-oriented, packet-like
switching and multiplexing technique requiring 53-byte,
fixed-sized cells.
Backbone..................... An element of the network infrastructure that provides
high-speed, high capacity connections among the network's
physical points of presence, i.e., connection points and
Metro Service Centers. The backbone is used to transport end
user traffic across the metropolitan area and across the
United States.
Bandwidth.................... Refers to the maximum amount of data that can be transferred
through a computer's backbone or communication channel in a
given time. It is usually measured in Hertz, cycles per
second, for analog communications and bits per second for
digital communications.
Central Office............... Incumbent carrier facility where subscriber lines are joined
to ILEC switching equipment.
Collocation.................. A location where a competitive carrier network interconnects
with the network of an incumbent carrier inside an incumbent
carrier's central office.
Competitive Carrier.......... Category of telephone service provider, or carrier, that
offers local exchange and other services similar to and in
competition with those of the incumbent carrier, as allowed
by recent changes in telecommunications law and regulation. A
competitive carrier may also provide other types of services
such as long distance telephone, data communications,
Internet access and video.
Copper Line or Loop.......... A pair of traditional copper telephone lines using electric
current to carry signals.
Digital...................... Describes a method of storing, processing and transmitting
information through the use of distinct electronic or optical
pulses that represent the binary digits 0 and 1. Digital
transmission and switching technologies employ a sequence of
these pulses to convey information, as opposed to the
continuously variable analog signal. The precise digital
numbers preclude distortion, such as graininess or "snow", in
the case of video transmission, or static or other background
distortion in the case of audio transmission.
Downstream................... Refers to the transmission speed of a connection between our
connection point and the end user.
DS-0......................... DIGITAL SERVICE 0. Standard telecommunications industry
digital signal format, which is distinguishable by bit rate
-- the number of binary digits transmitted per second. DS-0
service has a bit rate of 64 Kilobits per second.
DS-1......................... DIGITAL SERVICE 1. In the digital hierarchy, this signaling
standard defines a transmission speed of 1.544 Mbps.
DS-3......................... DIGITAL SERVICE 3. In the digital hierarchy, this signaling
standard defines a transmission speed of 44.736 Mbps,
equivalent to 28 T-1 channels. This term is often used
interchangeably with T-3.
</TABLE>
A-1
<PAGE>
<TABLE>
<S> <C>
DSL.......................... DIGITAL SUBSCRIBER LINE. A transmission technology enabling
high-speed access in the local copper loop, often referred to
as the last mile between the network service provider --
I.E., an incumbent carrier, competitive carrier or an
internet service provider -- and end user.
E-Commerce................... ELECTRONIC COMMERCE. An Internet service that supports
electronic transactions between customers and vendors to
purchase goods and services.
Encryption................... Applying a specific algorithm to data so as to alter the
data's appearance and prevent other devices from reading the
information. Decryption applies the algorithm in reverse to
restore the data to its original form.
Firewall..................... A computer device that separates a local area network from a
wide area network and prevents unauthorized access to the
local area network through the use of electronic security
mechanisms.
Frame Relay.................. A form of packet switching with variable length frames that
may be used with a variety of communications protocols.
Incumbent Carrier............ A company providing local exchange services on the date of
enactment of the Telecommunications Act of 1996. These
companies consist of the Regional Bell Operating Companies,
GTE and numerous independent telephone companies.
Interconnection Agreement.... A contract between an incumbent carrier and a competitive
carrier for the connection of a competitive carrier network
to the public switched telephone network, as well as
competitive carrier access to incumbent carrier unbundled
network elements, e.g., copper loops. This agreement sets out
some of the financial agreement and operational aspects of
such interconnection and access.
Internet..................... An array of interconnected networks using a common set of
protocols defining the information coding and processing
requirements that can communicate across hardware platforms
and over many links; now operated by a consortium of
telecommunications service providers and others.
Internet Protocol............ A standard for software that keeps track of the inter-network
addresses for different nodes, routes outgoing messages and
recognizes incoming messages.
ISDN......................... INTEGRATED SERVICES DIGITAL NETWORK. A transmission method
that provides circuit-switched access to the public network
at speeds of 64 or 128 Kbps for voice, data and video
transmission.
Internet Service Provider.... A company that provides direct access to the Internet.
Interexchange Carrier........ Usually referred to as a long-distance service provider.
There are many interexchange carriers, including AT&T, MCI
WorldCom, Sprint and Qwest.
Kbps......................... KILOBITS PER SECOND. 1,000 bits per second.
</TABLE>
A-2
<PAGE>
<TABLE>
<S> <C>
Long Distance Carrier........ A long distance carrier providing services between local
exchanges on an intrastate or interstate basis, also referred
to in the industry as an "interexchange carrier". A long
distance carrier may also be a long distance resale company.
Mbps......................... MEGABITS PER SECOND. Millions of bits per second.
Modem........................ An abbreviation of Modulator-Demodulator. An electronic
signal-conversion device used to convert digital signals from
a computer to analog form for transmission over the telephone
network. At the transmitting end, a modem working as a
modulator converts the computer's digital signals into analog
signals that can be transmitted over a telephone line. At the
receiving end, another modem working as a demodulator
converts analog signals back into digital signals and sends
them to the receiving computer.
Multiplexing................. An electronic or optical process that combines several lower
speed transmission signals into one higher speed signal.
Network...................... An integrated system composed of switching equipment and
transmission facilities designed to provide for the
direction, transport and recording of telecommunications
traffic.
OC-3......................... OPTICAL CARRIER 3. Standard telecommunications industry
digital single format, which is distinguishable by bit rate
-- the number of binary digits transmitted per second. OC-3
service has a bit rate of 155.5 Mbps.
OC-12........................ OPTICAL CARRIER 12. Standard telecommunications industry
digital single format, which is distinguishable by bit rate
-- the number of binary digits transmitted per second. OC-12
service has a bit rate of 622.8 Mbps.
Packets...................... Information represented as bytes grouped together through a
communication node with a common destination address and
other attribute information.
Resellers.................... Generally used to refer to a telecommunications provider who
does not own any switching or transmission facilities. In
reality, a large number of providers furnish services through
a combination of owned and resold facilities.
Router....................... A device that accepts the Internet Protocol from a local area
network or another wide area network device and
switches/routes Internet Protocol packets across a network
backbone. Routers also provide protocol conversion services
to transfer Internet Protocol packets over frame relay,
Asynchronous Transfer Mode, and other backbone network
services.
T-1.......................... This is a Bell System term for a digital transmission link
with a capacity of 1.544 Mbps.
TCP/IP....................... TRANSMISSION CONTROL PROTOCOL/INTERNET PROTOCOL. A set of
network protocols that allow computers with different
architectures and operating system software to communicate
with other computers on the Internet.
Upstream..................... Refers to the transmission speed of a connection between the
end user and our connection point.
</TABLE>
A-3
<PAGE>
RHYTHMS NETCONNECTIONS INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Accountants.................................................... F-2
Financial Statements:
Consolidated Balance Sheets........................................................ F-3
Consolidated Statements of Operations.............................................. F-4
Consolidated Statements of Cash Flows.............................................. F-5
Consolidated Statement of Stockholders' Equity..................................... F-6
Notes to Consolidated Financial Statements......................................... F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of Rhythms NetConnections Inc.
The stock split described in Note 12 to the consolidated financial
statements has not been consummated at March 16, 1999. When it has been
consummated, we will be in a position to furnish the following report:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of cash flows, and of stockholders'
equity present fairly, in all material respects, the financial position of
Rhythms NetConnections Inc. and subsidiaries at December 31, 1997 and 1998, and
the results of their operations and their cash flows for the period from
February 27, 1997 (inception) through December 31, 1997 and for the year ended
December 31, 1998 in conformity with generally accepted accounting principles.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
PRICEWATERHOUSECOOPERS LLP
Denver, Colorado
March 4, 1999
F-2
<PAGE>
RHYTHMS NETCONNECTIONS INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1998
------------- --------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents....................................................... $ 10,166,000 $ 21,315,000
Short-term investments.......................................................... -- 115,497,000
Accounts, loans and other receivables, net...................................... -- 2,376,000
Inventory....................................................................... -- 340,000
Prepaid expenses and other current assets....................................... 95,000 230,000
------------- --------------
Total current assets............................................................ 10,261,000 139,758,000
Equipment and furniture, net...................................................... 1,621,000 11,510,000
Collocation fees, net............................................................. 327,000 13,804,000
Deferred debt issue costs, net.................................................... -- 6,304,000
Other assets...................................................................... 32,000 350,000
------------- --------------
$ 12,241,000 $ 171,726,000
------------- --------------
------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt............................................... $ 126,000 $ 333,000
Accounts payable................................................................ 951,000 10,601,000
Accrued expenses and other current liabilities.................................. 376,000 2,855,000
------------- --------------
Total current liabilities..................................................... 1,453,000 13,789,000
Long-term debt.................................................................... 442,000 472,000
13.5% senior discount notes, net.................................................. -- 157,465,000
Other liabilities................................................................. -- 180,000
------------- --------------
Total liabilities............................................................. 1,895,000 171,906,000
------------- --------------
Commitments (note 10)
Mandatorily redeemable common stock warrants...................................... -- 6,567,000
------------- --------------
Stockholders' equity (deficit):
Series A convertible preferred stock, $0.001 par value; 17,000,000 shares
authorized in 1997, 12,900,000 shares in 1998; 12,490,000 shares issued and
outstanding in 1997, 12,855,094 shares in 1998................................ 12,000 13,000
Series B convertible preferred stock, $0.001 par value; no shares authorized in
1997, 4,044,943 shares in 1998; no shares issued and outstanding in 1997,
4,044,943 shares in 1998...................................................... -- 4,000
Common stock, $0.001 par value; 54,635,294 shares authorized in 1997, 80,049,892
shares in 1998; 2,482,222 shares issued in 1997, 8,042,530 shares in 1998..... 2,000 8,000
Treasury stock, at cost; 438,115 shares......................................... -- (18,000)
Additional paid-in capital...................................................... 14,012,000 37,212,000
Deferred compensation........................................................... (1,258,000) (5,210,000)
Accumulated deficit............................................................. (2,422,000) (38,756,000)
------------- --------------
Total stockholders' equity (deficit).......................................... 10,346,000 (6,747,000)
------------- --------------
$ 12,241,000 $ 171,726,000
------------- --------------
------------- --------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
RHYTHMS NETCONNECTIONS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD FROM
FEBRUARY 27, 1997
(INCEPTION)
THROUGH YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1998
------------------ -----------------
<S> <C> <C>
Revenue:
Service and installation, net......................................... $ -- $ 528,000
------------------ -----------------
Operating Expenses:
Network and service costs............................................. -- 4,695,000
Selling and marketing................................................. 33,000 3,776,000
General and administrative............................................ 2,501,000 19,377,000
Depreciation and amortization......................................... 1,000 1,081,000
------------------ -----------------
Total operating expenses............................................ 2,535,000 28,929,000
------------------ -----------------
Loss from Operations.................................................... (2,535,000) (28,401,000)
------------------ -----------------
Other Income and Expense:
Interest income....................................................... 114,000 5,813,000
Interest expense (including amortized debt discount and issue
costs).............................................................. (1,000) (13,779,000)
Other................................................................. -- 33,000
------------------ -----------------
Net Loss................................................................ $ (2,422,000) $ (36,334,000)
------------------ -----------------
------------------ -----------------
Net Loss Per Share:
Basic................................................................. $ (1.12) $ (12.18)
------------------ -----------------
------------------ -----------------
Diluted............................................................... $ (1.12) $ (12.18)
------------------ -----------------
------------------ -----------------
Shares Used in Computing Net Loss Per Share:
Basic................................................................. 2,161,764 2,984,216
------------------ -----------------
------------------ -----------------
Diluted............................................................... 2,161,764 2,984,216
------------------ -----------------
------------------ -----------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
RHYTHMS NETCONNECTIONS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM
FEBRUARY 27, 1997
(INCEPTION)
THROUGH YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1998
------------------ -----------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net Loss................................................................. $ (2,422,000) $ (36,334,000)
Adjustments to reconcile net loss to net cash used for operating
activities:
Depreciation of equipment and furniture................................ 1,000 454,000
Amortization of collocation fees....................................... -- 85,000
Amortization of debt discount and deferred debt issue costs............ -- 13,882,000
Amortization of deferred compensation.................................. 192,000 725,000
Compensation expense from stock option issued to employee.............. 73,000 --
Loss on sale of equipment to leasing company........................... -- 387,000
Changes in assets and liabilities:
Increase in accounts, loans and other receivables, net............... -- (2,376,000)
Increase in inventory................................................ -- (340,000)
Increase in prepaid expenses and other current assets................ (95,000) (135,000)
Increase in other assets............................................. (32,000) (318,000)
Increase in accounts payable......................................... 388,000 2,287,000
Increase in accrued expenses and other current liabilities........... 335,000 2,479,000
Increase in other liabilities........................................ -- 180,000
------------------ -----------------
Net cash used for operating activities................................. (1,560,000) (19,024,000)
------------------ -----------------
Cash Flows from Investing Activities:
Purchases of short-term investments...................................... -- (451,870,000)
Maturities of short-term investments..................................... -- 336,373,000
Purchases of equipment and furniture..................................... (1,018,000) (9,973,000)
Payment of collocation fees.............................................. (327,000) (13,562,000)
------------------ -----------------
Net cash used for investing activities................................. (1,345,000) (139,032,000)
------------------ -----------------
Cash Flows from Financing Activities:
Proceeds from leasing company for equipment.............................. -- 6,606,000
Proceeds from issuance of 13.5% senior discount notes and warrants....... -- 150,365,000
Payment of debt issue costs on 13.5% senior discount notes............... -- (6,519,000)
Proceeds from borrowings on long-term debt............................... 568,000 432,000
Repayments on long-term debt............................................. -- (195,000)
Proceeds from issuance of common stock................................... 13,000 242,000
Proceeds from issuance of preferred stock................................ 12,490,000 18,292,000
Purchase of treasury stock............................................... -- (18,000)
------------------ -----------------
Net cash provided by financing activities.............................. 13,071,000 169,205,000
------------------ -----------------
Net increase in cash and cash equivalents.................................. 10,166,000 11,149,000
Cash and cash equivalents at beginning of period........................... -- 10,166,000
------------------ -----------------
Cash and cash equivalents at end of period................................. $ 10,166,000 $ 21,315,000
------------------ -----------------
------------------ -----------------
Supplemental schedule of cash flow information:
Cash paid for interest................................................... $ 3,000 $ 66,000
------------------ -----------------
------------------ -----------------
Supplemental schedule of non-cash financing activities:
Equipment purchases payable, to be financed through operating leases..... $ 604,000 $ --
------------------ -----------------
------------------ -----------------
Equipment and furniture purchases payable................................ $ -- $ 7,363,000
------------------ -----------------
------------------ -----------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
RHYTHMS NETCONNECTIONS INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
SERIES A SERIES B
CONVERTIBLE CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK COMMON STOCK
$0.001 PAR VALUE $0.001 PAR VALUE $0.001 PAR VALUE
------------------- ----------------- -----------------
# SHARES AMOUNT # SHARES AMOUNT # SHARES AMOUNT
---------- ------- --------- ------ --------- ------
<S> <C> <C> <C> <C> <C> <C>
Issuance of common stock to Founders (at
inception)............................ -- $ -- -- $-- 2,161,764 $2,000
Issuance of Series A preferred stock for
cash ($1.00 per share)................ 12,490,000 12,000 -- -- -- --
Issuance of common stock upon exercise
of options ($0.04 per share exercise
price)................................ -- -- -- -- 320,458 --
Grant of options to purchase Series A
preferred stock ($0.80 per share
exercise price)....................... -- -- -- -- -- --
Deferred compensation from grants of
options to purchase common stock...... -- -- -- -- -- --
Amortization of deferred compensation... -- -- -- -- -- --
Net loss for 1997....................... -- -- -- -- -- --
---------- ------- --------- ------ --------- ------
Balance at December 31, 1997............ 12,490,000 12,000 -- -- 2,482,222 2,000
Issuance of Series A preferred stock for
cash ($0.80 per share)................ 365,094 1,000 -- -- -- --
Issuance of Series B preferred stock for
cash ($4.45 per share)................ -- -- 4,044,943 4,000 -- --
Issuance of common stock upon exercise
of options ($0.04 to $0.25 per share
exercise price)....................... -- -- -- -- 5,560,308 6,000
Purchase of treasury stock for cash
($0.04 per share)..................... -- -- -- -- -- --
Deferred compensation from grants of
options to purchase common stock...... -- -- -- -- -- --
Amortization of deferred compensation... -- -- -- -- -- --
Reversal of deferred compensation from
cancellation of grants to purchase
common stock.......................... -- -- -- -- -- --
Net loss for 1998....................... -- -- -- -- -- --
---------- ------- --------- ------ --------- ------
Balance at December 31, 1998............ 12,855,094 $13,000 4,044,943 $4,000 8,042,530 $8,000
---------- ------- --------- ------ --------- ------
---------- ------- --------- ------ --------- ------
<CAPTION>
TREASURY STOCK TOTAL
AT COST ADDITIONAL STOCKHOLDERS'
------------------- PAID-IN DEFERRED ACCUMULATED EQUITY
# SHARES AMOUNT CAPITAL COMPENSATION DEFICIT (DEFICIT)
-------- -------- ----------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Issuance of common stock to Founders (at
inception)............................ -- $ -- $ -- $ -- $ -- $ 2,000
Issuance of Series A preferred stock for
cash ($1.00 per share)................ -- -- 12,477,000 -- -- 12,489,000
Issuance of common stock upon exercise
of options ($0.04 per share exercise
price)................................ -- -- 12,000 -- -- 12,000
Grant of options to purchase Series A
preferred stock ($0.80 per share
exercise price)....................... -- -- 73,000 -- -- 73,000
Deferred compensation from grants of
options to purchase common stock...... -- -- 1,450,000 (1,450,000) -- --
Amortization of deferred compensation... -- -- -- 192,000 -- 192,000
Net loss for 1997....................... -- -- -- -- (2,422,000 ) (2,422,000)
-------- -------- ----------- ------------ ------------ -------------
Balance at December 31, 1997............ -- -- 14,012,000 (1,258,000) (2,422,000 ) 10,346,000
Issuance of Series A preferred stock for
cash ($0.80 per share)................ -- -- 291,000 -- -- 292,000
Issuance of Series B preferred stock for
cash ($4.45 per share)................ -- -- 17,996,000 -- -- 18,000,000
Issuance of common stock upon exercise
of options ($0.04 to $0.25 per share
exercise price)....................... -- -- 236,000 -- -- 242,000
Purchase of treasury stock for cash
($0.04 per share)..................... 438,115 (18,000) -- -- -- (18,000)
Deferred compensation from grants of
options to purchase common stock...... -- -- 4,908,000 (4,908,000) -- --
Amortization of deferred compensation... -- -- -- 725,000 -- 725,000
Reversal of deferred compensation from
cancellation of grants to purchase
common stock.......................... -- -- (231,000) 231,000 -- --
Net loss for 1998....................... -- -- -- -- (36,334,000 ) (36,334,000)
-------- -------- ----------- ------------ ------------ -------------
Balance at December 31, 1998............ 438,115 $(18,000) $37,212,000 $(5,210,000) $(38,756,000) $(6,747,000)
-------- -------- ----------- ------------ ------------ -------------
-------- -------- ----------- ------------ ------------ -------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
RHYTHMS NETCONNECTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--THE COMPANY
Rhythms NetConnections Inc. (the "Company"), a Delaware corporation, was
organized under the name Accelerated Connections Inc. effective February 27,
1997. The Company's name was changed to Rhythms NetConnections Inc. as of August
15, 1997. The Company is in the business of providing high-speed data
communications services on an end-to end basis to business customers and end
users. The Company began service trials in the San Diego, California, market in
December 1997 and began commercial operations in San Diego effective April 1,
1998.
The Company's ultimate success depends upon, among other factors, rapidly
expanding the geographic coverage of its network services; entering into
interconnection agreements with incumbent local exchange carriers, some of which
are competitors or potential competitors of the Company; deploying network
infrastructure; attracting and retaining customers; accurately assessing
potential markets; continuing to develop and integrate its operational support
system and other back office systems; obtaining any required governmental
authorizations; responding to competitive developments; continuing to attract,
retain and motivate qualified personnel; and continuing to upgrade its
technologies and commercialize its network services incorporating such
technologies. There can be no assurance that the Company will be successful in
addressing these matters and failure to do so could have a material adverse
effect on the Company's business, prospects, operating results and financial
condition. As the Company continues the development of its business, it will
seek additional sources of financing to fund its development. If unsuccessful in
obtaining such financing, the Company will continue expansion of its operations
on a reduced scale based on its existing capital resources.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION: The accompanying consolidated financial
statements include the transactions and balances of Rhythms NetConnections Inc.
and its wholly owned subsidiaries ACI Corp. and ACI Corp.--Virginia (since
February 1998). All material intercompany transactions and balances have been
eliminated.
USE OF ESTIMATES: The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the
financial statement date, as well as the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
REVENUE RECOGNITION: Revenue is recorded in the period services are
provided to customers.
CASH AND CASH EQUIVALENTS: Cash and cash equivalents include cash on hand,
money market funds, certificates of deposit, obligations of the U.S. Government
and its agencies and commercial paper with a maturity of 90 days or less at the
time of purchase.
SHORT-TERM INVESTMENTS. Short-term investments consist of obligations of
the U.S. Government and its agencies and commercial paper that have an original
maturity between 91 days and one year from the date of purchase. Management
determines the appropriate classification of marketable debt and equity
securities at the time of purchase and reevaluates such designation as of each
balance sheet date.
FAIR VALUE OF FINANCIAL INSTRUMENTS: The carrying amounts of the Company's
financial instruments as presented are reasonable estimates of those
instruments' fair values because of the short maturity of
F-7
<PAGE>
RHYTHMS NETCONNECTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
those instruments or based on the current rates offered to the Company for debt
of the same remaining maturities.
INVENTORY: Inventory consists of communications equipment that will be
installed at customer locations. Inventory is accounted for on a FIFO basis at
the lower of cost or market.
EQUIPMENT AND FURNITURE: Equipment and furniture consists of purchased
equipment, furniture, computer software, and leasehold improvements. Equipment
and furniture is recorded at cost. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets, generally
three to seven years or the lease term if shorter. When equipment and furniture
is retired, sold or otherwise disposed of, the cost and related accumulated
depreciation are removed from the accounts and gains and losses resulting from
such transactions are reflected in operations.
COLLOCATION FEES: Collocation fees represent nonrecurring fees paid to
secure Central Office space for location of certain Company equipment. The fees
are amortized over their estimated useful lives of ten years.
IMPAIRMENT OF LONG-LIVED ASSETS: The Company investigates potential
impairments of their long-lived assets on an exception basis when evidence
exists that events or changes in circumstances may have made recovery of an
asset's carrying value unlikely. An impairment loss is recognized when the sum
of the expected undiscounted future net cash flows is less than the carrying
amount of the asset. No such losses have been identified.
CONCENTRATIONS OF CREDIT RISK: Credit risk is primarily concentrated in
cash equivalents and short-term investments. Cash in excess of operating
requirements is conservatively invested in money market funds, certificates of
deposit with high-quality financial institutions, obligations of the U.S.
Government and its agencies and commercial paper rated A-1, P-1 to minimize
risk.
Two customers comprise 14.9 percent and 7.5 percent of the Company's net
trade receivable balance at December 31, 1998 and 36.7 percent and 13.7 percent
of revenues for the year ended December 31, 1998.
INCOME TAXES: The Company provides for income taxes utilizing the liability
method. Under the liability method, current income tax expense or benefit
represents income taxes expected to be payable or refundable for the current
period. Deferred income tax assets and liabilities are established for both the
impact of differences between the financial reporting bases and tax bases of
assets and liabilities and for the expected future tax benefit to be derived
from tax credits and tax loss carryforwards. Deferred income tax expense or
benefit represents the change during the reporting period in the net deferred
income tax assets and liabilities. Deferred tax assets are reduced by a
valuation allowance when, in the opinion of management, it is more likely than
not that some portion or all of the deferred tax assets will not be realized.
NET LOSS PER SHARE: The Company has adopted Statement of Financial
Accounting Standard ("SFAS") No. 128, "Earnings Per Share." Basic earnings per
share ("EPS") is calculated by dividing the income or loss available to common
stockholders by the weighted average number of common shares outstanding for the
period, without consideration for common stock equivalents. Diluted EPS is
computed by dividing the income or loss available to common stockholders by the
weighted average number of common shares outstanding for the period in addition
to the weighted average number of
F-8
<PAGE>
RHYTHMS NETCONNECTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
common stock equivalents outstanding for the period. Shares subject to
repurchase by the Company are considered common stock equivalents for purposes
of this calculation. Shares issuable upon conversion of the Series A and Series
B preferred stock, upon the exercise of outstanding stock options and warrants
and shares issued subject to repurchase by the Company totaling 36,653,940 and
52,958,513 at December 31, 1997 and 1998, respectively, have been excluded from
the computation since their effect would be antidilutive.
STOCK-BASED COMPENSATION: The Company measures compensation expense for
their employee stock-based compensation using the intrinsic value method and
provides pro forma disclosures of net loss as if the fair value method had been
applied in measuring compensation expense. Under the intrinsic value method of
accounting for stock-based compensation, when the exercise price of options
granted to employees is less than the fair value of the underlying stock on the
date of grant, compensation expense is to be recognized over the applicable
vesting period.
NEW ACCOUNTING PRONOUNCEMENTS: In June 1998, SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," was issued. This statement
establishes accounting and reporting standards for derivative instruments and
for hedging activities. The Company will adopt SFAS No. 133 as required in 2000.
The Company expects that adoption will have no impact on their consolidated
financial statements.
RECLASSIFICATIONS: Certain 1997 balances have been reclassified to conform
to the 1998 presentation.
NOTE 3--SHORT-TERM INVESTMENTS
The Company's marketable debt securities are classified as held-to-maturity
and carried at amortized cost, which approximates fair value. Short-term
investments consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1998
------------ --------------
<S> <C> <C>
Commercial Paper............................................... $ -- $ 33,170,000
U.S. Government Securities..................................... -- 82,327,000
------------ --------------
$ -- $ 115,497,000
------------ --------------
------------ --------------
</TABLE>
F-9
<PAGE>
RHYTHMS NETCONNECTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--COMPOSITION OF CERTAIN BALANCE SHEET COMPONENTS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1998
----------------- ------------------
<S> <C> <C>
Accounts, loans and other receivables, net:
Interest............................................. $ -- $ 2,135,000
Trade, net of allowance for doubtful accounts of
$50,000 in 1998.................................... -- 197,000
Employee expense advances and loans.................. -- 44,000
----------------- ------------------
$ -- $ 2,376,000
----------------- ------------------
----------------- ------------------
Equipment and furniture, net:
Operating equipment.................................. $ 1,241,000 $ 9,633,000
Office furniture..................................... 43,000 917,000
Leasehold improvements............................... 32,000 668,000
Computer software.................................... 173,000 456,000
Computer equipment................................... 133,000 274,000
Lab equipment........................................ -- 17,000
Accumulated depreciation............................. (1,000) (455,000)
----------------- ------------------
$ 1,621,000 $ 11,510,000
----------------- ------------------
----------------- ------------------
Accrued expenses and other current liabilities:
Accrued payroll...................................... $ 217,000 $ 1,524,000
Carrier services and other operating costs........... -- 991,000
Other................................................ 159,000 340,000
----------------- ------------------
$ 376,000 $ 2,855,000
----------------- ------------------
----------------- ------------------
</TABLE>
NOTE 5--DEBT
As of December 31, 1997 and 1998, the Company had a note payable of $568,000
and $805,000, respectively, to a financial institution. Terms of the note
payable include an interest rate of prime plus 0.25 percent (8.75 percent and
8.0 percent at December 31, 1997 and 1998, respectively) payable monthly on the
outstanding principal. The note is collateralized by assets of the Company and
is to be amortized over a 36-month repayment period. The $805,000 will be repaid
during the years 1999 through 2001 in the amounts of $333,000 each in 1999 and
2000 and $139,000 in 2001.
On May 5, 1998, the Company issued 13.5 percent senior discount notes due
2008 in the principal amount of $290,000,000 at maturity, combined with warrants
to purchase 4,732,800 shares of common stock. The notes were issued at a
discount; cash proceeds from the issuance of the notes and warrants were
$150,365,000. The Company additionally incurred approximately $6,519,000 in debt
issue costs. The notes will accrete in value through May 15, 2003 at a rate of
13.5 percent per annum, compounded semi-annually; no cash interest will be
payable prior to that date. Upon a change in control or upon certain asset
sales, the Company must offer to repurchase all or a portion of the outstanding
notes. In addition, the Company has the option to repurchase the notes upon
payment of a premium of accreted value at that point in time. The notes contain
covenants that restrict the Company's ability to make certain payments,
including dividend payments, and incur additional debt.
F-10
<PAGE>
RHYTHMS NETCONNECTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--DEBT (CONTINUED)
The warrants issued in connection with the senior discount notes are
exercisable at a price of $0.004 per share. The warrants expire May 15, 2008.
The warrants may be required to be repurchased by the Company for cash upon the
occurrence of a repurchase event, such as a consolidation, merger, or sale of
assets to another entity, as defined in the provisions of the Warrant Agreement,
at a price to be determined by an independent financial expert selected by the
Company. In the event a repurchase event occurs, the difference between the
repurchase price and the carrying value of the warrants would be charged to
equity. The value ascribed to the warrants of $6,567,000 resulted in additional
debt discount, which, together with the debt issue costs are being amortized to
interest expense using the effective interest method over the period that the
notes are outstanding.
Effective November 20, 1998, the Company completed an exchange offer of the
13.5 percent senior discount notes that allowed for registration of such notes
under the Securities Act of 1933, as amended. $289,000,000 of the original issue
notes were tendered for exchange. The registered notes have substantially the
same terms and conditions as the unregistered notes, except that the registered
notes are not subject to the restrictions on resale or transfer that applied to
the unregistered notes.
During May 1998 the Company entered into a 36-month lease line that provides
for $24.5 million in equipment on an operating lease basis. In connection with
this lease agreement, the Company issued 574,380 warrants to purchase common
stock at a price of $1.85 per share, exercisable immediately.
NOTE 6--STOCKHOLDERS' EQUITY
The Company was initially capitalized in February 1997 with common stock. In
July 1997, the Company was granted authority to issue two classes of stock
consisting of up to 17,000,000 shares of Series A preferred stock and 54,635,294
shares of common stock, as adjusted for the November 1998 and March 1999 stock
splits, both with a $0.001 par value per share.
Effective March 6, 1998, the Company amended its Certificate of
Incorporation to increase the number of authorized common shares to 54,983,160,
as adjusted for the November 1998 and March 1999 stock splits, to decrease the
number of authorized preferred shares to 16,944,943, and to designate 12,900,000
of the preferred shares as Series A and 4,044,943 shares as Series B.
Effective April 28, 1998, the Company amended its Certificate of
Incorporation to increase the number of authorized common shares to 59,715,960,
as adjusted for the November 1998 and March 1999 stock splits.
Effective November 4, 1998, the Company completed a two-for-one split of its
common stock. The accompanying consolidated financial statements have been
restated for all periods presented to reflect the stock split.
The Company's Series A and Series B preferred stock may be converted, at the
option of the holder, into the Company's common stock on a 2.4 to 1 basis,
subject to antidilution protection on a broad-based weighted-average basis. The
preferred stock will also be automatically converted upon certain closings of
registered public offerings of common stock. The holders of the Series A
preferred stock are entitled to receive non-cumulative dividends in the amount
equal to $0.08 per share per annum and the holders of the Series B preferred
stock are entitled to receive non-cumulative dividends of $0.356 per share per
annum, as and if declared by the Board of Directors, or an amount equal to that
paid on any other outstanding shares of the Company, payable quarterly, as and
if declared by the Board of Directors. In the event of a liquidation of the
Company, the holders of the Series A and
F-11
<PAGE>
RHYTHMS NETCONNECTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--STOCKHOLDERS' EQUITY (CONTINUED)
Series B preferred stock will be entitled, in preference to the holders of
common stock, to an amount equal to $1.00 per share and $4.45 per share,
respectively, plus all declared and unpaid dividends. The preferred shares
entitle holders to two votes per share, on an "as-converted" basis.
NOTE 7--STOCK OPTIONS
The Company has established the 1997 Stock Option/Stock Issuance Plan (the
"Plan"), which provides for the grant of options to employees, directors and
outside consultants for purchase of up to an aggregate of 11,673,530 shares of
common stock. The options are immediately exercisable and expire within ten
years after the date of grant. Shares acquired upon exercise are subject to
repurchase by the Company ratably over a four-year period from the date of
grant, at the option of the Company and at the exercise price. The Plan provides
for both incentive option and non-statutory option grants and for accelerated
vesting in the event of a 50 percent or more change in control of the Company.
Plan activity is as follows:
<TABLE>
<CAPTION>
NUMBER OF WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES FAIR VALUE EXERCISE PRICE
----------- ----------------- -----------------
<S> <C> <C> <C>
Granted..................................................... 5,801,714 $ 0.29 $ 0.04
Exercised................................................... (320,458) $ 0.29 $ 0.04
-----------
Outstanding at December 31, 1997........................ 5,481,256 $ 0.29 $ 0.04
Granted..................................................... 3,364,680 $ 2.63 $ 0.84
Exercised................................................... (5,560,308) $ 0.30 $ 0.04
Canceled.................................................... (136,349) $ 1.10 $ 0.23
-----------
Outstanding at December 31, 1998........................ 3,149,279 $ 2.73 $ 0.88
-----------
-----------
</TABLE>
The following summarizes the outstanding and exercisable options under the
Plan at December 31, 1998:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE PRICE OUTSTANDING LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- ----------------- ----------- ------------- --------------- --------- ---------------
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
<S> <C> <C> <C> <C> <C>
------------------------------ --------------------------
$0.04 177,480 9.03 years $ 0.04 177,480 $ 0.04
$0.21 to $0.25 1,591,680 9.42 years $ 0.23 1,591,680 $ 0.23
$1.67 to $1.88 1,380,120 9.83 years $ 1.75 1,380,120 $ 1.75
</TABLE>
During 1997 and 1998, all options were granted to employees at less than
fair value on the date of grant, resulting in $1,450,000 and $4,908,000,
respectively, of deferred compensation recorded as a reduction of stockholders'
equity. These amounts are being amortized as a charge to general and
administrative expenses over the vesting periods of the applicable options; such
amortization totaled $192,000 and $725,000 for the periods ended December 31,
1997 and 1998, respectively.
An option to purchase 365,094 shares of Series A Preferred Stock at $0.80
per share was granted to an employee during 1997. The Company recorded $73,000
in compensation expense during 1997 related to this grant.
F-12
<PAGE>
RHYTHMS NETCONNECTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--STOCK OPTIONS (CONTINUED)
Had compensation expense for the Company's Plan and the Preferred Stock
option been determined based on the fair value method of accounting for
stock-based compensation, the Company's net loss and net loss per share for the
periods ended December 31, 1997 and 1998 would have been increased by $11,000
and $60,000 and $0.01 and $0.02 per share, respectively. For purposes of
determining this compensation expense, the fair value of each option grant is
estimated on the grant date using the Black Scholes option pricing model with
the following weighted average assumptions used for grants during the periods
ended December 31, 1997 and 1998, respectively: no dividend yield, risk free
interest rates of 5.3 percent and 4.9 percent, respectively, expected volatility
of nil, and expected term of four years for common options and six months for
the preferred option.
NOTE 8--INCOME TAXES
As of December 31, 1998, the Company had net operating loss carryforwards of
approximately $37,000,000, which are available to offset future taxable income
through 2018 for federal taxes and 2005 for state taxes, subject to the
limitations of Internal Revenue Code Section 382 relating to changes in
ownership of the Company. The deferred tax asset arising from the loss
carryforwards has been fully offset by a valuation allowance since it is more
likely than not that it will not be realized. The valuation allowance increased
by $13,905,000 during 1998, primarily as a result of the additional losses in
1998.
Components of deferred income taxes are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1998
----------------- -----------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards..................... $ 908,000 $ 14,724,000
Accrued vacation and other........................... 89,000 178,000
-------- -----------------
Gross deferred tax asset............................... 997,000 14,902,000
Valuation allowance.................................... (997,000) (14,902,000)
-------- -----------------
Net deferred income taxes.............................. $ -- $ --
-------- -----------------
-------- -----------------
</TABLE>
The provision for (benefit from) income taxes reconciles to the statutory
federal tax rate as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1998
------------------- -------------------
<S> <C> <C>
Statutory federal tax rate............................. (34.0)% (34.0)%
State income tax, net of federal benefit............... (5.4) (5.4)
Other.................................................. (1.8) 0.9
Deferred tax asset valuation allowance................. 41.2 38.5
----- -----
-- % -- %
----- -----
----- -----
</TABLE>
NOTE 9--RELATED PARTY TRANSACTIONS
The Company's in-house counsel is also a partner in a law firm used
externally by the Company. During 1997 and 1998, the Company incurred legal fees
and expenses of approximately $92,000 and
F-13
<PAGE>
RHYTHMS NETCONNECTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9--RELATED PARTY TRANSACTIONS (CONTINUED)
$1,269,000, respectively, to the external firm, in addition to the salary paid
to the in-house counsel. At December 31, 1998, the Company had a balance payable
of $372,000 to this entity.
Two members of the Company's Board of Directors serve as directors to a
company that supplies equipment to the Company. The total purchases during 1997
and 1998 from the equipment supplier were approximately $419,000 and
$13,005,000, respectively. At December 31, 1998, the Company had a balance
payable of $2,451,000 to this entity.
NOTE 10--COMMITMENTS
The Company leases office space and certain office equipment under
non-cancelable operating lease agreements. The leases range in term from 24
months to 60 months and, in certain instances, provide for options to extend.
Rent expense under the operating leases for 1997 and 1998 totaled $46,000 and
$2,044,000, respectively. Future minimum rental payments under the leases are
$11,169,000 in 1999, $11,251,000 in 2000, $9,667,000 in 2001, $1,710,000 in
2002, and $1,190,000 in 2003.
NOTE 11--SUBSEQUENT EVENTS
Effective March 2, 1999, the Company amended its Certificate of
Incorporation to increase the number of authorized common shares to 84,527,584,
as adjusted for the November 1998 and March 1999 stock splits, and to authorize
3,731,410 shares of Series C Preferred Stock.
Effective March 4, 1999, the Company issued 3,731,410 shares of its Series C
preferred stock to MCI WorldCom's investment fund at a price of $8.04 per share
for total proceeds to the Company of $30,000,000. In connection with this
investment, MCI WorldCom also received warrants to purchase up to 720,000 shares
of common stock at a price of $6.70 per share. The terms of the transaction also
provide for the Company and MCI WorldCom to enter into various business
relationships, including MCI WorldCom's commitment to sell 100,000 of the
Company's DSL lines over a period of five years, subject to penalties for
failure to reach target commitments.
During January and February 1999, the Company granted options to purchase
1,615,686 shares of common stock pursuant to the Plan. The grant of these
options will result in additional deferred compensation in 1999 and compensation
expense in 1999 and future years as the options vest.
NOTE 12--SUBSEQUENT EVENTS (UNAUDITED)
In March 1999, the Company expects to complete a six for five split of its
common stock. The accompanying consolidated financial statements have been
restated for all periods presented to reflect the stock split.
On March 16, 1999, the Company issued 3,731,409 shares of its Series C
Preferred Stock to Microsoft at a price of $8.04 per share for total proceeds to
the Company of $30,000,000. In connection with this investment, Microsoft also
received warrants to purchase up to 720,000 shares of common stock at a price of
$6.70 per share. The terms of the transaction also provide for the Company and
Microsoft to enter into various business relationships.
The Company has filed a registration statement for a public offering of
approximately 9,375,000 shares of common stock.
F-14
<PAGE>
RHYTHMS NETCONNECTIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12--SUBSEQUENT EVENTS (UNAUDITED) (CONTINUED)
On March 16, 1999, the Company's Board of Directors approved the 1999 Stock
Incentive Plan and the 1999 Employee Stock Purchase Plan, subject to stockholder
approval. The 1999 Stock Incentive Plan is intended to serve as the successor
equity incentive program to the 1997 Stock Option/Stock Issuance Plan. An
initial reserve of 7,440,000 shares of common stock has been authorized for
issuance under the 1999 Stock Incentive Plan. The Company has also initially
reserved an additional 1,200,000 shares of common stock for the 1999 Employee
Stock Purchase Plan. The 1999 Stock Incentive Plan will become effective upon
the effectiveness of the public offering. The 1999 Stock Incentive Plan will
become effective upon the execution of an Underwriting Agreement for the public
offering.
F-15
<PAGE>
[MAPS OF SAN DIEGO, CA AND CHICAGO, IL SHOWING RHYTHMS DEPLOYMENT]
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
9,375,000 SHARES
[LOGO]
RHYTHMS NETCONNECTIONS INC.
COMMON STOCK
------------------
P R O S P E C T U S
------------------
MERRILL LYNCH & CO.
SALOMON SMITH BARNEY
HAMBRECHT & QUIST
THOMAS WEISEL PARTNERS LLC
, 1999
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. 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 NASD fee.
<TABLE>
<S> <C>
Registration fee................................................ $ 45,870
Nasdaq National Market fee...................................... 70,000
NASD fee........................................................ 17,000
Blue Sky fees and expenses...................................... 5,000
Printing and engraving expenses................................. 350,000
Legal fees and expenses......................................... 500,000
Accounting fees and expenses.................................... 200,000
Transfer Agent and Registrar fees............................... 10,000
Miscellaneous expenses.......................................... 52,130
---------
Total....................................................... $1,250,000
---------
---------
</TABLE>
ITEM 14. 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
indemnity 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 or 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.
II-1
<PAGE>
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 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
reasonably 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 directors' 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 underwriting agreement (Exhibit 1.1 hereto) contains provisions by which
the underwriters have agreed to indemnify the Registrant, each person, if any,
who controls the Registrant within the meaning of Section 15 of the Securities
Act, each director of the Registrant, and each officer of the Registrant who
signs this registration statement, with respect to information furnished in
writing by or on behalf of the underwriters for use in the registration
statement.
ITEM 15. 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 shares 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
are currently convertible 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
are currently convertible 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
are currently convertible 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
are currently convertible 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
II-2
<PAGE>
Sprout Group and Enron Communications Group, Inc. The consideration received
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, 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.
(9) From August 1997 through March 16, 1999, the Registrant granted
stock options to purchase an aggregate of 10,508,781 shares of common stock
to employees and consultants with aggregate exercise prices ranging from
$0.04 to $3.33 per share pursuant to the Registrant's stock option plan. As
of March 16, 1999, 7,017,775 shares of common stock have been issued upon
exercise of options.
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. The sales and issuances of these securities except for those in (6) 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 issuance in (6) above were exempt from registration
under the Securities Act pursuant to Section 4(2) and, in connection with the
resale by the initial purchasers of the securities described in (6) above, Rule
144A thereunder.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibits.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
1.1 Form of Purchase Agreement.
3.1 Restated Certificate of Incorporation of the Registrant, as amended.
3.2+ Form of Restated Certificate of Incorporation of the Registrant to become effective immediately prior
to the Offering.
3.3** Bylaws of the Registrant, as amended.
3.4+ Form of Restated Bylaws of the Registrant to be effective upon completion of the Offering.
4.1+ Form of Certificate of common stock.
4.2* 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 the Registrant's 13 1/2% Senior Discount Notes due 2008, Series
B.
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
4.3* Warrant Agreement, dated as of May 5, 1998, by and between the Registrant and State Street Bank and
Trust Company of California, N.A.
4.4* 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.
4.5** Warrant to Purchase Shares of Common Stock, dated May 19, 1998, by and between the Registrant and Sun
Financial Group, Inc.
4.6** Common Stock Purchase Warrant, dated March 3, 1999, by and between the Registrant and MCI WorldCom
Venture Fund, Inc.
4.7 Common Stock Purchase Warrant, dated March 16, 1999, by and between the Registrant and Microsoft
Corporation.
5.1+ Opinion of Brobeck, Phleger & Harrison LLP with respect to the common stock being registered.
9.1* Voting Trust Agreement, dated as of May 5, 1998, by and among Sprout Capital VII, L.P., Donaldson
Lufkin & Jenrette Securities Corporation, and First Union Trust Company, National Association, as
trustee.
9.2* Voting Trust Agreement, dated as of March 12, 1998, by and between Enron Communications Group, Inc.
and the Registrant, as trustee.
9.3* Amended and Restated Voting Agreement, dated March 12, 1998, by and among the Registrant and the
parties listed on the Schedule of Investors attached thereto as Schedule A, as amended.
9.4** Voting Trust Agreement, dated March 3, 1999, by and between MCI WorldCom Venture Fund, Inc. and the
Registrant, as trustee.
10.1* Series A Preferred Stock Purchase Agreement, dated July 3, 1997, by and among the Registrant and the
Investors listed on Schedule A thereto.
10.2* Subsequent Closing Purchase Agreement, dated December 23, 1997, by and among the Registrant and the
Investors listed on Schedule A thereto.
10.3* Series B Preferred Stock Purchase Agreement, dated March 12, 1998, by and among the Registrant and
the Investors listed on Schedule A thereto.
10.4** Enterprise Services Solution Agreement between Cisco Systems, Inc. and the Registrant, dated December
3, 1998
10.5** Series C Preferred Stock Purchase Agreement, dated March 3, 1999, by and among the Registrant and MCI
WorldCom Venture Fund, Inc.
10.6** Amended and Restated Investors' Rights Agreement, dated March 3, 1999, by and among the Registrant
and the Investors listed on Schedule A thereto.
10.7** Agreement, dated March 3, 1999, by and between the Registrant and MCI WorldCom, Inc.
10.8 Series C Preferred Stock and Warrant Purchase Agreement, dated March 16, 1999, by and among the
Registrant and Microsoft Corporation.
10.9 Amended and Restated Investors' Rights Agreement, dated March 16, 1999, by and among the Registrant
and the Investors listed on Schedule A thereto.
10.10 Distribution Agreement, dated March 16, 1999, by and among the Registrant and Microsoft Corporation.
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
10.11* Master Lease Agreement No. 1642 and Addendum thereto, each dated November 19, 1997, and Second
Addendum thereto, dated as of May 19, 1998, between the Registrant and Sun Financial Group, Inc.
10.12** Business Lease (Single Tenant) between the Registrant and BR Venture, LLC dated September 1998.
10.13* Employment Agreement between the Registrant and Catherine M. Hapka, dated June 10, 1997.
10.14* Employment Agreement between the Registrant and Jeffrey Blumenfeld, dated August 10, 1997.
10.15* Employment Agreement between the Registrant and James A. Greenberg, dated July 14, 1997.
10.16* Employment Agreement between the Registrant and Rand A. Kennedy, dated August 22, 1997.
10.17* 1997 Stock Option/Stock Issuance Plan.
10.18+ 1999 Stock Incentive Plan.
10.19+ 1999 Stock Incentive Plan Form of Notice of Grant.
10.20+ 1999 Stock Incentive Plan Form of Stock Option Agreement.
10.21+ 1999 Stock Incentive Plan Form of Stock Issuance Agreement.
10.22+ 1999 Employee Stock Purchase Plan.
10.23* Form of Indemnification Agreement between the Registrant and each of its directors.
10.24* Form of Indemnification Agreement between the Registrant and each of its officers.
10.25* QuickStart Loan and Security Agreement, dated October 29, 1997, between the Registrant and Silicon
Valley Bank.
21.1* Subsidiaries of the Registrant.
23.1+ Consent of Brobeck, Phleger & Harrison LLP (filed with Exhibit 5.1)
23.2 Consent of PricewaterhouseCoopers LLP.
24.1** Powers of Attorney.
24.2 Powers of Attorney.
27.1** Financial Data Schedule.
</TABLE>
- ------------------------
* 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.
+ To be filed by amendment.
(b) Financial Statement Schedules included separately in the registration
statement.
All other schedules are omitted because they are not required, are not
applicable or the information is included in the Financial Statements or notes
thereto.
ITEM 17. UNDERTAKINGS.
The undersigned hereby undertakes to provide to the underwriters at the
closing specified in the underwriting agreement certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
II-5
<PAGE>
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the provisions described in Item 14, 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
Securities Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the Registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act, the
information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be part of this registration
statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act,
each post-effective amendment that contains a form of prospectus shall be deemed
to be a new registration statement relating to the securities offered therein,
and the offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof.
II-6
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Englewood, State of
Colorado, on the 16th day of March 1999.
RHYTHMS NETCONNECTIONS INC.
By: /s/ SCOTT C. CHANDLER
-----------------------------------------
Scott C. Chandler
CHIEF FINANCIAL OFFICER
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 DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
*
- ------------------------------ President, Chief Executive March 16, 1999
Catherine M. Hapka Officer and Director
/s/ SCOTT C. CHANDLER
- ------------------------------ Chief Financial Officer March 16, 1999
Scott C. Chandler
*
- ------------------------------ Director March 16, 1999
Kevin R. Compton
*
- ------------------------------ Director March 16, 1999
Keith B. Geeslin
*
- ------------------------------ Director March 16, 1999
Ken L. Harrison
*
- ------------------------------ Director March 16, 1999
Susan Mayer
*
- ------------------------------ Director March 16, 1999
William R. Stensrud
</TABLE>
II-7
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
*
- ------------------------------ Director March 16, 1999
John L. Walecka
*
- ------------------------------ Director March 16, 1999
Edward J. Zander
</TABLE>
<TABLE>
<S> <C> <C> <C>
*By: /s/ SCOTT C. CHANDLER
-------------------------
Scott C. Chandler
ATTORNEY IN FACT
</TABLE>
II-8
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
EXHIBITS
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------------
RHYTHMS NETCONNECTIONS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
RHYTHMS NETCONNECTIONS INC.
(a Delaware corporation)
Shares of Common Stock
PURCHASE AGREEMENT
Dated: , 1999
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
SECTION 1. Representations and Warranties.. . . . . . . . . . . . . . . . . .2
(a) Representations and Warranties by the Company. . . . . . . . . . . .2
(i) Compliance with Registration Requirements. . . . . . . . .2
(ii) Independent Accountants. . . . . . . . . . . . . . . . . .3
(iii) Financial Statements.. . . . . . . . . . . . . . . . . . .3
(iv) No Material Adverse Change in Business.. . . . . . . . . .4
(v) Good Standing of the Company.. . . . . . . . . . . . . . .4
(vi) Good Standing of Subsidiaries. . . . . . . . . . . . . . .4
(vii) Capitalization.. . . . . . . . . . . . . . . . . . . . . .5
(viii) Authorization of Agreement.. . . . . . . . . . . . . . . .5
(ix) Authorization and Description of Securities. . . . . . . .5
(x) Absence of Defaults and Conflicts. . . . . . . . . . . . .5
(xi) Absence of Labor Dispute.. . . . . . . . . . . . . . . . .6
(xii) Absence of Proceedings.. . . . . . . . . . . . . . . . . .6
(xiii) Accuracy of Exhibits.. . . . . . . . . . . . . . . . . . .6
(xiv) Possession of Intellectual Property. . . . . . . . . . . .6
(xv) Absence of Further Requirements. . . . . . . . . . . . . .7
(xvi) Possession of Licenses and Permits.. . . . . . . . . . . .7
(xvii) Title to Property. . . . . . . . . . . . . . . . . . . . .8
(xviii) Compliance with Cuba Act.. . . . . . . . . . . . . . . . .9
(xix) Investment Company Act.. . . . . . . . . . . . . . . . . .9
(xx) Environmental Laws.. . . . . . . . . . . . . . . . . . . .9
(xxi) Registration Rights. . . . . . . . . . . . . . . . . . . 10
(xxii) Tax Returns. . . . . . . . . . . . . . . . . . . . . . . 10
(xxiii) Insurance. . . . . . . . . . . . . . . . . . . . . . . . 10
(xxiv) Internal Accounting Controls . . . . . . . . . . . . . . 10
(b) OFFICER'S CERTIFICATES . . . . . . . . . . . . . . . . . . . . . . 10
SECTION 2. Sale and Delivery to Underwriters; Closing. . . . . . . . . . . . 11
(a) Initial Securities.. . . . . . . . . . . . . . . . . . . . . . . . 11
(b) Option Securities. . . . . . . . . . . . . . . . . . . . . . . . . 11
(c) Payment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
(d) Denominations; Registration. . . . . . . . . . . . . . . . . . . . 12
SECTION 3. Covenants of the Company. . . . . . . . . . . . . . . . . . . . . 12
(a) Compliance with Securities Regulations and Commission Requests. . .12
(b) Filing of Amendments.. . . . . . . . . . . . . . . . . . . . . . . 12
(c) Delivery of Registration Statements. . . . . . . . . . . . . . . . 13
(d) Delivery of Prospectuses.. . . . . . . . . . . . . . . . . . . . . 13
(e) Continued Compliance with Securities Laws. . . . . . . . . . . . . 13
(f) Blue Sky Qualifications. . . . . . . . . . . . . . . . . . . . . . 14
(g) Rule 158.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
(h) Use of Proceeds. . . . . . . . . . . . . . . . . . . . . . . . . . 14
i
<PAGE>
(i) Listing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
(j) Restriction on Sale of Securities. . . . . . . . . . . . . . . . . 14
(k) Reporting Requirements.. . . . . . . . . . . . . . . . . . . . . . 15
(l) Compliance with Rule 463.. . . . . . . . . . . . . . . . . . . . . 15
SECTION 4. Payment of Expenses.. . . . . . . . . . . . . . . . . . . . . . . 15
(a) Expenses.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
(b) Termination of Agreement.. . . . . . . . . . . . . . . . . . . . . 15
SECTION 5. Conditions of Underwriters' Obligations.. . . . . . . . . . . . . 15
(a) Effectiveness of Registration Statement. . . . . . . . . . . . . . 15
(b) Opinion of Counsel for Company.. . . . . . . . . . . . . . . . . . 16
(c) Opinion of Counsel for Underwriters. . . . . . . . . . . . . . . . 16
(d) Officers' Certificate. . . . . . . . . . . . . . . . . . . . . . . 16
(e) Accountant's Comfort Letter. . . . . . . . . . . . . . . . . . . . 17
(f) Bring-down Comfort Letter. . . . . . . . . . . . . . . . . . . . . 17
(g) Approval of Listing. . . . . . . . . . . . . . . . . . . . . . . . 17
(h) No Objection.. . . . . . . . . . . . . . . . . . . . . . . . . . . 17
(i) Lock-up Agreements.. . . . . . . . . . . . . . . . . . . . . . . . 17
(j) Conditions to Purchase of Option Securities. . . . . . . . . . . . 17
(i) Officers' Certificate. . . . . . . . . . . . . . . . . . 17
(ii) Opinions of Counsel for Company. . . . . . . . . . . . . 18
(iii) Opinion of Counsel for Underwriters. . . . . . . . . . . 18
(iv) Bring-down Comfort Letter. . . . . . . . . . . . . . . . 18
(k) Additional Documents.. . . . . . . . . . . . . . . . . . . . . . . 18
(l) Termination of Agreement.. . . . . . . . . . . . . . . . . . . . . 18
SECTION 6. Indemnification.. . . . . . . . . . . . . . . . . . . . . . . . . 18
(a) Indemnification of Underwriters. . . . . . . . . . . . . . . . . . 18
(b) Indemnification of Company, Directors and Officers.. . . . . . . . 20
(c) Actions against Parties; Notification. . . . . . . . . . . . . . . 20
(d) Settlement without Consent if Failure to Reimburse.. . . . . . . . 21
SECTION 7. Contribution.. . . . . . . . . . . . . . . . . . . . . . . . . . 21
SECTION 8. Representations, Warranties and Agreements to Survive Delivery.. 22
SECTION 9. Termination of Agreement.. . . . . . . . . . . . . . . . . . . . 22
(a) Termination; General.. . . . . . . . . . . . . . . . . . . . . . . 22
(b) Liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
SECTION 10. Default by One or More of the Underwriters.. . . . . . . . . . . 23
SECTION 11. Notices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
SECTION 12. Parties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
ii
<PAGE>
SECTION 13. GOVERNING LAW AND TIME.. . . . . . . . . . . . . . . . . . . . . 24
SECTION 14. Effect of Headings.. . . . . . . . . . . . . . . . . . . . . . . 24
SCHEDULES
Schedule A - List of Underwriters. . . . . . . . . . . . . . .Sch A-1
Schedule B - Pricing Information . . . . . . . . . . . . . . .Sch B-1
Schedule C - List of Persons subject to Lock-up. . . . . . . .Sch C-1
EXHIBITS
Exhibit A - Forms of Opinions of Company's Counsel . . . . . . . .A-1
Exhibit B - Form of Lock-up Letter . . . . . . . . . . . . . . . .B-1
</TABLE>
iii
<PAGE>
DRAFT OF [MARCH 12, 1999]
RHYTHMS NETCONNECTIONS INC.
(a Delaware corporation)
Shares of Common Stock
(Par Value $.001 Per Share)
PURCHASE AGREEMENT
, 1999
MERRILL LYNCH & CO.
Merrill Lynch, Pierce, Fenner & Smith
Incorporated
Salomon Smith Barney Inc.
Hambrecht & Quist
Thomas Weisel Partners LLC
as Representatives of the several Underwriters
c/o Merrill Lynch & Co.
Merrill Lynch, Pierce, Fenner & Smith
Incorporated
North Tower
World Financial Center
New York, New York 10281-1209
Ladies and Gentlemen:
Rhythms NetConnections Inc., a Delaware corporation (the "Company"), and
confirms its agreement with Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner &
Smith Incorporated ("Merrill Lynch"), Salomon Smith Barney Inc. ("Salomon") and
each of the other Underwriters named in Schedule A hereto (collectively, the
"Underwriters", which term shall also include any underwriter substituted as
hereinafter provided in Section 10 hereof), for whom Merrill Lynch, Salomon,
Hambrecht & Quist and Thomas Weisel Partners LLC are acting as representatives
(in such capacity, the "Representatives"), with respect to the issue and sale by
the Company and the purchase by the Underwriters, acting severally and not
jointly, of the respective numbers of shares of Common Stock, par value $.001
per share, of the Company ("Common Stock") set forth in said Schedule A, and
with respect to the grant by the Company to the Underwriters, acting severally
and not jointly, of the option described in Section 2(b) hereof to purchase all
or any part of - additional shares of Common Stock to cover over-allotments, if
any. The aforesaid - shares of Common Stock (the "Initial Securities") to be
purchased by the Underwriters and all or any part of the - shares of Common
Stock subject to the option described in Section 2(b) hereof (the "Option
Securities") are hereinafter called, collectively, the "Securities".
The Company understands that the Underwriters propose to make a public
offering of the Securities as soon as the Representatives deem advisable after
this Agreement has been executed and delivered.
<PAGE>
The Company has filed with the Securities and Exchange Commission (the
"Commission") a registration statement on Form S-1 (No. 333-72409) covering the
registration of the Securities under the Securities Act of 1933, as amended (the
"1933 Act"), including the related preliminary prospectus or prospectuses.
Promptly after execution and delivery of this Agreement, the Company will either
(i) prepare and file a prospectus in accordance with the provisions of Rule 430A
("Rule 430A") of the rules and regulations of the Commission under the 1933 Act
(the "1933 Act Regulations") and paragraph (b) of Rule 424 ("Rule 424(b)") of
the 1933 Act Regulations or (ii) if the Company has elected to rely upon Rule
434 ("Rule 434") of the 1933 Act Regulations, prepare and file a term sheet (a
"Term Sheet") in accordance with the provisions of Rule 434 and Rule 424(b). The
information included in such prospectus or in such Term Sheet, as the case may
be, that was omitted from such registration statement at the time it became
effective but that is deemed to be part of such registration statement at the
time it became effective (a) pursuant to paragraph (b) of Rule 430A is referred
to as "Rule 430A Information" or (b) pursuant to paragraph (d) of Rule 434 is
referred to as "Rule 434 Information." Each prospectus used before such
registration statement became effective, and any prospectus that omitted, as
applicable, the Rule 430A Information or the Rule 434 Information, that was used
after such effectiveness and prior to the execution and delivery of this
Agreement, is herein called a "preliminary prospectus." Such registration
statement, including the exhibits thereto and schedules thereto at the time it
became effective and including the Rule 430A Information and the Rule 434
Information, as applicable, is herein called the "Registration Statement." Any
registration statement filed pursuant to Rule 462(b) of the 1933 Act Regulations
is herein referred to as the "Rule 462(b) Registration Statement," and after
such filing the term "Registration Statement" shall include the Rule 462(b)
Registration Statement. The final prospectus in the form first furnished to the
Underwriters for use in connection with the offering of the Securities is herein
called the "Prospectus." If Rule 434 is relied on, the term "Prospectus" shall
refer to the preliminary prospectus dated March __, 1999 together with the Term
Sheet and all references in this Agreement to the date of the Prospectus shall
mean the date of the Term Sheet. For purposes of this Agreement, all references
to the Registration Statement, any preliminary prospectus, the Prospectus or any
Term Sheet or any amendment or supplement to any of the foregoing shall be
deemed to include the copy filed with the Commission pursuant to its Electronic
Data Gathering, Analysis and Retrieval system ("EDGAR").
SECTION 1. Representations and Warranties.
(a) REPRESENTATIONS AND WARRANTIES BY THE COMPANY. The Company
represents and warrants to each Underwriter as of the date hereof, as of the
Closing Time referred to in Section 2(c) hereof, and as of each Date of Delivery
(if any) referred to in Section 2(b) hereof, and agrees with each Underwriter,
as follows:
(i) COMPLIANCE WITH REGISTRATION REQUIREMENTS. Each of the
Registration Statement and any Rule 462(b) Registration Statement has
become effective under the 1933 Act and no stop order suspending the
effectiveness of the Registration Statement or any Rule 462(b)
Registration Statement has been issued under the 1933 Act and no
proceedings for that purpose have been instituted or are pending or, to
the knowledge of
2
<PAGE>
the Company, are contemplated by the Commission, and any request on the
part of the Commission for additional information has been complied with.
At the respective times the Registration Statement, any Rule
462(b) Registration Statement and any post-effective amendments thereto
became effective and at the Closing Time (and, if any Option Securities
are purchased, at the Date of Delivery), the Registration Statement, the
Rule 462(b) Registration Statement and any amendments and supplements
thereto complied and will comply in all material respects with the
requirements of the 1933 Act and the 1933 Act Regulations and did not and
will not contain an untrue statement of a material fact or omit to state
a material fact required to be stated therein or necessary to make the
statements therein not misleading. Neither the Prospectus nor any
amendments or supplements thereto, at the time the Prospectus or any such
amendment or supplement was issued and at the Closing Time (and, if any
Option Securities are purchased, at the Date of Delivery), included or
will include an untrue statement of a material fact or omitted or will
omit to state a material fact necessary in order to make the statements
therein, in the light of the circumstances under which they were made,
not misleading. If Rule 434 is used, the Company will comply with the
requirements of Rule 434 and the Prospectus shall not be "materially
different", as such term is used in Rule 434, from the prospectus
included in the Registration Statement at the time it became effective.
The representations and warranties in this subsection shall not apply to
statements in or omissions from the Registration Statement or Prospectus
made in reliance upon and in conformity with information furnished to the
Company in writing by any Underwriter through Merrill Lynch or Salomon
expressly for use in the Registration Statement or Prospectus.
Each preliminary prospectus and the prospectus filed as part of
the Registration Statement as originally filed or as part of any
amendment thereto, or filed pursuant to Rule 424 under the 1933 Act,
complied when so filed in all material respects with the 1933 Act
Regulations and each preliminary prospectus and the Prospectus delivered
to the Underwriters for use in connection with this offering was
identical to the electronically transmitted copies thereof filed with the
Commission pursuant to EDGAR, except to the extent permitted by
Regulation S-T.
(ii) INDEPENDENT ACCOUNTANTS. The accountants who certified
the financial statements and supporting schedules included in the
Registration Statement are independent public accountants as required by
the 1933 Act and the 1933 Act Regulations.
(iii) FINANCIAL STATEMENTS. The financial statements included in
the Registration Statement and the Prospectus, together with the related
schedules and notes, present fairly the financial position of the Company
and its consolidated subsidiaries at the dates indicated and the
statement of operations, stockholders' equity and cash flows of the
Company and its consolidated subsidiaries for the periods specified; said
financial statements have been prepared in conformity with generally
accepted accounting principles ("GAAP") applied on a consistent basis
throughout the periods involved. The
3
<PAGE>
supporting schedules included in the Registration Statement present
fairly in accordance with GAAP the information required to be stated
therein. The selected financial data and the summary financial
information included in the Prospectus present fairly the information
shown therein and have been compiled on a basis consistent with that of
the audited financial statements included in the Registration Statement.
(iv) NO MATERIAL ADVERSE CHANGE IN BUSINESS. Since the
respective dates as of which information is given in the Registration
Statement and the Prospectus, except as otherwise stated therein,
(A) there has been no material adverse change in the condition, financial
or otherwise, or in the earnings, business affairs or business prospects
of the Company and its subsidiaries considered as one enterprise (a
"Material Adverse Effect"), whether or not arising in the ordinary course
of business, (B) there have been no transactions entered into by the
Company or any of its subsidiaries, other than those in the ordinary
course of business, which are material with respect to the Company and
its subsidiaries considered as one enterprise, and (C) there has been no
dividend or distribution of any kind declared, paid or made by the
Company on any class of its capital stock.
(v) GOOD STANDING OF THE COMPANY. The Company has been duly
organized and is validly existing as a corporation in good standing under
the laws of the State of Delaware and has corporate power and authority
to own, lease and operate its properties and to conduct its business as
described in the Prospectus and to enter into and perform its obligations
under this Agreement; and the Company is duly qualified as a foreign
corporation to transact business and is in good standing in each other
jurisdiction in which such qualification is required, whether by reason
of the ownership or leasing of property or the conduct of business,
except where the failure so to qualify or to be in good standing would
not result in a Material Adverse Effect.
(vi) GOOD STANDING OF DESIGNATED SUBSIDIARIES. Each of ACI
Corp. and ACI Corp.-Virginia (collectively, the "Designated
Subsidiaries") has been duly organized and is validly existing as a
corporation (or, in the case of ACI Corp.-Virginia, a Virginia public
benefit corporation) in good standing under the laws of the jurisdiction
of its incorporation, has corporate power and authority to own, lease and
operate its properties and to conduct its business as described in the
Prospectus and is duly qualified as a foreign corporation to transact
business and is in good standing in each jurisdiction in which such
qualification is required, whether by reason of the ownership or leasing
of property or the conduct of business, except where the failure so to
qualify or to be in good standing would not result in a Material Adverse
Effect; except as otherwise disclosed in the Registration Statement, all
of the issued and outstanding capital stock of each Designated Subsidiary
has been duly authorized and validly issued, is fully paid and
non-assessable and is owned by the Company, directly or through
subsidiaries, free and clear of any security interest, mortgage, pledge,
lien, encumbrance, claim or equity; none of the outstanding shares of
capital stock of any Designated Subsidiary was issued in violation of the
preemptive or similar rights arising by operation of law, or under the
charter or by-laws of such Designated Subsidiary or under any agreement
to which the
4
<PAGE>
Company or such Designated Subsidiary is a party. The only subsidiaries
of the Company are the subsidiaries listed on Exhibit 21 to the
Registration Statement.
(vii) CAPITALIZATION. The authorized, issued and outstanding
capital stock of the Company is as set forth in the Prospectus in the
column entitled "Actual" under the caption "Capitalization" (except for
subsequent issuances, if any, pursuant to this Agreement, pursuant to
employee benefit or stock option plans referred to in the Prospectus or
pursuant to the exercise of convertible securities or options referred to
in the Prospectus). The shares of issued and outstanding capital stock
of the Company have been duly authorized and validly issued and are fully
paid and non-assessable; none of the outstanding shares of capital stock
of the Company was issued in violation of the preemptive or other similar
rights of any securityholder of the Company.
(viii) AUTHORIZATION OF AGREEMENT. This Agreement has been duly
authorized, executed and delivered by the Company.
(ix) AUTHORIZATION AND DESCRIPTION OF SECURITIES. The
Securities have been duly authorized for issuance and sale to the
Underwriters pursuant to this Agreement and, when issued and delivered by
the Company pursuant to this Agreement against payment of the
consideration set forth herein, will be validly issued and fully paid and
non-assessable; the Common Stock conforms to all statements relating
thereto contained in the Prospectus and such description conforms to the
rights set forth in the instruments defining the same; no holder of the
Securities will be subject to personal liability by reason of being such
a holder; and the issuance of the Securities is not subject to the
preemptive or other similar rights of any securityholder of the Company.
(x) ABSENCE OF DEFAULTS AND CONFLICTS. Neither the Company
nor any of its subsidiaries is in violation of its charter or by-laws or
in default in the performance or observance of any obligation, agreement,
covenant or condition contained in any contract, indenture, mortgage,
deed of trust, loan or credit agreement, note, lease or other agreement
or instrument to which the Company or any of its subsidiaries is a party
or by which it or any of them may be bound, or to which any of the
property or assets of the Company or any subsidiary is subject
(collectively, "Agreements and Instruments") except for such defaults
that would not result in a Material Adverse Effect, and the execution,
delivery and performance of this Agreement and the consummation of the
transactions contemplated herein and in the Registration Statement
(including the issuance and sale of the Securities and the use of the
proceeds from the sale of the Securities as described in the Prospectus
under the caption "Use of Proceeds") and compliance by the Company with
its obligations hereunder have been duly authorized by all necessary
corporate action and do not and will not, whether with or without the
giving of notice or passage of time or both, conflict with or constitute
a breach of, or default or a Repayment Event (as defined below) under, or
result in the creation or imposition of any lien, charge or encumbrance
upon any property or assets of the Company or any subsidiary pursuant to,
the Agreements and Instruments (except for such conflicts, breaches or
defaults or liens, charges or encumbrances that, singly or in the
aggregate,
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would not result in a Material Adverse Effect), nor will such action
result in any violation of the provisions of the charter or by-laws of
the Company or any subsidiary or any applicable law, statute, rule,
regulation, judgment, order, writ or decree of any government, government
instrumentality or court, domestic or foreign, having jurisdiction over
the Company or any of its subsidiaries or any of their assets, properties
or operations. As used herein, a "Repayment Event" means any event or
condition which gives the holder of any note, debenture or other evidence
of indebtedness or preferred stock (or any person acting on such holder's
behalf) the right to require the repurchase, redemption or repayment of
all or a portion of such indebtedness or preferred stock by the Company
or any of its subsidiaries.
(xi) ABSENCE OF LABOR DISPUTE. No labor dispute with the
employees of the Company or any of its subsidiaries exists or, to the
knowledge of the Company, is imminent, and the Company is not aware of
any existing or imminent labor disturbance by the employees of any of its
or any of its subsidiaries' principal suppliers, manufacturers, customers
or contractors, which, in either case, may reasonably be expected to
result in a Material Adverse Effect.
(xii) ABSENCE OF PROCEEDINGS. There is no action, suit,
proceeding, inquiry or investigation before or brought by any court or
governmental agency or body, domestic or foreign, now pending, or, to the
knowledge of the Company, threatened, against or affecting the Company or
any subsidiary, which is required to be disclosed in the Registration
Statement (other than as disclosed therein), or which might reasonably be
expected to result in a Material Adverse Effect, or which might
reasonably be expected to materially and adversely affect the properties
or assets thereof or the consummation of the transactions contemplated in
this Agreement or the performance by the Company of its obligations
hereunder. The aggregate of all pending legal or governmental proceedings
to which the Company or any subsidiary is a party or of which any of
their respective property or assets is the subject which are not
described in the Registration Statement, including ordinary routine
litigation incidental to the business, could not reasonably be expected
to result in a Material Adverse Effect.
(xiii) ACCURACY OF EXHIBITS. There are no contracts or documents
which are required to be described in the Registration Statement or the
Prospectus or to be filed as exhibits thereto which have not been so
described and filed as required.
(xiv) POSSESSION OF INTELLECTUAL PROPERTY. Except as disclosed
in the Registration Statement, (A) the Company and its subsidiaries own
or possess, or can acquire on reasonable terms, adequate patents, patent
rights, licenses, inventions, copyrights, know-how (including trade
secrets and other unpatented and/or unpatentable proprietary or
confidential information, systems or procedures), trademarks, service
marks, trade names or other intellectual property (collectively,
"Intellectual Property") necessary to carry on the business now operated
by them except that the Company and its subsidiaries may fail to so own,
possess or have the ability to acquire on reasonable terms any
Intellectual Property if such failure would not result, singly or in the
aggregate, in a
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Material Adverse Effect, and (B) neither the Company nor any of its
subsidiaries has received any notice or is otherwise aware of any
infringement of or conflict with asserted rights of others with respect
to any Intellectual Property or of any facts or circumstances which would
render any Intellectual Property invalid or inadequate to protect the
interest of the Company or any of its subsidiaries therein, and which
infringement or conflict (if the subject of any unfavorable decision,
ruling or finding) or invalidity or inadequacy, singly or in the
aggregate, would result in a Material Adverse Effect.
(xv) ABSENCE OF FURTHER REQUIREMENTS. No filing with, or
authorization, approval, consent, license, order, registration,
qualification or decree of, any court or governmental authority or agency
is necessary or required for the performance by the Company of its
obligations hereunder, in connection with the offering, issuance or sale
of the Securities hereunder or the consummation of the transactions
contemplated by this Agreement, except such as have been already obtained
or as may be required under the 1933 Act or the 1933 Act Regulations or
state securities laws.
(xvi) POSSESSION OF LICENSES AND PERMITS. Except as disclosed
in the Registration Statement, the Company and its subsidiaries possess
such permits, licenses, approvals, consents and other authorizations
issued by the appropriate federal, state, local or foreign regulatory
agencies or bodies necessary to conduct the business now operated by them
(collectively, "Governmental Licenses"); the Company and its subsidiaries
are in compliance with the terms and conditions of all such Governmental
Licenses, except where the failure so to comply would not, singly or in
the aggregate, have a Material Adverse Effect; all of the Governmental
Licenses are valid and in full force and effect, except where the
invalidity of such Governmental Licenses or the failure of such
Governmental Licenses to be in full force and effect would not have a
Material Adverse Effect; and neither the Company nor any of its
subsidiaries has received any notice of proceedings relating to the
revocation or modification of any such Governmental Licenses which,
singly or in the aggregate, if the subject of an unfavorable decision,
ruling or finding, would result in a Material Adverse Effect. The
Company has not been informed of any fact, event or circumstance that is
reasonably likely to impair the Company's (or its subsidiaries') ability
to obtain any Governmental Licenses necessary or advisable in order to
effectuate the Company's future plans and strategies described in the
Prospectus. Without limiting the generality of this paragraph:
(A) The Company and each of its subsidiaries hold all
telecommunications regulatory licenses, permits, authorizations,
consents and approvals (the "Telecommunications Licenses")
required from the Federal Communications Commission (the "FCC")
for the Company and its subsidiaries to conduct their business on
and as of the date hereof in the manner described in the
Prospectus, except as would not have, individually or in the
aggregate, a Material Adverse Effect; the Telecommunications
Licenses have been duly and validly issued and are in full force
and effect, except where the failure to be in full force and
effect would not have, individually or in the aggregate, a
Material Adverse Effect; no proceedings to revoke or restrict the
Telecommunications
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Licenses are pending or, to the best of the Company's knowledge,
threatened; neither the Company nor its subsidiaries are in
violation of any of the terms and conditions of any of the
Telecommunications Licenses, are in violation of the
Communications Act of 1934, as amended (the "Communications Act"),
or are in violation of any FCC rules and regulations, except as
would not have, individually or in the aggregate, a Material
Adverse Effect; and the Company and its subsidiaries have in
effect with the FCC all international and domestic service tariffs
necessary to conduct their business on and as of the date hereof
in the manner described in the Prospectus except as would not
have, individually or in the aggregate, a Material Adverse Effect;
(B) The Company and its subsidiaries have obtained all
state and municipal Telecommunications Licenses and filed all
tariffs required for the provision of telecommunications services
in any state to conduct their business on and as of the date
hereof in the manner described in the Prospectus, except where the
failure to do so would not have, individually or in the aggregate,
a Material Adverse Effect;
(C) There is no outstanding adverse judgment,
injunction, decree or order that has been issued by the FCC or any
state utility commission or similar state agency ("PUC") or
municipality against the Company or its subsidiaries or any
action, proceeding or investigation pending before the FCC or any
state PUC or municipality, or, to the Company's knowledge,
threatened by the FCC or any state PUC or municipality against the
Company or its subsidiaries which, if the subject of any
unfavorable decision, ruling or finding, would have a Material
Adverse Effect on the Company or its subsidiaries;
(D) No license, permit, consent, approval, order or
authorization of, or filing with, the FCC or with any state PUC or
municipal authority on the part of the Company or its subsidiaries
is required in connection with the issuance or sale of the
Securities; and
(E) Neither the issuance and sale of the Securities nor
the performance by the Company or its subsidiaries of their
obligations under this Agreement will result in a violation in any
material respect of: (1) the Communications Act or the applicable
rules or regulations, or any order, writ, judgment, injunction,
decree or award of the FCC binding on the Company or its
subsidiaries; (2) any state telecommunications laws or any
applicable state PUC rules or regulations, or any order, writ,
judgment, injunction, decree or award of any state PUC binding on
the Company or its subsidiaries; or (3) any municipal rules or
regulations applicable to the Company or its subsidiaries.
(xvii) TITLE TO PROPERTY. The Company and its subsidiaries have
good and marketable title to all real property owned by the Company and
its subsidiaries and good title to all other properties owned by them, in
each case, free and clear of all mortgages,
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pledges, liens, security interests, claims, restrictions or encumbrances
of any kind except such as (a) are described in the Prospectus or (b) do
not, singly or in the aggregate, materially affect the value of such
property and do not interfere with the use made and proposed to be made
of such property by the Company or any of its subsidiaries; and all of
the leases and subleases material to the business of the Company and its
subsidiaries, considered as one enterprise, and under which the Company
or any of its subsidiaries holds properties described in the Prospectus,
are in full force and effect, and neither the Company nor any of its
subsidiaries has any notice of any material claim of any sort that has
been asserted by anyone adverse to the rights of the Company or any of
its subsidiaries under any of the leases or subleases mentioned above, or
affecting or questioning the rights of the Company or any subsidiary to
the continued possession of the leased or subleased premises under any
such lease or sublease.
(xviii) COMPLIANCE WITH CUBA ACT. The Company has complied with,
and is and will be in compliance with, the provisions of that certain
Florida act relating to disclosure of doing business with Cuba, codified
as Section 517.075 of the Florida statutes, and the rules and regulations
thereunder (collectively, the "Cuba Act") or is exempt therefrom.
(xix) INVESTMENT COMPANY ACT. The Company is not, and upon the
issuance and sale of the Securities as herein contemplated and the
application of the net proceeds therefrom as described in the Prospectus
will not be, an "investment company" or an entity "controlled" by an
"investment company" as such terms are defined in the Investment Company
Act of 1940, as amended (the "1940 Act").
(xx) ENVIRONMENTAL LAWS. Except as described in the
Registration Statement and except as would not, singly or in the
aggregate, result in a Material Adverse Effect, (A) neither the Company
nor any of its subsidiaries is in violation of any federal, state, local
or foreign statute, law, rule, regulation, ordinance, code, policy or
rule of common law or any judicial or administrative interpretation
thereof, including any judicial or administrative order, consent, decree
or judgment, relating to pollution or protection of human health, the
environment (including, without limitation, ambient air, surface water,
groundwater, land surface or subsurface strata) or wildlife, including,
without limitation, laws and regulations relating to the release or
threatened release of chemicals, pollutants, contaminants, wastes, toxic
substances, hazardous substances, petroleum or petroleum products
(collectively, "Hazardous Materials") or to the manufacture, processing,
distribution, use, treatment, storage, disposal, transport or handling of
Hazardous Materials (collectively, "Environmental Laws"), (B) the Company
and its subsidiaries have all permits, authorizations and approvals
required under any applicable Environmental Laws and are each in
compliance with their requirements, (C) there are no pending or
threatened administrative, regulatory or judicial actions, suits,
demands, demand letters, claims, liens, notices of noncompliance or
violation, investigation or proceedings relating to any Environmental Law
against the Company or any of its subsidiaries and (D) there are no
events or circumstances that might reasonably be expected to form the
basis of an order for clean-up or remediation, or an action, suit or
proceeding by any private party or governmental body or agency, against
or affecting the
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Company or any of its subsidiaries relating to Hazardous Materials or any
Environmental Laws.
(xxi) REGISTRATION RIGHTS. There are no persons with
registration rights or other similar rights to have any securities
registered pursuant to the Registration Statement.
(xxii) TAX RETURNS. The Company and its subsidiaries have filed
all federal, state, local and foreign tax returns that are required to be
filed or have duly requested extensions thereof and have paid all taxes
required to be paid by any of them and any related assessments, fines or
penalties, except for any such tax, assessment, fine or penalty that is
being contested in good faith and by appropriate proceedings, and
adequate charges, accruals and reserves have been provided for in the
financial statements referred to in Section 1(a)(iii) above in respect of
all federal, state, local and foreign taxes for all periods as to which
the tax liability of the Company or any of its subsidiaries has not been
finally determined or remains open to examination by applicable taxing
authorities, except for such failures to file, request extensions, make
payments and provide for adequate charges, accruals and reserves as would
not, singly or in the aggregate, result in a Material Adverse Effect.
(xxiii) INSURANCE. The Company and each of its subsidiaries
maintains insurance covering its properties, operations, personnel and
business. Such insurance insures against such losses and risks as are
adequate in accordance with customary industry practice to protect the
Company, each of its subsidiaries and their businesses. Neither the
Company or any of its subsidiaries has received notice from any insurer
or agent of such insurer that substantial capital improvement or other
expenditures will have to be made in order to continue such insurance.
All such insurance is outstanding and duly in force on the date hereof.
(xxiv) INTERNAL ACCOUNTING CONTROLS. The Company maintains a
system of internal accounting controls sufficient to provide reasonable
assurances that (A) transactions are executed in accordance with
management's general or specific authorization; (B) transactions are
recorded as necessary to permit preparation of financial statements in
conformity with generally accepted accounting principles and to maintain
accountability for assets; (C) access to assets is permitted only in
accordance with management's general or specific authorization; and (D)
the recorded accountability for assets is compared with existing assets
at reasonable intervals and appropriate action is taken with respect to
any differences.
(b) OFFICER'S CERTIFICATES. Any certificate signed by any officer of
the Company or any of its subsidiaries delivered to the Representatives or to
counsel for the Underwriters shall be deemed a representation and warranty by
the Company to each Underwriter as to the matters covered thereby.
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SECTION 2. SALE AND DELIVERY TO UNDERWRITERS; CLOSING.
(a) INITIAL SECURITIES. On the basis of the representations and
warranties herein contained and subject to the terms and conditions herein set
forth, the Company agrees to sell to each Underwriter, severally and not
jointly, and each Underwriter, severally and not jointly, agrees to purchase
from the Company at the price per share set forth in Schedule B, the number of
Initial Securities set forth in Schedule A opposite the name of such
Underwriter, plus any additional number of Initial Securities which such
Underwriter may become obligated to purchase pursuant to the provisions of
Section 10 hereof.
(b) OPTION SECURITIES. In addition, on the basis of the
representations and warranties herein contained and subject to the terms and
conditions herein set forth, the Company hereby grants an option to the
Underwriters, severally and not jointly, to purchase up to an additional
shares of Common Stock at the price per share set forth in Schedule B, less an
amount per share equal to any dividends or distributions declared by the Company
and payable on the Initial Securities but not payable on the Option Securities.
The option hereby granted will expire 30 days after the date hereof and may be
exercised in whole or in part from time to time only for the purpose of covering
over-allotments which may be made in connection with the offering and
distribution of the Initial Securities upon notice by the Representatives to the
Company setting forth the number of Option Securities as to which the several
Underwriters are then exercising the option and the time and date of payment and
delivery for such Option Securities. Any such time and date of delivery (a
"Date of Delivery") shall be determined by the Representatives, but shall not be
later than seven full business days after the exercise of said option, nor in
any event prior to the Closing Time, as hereinafter defined. If the option is
exercised as to all or any portion of the Option Securities, each of the
Underwriters, acting severally and not jointly, will purchase that proportion of
the total number of Option Securities then being purchased which the number of
Initial Securities set forth in Schedule A opposite the name of such Underwriter
bears to the total number of Initial Securities, subject in each case to such
adjustments as the Representatives in their discretion shall make to eliminate
any sales or purchases of fractional shares.
(c) PAYMENT. Payment of the purchase price for, and delivery of
certificates for, the Initial Securities shall be made at the offices of Baker &
McKenzie, 805 Third Avenue, New York, New York 10022, or at such other place as
shall be agreed upon by the Representatives and the Company, at 9:00 A.M.
(Eastern time) on the third (fourth, if the pricing occurs after 4:30 P.M.
(Eastern time) on any given day) business day after the date hereof (unless
postponed in accordance with the provisions of Section 10), or such other time
not later than ten business days after such date as shall be agreed upon by the
Representatives and the Company (such time and date of payment and delivery
being herein called "Closing Time").
In addition, in the event that any or all of the Option Securities are
purchased by the Underwriters, payment of the purchase price for, and delivery
of certificates for, such Option Securities shall be made at the above-mentioned
offices, or at such other place as shall be agreed upon by the Representatives
and the Company, on each Date of Delivery as specified in the notice from the
Representatives to the Company.
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Payment shall be made to the Company by wire transfer of immediately
available funds to a bank account designated by the Company against delivery to
the Representatives for the respective accounts of the Underwriters of
certificates for the Securities to be purchased by them. It is understood that
each Underwriter has authorized the Representatives, for its account, to accept
delivery of, receipt for, and make payment of the purchase price for, the
Initial Securities and the Option Securities, if any, which it has agreed to
purchase. Merrill Lynch or Salomon, individually and not as representative of
the Underwriters, may (but shall not be obligated to) make payment of the
purchase price for the Initial Securities or the Option Securities, if any, to
be purchased by any Underwriter whose funds have not been received by the
Closing Time or the relevant Date of Delivery, as the case may be, but such
payment shall not relieve such Underwriter from its obligations hereunder.
(d) DENOMINATIONS; REGISTRATION. Certificates for the Initial
Securities and the Option Securities, if any, shall be in such denominations and
registered in such names as the Representatives may request in writing at least
one full business day before the Closing Time or the relevant Date of Delivery,
as the case may be. The certificates for the Initial Securities and the Option
Securities, if any, will be made available for examination and packaging by the
Representatives in The City of New York not later than 10:00 A.M. (Eastern time)
on the business day prior to the Closing Time or the relevant Date of Delivery,
as the case may be.
SECTION 3. COVENANTS OF THE COMPANY. The Company covenants with each
Underwriter as follows:
(a) COMPLIANCE WITH SECURITIES REGULATIONS AND COMMISSION REQUESTS.
The Company, subject to Section 3(b), will comply with the requirements of Rule
430A or Rule 434, as applicable, and will notify the Representatives
immediately, and confirm the notice in writing, (i) when any post-effective
amendment to the Registration Statement shall become effective, or any
supplement to the Prospectus or any amended Prospectus shall have been filed,
(ii) of the receipt of any comments from the Commission, (iii) of any request by
the Commission for any amendment to the Registration Statement or any amendment
or supplement to the Prospectus or for additional information, and (iv) of the
issuance by the Commission of any stop order suspending the effectiveness of the
Registration Statement or of any order preventing or suspending the use of any
preliminary prospectus, or of the suspension of the qualification of the
Securities for offering or sale in any jurisdiction, or of the initiation or
threatening of any proceedings for any of such purposes. The Company will
promptly effect the filings necessary pursuant to Rule 424(b) and will take such
steps as it deems necessary to ascertain promptly whether the form of prospectus
transmitted for filing under Rule 424(b) was received for filing by the
Commission and, in the event that it was not, it will promptly file such
prospectus. The Company will make every reasonable effort to prevent the
issuance of any stop order and, if any stop order is issued, to obtain the
lifting thereof at the earliest possible moment.
(b) FILING OF AMENDMENTS. The Company will give the Representatives
notice of its intention to file or prepare any amendment to the Registration
Statement (including any filing under Rule 462(b)), any Term Sheet or any
amendment, supplement or revision to either the prospectus, included in the
Registration Statement at the time it became effective or to the
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Prospectus, will furnish the Representatives with copies of any such documents a
reasonable amount of time prior to such proposed filing or use, as the case may
be, and will not file or use any such document to which the Representatives or
counsel for the Underwriters shall object.
(c) DELIVERY OF REGISTRATION STATEMENTS. The Company has furnished or
will deliver to the Representatives and counsel for the Underwriters, without
charge, signed copies of the Registration Statement as originally filed and of
each amendment thereto (including exhibits filed therewith or incorporated by
reference therein) and signed copies of all consents and certificates of
experts, and will also deliver to the Representatives, without charge, a
conformed copy of the Registration Statement as originally filed and of each
amendment thereto (without exhibits) for each of the Underwriters. The copies
of the Registration Statement and each amendment thereto furnished to the
Underwriters will be identical to the electronically transmitted copies thereof
filed with the Commission pursuant to EDGAR, except to the extent permitted by
Regulation S-T.
(d) DELIVERY OF PROSPECTUSES. The Company has delivered to each
Underwriter, without charge, as many copies of each preliminary prospectus as
such Underwriter reasonably requested, and the Company hereby consents to the
use of such copies for purposes permitted by the 1933 Act. The Company will
furnish to each Underwriter, without charge, during the period when the
Prospectus is required to be delivered under the 1933 Act or the Securities
Exchange Act of 1934 (the "1934 Act"), such number of copies of the Prospectus
(as amended or supplemented) as such Underwriter may reasonably request. The
Prospectus and any amendments or supplements thereto furnished to the
Underwriters will be identical to the electronically transmitted copies thereof
filed with the Commission pursuant to EDGAR, except to the extent permitted by
Regulation S-T.
(e) CONTINUED COMPLIANCE WITH SECURITIES LAWS The Company will
comply with the 1933 Act and the 1933 Act Regulations so as to permit the
completion of the distribution of the Securities as contemplated in this
Agreement and in the Prospectus. If at any time when a prospectus is required
by the 1933 Act to be delivered in connection with sales of the Securities, any
event shall occur or condition shall exist as a result of which it is necessary,
in the opinion of counsel for the Underwriters or for the Company, to amend the
Registration Statement or amend or supplement the Prospectus in order that the
Prospectus will not include any untrue statements of a material fact or omit to
state a material fact necessary in order to make the statements therein not
misleading in the light of the circumstances existing at the time it is
delivered to a purchaser, or if it shall be necessary, in the opinion of such
counsel, at any such time to amend the Registration Statement or amend or
supplement the Prospectus in order to comply with the requirements of the 1933
Act or the 1933 Act Regulations, the Company will promptly prepare and file with
the Commission, subject to Section 3(b), such amendment or supplement as may be
necessary to correct such statement or omission or to make the Registration
Statement or the Prospectus comply with such requirements, and the Company will
furnish to the Underwriters such number of copies of such amendment or
supplement as the Underwriters may reasonably request.
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(f) BLUE SKY QUALIFICATIONS. The Company will use its best efforts,
in cooperation with the Underwriters, to qualify the Securities for offering and
sale under the applicable securities laws of such states and other jurisdictions
as the Representatives may designate and to maintain such qualifications in
effect for a period of not less than one year from the later of the effective
date of the Registration Statement and any Rule 462(b) Registration Statement;
provided, however, that the Company shall not be obligated to file any general
consent to service of process or to qualify as a foreign corporation or as a
dealer in securities in any jurisdiction in which it is not so qualified or to
subject itself to taxation in respect of doing business in any jurisdiction in
which it is not otherwise so subject. In each jurisdiction in which the
Securities have been so qualified, the Company will file such statements and
reports as may be required by the laws of such jurisdiction to continue such
qualification in effect for a period of not less than one year from the
effective date of the Registration Statement and any Rule 462(b) Registration
Statement.
(g) RULE 158. The Company will timely file such reports pursuant to
the 1934 Act as are necessary in order to make generally available to its
securityholders as soon as practicable an earnings statement for the purposes
of, and to provide the benefits contemplated by, the last paragraph of Section
11(a) of the 1933 Act.
(h) USE OF PROCEEDS. The Company will use the net proceeds received
by it from the sale of the Securities in the manner specified in the Prospectus
under "Use of Proceeds".
(i) LISTING. The Company will use its best efforts to effect and
maintain the quotation of the Securities on the Nasdaq National Market and will
file with the Nasdaq National Market all documents and notices required by the
Nasdaq National Market of companies that have securities that are traded in the
over-the-counter market and quotations for which are reported by the Nasdaq
National Market.
(j) RESTRICTION ON SALE OF SECURITIES. During a period of [180] days
from the date of the Prospectus, the Company will not, without the prior written
consent of Merrill Lynch and Salomon, (i) directly or indirectly, offer, pledge,
sell, contract to sell, sell any option or contract to purchase, purchase any
option or contract to sell, grant any option, right or warrant to purchase or
otherwise transfer or dispose of any share of Common Stock or any securities
convertible into or exercisable or exchangeable for Common Stock or file any
registration statement under the 1933 Act with respect to any of the foregoing
or (ii) enter into any swap or any other agreement or any transaction that
transfers, in whole or in part, directly or indirectly, the economic consequence
of ownership of the Common Stock, whether any such swap or transaction described
in clause (i) or (ii) above is to be settled by delivery of Common Stock or such
other securities, in cash or otherwise. The foregoing sentence shall not apply
to (A) the Securities to be sold hereunder, (B) any shares of Common Stock
issued by the Company upon the exercise of an option or warrant or the
conversion of a security outstanding on the date hereof and referred to in the
Prospectus, (C) any shares of Common Stock issued or options to purchase Common
Stock granted pursuant to existing employee benefit plans of the Company
referred to in the Prospectus or (D) any shares of Common Stock issued pursuant
to any non-employee director stock plan or dividend reinvestment plan.
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(k) REPORTING REQUIREMENTS. The Company, during the period when the
Prospectus is required to be delivered under the 1933 Act or the 1934 Act, will
file all documents required to be filed with the Commission pursuant to the 1934
Act within the time periods required by the 1934 Act and the rules and
regulations of the Commission thereunder.
(l) COMPLIANCE WITH RULE 463. The Company will file with the
Commission such reports on Form 10-Q as may be required pursuant to Rule 463 of
the 1933 Act Regulations.
SECTION 4. PAYMENT OF EXPENSES.
(a) EXPENSES. Whether or not any sale of the Securities is
consummated, the Company will pay all expenses incident to the performance of
its obligations under this Agreement, including (i) the preparation, printing
and filing of the Registration Statement (including financial statements and
exhibits) as originally filed and of each amendment thereto, (ii) the
preparation, printing and delivery to the Underwriters of this Agreement, and
such other documents as may be required in connection with the offering,
purchase, sale, issuance or delivery of the Securities, (iii) the preparation,
issuance and delivery of the certificates for the Securities to the
Underwriters, including any stock or other transfer taxes and any stamp or other
duties payable upon the sale, issuance or delivery of the Securities to the
Underwriters, (iv) the fees and disbursements of the Company's counsel,
accountants and other advisors, (v) the qualification of the Securities under
securities laws in accordance with the provisions of Section 3(f) hereof,
including filing fees and the reasonable fees and disbursements of counsel for
the Underwriters in connection therewith and in connection with the preparation
of the Blue Sky Survey and any supplement thereto which amounts shall not exceed
[$2500], (vi) the printing and delivery to the Underwriters of copies of each
preliminary prospectus, any Term Sheets and of the Prospectus and any amendments
or supplements thereto, (vii) the fees and expenses of any transfer agent or
registrar for the Securities, (viii) the filing fees incident to, and the
reasonable fees and disbursements of counsel to the Underwriters in connection
with, the review by the National Association of Securities Dealers, Inc. (the
"NASD") of the terms of the sale of the Securities, and (ix) the fees and
expenses incurred in connection with the inclusion of the Securities in the
Nasdaq National Market.
(b) TERMINATION OF AGREEMENT. If this Agreement is terminated by the
Representatives in accordance with the provisions of Section 5 or
Section 9(a)(i) hereof, the Company shall reimburse the Underwriters for all of
their out-of-pocket expenses, including the reasonable fees and disbursements of
counsel for the Underwriters.
SECTION 5. CONDITIONS OF UNDERWRITERS' OBLIGATIONS. The obligations of
the several Underwriters hereunder are subject to the accuracy of the
representations and warranties of the Company contained in Section 1 hereof or
in certificates of any officer of the Company or any subsidiary of the Company
delivered pursuant to the provisions hereof, to the performance by the Company
of its covenants and other obligations hereunder, and to the following further
conditions:
(a) EFFECTIVENESS OF REGISTRATION STATEMENT. The Registration
Statement, including any Rule 462(b) Registration Statement, has become
effective and at Closing Time no stop order
15
<PAGE>
suspending the effectiveness of the Registration Statement shall have been
issued under the 1933 Act or proceedings therefor initiated or threatened by the
Commission, and any request on the part of the Commission for additional
information shall have been complied with to the reasonable satisfaction of
counsel to the Underwriters. A prospectus containing the Rule 430A Information
shall have been filed with the Commission in accordance with Rule 424(b) (or a
post-effective amendment providing such information shall have been filed and
declared effective in accordance with the requirements of Rule 430A) or, if the
Company has elected to rely upon Rule 434, a Term Sheet shall have been filed
with the Commission in accordance with Rule 424(b).
(b) OPINIONS OF COUNSEL FOR COMPANY. At the Closing Time, the
Representatives shall have received the favorable opinions, dated as of the
Closing Time, together with signed or reproduced copies of such letters for each
of the other Underwriters, (i) of Brobeck, Phleger & Harrison LLP, counsel for
the Company, to the effect set forth in Exhibit A-1 hereto, (ii) of Hale and
Dorr LLP, counsel for the Company, to the effect set forth in Exhibit A-2
hereto, (iii) of Blumenfeld & Cohen, counsel for the Company, to the effect set
forth in Exhibit A-3 hereto, (iv) of Leboeuf, Lamb, Greene & MacRae L.L.P.,
counsel for the Company, to the effect set forth on Exhibit A-4 hereto, (v) of
Dow, Lohnes & Albertson LLC, counsel for the Company, to the effect set forth on
Exhibit A-5 hereto and (vi) of Jeffrey Blumenfeld, General Counsel of the
Company, to the effect set forth on Exhibit A-6 hereto. In giving the opinion
described in clause (i) above such counsel may rely, as to all matters governed
by the laws of jurisdictions other than the law of the State of New York, the
federal law of the United States and the General Corporation Law of the State of
Delaware, upon the opinions of counsel satisfactory to the Representatives.
Such counsel may also state that, insofar as such opinion involves factual
matters, they have relied, to the extent they deem proper, upon certificates of
officers of the Company and its subsidiaries and certificates of public
officials.
(c) OPINION OF COUNSEL FOR UNDERWRITERS. At Closing Time, the
Representatives shall have received the favorable opinion, dated as of Closing
Time, of Baker & McKenzie, counsel for the Underwriters, together with signed or
reproduced copies of such letter for each of the other Underwriters,
substantially to the effect set forth in Exhibit A-7 hereto. In giving such
opinion such counsel may rely, as to all matters governed by the laws of
jurisdictions other than the law of the State of New York, the federal law of
the United States and the General Corporation Law of the State of Delaware, upon
the opinions of counsel satisfactory to the Representatives. Such counsel may
also state that, insofar as such opinion involves factual matters, they have
relied, to the extent they deem proper, upon certificates of officers of the
Company and its subsidiaries and certificates of public officials.
(d) OFFICERS' CERTIFICATE. At Closing Time, there shall not have
been, since the date hereof or since the respective dates as of which
information is given in the Prospectus, any material adverse change in the
condition, financial or otherwise, or in the earnings, business affairs or
business prospects of the Company and its subsidiaries considered as one
enterprise, whether or not arising in the ordinary course of business, and the
Representatives shall have received a certificate of the President or a Vice
President of the Company and of the chief financial or chief accounting officer
of the Company, dated as of Closing Time, to the effect that
16
<PAGE>
(i) there has been no such material adverse change, (ii) the representations and
warranties in Section 1(a) hereof are true and correct with the same force and
effect as though expressly made at and as of Closing Time, (iii) the Company has
complied with all agreements and satisfied all conditions on its part to be
performed or satisfied at or prior to Closing Time, and (iv) no stop order
suspending the effectiveness of the Registration Statement has been issued and
no proceedings for that purpose have been instituted or are pending or are
contemplated by the Commission.
(e) ACCOUNTANT'S COMFORT LETTER. At the time of the execution of this
Agreement, the Representatives shall have received from PricewaterhouseCoopers
L.L.P. a letter dated such date, in form and substance satisfactory to the
Representatives, together with signed or reproduced copies of such letter for
each of the other Underwriters containing statements and information of the type
ordinarily included in accountants' "comfort letters" to underwriters with
respect to the financial statements and certain financial information contained
in the Registration Statement and the Prospectus.
(f) BRING-DOWN COMFORT LETTER. At Closing Time, the Representatives
shall have received from PricewaterhouseCoopers L.L.P. a letter, dated as of
Closing Time, to the effect that they reaffirm the statements made in the letter
furnished pursuant to subsection (e) of this Section, except that the specified
date referred to shall be a date not more than three business days prior to
Closing Time.
(g) APPROVAL OF LISTING. At Closing Time, the Securities shall have
been approved for inclusion in the Nasdaq National Market, subject only to
official notice of issuance.
(h) NO OBJECTION. The NASD has confirmed that it has not raised any
objection with respect to the fairness and reasonableness of the underwriting
terms and arrangements.
(i) LOCK-UP AGREEMENTS. At the date of this Agreement, the
Representatives shall have received an agreement substantially in the form of
Exhibit B hereto signed by the persons listed on Schedule C hereto.
(j) CONDITIONS TO PURCHASE OF OPTION SECURITIES. In the event that
the Underwriters exercise their option provided in Section 2(b) hereof to
purchase all or any portion of the Option Securities, the representations and
warranties of the Company contained herein and the statements in any
certificates furnished by the Company or any subsidiary of the Company hereunder
shall be true and correct as of each Date of Delivery and, at the relevant Date
of Delivery, the Representatives shall have received:
(i) OFFICERS' CERTIFICATE. A certificate, dated such Date of
Delivery, of the President or a Vice President of the Company and of the
chief financial or chief accounting officer of the Company confirming
that the certificate delivered at the Closing Time pursuant to
Section 5(d) hereof remains true and correct as of such Date of Delivery.
17
<PAGE>
(ii) OPINIONS OF COUNSEL FOR COMPANY. The favorable opinions
of Brobeck, Phleger & Harrison LLP, Hale and Dorr LLP, Blumenfeld &
Cohen, Leboeuf, Lamb, Greene & MacRae L.L.P. and Dow, Lohnes & Albertson
LLC, each counsel for the Company, and of Jeffrey Blumenfeld, General
Counsel of the Company, each, in form and substance satisfactory to
counsel for the Underwriters, dated such Date of Delivery, relating to
the Option Securities to be purchased on such Date of Delivery and
otherwise to the same effect as the opinion required by Section 5(b)
hereof.
(iii) OPINION OF COUNSEL FOR UNDERWRITERS. The favorable
opinion of Baker & McKenzie, counsel for the Underwriters, dated such
Date of Delivery, relating to the Option Securities to be purchased on
such Date of Delivery and otherwise to the same effect as the opinion
required by Section 5(c) hereof.
(iv) BRING-DOWN COMFORT LETTER. A letter from
PricewaterhouseCoopers L.L.P., in form and substance satisfactory to the
Representatives and dated such Date of Delivery, substantially in the
same form and substance as the letter furnished to the Representatives
pursuant to Section 5(f) hereof, except that the "specified date" in the
letter furnished pursuant to this paragraph shall be a date not more than
five days prior to such Date of Delivery.
(k) ADDITIONAL DOCUMENTS. At Closing Time and at each Date of
Delivery, counsel for the Underwriters shall have been furnished with such
documents and opinions as they may require for the purpose of enabling them to
pass upon the issuance and sale of the Securities as herein contemplated, or in
order to evidence the accuracy of any of the representations or warranties, or
the fulfillment of any of the conditions, herein contained; and all proceedings
taken by the Company in connection with the issuance and sale of the Securities
as herein contemplated shall be satisfactory in form and substance to the
Representatives and counsel for the Underwriters.
(l) TERMINATION OF AGREEMENT. If any condition specified in this
Section shall not have been fulfilled when and as required to be fulfilled, this
Agreement, or, in the case of any condition to the purchase of Option
Securities, on a Date of Delivery which is after the Closing Time, the
obligations of the several Underwriters to purchase the relevant Option
Securities, may be terminated by the Representatives by notice to the Company at
any time at or prior to Closing Time or such Date of Delivery, as the case may
be, and such termination shall be without liability of any party to any other
party except as provided in Section 4 and except that Sections 1, 6, 7 and 8
shall survive any such termination and remain in full force and effect.
SECTION 6 INDEMNIFICATION.
(a) INDEMNIFICATION OF UNDERWRITERS. The Company agrees to indemnify
and hold harmless each Underwriter and each person, if any, who controls any
Underwriter within the meaning of Section 15 of the 1933 Act or Section 20 of
the 1934 Act as follows:
(i) against any and all loss, liability, claim, damage and
expense whatsoever, as incurred, arising out of any untrue statement or
alleged untrue statement of a material
18
<PAGE>
fact contained in the Registration Statement (or any amendment thereto),
including the Rule 430A Information and the Rule 434 Information, if
applicable, or the omission or alleged omission therefrom of a material
fact required to be stated therein or necessary to make the statements
therein not misleading or arising out of any untrue statement or alleged
untrue statement of a material fact included in any preliminary
prospectus or the Prospectus (or any amendment or supplement thereto), or
the omission or alleged omission therefrom of a material fact necessary
in order to make the statements therein, in the light of the
circumstances under which they were made, not misleading;
(ii) against any and all loss, liability, claim, damage and
expense whatsoever, as incurred, to the extent of the aggregate amount
paid in settlement of any litigation, or any investigation or proceeding
by any governmental agency or body, commenced or threatened, or of any
claim whatsoever based upon any such untrue statement or omission, or any
such alleged untrue statement or omission; provided that (subject to
Section 6(d) below) any such settlement is effected with the written
consent of the Company; and
(iii) against any and all expense whatsoever, as incurred
(including the fees and disbursements of counsel chosen by Merrill
Lynch), reasonably incurred in investigating, preparing or defending
against any litigation, or any investigation or proceeding by any
governmental agency or body, commenced or threatened, or any claim
whatsoever based upon any such untrue statement or omission, or any such
alleged untrue statement or omission, to the extent that any such expense
is not paid under (i) or (ii) above;
PROVIDED, HOWEVER, that this indemnity agreement shall not apply to any loss,
liability, claim, damage or expense to the extent arising out of any untrue
statement or omission or alleged untrue statement or omission made in reliance
upon and in conformity with written information furnished to the Company by any
Underwriter through Merrill Lynch or Salomon expressly for use in the
Registration Statement (or any amendment thereto), including the Rule 430A
Information and the Rule 434 Information, if applicable, or any preliminary
prospectus or the Prospectus (or any amendment or supplement thereto); and
PROVIDED further that the Company will not be liable to an Underwriter with
respect to any Preliminary Prospectus to the extent that the Company shall
sustain the burden of proof of proving that any such loss, liability, claim,
damage or expense resulted from the fact that such Underwriter, in contravention
of a requirement of this Agreement [or applicable law], sold Shares to a person
to whom such Underwriter failed to send or give, at or prior to the Closing
Date, a copy of the Final Prospectus as then amended or supplemented if (i) the
Company has previously furnished copies thereof (sufficiently in advance of the
Closing Date to allow for the distribution by the Closing Date) to the
Underwriter and the loss, liability, claim, damage or expense of such
Underwriter resulted from an untrue statement or omission or alleged untrue
statement or omission of a material fact contained in or omitted from the
Preliminary Prospectus which was corrected in the Final Prospectus as, if
applicable, amended or supplemented prior to the Closing Date and (ii) giving or
sending such Final Prospectus by the Closing Date to the party or parties
asserting such loss,
19
<PAGE>
liability, claim, damage or expense would have constituted a complete defense to
the claim asserted by such person.
(b) INDEMNIFICATION OF COMPANY, DIRECTORS AND OFFICERS. Each
Underwriter severally agrees to indemnify and hold harmless the Company, its
directors, each of its officers who signed the Registration Statement, and each
person, if any, who controls the Company within the meaning of Section 15 of the
1933 Act or Section 20 of the 1934 Act against any and all loss, liability,
claim, damage and expense described in the indemnity contained in subsection (a)
of this Section, as incurred, but only with respect to untrue statements or
omissions, or alleged untrue statements or omissions, made in the Registration
Statement (or any amendment thereto), including the Rule 430A Information and
the Rule 434 Information, if applicable, or any preliminary prospectus or the
Prospectus (or any amendment or supplement thereto) in reliance upon and in
conformity with written information furnished to the Company by such Underwriter
through Merrill Lynch expressly for use in the Registration Statement (or any
amendment thereto) or such preliminary prospectus or the Prospectus (or any
amendment or supplement thereto).
(c) ACTIONS AGAINST PARTIES; NOTIFICATION. Each indemnified party
shall give notice as promptly as reasonably practicable to each indemnifying
party of any action commenced against it in respect of which indemnity may be
sought hereunder, but failure to so notify an indemnifying party shall not
relieve such indemnifying party from any liability hereunder to the extent it is
not materially prejudiced as a result thereof and in any event shall not relieve
it from any liability which it may have otherwise than on account of this
indemnity agreement. In the case of parties indemnified pursuant to Section
6(a) above, counsel to the indemnified parties shall be selected by Merrill
Lynch, and, in the case of parties indemnified pursuant to Section 6(b) above,
counsel to the indemnified parties shall be selected by the Company. An
indemnifying party may participate at its own expense in the defense of any such
action; provided, however, that counsel to the indemnifying party shall not
(except with the consent of the indemnified party) also be counsel to the
indemnified party. In no event shall the indemnifying parties be liable for
fees and expenses of more than one counsel (in addition to any local counsel)
separate from their own counsel for all indemnified parties in connection with
any one action or separate but similar or related actions in the same
jurisdiction arising out of the same general allegations or circumstances. No
indemnifying party shall, without the prior written consent of the indemnified
parties, settle or compromise or consent to the entry of any judgment with
respect to any litigation, or any investigation or proceeding by any
governmental agency or body, commenced or threatened, or any claim whatsoever in
respect of which indemnification or contribution could be sought under this
Section 6 or Section 7 hereof (whether or not the indemnified parties are actual
or potential parties thereto), unless such settlement, compromise or consent (i)
includes an unconditional release of each indemnified party from all liability
arising out of suc litigation, investigation, proceeding or claim and (ii) does
not include a statement as to or an admission of fault, culpability or a failure
to act by or on behalf of any indemnified party.
20
<PAGE>
(d) SETTLEMENT WITHOUT CONSENT IF FAILURE TO REIMBURSE. If at any
time an indemnified party shall have requested an indemnifying party to
reimburse the indemnified party for fees and expenses of counsel, such
indemnifying party agrees that it shall be liable for any settlement of the
nature contemplated by Section 6(a)(ii) effected without its written consent if
(i) such settlement is entered into more than 45 days after receipt by such
indemnifying party of the aforesaid request, (ii) such indemnifying party shall
have received notice of the terms of such settlement at least 30 days prior to
such settlement being entered into and (iii) such indemnifying party shall not
have reimbursed such indemnified party in accordance with such request prior to
the date of such settlement.
SECTION 7. CONTRIBUTION. If the indemnification provided for in
Section 6 hereof is for any reason unavailable to or insufficient to hold
harmless an indemnified party in respect of any losses, liabilities, claims,
damages or expenses referred to therein, then each indemnifying party shall
contribute to the aggregate amount of such losses, liabilities, claims, damages
and expenses incurred by such indemnified party, as incurred, (i) in such
proportion as is appropriate to reflect the relative benefits received by the
Company on the one hand and the Underwriters on the other hand from the offering
of the Securities pursuant to this Agreement or (ii) if the allocation provided
by clause (i) is not permitted by applicable law, in such proportion as is
appropriate to reflect not only the relative benefits referred to in clause (i)
above but also the relative fault of the Company on the one hand and of the
Underwriters on the other hand in connection with the statements or omissions
which resulted in such losses, liabilities, claims, damages or expenses, as well
as any other relevant equitable considerations.
The relative benefits received by the Company on the one hand and the
Underwriters on the other hand in connection with the offering of the Securities
pursuant to this Agreement shall be deemed to be in the same respective
proportions as the total net proceeds from the offering of the Securities
pursuant to this Agreement (before deducting expenses) received by the Company
and the total underwriting discount received by the Underwriters, in each case
as set forth on the cover of the Prospectus, or, if Rule 434 is used, the
corresponding location on the Term Sheet, bear to the aggregate initial public
offering price of the Securities as set forth on such cover.
The relative fault of the Company on the one hand and the Underwriters on
the other hand shall be determined by reference to, among other things, whether
any such untrue or alleged untrue statement of a material fact or omission or
alleged omission to state a material fact relates to information supplied by the
Company or by the Underwriters and the parties' relative intent, knowledge,
access to information and opportunity to correct or prevent such statement or
omission.
The Company and the Underwriters agree that it would not be just and
equitable if contribution pursuant to this Section 7 were determined by pro rata
allocation (even if the Underwriters were treated as one entity for such
purpose) or by any other method of allocation which does not take account of the
equitable considerations referred to above in this Section 7. The aggregate
amount of losses, liabilities, claims, damages and expenses incurred by an
indemnified party and referred to above in this Section 7 shall be deemed to
include any legal or other expenses reasonably incurred by such indemnified
party in investigating, preparing or
21
<PAGE>
defending against any litigation, or any investigation or proceeding by any
governmental agency or body, commenced or threatened, or any claim whatsoever
based upon any such untrue or alleged untrue statement or omission or alleged
omission.
Notwithstanding the provisions of this Section 7, no Underwriter shall be
required to contribute any amount in excess of the amount by which the total
price at which the Securities underwritten by it and distributed to the public
were offered to the public exceeds the amount of any damages which such
Underwriter has otherwise been required to pay by reason of any such untrue or
alleged untrue statement or omission or alleged omission.
No person guilty of fraudulent misrepresentation (within the meaning of
Section 11(f) of the 1933 Act) shall be entitled to contribution from any person
who was not guilty of such fraudulent misrepresentation.
For purposes of this Section 7, each person, if any, who controls an
Underwriter within the meaning of Section 15 of the 1933 Act or Section 20 of
the 1934 Act shall have the same rights to contribution as such Underwriter, and
each director of the Company, each officer of the Company who signed the
Registration Statement, and each person, if any, who controls the Company within
the meaning of Section 15 of the 1933 Act or Section 20 of the 1934 Act shall
have the same rights to contribution as the Company. The Underwriters'
respective obligations to contribute pursuant to this Section 7 are several in
proportion to the number of Initial Securities set forth opposite their
respective names in Schedule A hereto and not joint.
SECTION 8. REPRESENTATIONS, WARRANTIES AND AGREEMENTS TO SURVIVE
DELIVERY. All representations, warranties and agreements contained in this
Agreement or in certificates of officers of the Company or any of its
subsidiaries submitted pursuant hereto, shall remain operative and in full force
and effect, regardless of any investigation made by or on behalf of any
Underwriter or controlling person, or by or on behalf of the Company, and shall
survive delivery of the Securities to the Underwriters.
SECTION 9. TERMINATION OF AGREEMENT.
(a) TERMINATION; GENERAL. The Representatives may terminate this
Agreement, by notice to the Company, at any time at or prior to Closing Time
(i) if there has been, since the time of execution of this Agreement or since
the respective dates as of which information is given in the Prospectus, any
material adverse change in the condition, financial or otherwise, or in the
earnings, business affairs or business prospects of the Company and its
subsidiaries considered as one enterprise, whether or not arising in the
ordinary course of business, or (ii) if there has occurred any material adverse
change in the financial markets in the United States or the international
financial markets, any outbreak of hostilities or escalation thereof or other
calamity or crisis or any change or development involving a prospective change
in national or international political, financial or economic conditions, in
each case the effect of which is such as to make it, in the judgment of the
Representatives, impracticable to market the Securities or to enforce contracts
for the sale of the Securities, or (iii) if trading in any securities of the
Company has been suspended or materially limited by the Commission or the Nasdaq
National Market, or if trading generally on the American Stock Exchange or the
New York Stock Exchange or in the
22
<PAGE>
Nasdaq National Market has been suspended or materially limited, or minimum or
maximum prices for trading have been fixed, or maximum ranges for prices have
been required, by any of said exchanges or by such system or by order of the
Commission, the National Association of Securities Dealers, Inc. or any other
governmental authority, or (iv) if a banking moratorium has been declared by
either Federal or New York authorities.
(b) LIABILITIES. If this Agreement is terminated pursuant to this
Section, such termination shall be without liability of any party to any other
party except as provided in Section 4 hereof, and provided further that Sections
1, 6, 7 and 8 shall survive such termination and remain in full force and
effect.
SECTION 10. DEFAULT BY ONE OR MORE OF THE UNDERWRITERS. If one or more
of the Underwriters shall fail at Closing Time or a Date of Delivery to purchase
the Securities which it or they are obligated to purchase under this Agreement
(the "Defaulted Securities"), the Representatives shall have the right, within
24 hours thereafter, to make arrangements for one or more of the non-defaulting
Underwriters, or any other underwriters, to purchase all, but not less than all,
of the Defaulted Securities in such amounts as may be agreed upon and upon the
terms herein set forth; if, however, the Representatives shall not have
completed such arrangements within such 24-hour period, then:
(a) if the number of Defaulted Securities does not exceed 10%
of the number of Securities to be purchased on such date, each of the
non-defaulting Underwriters shall be obligated, severally and not
jointly, to purchase the full amount thereof in the proportions that
their respective underwriting obligations hereunder bear to the
underwriting obligations of all non-defaulting Underwriters, or
(b) if the number of Defaulted Securities exceeds 10% of the
number of Securities to be purchased on such date, this Agreement or,
with respect to any Date of Delivery which occurs after the Closing Time,
the obligation of the Underwriters to purchase and of the Company to sell
the Option Securities to be purchased and sold on such Date of Delivery
shall terminate without liability on the part of any non-defaulting
Underwriter.
No action taken pursuant to this Section shall relieve any defaulting
Underwriter from liability in respect of its default.
In the event of any such default which does not result in a termination
of this Agreement or, in the case of a Date of Delivery which is after the
Closing Time, which does not result in a termination of the obligation of the
Underwriters to purchase and the Company to sell the relevant Option Securities,
as the case may be, either the Representatives or the Company shall have the
right to postpone Closing Time or the relevant Date of Delivery, as the case may
be, for a period not exceeding seven days in order to effect any required
changes in the Registration Statement or Prospectus or in any other documents or
arrangements. As used herein, the term "Underwriter" includes any person
substituted for an Underwriter under this Section 10.
23
<PAGE>
SECTION 11. NOTICES. All notices and other communications hereunder
shall be in writing and shall be deemed to have been duly given if mailed or
transmitted by any standard form of telecommunication. Notices to the
Underwriters shall be directed to the Representatives at North Tower, World
Financial Center, New York, New York 10281-1201, attention of Marcey Becker;
notices to the Company shall be directed to it at 6933 South Revere Parkway,
Englewood, Colorado 80112, attention of Scott Chandler; in each case, with
copies to their respective primary outside legal counsel, if known.
SECTION 12. PARTIES. This Agreement shall each inure to the benefit of
and be binding upon the Underwriters, the Company and their respective
successors. Nothing expressed or mentioned in this Agreement is intended or
shall be construed to give any person, firm or corporation, other than the
Underwriters and the Company and their respective successors and the controlling
persons and officers and directors referred to in Sections 6 and 7 and their
heirs and legal representatives, any legal or equitable right, remedy or claim
under or in respect of this Agreement or any provision herein contained. This
Agreement and all conditions and provisions hereof are intended to be for the
sole and exclusive benefit of the Underwriters and the Company and their
respective successors, and said controlling persons and officers and directors
and their heirs and legal representatives, and for the benefit of no other
person, firm or corporation. No purchaser of Securities from any Underwriter
shall be deemed to be a successor by reason merely of such purchase.
SECTION 13. GOVERNING LAW AND TIME. THIS AGREEMENT SHALL BE GOVERNED
BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK.
SPECIFIED TIMES OF DAY REFER TO NEW YORK CITY TIME.
SECTION 14. EFFECT OF HEADINGS. The Article and Section headings
herein and the Table of Contents are for convenience only and shall not affect
the construction hereof.
24
<PAGE>
If the foregoing is in accordance with your understanding of our
agreement, please sign and return to the Company a counterpart hereof, whereupon
this instrument, along with all counterparts, will become a binding agreement
between the Underwriters and the Company in accordance with its terms.
Very truly yours,
RHYTHMS NETCONNECTIONS INC.
By
-------------------------------
Title:
CONFIRMED AND ACCEPTED, By:
as of the date first above written: -------------------------------
As Attorney-in-Fact acting on behalf
of the Selling Stockholders named in
Schedule D hereto.
MERRILL LYNCH & CO.
MERRILL LYNCH, PIERCE, FENNER & SMITH
INCORPORATED
SALOMON SMITH BARNEY INC.
HARMBRECHT & QUIST
THOMAS WEISEL PARTNERS LLC
By: MERRILL LYNCH, PIERCE, FENNER & SMITH
INCORPORATED
By
----------------------------
Authorized Signatory
By: SALOMON SMITH BARNEY INC.
By
----------------------------
Authorized Signatory
For themselves and as Representatives of the other Underwriters named in
Schedule A hereto.
25
<PAGE>
SCHEDULE A
<TABLE>
<CAPTION>
Number of
Name of Underwriter Initial Securities
------------------- ------------------
<S> <C>
Merrill Lynch, Pierce, Fenner & Smith Incorporated . .
Salomon Smith Barney Inc. . . . . . . . . . . . . . . .
Hambrecht & Quist . . . . . . . . . . . . . . . . . . .
Thomas Weisel Partners LLC . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . .
</TABLE>
Sch A-1
<PAGE>
SCHEDULE B
RHYTHMS NETCONNECTIONS INC.
Shares of Common Stock
(Par Value $.001 Per Share)
1. The initial public offering price per share for the Securities,
determined as provided in said Section 2, shall be $ .
2. The purchase price per share for the Securities to be paid by the
several Underwriters shall be $ , being an amount equal to the initial public
offering price set forth above less $ per share; provided that the purchase
price per share for any Option Securities purchased upon the exercise of the
over-allotment option described in Section 2(b) shall be reduced by an amount
per share equal to any dividends or distributions declared by the Company and
payable on the Initial Securities but not payable on the Option Securities.
Sch B-1
<PAGE>
SCHEDULE C
List of persons and entities
subject to lock-up
Sch C-1
<PAGE>
Exhibit A-1
[Form of Brobeck, Phleger & Harrison LLP Opinion]
Exh A-1
<PAGE>
Exhibit A-2
[Form of Hale and Dorr LLP Opinion]
Exh A-2
<PAGE>
Exhibit A-3
[Form of Blumenfeld & Cohen Opinion]
Exh A-3
<PAGE>
Exhibit A-4
[Form of Leboeuf, Lamb, Greene & MacRae L.L.P Opinion]
Exh A-4
<PAGE>
Exhibit A-5
[Form of Dow, Lohnes & Albertson Opinion]
Exh A-5
<PAGE>
Exhibit A-6
[Form of General Counsel Opinion]
Exh A-6
<PAGE>
Exhibit A-7
[Form of Baker & McKenzie Opinion]
Exh A-7
<PAGE>
Exhibit B
March __, 1999
MERRILL LYNCH & CO.
Merrill Lynch, Pierce, Fenner & Smith
Incorporated
as Representatives of the several
Underwriters to be named in the
within-mentioned Purchase Agreement
c/o Merrill Lynch & Co.
Merrill Lynch, Pierce, Fenner & Smith
Incorporated
North Tower
World Financial Center
New York, New York 10281-1209
Re: Proposed Public Offering by Rhythms NetConnections Inc.
-------------------------------------------------------
Dear Sirs:
The undersigned, a stockholder, officer and/or director of Rhythms
NetConnections Inc., a Delaware corporation (the "Company"), understands that
Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner & Smith Incorporated
("Merrill Lynch") and certain other lead managers propose to enter into a
Purchase Agreement (the "Purchase Agreement") with the Company providing for the
public offering of shares (the "Securities") of the Company's common stock, par
value $.001 per share (the "Common Stock"). In recognition of the benefit that
such an offering will confer upon the undersigned as a stockholder, officer
and/or director of the Company, and for other good and valuable consideration,
the receipt and sufficiency of which are hereby acknowledged, the undersigned
agrees with each underwriter to be named in the Purchase Agreement that, during
a period of 180 days from the date of the Purchase Agreement, the undersigned
will not, without the prior written consent of Merrill Lynch, directly or
indirectly, (i) offer, pledge, sell, contract to sell, sell any option or
contract to purchase, purchase any option or contract to sell, grant any option,
right or warrant for the sale of, or otherwise dispose of or transfer any shares
of the Company's Common Stock or any securities convertible into or exchangeable
or exercisable for Common Stock, whether now owned or hereafter acquired by the
undersigned or with respect to which the undersigned has or hereafter acquires
the power of disposition, or file any registration statement under the
Securities Act of 1933, as amended, with respect to any of the foregoing or (ii)
enter into any swap or any other agreement or any transaction that transfers, in
whole or in part, directly or indirectly, the economic consequence of ownership
of the Common Stock, whether any such swap or transaction is to be settled by
delivery of Common Stock or other securities, in cash or otherwise.
Very truly yours,
Signature:
------------------------
Print Name:
-----------------------
Exh B-1
<PAGE>
RESTATED CERTIFICATE OF INCORPORATION
OF RHYTHMS NETCONNECTIONS INC.,
a Delaware Corporation
1. Rhythms NetConnections Inc., a corporation organized and existing
under the laws of the state of Delaware, hereby certifies as follows:
2. The name of the corporation is Rhythms NetConnections Inc. The
corporation was originally incorporated under the name "Accelerated Connections,
Inc." The date the corporation filed its original Certificate of Incorporation
with the Secretary of State was February 27, 1997.
3. This Restated Certificate of Incorporation restates and amends the
provisions of the original Certificate of Incorporation of this corporation as
heretofore in effect and was duly adopted by the corporation's Board of
Directors in accordance with Sections 241 and 245 of the General Corporation Law
of the State of Delaware.
The text of the Certificate of Incorporation is hereby restated to read as
herein set forth in full:
ARTICLE I
The name of this corporation is Rhythms NetConnections Inc.
ARTICLE II
The address of the registered office of the corporation in the State of
Delaware is 30 Old Rudnick Lane, City of Dover, County of Kent 19901. The name
of its registered agent at such address is CorpAmerica, Inc.
ARTICLE III
The nature of the business or purposes to be conducted or promoted is to
engage in any lawful act or activity for which corporations may be organized
under the General Corporation Law of Delaware.
ARTICLE IV
A. CLASSES OF STOCK. This corporation is authorized to issue two classes
of stock to be designated, respectively, "Common Stock" and "Preferred Stock."
The total number of shares which the corporation is authorized to issue is
Ninety-Eight Million Five Hundred Seventy-Eight Thousand Eight Hundred
Twenty-Four (98,578,824) shares. Seventy-Four Million One Hundred Seventy-One
Thousand Sixty-Two (74,171,062) shares shall be Common Stock, $0.001 par
<PAGE>
value per share and Twenty-Four Million Four Hundred Seven Thousand Seven
Hundred Sixty-Two (24,407,762) shares shall be Preferred Stock, $0.001 par value
per share.
B. RIGHTS, PREFERENCES AND RESTRICTIONS OF PREFERRED STOCK. The
Preferred Stock authorized by this Restated Certificate of Incorporation may be
issued from time to time in series. The rights, preferences, privileges, and
restrictions granted to and imposed on (i) the Series A Preferred Stock, which
series shall consist of 12,900,000 shares, (ii) the Series B Preferred Stock,
which series shall consist of 4,044,943 shares, and (iii) the Series C Preferred
Stock, which series shall consist of 7,462,819 shares, are as set forth below in
this Article IV(B). The Board of Directors is hereby authorized to fix or alter
the rights, preferences, privileges and restrictions granted to or imposed upon
additional series of Preferred Stock, and the number of shares constituting any
such series and the designation thereof, or of any of them. Subject to
compliance with applicable protective voting rights which have been or may be
granted to the Preferred Stock or series thereof in Certificates of
Determination or the corporation's Restated Certificate of Incorporation
("Protective Provisions"), but notwithstanding any other rights of the Preferred
Stock or any series thereof, the rights, privileges, preferences and
restrictions of any such additional series may be subordinated to, pari passu
with (including, without limitation, inclusion in provisions with respect to
liquidation and acquisition preferences, redemption and/or approval of matters
by vote or written consent), or senior to any of those of any present or future
class or series of Preferred or Common Stock. Subject to compliance with
applicable Protective Provisions, the Board of Directors is also authorized to
increase or decrease the number of shares of any series (other than the Series A
Preferred Stock, Series B Preferred Stock or Series C Preferred Stock) prior or
subsequent to the issue of that series, but not below the number of shares of
such series then outstanding. In case the number of shares of any series shall
be so decreased, the shares constituting such decrease shall resume the status
which they had prior to the adoption of the resolution originally fixing the
number of shares of such series.
1. DIVIDEND PROVISIONS.
(a) Subject to the rights of series of Preferred Stock which may
from time to time come into existence, the holders of shares of Series A
Preferred Stock, Series B Preferred Stock and Series C Preferred Stock shall be
entitled to receive dividends, out of any assets legally available therefor,
prior and in preference to any declaration or payment of any dividend payable
other than in: (a) Common Stock or other securities and rights convertible into
or entitling the holder thereof to receive, directly or indirectly, additional
shares of Common Stock of this corporation; or (b) capital stock of other
persons (including without limitation subsidiaries of this corporation) or
options or rights to purchase any such capital stock) on the Common Stock of
this corporation, at the rate of (i) $0.08 per share of Series A Preferred Stock
per annum, $0.356 per share of Series B Preferred Stock per annum and $0.6432
per share of Series C Preferred Stock per annum, or (ii) if greater, the amount
per annum which would be paid per share of Series A Preferred Stock, Series B
Preferred Stock and Series C Preferred Stock, as the case may be, on the number
of shares of Common Stock into which such share is convertible as of the record
date fixed for determination of the stockholders entitled to receive such
distribution (assuming conversion of all convertible Preferred Stock), payable
quarterly when, as and if declared by the Board of Directors. Such dividends
shall not be cumulative. Dividends paid in a form other than cash shall be
deemed to be the fair value thereof as determined by the Board of Directors
irrespective of any accounting treatment.
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(b) In the event this corporation shall declare a distribution
payable in capital stock of other persons or options or rights to purchase any
such capital stock, then, (i) in the event this corporation distributes at the
same time (A) common stock of another person and (B) Series A preferred stock,
Series B preferred stock and Series C preferred stock of such other person, with
rights, preferences, privileges and restrictions substantially the same as the
Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock,
and the number of shares of common stock, Series A preferred stock, Series B
preferred stock and Series C preferred stock distributed are in substantially
the same relative proportions as this corporation's then outstanding shares of
Common Stock, Series A Preferred Stock, Series B Preferred Stock and Series C
Preferred Stock, then (V) all such common stock shall be distributed to the
Common Stock, (W) all such Series A Preferred Stock shall be distributed to the
Series A Preferred Stock, (X) all such Series B Preferred Stock shall be
distributed to the Series B Preferred Stock, and (Y) all such Series C Preferred
Stock shall be distributed to the Series C Preferred Stock and (ii) in all other
cases the holders of the Series A Preferred Stock, Series B Preferred Stock and
Series C Preferred Stock shall be entitled (together with the Common Stock) to a
proportionate share, and no more, of any such distribution as though the holders
of the Series A Preferred Stock, Series B Preferred Stock and Series C Preferred
Stock were the holders of the number of shares of Common Stock of this
corporation into which their respective shares of Series A Preferred Stock,
Series B Preferred Stock and Series C Preferred Stock are convertible as of the
record date fixed for the determination of the stockholders entitled to receive
such distribution.
2. LIQUIDATION PREFERENCE.
(a) In the event of any liquidation, dissolution or winding up
of this corporation, either voluntary or involuntary, subject to the rights of
series of Preferred Stock which may from time to time come into existence, the
holders of Series A Preferred Stock, Series B Preferred Stock and Series C
Preferred Stock shall be entitled to receive, prior and in preference to any
distribution of any of the assets of this corporation to the holders of Common
Stock by reason of their ownership thereof, an amount per share equal to the sum
of (i) $1.00 for each outstanding share of Series A Preferred Stock, $4.45 for
each outstanding share of Series B Preferred Stock and $8.04 for each
outstanding share of Series C Preferred Stock (hereafter referred to as the
"Original Series A Issue Price", "Original Series B Issue Price," and "Original
Series C Issue Price", respectively), and (ii) an amount equal to declared but
unpaid dividends on such share. If upon the occurrence of such event, the
assets and funds thus distributed among the holders of the Series A Preferred
Stock, Series B Preferred Stock and Series C Preferred Stock shall be
insufficient to permit the payment to such holders of the full aforesaid
preferential amounts, then, subject to the rights of series of Preferred Stock
which may from time to time come into existence, the entire assets and funds of
the corporation legally available for distribution shall be distributed ratably
among the holders of the Series A Preferred Stock, Series B Preferred Stock and
Series C Preferred Stock in proportion to the product of the liquidation
preference of each such share and the number of such shares owned by each such
holder.
(b) After the distributions described in subsection (a) above
have been paid, subject to the rights of series of Preferred Stock which may
from time to time come into existence, the remaining assets of the corporation
available for distribution to stockholders shall be distributed among the
holders of Common Stock pro rata based on the number of shares of Common Stock
held by each.
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(c) A consolidation or merger reorganization of this corporation
with or into any other corporation or corporations, or the effectuation by the
corporation of a transaction or series of related transactions in which more
than 50% of the voting power of the corporation is disposed of, or a sale,
conveyance or disposition of all or substantially all of the assets of this
corporation shall be deemed to be a liquidation within the meaning of this
Section 2.
3. CONVERSION. The holders of the Series A Preferred Stock, Series
B Preferred Stock and Series C Preferred Stock shall have conversion rights as
follows (the "Conversion Rights"):
(a) RIGHT TO CONVERT.
i) Subject to subsection (c), each share of Series A
Preferred Stock, each share of Series B Preferred Stock and each share of Series
C Preferred Stock shall be convertible, at the option of the holder thereof, at
any time after the date of issuance of such share at the office of this
corporation or any transfer agent for the Series A Preferred Stock, Series B
Preferred Stock or Series C Preferred Stock, into such number of fully paid and
nonassessable shares of Common Stock as is determined by dividing (A) the
Original Series A Issue Price for each share of Series A Preferred Stock, (B)
the Original Series B Issue Price for each share of Series B Preferred Stock and
(C) the Original Series C Issue Price for each share of Series C Preferred
Stock, by the Conversion Price at the time in effect for such share. The
initial Conversion Price per share for shares of Series A Preferred Stock shall
be the Original Series A Issue Price, the initial Conversion Price per share for
shares of Series B Preferred Stock shall be the Original Series B Issue Price
and the initial Conversion Price per share for shares of Series C Preferred
Stock shall be the Original Series C Issue Price; provided, however, that the
Conversion Price for the Series A Preferred Stock, Series B Preferred Stock and
Series C Preferred Stock shall be subject to adjustment as set forth in
subsection 3(c).
ii) Each share of Series A Preferred Stock, each share of
Series B Preferred Stock and each share of Series C Preferred Stock shall
automatically be converted into shares of Common Stock at the Conversion Price
at the time in effect for such Series A Preferred Stock, Series B Preferred
Stock and Series C Preferred Stock immediately upon the earlier of (A) the
consummation of the corporation's sale of its Common Stock in a bona fide, firm
commitment underwriting pursuant to a registration statement under the
Securities Act of 1933, as amended, the public offering price of which is not
less than $20,000,000 in the aggregate or (B) the date upon which the
corporation obtains the consent of the holders of 66-2/3% of the then
outstanding shares of Series A Preferred Stock, Series B Preferred Stock and
Series C Preferred Stock.
(b) MECHANICS OF CONVERSION. Before any holder of Series A
Preferred Stock, Series B Preferred Stock or Series C Preferred Stock shall be
entitled to convert the same into shares of Common Stock, such holder shall
surrender the certificate or certificates therefor, duly endorsed, at the office
of this corporation or of any transfer agent for the particular series of
Preferred Stock, and shall give written notice by mail, postage prepaid, to this
corporation at its principal corporate office, of the election to convert the
same and shall state therein the name or names in which the certificate or
certificates for shares of Common Stock are to be issued. This corporation
shall, as soon as practicable thereafter, issue and deliver at such office to
such holder
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<PAGE>
of Series A Preferred Stock, Series B Preferred Stock and/or Series C Preferred
Stock, or to the nominee or nominees of such holder, a certificate or
certificates for the number of shares of Common Stock to which such holder shall
be entitled as aforesaid. Such conversion shall be deemed to have been made
immediately prior to the close of business on the date of such surrender of the
shares of Series A Preferred Stock, Series B Preferred Stock and/or Series C
Preferred Stock to be converted, and the person or persons entitled to receive
the shares of Common Stock issuable upon such conversion shall be treated for
all purposes as the record holder or holders of such shares of Common Stock as
of such date. If the conversion is in connection with an underwritten offer of
securities registered pursuant to the Securities Act of 1933, the conversion
may, at the option of any holder tendering such Preferred Stock for conversion,
be conditioned upon the closing with the underwriter of the sale of securities
pursuant to such offering, in which event the person(s) entitled to receive the
Common Stock issuable upon such conversion of the Series A Preferred Stock,
Series B Preferred Stock and/or Series C Preferred Stock shall not be deemed to
have converted such Series A Preferred Stock, Series B Preferred Stock and/or
Series C Preferred Stock until immediately prior to the closing of such sale of
securities.
(c) CONVERSION PRICE ADJUSTMENTS OF PREFERRED STOCK. The
Conversion Prices of the Series A Preferred Stock, Series B Preferred Stock and
Series C Preferred Stock shall be subject to adjustment from time to time as
follows:
i) A. Except as otherwise set forth in subsection
3(c)(i)(F) with respect to the Series C Preferred Stock, upon each issuance by
the corporation of any Additional Stock (as defined below), after the date
hereof, without consideration or for a consideration per share less than the
Conversion Price for such series in effect immediately prior to the issuance of
such Additional Stock, the Conversion Price for such series in effect
immediately prior to each such issuance shall forthwith (except as otherwise
provided in this clause (i)) be adjusted to a price determined by multiplying
such Conversion Price by a fraction, the numerator of which shall be the number
of shares of Common Stock outstanding immediately prior to such issuance
(including, without limitation, the number of shares of Common Stock issuable
upon the conversion of all outstanding Preferred Stock and all other convertible
securities and the exercise of all outstanding options, warrants or other rights
to purchase Common Stock or other securities convertible into Common Stock) plus
the number of shares of Common Stock which the aggregate consideration received
by the corporation for such issuance would purchase at such Conversion Price;
and the denominator of which shall be the number of shares of Common Stock
outstanding immediately prior to such issuance (including, without limitation,
the number of shares of Common Stock issuable upon the conversion of all
outstanding Preferred Stock and all other convertible securities and the
exercise of all outstanding options, warrants or other rights to purchase Common
Stock or other securities convertible into Common Stock) plus the number of
shares of such Additional Stock.
B. No adjustment of the Conversion Price for the
Series A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock
shall be made in an amount less than one cent per share, provided that any
adjustments which are not required to be made by reason of this sentence shall
be carried forward and shall be either taken into account in any subsequent
adjustment made prior to 3 years from the date of the event giving rise to the
adjustment being carried forward, or shall be made at the end of 3 years from
the date of the
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<PAGE>
event giving rise to the adjustment being carried forward. Except to the
limited extent provided for in subsections 3(c)(i)(E)(3) and 3(c)(i)(E)(4), no
adjustment of such Conversion Price pursuant to this subsection 3(c)(i) shall
have the effect of increasing the Conversion Price above the Conversion Price in
effect immediately prior to such adjustment.
C. In the case of the issuance of Common Stock for
cash, the consideration shall be deemed to be the amount of cash paid therefor
before deducting any reasonable discounts, commissions or other expenses
allowed, paid or incurred by this corporation for any underwriting or otherwise
in connection with the issuance and sale thereof.
D. In the case of the issuance of the Common Stock
for a consideration in whole or in part other than cash, the consideration other
than cash shall be deemed to be the fair value thereof as determined by the
Board of Directors irrespective of any accounting treatment.
E. In the case of the issuance (whether before, on or
after the date upon which any shares of Series A Preferred Stock, Series B
Preferred Stock or Series C Preferred Stock were first issued (the "Purchase
Date" with respect to such series)) of options to purchase or rights to
subscribe for Common Stock, securities by their terms convertible into or
exchangeable for Common Stock or options to purchase or rights to subscribe for
such convertible or exchangeable securities, the following provisions shall
apply for all purposes of this subsection 3(c)(i) and subsection 3(c)(ii):
1. The aggregate maximum number of shares of
Common Stock deliverable upon exercise (assuming the satisfaction of any
conditions to exercisability, including without limitation, the passage of time,
but without taking into account potential antidilution adjustments) of such
options to purchase or rights to subscribe for Common Stock shall be deemed to
have been issued at the time such options or rights were issued and for a
consideration equal to the consideration (determined in the manner provided in
subsections 3(c)(i)(C) and (c)(i)(D)), if any, received by the corporation upon
the issuance of such options or rights plus the exercise price provided in such
options or rights (without taking into account potential antidilution
adjustments) for the Common Stock covered thereby.
2. The aggregate maximum number of shares of
Common Stock deliverable upon conversion of or in exchange (assuming the
satisfaction of any conditions to convertibility or exchangeability, including,
without limitation, the passage of time, but without taking into account
potential antidilution adjustments) for any such convertible or exchangeable
securities or upon the exercise of options to purchase or rights to subscribe
for such convertible or exchangeable securities and subsequent conversion or
exchange thereof shall be deemed to have been issued at the time such securities
were issued or such options or rights were issued and for a consideration equal
to the consideration, if any, received by the corporation for any such
securities and related options or rights (excluding any cash received on account
of accrued interest or accrued dividends), plus the additional consideration, if
any, to be received by the corporation (without taking into account potential
antidilution adjustments) upon the conversion or exchange of such securities or
the exercise of any related options or rights (the consideration in each case to
be determined in the manner provided in subsections 3(c)(i)(C) and (c)(i)(D)).
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<PAGE>
3. In the event of any change in the number of
shares of Common Stock deliverable or in the consideration payable to this
corporation upon exercise of such options or rights or upon conversion of or in
exchange for such convertible or exchangeable securities, including, but not
limited to, a change resulting from the antidilution provisions thereof, the
Conversion Price of the Series A Preferred Stock, Series B Preferred Stock
and/or Series C Preferred Stock, as applicable, and to the extent in any way
affected by or computed using such options, rights or securities, shall be
recomputed to reflect such change, but no further adjustment shall be made for
the actual issuance of Common Stock or any payment of such consideration upon
the exercise of any such options or rights or the conversion or exchange of such
securities.
4. Upon the expiration of any such options or
rights, the termination of any such rights to convert or exchange or the
expiration of any options or rights related to such convertible or exchangeable
securities, the Conversion Price of the Series A Preferred Stock, Series B
Preferred Stock and/or Series C Preferred Stock, as applicable, to the extent in
any way affected by or computed using such options, rights or securities or
options or rights related to such securities, shall be recomputed to reflect the
issuance of only the number of shares of Common Stock (and convertible or
exchangeable securities which remain in effect) actually issued upon the
exercise of such options or rights, upon the conversion or exchange of such
securities or upon the exercise of the options or rights related to such
securities.
5. The number of shares of Common Stock deemed
issued and the consideration deemed paid therefor pursuant to subsections
3(c)(i)(E)(1) and (2) shall be appropriately adjusted to reflect any change,
termination or expiration of the type described in either subsection
3(c)(i)(E)(3) or (4).
F. Upon each issuance by the corporation of any
Additional Stock (as defined below), after the Purchase Date for the Series C
Preferred Stock, without consideration or for a consideration per share less
than the Conversion Price for such Series C Preferred Stock in effect
immediately prior to the issuance of such Additional Stock, the Conversion Price
for such Series C Preferred Stock in effect immediately prior to each such
issuance shall forthwith (except as otherwise provided in this clause (i)) be
adjusted to a price (calculated to the nearest cent) equal to the consideration
per share for which such Additional Stock is issued; provided, however, that at
such time as such Conversion Price has been adjusted pursuant to this subsection
3(c)(i)(F) to a price per share equal to the Original Series B Issue Price (as
adjusted for stock splits, stock dividends, combinations and other
recapitalizations) any further adjustment to such Conversion Price shall be made
pursuant to subsection 3(c)(i)(A) and the provisions of this subsection
3(c)(i)(F) shall no longer apply. If such Additional Stock is issued for no
consideration, then the consideration per share shall be deemed to be $0.001.
ii) "Additional Stock" shall mean any shares of Common
Stock issued (or deemed to have been issued pursuant to subsection 3(c)(i)(E))
by this corporation after the applicable Purchase Date other than
A. Common Stock issued pursuant to a transaction
described in subsection 3(c)(iii) hereof, or
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B. shares of Common Stock issuable or issued to
employees, consultants or directors of this corporation directly or pursuant to
a stock option plan or restricted stock plan approved by the Board of Directors
of this corporation, or
C. shares of Common Stock issued upon conversion of
the Series A Preferred Stock, Series B Preferred Stock or Series C Preferred
Stock, or
D. shares of Common Stock issued or issuable (I) in a
public offering before or in connection with which all outstanding shares of
Series A Preferred Stock, Series B Preferred Stock and Series C Preferred Stock
will be converted to Common Stock or (II) upon exercise of warrants or rights
granted to underwriters in connection with such a public offering, or
E. shares of Common Stock issued or issuable to
persons or entities with which the corporation has business relationships
provided such issuances are for other than primarily equity financing purposes
approved by the Board of Directors, or
F. shares of Common Stock or Preferred Stock issued
or issuable (I) in a private placement pursuant to Rule 144A of the Securities
Act of 1933, as amended, or (II) upon exercise of warrants or rights granted to
purchasers in connection with such placement.
iii) In the event the corporation should at any time or from
time to time after the Purchase Date fix a record date for the effectuation of a
split or subdivision of the outstanding shares of Common Stock or the
determination of holders of Common Stock entitled to receive a dividend or other
distribution payable in additional shares of Common Stock or other securities or
rights convertible into, or entitling the holder thereof to receive directly or
indirectly, additional shares of Common Stock (hereinafter referred to as
"Common Stock Equivalents") without payment of any consideration by such holder
for the additional shares of Common Stock or the Common Stock Equivalents
(including the additional shares of Common Stock issuable upon conversion or
exercise thereof), then, as of such record date (or the date of such dividend
distribution, split or subdivision if no record date is fixed), the Conversion
Price of the Series A Preferred Stock, Series B Preferred Stock and Series C
Preferred Stock then in effect shall be appropriately decreased so that the
number of shares of Common Stock issuable on conversion of each share of such
series shall be increased in proportion to such increase of the aggregate of
shares of Common Stock outstanding and those issuable with respect to such
Common Stock Equivalents with the number of shares issuable with respect to
Common Stock Equivalents determined from time to time in the manner provided for
deemed issuances in subsection 3(c)(i)(E).
iv) If the number of shares of Common Stock outstanding at
any time after the Purchase Date is decreased by a combination of the
outstanding shares of Common Stock, then, following the record date of such
combination, the Conversion Price for the Series A Preferred Stock, Series B
Preferred Stock and Series C Preferred Stock then in effect shall be
appropriately increased so that the number of shares of Common Stock issuable on
conversion of each share of such series shall be decreased in proportion to such
decrease in outstanding shares.
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(d) RECAPITALIZATIONS. If at any time or from time to time
there shall be a recapitalization of the Common Stock (other than a subdivision,
combination or merger or sale of assets transaction provided for elsewhere in
this Section 3) provision shall be made so that the holders of the Series A
Preferred Stock, Series B Preferred Stock and Series C Preferred Stock shall
thereafter be entitled to receive upon conversion of the Series A Preferred
Stock, Series B Preferred Stock and Series C Preferred Stock the number of
shares of stock or other securities or property of the Company or otherwise, to
which a holder of Common Stock deliverable upon conversion would have been
entitled on such recapitalization. In any such case, appropriate adjustment
shall be made in the application of the provisions of this Section 3 with
respect to the rights of the holders of the Series A Preferred Stock, Series B
Preferred Stock and Series C Preferred Stock after the recapitalization to the
end that the provisions of this Section 3 (including adjustment of the
Conversion Price then in effect and the number of shares purchasable upon
conversion of the Series A Preferred Stock, Series B Preferred Stock and Series
C Preferred Stock) shall be applicable after that event as nearly equivalent as
may be practicable.
(e) NO IMPAIRMENT. This corporation will not, by amendment of
its Certificate of Incorporation or through any reorganization,
recapitalization, transfer of assets, consolidation, merger, dissolution, issue
or sale of securities or any other voluntary action, avoid or seek to avoid the
observance or performance of any of the terms to be observed or performed
hereunder by this corporation, but will at all times in good faith assist in the
carrying out of all the provisions of this Section 3 and in the taking of all
such action as may be necessary or appropriate in order to protect the
Conversion Rights of the holders of the Series A Preferred Stock, Series B
Preferred Stock and Series C Preferred Stock against impairment.
(f) NO FRACTIONAL SHARES AND CERTIFICATE AS TO ADJUSTMENTS.
i) No fractional shares shall be issued upon conversion of
the Series A Preferred Stock, Series B Preferred Stock and/or Series C Preferred
Stock, and the number of shares of Common Stock to be issued shall be rounded to
the nearest whole share. Whether or not fractional shares are issuable upon
such conversion shall be determined on the basis of the total number of shares
of Series A Preferred Stock, Series B Preferred Stock and/or Series C Preferred
Stock the holder is at the time converting into Common Stock and the number of
shares of Common Stock issuable upon such aggregate conversion.
ii) Upon the occurrence of each adjustment or readjustment
of the Conversion Price of Series A Preferred Stock, Series B Preferred Stock
and/or Series C Preferred Stock pursuant to this Section 3, this corporation, at
its expense, shall promptly compute such adjustment or readjustment in
accordance with the terms hereof and prepare and furnish to each holder of
Series A Preferred Stock, Series B Preferred Stock and/or Series C Preferred
Stock a certificate setting forth such adjustment or readjustment and showing in
detail the facts upon which such adjustment or readjustment is based. This
corporation shall, upon the written request at any time of any holder of Series
A Preferred Stock, Series B Preferred Stock or Series C Preferred Stock, furnish
or cause to be furnished to such holder a like certificate setting forth (A)
such adjustment and readjustment, (B) the Conversion Price at the time in
effect, and (C) the number of shares of Common Stock and the amount, if any, of
other property which at
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the time would be received upon the conversion of a share of Series A Preferred
Stock, Series B Preferred Stock or Series C Preferred Stock.
(g) NOTICES OF RECORD DATE. In the event of any taking by this
corporation of a record of the holders of any class of securities for the
purpose of determining the holders thereof who are entitled to receive any
dividend (other than a cash dividend) or other distribution, any right to
subscribe for, purchase or otherwise acquire any shares of stock of any class or
any other securities or property, or to receive any other right, this
corporation shall mail to each holder of Series A Preferred Stock, Series B
Preferred Stock and Series C Preferred Stock, at least 20 days prior to the date
specified therein, a notice specifying the date on which any such record is to
be taken for the purpose of such dividend, distribution or right, and the amount
and character of such dividend, distribution or right.
(h) RESERVATION OF STOCK ISSUABLE UPON CONVERSION. This
corporation shall at all times reserve and keep available out of its authorized
but unissued shares of Common Stock solely for the purpose of effecting the
conversion of the shares of the Series A Preferred Stock, Series B Preferred
Stock and Series C Preferred Stock such number of its shares of Common Stock as
shall from time to time be sufficient to effect the conversion of all
outstanding shares of the Series A Preferred Stock, Series B Preferred Stock and
Series C Preferred Stock; and if at any time the number of authorized but
unissued shares of Common Stock shall not be sufficient to effect the conversion
of all then outstanding shares of the Series A Preferred Stock, Series B
Preferred Stock and Series C Preferred Stock, in addition to such other remedies
as shall be available to the holder of such Preferred Stock, this corporation
will take such corporate action as may, in the opinion of its counsel, be
necessary to increase its authorized but unissued shares of Common Stock to such
number of shares as shall be sufficient for such purposes.
(i) NOTICES. Any notice required by the provisions of this
Section 3 to be given to the holders of shares of Series A Preferred Stock,
Series B Preferred Stock or Series C Preferred Stock shall be deemed given if
deposited in the United States mail, postage prepaid, and addressed to each
holder of record at his address appearing on the books of this corporation.
4. VOTING RIGHTS.
(a) GENERAL VOTING RIGHTS. Except as set forth in subsection
4(b) below, the holder of each share of Series A Preferred Stock, the holder of
each share of Series B Preferred Stock and the holder of each share of Series C
Preferred Stock shall have the right to one vote for each share of Common Stock
into which such share of Series A Preferred Stock, such share of Series B
Preferred Stock and/or such share of Series C Preferred Stock could then be
converted (with any fractional share determined on an aggregate conversion basis
being rounded to the nearest whole share), and with respect to such vote, each
such holder shall have full voting rights and powers equal to the voting rights
and powers of the holders of Common Stock, and shall be entitled,
notwithstanding any provision hereof, to notice of any stockholders' meeting in
accordance with the by-laws of this corporation, and shall be entitled to vote,
together with holders of Common Stock, with respect to any question upon which
holders of Common Stock have the right to vote.
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(b) ELECTION OF DIRECTORS. Notwithstanding the provisions of
subsection 4(a) above, (i) so long as any shares of Series A Preferred Stock are
outstanding, the holders of the then outstanding shares of Series A Preferred
Stock, by a majority vote voting as a separate class, shall be entitled to elect
four (4) directors of the corporation (the "Series A Directors") and the holders
of Common Stock and Series A Preferred Stock, by a majority vote voting as a
single class, shall be entitled to elect one (1) director of the corporation
(the "Common/Series A Director"); (ii) so long as any shares of Series B
Preferred are outstanding, the holders of the then outstanding shares of Series
B Preferred Stock, by a majority vote voting as a separate class, shall be
entitled to elect one (1) director of the corporation (the "Series B Director");
(iii) so long as any shares of Series C Preferred are outstanding, the holders
of the then outstanding shares of Series C Preferred Stock, by a majority vote
voting as a separate class, shall be entitled to elect one (1) director of the
corporation (the "Series C Director"); and (iv) all remaining directors shall be
elected by the holders of the Preferred Stock and the holders of Common Stock,
by a majority vote voting as provided in paragraph 4(a) above. At any meeting
held for the purpose of electing or nominating directors, the presence in person
or by proxy of the holders of a majority of the Series A Preferred Stock then
outstanding shall constitute a quorum of the Series A Preferred Stock for the
election or nomination of the Series A Directors, the presence in person or by
proxy of the holders of a majority of the shares of Series B Preferred Stock
then outstanding, shall constitute a quorum of the Series B Preferred Stock for
the election or nomination of the Series B Director, the presence in person or
by proxy of the holders of a majority of the Series C Preferred Stock then
outstanding shall constitute a quorum of the Series C Preferred Stock for the
election or nomination of the Series C Director, the presence in person or by
proxy of the holders of a majority of the Common Stock and Series A Preferred
Stock, on an as-converted basis, then outstanding shall constitute a quorum of
the Common Stock and Series A Preferred Stock for the election or nomination of
the Common/Series A Director, and the presence in person or by proxy of the
holders of a majority of the Preferred Stock and Common Stock, on an
as-converted basis, then outstanding shall constitute a quorum of the Preferred
Stock and Common Stock for the election or nomination of all remaining
directors. A vacancy in any directorship elected solely by the holders of
Series A Preferred Stock shall be filled only by vote of the holders of Series A
Preferred Stock, a vacancy in the directorship elected solely by the holders of
the Series B Preferred Stock shall be filled only by vote of the Series B
Preferred Stock, a vacancy in the directorship elected solely by the holders of
the Series C Preferred Stock shall be filled only by vote of the Series C
Preferred Stock, a vacancy in the directorship elected by the holders of the
Common Stock and Series A Preferred Stock shall be filled only by vote of the
Common Stock and Series A Preferred Stock, voting together as provided above,
and a vacancy in any directorship elected by the holders of Preferred Stock and
Common Stock shall be filled only by the vote of the holders of Preferred Stock
and Common Stock voting as provided in paragraph 4(a) above. Any director
elected by the holders of Series A Preferred Stock may be removed during such
director's term of office, either for or without cause, by and only by the
affirmative vote of the holders of a majority of the outstanding shares of
Series A Preferred Stock, any director elected by the holders of Series B
Preferred Stock may be removed during such director's term of office, either for
or without cause, by and only by the affirmative vote of the holders of a
majority of the outstanding shares of Series B Preferred Stock, any director
elected by the holders of Series C Preferred Stock may be removed during such
director's term of office, either for or without cause, by and only by the
affirmative vote of the holders of a majority of the outstanding shares of
Series C Preferred Stock, any director elected by the holders of Common
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<PAGE>
Stock and Series A Preferred Stock may be removed during such director's term of
office, either for or without cause, by and only by the affirmative vote of the
holders of a majority of the outstanding shares of Common Stock and Series A
Preferred Stock, voting together as provided above, and any director elected by
the holders of Preferred Stock and Common Stock may be removed during such
director's term of office, either for or without cause, by and only by the
affirmative vote of the holders of a majority of the outstanding shares of
Preferred Stock and Common Stock, voting together as provided in paragraph 4(a)
above.
5. PROTECTIVE PROVISIONS.
(a) SERIES C PREFERRED STOCK. Subject to the rights of series
of Preferred Stock which may from time to time come into existence, so long as
shares of Series C Preferred Stock are outstanding, this corporation shall not
without first obtaining the approval (by vote or written consent, as provided by
law) of the holders of at least a majority of the then outstanding shares of
Series C Preferred Stock, voting together as a separate series on an as
converted basis:
i) take any action that would materially and adversely
alter the rights, preferences or privileges of the Series C Preferred Stock as a
separate series in a manner that is dissimilar and disproportionate relative to
the manner in which the rights, preferences or privileges of the Series A
Preferred Stock and Series B Preferred Stock are altered; or
ii) authorize additional shares of Series C Preferred
Stock; or
iii) amend Article IV(B)(3)(a)(i) (provided that, subject to
Section IV(B)(5)(a)(i), the corporation shall not be prohibited from amending
Article IV(B)(3)(c)); or
iv) take any action that would alter the right of the
holders of the then outstanding shares of Series C Preferred Stock to elect one
(1) director of the corporation pursuant to subitem (iii) of Article IV(B)4(b);
or
v) amend this Article IV(B)5(a).
(b) SERIES B PREFERRED STOCK. Subject to the rights of series
of Preferred Stock which may from time to time come into existence, so long as
shares of Series B Preferred Stock are outstanding, this corporation shall not
without first obtaining the approval (by vote or written consent, as provided by
law) of the holders of at least a majority of the then outstanding shares of
Series B Preferred Stock, voting together as a separate series on an as
converted basis:
i) take any action that would materially and adversely
alter the rights, preferences or privileges of the Series B Preferred Stock as a
separate series in a manner that is dissimilar and disproportionate relative to
the manner in which the rights, preferences or privileges of the Series A
Preferred Stock are altered; or
ii) authorize additional shares of Series B Preferred
Stock; or
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<PAGE>
iii) take any action that would cause it to become a "public
utility" or a "holding company" as those terms are defined under the Public
Utility Holding Company Act of 1935, as amended; or
iv) amend Article IV(B)(3)(a)(i) (provided that, subject to
Section IV(B)(5)(b)(i), the corporation shall not be prohibited from amending
Article IV(B)(3)(c)); or
v) take any action that would alter the right of the
holders of the then outstanding shares of Series B Preferred Stock to elect one
(1) director of the corporation pursuant to subitem (ii) of Article IV(B)4(b);
or
vi) amend this Article IV(B)5(b).
(c) PREFERRED STOCK. Subject to the rights of series of
Preferred Stock which may from time to time come into existence, so long as
shares of Series A Preferred Stock, Series B Preferred Stock and/or Series C
Preferred Stock are outstanding, this corporation shall not without first
obtaining the approval (by vote or written consent, as provided by law) of the
holders of at least 60-2/3% or more of the then outstanding shares of Series A
Preferred Stock, Series B Preferred Stock and Series C Preferred Stock , voting
together as a single class on an as converted basis:
i) sell, convey, or otherwise dispose of or encumber all
or substantially all of its property or business or merge into or consolidate
with any other corporation (other than a wholly owned subsidiary corporation) or
effect any transaction or series of related transactions in which more than 50%
of the voting power of the corporation is disposed of; or
ii) create any new class or series of stock or any other
securities convertible into equity securities of the corporation having any
preference over, or being on a parity with, the Series A Preferred Stock, Series
B Preferred Stock or Series C Preferred Stock with respect to voting, dividends
or upon liquidation; or
iii) authorize additional shares of Preferred Stock.
6. STATUS OF CONVERTED STOCK. In the event any shares of Series A
Preferred Stock, Series B Preferred Stock or Series C Preferred Stock shall be
converted pursuant to Section 3 hereof, the shares so converted shall be
cancelled and shall not be issuable by the corporation. The Certificate of
Incorporation of this corporation shall be appropriately amended to effect the
corresponding reduction in the corporation's authorized capital stock.
C. COMMON STOCK.
1. DIVIDEND RIGHTS. Subject to the prior rights of holders of all
classes of stock at the time outstanding having prior rights as to dividends,
the holders of the Common Stock shall be entitled to receive, when and as
declared by the Board of Directors, out of any assets of the corporation legally
available therefor, such dividends as may be declared from time to time by the
Board of Directors.
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<PAGE>
2. LIQUIDATION RIGHTS. Upon the liquidation, dissolution or winding
up of the corporation, the assets of the corporation shall be distributed as
provided in Article IV(B)2 hereof.
3. REDEMPTION. The Common Stock is not redeemable.
4. VOTING RIGHTS. The holder of each share of Common Stock shall
have the right to one vote for each share of Common Stock held by such holder,
and shall be entitled to notice of any stockholders' meeting in accordance with
the By-laws of this corporation, and shall be entitled to vote upon such matters
and in such manner as may be provided by law.
ARTICLE V
A. EXCULPATION. A director of the corporation shall not be personally
liable to the corporation or its stockholders for monetary damages for breach of
fiduciary duty as a director, except for liability (i) for any breach of the
director's duty of loyalty to the corporation or its stockholders, (ii) for acts
or omissions not in good faith or which involve intentional misconduct or a
knowing violation of law, (iii) under Section 174 of the Delaware General
Corporation Law or (iv) for any transaction from which the director derived any
improper personal benefit. If the Delaware General Corporation Law is hereafter
amended to further reduce or to authorize, with the approval of the
corporation's stockholders, further reductions in the liability of the
corporation's directors for breach of fiduciary duty, then a director of the
corporation shall not be liable for any such breach to the fullest extent
permitted by the Delaware General Corporation Law as so amended.
B. INDEMNIFICATION. To the extent not prohibited by applicable law, this
corporation shall provide indemnification of (and advancement of expenses to)
such agents (and any other persons to which Delaware law permits this
corporation to provide indemnification) through bylaw provisions, agreements
with such agents or other persons, vote of stockholders or disinterested
directors or otherwise, in excess of the indemnification and advancement
otherwise permitted by Section 145 of the Delaware General Corporation Law,
subject only to limits created by applicable Delaware law (statutory or
non-statutory), with respect to actions for breach of duty to the corporation,
its stockholders, and others.
C. EFFECT OF REPEAL OR MODIFICATION. Any repeal or modification of any
of the foregoing provisions of this Article V shall not adversely affect any
right or protection of a director, officer or agent of the corporation (or any
other person to which Delaware law permits this corporation to provide
indemnification) existing at the time of, or increase the liability of any
director, officer or agent of the corporation (or other person) with respect to
any acts or omissions of such director, officer or agent (or other person)
occurring prior to, such repeal or modification.
ARTICLE VI
The corporation shall have perpetual existence.
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<PAGE>
ARTICLE VII
Except as otherwise provided in this Restated Certificate of Incorporation,
in furtherance and not in limitation of the powers conferred by statute, the
Board of Directors is expressly authorized to make, repeal, alter, amend and
rescind any or all of the Bylaws of the corporation.
ARTICLE VIII
Elections of directors need not be by written ballot except and to the
extent provided in the Bylaws of the corporation.
ARTICLE IX
The corporation reserves the right to amend, alter, change or repeal any
provision contained in this Restated Certificate of Incorporation, in the manner
now or hereafter prescribed by statute, and all rights conferred upon
stockholders herein are granted subject to this reservation.
ARTICLE X
The corporation shall not be subject to the provisions of Section 203 of
the Delaware General Corporation Law.
[REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]
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<PAGE>
IN WITNESS WHEREOF, this Restated Certificate of Incorporation has been
executed as of this 15th day of March, 1999.
RHYTHMS NETCONNECTIONS INC.
By: /s/ Catherine Hapka
------------------------------
Catherine Hapka, President
[SIGNATURE PAGE TO CERTIFICATE OF AMENDMENT]
<PAGE>
THE TRANSFER OF THIS WARRANT IS SUBJECT TO
RESTRICTIONS CONTAINED HEREIN. THIS WARRANT
HAS BEEN ISSUED IN RELIANCE UPON THE
REPRESENTATION OF THE HOLDER THAT IT HAS BEEN
ACQUIRED FOR INVESTMENT PURPOSES AND NOT WITH
A VIEW TOWARD THE RESALE OR OTHER DISTRIBUTION
THEREOF. NEITHER THIS WARRANT NOR THE SHARES
ISSUABLE UPON THE EXERCISE OF THIS WARRANT
HAVE BEEN REGISTERED UNDER THE SECURITIES
ACT OF 1933 OR ANY STATE SECURITIES LAWS.
RHYTHMS NETCONNECTIONS INC.
Common Stock Purchase Warrant
To Subscribe for and Purchase March 16, 1999
600,000 Shares of Common Stock of
Rhythms NetConnections Inc.
THIS CERTIFIES that, for the purchase price of $8.04 per share, Microsoft
Corporation or its registered assigns (the "Holder") is entitled to subscribe
for and purchase from Rhythms NetConnections Inc., a Delaware corporation
(hereinafter called the "Company"), up to 600,000 shares (subject to adjustment
as hereinafter provided) of fully paid and non-assessable Common Stock of the
Company (the "Common Stock"), subject to the provisions and upon the terms and
conditions hereinafter set forth at the price of $8.04 per share (such price as
from time to time to be adjusted as provided herein is called the "Warrant
Price"), at or prior to 5:00 p.m. Pacific time on March 15, 2004 (the "Exercise
Period).
This Warrant and any Warrant subsequently issued upon exchange or
transfer hereof are hereinafter collectively called the "Warrant."
Section 1. EXERCISE OF WARRANT. The rights represented by this Warrant
may be exercised by the Holder, in whole or in part (but not as to fractional
shares) at any time or from time to time during the Exercise Period by the
completion of the purchase form attached hereto and by the surrender of this
Warrant (properly endorsed) at the office of the Company as it may designate by
notice in writing to the Holder hereof at the address of the Holder appearing on
the books of the Company, and by payment to the Company of the Warrant Price in
cash or by certified or official bank check, for each share being purchased.
(In addition, see Section 2 below for net issuance provisions.) In the event of
any exercise of the rights represented by this Warrant, a certificate or
certificates for the shares of Common Stock so purchased, registered in the name
of the Holder, or its nominee or other party designated in the purchase form by
the Holder hereof, shall be delivered to the Holder within thirty (30) business
days after the date on which the rights represented by this Warrant shall have
been so exercised; and, unless this Warrant has expired or has been exercised in
full, a new Warrant representing the number of
<PAGE>
shares (except a remaining fractional share), if any, with respect to which this
Warrant shall not then have been exercised shall also be issued to the Holder
within such time. The person in whose name any certificate for shares of Common
Stock is issued upon exercise of this Warrant shall for all purposes be deemed
to have become the holder of record of such shares on the date on which this
Warrant was surrendered and payment of the Warrant is made, except that, if the
date of such surrender and payment is a date on which the stock transfer books
of the Company are closed, such person shall be deemed to have become the holder
of such shares at the close of business on the next succeeding date on which the
stock transfer books are open. No fractional shares shall be issued upon
exercise of this Warrant and no payment or adjustment shall be made upon any
exercise on account of any cash dividends on the Common Stock issued upon such
exercise. If any fractional interest in a share of Common Stock would, except
for the provision of this Section 1, be delivered upon such exercise, the
Company, in lieu of delivery of a fractional share thereof, shall pay to the
Holder an amount in cash equal to the current market price of such fractional
share as determined in good faith by the Board of Directors of the Company.
Section 2. NET ISSUANCE.
(a) RIGHT TO CONVERT. In addition to and without limiting the
rights of the Holder under the terms of this Warrant, if the fair market value
of a share of Common Stock is greater than the Warrant Price, in lieu of
exercising this Warrant for cash the Holder shall have the right to convert this
Warrant or any portion thereof (the "Conversion Right") into shares of Common
Stock equal to the value of this Warrant or the portion thereof being canceled
as provided in this Section 2 at any time or from time to time during the
Exercise Period. Upon exercise of the Conversion Right with respect to a
particular number of shares subject to the Warrant (the "Converted Warrant
Shares"), the Company shall deliver to the Holder (without payment by the Holder
of any exercise price or any cash or other consideration) that number of shares
of fully paid and nonassessable Common Stock computed using the following
formula:
X = Y (A - B)
---------
A
Where X = the number of shares of Common Stock to be delivered to
the holder
Y = the number of Converted Warrant Shares
A = the fair market value of one share of the
Company's Common Stock on the Conversion Date
(as defined below)
B = the per share exercise price of the Warrant (as
adjusted to the Conversion Date)
The Conversion Right may only be exercised with respect to a whole number of
shares subject to the Warrant. No fractional shares shall be issuable upon
exercise of the Conversion Right, and if the number of shares to be issued
determined in accordance with the foregoing formula is other than a whole
number, the Company shall pay to the Holder an amount in cash equal to the fair
market value of the resulting fractional share on the Conversion Date (as
defined below). Shares
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<PAGE>
issued pursuant to the Conversion Right shall be treated as if they were issued
upon the exercise of the Warrant.
(b) METHOD OF EXERCISE. The Conversion Right may be exercised
by the Holder by the surrender of the Warrant at the principal office of the
Company together with a written statement specifying that the Holder thereby
intends to exercise the Conversion Right and indicating the total number of
shares under the Warrant that the Holder is exercising through the Conversion
Right. Such conversion shall be effective upon receipt by the Company of the
Warrant together with the aforesaid written statement, or on such later date as
is specified therein (the "Conversion Date"). Certificates for the shares
issuable upon exercise of the Conversion Right and, if applicable, a new warrant
evidencing the balance of the shares remaining subject to the Warrant, shall be
issued as of the Conversion Date and shall be delivered to the Holder promptly
following the Conversion Date.
(c) DETERMINATION OF FAIR MARKET VALUE. For purposes of this
Section 2, fair market value of a share of Common Stock on the Conversion Date
shall mean:
(i) If traded on a stock exchange, the fair market value
of the Common Stock shall be deemed to be the average of the closing selling
prices of the Common Stock on the stock exchange determined by the Board to be
the primary market for the Common Stock over the ten (10) trading day period (or
such shorter period immediately following the closing of an initial public
offering) ending on the date prior to the Conversion Date, as such prices are
officially quoted in the composite tape of transactions on such exchange;
(ii) If traded over-the-counter, the fair market value of
the Common Stock shall be deemed to be the average of the closing bid prices
(or, if such information is available, the closing selling prices) of the Common
Stock over the ten (10) trading day period (or such shorter period immediately
following the closing of an initial public offering) ending on the date prior to
the Conversion Date, as such prices are reported by the National Association of
Securities Dealers through its NASDAQ system, any successor system or any
exchange on which it is listed, whichever is applicable; or
(iii) If there is no public market for the Common Stock,
then the fair market value shall be determined by mutual agreement of the holder
of the Warrant and the Company, and if the holder and the Company are unable to
so agree, by an investment banker of national reputation selected by the Company
and reasonably acceptable to the holder of the Warrant.
Section 3. STOCK SPLITS, CONSOLIDATION, MERGER AND SALE. In the event
that before the issuance of the shares of Common Stock into which this Warrant
may be exercised the outstanding shares of Common Stock shall be split, combined
or consolidated, by dividend, reclassification or otherwise, into a greater or
lesser number of shares of Common Stock or any other class or classes of stock,
as appropriate, the Warrant Price in effect immediately prior to such
combination or consolidation and the number of shares purchasable under this
Warrant shall, concurrently with the effectiveness of such combination or
consolidation, be proportionately adjusted. If there shall be effected any
consolidation or merger of the Company with another corporation, or a sale of
all or substantially all of the Company's assets to another
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<PAGE>
corporation, and if the holders of Common Stock shall be entitled pursuant to
the terms of any such transaction to receive stock, securities or assets with
respect to or in exchange for Common Stock, then, as a condition of such
consolidation, merger or sale, lawful and adequate provisions shall be made
whereby the Holder of this Warrant shall thereafter have the right to receive,
upon the basis and upon the terms and conditions specified herein and in lieu of
the shares of Common Stock immediately theretofore receivable upon the exercise
of such Warrant, such shares of stock, securities or assets as may be issuable
or payable with respect to or in exchange for a number of outstanding shares of
such Common Stock equal to the number of shares of such Common Stock immediately
theretofore so receivable had such consolidation, merger or sale not taken
place, and in any such case appropriate provisions shall be made with respect to
the rights and interests of the Holder to the end that the provisions hereof
shall thereafter be applicable, as nearly as may be, in relation to any shares
of stock, securities or assets thereafter deliverable upon the exercise of this
Warrant.
(a) STOCK TO BE RESERVED. The Company will at all times reserve
and keep available out of its authorized Common Stock, solely for the purpose of
issue upon the exercise of this Warrant as herein provided, such number of
shares of Common Stock as shall then be issuable upon the exercise of this
Warrant.
(b) ISSUE TAX. The issuance of certificates for shares of
Common Stock upon exercise of this Warrant shall be made without charge to the
Holders of this Warrant for any issuance tax in respect thereof provided that
the Company shall not be required to pay any tax which may be payable in respect
of any transfer involved in the issuance and delivery of any certificate in a
name other than that of the Holder of this Warrant.
(c) CLOSING OF BOOKS. The Company will at no time close its
transfer books against the transfer of the shares of Common Stock issued or
issuable upon the exercise of this Warrant in any manner which interferes with
the timely exercise of this Warrant.
Section 4. NOTICES OF RECORD DATES. In the event of:
(a) any taking by the Company of a record of the holders of any
class of securities for the purpose of determining the holders thereof who are
entitled to receive any dividend or other distribution (other than cash
dividends out of earned surplus), or any right to subscribe for, purchase or
otherwise acquire any shares of stock of any class or any other securities or
property, or to receive any other right, or
(b) any capital reorganization of the Company, any
reclassification or recapitalization of the capital stock of the Company or any
transfer of all or substantially all the assets of the Company to or
consolidation or merger of the Company with or into any other corporation, or
(c) any voluntary or involuntary dissolution, liquidation or
winding-up of the Company,
then and in each such event the Company will give notice to the Holder of this
Warrant specifying (i) the date on which any such record is to be taken for the
purpose of such dividend, distribution or right and stating the amount and
character of such dividend, distribution or right,
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<PAGE>
and (ii) the date on which any such reorganization, reclassification,
recapitalization, transfer, consolidation, merger, dissolution, liquidation or
winding-up is to take place, and the time, if any is to be fixed, as of which
the holders of record of Common Stock will be entitled to exchange their shares
of Common Stock for securities or other property deliverable upon such
reorganization, reclassification, recapitalization, transfer, consolidation,
merger, dissolution, liquidation or winding-up. Such notice shall be given at
least ten (10) days and not more than ninety (90) days prior to the date therein
specified, and such notice shall state that the action in question or the record
date is subject to the effectiveness of a registration statement under the
Securities Act of 1933, as amended (the "Securities Act") or to a favorable vote
of shareholders, if either is required.
Section 5. NO SHAREHOLDER RIGHTS OR LIABILITIES. This Warrant shall
not entitle the Holder hereof to any voting rights or other rights as a
shareholder of the Company. No provision hereof, in the absence of affirmative
action by the Holder hereof to purchase shares of Common Stock, and no mere
enumeration hereon of the rights or privileges of the Holder hereof, shall give
rise to any liability of such Holder for the Warrant Price or as a shareholder
of the Company, whether such liability is asserted by the Company or by
creditors of the Company.
Section 6. REPRESENTATIONS OF HOLDER. The Holder hereby represents and
acknowledges to the Company that:
(a) this Warrant, the Common Stock issuable upon exercise of
this Warrant and any securities issued with respect to any of them by way of a
stock dividend or stock split or in connection with a recapitalization, merger,
consolidation or other reorganization will be "restricted securities" as such
term is used in the rules and regulations under the Securities Act and that such
securities have not been and may not be registered under the Securities Act or
any state securities law, and that such securities must be held indefinitely
unless registration is effected or transfer can be made pursuant to appropriate
exemptions;
(b) the Holder has read, and fully understands, the terms of
this Warrant set forth on its face and the attachments hereto, including the
restrictions on transfer contained herein;
(c) the Holder is purchasing for investment for its own account
and not with a view to or for sale in connection with any distribution of this
Warrant or the Common Stock of the Company issuable upon exercise of this
Warrant and it has no intention of selling such securities in a public
distribution in violation of the federal securities laws or any applicable state
securities laws; provided that nothing contained herein will prevent Holder from
transferring such securities in compliance with the terms of this Warrant and
the applicable federal and state securities laws;
(d) the Holder is an "accredited investor" within the meaning of
paragraph (a) of Rule 501 of Regulation D promulgated by the Securities and
Exchange Commission and an "excluded purchaser" within the meaning of Section
25102(f) of the California Corporate Securities Law of 1968; and
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<PAGE>
(e) the Company may affix the following legend (in addition to
any other legend(s), if any, required by applicable state corporate and/or
securities laws) to certificates for shares of Common Stock (or other
securities) issued upon exercise of this Warrant ("Warrant Shares"):
"These securities have not been registered under the
Securities Act of 1933, as amended. They may not be
sold, offered for sale, pledged or hypothecated in
the absence of a registration statement in effect
with respect to the securities under such Act or an
opinion of counsel satisfactory to the Company that
such registration is not required or unless sold
pursuant to Rule 144 of such Act."
Section 7. LIMITATIONS ON DISPOSITION.
(a) The Holder of this Warrant, by acceptance hereof, agrees to
comply in all respects with the provisions of this Section 7. Without in any
way limiting the representations set forth above, the Holder of this Warrant
agrees not to make any disposition of this Warrant or any Warrant Shares, unless
and until the transferee has agreed in writing for the benefit of the Company to
be bound by this Section 7 and the other provisions of this Warrant as if such
transferee were the original Holder hereof, provided and to the extent such
provisions are then applicable, and:
(i) There is then in effect a Registration Statement
under the Securities Act covering such proposed disposition and such disposition
is made in accordance with such Registration Statement; or
(ii) (A) the Holder shall have notified the Company of the
proposed disposition and shall have furnished the Company with a detailed
statement of the circumstances surrounding the proposed disposition, and the
Company has given its prior written consent, and (B) if reasonably requested by
the Company, the Holder shall have furnished the Company with an opinion of
counsel, reasonably satisfactory to the Company, that such disposition will not
require registration of the Warrant and/or the Warrant Shares under the Act. It
is agreed that the Company will not require opinions of counsel for transactions
made pursuant to Rule 144 except in unusual circumstances.
(b) Notwithstanding the provisions of paragraph (a) above, (i)
no such Registration Statement, prior consent or opinion of counsel shall be
necessary for a transfer (A) by a Holder which is a partnership to a partner of
such partnership or a retired partner of such partnership who retires after the
date hereof, or to the estate of any such partner or retired partner or to the
transfer by gift, will or intestate succession of any partner to his spouse or
to the siblings, lineal descendants or ancestors of such partner or his spouse,
or (B) to an "affiliate" of the Holder as that term is defined in Rule 405
promulgated by the Securities and Exchange Commission under the Securities Act,
if the transferee agrees in writing to be subject to the terms hereof to the
same extent as if he were an original Holder hereunder, and (ii) no transferee
shall be required, as a condition to any transfer of the Warrant or the Warrant
Shares by the Holder, to agree to be bound by this Section 7, if the transferee
is acquiring the Warrant and/or Warrant Shares pursuant to a Registration
Statement under the Securities Act or in a transaction made
-6-
<PAGE>
pursuant to Rule 144. Each new certificate evidencing the Warrant and/or
Warrant Shares so transferred shall bear the appropriate restrictive legends set
forth in Section 6(f) above, except that such certificate shall not bear such
restrictive legend if, in the opinion of counsel for the Company, such legend is
not required in order to establish or assist in compliance with any provisions
of the Securities Act or any applicable state securities laws.
Section 8. LOST, STOLEN, MUTILATED OR DESTROYED WARRANT. If this
Warrant is lost, stolen, mutilated or destroyed, the Company may, on such terms
as to indemnity or otherwise as it may in its discretion reasonably impose
(which shall, in the case of a mutilated Warrant, include the surrender
thereof), issue a new Warrant of like denomination and tenor as the Warrant so
lost, stolen, mutilated or destroyed. Any such new Warrant shall constitute an
original contractual obligation of the Company, whether or not the allegedly
lost, stolen, mutilated or destroyed Warrant shall be at any time enforceable by
anyone.
Section 9. PRESENTMENT. Prior to due presentment of this Warrant
together with a completed assignment form attached hereto for registration of
transfer, the Company may deem and treat the Holder as the absolute owner of the
Warrant, notwithstanding any notation of ownership or other writing thereon, for
the purpose of any exercise thereof and for all other purposes, and the Company
shall not be affected by any notice to the contrary.
Section 10. NOTICE. Notice or demand pursuant to this Warrant shall be
sufficiently given or made, if sent by first-class mail, postage prepaid,
addressed, if to the Holder of this Warrant, to the Holder at its last known
address as it shall appear in the records of the Company, and if to the Company,
at 6933 South Revere Parkway, Englewood, Colorado 80112, Attention: Secretary.
The Company may alter the address to which communications are to be sent by
giving notice of such change of address in conformity with the provisions of
this Section 10 for the giving of notice.
Section 11. GOVERNING LAW. The validity, interpretation and performance
of this Warrant shall be governed by the laws of the State of Delaware without
regard to principles of conflicts of laws.
Section 12. SUCCESSORS, ASSIGNS. Subject to the restrictions on
transfer by Holder set forth in Section 7 hereof, all the terms and provisions
of the Warrant shall be binding upon and inure to the benefit of and be
enforceable by the respective successors and assigns of the parties hereto.
Section 13. AMENDMENT. This Warrant may be modified, amended or
terminated by a writing signed by the Company and the Holder.
Section 14. SEVERABILITY. Should any part but not the whole of this
Warrant for any reason be declared invalid, such decision shall not affect the
validity of any remaining portion, which remaining portion shall remain in force
and effect as if this Warrant had been executed with the invalid portion thereof
eliminated, and it is hereby declared the intention of the parties hereto that
they would have executed the remaining portion of this Warrant without including
therein any such part which may, for any reason, be hereafter declared invalid.
-7-
<PAGE>
Section 15. "MARKET STAND-OFF" AGREEMENT. Holder hereby agrees that,
during the period of duration (such period not to exceed 180 days) specified by
the Company and an underwriter of Common Stock or other securities of the
Company, following the effective date of a registration statement of the Company
filed under the Securities Act of 1933, as amended, it shall not, to the extent
requested by the Company and such underwriter, directly or indirectly sell,
offer to sell, contract to sell (including, without limitation, any short sale),
grant any option to purchase or otherwise transfer or dispose of (other than to
donees who agree to be similarly bound) any securities of the Company held by it
at any time during such period except Common Stock included in such
registration; PROVIDED, HOWEVER, that:
(i) such agreement shall be applicable only to the first
two such registration statements of the Company which cover common stock (or
other securities) to be sold on its behalf to the public in an underwritten
offering; and
(ii) all officers and directors of the Company and all
other persons with registration rights enter into similar agreements.
In order to enforce the foregoing covenant, the Company may impose stop-transfer
instructions with respect to the Common Stock of the Holder (and the shares or
securities of every other person subject to the foregoing restriction) until the
end of such period.
Section 16. NO IMPAIRMENT. The Company will not, by any voluntary
action, avoid or seek to avoid the observance or performance of any of the terms
to be observed or performed hereunder by the Company, but will at all times in
good faith assist in the carrying out of all the provisions of this Warrant and
in the taking of all such action as may be necessary or appropriate in order to
protect the rights of the Holder of this Warrant against impairment.
Section 17. NO RIGHT TO REDEEM. Except as explicitly provided herein,
this Warrant may not be called by the Company.
[REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]
-8-
<PAGE>
IN WITNESS WHEREOF, the Company has caused this Warrant to be duly
executed and delivered on and as of the day and year first above written by one
of its officers thereunto duly authorized.
RHYTHMS NETCONNECTIONS INC.,
a Delaware corporation
Dated: March 16, 1999 /s/ Catherine Hapka
-------------------------------------
Catherine Hapka, President and
Chief Executive Officer
The undersigned Holder agrees and accepts this Warrant and
acknowledges that it has read and confirms each of the representations contained
in Section 6.
MICROSOFT CORPORATION
By: /s/ [Illegible]
----------------------------------
Its:
----------------------------------
Address: One Microsoft Way
Redmond, WA 98052-6399
[SIGNATURE PAGE TO COMMON STOCK PURCHASE WARRANT]
<PAGE>
PURCHASE FORM
(To be executed by the Warrant Holder if he desires to exercise the Warrant in
whole or in part)
To: RHYTHMS NETCONNECTIONS INC.
The undersigned, whose Social Security or other identifying number
is _______________, hereby irrevocably elects the right of purchase represented
by the within Warrant for, and to purchase thereunder, ______________ shares of
Common Stock provided for therein and tenders payment herewith to the order of
RHYTHMS NETCONNECTIONS INC.
in the amount of
$_______________
The undersigned requests that certificates for such shares be issued as
follows:
Name:
------------------------------------------------------------------------
Address:
---------------------------------------------------------------------
Deliver to:
------------------------------------------------------------------
Address:
---------------------------------------------------------------------
and, if said number of shares shall not be all the shares purchasable hereunder,
that a new Warrant for the balance remaining of the shares purchasable under the
within Warrant be registered in the name of, and delivered to, the undersigned
at the address stated below:
Address:
--------------------------------------------------------
--------------------------------------------------------
Dated:______________, 199__ Signature:
-----------------------------------
(Signature must conform in all
respects to the name of the Warrant
Holder as specified on the face of
the Warrant, without alteration,
enlargement or any change
whatsoever)
<PAGE>
ASSIGNMENT
(To be executed by the Warrant Holder if he desires to effect a transfer of the
Warrant)
FOR VALUE RECEIVED, the undersigned hereby sells, assigns
and transfers unto ________________________________, whose Social Security or
other identification number is ________________________ [residing/located] at
____________________________ ____________________ the attached Warrant, and
appoints _____________________________ residing at
__________________________________________________________________ the
undersigned's attorney-in-fact to transfer said Warrant on the books of the
Company, with full power of substitution in the premises.
Dated:_______________, 199__.
In the presence of:
- ------------------------------------- -----------------------------------
(Signature must conform in all
respects to the name of the Warrant
Holder as specified on the face of
the Warrant, without alteration,
enlargement or any change
whatsoever).
<PAGE>
RHYTHMS NETCONNECTIONS INC.
SERIES C PREFERRED STOCK AND WARRANT PURCHASE AGREEMENT
March 16, 1999
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
1. Purchase and Sale of Stock and Warrant. . . . . . . . . . . . . . . 1
1.1 Sale and Issuance of Preferred Stock and Warrant.. . . . . . . 1
1.2 Closing. . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
2. Representations and Warranties of the Company.. . . . . . . . . . . 1
2.1 Organization, Good Standing and Qualification. . . . . . . . . 1
2.2 Capitalization and Voting Rights.. . . . . . . . . . . . . . . 2
2.3 Subsidiaries.. . . . . . . . . . . . . . . . . . . . . . . . . 3
2.4 Authorization. . . . . . . . . . . . . . . . . . . . . . . . . 3
2.5 Valid Issuance of Preferred Stock, Warrant and Common Stock. . 3
2.6 Consents.. . . . . . . . . . . . . . . . . . . . . . . . . . . 4
2.7 Product Warranty and Product Liability.. . . . . . . . . . . . 4
2.8 Litigation.. . . . . . . . . . . . . . . . . . . . . . . . . . 4
2.9 Proprietary Information Agreements.. . . . . . . . . . . . . . 4
2.10 Intellectual Property. . . . . . . . . . . . . . . . . . . . . 4
2.11 Compliance with Other Instruments. . . . . . . . . . . . . . . 5
2.12 Agreements; Action.. . . . . . . . . . . . . . . . . . . . . . 6
2.13 Related-Party Transactions.. . . . . . . . . . . . . . . . . . 7
2.14 Permits. . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
2.15 Environmental and Safety Laws. . . . . . . . . . . . . . . . . 7
2.16 Manufacturing and Marketing Rights.. . . . . . . . . . . . . . 8
2.17 Disclosure.. . . . . . . . . . . . . . . . . . . . . . . . . . 8
2.18 Registration Rights. . . . . . . . . . . . . . . . . . . . . . 9
2.19 Corporate Documents. . . . . . . . . . . . . . . . . . . . . . 9
2.20 Title to Property and Assets.. . . . . . . . . . . . . . . . . 9
2.21 Employee Benefit Plans.. . . . . . . . . . . . . . . . . . . . 9
2.22 Financial Statements.. . . . . . . . . . . . . . . . . . . . . 9
2.23 Tax Returns, Payments and Elections. . . . . . . . . . . . . . 9
2.24 Insurance. . . . . . . . . . . . . . . . . . . . . . . . . . . 10
2.25 Minute Books.. . . . . . . . . . . . . . . . . . . . . . . . . 10
2.26 Labor Agreements and Actions.. . . . . . . . . . . . . . . . . 10
2.27 Inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . 10
2.28 Notes and Accounts Receivable. . . . . . . . . . . . . . . . . 11
2.29 Powers of Attorney.. . . . . . . . . . . . . . . . . . . . . . 11
2.30 Guaranties.. . . . . . . . . . . . . . . . . . . . . . . . . . 11
3. Representations and Warranties of the Investor. . . . . . . . . . . 11
3.1 Authorization. . . . . . . . . . . . . . . . . . . . . . . . . 11
3.2 Purchase Entirely for Own Account. . . . . . . . . . . . . . . 11
3.3 Disclosure of Information. . . . . . . . . . . . . . . . . . . 12
3.4 Investment Experience. . . . . . . . . . . . . . . . . . . . . 12
3.5 Accredited Investor. . . . . . . . . . . . . . . . . . . . . . 12
3.6 Qualified Institutional Buyer. . . . . . . . . . . . . . . . . 12
3.7 Restricted Securities. . . . . . . . . . . . . . . . . . . . . 12
3.8 Qualified Passive Investor.. . . . . . . . . . . . . . . . . . 12
(i)
<PAGE>
Page
----
<S> <C>
4. Covenants of the Investor.. . . . . . . . . . . . . . . . . . . . . 13
4.1 Further Limitations on Disposition.. . . . . . . . . . . . . . 13
4.2 Legends. . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
4.3 Corporate Securities Law.. . . . . . . . . . . . . . . . . . . 14
4.4 Waiver of "Piggy-Back" Registration Rights.. . . . . . . . . . 14
5. Conditions of Investor's Obligations at the Closing.. . . . . . . . 14
5.1 Representations and Warranties.. . . . . . . . . . . . . . . . 14
5.2 Performance. . . . . . . . . . . . . . . . . . . . . . . . . . 14
5.3 Compliance Certificate.. . . . . . . . . . . . . . . . . . . . 14
5.4 Qualifications.. . . . . . . . . . . . . . . . . . . . . . . . 15
5.5 Proceedings and Documents. . . . . . . . . . . . . . . . . . . 15
5.6 Opinion of Company Counsel.. . . . . . . . . . . . . . . . . . 15
5.7 Board of Directors.. . . . . . . . . . . . . . . . . . . . . . 15
5.8 Investors' Rights Agreement. . . . . . . . . . . . . . . . . . 15
5.9 Hart-Scott-Rodino. . . . . . . . . . . . . . . . . . . . . . . 15
6. Conditions of the Company's Obligations at the Closing. . . . . . . 16
6.1 Representations and Warranties.. . . . . . . . . . . . . . . . 16
6.2 Qualifications.. . . . . . . . . . . . . . . . . . . . . . . . 16
6.3 Performance. . . . . . . . . . . . . . . . . . . . . . . . . . 16
6.4 Investors' Rights Agreement. . . . . . . . . . . . . . . . . . 16
7. Indemnification.. . . . . . . . . . . . . . . . . . . . . . . . . . 16
7.1 Indemnity by Company.. . . . . . . . . . . . . . . . . . . . . 16
7.2 Indemnity by Investor. . . . . . . . . . . . . . . . . . . . . 17
8. Miscellaneous.. . . . . . . . . . . . . . . . . . . . . . . . . . . 17
8.1 Survival of Warranties.. . . . . . . . . . . . . . . . . . . . 17
8.2 Successors and Assigns.. . . . . . . . . . . . . . . . . . . . 17
8.3 Governing Law. . . . . . . . . . . . . . . . . . . . . . . . . 17
8.4 Counterparts.. . . . . . . . . . . . . . . . . . . . . . . . . 18
8.5 Titles and Subtitles.. . . . . . . . . . . . . . . . . . . . . 18
8.6 Notices. . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
8.7 Finder's Fee.. . . . . . . . . . . . . . . . . . . . . . . . . 18
8.8 Expenses.. . . . . . . . . . . . . . . . . . . . . . . . . . . 18
8.9 Amendments and Waivers.. . . . . . . . . . . . . . . . . . . . 18
8.10 Severability.. . . . . . . . . . . . . . . . . . . . . . . . . 19
8.11 Aggregation of Stock.. . . . . . . . . . . . . . . . . . . . . 19
8.12 Entire Agreement.. . . . . . . . . . . . . . . . . . . . . . . 19
SCHEDULE A - Schedule of Investors
SCHEDULE B - Schedule of Series A Preferred Holders
SCHEDULE C - Schedule of Series B Preferred Holders
SCHEDULE D - Schedule of Common Holders
EXHIBIT A - Restated Certificate of Incorporation
EXHIBIT B - Amended and Restated Investors' Right Agreement
EXHIBIT C - Form of Warrant
</TABLE>
(ii)
<PAGE>
SERIES C PREFERRED STOCK AND WARRANT PURCHASE AGREEMENT
THIS SERIES C PREFERRED STOCK AND WARRANT PURCHASE AGREEMENT (the
"Agreement") is made as of the 16th day of March 1999, by and between Rhythms
NetConnections Inc., a Delaware corporation (the "Company"), and Microsoft
Corporation (the "Investor").
THE PARTIES HEREBY AGREE AS FOLLOWS:
1. PURCHASE AND SALE OF STOCK AND WARRANT.
1.1 SALE AND ISSUANCE OF PREFERRED STOCK AND WARRANT.
(a) RESTATED CERTIFICATE. The Company shall adopt and file with
the Secretary of State of Delaware before the Closing (as defined below) the
Restated Certificate of Incorporation in the form attached hereto as EXHIBIT A
(the "Restated Certificate").
(b) PURCHASE OF PREFERRED STOCK AND WARRANT. Subject to the
terms and conditions of this Agreement, the Investor agrees to purchase at the
Closing (defined below) and the Company agrees to sell and issue to such
Investor at the Closing (i) that number of shares of the Company's Series C
Preferred Stock set forth opposite the Investor's name on SCHEDULE A hereto; and
(ii) a warrant, substantially in the form of EXHIBIT D attached hereto (the
"Warrant"), to purchase 600,000 shares of the Company's Common Stock at an
exercise price per share of $8.04 per share. The purchase price of each share
of Series C Preferred Stock shall be $8.04 per share and the purchase price for
each warrant to purchase one (1) share of Common Stock shall be $0.001 per
share.
1.2 CLOSING. The purchase and sale of the Series C Preferred
Stock shall take place at the offices of Brobeck, Phleger & Harrison LLP, 550
West "C" Street, Suite 1200, San Diego California, at 11:00 a.m., on March
16, 1999, or at such other time and place as the Company and the Investor
mutually agree upon orally or in writing (which time and place are designated
as the "Closing"). At the Closing the Company shall deliver to the Investor
a certificate representing the Series C Preferred Stock and the Warrant which
such Investor is purchasing at the Closing (as set forth on Schedule A)
against delivery to the Company by such Investor of a check or wire transfer
in the amount of the purchase price therefor payable to the Company's order.
2. Representations and Warranties of the Company. The Company hereby
represents and warrants to the Investor that, except as set forth on a Schedule
of Exceptions furnished to the Investor, which exceptions shall be deemed to be
representations and warranties as if made hereunder:
2.1 Organization, Good Standing and Qualification. The Company is a
corporation duly organized, validly existing and in good standing under the laws
of the State of Delaware and has all requisite corporate power and authority to
enter into this Agreement and to carry on its business as now conducted and as
proposed to be conducted. The Company is duly
<PAGE>
qualified to transact business and is in good standing in each jurisdiction in
which the failure so to qualify would have a material adverse effect on its
business or properties.
2.2 CAPITALIZATION AND VOTING RIGHTS. The authorized capital of the
Company consists, or will consist prior to the Closing, of:
(i) PREFERRED STOCK. 24,407,762 shares of Preferred Stock
(the "Preferred Stock"), of which 12,900,000 have been designated Series A
Preferred Stock of which 12,855,094 are issued and outstanding (as set forth on
Schedule B) and which are currently convertible into 25,710,188 shares of Common
Stock, of which 4,044,943 have been designated Series B Preferred Stock all of
which are issued and outstanding (as set forth on Schedule C) and which are
currently convertible into 8,089,886 shares of Common Stock and 7,462,819 shares
of which have been designated Series C Preferred Stock 3,731,410 of which are
issued and outstanding and the rest will be sold pursuant to this Agreement.
The rights, privileges and preferences of the Series C Preferred Stock as of the
Closing will be as stated in the Company's Restated Certificate attached hereto
as EXHIBIT A.
(ii) COMMON STOCK. 70,439,653 shares of common stock
("Common Stock"), of which 7,119,208 shares are issued and outstanding and are
owned by the persons, and in the numbers specified in Schedule D hereto, and of
which 365,096 shares are held by the Company as treasury stock. The outstanding
shares of common stock are all duly and validly authorized and issued, fully
paid and nonassessable, and were issued in accordance with the registration or
qualification provisions of the Securities Act of 1933, as amended, and any
relevant state securities laws, or pursuant to valid exceptions therefrom.
(iii) Except for (A) the Warrant to be issued under this
Agreement, (B) the conversion privileges of each of the Series A Preferred Stock
and the Series B Preferred Stock and the Series C Preferred Stock to be issued
under this Agreement, the rights provided in paragraph 2.4 of the Amended and
Restated Investors' Rights Agreement (the "Investors' Rights Agreement") of even
date herewith in the form attached hereto as EXHIBIT B, (D) the Company's
reservation of 9,727,942 shares of Common Stock for issuance to employees,
directors and consultants pursuant to options granted, and to be granted in the
future, under a stock option plan, (E) warrants to purchase up to 3,944,000
shares of Common Stock issued in connection with the Company's sale and issuance
of 290,000 units consisting of 13-1/2% senior discount notes and warrants, all
pursuant to that certain Purchase Agreement dated April 28,1998 and (F) a
warrant to purchase up to 478,650 shares of Common Stock issued in connection
with a lease financing there are not outstanding any options, warrants, rights
(including conversion or preemptive rights) or agreements for the purchase or
acquisition from the Company of any shares of its capital stock. The Company is
not a party or subject to any agreement or understanding, and, to the Company's
knowledge, there is no agreement or understanding between any persons and/or
entities, which affects or relates to the voting or giving of written consents
with respect to any security or by a director of the Company.
-2-
<PAGE>
2.3 SUBSIDIARIES. The Company does not presently own or control,
directly or indirectly, any interest in any other corporation, association, or
other business entity.
2.4 AUTHORIZATION. All corporate action on the part of the
Company, its officers, directors and shareholders necessary for the
authorization, execution and delivery of this Agreement and the Investors'
Rights Agreement, the performance of all obligations of the Company hereunder
and thereunder and the authorization, issuance (or reservation for issuance),
sale and delivery of the Series C Preferred Stock and Warrant being sold
hereunder and the Common Stock issuable upon conversion of the Series C
Preferred Stock and upon exercise of the Warrant has been taken or will be taken
prior to the Closing, and this Agreement and the Investors' Rights Agreement
constitute valid and legally binding obligations of the Company, enforceable in
accordance with their respective terms, except (i) as limited by applicable
bankruptcy, insolvency, reorganization, moratorium, and other laws of general
application affecting enforcement of creditors' rights generally, (ii) as
limited by laws relating to the availability of specific performance, injunctive
relief, or other equitable remedies, and (iii) to the extent the indemnification
provisions contained in the Investors' Rights Agreement may be limited by
applicable federal or state securities laws.
2.5 VALID ISSUANCE OF PREFERRED STOCK, WARRANT AND COMMON STOCK.
(a) The Series C Preferred Stock and Warrant which are being
purchased by the Investor hereunder, when issued, sold and delivered in
accordance with the terms hereof for the consideration expressed herein, will be
duly and validly issued, fully paid and nonassessable and, based in part upon
the representations of the Investor in this Agreement, will be issued in
compliance with all applicable federal and state securities laws and will be
free of restrictions on transfer other than restrictions on transfer under this
Agreement and the Investors' Rights Agreement and under applicable state and
federal securities law. The Common Stock issuable upon conversion of the Series
C Preferred Stock and/or upon exercise of the Warrant purchased under this
Agreement has been duly and validly reserved for issuance and, upon issuance in
accordance with the terms of the Restated Certificate, shall be duly and validly
issued, fully paid and nonassessable, and issued in compliance with all
applicable securities laws and will be free of restrictions on transfer other
than restrictions on transfer under this Agreement and the Investors' Rights
Agreement and under applicable state and federal securities law, as presently in
effect, of the United States and each of the states whose securities laws govern
the issuance of any of the Securities (as defined in Section 3.2) hereunder.
(b) The outstanding shares of Common Stock, Series A Preferred
Stock and Series B Preferred Stock are all duly and validly authorized and
issued, fully paid and nonassessable, and were issued in compliance with all
applicable federal and state securities laws.
2.6 CONSENTS. No consent, approval, order or authorization of, or
registration, qualification, designation, declaration or filing with, any person
or entity not a party hereto or any federal, state, local or provincial
governmental authority on the part of the Company is required in connection with
the consummation of the transactions contemplated by this Agreement, except for
the filing pursuant to Section 25102(f) of the California Corporate
-3-
<PAGE>
Securities Law of 1968, as amended, and the rules thereunder, which filing will
be effected within 15 days of the sale of the Series C Preferred Stock
hereunder.
2.7 PRODUCT WARRANTY AND PRODUCT LIABILITY. Each product
manufactured, sold, leased, or delivered by the Company has been in material
conformity with all applicable contractual commitments and all express and
implied warranties, and the Company has no liability (and there is no basis for
any present or future action, suit, proceeding, hearing, investigation, charge,
complaint, claim, or demand against the Company giving rise to any liability)
for replacement or repair thereof or other damages in connection therewith. The
Company has received no customer complaints concerning its products and/or
services, nor has it had any of its products returned by a purchaser thereof.
The Company has no material liability (and there is no basis for any present or
future action, suit, proceeding, hearing, investigation, charge, complaint,
claim, or demand against any of them giving rise to any liability) arising out
of any injury to individuals or property as a result of the ownership,
possession, or use of any product manufactured, sold, leased, or delivered by
the Company.
2.8 LITIGATION. There is no action, suit, proceeding or
investigation pending or, to its knowledge, currently threatened against the
Company. The foregoing includes, without limitation, actions pending or
threatened involving the prior employment of any of the Company's employees,
their use in connection with the Company's business of any information or
techniques allegedly proprietary to any of their former employers, or their
obligations under any agreements with prior employers. The Company is not a
party or subject to the provisions of any order, writ, injunction, judgment or
decree of any court or government agency or instrumentality. There is no
action, suit, proceeding or investigation by the Company currently pending or
which the Company intends to initiate.
2.9 PROPRIETARY INFORMATION AGREEMENTS. Each employee, officer and
consultant of the Company has executed a Proprietary Information and Inventions
Agreement in the form provided to the Investor. The Company, after reasonable
investigation, is not aware that any of its employees, officers or consultants
are in violation thereof, and the Company will use its best efforts to prevent
any such violation.
2.10 INTELLECTUAL PROPERTY. The Company has sufficient title and
ownership of all patents, trademarks, service marks, trade names, copyrights,
trade secrets, information, proprietary rights and processes necessary for its
business as now conducted and as proposed to be conducted without any conflict
with or infringement of the rights of others. There are no outstanding options,
licenses, or agreements of any kind relating to the foregoing, nor is the
Company bound by or a party to any options, licenses or agreements of any kind
with respect to the patents, trademarks, service marks, trade names, copyrights,
trade secrets, licenses, information, proprietary rights and processes of any
other person or entity. The Company has not interfered with, infringed upon,
misappropriated, or otherwise come into conflict with any patents, trademarks,
service marks, trade names, copyrights, trade secrets, information, proprietary
rights, or processes of third parties, nor has the Company received any
communications alleging that the Company has violated or, by conducting its
business as proposed, would violate any of the patents, trademarks, service
marks, trade names, copyrights, trade secrets, information, proprietary rights,
processes, or other proprietary rights of any other
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person or entity. The Company is not aware after due inquiry of its employees
that any of its employees is obligated under any contract (including licenses,
covenants or commitments of any nature) or other agreement, or subject to any
judgment, decree or order of any court or administrative agency, that would
interfere with the use of his or her best efforts to promote the interests of
the Company or that would conflict with the Company's business as proposed to be
conducted. Neither the execution nor delivery of this Agreement and the
Investors' Rights Agreement, nor the carrying on of the Company's business by
the employees of the Company, nor the conduct of the Company's business as
proposed, will, to the Company's knowledge after due inquiry of its employees,
conflict with or result in a breach of the terms, conditions or provisions of,
or constitute a default under, any law, contract, covenant or instrument under
which any of such employees is now subject to or obligated. The Company does
not believe it is or will be necessary to utilize any inventions of any of its
employees (or people it currently intends to hire) made prior to their
employment by the Company.
2.11 COMPLIANCE WITH OTHER INSTRUMENTS. (i) The Company is not in
violation or default of any provisions of its Certificate of Incorporation or
Bylaws or of any instrument, judgment, order, writ, decree, lien, indenture,
mortgage, lease, or contract to which it is a party or by which it is bound or
of any provision of federal or state statute, rule or regulation applicable to
the Company. The execution, delivery and performance of this Agreement, the
Investors' Rights Agreement or any ancillary agreements and the consummation of
the transactions contemplated hereby and thereby, and the issuance and sale of
Securities (as defined in Section 3.2), will not result in any such violation,
will not permit the acceleration of the maturity of, or be in conflict with or
constitute, with or without the passage of time and giving of notice, either a
default under any such provision, instrument, judgment, order, writ, decree,
lien, indenture, mortgage, lease, contract, statute, rule, or regulation, or an
event which results in the creation of any lien, charge or encumbrance upon any
assets of the Company or the Securities or the suspension, revocation,
impairment, forfeiture, or nonrenewal of any material permit, license,
authorization, or approval applicable to the Company, its business or operations
or any of its assets or properties; and (ii) there is no judgment, order, writ
or decree issued by a court of law that specifically names the Company.
2.12 AGREEMENTS; ACTION.
(a) Except for agreements explicitly contemplated hereby and by
the Investors' Rights Agreement, there are no agreements, understandings or
proposed transactions between the Company and any of its officers, directors,
affiliates, or any affiliate thereof.
(b) There are no agreements, understandings, instruments,
contracts, proposed transactions, judgments, orders, writs or decrees to which
the Company is a party or by which it is bound which may involve (i) obligations
of the Company (contingent or otherwise) of, or payments to the Company
individually in excess of $100,000 or, in case of agreements, understandings,
instruments, contracts, proposed transactions, judgments, orders, writs or
decrees to which the Company is a party or by which it is bound are individually
less than $100,000, in excess of $250,000 in the aggregate, or (ii) the license
of any patent, copyright, trade secret or other proprietary right to or from the
Company or (iii) provisions restricting or
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affecting the development, manufacture or distribution of the Company's products
or services, or (iv) indemnification by the Company with respect to infringement
of proprietary rights.
(c) The Company has not (i) declared or paid any dividends, or
authorized or made any distribution upon or with respect to any class or series
of its capital stock, (ii) incurred any indebtedness for money borrowed or any
other liabilities individually in excess of $100,000 or, in the case of
indebtedness and/or liabilities individually less than $100,000, in excess of
$250,000 in the aggregate, (iii) made any loans or advances to any person, other
than ordinary advances for travel expenses, or (iv) sold, exchanged or otherwise
disposed of any of its assets or rights, other than the sale of its inventory in
the ordinary course of business.
(d) For the purposes of subsections (b) and (c) above, all
indebtedness, liabilities, agreements, understandings, instruments, contracts
and proposed transactions involving the same person or entity (including persons
or entities the Company has reason to believe are affiliated therewith) shall be
aggregated for the purpose of meeting the individual minimum dollar amounts of
such subsections.
(e) The Company is not a party to and is not bound by any
contract, agreement or instrument, or subject to any restriction under its
Restated Certificate or Bylaws, which adversely affects its business as now
conducted or as proposed to be conducted, its properties or its financial
condition.
(f) The Company has not engaged in the past three (3) months in
any discussion (i) with any representative of any corporation or corporations
regarding the consolidation or merger of the Company with or into any such
corporation or corporations, (ii) with any corporation, partnership, association
or other business entity or any individual regarding the sale, conveyance or
disposition of all or substantially all of the assets of the Company in a
transaction or series of related transactions in which more than fifty percent
(50%) of the voting power of the Company is disposed of, or (iii) regarding any
other form of acquisition, liquidation, dissolution or winding up of the
Company.
(g) As of the Closing, the Company has not incurred any expenses
and has no liabilities individually in excess of $100,000 or, in the case of
expenses and/or liabilities individually less than $100,000, in excess of
$250,000 in the aggregate.
2.13 RELATED-PARTY TRANSACTIONS. No employee, officer, or director of
the Company or member of his or her immediate family is indebted to the Company,
nor is the Company indebted (or committed to make loans or extend or guarantee
credit) to any of them. To the best of the Company's knowledge, none of such
persons has any direct or indirect ownership interest in any firm or corporation
with which the Company is affiliated or with which the Company has a business
relationship, or any firm or corporation that competes with the Company, except
that employees, officers, or directors of the Company and members of their
immediate families may own stock in publicly traded companies that may compete
with the Company. No member of the immediate family of any officer or director
of the Company is directly or indirectly interested in any material contract
with the Company.
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2.14 PERMITS. The Company has all franchises, permits, licenses, and
other similar authorities necessary for the conduct of its business as now being
conducted by it, the lack of which could materially and adversely affect the
business, properties, prospects, or financial condition of the Company and
believes it can obtain, without undue burden or expense, any similar authority
for the conduct of its business as planned to be conducted. The Company is not
in default in any material respect under any of such franchises, permits,
licenses, or other similar authority.
2.15 ENVIRONMENTAL AND SAFETY LAWS.
(i) The Company is not in violation of any federal, state, local or
foreign statute, regulation, ordinance or other provision having the force or
effect of law, any judicial or administrative order or determination, any
contractual obligation or any common law concerning public health and safety,
worker health and safety, or pollution or protection of the environment,
including without limitation any of those relating to the presence, use,
production, generation, handling, transportation, treatment, storage, disposal,
distribution, labeling, testing, processing, discharge, release, threatened
release, control, or cleanup of any hazardous materials, substances or wastes,
chemical substances or mixtures, pesticides, pollutants, contaminants, toxic
chemicals, petroleum products or byproducts, asbestos, polychlorinated
biphenyls, noise or radiation, each as amended and as now or hereafter in effect
(referred to herein collectively as the "Environmental, Health, and Safety
Requirements"), and no material expenditures are or will be required in order to
comply with the Environmental, Health, and Safety Requirements.
(ii) The Company has obtained and complied with, and is in compliance
with, all permits, licenses and other authorizations that are required pursuant
to all Environmental, Health, and Safety Requirements for the occupation of its
facilities and the operation of its business.
(iii) The Company has not received any written or oral notice, report
or other information regarding any actual or alleged violation of Environmental,
Health, and Safety Requirements, or any liabilities or potential liabilities
(whether accrued, absolute, contingent, unliquidated or otherwise), including
any investigatory, remedial or corrective obligations, relating to Company or
its facilities arising under the Environmental, Health, and Safety Requirements.
(iv) None of the following exists at any property or facility owned or
operated by the Company: (1) underground storage tanks, (2) asbestos-containing
material in any form or condition, (3) materials or equipment containing
polychlorinated biphenyls, or (4) landfills, surface impoundments, or disposal
areas.
(v) The Company has not treated, stored, disposed of, arranged for or
permitted the disposal of, transported, handled, or released any substance,
including without limitation any hazardous substance, or owned or operated any
property or facility (and no such property or facility is contaminated by any
such substance) in a manner that has given or would give rise to liabilities,
including any liability for response costs, corrective action costs, personal
injury, property damage, natural resources damages or attorney fees, pursuant to
the
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Comprehensive Environmental Response, Compensation and Liability Act of 1980, as
amended ("CERCLA"), the Solid Waste Disposal Act, as amended ("SWDA"), or any of
the Environmental, Health, and Safety Requirements.
(vi) Neither this Agreement nor the consummation of the transaction
that is the subject of this Agreement will result in any obligations for site
investigation or cleanup, or notification to or consent of government agencies
or third parties, pursuant to any of the so-called "transaction-triggered" or
"responsible property transfer" Environmental, Health, and Safety Requirements.
(vii) The Company has not, either expressly or by operation of law,
assumed or undertaken any liability, including without limitation any obligation
for corrective or remedial action, of any person or entity relating to the
Environmental, Health, and Safety Requirements.
(viii) No facts, events or conditions relating to the past or present
facilities, properties or operations of the Company will prevent, hinder or
limit continued compliance with the Environmental, Health, and Safety
Requirements, give rise to any investigatory, remedial or corrective obligations
pursuant to the Environmental, Health, and Safety Requirements, or give rise to
any other liabilities (whether accrued, absolute, contingent, unliquidated or
otherwise) pursuant to the Environmental, Health, and Safety Requirements,
including without limitation any relating to onsite or offsite releases or
threatened releases of hazardous materials, substances or wastes, personal
injury, property damage or natural resources damage.
2.16 MANUFACTURING AND MARKETING RIGHTS. The Company has not granted
rights to manufacture, produce, assemble, license, market, or sell its products
to any other person and is not bound by any agreement that affects the Company's
exclusive right to develop, manufacture, assemble, distribute, market, or sell
its products.
2.17 DISCLOSURE. The Company has fully provided the Investor with all
the information which such Investor has requested for deciding whether to
purchase the Series C Preferred Stock and all information that is material to
enable such Investor to make such decision. Neither this Agreement, the
Investors' Rights Agreement, nor any other statements or certificates made or
delivered in connection herewith or therewith contains any untrue statement of a
material fact or omits to state a material fact necessary to make the statements
herein or therein not misleading.
2.18 REGISTRATION RIGHTS. Except as provided in the Investors' Rights
Agreement, the Company has not granted or agreed to grant any registration
rights, including piggyback rights, to any person or entity.
2.19 CORPORATE DOCUMENTS. Except for amendments necessary to satisfy
representations and warranties or conditions contained herein (the form of which
amendments has been approved by the Investor), the Certificate of Incorporation
and Bylaws of the Company as currently in effect are in the form previously
provided to the Investor.
2.20 TITLE TO PROPERTY AND ASSETS. The Company owns its property and
assets free and clear of all mortgages, liens, loans and encumbrances, except
such encumbrances and
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liens which arise in the ordinary course of business and do not materially
impair the Company's ownership or use of such property or assets. With respect
to the property and assets it leases, the Company is in compliance with such
leases and holds a valid leasehold interest free of any liens, claims or
encumbrances.
2.21 EMPLOYEE BENEFIT PLANS. The Company does not have any Employee
Benefit Plan as defined in the Employee Retirement Income Security Act of 1974.
2.22 FINANCIAL STATEMENTS. The Company has provided to the Investor
copies of its unaudited balance sheet and statement of operations at
December 31, 1998 and for the period then ended (the "Financial Statements").
The Financial Statements are true, complete and correct, present fairly the
financial condition of the Company and the results of operations as of the date
of such statements and have been prepared in accordance with generally accepted
accounting principles ("GAAP"), except that the unaudited Financial Statements
do not contain the footnotes required by GAAP. The Financial Statements
accurately set forth and describe the financial condition and operating results
of the Company as of the date, and for the period, indicated therein, subject to
normal year-end audit adjustments.
2.23 TAX RETURNS, PAYMENTS AND ELECTIONS. The Company has filed all
tax returns and reports required by law. These returns and reports are true and
correct in all material respects. The Company has paid all taxes and other
assessments due, except those contested by it in good faith which are listed in
the Schedule of Exceptions. The provision for taxes of the Company as shown in
its Financial Statements is adequate for taxes due or accrued as of the date
thereof. The Company has not elected pursuant to the Internal Revenue Code of
1986, as amended ("Code"), to be treated as a Subchapter S corporation or a
collapsible corporation pursuant to Section 341(f) or Section 1362(a) of the
Code, nor has it made any other elections pursuant to the Code (other than
elections which relate solely to methods of accounting, depreciation or
amortization) which would have a material effect on the Company, its financial
condition, its business as presently conducted or proposed to be conducted or
any of its properties or material assets.
2.24 INSURANCE. The Company has in full force and effect and shall
maintain fire and casualty insurance policies, with extended coverage,
sufficient in amount (subject to reasonable deductibles) to allow it to replace
any of its properties that might be damaged or destroyed. The Company shall
also maintain broad form comprehensive general liability insurance in the
minimum amount of $2,000,000 per year.
2.25 MINUTE BOOKS. The minute books of the Company provided to the
Investor contain a complete summary of all meetings of directors and
stockholders since the time of incorporation and reflect all transactions
referred to in such minutes accurately in all material respects.
2.26 LABOR AGREEMENTS AND ACTIONS. The Company is not bound by or
subject to (and none of its assets or properties is bound by or subject to) any
written or oral, express or implied, contract, commitment or arrangement with
any labor union, and no labor union has requested or, to the knowledge of the
Company, has sought to represent any of the employees,
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representatives or agents of the Company. There is no strike or other labor
dispute involving the Company pending, or to the knowledge of the Company
threatened, which could have a material adverse effect on the assets,
properties, financial condition, operating results, or business of the Company
(as such business is presently conducted and as it is proposed to be conducted),
nor is the Company aware of any labor organization activity involving its
employees. The Company is not aware that any officer or key employee, or that
any group of key employees, intends to terminate their employment with the
Company, nor does the Company have a present intention to terminate the
employment of any of the foregoing. Subject to general principles related to
wrongful termination of employees, the employment of each officer and employee
of the Company is terminable at the will of the Company.
2.27 INVENTORY. All inventory of the Company consists of raw
materials and supplies, manufactured and purchased parts, goods in process, and
finished goods, all of which is merchantable and fit for the purpose for which
it was procured or manufactured, and none of which is slow-moving, obsolete,
damaged, or defective, subject only to the reserve for inventory writedown set
forth on the face of the Company's most recent balance sheet (rather than in any
notes thereto) as adjusted for the passage of time through the Closing in
accordance with the past custom and practice of the Company.
2.28 NOTES AND ACCOUNTS RECEIVABLE. All notes and accounts
receivable of the Company are reflected properly on the Company's books and
records, are valid receivables subject to no setoffs or counterclaims, are
current and collectible, and will be collected in accordance with their terms at
their recorded amounts, subject only to the reserve for bad debts set forth on
the face of the Company's most recent balance sheet (rather than in any notes
thereto) as adjusted for the passage of time through the Closing in accordance
with the past custom and practice of the Company.
2.29 POWERS OF ATTORNEY. There are no outstanding powers of
attorney executed on behalf of the Company.
2.30 GUARANTIES. The Company is not a guarantor or otherwise is
liable for any liability or obligation (including indebtedness) of any other
person or entity other than its wholly owned subsidiaries.
3. REPRESENTATIONS AND WARRANTIES OF THE INVESTOR. The Investor hereby
represents and warrants to the Company that:
3.1 AUTHORIZATION. The Investor has full power and authority to
enter into this Agreement, the Warrant and the Investors' Rights Agreement and
each such agreement constitutes its valid and legally binding obligation,
enforceable in accordance with its terms except (i) as limited by applicable
bankruptcy, insolvency, reorganization, moratorium, and other laws of general
application affecting enforcement of creditors' rights generally, (ii) as
limited by laws relating to the availability of specific performance, injunctive
relief, or other equitable remedies, and (iii) to the extent the indemnification
provisions contained in the Investors' Rights Agreement may be limited by
applicable Federal or state securities laws.
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3.2 PURCHASE ENTIRELY FOR OWN ACCOUNT. This Agreement and the
Warrant are made with the Investor in reliance upon such Investor's
representation to the Company that the Series C Preferred Stock and the Warrant
to be received by such Investor and the Common Stock issuable upon conversion
and/or exercise thereof (collectively, the "Securities") will be acquired for
investment for such Investor's own account, not as a nominee or agent, and not
with a view to the resale or distribution of any part thereof, and that such
Investor has no present intention of selling, granting any participation in, or
otherwise distributing the same. The Investor does not have any contract,
undertaking, agreement or arrangement with any person to sell, transfer or grant
participations to such person or to any third person, with respect to any of the
Securities. The Investor has full power and authority to enter into this
Agreement.
3.3 DISCLOSURE OF INFORMATION. The Investor has had an opportunity
to ask questions and receive answers from the Company regarding the terms and
conditions of the offering of the Series C Preferred Stock and the Warrant. The
foregoing, however, does not limit or modify the representations and warranties
of the Company in Section 2 of this Agreement or the right of the Investor to
rely thereon.
3.4 INVESTMENT EXPERIENCE. The Investor acknowledges that it is able
to fend for itself, can bear the economic risk of its investment and has such
knowledge and experience in financial or business matters that it is capable of
evaluating the merits and risks of the investment in the Series C Preferred
Stock and the Warrant. If other than an individual, it has not been organized
for the purpose of acquiring the Series C Preferred Stock or the Warrant.
3.5 ACCREDITED INVESTOR. The Investor is an "accredited investor"
within the meaning of SEC Rule 501 of Regulation D, as presently in effect.
3.6 QUALIFIED INSTITUTIONAL BUYER. The Investor is a "qualified
institutional buyer" within the meaning of SEC Rule 144A, as presently in
effect.
3.7 RESTRICTED SECURITIES. It understands that the Securities it
is purchasing are characterized as "restricted securities" under the federal
securities laws inas much as they are being acquired from the Company in a
transaction not involving a public offering and that under such laws and
applicable regulations such Securities may be resold without registration
under the Securities Act of 1933, as amended (the "act"), only in certain
limited circumstances. In this connection, Investor is familiar with SEC Rule
144, as presently in effect, and understands the resale limitations imposed
thereby and by the Act.
3.8 QUALIFIED PASSIVE INVESTOR. The Investor represents and warrants
to the Company that the voting securities of the Company are being acquired by,
and will be held by the Investor solely for the purpose of investment within the
meaning of Section 7A(c)(9) of the Clayton Act, and 16 C.F.R. Sections 801.1(j)
and 802.9, and that the Investor has no intention of participating in the
formulation, determination, or direction of the basic business decisions of the
Company.
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4. COVENANTS OF THE INVESTOR.
4.1 FURTHER LIMITATIONS ON DISPOSITION.
(a) Without in any way limiting the representations set forth
above, the Investor further agrees not to make any disposition of all or any
portion of the Securities unless and until the transferee has agreed in writing
for the benefit of the Company to be bound by this Section 4.1 and Section 7,
provided and to the extent such sections are then applicable, and the Investors'
Rights Agreement and:
(i) There is then in effect a Registration Statement under
the Act covering such proposed disposition and such disposition is made in
accordance with such Registration Statement; or
(ii) (A) Such Investor shall have notified the Company of
the proposed disposition and shall have furnished the Company with a detailed
statement of the circumstances surrounding the proposed disposition, and (B) if
reasonably requested by the Company, such Investor shall have furnished the
Company with an opinion of counsel, reasonably satisfactory to the Company, that
such disposition will not require registration of such shares under the Act. It
is agreed that the Company will not require opinions of counsel for transactions
made pursuant to Rule 144 except in unusual circumstances.
(b) Notwithstanding the provisions of paragraph (a) above, (i)
no such Registration Statement or opinion of counsel shall be necessary for a
transfer (A) by an Investor which is a partnership to a partner of such
partnership or a retired partner of such partnership who retires after the date
hereof, or to the estate of any such partner or retired partner or to the
transfer by gift, will or intestate succession of any partner to his spouse or
to the siblings, lineal descendants or ancestors of such partner or his spouse,
or (B) to an "affiliate" of the Investor as that term is defined in Rule 405
promulgated by the Securities and Exchange Commission under the Act, if the
transferee agrees in writing to be subject to the terms hereof to the same
extent as if he were an original Investor hereunder, and (ii) no transferee
shall be required, as a condition to any transfer of Securities by the Investor,
to agree to be bound by this Section 4.1, if the transferee is acquiring such
Securities pursuant to a Registration Statement under the Act or in a
transaction made pursuant to Rule 144.
4.2 LEGENDS. It is understood that the certificates evidencing the
Securities (and the Common Stock issuable upon conversion and/or exercise
thereof) may bear one or all of the following legends:
(a) "These securities have not been registered under the
Securities Act of 1933. They may not be sold, offered for sale, pledged or
hypothecated in the absence of a registration statement in effect with respect
to the securities under such Act or an opinion of counsel satisfactory to the
Company that such registration is not required or unless sold pursuant to Rule
144 of such Act."
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(b) Any legend required by the laws of the State of California,
including any legend required by the California Department of Corporations and
Sections 417 and 418 of the Code.
4.3 CORPORATE SECURITIES LAW. THE SALE OF THE SECURITIES WHICH ARE
THE SUBJECT OF THIS AGREEMENT HAS NOT BEEN QUALIFIED WITH THE COMMISSIONER OF
CORPORATIONS OF THE STATE OF CALIFORNIA AND THE ISSUANCE OF SUCH SECURITIES OR
THE PAYMENT OR RECEIPT OF ANY PART OF THE CONSIDERATION FOR SUCH SECURITIES
PRIOR TO SUCH QUALIFICATION IS UNLAWFUL, UNLESS THE SALE OF SECURITIES IS EXEMPT
FROM QUALIFICATION BY SECTION 25100, 25102 OR 25105 OF THE CALIFORNIA
CORPORATIONS CODE. THE RIGHTS OF ALL PARTIES TO THIS AGREEMENT ARE EXPRESSLY
CONDITIONED UPON SUCH QUALIFICATION BEING OBTAINED, UNLESS THE SALE IS SO
EXEMPT.
4.4 WAIVER OF "PIGGY-BACK" REGISTRATION RIGHTS. The Investor hereby
waives, solely with respect to the Company's filing, within six months of the
Closing, of a registration statement under the Act in connection with an initial
public offering of its Common Stock, any "piggy-back" registration rights it may
have under Section 1.3 of the Investors' Rights Agreement; PROVIDED, HOWEVER,
that such waiver shall only be deemed effective if the Company shall obtain a
similar waiver of such rights on behalf of all other holders of Registrable
Securities (as defined in the Investors' Rights Agreement) under the Investors'
Rights Agreement.
5. CONDITIONS OF INVESTOR'S OBLIGATIONS AT THE CLOSING. With respect to
the Closing, the obligations of the Investor under subsections 1.1 and 1.2 of
this Agreement are subject to the fulfillment on or before the Closing of each
of the following conditions, the waiver of which shall not be effective against
the Investor unless such Investor consents thereto:
5.1 REPRESENTATIONS AND WARRANTIES. The representations and
warranties of the Company contained in Section 2 shall be true on and as of the
date of the Closing with the same effect as though such representations and
warranties had been made on and as of the date of Closing.
5.2 PERFORMANCE. The Company shall have performed and complied with
all agreements, obligations and conditions contained in this Agreement that are
required to be performed or complied with by it on or before the Closing.
5.3 COMPLIANCE CERTIFICATE. The President of the Company shall have
delivered to the Investor at the Closing a certificate certifying that the
conditions specified in Sections 5.1 and 5.2 have been fulfilled and stating
that there has been no adverse change in the business, affairs, operations,
properties, assets or condition of the Company since the date of this Agreement.
5.4 QUALIFICATIONS. The Commissioner of Corporations of the State of
California shall have issued a permit qualifying the offer and sale of the
Series C Preferred Stock and the Warrant and the underlying Common Stock to the
Investor pursuant to this Agreement, or such offer and sale shall be exempt from
such qualification under the California Corporate
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Securities Law of 1968, as amended. Any other authorizations, approvals, or
permits, if any, of any governmental authority or regulatory body of the United
States or of any state that are required in connection with the lawful issuance
and sale of the Series C Preferred Stock pursuant to this Agreement, shall be
duly obtained and effective as of the Closing.
5.5 PROCEEDINGS AND DOCUMENTS. All corporate and other proceedings
in connection with the transactions contemplated at the Closing and all
documents incident thereto shall be reasonably satisfactory in form and
substance to the Investor, and the Investor shall have received all such
counterpart original and certified or other copies of such documents as such
Investor may reasonably request.
5.6 OPINION OF COMPANY COUNSEL. The Investor shall have received
from Brobeck, Phleger & Harrison LLP, counsel for the Company, an opinion, dated
the date of the Closing, in form and substance satisfactory to the Investor.
5.7 BOARD OF DIRECTORS. The Board of Directors of the Company as of
the Closing shall consist of Catherine Hapka, Kevin Compton, Keith Geeslin, Ken
Harrison, William Stensrud, John Walecka and Susan Mayer.
5.8 INVESTORS' RIGHTS AGREEMENT. The Company and the Investor shall
have entered into the Investors' Rights Agreement in the form attached as
EXHIBIT B.
5.9 HART-SCOTT-RODINO. All applicable waiting periods (and any
extensions thereof) under the Hart-Scott-Rodino Antitrust Improvements Act of
1976, as amended, shall have expired or otherwise been terminated and the
parties shall have received all other required authorizations, consents, and
approvals of governments and governmental agencies.
6. CONDITIONS OF THE COMPANY'S OBLIGATIONS AT THE CLOSING. The
obligations of the Company to the Investor under this Agreement are subject to
the fulfillment on or before the Closing of each of the following conditions by
the Investor:
6.1 REPRESENTATIONS AND WARRANTIES. The representations and
warranties of the Investor contained in Section 3 shall be true on and as of the
date of the Closing with the same effect as though such representations and
warranties had been made on and as of the Closing.
6.2 QUALIFICATIONS. The Commissioner of Corporations of the State of
California shall have issued a permit qualifying the offer and sale to the
Investor of the Series C Preferred Stock and the Warrant and the Common Stock
issuable upon the conversion and/or exercise thereof or such offer and sale
shall be exempt from such qualification under the California Corporate
Securities Law of 1968, as amended. Any other authorizations, approvals, or
permits, if any, of any governmental authority or regulatory body of the United
States or of any state that are required in connection with the lawful issuance
and sale of the securities pursuant to this Agreement shall be duly obtained and
effective as of the Closing.
6.3 PERFORMANCE. The Investor shall have performed and complied with
all agreements, obligations and conditions contained in this Agreement that are
required to be performed or complied with by it on or before the Closing.
-14-
<PAGE>
6.4 INVESTORS' RIGHTS AGREEMENT. The Company and the Investor shall
have entered into the Investors' Rights Agreement in the form attached as
EXHIBIT B.
7. INDEMNIFICATION.
7.1 INDEMNITY BY COMPANY. Company shall indemnify and hold Investor
harmless from and against any and all liability (including, without limitation,
strict liability), loss, damage, or deficiency (including, without limitation,
reasonable attorneys' fees and associated costs) resulting from any
misrepresentation, breach of warranty, or nonfulfillment of any agreement on the
part of Company under this Agreement or under any certificate or other
instrument furnished or to be furnished by Company hereunder, and from the
ownership, management, operations, and interests of Company prior to Closing,
and from any act or omission of Company, or its agents, employees, and
independent contractors in respect of periods prior to the Closing. To be
entitled to such indemnification, Investor must give Company written notice of
the assertion by a third party, to which Investor has knowledge, of any claim
with respect to which Investor might bring a claim for indemnification
hereunder, and in all events must have supplied such notice to Company within
the applicable period for defense of such claim by Company. Upon Company's
agreement to indemnify Investor hereunder, Company shall have the right, at
Company's own expense, to defend and litigate any such third party claim. In no
event shall Company be liable for the acts or omissions of prior owners,
operators, or managers of the Investor or their agents, independent contractors,
or employees, including, without limitation, any liability arising out of or in
connection with claims which occurred prior to the Closing.
7.2 INDEMNITY BY INVESTOR. Investor shall indemnify and hold Company
harmless from and against any and all liability (including, without limitation,
strict liability), loss, damage or deficiency (including, without limitation,
reasonable attorneys' fees and associated costs) resulting from any
misrepresentation, breach of warranty, or nonfulfillment under any agreement on
the part of Investor under this Agreement or under any certificate or other
instrument furnished by Investor or to be furnished by Investor hereunder, and
from any act or omission of Investor, or its agents, employees, and independent
contractors in respect of periods prior to the Closing. To be entitled to such
indemnification, Company must give Investor written notice of the assertion by a
third party, to which Company has knowledge, of any claim with respect to which
Company might bring a claim for indemnification hereunder, and in all events
must have provided such notice within the applicable period for defense of such
claim by Investor. Upon Investor's agreement to indemnify Company hereunder,
Investor shall have the right, at Investor's own expense, to defend and litigate
any such third party claim. In no event shall Investor be liable for the acts
or omissions of prior owners, operators, or managers of the Company or their
agents, independent contractors, or employees, including, without limitation,
any liability arising out of or in connection with claims which occurred prior
to the Closing.
8. MISCELLANEOUS.
8.1 SURVIVAL OF WARRANTIES. The warranties, representations and
covenants of the Company and the Investor contained in or made pursuant to this
Agreement shall survive the
-15-
<PAGE>
execution and delivery of this Agreement and the Closing and shall in no way be
affected by any investigation of the subject matter thereof made by or on behalf
of the Investor or the Company.
8.2 SUCCESSORS AND ASSIGNS. Except as otherwise provided herein, the
terms and conditions of this Agreement shall inure to the benefit of and be
binding upon the respective successors and assigns of the parties (including
transferees of any shares of Securities sold hereunder or any Common Stock
issued upon conversion and/or exercise thereof). Nothing in this Agreement,
express or implied, is intended to confer upon any party other than the parties
hereto or their respective successors and assigns any rights, remedies,
obligations, or liabilities under or by reason of this Agreement, except as
expressly provided in this Agreement.
8.3 GOVERNING LAW. This Agreement shall be governed by and construed
under the laws of the State of Delaware without regard to choice of law
principles.
8.4 COUNTERPARTS. This Agreement may be executed in any number of
counterparts, each of which shall be deemed an original, but all of which
together shall constitute one and the same instrument.
8.5 TITLES AND SUBTITLES. The titles and subtitles used in this
Agreement are used for convenience only and are not to be considered in
construing or interpreting this Agreement.
8.6 NOTICES. Unless otherwise provided, any notice required or
permitted under this Agreement shall be given in writing and shall be deemed
effectively given upon receipt, and shall be addressed to the party to be
notified at the address indicated for such party on the signature page hereof,
or at such other address as such party may designate by ten (10) days' advance
written notice to the other parties.
8.7 FINDER'S FEE. Each party represents that it neither is nor will
be obligated for any finders' fee or commission in connection with this
transaction. The Investor agrees to indemnify and to hold harmless the Company
from any liability for any commission or compensation in the nature of a
finders' fee (and the costs and expenses of defending against such liability or
asserted liability) for which the Investor or any of its officers, partners,
employees, or representatives is responsible.
The Company agrees to indemnify and hold harmless the Investor
from any liability for any commission or compensation in the nature of a
finders' fee (and the costs and expenses of defending against such liability or
asserted liability) for which the Company or any of its officers, employees or
representatives is responsible.
8.8 EXPENSES. Irrespective of whether the Closing is effected, the
Company shall pay all costs and expenses that it incurs with respect to the
negotiation, execution, delivery and performance of this Agreement. If any
action at law or in equity is necessary to enforce or interpret the terms of
this Agreement or the Restated Certificate, the prevailing party shall be
entitled to reasonable attorneys' fees, costs and necessary disbursements in
addition to any other relief to which such party may be entitled.
-16-
<PAGE>
8.9 AMENDMENTS AND WAIVERS. Any term of this Agreement may be
amended and the observance of any term of this Agreement may be waived (either
generally or in a particular instance and either retroactively or
prospectively), only with the written consent of the Company and the holders of
a majority of the Common Stock issued or issuable upon conversion of the Series
C Preferred Stock issued or issuable pursuant to this Agreement. Any amendment
or waiver effected in accordance with this paragraph shall be binding upon each
holder of any Securities purchased under this Agreement at the time outstanding
(including securities into which such Securities are convertible and/or
exercisable), each future holder of all such securities, and the Company.
8.10 SEVERABILITY. If one or more provisions of this Agreement are
held to be unenforceable under applicable law, such provision shall be excluded
from this Agreement and the balance of the Agreement shall be interpreted as if
such provision were so excluded and shall be enforceable in accordance with its
terms.
8.11 AGGREGATION OF STOCK. All shares of the Preferred Stock held or
acquired by affiliated entities or persons shall be aggregated together for the
purpose of determining the availability of any rights under this Agreement.
8.12 ENTIRE AGREEMENT. This Agreement and the documents referred to
herein constitute the entire agreement among the parties and no party shall be
liable or bound to any other party in any manner by any warranties,
representations, or covenants except as specifically set forth herein or
therein.
[REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]
-17-
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date
first above written.
RHYTHMS NETCONNECTIONS INC.
By: /s/ Catherine Hapka
-----------------------------------
Catherine Hapka, President
Address: 6933 South Revere Parkway
Englewood, CO 80112-3931
INVESTOR:
MICROSOFT CORPORATION
By: /s/ [Illegible]
------------------------------------
Its:
----------------------------------
Address: One Microsoft Way
Redmond, WA 98052-6399
[SIGNATURE TO STOCK PURCHASE AGREEMENT]
<PAGE>
SCHEDULE A
Schedule of Investor
<TABLE>
<CAPTION>
AGGREGATE NUMBER OF SERIES C NUMBER OF
SHARE WARRANT AGGREGATE PURCHASE PREFERRED SHARES WARRANT SHARES
PURCHASE PURCHASE PRICE PAID TO BE ISSUED TO BE ISSUED AT
INVESTOR PRICE PRICE AT CLOSING AT CLOSING CLOSING
-------- ----- ----- ---------- ---------- -------
<S> <C> <C> <C> <C> <C>
Microsoft Corporation. $30,000,528.36 $600 $30,001,128.36 3,731,409 600,000
TOTALS $30,000,528.36 $600 $30,001,128.36 3,731,409 600,000
-------------- ---- -------------- --------- -------
-------------- ---- -------------- --------- -------
</TABLE>
A-1
<PAGE>
SCHEDULE B
Schedule of Series A Preferred Holders
<TABLE>
<CAPTION>
FIRST CLOSING (JULY 3, 1997)
TOTAL SERIES
A STOCK
<S> <C>
Enterprise Partners III, L.P. 1,380,000
Enterprise Partners III Associates, L.P. 120,000
Enterprise Partners IV, L.P. --
Brentwood Associates VII, L.P. 1,060,000
Brentwood Affiliates Fund, L.P. 60,000
Kleiner Perkins Caufield & Byers VIII 1,462,500
KPCB VIII Information Sciences Zaibatsu Fund II 37,500
DLJ Capital Corporation 30,000
DLJ First ESC L.L.C. 150,000
Sprout Capital VII, L.P. 1,304,843
The Sprout CEO Fund, L.P. 15,157
Epley Investors II, LLC 125,000
Stanford University 15,000
---------
FIRST CLOSING TOTAL 5,760,000
---------
---------
SECOND CLOSING (JULY 29, 1997)
Brentwood Associates VII, L.P. 380,000
SECOND CLOSING TOTAL 380,000
---------
---------
FIRST & SECOND CLOSING TOTAL 6,140,000
---------
---------
FRIENDS AND FAMILY CLOSING (DECEMBER 23, 1997)
Other Purchasers 210,000
</TABLE>
B-1
<PAGE>
THIRD CLOSING (DECEMBER 23, 1997)
<TABLE>
<CAPTION>
TOTAL SERIES
A STOCK
<S> <C>
Enterprise Partners III, L.P. 1,380,000
Enterprise Partners III Associates, L.P. 120,000
Brentwood Associates VII, L.P. 1,440,000
Brentwood Affiliates Fund, L.P. 60,000
Kleiner Perkins Caufield & Byers VIII 1,462,500
KPCB VIII Information Sciences Zaibatsu Fund II 37,500
DLJ Capital Corporation 30,000
DLJ First ESC L.L.C. 150,000
Sprout Capital VII, L.P. 1,304,843
The Sprout CEO Fund, L.P. 15,157
Epley Investors II, LLC 125,000
Stanford University 15,000
Catherine M. Hapka 365,094
---------
THIRD CLOSING TOTAL 6,505,094
----------
----------
FIRST, SECOND & THIRD CLOSING TOTAL 12,855,094
----------
</TABLE>
B-2
<PAGE>
SCHEDULE C
Schedule of Series B Preferred Holders
<TABLE>
<CAPTION>
Number of Shares
<S> <C>
Enron Communications Group, Inc. 2,247,191
Enterprise Partners III, L.P. 413,483
Enterprise Partners III Associates, L.P. 35,955
Kleiner Perkins Caufield & Byers VIII 414,202
KPCB VIII Founders Fund 24,000
KPCB Information Sciences Zaibatsu Fund II 11,236
Brentwood Associates VII, L.P. 431,461
Brentwood Affiliates Fund, L.P. 17,977
DLJ Capital Corporation 8,989
DLJ First ESC L.L.C. 44,944
Sprout Capital VII, L.P. 390,966
The Sprout CEO Fund, L.P 4,539
TOTAL 4044,943
--------
--------
</TABLE>
C-1
<PAGE>
SCHEDULE D
Schedule of Common Holders
<TABLE>
<CAPTION>
Number of Shares
<S> <C>
Enterprise Partners III, L.P. 1,104,902
Enterprise Partners III Associates, L.P. 96,078
Enterprise Partners IV, L.P. 600,490
Employees of the Company who have exercised stock options 5,317,738
----------
TOTAL 7,119,208
----------
----------
</TABLE>
D-1
<PAGE>
EXHIBIT A
RESTATED CERTIFICATE OF INCORPORATION
EXHIBIT A-1
<PAGE>
EXHIBIT B
AMENDED AND RESTATED INVESTORS' RIGHTS AGREEMENT
EXHIBIT B-1
<PAGE>
EXHIBIT C
FORM OF WARRANT
EXHIBIT C-1
<PAGE>
RHYTHMS NETCONNECTIONS INC.
AMENDED AND RESTATED
INVESTORS' RIGHTS AGREEMENT
March 16, 1999
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
1. Registration Rights.. . . . . . . . . . . . . . . . . . . . . . . . .1
1.1 Definitions. . . . . . . . . . . . . . . . . . . . . . . . . . .1
1.2 REQUEST FOR REGISTRATION.. . . . . . . . . . . . . . . . . . . .2
1.3 COMPANY REGISTRATION.. . . . . . . . . . . . . . . . . . . . . .6
1.4 OBLIGATIONS OF THE COMPANY.. . . . . . . . . . . . . . . . . . .6
1.5 FURNISH INFORMATION. . . . . . . . . . . . . . . . . . . . . . .7
1.6 EXPENSES OF DEMAND REGISTRATION. . . . . . . . . . . . . . . . .7
1.7 EXPENSES OF COMPANY REGISTRATION.. . . . . . . . . . . . . . . .8
1.8 UNDERWRITING REQUIREMENTS. . . . . . . . . . . . . . . . . . . .8
1.9 DELAY OF REGISTRATION. . . . . . . . . . . . . . . . . . . . . .9
1.10 INDEMNIFICATION. . . . . . . . . . . . . . . . . . . . . . . . .9
1.11 REPORTS UNDER SECURITIES EXCHANGE ACT OF 1934. . . . . . . . . 11
1.12 FORM S-3 REGISTRATION. . . . . . . . . . . . . . . . . . . . . 11
1.13 ASSIGNMENT OF REGISTRATION RIGHTS. . . . . . . . . . . . . . . 12
1.14 LIMITATIONS ON SUBSEQUENT REGISTRATION RIGHTS. . . . . . . . . 13
1.15 "MARKET STAND-OFF" AGREEMENT.. . . . . . . . . . . . . . . . . 14
1.16 TERMINATION OF REGISTRATION RIGHTS.. . . . . . . . . . . . . . 14
2. COVENANTS OF THE COMPANY. . . . . . . . . . . . . . . . . . . . . . 14
2.1 DELIVERY OF FINANCIAL STATEMENTS.. . . . . . . . . . . . . . . 14
2.2 INSPECTION.. . . . . . . . . . . . . . . . . . . . . . . . . . 14
2.3 TERMINATION OF INFORMATION AND INSPECTION COVENANTS. . . . . . 15
2.4 RIGHT OF FIRST OFFER.. . . . . . . . . . . . . . . . . . . . . 15
2.5 EMPLOYEE STOCK POOL. . . . . . . . . . . . . . . . . . . . . . 16
2.6 EXCLUDED INVESTMENTS.. . . . . . . . . . . . . . . . . . . . . 16
3. COVENANTS OF THE INVESTORS. . . . . . . . . . . . . . . . . . . . . 17
3.1 CERTAIN CORPORATE TRANSACTIONS.. . . . . . . . . . . . . . . . 17
3.2 STANDSTILL.. . . . . . . . . . . . . . . . . . . . . . . . . . 17
3.3 ADDITIONAL PREFERRED INVESTORS.. . . . . . . . . . . . . . . . 17
4. CORPORATE OPPORTUNITY MATTERS.. . . . . . . . . . . . . . . . . . . 17
5. MISCELLANEOUS.. . . . . . . . . . . . . . . . . . . . . . . . . . . 19
5.1 SUCCESSORS AND ASSIGNS.. . . . . . . . . . . . . . . . . . . . 19
5.2 GOVERNING LAW. . . . . . . . . . . . . . . . . . . . . . . . . 19
5.3 COUNTERPARTS.. . . . . . . . . . . . . . . . . . . . . . . . . 19
5.4 TITLES AND SUBTITLES.. . . . . . . . . . . . . . . . . . . . . 19
5.5 NOTICES. . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
5.6 EXPENSES.. . . . . . . . . . . . . . . . . . . . . . . . . . . 19
5.7 AMENDMENTS AND WAIVERS.. . . . . . . . . . . . . . . . . . . . 20
5.8 SEVERABILITY.. . . . . . . . . . . . . . . . . . . . . . . . . 20
5.9 AGGREGATION OF STOCK.. . . . . . . . . . . . . . . . . . . . . 20
5.10 ENTIRE AGREEMENT; AMENDMENT; WAIVER. . . . . . . . . . . . . . 20
</TABLE>
(i)
<PAGE>
AMENDED AND RESTATED INVESTORS' RIGHTS AGREEMENT
THIS AMENDED AND RESTATED INVESTORS' RIGHTS AGREEMENT ("Agreement") is
made as of the ___ day of March, 1999, by and between Rhythms NetConnections
Inc., a Delaware corporation (the "Company"), and the investors listed on
SCHEDULE A hereto, each of which is herein referred to as an "Investor."
RECITALS
WHEREAS, the Company and one or more of the Investors are parties to
the Series C Preferred Stock and Warrant Purchase Agreement of even date
herewith (the "Preferred Stock Agreement");
WHEREAS, certain of the Investors are presently holders of the
Company's Series A Preferred Stock, Series B Preferred Stock and/or Series C
Preferred Stock and have entered into an Amended and Restated Investors' Rights
Agreement with the Company dated March 3, 1999 (the "Existing Rights
Agreement"); and
WHEREAS, in order to induce the Company to enter into the Preferred
Stock Agreement and to induce one or more Investors to invest funds in the
Company pursuant to the Preferred Stock Agreement, all the Investors and the
Company wish to amend and restate the Existing Rights Agreement so that this
Agreement will supersede and replace the Existing Rights Agreement in its
entirety and will govern the rights of all the Investors to cause the Company to
register shares of the Company's common stock ("Common Stock") issuable to any
Investors upon conversion of their respective shares of the Company's preferred
stock ("Preferred Stock"), and certain other matters as set forth in this
Agreement.
NOW, THEREFORE, THE PARTIES HEREBY AGREE AS FOLLOWS:
1. Registration Rights. The Company covenants and agrees as follows:
1.1 Definitions. For purposes of this Section 1:
(a) The term "Act" means the Securities Act of 1933, as
amended.
(b) The terms "register", "registered," and "registration"
refer to a registration effected by preparing and filing a registration
statement or similar document in compliance with the Act, and the declaration or
ordering of effectiveness of such registration statement or document;
(c) The term "Registrable Securities" means (1) the Common
Stock issuable or issued upon conversion of the Series A Preferred Stock, Series
B Preferred Stock or Series C Preferred Stock (2) the 900,735 shares of Common
Stock held by Enterprise Partners as of the date of this Agreement, and (3) any
Common Stock of the Company issued as (or issuable upon the conversion or
exercise of any warrant, right or other security which is issued as) a dividend
or other distribution with respect to, or in exchange for or in replacement of,
such Series A Preferred Stock, Series B Preferred Stock, Series C Preferred
Stock or Common Stock
<PAGE>
held by Enterprise Partners, excluding in all cases, however, any Registrable
Securities sold by a person in a transaction in which his rights under this
Section 1 are not assigned;
(d) The number of shares of Registrable Securities then
outstanding and the Registrable Securities held by any person shall each be
determined by the number of shares of Common Stock outstanding which are, and
the number of shares of Common Stock issuable pursuant to then exercisable or
convertible securities which are, Registrable Securities;
(e) The term "Holder" means any person owning or having the
right to acquire Registrable Securities or any assignee thereof in accordance
with Section 1.13 hereof; and
(f) The term "Form S-3" means such form under the Act as in
effect on the date hereof or any registration form under the Act subsequently
adopted by the Securities and Exchange Commission ("SEC") which permits
inclusion or incorporation of substantial information by reference to other
documents filed by the Company with the SEC.
1.2 REQUEST FOR REGISTRATION.
(a) If the Company shall receive at any time after the
earlier of (i) March 11, 2002, or (ii) six (6) months after the effective
date of the first registration statement for a public offering of securities
of the Company (other than a registration statement relating either to the
sale of securities to employees of the Company pursuant to a stock option,
stock purchase or similar plan or a SEC Rule 145 transaction), a written
request from the Holders of 60% or more of the Registrable Securities (the
"Initiating Holders") then outstanding that the Company file a registration
statement under the Act covering the registration of at least twenty percent
(20%) of the Registrable Securities then outstanding (or a lesser percent if
the anticipated aggregate offering price, net of underwriting discounts and
commissions, would exceed $20,000,000), then the Company shall, within ten
(10) days of the receipt thereof, give written notice of such request to all
Holders and any other Holder may also request the registration of Registrable
Securities held by such Holder. The Company shall, subject to the limitations
of subsection 1.2(e), effect as soon as practicable, and in any event shall
use its best efforts to effect within 60 days of the receipt of such request,
the registration under the Act of all Registrable Securities which the
Holders request to be registered within twenty (20) days of the mailing of
such notice by the Company in accordance with paragraph 5.5.
(b) If the Company shall receive at any time after the
earlier of (i) March 11, 2002, or (ii) six (6) months after the effective date
of the first registration statement for a public offering of securities of the
Company (other than a registration statement relating either to the sale of
securities to employees of the Company pursuant to a stock option, stock
purchase or similar plan or a SEC Rule 145 transaction), a written request from
Enron Communications Group, Inc. or any assignee of the rights of Enron
Communications Group, Inc. pursuant to Section 1.13 ("Enron") that the Company
file a registration statement under the Act covering the registration of at
least twenty percent (20%) of the Registrable Securities then held by Enron (or
a lesser percent if the anticipated aggregate offering price, net of
underwriting discounts and commissions, would exceed $20,000,000), then the
Company shall, within ten (10) days of the receipt thereof, give written notice
of such request to all other Holders and any other
2
<PAGE>
Holder may also request the registration of Registrable Securities held by such
Holder. The Company shall, subject to the limitations of subsection 1.2(f),
effect as soon as practicable, and in any event shall use its best efforts to
effect within 60 days of the receipt of such request, the registration under the
Act of all Registrable Securities which Enron and the Holders request to be
registered within twenty (20) days of the mailing of such notice by the Company
in accordance with paragraph 5.5.
(c) If the Company shall receive at any time after the
earlier of (i) March 11, 2002, or (ii) six (6) months after the effective date
of the first registration statement for a public offering of securities of the
Company (other than a registration statement relating either to the sale of
securities to employees of the Company pursuant to a stock option, stock
purchase or similar plan or a SEC Rule 145 transaction), a written request from
MCI Worldcom Venture Fund, Inc. or any assignee of the rights of MCI Worldcom
Venture Fund, Inc. pursuant to Section 1.13 ("MCI WorldCom") that the Company
file a registration statement under the Act covering the registration of at
least twenty percent (20%) of the Registrable Securities then held by MCI
WorldCom (or a lesser percent if the anticipated aggregate offering price, net
of underwriting discounts and commissions, would exceed $20,000,000), then the
Company shall, within ten (10) days of the receipt thereof, give written notice
of such request to all other Holders and any other Holder may also request the
registration of Registrable Securities held by such Holder. The Company shall,
subject to the limitations of subsection 1.2(g), effect as soon as practicable,
and in any event shall use its best efforts to effect within 60 days of the
receipt of such request, the registration under the Act of all Registrable
Securities which MCI WorldCom and the Holders request to be registered within
twenty (20) days of the mailing of such notice by the Company in accordance with
paragraph 5.5.
(d) Subject to the limitations set forth in Section 2.6
hereof, in the event that, subsequent to expiration of the Exclusion Period (as
defined in Section 2.6), an Excluded Investor (as defined in Section 2.6)
acquires greater than five percent (5%) of the Common Stock of the Company (on a
fully diluted, as converted to Common Stock basis) (the "Excluded Investment"),
then if the Company shall receive a written request from MCI WorldCom that the
Company file a registration statement under the Act covering the registration of
all of the Registrable Securities then held by MCI WorldCom, then the Company
shall, within ten (10) days of the receipt thereof, give written notice of such
request to all other Holders and any other Holder may also request the
registration of Registrable Securities held by such Holder. The Company shall,
subject to the limitations of subsection 1.2(h), effect as soon as practicable,
and in any event shall use its best efforts to effect within the later to occur
of (i) sixty (60) days of the receipt of such request or (ii) one hundred eighty
(180) days of the closing of the Excluded Investment, the registration under the
Act of all Registrable Securities which MCI WorldCom and the Holders request to
be registered within twenty (20) days of the mailing of such notice by the
Company in accordance with paragraph 5.5.
(e) If the Initiating Holders intend to distribute the
Registrable Securities covered by their request by means of an underwriting,
they shall so advise the Company as a part of their request made pursuant to
this Section 1.2 and the Company shall include such information in the written
notice referred to in subsection 1.2(a). The underwriter will be selected by
Initiating Holders holding a majority of the Registrable Securities proposed to
3
<PAGE>
be included in the registration and shall be reasonably acceptable to the
Company. In such event, the right of any Holder to include his Registrable
Securities in such registration shall be conditioned upon such Holder's
participation in such underwriting and the inclusion of such Holder's
Registrable Securities in the underwriting (unless otherwise mutually agreed by
a majority in interest of the Initiating Holders and such Holder) to the extent
provided herein. All Holders proposing to distribute their securities through
such underwriting shall (together with the Company as provided in subsection
1.4(e)) enter into an underwriting agreement in customary form with the
underwriter or underwriters selected for such underwriting by the Initiating
Holders holding a majority of the Registrable Securities proposed to be included
in the registration. Notwithstanding any other provision of this Section 1.2,
if the underwriter advises the Initiating Holders in writing that marketing
factors require a limitation of the number of shares to be underwritten, then
the Initiating Holders shall so advise all Holders of Registrable Securities
which would otherwise be underwritten pursuant hereto, and the number of shares
of Registrable Securities that may be included in the underwriting shall be
allocated: (i) first, among all Holders thereof, including the Initiating
Holders, allocated among such Holders in proportion (as nearly as practicable)
to the amount of Registrable Securities of the Company proposed to be included
in the registration by each Holder; and (ii) second, to the extent of any
remaining shares that may be underwritten, to the holders of any other
securities.
(f) If Enron intends to distribute the Registrable
Securities covered by its request under subsection 1.2(b) by means of an
underwriting, it shall so advise the Company as a part of its request made
pursuant to this Section 1.2 and the Company shall include such information in
the written notice referred to in subsection 1.2(b). The underwriter will be
selected by Enron and shall be reasonably acceptable to the Company. In such
event, the right of any other Holder to include its Registrable Securities in
such registration shall be conditioned upon such Holder's participation in such
underwriting and the inclusion of such Holder's Registrable Securities in the
underwriting (unless otherwise mutually agreed by Enron and such Holder) to the
extent provided herein. Enron and all Holders proposing to distribute their
securities through such underwriting shall (together with the Company as
provided in subsection 1.4(e)) enter into an underwriting agreement in customary
form with the underwriter or underwriters selected for such underwriting by
Enron. Notwithstanding any other provision of this Section 1.2, if the
underwriter advises the Company in writing that marketing factors require a
limitation of the number of shares to be underwritten, then the Company shall so
advise all Holders of Registrable Securities which would otherwise be
underwritten pursuant hereto, and the number of shares of Registrable Securities
that may be included in the underwriting shall be allocated: (i) first, to
Enron or its assignee; (ii) second, to the extent of any remaining shares that
may be underwritten, among all other Holders thereof in proportion (as nearly as
practicable) to the amount of Registrable Securities of the Company proposed to
be included in the registration by each such Holder; and (iii) third, to the
extent of any remaining shares that may be underwritten, to the holders of any
other securities.
(g) If MCI WorldCom intends to distribute the Registrable
Securities covered by its request under subsection 1.2(c) by means of an
underwriting, it shall so advise the Company as a part of its request made
pursuant to this Section 1.2 and the Company shall include such information in
the written notice referred to in subsection 1.2(c). The underwriter will be
selected by MCI WorldCom and shall be reasonably acceptable to the Company. In
such
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event, the right of any other Holder to include its Registrable Securities in
such registration shall be conditioned upon such Holder's participation in such
underwriting and the inclusion of such Holder's Registrable Securities in the
underwriting (unless otherwise mutually agreed by MCI WorldCom and such Holder)
to the extent provided herein. MCI WorldCom and all Holders proposing to
distribute their securities through such underwriting shall (together with the
Company as provided in subsection 1.4(e)) enter into an underwriting agreement
in customary form with the underwriter or underwriters selected for such
underwriting by MCI WorldCom. Notwithstanding any other provision of this
Section 1.2, if the underwriter advises the Company in writing that marketing
factors require a limitation of the number of shares to be underwritten, then
the Company shall so advise all Holders of Registrable Securities which would
otherwise be underwritten pursuant hereto, and the number of shares of
Registrable Securities that may be included in the underwriting shall be
allocated: (i) first, to MCI WorldCom or its assignee; (ii) second, to the
extent of any remaining shares that may be underwritten, among all other Holders
thereof in proportion (as nearly as practicable) to the amount of Registrable
Securities of the Company proposed to be included in the registration by each
such Holder; and (iii) third, to the extent of any remaining shares that may be
underwritten, to the holders of any other securities.
(h) If MCI WorldCom intends to distribute the Registrable
Securities covered by its request under subsection 1.2(d) by means of an
underwriting, it shall so advise the Company as a part of its request made
pursuant to this Section 1.2 and the Company shall include such information in
the written notice referred to in subsection 1.2(d). The underwriter will be
selected by MCI WorldCom and shall be reasonably acceptable to the Company. In
such event, the right of any other Holder to include its Registrable Securities
in such registration shall be conditioned upon such Holder's participation in
such underwriting and the inclusion of such Holder's Registrable Securities in
the underwriting (unless otherwise mutually agreed by MCI WorldCom and such
Holder) to the extent provided herein. MCI WorldCom and all Holders proposing
to distribute their securities through such underwriting shall (together with
the Company as provided in subsection 1.4(e)) enter into an underwriting
agreement in customary form with the underwriter or underwriters selected for
such underwriting by MCI WorldCom. Notwithstanding any other provision of this
Section 1.2, if the underwriter advises the Company in writing that marketing
factors require a limitation of the number of shares to be underwritten, then
the Company shall so advise all Holders of Registrable Securities which would
otherwise be underwritten pursuant hereto, and the number of shares of
Registrable Securities that may be included in the underwriting shall be
allocated: (i) first, to MCI WorldCom or its assignee; (ii) second, to the
extent of any remaining shares that may be underwritten, among all other Holders
thereof in proportion (as nearly as practicable) to the amount of Registrable
Securities of the Company proposed to be included in the registration by each
such Holder; and (iii) third, to the extent of any remaining shares that may be
underwritten, to the holders of any other securities.
(i) The Company is obligated to effect only (i) two (2) such
registrations pursuant to subsection 1.2(a), (ii) one (1) such registration
pursuant to subsection 1.2(b), (iii) one (1) such registration pursuant to
subsection 1.2(c) and (iv) one (1) such registration pursuant to subsection
1.2(d).
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(j) Notwithstanding the foregoing, if the Company shall
furnish to either Holders requesting a registration statement pursuant to this
Section 1.2, to Enron or to MCI WorldCom, a certificate signed by the President
of the Company stating that in the good faith judgment of the Board of Directors
of the Company, it would be seriously detrimental to the Company and its
shareholders for such registration statement to be filed and it is therefore
essential to defer the filing of such registration statement, the Company shall
have the right to defer taking action with respect to such filing for a period
of not more than one hundred twenty (120) days after receipt of the request of
the Initiating Holders, Enron or MCI WorldCom, as applicable; provided, however,
that the Company may not utilize this right more than twice in any twelve month
period.
1.3 COMPANY REGISTRATION. If (but without any obligation under
this Agreement to do so) the Company proposes to register (including for this
purpose a registration effected by the Company for shareholders other than
pursuant to this Agreement) any of its stock or other securities under the Act
in connection with the public offering of such securities solely for cash (other
than a registration relating solely to the sale of securities to participants in
a Company stock plan, or a registration on any form which does not include
substantially the same information as would be required to be included in a
registration statement covering the sale of the Registrable Securities), the
Company shall, at such time, promptly give each Holder written notice of such
registration. Upon the written request of any Holder given within twenty (20)
days after mailing of such notice by the Company in accordance with Section 5.5,
the Company shall, subject to (i) the provisions of Section 1.8 and (ii) any
senior "piggy-back" registration rights granted by the Company pursuant to that
certain Warrant Registration Rights Agreement dated as of May 5, 1998 between
the Company and Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner & Smith
Incorporated and Donaldson Lufkin & Jenrette Securities Corporation or pursuant
to that certain Warrant to Purchase Shares of Common Stock granted to Sun
Financial Group, Inc., dated as of May 19, 1998, cause to be registered under
the Act all of the Registrable Securities that such Holder has requested to be
registered.
1.4 OBLIGATIONS OF THE COMPANY. Whenever required under this
Section 1 to effect the registration of any Registrable Securities, the Company
shall, as expeditiously as reasonably possible:
(a) Prepare and file with the SEC a registration statement
with respect to such Registrable Securities and use its best efforts to cause
such registration statement to become effective, and, upon the request of the
Holders of a majority of the Registrable Securities registered thereunder, keep
such registration statement effective for up to one hundred twenty (120) days.
(b) Prepare and file with the SEC such amendments and
supplements to such registration statement and the prospectus used in connection
with such registration statement as may be necessary to comply with the
provisions of the Act with respect to the disposition of all securities covered
by such registration statement.
(c) Furnish to the Holders such numbers of copies of a
prospectus, including a preliminary prospectus, in conformity with the
requirements of the Act, and such
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other documents as they may reasonably request in order to facilitate the
disposition of Registrable Securities owned by them.
(d) Use its best efforts to register and qualify the
securities covered by such registration statement under such other securities or
Blue Sky laws of such jurisdictions as shall be reasonably requested by the
Holders, provided that the Company shall not be required in connection therewith
or as a condition thereto to qualify to do business or to file a general consent
to service of process in any such states or jurisdictions.
(e) In the event of any underwritten public offering, enter
into and perform its obligations under an underwriting agreement, in usual and
customary form, with the managing underwriter of such offering. Each Holder
participating in such underwriting shall also enter into and perform its
obligations under such an agreement.
(f) Notify each Holder of Registrable Securities covered by
such registration statement at any time when a prospectus relating thereto is
required to be delivered under the Act of the happening of any event as a result
of which the prospectus included in such registration statement, as then in
effect, includes an untrue statement of a material fact or omits to state a
material fact required to be stated therein or necessary to make the statements
therein not misleading in the light of the circumstances then existing.
1.5 FURNISH INFORMATION.
(a) It shall be a condition precedent to the obligations of
the Company to take any action pursuant to this Section 1 with respect to the
Registrable Securities of any selling Holder that such Holder shall furnish to
the Company such information regarding itself, the Registrable Securities held
by it, and the intended method of disposition of such securities as shall be
required to effect the registration of such Holder's Registrable Securities.
(b) The Company shall have no obligation with respect to any
registration requested pursuant to Section 1.2 or Section 1.12 if, due to the
operation of subsections 1.5(a) or 1.8, the number of shares or the anticipated
aggregate offering price of the Registrable Securities to be included in the
registration does not equal or exceed the number of shares or the anticipated
aggregate offering price required to originally trigger the Company's obligation
to initiate such registration as specified in subsections 1.2(a), 1.2(b), 1.2(c)
or 1.2(d) or subsection 1.12(b)(2), whichever is applicable. Any registration
that is withdrawn without becoming effective pursuant to this Section 1.5 shall
not be counted as a registration for purposes of Section 1.2(i).
1.6 EXPENSES OF DEMAND REGISTRATION. All expenses (other than
underwriting discounts and commissions incurred in connection with
registrations, filings or qualifications pursuant to Section 1.2), including
(without limitation) all registration, filing and qualification fees, printers'
and accounting fees, fees and disbursements of counsel for the Company, and the
reasonable fees and disbursements of one counsel for the selling Holders
(selected by Holders of a majority of Registrable Securities to be included in
the registration if under subsection (a), by Enron if under subsection 1.2(b) or
by MCI WorldCom if under subsections 1.2(c) or 1.2(d)) ("Holders' Counsel")
shall be borne by the Company; provided, however, that the Company
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shall not be required to pay for any expenses of any registration proceeding
begun pursuant to Section 1.2 if the registration request is subsequently
withdrawn at the request of the Holders of a majority of the Registrable
Securities to be registered if under subsection 1.2(a), of Enron if under
subsection 1.2(b), or of MCI WorldCom if under subsections 1.2(c) or 1.2(d) (in
which case all participating Holders shall bear such expenses allocated among
them in proportion to the amount of Registrable Securities originally proposed
to be registered), unless the Holders of a majority of the Registrable
Securities if under subsection 1.2(a), of Enron if under subsection 1.2(b), or
of MCI WorldCom if under subsections 1.2(c) or 1.2(d) agree to forfeit their or
its right to one demand registration pursuant to Section 1.2; provided further,
however, that if at the time of such withdrawal, the Holders, Enron or MCI
WorldCom, as applicable, have learned of a material adverse change in the
condition, business, or prospects of the Company from that known to the Holders,
Enron or MCI WorldCom, as applicable, at the time of their or its request and
have withdrawn the request with reasonable promptness following disclosure by
the Company of such material adverse change, then the Company shall pay such
expenses and the Holders, Enron or MCI WorldCom, as applicable, shall not be
required to pay any of such expenses and shall retain their or its rights
pursuant to Section 1.2.
1.7 EXPENSES OF COMPANY REGISTRATION. The Company shall bear and
pay all expenses incurred in connection with any registration, filing or
qualification of Registrable Securities with respect to the registrations
pursuant to Section 1.3 for each Holder (which right may be assigned as provided
in Section 1.13), including (without limitation) all registration, filing, and
qualification fees, printers and accounting fees relating or apportionable
thereto, but excluding underwriting discounts and commissions relating to
Registrable Securities.
1.8 UNDERWRITING REQUIREMENTS. In connection with any offering
involving an underwriting of shares of the Company's capital stock, the Company
shall not be required under Section 1.3 to include any of the Holders'
securities in such underwriting unless they accept the terms of the underwriting
as agreed upon between the Company and the underwriters selected by it (or by
other persons entitled to select the underwriters), and then only in such
quantity as the underwriters determine in their sole discretion will not
jeopardize the success of the offering by the Company. If the total amount of
securities, including Registrable Securities, requested by shareholders to be
included in such offering exceeds the amount of securities sold other than by
the Company that the underwriters determine in their sole discretion is
compatible with the success of the offering, then the Company shall be required
to include in the offering only that number of such securities, including
Registrable Securities, which the underwriters determine in their sole
discretion will not jeopardize the success of the offering (the securities so
included to be apportioned pro rata among the selling shareholders according to
the total amount of securities entitled to be included therein owned by each
selling Shareholder or in such other proportions as shall mutually be agreed to
by such selling shareholders) but in no event shall (i) the amount of securities
of the selling Holders included in the offering be reduced below thirty percent
(30%) of the total amount of securities included in such offering, unless such
offering is the initial public offering of the Company's securities in which
case the selling shareholders may be excluded if the underwriters make the
determination described immediately above or (ii) notwithstanding (i) above, any
shares being sold by a shareholder exercising a demand registration right
similar to that granted in Section 1.2 be excluded from such offering. For
purposes of the preceding parenthetical concerning apportionment, for any
selling shareholder
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which is a holder of Registrable Securities and which is a partnership or
corporation, the partners, retired partners and shareholders of such holder, or
the estates and family members of any such partners and retired partners and any
trusts for the benefit of any of the foregoing persons shall be deemed to be a
single "selling shareholder", and any pro-rata reduction with respect to such
"selling shareholder" shall be based upon the aggregate amount of shares
carrying registration rights owned by all entities and individuals included in
such "selling shareholder", as defined in this sentence.
1.9 DELAY OF REGISTRATION. No Holder shall have any right to
obtain or seek an injunction restraining or otherwise delaying any such
registration as the result of any controversy that might arise with respect to
the interpretation or implementation of this Section 1.
1.10 INDEMNIFICATION. In the event any Registrable Securities are
included in a registration statement under this Section 1:
(a) To the extent permitted by law, the Company will
indemnify and hold harmless each Holder, the partners or officers, directors and
shareholders of each Holder, any underwriter (as defined in the Act) for such
Holder and each person, if any, who controls such Holder or underwriter within
the meaning of the Act or the Securities Exchange Act of 1934, as amended (the
"1934 Act"), against any losses, claims, damages, or liabilities (joint or
several) to which they may become subject under the Act, or the 1934 Act,
insofar as such losses, claims, damages, or liabilities (or actions in respect
thereof) arise out of or are based upon any of the following statements,
omissions or violations (collectively a "Violation"): (i) any untrue statement
or alleged untrue statement of a material fact contained in such registration
statement, including any preliminary prospectus or final prospectus contained
therein or any amendments or supplements thereto, (ii) the omission or alleged
omission to state therein a material fact required to be stated therein, or
necessary to make the statements therein not misleading, or (iii) any violation
or alleged violation by the Company of the Act, the 1934 Act, or any rule or
regulation promulgated under the Act, or the 1934 Act; and the Company will pay
to each such Holder, underwriter or controlling person any legal or other
expenses reasonably incurred by them in connection with investigating or
defending any such loss, claim, damage, liability, or action; provided, however,
that the indemnity agreement contained in this subsection 1.10(a) shall not
apply to amounts paid in settlement of any such loss, claim, damage, liability,
or action if such settlement is effected without the consent of the Company
(which consent shall not be unreasonably withheld), nor shall the Company be
liable in any such case for any such loss, claim, damage, liability, or action
to the extent that it arises out of or is based upon a Violation which occurs in
reliance upon and in conformity with written information furnished expressly for
use in connection with such registration by a Holder requesting indemnification
hereunder or any such underwriter or controlling person.
(b) To the extent permitted by law, each selling Holder will
indemnify and hold harmless the Company, each of its directors, each of its
officers who has signed the registration statement, each person, if any, who
controls the Company within the meaning of the Act, any underwriter, any other
Holder selling securities in such registration statement and any controlling
person of any such underwriter or other Holder, against any losses, claims,
damages, or liabilities (joint or several) to which any of the foregoing persons
may become subject, under
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the Act, or the 1934 Act insofar as such losses, claims, damages, or liabilities
(or actions in respect thereto) arise out of or are based upon any Violation, in
each case to the extent (and only to the extent) that such Violation occurs in
reliance upon and in conformity with written information furnished by such
Holder expressly for use in connection with such registration; and each such
Holder will pay any legal or other expenses reasonably incurred by any person
intended to be indemnified pursuant to this subsection 1.10(b), in connection
with investigating or defending any such loss, claim, damage, liability, or
action; provided, however, that the indemnity agreement contained in this
subsection 1.10(b) shall not apply to amounts paid in settlement of any such
loss, claim, damage, liability or action if such settlement is effected without
the consent of the Holder, which consent shall not be unreasonably withheld;
provided, that, in no event shall any indemnity under this subsection 1.10(b)
exceed the gross proceeds from the offering received by such Holder.
(c) Promptly after receipt by an indemnified party under
this Section 1.10 of notice of the commencement of any action (including any
governmental action), such indemnified party will, if a claim in respect thereof
is to be made against any indemnifying party under this Section 1.10, deliver to
the indemnifying party a written notice of the commencement thereof and the
indemnifying party shall have the right to participate in, and, to the extent
the indemnifying party so desires and has acknowledged its obligation to
indemnify the indemnified party with respect to such action, jointly with any
other indemnifying party similarly noticed, to assume the defense thereof with
counsel mutually satisfactory to the parties; provided, however, that an
indemnified party (together with all other indemnified parties which may be
represented without conflict by one counsel) shall have the right to retain one
separate counsel, with the fees and expenses to be paid by the indemnifying
party, if representation of such indemnified party by the counsel retained by
the indemnifying party would be inappropriate due to actual or potential
differing interests between such indemnified party and any other party
represented by such counsel in such proceeding. The failure to deliver written
notice to the indemnifying party within a reasonable time of the commencement of
any such action shall not relieve such indemnifying party of any liability to
the indemnified party under this Section 1.10 except to the extent that the
indemnifying party is prejudiced thereby in its ability to defend such action,
but the omission so to deliver written notice to the indemnifying party will not
relieve it of any liability that it may have to any indemnified party otherwise
than under this Section 1.10.
(d) If the indemnification provided for in this Section 1.10
is held by a court of competent jurisdiction to be unavailable to an indemnified
party with respect to any loss, liability, claim, damage, or expense referred to
therein, then the indemnifying party, in lieu of indemnifying such indemnified
party hereunder, shall contribute to the amount paid or payable by such
indemnified party as a result of such loss, liability, claim, damage, or expense
in such proportion as is appropriate to reflect the relative fault of the
indemnifying party on the one hand and of the indemnified party on the other in
connection with the statements or omissions that resulted in such loss,
liability, claim, damage, or expense as well as any other relevant equitable
considerations. The relative fault of the indemnifying party and of the
indemnified party shall be determined by reference to, among other things,
whether the untrue or alleged untrue statement of a material fact or the
omission to state a material fact relates to information supplied by the
indemnifying party or by the indemnified party and the parties' relative intent,
knowledge, access to information, and opportunity to correct or prevent such
statement or omission.
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(e) Notwithstanding the foregoing, to the extent that any
customary and reasonable provisions on indemnification and contribution
contained in the underwriting agreement entered into in connection with the
underwritten public offering are in conflict with the foregoing provisions, the
provisions in the underwriting agreement shall control.
(f) The obligations of the Company and Holders under this
Section 1.10 shall survive the completion of any offering of Registrable
Securities in a registration statement under this Section 1.
1.11 REPORTS UNDER SECURITIES EXCHANGE ACT OF 1934. With a view to
making available to the Holders the benefits of Rule 144 promulgated under the
Act and any other rule or regulation of the SEC that may at any time permit a
Holder to sell securities of the Company to the public without registration or
pursuant to a registration on Form S-3, the Company agrees to:
(a) make and keep public information available, as those
terms are understood and defined in SEC Rule 144, at all times after ninety (90)
days after the effective date of the first registration statement filed by the
Company for the offering of its securities to the general public;
(b) file with the SEC in a timely manner all reports and
other documents required of the Company under the Act and the 1934 Act; and
(c) furnish to any Holder, so long as the Holder owns any
Registrable Securities, forthwith upon request (i) a written statement by the
Company that it has complied with the reporting requirements of SEC Rule 144 (at
any time after ninety (90) days after the effective date of the first
registration statement filed by the Company), the Act and the 1934 Act (at any
time after it has become subject to such reporting requirements), or that it
qualifies as a registrant whose securities may be resold pursuant to Form S-3
(at any time after it so qualifies), (ii) a copy of the most recent annual or
quarterly report of the Company and such other reports and documents so filed by
the Company, and (iii) such other information as may be reasonably requested in
availing any Holder of any rule or regulation of the SEC which permits the
selling of any such securities without registration or pursuant to such form.
1.12 FORM S-3 REGISTRATION. In case the Company shall receive from
the Holders of forty percent (40%) or more of the Registrable Securities a
written request or requests that the Company effect a registration on Form S-3
and any related qualification or compliance with respect to all or a part of the
Registrable Securities owned by such Holder or Holders, the Company will:
(a) promptly give written notice of the proposed
registration, and any related qualification or compliance, to all other Holders;
and
(b) as soon as practicable, effect such registration and all
such qualifications and compliances as may be so requested and as would permit
or facilitate the sale and distribution of all or such portion of such Holder's
or Holders' Registrable Securities as are specified in such request, together
with all or such portion of the Registrable Securities of any other Holder or
Holders joining in such request as are specified in a written request given
within
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15 days after receipt of such written notice from the Company; provided,
however, that the Company shall not be obligated to effect any such
registration, qualification or compliance, pursuant to this section 1.12: (1) if
Form S-3 is not available for such offering by the Holders; (2) if the Holders,
together with the holders of any other securities of the Company entitled to
inclusion in such registration, propose to sell Registrable Securities and such
other securities (if any) at an aggregate price to the public (net of any
underwriters' discounts or commissions) of less than $5,000,000; (3) if the
Company shall furnish to the Holders a certificate signed by the President of
the Company stating that in the good faith judgment of the Board of Directors of
the Company, it would be seriously detrimental to the Company and its
shareholders for such Form S-3 Registration to be effected at such time, in
which event the Company shall have the right to defer the filing of the Form S-3
registration statement for a period of not more than 120 days after receipt of
the request of the Holder or Holders under this Section 1.12; provided, however,
that the Company shall not utilize this right more than once in any twelve month
period; or (4) if the Company has, within the twelve (12) month period preceding
the date of such request, already effected two registrations on Form S-3 for the
Holders pursuant to this Section 1.12.
(c) Subject to the foregoing, the Company shall file a
registration statement covering the Registrable Securities and other securities
so requested to be registered as soon as practicable after receipt of the
request or requests of the Holders. All expenses incurred in connection with a
registration requested pursuant to Section 1.12, including (without limitation)
all registration, filing, qualification, printer's and accounting fees and the
reasonable fees and disbursements of Holders' Counsel and counsel for the
Company, shall be borne pro rata by the Holder or Holders participating in the
Form S-3 Registration. Registrations effected pursuant to this Section 1.12
shall not be counted as demands for registration or registrations effected
pursuant to Section 1.2.
1.13 ASSIGNMENT OF REGISTRATION RIGHTS. The rights to cause the
Company to register Registrable Securities pursuant to subsection 1.2(a) may be
assigned (but only with all related obligations) by a Holder to a transferee or
assignee of such securities who, after such assignment or transfer, holds at
least 2,000,000 shares of Registrable Securities (subject to appropriate
adjustment for stock splits, stock dividends, combinations and other
recapitalizations), provided the Company is, within a reasonable time after such
transfer, furnished with written notice of the name and address of such
transferee or assignee and the securities with respect to which such
registration rights are being assigned; and provided, further, that such
assignment shall be effective only if immediately following such transfer the
further disposition of such securities by the transferee or assignee is
restricted under the Act. The rights to cause the Company to register
Registrable Securities pursuant to subsection 1.2(b) may be assigned (but only
with all related obligations) by Enron to a transferee or assignee of such
securities who, after such assignment or transfer, holds at least 1,500,000
shares of Registrable Securities (subject to appropriate adjustment for stock
splits, stock dividends, combinations and other recapitalizations), provided the
Company is, within a reasonable time after such transfer, furnished with written
notice of the name and address of such transferee or assignee and the securities
with respect to which such registration rights are being assigned; and provided,
further, that such assignment shall be effective only if immediately following
such transfer the further disposition of such securities by the transferee or
assignee is restricted under the Act. The rights to cause the Company to
register Registrable Securities pursuant to subsections 1.2(c) or 1.2(d)
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may be assigned (but only with all related obligations) by MCI WorldCom to a
transferee or assignee of such securities who, after such assignment or
transfer, holds at least 1,250,000 shares of Registrable Securities (subject to
appropriate adjustment for stock splits, stock dividends, combinations and other
recapitalizations), provided the Company is, within a reasonable time after such
transfer, furnished with written notice of the name and address of such
transferee or assignee and the securities with respect to which such
registration rights are being assigned; and provided, further, that such
assignment shall be effective only if immediately following such transfer the
further disposition of such securities by the transferee or assignee is
restricted under the Act. For the purposes of determining the number of shares
of Registrable Securities held by a transferee or assignee, the holdings of
transferees and assignees of a partnership who are partners or retired partners
of such partnership (including spouses and ancestors, lineal descendants and
siblings of such partners or spouses who acquire Registrable Securities by gift,
will or intestate succession) shall be aggregated together and with the
partnership; provided that all assignees and transferees who would not qualify
individually for assignment of registration rights shall have a single
attorney-in-fact for the purpose of exercising any rights, receiving notices or
taking any action under this Section 1.
1.14 LIMITATIONS ON SUBSEQUENT REGISTRATION RIGHTS. From and after
the date of this Agreement, the Company shall not, without the prior written
consent of the Holders of 60% or more of the outstanding Registrable Securities,
enter into any agreement with any holder or prospective holder of any securities
of the Company which would allow such holder or prospective holder (a) to
include such securities in any registration filed under Section 1.2 hereof,
unless under the terms of such agreement, such holder or prospective holder may
include such securities in any such registration only to the extent that the
inclusion of his securities will not reduce the amount of the Registrable
Securities of the Holders which is included or adversely affect the market for
the Registrable Securities that are included or (b) to make a demand
registration which could result in such registration statement being declared
effective prior to the earlier of any of the dates set forth in subsections
1.2(a), 1.2(b) or 1.2(c) or within one hundred twenty (120) days of the
effective date of any registration effected pursuant to Section 1.2.
1.15 "MARKET STAND-OFF" AGREEMENT. Each Investor hereby agrees
that, during the period of duration (such period not to exceed 180 days)
specified by the Company and an underwriter of common stock or other securities
of the Company, following the effective date of a registration statement of the
Company filed under the Act, it shall not, to the extent requested by the
Company and such underwriter, directly or indirectly sell, offer to sell,
contract to sell (including, without limitation, any short sale), grant any
option to purchase or otherwise transfer or dispose of (other than to donees or
commonly-controlled affiliates of the transferor who agree to be similarly
bound) any securities of the Company held by it at any time during such period
except common stock included in such registration; provided, however, that:
(a) such agreement shall be applicable only to the first two
such registration statements of the Company which cover common stock (or other
securities) to be sold on its behalf to the public in an underwritten offering;
and
13
<PAGE>
(b) all officers and directors of the Company and all other
persons with registration rights (whether or not pursuant to this Agreement)
enter into similar agreements.
In order to enforce the foregoing covenant, the Company may
impose stop-transfer instructions with respect to the Registrable Securities of
each Investor (and the shares or securities of every other person subject to the
foregoing restriction) until the end of such period.
1.16 TERMINATION OF REGISTRATION RIGHTS. No Holder shall be
entitled to exercise any right provided for in this Section 1 after five (5)
years following the consummation of the sale of securities pursuant to a
registration statement filed by the Company under the Act in connection with the
initial firm commitment underwritten offering of its securities to the general
public.
2. COVENANTS OF THE COMPANY.
2.1 DELIVERY OF FINANCIAL STATEMENTS. The Company shall deliver
to each Investor holding at least 1,000,000 shares of Registrable Securities:
(a) as soon as practicable, but in any event within ninety
(90) days after the end of each fiscal year of the Company, an income statement
for such fiscal year, a balance sheet of the Company and statement of
shareholder's equity as of the end of such year, and a schedule as to the
sources and applications of funds for such year, such year-end financial reports
to be in reasonable detail, prepared in accordance with generally accepted
accounting principles ("GAAP"), and audited and certified by independent public
accountants of nationally recognized standing selected by the Company;
(b) as soon as practicable, but in any event within
forty-five (45) days after the end of each of the first three (3) quarters of
each fiscal year of the Company, an unaudited profit or loss statement, schedule
as to the sources and application of funds for such fiscal quarter and an
unaudited balance sheet as of the end of such fiscal quarter.
(c) within thirty (30) days of the end of each month, an
unaudited income statement and schedule as to the sources and application of
funds and balance sheet for and as of the end of such month, in reasonable
detail; and
(d) as soon as practicable, but in any event thirty (30)
days prior to the end of each fiscal year, a budget for the next fiscal year,
prepared on a monthly basis, including balance sheets and sources and
applications of funds statements for such months and, as soon as prepared, any
other budgets or revised budgets prepared by the Company.
2.2 INSPECTION. The Company shall permit each Investor, at such
Investor's expense, to visit and inspect the Company's properties, to examine
its books of account and records and to discuss the Company's affairs, finances
and accounts with its officers, all at such reasonable times as may be requested
by the Investor; provided, however, that the Company
14
<PAGE>
shall not be obligated pursuant to this Section 2.2 to provide access to any
information which it reasonably considers to be a trade secret or similar
confidential information.
2.3 TERMINATION OF INFORMATION AND INSPECTION COVENANTS. The
covenants set forth in subsections 2.1(c) and (d) and Section 2.2 shall
terminate as to Investors and be of no further force or effect when the sale of
securities pursuant to a registration statement filed by the Company under the
Act in connection with the firm commitment underwritten offering of its
securities raising at least $20,000,000 to the general public is consummated or
when the Company first becomes subject to the periodic reporting requirements of
Sections 12(g) or 15(d) of the 1934 Act, whichever event shall first occur.
2.4 RIGHT OF FIRST OFFER. Subject to the terms and conditions
specified in this paragraph 2.4, the Company hereby grants to each Major
Investor (as hereinafter defined) a right of first offer with respect to future
sales by the Company of its Shares (as hereinafter defined). For purposes of
this Section 2.4, a Major Investor shall mean (i) any Investor who holds at
least 50% of such Investor's originally acquired shares of Series A Preferred
Stock, Series B Preferred Stock or Series C Preferred Stock issued pursuant to
(A) that certain Series A Preferred Stock Purchase Agreement dated July 3, 1997
(the "Series A Agreement"), (B) that certain Series B Preferred Stock Purchase
Agreement dated March 12, 1998 (the "Series B Agreement") or (C) the Preferred
Stock Agreement, as applicable, and (ii) any person who acquires at least (A)
10% of the Series A Preferred Stock (or the common stock issued upon conversion
thereof) issued pursuant to the Series A Agreement, (B) 10% of the Series B
Preferred Stock (or the common stock issued upon conversion thereof) issued
pursuant to the Series B Agreement or (C) 10% of the Series C Preferred Stock
(or the common stock issued upon conversion thereof) issued pursuant to the
Preferred Stock Agreement. For purposes of this Section 2.4, Investor includes
any general or limited partners and affiliates of an Investor. An Investor
shall be entitled to apportion the right of first offer hereby granted it among
itself and its partners and affiliates in such proportions as it deems
appropriate.
Each time the Company proposes to offer any shares of, or
securities convertible into or exercisable for any shares of, any class of its
capital stock ("Shares"), the Company shall first make an offering of such
Shares to each Major Investor in accordance with the following provisions:
(a) The Company shall deliver a notice by certified mail
("Notice") to the Major Investors stating (i) its bona fide intention to offer
such Shares, (ii) the number of such Shares to be offered, and (iii) the price
and terms, if any, upon which it proposes to offer such Shares.
(b) Within 20 calendar days after receipt of the Notice, the
Major Investor may elect to purchase or obtain, at the price and on the terms
specified in the Notice, up to that portion of such Shares which equals the
proportion that the number of shares of common stock issued and held, or
issuable upon conversion of the Series A Preferred Stock, Series B Preferred
Stock and/or Series C Preferred Stock then held, by such Major Investor bears to
the total number of shares of common stock of the Company then outstanding
(assuming full conversion and exercise of all convertible or exercisable
securities) as of the date of the Notice.
15
<PAGE>
The Company shall promptly, in writing, inform each Major Investor which
purchases all the shares available to it ("Fully-Exercising Investor") of any
other Major Investor's failure to do likewise. During the ten-day period
commencing after receipt of such information, each Fully-Exercising Investor
shall be entitled to obtain that portion of the Shares for which Major Investors
were entitled to subscribe but which were not subscribed for by the Major
Investors which is equal to the proportion that the number of shares of common
stock issued and held, or issuable upon conversion of Series A Preferred Stock,
Series B Preferred Stock and/or Series C Preferred Stock then held, by such
Fully-Exercising Investor bears to the total number of shares of common stock
issued and held, or issuable upon conversion of the Series A Preferred Stock,
Series B Preferred Stock and/or Series C Preferred Stock then held, by all
Fully-Exercising Investors who wish to purchase some of the unsubscribed shares.
(c) If all Shares referred to in the Notice are not elected
to be obtained as provided in subsection 2.4(b) hereof, the Company may, during
the 60-day period following the expiration of the period provided in subsection
2.4(b) hereof, offer the remaining unsubscribed portion of such Shares to any
person or persons at a price not less than, and upon terms no more favorable to
the offeree than those specified in the Notice. If the Company does not enter
into an agreement for the sale of the Shares within such period, or if such
agreement is not consummated within 60 days of the execution thereof, the right
provided hereunder shall be deemed to be revived and such Shares shall not be
offered unless first reoffered to the Major Investors in accordance herewith.
(d) The right of first offer in this paragraph 2.4 shall not
be applicable (i) to the issuance or sale of common stock (or options therefor)
to employees, consultants or directors of the Company directly or pursuant to a
stock option plan or restricted stock plan approved by the Board of Directors of
the Company, (ii) to or after consummation of a bona fide, firmly underwritten
public offering of shares of common stock, registered under the Act pursuant to
a registration statement on Form S-1, at an offering price of at least
$20,000,000 in the aggregate, (iii) to the issuance of securities pursuant to
the conversion or exercise of convertible or exercisable securities, (iv) to the
issuance of securities in connection with a bona fide business acquisition of or
by the Company, whether by merger, consolidation, sale of assets, sale or
exchange of stock or otherwise or (v) to the issuance of stock, warrants or
other securities or rights to persons or entities with which the Company has
business relationships provided such issuances are for other than primarily
equity financing purposes approved by the Board of Directors.
2.5 EMPLOYEE STOCK POOL. Any increase in the authorized number of
shares allocated to the Company's employee stock pool under the Company's 1997
Stock Option/Stock Issuance Plan shall be approved by the Board of Directors.
2.6 EXCLUDED INVESTMENTS. The Company agrees that, for a period
of one year from the date hereof (the "Exclusion Period"), it shall not issue
any of its equity securities in a private offering to any of the following
entities (each an "Excluded Investor"): AT&T Corporation, Sprint Corporation,
Qwest Communications International, Inc., Level 3 Communications, Inc., WilTel,
LLC, Frontier Corporation, British Telecommunications plc, GTE Corp. and the
Regional Bell Operating Companies. Notwithstanding anything else in this
16
<PAGE>
Agreement, if within thirty (30) days (unless such period is extended by the
mutual agreement of the Company and MCI WorldCom, Inc.) of the effective date
of that certain Framework Agreement dated as of the date hereof between the
Company and MCI WorldCom, Inc. (the "Framework Agreement"), MCI WorldCom,
Inc. has not executed any of the Carrier Services Agreement or the Network
Services Agreement or the OSS Licensing Agreement (as contemplated in the
Framework Agreement), the Exclusion Period shall terminate and the Company
thereafter shall be able to issue its equity securities to any of the
Excluded Investors and MCI WorldCom shall forfeit its demand registration
right granted pursuant to subsection 1.2(d) hereof.
3. COVENANTS OF THE INVESTORS.
3.1 CERTAIN CORPORATE TRANSACTIONS. In the event that the Board
of Directors of the Company and holders of a majority of the Common Stock
issuable or issued upon conversion of the Series A Preferred Stock, Series B
Preferred Stock and Series C Preferred Stock of the Company vote in favor of a
Corporate Transaction (as defined below), each Investor hereby agrees not to
take any action inconsistent with the pooling-of-interests accounting treatment
to the extent applicable to such Corporate Transaction, as reasonably deemed
necessary by the Company's Board of Directors, including without limitation
exercising any dissenter's rights any such Investor may have or selling or
purchasing any Company securities where prohibited under the then applicable
pooling-of-interests accounting rules. For purposes of this Section 3.1,
Corporate Transaction shall mean the acquisition of the Company by another
entity by means of any transaction or series of related transactions (including,
without limitation, any reorganization, merger or consolidation) that results in
the transfer of fifty percent (50%) or more of the outstanding voting power of
the Company.
3.2 STANDSTILL. Except as set forth in the Preferred Stock
Agreement, so long as an Investor has registration rights under this Agreement,
such Investor agrees not to purchase any additional shares of, or securities
convertible into or exercisable or exchangeable for any shares of, any class of
capital stock of the Company unless approved in advance by the Board of
Directors of the Company.
3.3 ADDITIONAL PREFERRED INVESTORS. Each Investor agrees to
permit other new preferred stock investors in the Company which are approved by
the Board of Directors to participate on a pari passu basis in the rights of
first offer, registration rights, information and access rights and the
protective provision rights held by the Investors set forth herein and in the
Restated Certificate of Incorporation.
4. CORPORATE OPPORTUNITY MATTERS. Except as expressly provided in this
Section 4, the Investors other than Enron (the "Rhythms Stockholders" for
purposes of this Section 4.1) and the Company acknowledge and agree that neither
Enron nor any of its Affiliates shall be expressly or implicitly restricted or
proscribed pursuant to this Agreement, the relationship that exists between
Enron and the Rhythms Stockholders, the relationship between Enron and the
Company or otherwise, from engaging in any type of business activity or owning
an interest in any type of business entity, regardless of whether such business
activity is (or such business entity engages in businesses that are) in direct
or indirect competition with the businesses or
17
<PAGE>
activities of the Company or of any of its Affiliates (as defined below) or any
other person or entity. Without limiting the foregoing and except as otherwise
expressly provided in this Section 4, the Rhythms Stockholders and the Company
acknowledge and agree that (i) neither the Rhythms Stockholders, the Company or
its Affiliates nor any other person or entity shall have any rights, by virtue
of this Agreement, the relationship that exists between Enron and the Rhythms
Stockholders, the relationship between Enron and the Company or otherwise, in
any business venture or business opportunity of Enron or any of its Affiliates,
and Enron and such Affiliates shall have no obligation to offer any interest in
any such business venture or business opportunity to the Rhythms Stockholders,
the Company, any Affiliate of the Company or any other person or entity, or
otherwise account to the Rhythms Stockholders, the Company, any Affiliate of the
Company or any other persons or entities in respect of any such business
ventures, (ii) the activities of Enron or any of its Affiliates that are in
direct or indirect competition with the activities of the Company or any of its
Affiliates are hereby approved by the Rhythms Stockholders and the Company, and
(iii) it shall be deemed not to be a breach of any fiduciary or other duties, if
any and whether express or implied, that may be owed by Enron or its Affiliates
to the Rhythms Stockholdersor the Company for Enron to permit itself or one of
its Affiliates to engage in a business opportunity in preference or to the
exclusion of the Rhythms Stockholders, the Company, its Affiliates or any other
person or entity.
4.1 Except as expressly provided in this Section 4, the
Investors other than MCI WorldCom (the "Rhythms Stockholders" for purposes of
this Section 4.2) and the Company acknowledge and agree that neither MCI
WorldCom nor any of its Affiliates shall be expressly or implicitly restricted
or proscribed pursuant to this Agreement, the relationship that exists between
MCI WorldCom and the Rhythms Stockholders, the relationship between MCI WorldCom
and the Company or otherwise, from engaging in any type of business activity or
owning an interest in any type of business entity, regardless of whether such
business activity is (or such business entity engages in businesses that are) in
direct or indirect competition with the businesses or activities of the Company
or of any of its Affiliates (as defined below) or any other person or entity.
Without limiting the foregoing and except as otherwise expressly provided in
this Section 4, the Rhythms Stockholders and the Company acknowledge and agree
that (i) neither the Rhythms Stockholders, the Company or its Affiliates nor any
other person or entity shall have any rights, by virtue of this Agreement, the
relationship that exists between MCI WorldCom and the Rhythms Stockholders, the
relationship between MCI WorldCom and the Company or otherwise, in any business
venture or business opportunity of MCI WorldCom or any of its Affiliates, and
MCI WorldCom and such Affiliates shall have no obligation to offer any interest
in any such business venture or business opportunity to the Rhythms
Stockholders, the Company, any Affiliate of the Company or any other person or
entity, or otherwise account to the Rhythms Stockholders, the Company, any
Affiliate of the Company or any other persons or entities in respect of any such
business ventures, (ii) the activities of MCI WorldCom or any of its Affiliates
that are in direct or indirect competition with the activities of the Company or
any of its Affiliates are hereby approved by the Rhythms Stockholders and the
Company, and (iii) it shall be deemed not to be a breach of any fiduciary or
other duties, if any and whether express or implied, that may be owe by MCI
WorldCom or its Affiliates to the Rhythms Stockholders or the Company for MCI
WorldCom to permit itself or one of its Affiliates to engage in a business
opportunity in preference or to the exclusion of the Rhythms Stockholders, the
Company, its Affiliates or any other person or entity.
18
<PAGE>
4.2 For purposes of this Section 4, the term "Affiliate" shall
mean (i) a person or entity that directly, or indirectly through one or more
intermediaries, controls, or is controlled by, or is under common control with
another person or entity or (ii) a person or entity that owns beneficially at
least 50% of the equity of such other person or entity; provided, however, that
when used to refer to Affiliates of the Company (as opposed to Affiliates of any
other person or entity, such as Enron or MCI WorldCom), shall only mean persons
or entities controlled by the Company (rather than persons or entities under
common control with the Company), and when used to refer to Affiliates of Enron
or MCI WorldCom, shall exclude the Company and its Affiliates. The term
"control," including the correlative terms "controlling," "controlled by" and
"under common control with" shall mean possession, directly or indirectly of the
power to direct or cause the direction of management or policies (whether
through ownership of securities or any partnership or other ownership interest,
by contract or otherwise) of a person or entity.
5. MISCELLANEOUS.
5.1 SUCCESSORS AND ASSIGNS. Except as otherwise provided herein,
the terms and conditions of this Agreement shall inure to the benefit of and be
binding upon the respective successors and assigns of the parties (including
transferees of any shares of Registrable Securities). Nothing in this
Agreement, express or implied, is intended to confer upon any party other than
the parties hereto or their respective successors and assigns any rights,
remedies, obligations, or liabilities under or by reason of this Agreement,
except as expressly provided in this Agreement.
5.2 GOVERNING LAW. This Agreement shall be governed by and
construed under the laws of the State of Delaware without regard to choice of
law principles.
5.3 COUNTERPARTS. This Agreement may be executed in two or more
counterparts, each of which shall be deemed an original, but all of which
together shall constitute one and the same instrument.
5.4 TITLES AND SUBTITLES. The titles and subtitles used in this
Agreement are used for convenience only and are not to be considered in
construing or interpreting this Agreement.
5.5 NOTICES. Unless otherwise provided, any notice required or
permitted under this Agreement shall be given in writing and shall be deemed
effectively given upon receipt addressed to the party to be notified at the
address indicated for such party on the signature page hereof, or at such other
address as such party may designate by ten (10) days' advance written notice to
the other parties.
5.6 EXPENSES. If any action at law or in equity is necessary to
enforce or interpret the terms of this Agreement, the prevailing party shall be
entitled to reasonable attorneys' fees, costs and necessary disbursements in
addition to any other relief to which such party may be entitled.
19
<PAGE>
5.7 AMENDMENTS AND WAIVERS. Any term of this Agreement may be
amended and the observance of any term of this Agreement may be waived (either
generally or in a particular instance and either retroactively or
prospectively), only with the written consent of the Company and the holders of
60% or more of the Registrable Securities then outstanding. Any amendment or
waiver effected in accordance with this paragraph shall be binding upon each
holder of any Registrable Securities then outstanding, each future holder of all
such Registrable Securities, and the Company.
5.8 SEVERABILITY. If one or more provisions of this Agreement are
held to be unenforceable under applicable law, such provision shall be excluded
from this Agreement and the balance of the Agreement shall be interpreted as if
such provision were so excluded and shall be enforceable in accordance with its
terms.
5.9 AGGREGATION OF STOCK. All shares of Registrable Securities
held or acquired by affiliated entities or persons shall be aggregated together
for the purpose of determining the availability of any rights under this
Agreement.
5.10 ENTIRE AGREEMENT; AMENDMENT; WAIVER. This Agreement
(including the Exhibits hereto, if any) constitutes the full and entire
understanding and agreement between the parties with regard to the subjects
hereof and thereof.
[REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]
20
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
date first above written.
RHYTHMS NETCONNECTIONS INC.
By: /s/ Catherine Hapka
---------------------------
Catherine Hapka, President
Address: 6933 South Revere Parkway
Englewood, CO 80112-3931
INVESTOR:
MICROSOFT CORPORATION
By: /s/ [Illegible]
----------------------------
Its:
---------------------------
Address: One Microsoft Way
Redmond, WA 98052-6399
MCI WORLDCOM VENTURE FUND, INC.
By: /s/ Susan Mayer
----------------------------
Its:
---------------------------
Address:
-------------------------------
-------------------------------
ENRON COMMUNICATIONS GROUP, INC.
By: /s/ Ken Harrison
----------------------------
Its:
---------------------------
Address: 210 Southwest Morrison Street, Suite 400
Portland, Oregon 97204
[SIGNATURE PAGE TO AMENDED AND RESTATED
INVESTORS' RIGHTS AGREEMENT]
<PAGE>
ENTERPRISE PARTNERS III, L.P.
By: /s/ William Stensrud
----------------------------
Its:
---------------------------
Address: 7979 Ivanhoe, Suite 550
La Jolla, CA 92037
Attn: William Stensrud
ENTERPRISE PARTNERS III ASSOCIATES, L.P.
By: /s/ William Stensrud
----------------------------
Its:
---------------------------
Address: 7979 Ivanhoe, Suite 550
La Jolla, CA 92037
Attn: William Stensrud
ENTERPRISE PARTNERS IV, L.P.
By: /s/ William Stensrud
----------------------------
Its:
---------------------------
Address: 7979 Ivanhoe, Suite 550
La Jolla, CA 92037
Attn: William Stensrud
[SIGNATURE PAGE TO AMENDED AND RESTATED
INVESTORS' RIGHTS AGREEMENT]
<PAGE>
BRENTWOOD ASSOCIATES VII, L.P.
By: BRENTWOOD VII VENTURES, L.P.
Its General Partner
By: /s/ John Walecka
----------------------------
Its:
---------------------------
Address: 3000 Sand Hill Road
Bldg. 1, Suite 260
Menlo Park, CA 94025
Attn: John Walecka
BRENTWOOD AFFILIATES FUND, L.P.
By: BRENTWOOD VII VENTURES, L.P.
Its General Partner
By: /s/ John Walecka
----------------------------
Its:
---------------------------
Address: 3000 Sand Hill Road
Bldg. 1, Suite 260
Menlo Park, CA 94025
Attn: John Walecka
[SIGNATURE PAGE TO AMENDED AND RESTATED
INVESTORS' RIGHTS AGREEMENT]
<PAGE>
KLEINER PERKINS CAUFIELD & BYERS VIII
By: /s/ Kevin Compton
----------------------------
Its:
---------------------------
Address: 2750 Sand Hill Road
Menlo Park, CA 94025
Attn: Kevin Compton
KPCB VIII FOUNDERS FUND
By: /s/ Kevin Compton
----------------------------
Its:
---------------------------
Address: 2750 Sand Hill Road
Menlo Park, CA 94025
Attn: Kevin Compton
KPCB INFORMATION SCIENCES ZAIBATSU
FUND II
By: /s/ Kevin Compton
----------------------------
Its:
---------------------------
Address: 2750 Sand Hill Road
Menlo Park, CA 94025
Attn: Kevin Compton
[SIGNATURE PAGE TO AMENDED AND RESTATED
INVESTORS' RIGHTS AGREEMENT]
<PAGE>
SPROUT CAPITAL VII, L.P.
By: DLJ Capital Corporation
Managing General Partner
By: /s/ Keith Geeslin
-------------------------------
Keith Geeslin, Attorney-in-Fact
Address: 3000 Sand Hill Road
Building 3, Suite 170
Menlo Park, CA 94025
Attn: Keith Geeslin
THE SPROUT CEO FUND, L.P.
By: DLJ Capital Corporation
Its General Partner
By: /s/ Keith Geeslin
---------------------------------
Keith Geeslin, Attorney-in-Fact
Address: 3000 Sand Hill Road
Building 3, Suite 170
Menlo Park, CA 94025
Attn: Keith Geeslin
DLJ CAPITAL CORPORATION
By: /s/ Keith Geeslin
---------------------------------
Keith Geeslin, Attorney-in-Fact
Address: 3000 Sand Hill Road
Building 3, Suite 170
Menlo Park, CA 94025
Attn: Keith Geeslin
[SIGNATURE PAGE TO AMENDED AND RESTATED
INVESTORS' RIGHTS AGREEMENT]
<PAGE>
DLJ FIRST ESC L.L.C.
By: DLJ LBO Plans Management
Corporation
Its: Manager
By: /s/ Keith Geeslin
-----------------------------
Keith Geeslin, Attorney-in-Fact
Address: 3000 Sand Hill Road
Building 3, Suite 170
Menlo Park, CA 94025
Attn: Keith Geeslin
EPLEY INVESTORS II, LLC
By:
----------------------------
Its:
---------------------------
Address:
-------------------------------
-------------------------------
-------------------------------
Catherine Hapka
Address: 6933 South Revere Parkway
Englewood, CO 80112-3931
[SIGNATURE PAGE TO AMENDED AND RESTATED
INVESTORS' RIGHTS AGREEMENT]
<PAGE>
BLUMENFELD & COHEN
By:
----------------------------
Its:
---------------------------
Address: 1615 M Street, N.W., Suite 700
Washington, D.C. 20036
-------------------------------
Eileen Shapiro
Address: 987 Memorial Drive, Apt. 672
Cambridge, MA 02138
-------------------------------
Joel Portugal
Address: 30 East 72nd Street
New York, NY 10021
-------------------------------
John H. Ware
Address: c/o Spencer Stuart
3000 Sand Hill Road
Bldg. 2, Suite 175
Menlo Park, California 94025
-------------------------------
Brad A. Stirn
Address: c/o Spencer Stuart
3000 Sand Hill Road
Bldg. 2, Suite 175
Menlo Park, California 94025
[SIGNATURE PAGE TO AMENDED AND RESTATED
INVESTORS' RIGHTS AGREEMENT]
<PAGE>
---------------------------------
Steve R. Strain
Address: c/o Spencer Stuart
3000 Sand Hill Road
Bldg. 2, Suite 175
Menlo Park, California 94025
----------------------------------
Richard S. Gostyla
Address: c/o Spencer Stuart
3000 Sand Hill Road
Bldg. 2, Suite 175
Menlo Park, California 94025
----------------------------------
Nayla M. Rizk
Address: c/o Spencer Stuart
3000 Sand Hill Road
Bldg. 2, Suite 175
Menlo Park, California 94025
----------------------------------
Jane E. Carmena
Address: c/o Spencer Stuart
3000 Sand Hill Road
Bldg. 2, Suite 175
Menlo Park, California 94025
----------------------------------
Jeff Blumenfeld
Address: 1615 M Street, N.W., Suite 700
Washington, D.C. 20036
[SIGNATURE PAGE TO AMENDED AND RESTATED
INVESTORS' RIGHTS AGREEMENT]
<PAGE>
BROBECK, PHLEGER & HARRISON LLP
By:
-------------------------------
Its:
-----------------------------
Address: Spear Street Tower
One Market Street
San Francisco, California 94104
-----------------------------------
Craig S. Andrews
Address: Brobeck, Phleger & Harrison LLP
550 West "C" Street, Suite 1300
San Diego, California 92101
UMB AS TRUSTEE FOR BROBECK, PHLEGER &
HARRISON RETIREMENT SAVINGS TRUST
FBO JOHN A. DENNISTON
By:
----------------------------
Its:
---------------------------
Address: 1010 Grand Avenue
Kansas City, MO 64106
--------------------------------
Martin C. Nichols
Address: Brobeck, Phleger & Harrison LLP
550 West "C" Street, Suite 1300
San Diego, California 92101
[SIGNATURE PAGE TO AMENDED AND RESTATED
INVESTORS' RIGHTS AGREEMENT]
<PAGE>
SCHEDULE A
INVESTOR
Microsoft Corporation
MCI Worldcom Venture Fund, Inc.
Enron Communications Group, Inc.
Enterprise Partners III, L.P.
Enterprise Partners III Associates, L.P.
Enterprise Partners IV, L.P.
Brentwood Associates VII, L.P.
Brentwood Associates Fund, L.P.
Kleiner Perkins Caufield & Byers VIII
KPCB VIII Founders Fund
KPCB Information Sciences Zaibatsu Fund II
Sprout Capital VII, L.P.
The Sprout CEO Fund, L.P.
DLJ Capital Corporation
DLJ First ESC L.L.C.
Epley Investors II, LLC
Stanford University
Catherine M. Hapka
Blumenfeld & Cohen
Eileen Shapiro
Joel Portugal
John H. Ware
Brad A. Stirn
Stephen R. Strain
Richard S. Gostyla
Nayla M. Rizk
Jane E. Carmena
Jeffrey Blumenfeld
Brobeck, Phleger & Harrison LLP
Craig S. Andrews
UMB as Trustee for Brobeck, Phleger & Harrison Retirement
Savings Trust FBO John A. Denniston
Martin C. Nichols
<PAGE>
MICROSOFT-RHYTHMS CO-MARKETING AGREEMENT
This Microsoft-Rhythms Co-Marketing Agreement (this "Agreement") is made as
of this 16th day of March, 1999 (the "Effective Date") by and between Microsoft
Corporation ("Microsoft"), a Washington corporation with its principal offices
at One Microsoft Way, Redmond, WA 98052, and Rhythms NetConnections Inc.
("Rhythms"), a Delaware corporation with its principal offices at 6933 So.
Revere Parkway, Englewood, CO 80112 (Microsoft and Rhythms collectively, the
"Parties).
RECITALS
Whereas, Microsoft currently owns and operates a network of Web sites
currently titled "MSN", with a home page currently located at
http://www.msn.com, which network includes an aggregation of Web-based
properties, and which constitutes an Internet portal;
Whereas, Rhythms provides end-to-end broadband connectivity and solution
services including retailing and provisioning of various xDSL connectivity
services to customer premises over existing local loops which permit its
customers to access the Internet, private IP backbones and the PSTN;
Whereas, as part of its service offering, Rhythms wishes to market to
businesses and business teleworkers, and Microsoft is willing to provide,
portals based on MSN which contain a co-branded start page and for which Rhythms
shall be provided with revenue sharing opportunities;
Whereas the Parties desire to cooperate in joint marketing activities whereby
their direct sales forces and channel sales forces would offer in combination
the Rhythms' broadband connectivity and solution services with portals and
related services based on MSN.
Now therefore, in consideration of the mutual promises set forth hereunder,
Microsoft and Rhythms hereby agree as follows:
AGREEMENT
1. DEFINITIONS
1.1. "Advertising" shall mean advertising, promotions, sponsorships,
e-commerce distribution opportunities and all other revenue generating
placements and services ("Advertising").
1.2. "Small Office Portal" shall have the meaning ascribed in Section 2.1.
1.3. "Microsoft Internet Technologies" shall mean the technologies
described in Section 7.
1.4. "MSN Service" shall mean the aggregation of Web-based properties
controlled by Microsoft which is currently titled "MSN" and located on the
domain http://www.msn.com.
1.5. "Portal" shall mean a Web site which contains an aggregation of
Web-based properties (including without limitation Web pages with a variety
of information, advertising, features and functionality (such as e-mail,
search, instant messaging) and hosting of hyperlinks to communications,
entertainment, e-commerce, advertising, and other manner of Web sites), the
home page of which is often, but not always, the start page for users
accessing the Internet.
1.6. "Rhythms/Microsoft Portals" shall mean the Small Office Portal and
the Teleworker Portal, collectively.
1.7. "Rhythms Services" shall mean the various broadband connectivity
services and features marketed and sold by Rhythms.
1.8. "Small Office" shall mean a distinct business facility, whether a
branch office or the entire business facility.
1.9. "Teleworker Portal" shall have the meaning ascribed in Section 3.1.
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2. SMALL OFFICE PORTAL
2.1. Microsoft shall provide, host and maintain a co-branded version of the
MSN Service for Rhythms' Small Office customers ("Small Office Portal")
which shall be essentially the same as the MSN Service as it is now or may
be constituted in the future, except for the inclusion of the features and
functionality described below. Except as specifically set forth below,
Microsoft shall have sole control and discretion over the content of the
Small Office Portal which Microsoft intends to periodically upgrade and
modify.
2.2. The co-branding shall consist of a primary branding on the start page
only, which branding is mutually determined by the Parties prior to
implementation of the Small Office Portal and which shall be "MSN brought
to you by Rhythms" or such other similar branding. The mock-up attached as
Exhibit A illustrates a possible co-branding. There shall be no other
co-branding on the Small Office Portal.
2.3. The Small Office Portal shall be located at the uniform resource
locator ("URL") address RHYTHMS.MSN.COM. In addition, Rhythms customers
who enter the URL address SMALLBIZ.RHYTHMS.NET or START.RHYTHMS.NET shall
be automatically redirected to the Small Office Portal at RHYTHMS.MSN.COM.
Rhythms agrees to provide any assistance reasonably needed to facilitate
such redirection.
2.4. The visible user interface for RHYTHMS.MSN.COM shall be substantially
similar to MSN.COM, including colors, layout, fonts, etc. Rhythms will
have the ability to use its fonts and colors within the Rhythms Content
Module, if any, on the start page, subject to Section 2.5 below.
2.5. Upon Rhythms' request, Microsoft shall include a module for Rhythms
("Content Module") on the start page of the Small Office Portal, which
Content Module and its content shall be in accordance with any template,
guidelines, tools and procedures provided to Rhythms by Microsoft. The
content in the Content Module may be modified from time to time as
determined by Rhythms in its sole discretion (subject to the
previous-mentioned template, guidelines, tools and procedures) and
Microsoft shall replace any existing Content Module with any such updated
Content Module within a reasonable time following Rhythms' notice of such
modifications. An example of what the Content Module may look like appears
in the mock-up attached hereto as Exhibit A. Notwithstanding the
foregoing, Microsoft has the right, in its sole discretion, to require
Rhythms to remove content from the Content Module.
2.6. The presentation and appearance of the core MSN Service which forms
the basis for the non-co-branded elements of the Small Office Portal may
evolve over time to respond to user preferences. Microsoft will not make
any material changes to co-branded elements (such as the Content Module,
"MSN brought to you by Rhythms," Rhythms support links and URL) within the
Small Office Portal without the mutual consent of Rhythms.
2.7. Back button: On the Small Office Portal, a back button/home button
will be provided such that any user originating in the start page will
always be returned to the start page of the Small Office Portal. In no
event will users originating in the Small Office Portal start page be
re-directed to a non-co-branded page (MSN or Rhythms).
2.8. Microsoft intends to include in the Small Office Portal various
services directed at helping small businesses establish, promote and drive
revenue from their web sites, including, but not limited to, the present
and future offering of MSN LinkExchange. Such services shall be similar to
the types of services currently located in the "Small Business" section of
the MSN Service subject to Microsoft's sole discretion.
2.9. Rhythms shall provide Microsoft with links to Rhythms' customer
service web pages (such as help, customer support and corporate
information), which links shall be included at the bottom of the pages of
the Small Office Portal, the likely location of which is shown in the
mock-up attached hereto as Exhibit A. Rhythms will be able to change these
links at mutually agreeable time intervals.
3. TELEWORKER PORTAL
3.1. Microsoft shall provide, host and maintain a co-branded Internet
Portal for Rhythms' business customers for the use of their teleworkers
(the "Teleworker Portal") which shall be essentially the same as the Small
Office Portal with the exception that it shall not include the services
referenced in Section 2.8 above and shall default to the location(s) noted
in Section 3.2 below.
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3.2. The Teleworker Portal shall be located at CORP.MSN.COM (where "CORP"
is the name of the business customer whose teleworkers are being provided
such Portal); provided, however, that if such URL is already in use as a
result of a previously existing relationship between Microsoft and the
business customer, the URL shall be CORP.RHYTHMS.MSN.COM.
4. JOINT MARKETING OF MSN AND THE RHYTHMS/MICROSOFT PORTALS WITH RHYTHMS
SERVICES.
4.1. Rhythms shall market the Small Office Portal as its recommended
default Portal to its current and future business customers and shall
market the Teleworker Portal as its recommended default Internet Portal to
its current and future business customers for use by their teleworkers.
For the avoidance of doubt, "recommended default" Portal shall mean that
Rhythms shall recommend the Rhythms/Microsoft Portals, and no other
publicly available Portals, as its default Portal(s) unless a business
customer requests another publicly available Portal or requests that no
publicly available Portal be included.
4.2. Rhythms will use its commercially reasonable efforts to inform,
educate and market the MSN Service and the Rhythms/Microsoft Portals to its
direct sales force and its channel sales force with which it has alliances
or contracts for services, including, but not limited to, Internet Service
Providers, telecommunication companies and customer premises system
integrators as the recommended Portals therefor.
4.3. Microsoft will use its commercially reasonable efforts to inform,
educate and market Rhythms Services to its ICU (Internet Customer Unit) and
ECU (Enterprise Customer Unit) direct sales force and its channel sales
forces including, but not limited to, the ADCU (Application Developer
Customer Unit) channel of Independent Software Vendors, the OCU
(Organization Customer Unit) channel of Solution Providers, and the ICU
channel of Solution Partners who are members of the Microsoft Partner
Solution Center.
4.4. Microsoft and Rhythms agree to develop a joint marketing plan within
ninety (90) days after the Effective Date to specifically define and
implement the goals outlined above in this Section 4.
5. ENHANCEMENT OF PORTALS AND FUTURE JOINT MARKETING.
Concurrently herewith, the Parties are executing a Letter of Intent which sets
forth the Parties' intentions with regard to entering into a definitive
agreement concerning further enhancements to the Rhythms/Microsoft Portals and
further cooperative joint marketing efforts with regard to such Portals and the
Rhythms Services directed to businesses of all sizes and consumers.
6. ADVERTISING SALES.
Microsoft shall be solely responsible for managing and selling all Advertising
inventory on the Rhythms/Microsoft Portals, except for inside the Rhythms
Content Module. Microsoft shall collect and manage all revenue generated from
sales of Advertising on the Rhythms/Microsoft Portals, except for inside the
Rhythms Content Module. Rhythms shall not sell any Advertising for the
Rhythms/Microsoft Portals, except for inside the Rhythms Content Module subject
to Section 2.5. Microsoft agrees that it shall not place any Advertising on the
Rhythms/Microsoft Portals that advertise a direct competitor of Rhythms, the
list of which competitors shall be mutually agreed to in writing by the Parties.
Similarly, Rhythms shall not place any Advertising on the Rhythms Content Module
on the Rhythms/Microsoft Portals that advertise a direct competitor of
Microsoft, the list of which competitors shall be mutually agreed to in writing
by the Parties. Subject to terms to be negotiated between the Parties, Rhythms
will have the opportunity to purchase Advertising space or have its services
promoted on Microsoft's generic small business Portal, if any, or small business
channel of the MSN Service.
7. TECHNICAL SUPPORT FOR THE PORTALS.
7.1. Rhythms shall provide all technical support to its business customers
and their teleworkers (to the extent such technical support is provided to
Rhythms' other business customers which shall be further defined) in
connection with the Rhythms/Microsoft Portals. All help, contact and
support links in the Rhythms/Microsoft Portals shall point to the relevant
pages of Rhythms' Web site at http://www.rhythms.net.
7.2. In connection therewith, Microsoft shall provide Rhythms with access
to the support resources which shall be further defined but shall include
such resources as:
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7.2.1. Online access to its MSN Service technical support knowledge
base to provide real time support to Rhythms customers.
7.2.2. Online technical support modules for customer self-care, the
nature and choice of such modules shall be at Microsoft's sole
discretion.
7.2.3. A trouble ticket system for escalating technical support
issues, the nature of which system shall be at Microsoft's sole
discretion.
7.2.4. Access by Rhythms' Network Operations Center 24x7 to the
telephone support line at Microsoft's Network Operations Center for
the MSN Service.
8. MICROSOFT INTERNET TECHNOLOGIES.
The Rhythms/Microsoft Portals will contain some or all of the following
technologies/services: Passport (authentication technology for sharing user
credentials with other affiliated content, commerce or applications providers),
MSN Web Search (search engine), Hotmail (e-mail), MSN Personal Web Page and
User-Created Communities (community infrastructure), MSN Messenger Service
(instant messaging and buddy list technology), and other Microsoft Internet
services not otherwise specifically addressed in other Sections of this
Agreement that are available on the MSN Service. Some or all of such
technologies may also be available for distribution separately from the
Rhythms/Microsoft Portals. In addition, Microsoft's Internet-related products
Microsoft Internet Explorer, Outlook Express and Windows Media Technologies are
available for distribution separately from the Rhythms/Microsoft Portals. As
part of the marketing plan referenced in Section 4.4 above, the Parties agree to
develop commitments with regard to Rhythms' distribution of such Internet
technologies. Any such distribution shall be in accordance with Microsoft's
standard license and distribution terms and agreements.
9. IMPLEMENTATION TIMEFRAME
As soon as is reasonably possible after the Effective Date, Microsoft shall
locate initial versions of the Small Office Portal and Teleworker Portal at the
locations set forth in Sections 2.3 and 3.2 above. Such initial versions shall
be essentially identical to the MSN Service, but with the co-branding described
in Section 2.2. Thereafter, Microsoft will use its commercially reasonable best
efforts to deliver the technologies, specifications, licenses, tools and
application programming interfaces required for the Small Office Portal and
Teleworker Portal, as described in Sections 2 and 3, to Rhythms on or before
July 31, 1999. Within ninety (90) days after said delivery by Microsoft,
Rhythms will use its commercially reasonable best efforts to implement its
content, systems, and systems integration required for the Rhythms/Microsoft
Portals' Content Modules.
10. COMPENSATION.
10.1. Rhythms will receive compensation based upon Advertising revenues
generated by pages viewed by Rhythms users on the Rhythms/Microsoft Portals
(including the MSN Service properties/channels such as Carpoint, Hotmail,
MoneyCentral, etc. contained therein.) Compensation shall be based only on
Rhythms users who use the start page of the Small Office Portal or the
Teleworker Portal as the entry point, and will not include navigation that
starts in the Rhythms Content Module. As users click-through to the
channels, Microsoft will share with Rhythms a portion of the revenues
generated by the Rhythms users. If a Rhythms user leaves the
Rhythms/Microsoft Portal(s) and re-enters via other sources such as another
search engine or a third party referral, then those revenues generated by
Advertising viewed after such re-entry shall not apply under this sharing
agreement. Revenues from Advertising viewed through the use of the
Messenger feature or Communities feature also shall not apply. The
compensation methodology is set forth in Section 10.2 below.
10.2. Microsoft will compensate Rhythms for those pages generated by
Rhythms users while on the Rhythms/Microsoft Portals. Page views excluded
from this calculation include page views generated when entering the MSN
Service properties/channels (i) from a source other than the
Rhythms/Microsoft Portal; (ii) via other sources after leaving the
Rhythms/Microsoft Portal and re-entering; (iii) via instant messaging (e.g.
Messenger); (iv) community pages and (v) via the Rhythms Content Module.
Compensation shall be calculated based upon the number of unique users per
month (a user that visits the Rhythms/Microsoft Portal at least once in a
month) and the number of pages viewed, as measured by Microsoft measurement
system. Advertising revenues shall be converted to a cost per thousand
basis ("CPM"); that is Microsoft will calculate the number of
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pages viewed by Rhythms users while on the Rhythms/Microsoft Portals under
the conditions set forth above and divide such number by 1,000. Microsoft
shall then multiply such resulting number by a CPM rate to be negotiated by
the Parties within ninety (90) days after the Effective Date.
10.3. As soon as usage by Rhythms users makes "per subscriber per
month" pricing commercially reasonable, Microsoft shall convert the
compensation to a "per subscriber per month" model if mutually agreeable to
Rhythms.
10.4. Microsoft will provide Rhythms with quarterly reports within
forty-five (45) days following the end of a calendar quarter detailing the
activities of Rhythms customers usage of the Rhythms/Microsoft Portals and
the calculation of the compensation accrued thereby. Microsoft shall pay
such compensation at the same time as the quarterly report is delivered to
Rhythms.
10.5. Such compensation shall not be accrued and payable until the
features set forth in Sections 2 and 3 have been implemented into the Small
Office Portal and the Teleworker Portal, currently anticipated to occur on
or before July 31, 1999.
11. MIGRATION TO WINDOWS 2000
Rhythms shall make reasonable efforts to base all incremental and new network
and facility developments on Windows NT/2000-based solutions provided by
Microsoft and its Solution Partners, based on acceptable price, terms, features
and capabilities.
12. PROVISION OF RHYTHMS SERVICES
12.1. Subject to approval by Microsoft's Internal Technology Group,
availability of Rhythms' teleworker services in the Seattle/Redmond area,
and acceptable price, terms, features and capabilities from Rhythms,
Microsoft shall use its commercially reasonable best efforts to deploy
Rhythms teleworker services for a selected subset of its employees. The
target of this initial deployment is a minimum of 2500 employees.
Microsoft shall provide Rhythms with a contact in the Internal Technology
Group.
12.2. If requested by Microsoft, Rhythms shall provide any one or more
of its Rhythms Services to Microsoft on most favored nation pricing for
similar terms, quantities and scheduling.
13. PROPRIETARY RIGHTS
The Parties agree that Microsoft and/or its suppliers shall retain all right,
title, and interest in any and all content, technology and materials delivered
by Microsoft to Rhythms pursuant to this Agreement. The Parties further agree
that Rhythms shall retain all right, title and interest in and to the content
provided by Rhythms in the Content Module or otherwise delivered by Rhythms
pursuant to this Agreement. Neither Party shall have any rights to any
materials, content or technology provided by the other Party hereunder except as
specifically provided in this Agreement and shall not alter, modify, copy, edit,
format, translate, create derivative works of or otherwise use any materials,
content or technology provided by the other Party except as explicitly provided
herein or approved in advance in writing by the other Party.
14. CONFIDENTIALITY
14.1. The Parties acknowledge and agree that the terms and conditions
of the Microsoft Corporation Non-Disclosure Agreement dated concurrently
herewith ("NDA") entered into by and between the Parties are incorporated
into this Agreement and that all of the terms of this Agreement and all
discussions and negotiations related thereto and all information exchanged
pursuant hereto are considered Confidential Information as defined in the
NDA. In the event that any of the incorporated terms of the NDA are
inconsistent with or conflict with this Agreement, then the terms of this
Agreement shall control.
14.2. Each Party may disclose the terms and conditions of this
Agreement to its employees, affiliates and its immediate legal and
financial consultants on a need to know basis as required in the ordinary
course of that Party's business, provided that such employees, affiliates
and/or legal and/or financial consultants agree in writing in advance of
disclosure to be bound by this Section 14, and may disclose Confidential
Information as required by government or judicial order, provided each
Party gives the other Party prompt notice of such order
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and complies with any protective order (or equivalent) imposed on such
disclosure. Further, the Parties acknowledge that this Agreement, or
portions thereof, may be required under applicable law to be disclosed, as
part of or an exhibit to a Party's required public disclosure documents.
If either Party is advised by its legal counsel that such disclosure is
required, it will notify the other in writing and the Parties will jointly
seek confidential treatment of this Agreement to the maximum extent
reasonably possible, in documents approved by both Parties and filed with
the applicable governmental or regulatory authorities. Notwithstanding the
foregoing, a Party may describe, in a general manner, the business
relationship established in this Agreement as part of financial
presentations to potential investors in the Party.
14.3. Each Party acknowledges that monetary damages may not be a
sufficient remedy for unauthorized disclosure or use of Confidential
Information and that each Party may seek, without waiving any other rights
or remedies, such injunctive or equitable relief as may be deemed proper by
a court of competent jurisdiction.
15. TRADEMARK LICENSE
15.1. Microsoft hereby grants to Rhythms for the term of this Agreement
a non-exclusive, non-transferable, personal worldwide license to use the
MSN logo depicted on Exhibit A attached (the "Microsoft Mark"), solely as
part of the Rhythms/Microsoft Portals and in accordance with the terms of
this Agreement. Except as provided in this trademark license, this
Agreement does not grant Rhythms any right, title, interest, or license in
or to any of Microsoft' names, logos, trade dress, designs, or other
trademarks. Use of the Microsoft Mark shall be as specified in the
Agreement or as provided by Microsoft from time to time.
15.2. Rhythms acknowledges Microsoft's sole ownership of the Microsoft
Marks worldwide and all associated goodwill. Rhythms' use of the Microsoft
Mark shall inure solely to the benefit of Microsoft. Rhythms hereby
assigns and shall assign in the future to Microsoft all rights it may
acquire by operation of law or otherwise in the Microsoft Marks, including
all applications or registrations therefore, along with the goodwill
associated therewith.
15.3. Rhythms is authorized to use the Microsoft Mark only as affixed
to the Rhythms/Microsoft Portals in accordance with the terms of this
Agreement and as approved in advance by Microsoft. Rhythms shall fully
correct and remedy any deficiencies in its use of the Microsoft Mark, upon
reasonable notice from Microsoft.
15.4. Microsoft shall have the sole right to and in its sole discretion
may commence, prosecute or defend, and control any action concerning the
Microsoft Mark. Rhythms shall not during the term of this Agreement contest
the validity of, by act or omission jeopardize, or take any action
inconsistent with, Microsoft' rights or goodwill in the Microsoft Mark in
any country, including attempted registration of the Microsoft Mark, or use
or attempted registration of any mark confusingly similar thereto.
16. TERM/DEFAULT/TERMINATION
16.1. TERM. This Agreement shall commence on the Effective Date and
continue for a period of three (3) years following the Effective Date (the
"Term").
16.2. TERMINATION FOR CAUSE. In addition to any other rights
and/or remedies that either Party may have under the circumstances,
all of which are expressly reserved, either Party may terminate this
Agreement at any time if:
16.2.1. The other Party is in material breach of any warranty,
representation, term, condition or covenant of this Agreement, other
than those contained in Section 14, and fails to cure that breach
within thirty (30) days after written notice thereof; or
16.2.2. The other Party is in material breach of Section 14; or
16.2.3. Either Party becomes insolvent or makes any assignment for
the benefit of creditors or similar transfer evidencing insolvency; or
suffers or permits the commencement of any form of insolvency or
receivership proceeding; or has any petition under any bankruptcy law
filed against it, which petition is not dismissed within sixty (60)
days of such filing; or has a trustee or receiver appointed for its
business or assets or any part thereof.
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16.3. Termination shall be effective immediately upon written notice.
In the event of termination, the following sections shall survive: 13, 14,
16.3, 16.4, 17, 18, 19, and 21.
16.4. EFFECT OF TERMINATION.
16.4.1. Upon termination each Party shall, at the other Party's
direction, return or certify destruction of Confidential Information of
such other Party. Neither Party shall be liable to the other for damages
of any sort resulting solely from terminating this Agreement in accordance
with its terms.
16.4.2. Upon expiration or termination of this Agreement, each Party
shall provide reasonable assistance to the other for such reasonable time
and upon such terms and conditions as shall be mutually agreed upon in
order to assure an orderly transition and wind down in such a manner as
shall minimize disruption to the users of the Rhythms/Microsoft Portals.
The goal of both Parties is to ensure a smooth and seamless transition for
the user to maintain a high level of customer satisfaction.
17. REPRESENTATIONS AND COVENANTS.
17.1. Rhythms represents, warrants and covenants to Microsoft that:
17.1.1. Rhythms has the power and authority to enter into this Agreement
and to fully perform its obligations hereunder.
17.1.2. Rhythms has obtained, and shall maintain in full force during the
term hereof, such federal, state and local authorizations as are necessary
to operate and to otherwise perform its obligations under this Agreement,
and will be in compliance with all applicable laws and regulations
governing such performance.
17.1.3. The content provided by Rhythms for inclusion in the Content
Modules of the Rhythms/Microsoft Portals will not infringe the copyrights,
trademarks, service marks or trade secrets of any third party and is not
factually accurate or contains information, instructions or formulas that
are injurious to a third party's physical well-being, or defame or
disparage a third party.
17.1.4. Rhythms will not make any representations or warranties
concerning Rhythms/Microsoft Portals except as may be specifically
authorized in writing by Microsoft.
17.2. Microsoft represents, warrants and covenants to Rhythms that:
17.2.1. Microsoft has the power and authority to enter into this
Agreement and to fully perform its obligations hereunder.
17.2.2. Microsoft has obtained, and shall maintain in full force during
the term hereof, such federal, state and local authorizations as are
necessary to operate and to otherwise perform its obligations under this
Agreement, and will be in compliance with all applicable laws and
regulations governing such performance.
17.3. PRODUCTS OR SERVICES DELIVERED UNDER THE TERMS OF THIS AGREEMENT
SHALL BE SUBJECT TO THE TERMS OF THE LIMITED WARRANTY STATEMENT, IF ANY,
SPECIFIED BY THE DELIVERING PARTY FOR THE SPECIFIC PRODUCT OR SERVICE.
CERTAIN SOFTWARE PRODUCTS MAY BE PROVIDED TO THE OTHER PARTY "AS IS"
WITHOUT WARRANTY OR CONDITION OF ANY KIND, IF SO DESIGNATED BY THE
LICENSOR. FOR SUCH PRODUCTS, THE ENTIRE RISK AS TO THE RESULTS AND
PERFORMANCE OF SUCH SOFTWARE IS ASSUMED BY THE RECEIVING PARTY AND ITS
CUSTOMERS AND SUBLICENSEES, IF ANY. THE WARRANTIES SET FORTH IN THIS
SECTION 17 ARE THE ONLY WARRANTIES MADE BY THE PARTIES. EACH PARTY
DISCLAIMS ANY AND ALL OTHER WARRANTIES OR REPRESENTATION EXPRESS OR
IMPLIED, INCLUDING, BUT NOT LIMITED TO, THE IMPLIED WARRANTIES OF
MERCHANTABILITY, TITLE, AND FITNESS FOR A PARTICULAR PURPOSE. MICROSOFT
EXPRESSLY DISCLAIMS ANY WARRANTS THAT ACCESS TO OR USE OF THE CO-BRANDED
PORTALS WILL BE UNINTERRUPTED OR ERROR-FREE.
18. INDEMNIFICATION.
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A Party (the "Indemnifying Party") shall, at its expense and the request of
the other Party (the "Indemnified Party"), defend any third-party claim or
action brought against the Indemnified Party, and its affiliates, directors,
officers, employees, licensees, agents and independent contractors, to the
extent it is based upon a claim that, if true, would constitute a breach of a
warranty, representation or covenant of the Indemnifying Party set forth in
this Agreement (collectively, "Indemnified Claims"). The Indemnified Party
shall promptly notify the Indemnifying Party in writing, specifying the
nature of the action and the total monetary amount sought or other such
relief as is sought therein. The Indemnified Party shall cooperate with the
Indemnifying Party at the Indemnifying Party's expense in all reasonable
respects in connection with the defense of any such action. The Indemnifying
Party may upon written notice to the Indemnified Party undertake to control
and conduct all proceedings or negotiations in connection therewith, assume
and control the defense thereof, and if it so undertakes, it shall also
undertake all other required steps or proceedings to settle or defend any
such action, including the employment of counsel which shall be reasonably
satisfactory to the Indemnified Party, and payment of all reasonably incurred
expenses. The Indemnified Party shall have the right to employ separate
counsel to provide input into the defense, at the Indemnified Party's own
cost. The Indemnifying Party shall reimburse the Indemnified Party upon
demand for any payments made or loss suffered by it at any time after the
date of tender, based upon the judgment of any court of competent
jurisdiction or pursuant to a bona fide compromise or settlement of claims,
demands, or actions, in respect to any damages to which the foregoing
relates. The Indemnifying Party shall not settle any claim or action under
this Section 18 on the Indemnified Party's behalf without first obtaining the
Indemnified Party's written permission, which permission shall not be
unreasonably withheld, and the Indemnifying Party shall indemnify and hold
the Indemnified Party harmless from and against any costs, damages and fees
reasonably incurred by the Indemnified Party, including but not limited to
fees of attorneys and other professionals, that are attributable to such
Indemnified Claims.
19. LIMITATION OF LIABILITIES.
NEITHER PARTY SHALL BE LIABLE TO THE OTHER FOR ANY INDIRECT, INCIDENTAL,
CONSEQUENTIAL, PUNITIVE OR SPECIAL DAMAGES, ARISING OUT OF OR RELATED TO THIS
AGREEMENT INCLUDING, WITHOUT LIMITATION, DAMAGES FOR LOSS OF BUSINESS PROFITS,
BUSINESS INTERRUPTION, LOSS OF BUSINESS INFORMATION, AND THE LIKE, EVEN IF SUCH
PARTY HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES. THIS SECTION SHALL
NOT APPLY TO EITHER PARTY'S (A) ABILITY TO OBTAIN INJUNCTIVE OR OTHER EQUITABLE
RELIEF; (B) CONFIDENTIALITY OBLIGATIONS UNDER SECTION 14; AND (C)
INDEMNIFICATION OBLIGATIONS UNDER SECTION 18.
20. PRESS RELEASES.
Neither Party will issue any press release or make any public announcement(s)
relating in any way whatsoever to this Agreement or the relationship established
by this Agreement without the express prior written consent of the other Party,
which consent shall not be unreasonably withheld.
21. GENERAL PROVISIONS
21.1. INDEPENDENT CONTRACTORS. The Parties are independent contractors
with respect to each other, and nothing in this Agreement shall be
construed as creating an employer-employee relationship, a partnership,
agency relationship or a joint venture between the Parties.
21.2. GOVERNING LAW. This Agreement shall be governed by the laws of
the State of Washington as though entered into by Washington residents and
to be performed entirely within the State of Washington. In any action or
suit to enforce any right or remedy under this Agreement or to interpret
any provision of this Agreement, the prevailing Party shall be entitled to
recover its costs, including reasonable attorneys' fees.
21.3. ASSIGNMENT. Neither Party may assign this Agreement or any
rights and/or obligations hereunder without the other Party's prior written
approval, provided, however, that either shall have the right to assign its
rights, interests and obligations under this Agreement to a company with
whom it merges or consolidates or who acquires all or substantially all of
the stock or assets of the assigning Party (each such company, a "Permitted
Assignee"), provided that such Permitted Assignee or any of its Affiliates
(i) is not identified on a list provided in writing on or before the
Effective Date, or any entity with whom such listed entity has merged
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or has consolidated, or who has acquired all or substantially all of the
stock or assets of such listed entity and (ii) agrees in writing to be
bound by all of the obligations of the assigning Party under this
Agreement. An "Affiliate", for purposes of this Section, shall mean a
company or legal entity which controls, is controlled by, or is under
common control with, a Party. "Control" means the possession, directly or
indirectly, of the power to direct or cause the direction of the management
and policies of a legally recognizable entity, whether through the
ownership of voting shares, by contract, or otherwise. Any attempted
assignment, sub-license, transfer, encumbrance or other disposal without
such consent shall be void and shall constitute a material default and
breach of this Agreement. This Agreement shall be binding on, and shall
inure to the benefit of, the Parties hereto, and their respective
successors and Permitted Assigns.
21.4. CONSTRUCTION. In the event that any provision of this Agreement
conflicts with governing law or if any provision is held to be null, void
or otherwise ineffective or invalid by a court of competent jurisdiction,
(i) such provision shall be deemed to be restated to reflect as nearly as
possible the original intentions of the Parties in accordance with
applicable law, and (ii) the remaining terms, provisions, covenants and
restrictions of this Agreement shall remain in full force and effect. This
Agreement has been negotiated by the Parties and their respective counsel
and will be interpreted fairly in accordance with its terms and without any
strict construction in favor of or against either Party. The section
headings used in this Agreement are intended for convenience only and shall
not be deemed to affect in any manner the meaning or intent of this
Agreement or any provision hereof.
21.5. NOTICES. All notices and requests in connection with this
Agreement shall be given in writing and shall be deemed given as of the day
they are received either by messenger, delivery service, or in the United
States of America mail, postage prepaid, certified or registered, return
receipt requested, and addressed as follows:
TO RHYTHMS: TO MICROSOFT:
Rhythms NetConnections Inc. Microsoft Corporation
6933 So. Revere Parkway One Microsoft Way
Englewood, CO 80112 Redmond, WA 98052-6399
Phone: 303-476-4200 Phone: 425-882-8080
Fax: 303-476-5700 Fax: 425-936-7329
Attention: Chief Financial Attention: Vice President, Internet
Officer Customer Unit
Copy to:
Law & Corporate Affairs, US Legal
Fax: 425-936-7409
or to such other address as a Party may designate pursuant to this notice
provision.
21.6. ENTIRE AGREEMENT. This Agreement shall not be effective until
signed by both Parties. This Agreement, together with the letter of intent
referenced in Section 5,the NDA and any side letters referenced herein,
constitutes the entire agreement between the Parties with respect to the
subject matter hereof and supersedes all prior and contemporaneous
agreements or communications. This Agreement shall not be modified except
by a written agreement dated subsequent to the date of this Agreement and
signed on behalf of the Parties by their respective duly authorized
representatives. No waiver of any breach of any provision of this
Agreement shall constitute a waiver of any prior, concurrent or subsequent
breach of the same or any other provisions hereof, and no waiver shall be
effective unless made in writing and signed by an authorized representative
of the waiving Party.
[REST OF PAGE INTENTIONALLY LEFT BLANK]
-9-
<PAGE>
The Parties have caused this Agreement to be executed by their duly authorized
representatives as of the Effective Date.
MICROSOFT CORPORATION RHYTHMS NETCONNECTIONS INC.
By /s/ Thomas Koll By /s/ Catherine M. Hapka
------------------------------- ----------------------------------
Name (Print) Thomas Koll Name (Print) Catherine M. Hapka
---------------------- -------------------------
VICE PRESIDENT
Title INTERNET CONSUMER UNIT Title PRESIDENT AND CEO
---------------------------- --------------------------------
Date 3/16/99 Date 3/16/99
----------------------------- ----------------------------------
-10-
<PAGE>
EXHIBIT A
MOCK-UP OF START PAGES FOR RHYTHMS/MICROSOFT PORTALS
SEE ATTACHED
-11-
<PAGE>
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the inclusion in this registration statement on Form S-1 (File
No. 333-72409) of our report dated March 4, 1999 on our audits of the
consolidated financial statements of Rhythms NetConnections Inc. We also
consent to the reference to our firm under the caption "Experts."
PricewaterhouseCoopers LLP
Denver, Colorado
March 16, 1999
<PAGE>
POWERS OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Catherine M. Hapka and Scott C. Chandler, or
either of them, as his or her true and lawful attorneys-in-fact and agents, with
full power of substitution and resubstitution, for him or her and in his or her
name, place and stead, in any and all capacities, to sign any and all amendments
(including post-effective amendments) to this Registration Statement and any
registration statement related to this Registration Statement and filed pursuant
to Rule 462 under the Securities Act of 1933, and to file the same, with all
exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, full power and authority to do and perform each and every act and thing
requisite and necessary to be done in connection therewith as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents, or their substitute or
substitutes may lawfully do or cause to be done by virtue hereof.
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 DATE
--------- ----- ----
<S> <C> <C>
/s/ Susan Mayer Director March 12, 1999
- ------------------------------
Susan Mayer
/s/ Edward J. Zander Director March 12, 1999
- ------------------------------
Edward J. Zander
</TABLE>
