<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 22, 1998
REGISTRATION NO. 333-61293
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
AMENDMENT NO. 1
TO
FORM S-4
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
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SPLITROCK SERVICES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
DELAWARE 76-0529757 4825
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION (PRIMARY STANDARD INDUSTRIAL
INCORPORATION OR ORGANIZATION) NUMBER) CLASSIFICATION CODE NUMBER)
</TABLE>
8665 NEW TRAILS DRIVE, STE. 200
THE WOODLANDS, TEXAS 77381
(281) 465-1200
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
PATRICK J. MCGETTIGAN, JR., ESQ.
SENIOR VICE PRESIDENT
8665 NEW TRAILS DRIVE, STE. 200
THE WOODLANDS, TEXAS 77381
(281) 465-1200
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
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Copies to:
ARTHUR S. BERNER, ESQ.
WINSTEAD SECHREST & MINICK P.C.
910 TRAVIS, SUITE 2400
HOUSTON, TEXAS 77002
(713) 650-2729
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
If the securities being registered on this Form are to be offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
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If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
- ---------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
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The Information in this prospectus is not complete and may be changed. We may
not sell these securities until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus is not an offer
to sell these securities and it is not soliciting an offer to buy these
securities in any state where the offer and sale is not permitted.
SUBJECT TO COMPLETION, DATED SEPTEMBER 22, 1998
PRELIMINARY PROSPECTUS
[SPLITROCK LOGO]
$250,000,000
SPLITROCK SERVICES, INC.
OFFER TO EXCHANGE
11 3/4% SERIES B SENIOR NOTES DUE 2008 FOR ALL
OUTSTANDING 11 3/4% SENIOR NOTES DUE 2008
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M.,
NEW YORK CITY TIME, ON , 1998 (30 DAYS AFTER THE REGISTRATION
STATEMENT COVERING THIS EXCHANGE HAS BEEN DECLARED EFFECTIVE BY THE SECURITIES
AND EXCHANGE COMMISSION), UNLESS EXTENDED
Splitrock Services, Inc., a Delaware corporation ("Splitrock" or the
"Company") hereby offers, upon the terms and subject to the conditions set forth
in this prospectus (the "Prospectus") and the accompanying letter of transmittal
(the "Letter of Transmittal" and, together with the Prospectus, the "Exchange
Offer"), to exchange up to an aggregate principal amount of $250,000,000 of its
new 11 3/4% Series B Senior Notes due 2008 (the "Exchange Notes") for up to an
aggregate principal amount of $250,000,000 of its outstanding 11 3/4% Senior
Notes due 2008 (the "Original Notes" and together with Exchange Notes, the
"Notes") other than those Original Notes held by an affiliate of the Company. As
of the date hereof, Original Notes in the aggregate principal amount of $11.0
million are held by Linsang Partners L.L.C., an affiliate of the Company. See
"The Exchange Offer -- Purpose of the Exchange Offer." The Exchange Offer has
been registered under the Securities Act of 1933, as amended (the "Securities
Act") pursuant to a registration statement (the "Registration Statement") of
which this Prospectus is a part. The form and terms of the Exchange Notes are
substantially identical to the form and terms of the Original Notes, except for
certain transfer restrictions, registration rights and liquidated damages
relating to the Original Notes. The Exchange Notes will evidence the same debt
as the Original Notes and will be issued under and entitled to the benefits of
an indenture dated July 24, 1998 governing the Original Notes (the "Indenture").
The Exchange Notes will bear interest at the same rate and on the same
terms as the Original Notes. Interest on the Exchange Notes will accrue from the
date of issuance (the "Exchange Date") at the rate of 11 3/4% per annum and will
be payable semi-annually on January 15 and July 15 of each year, commencing on
January 15, 1999. Holders of the Exchange Notes will also, on January 15, 1999,
receive an amount equal to the accrued interest on the Original Notes exchanged
therefor. Interest on the Original Notes accepted for exchange will cease to
accrue upon issuance of the Exchange Notes. The Company has deposited with The
Chase Manhattan Bank, as escrow agent (the "Escrow Agent"), in an escrow account
(the "Escrow Account") established pursuant to the Escrow and Disbursement
Agreement (the "Escrow Agreement") dated July 24, 1998 between the Company and
the Escrow Agent, $56.8 million in Temporary Cash Investments (as defined) that,
together with the interest received
(continued on next page)
SEE "RISK FACTORS" BEGINNING ON PAGE 19 FOR A DISCUSSION OF CERTAIN FACTORS THAT
SHOULD BE CONSIDERED IN EVALUATING AN INVESTMENT IN THE EXCHANGE NOTES.
THIS PROSPECTUS AND THE LETTER OF TRANSMITTAL ARE FIRST BEING MAILED TO HOLDERS
OF OUTSTANDING NOTES ON OR ABOUT , 1998.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
THE DATE OF THIS PROSPECTUS IS , 1998.
<PAGE> 3
thereon, will be sufficient to pay when due the first four semi-annual interest
payments on the Notes. The Notes will mature on July 15, 2008. The Company may
redeem the Notes, in whole or in part, on or after July 15, 2003, at the
redemption prices set forth herein, together with accrued and unpaid interest
and liquidated damages, if any, to the date of redemption. In addition, at any
time and from time to time prior to July 15, 2001, the Company may, subject to
certain requirements, redeem up to 35% of the aggregate principal amount of the
Notes (calculated after giving effect to any issuance of Additional Notes, as
defined) with the Net Cash Proceeds (as defined) of one or more Equity Offerings
(as defined) by the Company, at a redemption price equal to 111.75% of the
principal amount thereof, plus accrued and unpaid interest and liquidated
damages, if any, to the date of redemption; provided, however, that at least 65%
of the original aggregate principal amount of the Notes remains outstanding
immediately after giving effect to such redemption. The Notes will not be
subject to any sinking fund requirement. Upon the occurrence of a Change of
Control (as defined), each holder of the Notes will have the right to require
the Company to repurchase all or any part of such holder's Notes at a price
equal to 101% of the aggregate principal amount of the Notes plus accrued and
unpaid interest and liquidated damages, if any, to the date of repurchase. There
can, however, be no assurance that upon any such Change of Control the Company
will be able to fund the repurchase obligation. Failure to fund such repurchase
obligation will constitute an Event of Default (as defined) under the Notes. See
"Description of the Notes."
The Notes will be Senior Indebtedness (as defined) of the Company, will
rank pari passu with all existing and future Senior Indebtedness of the Company
and will rank senior to all future Subordinated Obligations (as defined) of the
Company. The Notes will be unsecured (except that the Trustee (as defined) will
have a security interest in the Escrow Account for the benefit of the holders of
the Notes) and will therefore be effectively subordinated to all secured
indebtedness of the Company. Although the Company does not currently have any
subsidiaries, the Notes will be fully and unconditionally guaranteed on a
senior, unsecured basis by each of the Company's future Restricted Subsidiaries
(as defined) that incurs indebtedness. See "Description of the Notes -- Certain
Covenants -- Future Subsidiary Guarantors." At June 30, 1998, after giving pro
forma effect to the offering of the Original Notes and the application of the
proceeds therefrom, the Company would have had $21.2 million of indebtedness
outstanding (other than the Notes), all of which would have been Senior
Indebtedness and all of which would have been secured.
The Original Notes were issued and sold on July 24, 1998, as part of a unit
offering (the "Unit Offering") in which each unit (the "Units") consisted of one
Original Note and one warrant (the "Warrants") to purchase 10.125 shares of
common stock, par value $.001 per share (the "Common Stock"), of the Company.
The Unit Offering was not registered under the Securities Act, in reliance upon
the exemptions provided in Section 4(2) of and Rule 144A under the Securities
Act. Accordingly, the Original Notes may not be reoffered, resold or otherwise
pledged, hypothecated or transferred unless so registered or unless an
applicable exemption from the registration requirements of the Securities Act is
available. Under the Exchange Offering, the Company will accept for exchange all
Original Notes, other than Original Notes held by affiliates of the Company,
validly tendered and not withdrawn before 5:00 p.m., New York City time, on
, 1998 (30 days after the registration statement covering this
Exchange Offer has been declared effective by the Securities and Exchange
Commission) unless extended by the Company, in its sole discretion, to a date
not later than , 1998 (the "Expiration Date"). Tenders of
Original Notes may be withdrawn at any time before 5:00 p.m., New York City
time, on the Expiration Date. If the Company terminates the Exchange Offer and
does not accept for exchange any Original Notes with respect to the Exchange
Offer, the Company will promptly return the Original Notes to the holders
thereof. The Exchange Offer is not conditioned upon any minimum principal amount
of Original Notes being tendered for exchange, but is subject to certain other
conditions, which may be waived by the Company. See "The Exchange
Offer -- Certain Conditions." Notes may be tendered only in integral multiples
of $1,000.
Although the Notes are eligible for trading in the Private Offerings,
Resales and Trading through Automated Linkages ("PORTAL") market, there is no
established trading market for the Notes and the Company does not intend to list
the Notes on any securities exchange or to seek approval for quotation through
any automated quotation system. There can be no assurance that an active market
for the Notes will develop. To the extent that a market for the Notes does
develop, the market value of the Notes will depend on market conditions (such as
yields on alternative investments), general economic conditions, the Company's
2
<PAGE> 4
financial condition and other conditions. Such conditions might cause the Notes,
to the extent that they are actively traded, to trade at a significant discount
from face value. See "Risk Factors Absence of Public Market."
The Exchange Notes are being offered hereunder to satisfy certain
obligations of the Company contained in the Exchange and Registration Rights
Agreement dated as of July 24, 1998 (the "Exchange and Registration Rights
Agreement") by and between the Company and Chase Securities Inc. (the "Initial
Purchaser") executed in connection with the sale of the Original Notes. Although
the Company has agreed to bear the expenses of this Exchange Offer, the Company
will not receive any proceeds from this Exchange Offer and no underwriter is
being used in connection with this Exchange Offer. Based on no-action letters
issued by the staff of the Securities and Exchange Commission (the "Commission")
to third parties, the Company believes that the Exchange Notes issued pursuant
to this Exchange Offer in exchange for Original Notes may be offered for resale,
resold and otherwise transferred by a holder thereof (other than (i) a broker-
dealer who purchases such Exchange Notes directly from the Company to resell
pursuant to Rule 144A or any other available exemption under the Securities Act
or (ii) a person that is an affiliate of the Company within the meaning of Rule
405 under the Securities Act), without compliance with the registration and
prospectus delivery requirements of the Securities Act if the holder is
acquiring the Exchange Notes in the ordinary course of its business and is not
participating and had no arrangement or understanding with any person to
participate in a distribution of the Exchange Notes. Holders of Original Notes
wishing to accept the Exchange Offer must represent to the Company that such
conditions have been met. Only broker-dealers who acquired the Original Notes as
a result of market-making activities or other trading activities may participate
in the Exchange Offer. Each broker-dealer that receives Exchange Notes for its
own account in exchange for the Original Notes must acknowledge that it will
deliver a Prospectus in connection with any resale of such Exchange Notes. The
Letter of Transmittal states that by so acknowledging and by delivering a
Prospectus, a broker-dealer will not be deemed to admit that it is an
"underwriter" within the meaning of the Securities Act. This Prospectus, as it
may be amended or supplemented from time to time, may be used by a broker-dealer
in connection with resales of Exchange Notes received in exchange for Original
Notes if such Original Notes were acquired by such broker-dealer as a result of
market-making activities or other trading activities. The Company has indicated
its intention to make this Prospectus, as it may be amended or supplemented,
available to any broker-dealer for use in connection with any such resale for a
period of 180 days after the Expiration Date. See "Plan of Distribution."
THE EXCHANGE OFFER IS NOT BEING MADE TO, NOR WILL THE COMPANY ACCEPT
SURRENDERS FOR EXCHANGE FROM, HOLDERS OF OUTSTANDING NOTES IN ANY JURISDICTION
IN WHICH THE EXCHANGE OFFER OR THE ACCEPTANCE THEREOF WOULD NOT BE IN COMPLIANCE
WITH THE SECURITIES ACT OR BLUE SKY LAWS OF SUCH JURISDICTION.
NO PERSON IS AUTHORIZED IN CONNECTION WITH ANY OFFERING MADE HEREBY TO GIVE
ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS
OR THE ACCOMPANYING LETTER OF TRANSMITTAL, AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY. NEITHER THE DELIVERY OF THIS PROSPECTUS OR THE ACCOMPANYING
LETTER OF TRANSMITTAL, NOR ANY EXCHANGE MADE HEREUNDER SHALL UNDER ANY
CIRCUMSTANCES CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS
CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF.
ALL STATEMENTS OTHER THAN STATEMENTS OF HISTORICAL FACTS INCLUDED IN THIS
PROSPECTUS, INCLUDING WITHOUT LIMITATION STATEMENTS REGARDING THE COMPANY'S
FUTURE FINANCIAL POSITION, STRATEGY, PROJECTED COSTS AND PLANS, OBJECTIVES OF
MANAGEMENT FOR FUTURE OPERATIONS AND STATEMENTS REGARDING "YEAR 2000"
COMPLIANCE, MAY BE DEEMED TO BE FORWARD-LOOKING STATEMENTS. ALTHOUGH THE COMPANY
BELIEVES THAT THE EXPECTATIONS REFLECTED IN SUCH FORWARD-LOOKING STATEMENTS ARE
REASONABLE, IT CAN GIVE NO AS-
3
<PAGE> 5
SURANCE THAT SUCH EXPECTATIONS WILL PROVE TO HAVE BEEN CORRECT. IMPORTANT
FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THE COMPANY'S
EXPECTATIONS ("CAUTIONARY STATEMENTS") ARE DISCLOSED UNDER "RISK FACTORS" AND
ELSEWHERE IN THIS PROSPECTUS, INCLUDING WITHOUT LIMITATION IN CONJUNCTION WITH
THE FORWARD-LOOKING STATEMENTS INCLUDED IN THIS PROSPECTUS. ALL FORWARD-LOOKING
STATEMENTS ATTRIBUTABLE TO THE COMPANY OR PERSONS ACTING ON THEIR BEHALF ARE
EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THE CAUTIONARY STATEMENTS.
AVAILABLE INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-4 (including all amendments, annexes, exhibits and schedules thereto, the
"Registration Statement") under the Securities Act with respect to the Exchange
Notes offered hereby. As permitted by the rules and regulations of the
Commission, this Prospectus omits certain information, exhibits and undertakings
contained in the Registration Statement with respect to the Company and the
Exchange Notes offered hereby. For further information, reference is made to the
Registration Statement, including the exhibits and financial schedules filed as
a part thereof. Statements made in this Prospectus concerning the contents of
any document referred to herein are not necessarily complete. With respect to
each such document filed with the Commission as an exhibit to the Registration
Statement, reference is made to the exhibit for a more complete description of
the document or matter involved and each such statement shall be deemed
qualified in its entirety by such reference. The Registration Statement,
including the exhibits thereto, may be inspected and copied at the public
reference facilities maintained by the Commission at Room 1024, 450 Fifth
Street, N.W., Washington, D.C. 20549, or at the regional offices of the
Commission at Seven World Trade Center, Suite 1300, New York, New York 10048 and
Northwest Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois
60661. Copies of such materials can be obtained by mail from the Commission's
Public Reference Section, 450 Fifth Street, N.W., Washington, D.C. 20549, at
prescribed rates. Electronic filings filed through the Commission's Electronic
Data Gathering, Analysis and Retrieval system ("EDGAR") are publicly available
through the Commission's home page on the Internet at http://www.sec.gov.
As a result of this Exchange Offer, the Company will be subject to the
periodic reporting and other informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). As long as the Company is
subject to such periodic reporting and informational requirements, the Company
will furnish all reports and other information required thereby to the
Commission and pursuant to the Indenture will furnish copies of such reports and
other information to the Trustee.
The Company has agreed that, whether or not it is required to do so by the
rules and regulations of the Commission, for so long as any of the Notes remain
outstanding, the Company will furnish to the holders of Notes (excluding
exhibits, which will be available upon request) and file with the Commission
(unless the Commission will not accept such a filing) (i) all quarterly and
annual financial information that would be required to be contained in a filing
with the Commission on Forms 10-Q and 10-K if the Company were required to file
such forms, including a "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and, with respect to the annual information
only, a report thereon by the Company's certified independent accountants, and
(ii) all reports that would be required to be filed with the Commission on Form
8-K if the Company were required to file such reports. In addition, for so long
as any of the Notes remain outstanding, the Company has agreed to make
available, upon request, to any prospective purchaser of the Notes and
beneficial owner of the Notes in connection with any sale thereof the
information required by Rule 144A(d)(4) under the Securities Act. Information
may be obtained from the Company at 8665 New Trails Drive, Suite 200, The
Woodlands, Texas 77381 (telephone number: (281) 465-1200), Attention: Patrick J.
McGettigan, Jr., Senior Vice President and Secretary.
4
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TABLE OF CONTENTS
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PAGE
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SUMMARY..................................................... 6
RISK FACTORS................................................ 20
USE OF PROCEEDS............................................. 35
CAPITALIZATION.............................................. 36
THE EXCHANGE OFFER.......................................... 37
SELECTED HISTORICAL AND UNAUDITED PRO FORMA FINANCIAL
DATA...................................................... 46
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................. 50
INDUSTRY OVERVIEW........................................... 62
BUSINESS.................................................... 65
MANAGEMENT.................................................. 81
PRINCIPAL STOCKHOLDERS...................................... 88
DESCRIPTION OF CERTAIN INDEBTEDNESS......................... 89
DESCRIPTION OF CAPITAL STOCK................................ 89
DESCRIPTION OF THE NOTES.................................... 90
DESCRIPTION OF THE WARRANTS................................. 116
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS................... 120
PLAN OF DISTRIBUTION........................................ 122
LEGAL MATTERS............................................... 123
EXPERTS..................................................... 123
GLOSSARY.................................................... 124
INDEX TO FINANCIAL STATEMENTS............................... F-1
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5
<PAGE> 7
SUMMARY
The following summary is qualified in its entirety by, and should be read
in conjunction with, the more detailed information and financial statements and
notes thereto included elsewhere in this Prospectus. Unless the context
otherwise requires, references to the "Company" or "Splitrock' refer to
Splitrock Services, Inc., references to "Prodigy" refer to Prodigy, Inc.,
references to "Lucent" refer to Lucent Technologies, Inc. and references to
"Yurie" refer to Yurie Systems, Inc. Yurie was acquired by Lucent in May 1998.
Certain industry data provided herein have been provided by International Data
Corporation ("IDC") or Forrester Research, Inc. ("Forrester"), private market
research firms. In addition, certain Internet Service Provider ("ISP")
performance data have been provided by Inverse Network Technology Inc., an
independent Internet testing group ("Inverse"). Capitalized terms used in this
Prospectus which are not otherwise defined herein have the respective meanings
assigned thereto under the heading "Glossary." The Company effected a 100-for-1
stock split on June 3, 1997 and a 10-for-1 stock split on August 8, 1997. All
share amounts included in this Prospectus have been adjusted to reflect the
effect of these stock splits. All information contained in this Prospectus
relating to percentage ownership of the Common Stock does not take into account
the 2,642,613 shares of Common Stock issuable upon exercise of certain
outstanding warrants issued by the Company.
THE COMPANY
GENERAL
The Company is a provider of telecommunications services, including high
speed Internet access services, on an advanced nationwide network based on ATM
switching technology which is deployed in every operational point of presence
("POP") of the network (the "Splitrock Network" or the "Network"). The pervasive
deployment of ATM switches throughout the Network ("ATM-to-the-edge") enables
the Company to serve as a broad-based ISP through the creation of a
multi-service platform which efficiently delivers IP, frame relay and other
Internet services. This flexibility will allow the Company to expand its service
offerings to provide fully integrated data, video and voice services and to
incorporate future technological innovations into its Network architecture with
a lower incremental investment than that required by other, less flexible,
networks. The Company currently provides nationwide Internet dial access and
related services to Prodigy, the third largest U.S. ISP measured in minutes
on-line, for its subscribers. In addition, the Company is providing Internet
transit services to Orbis Internet Services Inc., an Internet connection service
provider to businesses ("Orbis"), and expects to begin providing virtual private
network ("VPN") services to NetworkTwo Communications Group, a value added
network service provider ("NetworkTwo") during the fourth quarter of 1998. For
the six months ended June 30, 1998, the Company had revenues of $32.2 million.
The Splitrock Network currently reaches more than 55% of U.S. households by
a local call with 56k modem access (currently the fastest modem speed
commercially available over residential phone lines), including households in
every market with a population of at least 100,000 as well as several second
tier markets. From September 1997 to April 1998, the Company deployed the
Splitrock Network infrastructure, primarily targeting densely populated markets
(the "Phase I Buildout"). The Phase I Buildout resulted in the deployment of the
nationwide ATM backbone portion of the Splitrock Network and POPs in 70
metropolitan areas across the nation. The Company is currently in the process of
constructing approximately 330 new POPs, deploying advanced processing equipment
and software to enhance and accelerate its ability to offer value added
services, such as ISDN video, web hosting and VPN, and augmenting its network
management infrastructure (the "Phase II Expansion"). The Company believes that
the Phase II Expansion will be substantially completed in the second quarter of
1999. Upon completion of the Phase II Expansion, the Network will have
approximately 400 active POPs with a physical presence in all 50 states,
reaching over 90% of U.S. households with a local call.
In order to provide services to Prodigy while the Splitrock Network was
being deployed, on July 1, 1997 the Company acquired Prodigy's existing legacy
network infrastructure (the "Legacy Network") and began immediately providing
Internet dial access and related services to Prodigy for its subscribers. See
"Risk
6
<PAGE> 8
Factors -- Reliance on Prodigy; Recent Discussions with Prodigy." Additionally,
the Company has an agreement with IBM to use IBM's network (the "IBM Global
Services Network") to cover market areas that are served neither by the
Splitrock Network nor the Legacy Network. The Company currently handles more
than 800 million minutes of Internet traffic per month for Prodigy (currently
the Company's only Internet dial access customer), with over 60% of the traffic
flowing on the Splitrock Network, approximately 30% on the IBM Global Services
Network and the remainder on the Legacy Network. As the Phase II Expansion
progresses, Legacy Network POPs will be decommissioned and access to specific
IBM Global Services Network POPs will be terminated when appropriate.
Substantially all Legacy Network POPs are expected to be decommissioned by the
end of 1998 and usage of the IBM Global Services Network is expected to be
terminated by the end of the second quarter of 1999.
INDUSTRY OVERVIEW
The Company believes that it is well-positioned to capture revenue
opportunities in the growing Internet services market. As a broad-based ISP, the
Company utilizes an advanced ATM-to-the-edge Network to offer services that
either directly address Internet connectivity (dial access and transit) or which
leverage Internet technology to provide cost-effective alternatives to
traditional corporate network solutions (VPN). While the Company is considering
broadening its service offerings to optimize Network utilization, the Company
believes that a significant amount of its revenues for the foreseeable future
will continue to be derived from Internet related applications.
The Internet services industry is one of the fastest growing segments of
the global telecommunications market. Forrester estimates that the U.S. market
for Internet and related services, including advanced Internet applications such
as VPN, voice communications, fax and video conferencing, was approximately $6.2
billion in 1997 and will grow to approximately $49.7 billion in 2002, reflecting
a compound annual growth rate of over 50%. The Company believes that Internet
dial access and transit services, VPN services and enhanced business services
represent three of the fastest growing segments of the industry.
Internet access services represent the means by which ISPs interconnect
either businesses or individual consumers to the Internet's resources or to
corporate intranets and extranets. Access services include dial-up access for
individuals and small businesses and high-speed dedicated access (transit
services) used primarily by mid-sized and larger organizations. According to
Forrester, business access services are projected to grow at a compound annual
growth rate of approximately 75%, from approximately $1.0 billion in 1997 to
approximately $16.0 billion in 2002.
In addition, the Company believes that many businesses desire to utilize
VPNs as a lower-cost alternative to certain traditional telecommunications
services. Historically, many corporations established and maintained their own
private wide-area networks ("WANs") to provide network-based services, such as
transaction processing, to their customers and to coordinate operations between
employees, suppliers and business partners. These networks, which have
traditionally required the use of leased telephone lines with dedicated
bandwidth and the purchase of vendor-specific networking equipment and software,
are inherently expensive to set up, operate and maintain. The Company believes
that VPNs present a cost-effective alternative to WANs since VPNs (i) eliminate
the need to invest significant amounts in proprietary equipment and software,
(ii) securely and efficiently connect multiple, geographically dispersed
locations, (iii) provide global remote access capabilities and (iv) offer a full
range of value added services, such as videoconferencing, that meet a company's
particular networking needs.
In addition to Internet access and VPN services, business customers
increasingly are seeking a variety of enhanced products and applications to take
full advantage of the Internet. The principal enhanced services currently
available to companies are Web hosting, including hosting of intranet sites,
e-mail outsourcing, e-mail broadcast and security. Forrester forecasts that
enhanced business services revenues will grow from approximately $0.4 billion in
1997 to approximately $10.5 billion in 2002, representing a compound annual
growth rate of 92%. See "Industry Overview."
7
<PAGE> 9
COMPETITIVE ADVANTAGES
Since July 1997, the Company has provided Internet dial access services to
Prodigy for its subscribers. The Company believes it benefits from the following
competitive advantages which will assist it in implementing its business
strategy:
Flexible and Efficient New Network Infrastructure. The Splitrock
Network is designed to provide reliable, flexible and efficient services to
the Company's current and future customers. Since the Splitrock Network is
newly-designed (and not based on or an upgrade to an older network), the
Company believes the Network contains many features that are not present in
older networks and is able to flexibly incorporate future developments and
innovations. Older networks were typically designed to provide one type of
service, such as voice or data, and are less efficient at carrying other
traffic. Unlike many networks which deploy ATM technology only along the
core sites in the backbone, the Splitrock Network deploys ATM-to-the-edge
at every core site, hub site and remote site. See "Business -- Splitrock's
Network." Each POP is supported by the Lucent LDR200 switch, which the
Company believes provides significant quality of service advantages over
typical ATM backbone switches. Management believes that the Network
contains more ATM-based switches than that of any other commercial network.
This pervasive use of ATM technology and the Lucent LDR200 switch enables
the Company to create a multi-service platform which delivers IP, frame
relay and other Internet services. In addition, ATM-to-the-edge provides
additional capabilities to expand the Company's service offerings to
provide fully integrated data, video and voice services and to incorporate
future technological innovations into the Splitrock Network architecture
with a lower incremental investment than that required by other, less
flexible, networks.
Provider of Wholesale Internet Dial Access and International
Services. The Company currently provides wholesale Internet dial access
services to Prodigy for its subscribers. The Company intends to market
Internet dial access services directly to ISPs rather than to individual
end-users. As a result, unlike many providers of network services, the
Company does not intend to compete against its ISP customers, thereby
broadening the potential customer base to include those ISPs unwilling to
strengthen their competitors with their own network business. Furthermore,
the Company believes it will be viewed as a non-competing vendor, and thus
a potential partner, by major foreign and regional telecommunications
carriers, providing an alternative to their primary U.S. competitors for
delivering data, video and voice services.
Experienced Management Team. The Company's co-founders, Kwok L. Li,
Chairman of the Board and Chief Technical Officer, and William R. Wilson,
President and Chief Executive Officer, have assembled a management team
with significant data and voice communications experience. The 10 most
senior executives and managers of the Company have an average of over 12
years experience in the data and voice communications industry. Previously,
Mr. Li and Mr. Wilson were both senior executives at the predecessor
corporation of WilTel Communications LLC ("WilTel"), a wholesale provider
of telecommunications services. During their tenure, WilTel designed,
constructed, developed and managed modern packet switched networks
(including frame relay and ATM) and marketed related services. At the time
of the sale of Yurie to Lucent in May 1998, Mr. Li was a Director, Vice
Chairman and Chief Technical Officer at Yurie, where he created and
designed the Lucent LDR200 switch which is a key component of the Splitrock
Network.
BUSINESS STRATEGY
Key elements of the Company's business strategy include:
Complete the Expansion of the Advanced Network Infrastructure. The
Company has designed, deployed and is in the process of expanding the
Splitrock Network, an advanced nationwide telecommunications network based
on ATM-to-the-edge switching technology. Through June 30, 1998, the Company
had spent approximately $25.0 million on the Phase I Buildout, which was
substantially completed in April 1998, and $14.2 million on the Phase II
Expansion. The Company anticipates that completion of the Phase II
Expansion will require an additional $139.6 million of capital
expenditures. The Company expects to spend approximately $45.9 million to
construct approximately 330 additional
8
<PAGE> 10
POPs, approximately $81.5 million to deploy advanced processing equipment
and software to enhance and accelerate the Company's ability to provide
value added services, such as ISDN video, web hosting and VPN, and
approximately $12.2 million to support the Company's network management
infrastructure. Of these amounts, the Company has spent $3.2 million since
June 30, 1998. The Company believes that having ATM-to-the-edge results in:
(i) a more easily upgradeable network; (ii) the ability to efficiently add
new services at a lower incremental investment; (iii) improved network
reliability; (iv) interoperability with other network platforms; and (v)
improved network manageability.
Offer a Comprehensive Range of Services to Optimize Network
Utilization. Given the fixed cost nature of the Splitrock Network's
infrastructure, the Company seeks to increase total network utilization
primarily by targeting providers of business services (daytime intensive
traffic) and, to a lesser extent, providers of consumer services (evening
intensive traffic) to balance the Network's usage throughout a 24-hour
period. The Network's flexibility will provide for service innovation
(including data, video and voice services) with lower incremental
investment than less flexible networks. To offer new services, the Company
will only need to add the appropriate protocol processors and billing and
service management systems without changes to the core ATM switching
platform. Therefore, the Company believes it will be able to maximize
Network utilization by offering both daytime business-oriented services
(such as video conferencing and VPN services) and evening-time
consumer-oriented services (such as Internet dial access services). The
ability of the Company to offer a wide range of services will enhance its
ability to optimize traffic at all times of the day, thereby increasing
revenue and profitability. As its business strategy is implemented, the
Company will evaluate offering complementary services as they are required
by its customer base.
Development of Advanced Business Support Systems. Through the
development of scalable business support systems, the Company believes that
it has the opportunity to establish a competitive advantage relative to
traditional network service providers. Traditional network service
providers typically operate extensive legacy business support systems with
compartmentalized architectures that limit their ability to scale rapidly
and introduce enhanced services and features. In connection with the
expansion of the Splitrock Network the Company is creating business support
systems with an architecture designed to maximize both reliability and
scalability. All database and billing systems will run on a PC or UNIX
distributed architecture rather than centralized mainframe systems.
Expand Target Market Opportunities. IDC estimates that the total
number of U.S. companies with Internet access will grow from an estimated
1.5 million, or 20.0% of total U.S. companies, in 1996 to 4.1 million, or
53.0% of total U.S. companies, in 2000. IDC also estimates that the number
of U.S. households with a personal computer and a modem will grow from an
estimated 8.8 million, or 24.0% of all U.S. households with a personal
computer in 1996, to 39.4 million, or 58.0% of all U.S. households with a
personal computer, in 2000. IDC estimates that there are currently over
4,000 ISPs in the U.S., consisting of national, regional and local
providers, of which the Company believes only a small percentage have
access to their own nationwide backbone network infrastructure. The Company
intends to capitalize on this expected growth in demand for network
services by aggressively marketing its services through a variety of
distribution channels and evaluating strategic alliances and acquisitions
as they present themselves. The Company believes that utilizing a range of
distribution channels will enable it to cost-effectively reach a broad base
of potential customers. The Company currently intends to develop and use a
direct sales force (which it expects to begin hiring late in the second
half of 1998) to attract ISPs, carriers, value added service providers and
medium and large businesses. In addition, the Company intends to use
alternative distribution channels, including agents, resellers and
wholesalers, to gain access to a substantially larger base of potential
customers than the Company could otherwise initially address through its
direct sales force. Through the combination of a direct sales force and
alternative distribution channels, the Company will seek to rapidly
increase revenue-producing traffic on its Network.
The Company also intends to evaluate strategic alliances and
acquisitions that could provide additional traffic over the Splitrock
Network. While the Company is primarily focused on the domestic services
market, it believes the demand for Internet services outside the U.S. will
grow over the next few years. As a result, the Company will evaluate
opportunities, primarily in Latin America, to partner with
9
<PAGE> 11
strong, established telecommunications service providers. For example, the
Company will consider entering into international alliances to originate
and terminate international traffic on the Splitrock Network.
Provide Superior Comprehensive Customer Service. Splitrock believes
that superior customer service is a critical element in attracting and
retaining customers, and expanding value added services to existing
customers. In particular, the Company believes it is critical to maintain
two geographically dispersed Network Operations Centers ("NOCs"), each of
which is able to monitor the entire Network and provide rapid problem
resolution. The Company has established a 24-hours per day, seven days per
week NOC at its Yorktown, NY facility. In addition, a new 24-hours per day,
seven days per week NOC recently became fully operational at The Woodlands,
TX facility.
RECENT DEVELOPMENTS
During the three months ended June 30, 1998, the Company began the Phase II
Expansion, the Company's largest build-out initiative to date. Until the
completion of the Phase II Expansion (expected in the second quarter of 1999),
the Company will continue to utilize the IBM Global Services Network. The
decrease in revenues between the first and second quarters of 1998 was primarily
the result of the switch in the calculation of charges for Prodigy services from
the Usage-Based Rate (as defined) to the Subscriber-Based Rate (as defined)
caused by an increase in average hourly use of subscribers and a decline in
total number of subscribers. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations." The larger EBITDA deficit, net
loss and negative operating cash flows compared to the first quarter of 1998 was
primarily the result of the lower revenues and the increased usage charges
related to the IBM Global Services Network described above and increased line
and telecommunications charges relating to the expansion of Splitrock Network.
The Company expects to continue to incur negative EBITDA, net loss and negative
operating cash flows through the completion of the Phase II Expansion. Cash flow
used in operating activities can vary significantly from period to period
depending upon the timing of operating cash receipts from Prodigy and the
payments to large vendors. The Company expects this variation to continue until
the Phase II Expansion is completed and the Company's base of customers has
increased. Thereafter, the Company's ability to generate positive EBITDA, net
income and cash flows will depend on the successful implementation of its
business strategy.
In cooperation with Telefonos de Mexico, S.A. de C.V. ("Telmex"), Mexico's
primary phone company, the Company expects to install a POP in Monterrey, Mexico
in the fourth quarter of 1998. This POP is currently intended only to test
connectivity between the Splitrock Network and Telmex's data network. Should
testing prove successful, the Company will consider entering into formal
negotiations to provide services to Telmex, including carrying all or a portion
of Telmex's U.S. bound data traffic over the Splitrock Network.
Carso Global Telecom, S.A. de C.V. ("Carso") is the controlling stockholder
of Prodigy and a significant stockholder of Telmex. Orient Star Holdings
("Orient Star"), a wholly owned subsidiary of Carso, owns 25.0 million shares,
or 30.2%, of the Common Stock of the Company. Mr. Eduardo Valdes Acra, as
attorney-in-fact, holds the sole voting and dispositive power with respect to
such Common Stock. See "Management -- Certain Relationships and Related
Transactions; Principal Stockholders."
THE PRIVATE PLACEMENT AND USE OF PROCEEDS
The Company sold the Units, which included the Original Notes, on July 24,
1998 to Chase Securities Inc. (the "Initial Purchaser"), as described in the
offering memorandum dated July 21, 1998 (the "Offering Memorandum"). The Initial
Purchaser thereupon offered and sold the Units that included Original Notes in
the aggregate principal amount of $250.0 million to certain qualified buyers and
Units that included Original Notes in the aggregate principal amount of $11.0
million to Linsang Partners L.L.C., an affiliate of the Company ("Linsang"). The
$252.9 million of net proceeds the Company received in connection with the sale
of the Original Notes, which were sold as units together with certain warrants
(the "Warrants") to purchase an aggregate of 2,642,613 shares of the Company's
common stock ("Common Stock"), as described in the Offering Memorandum were used
as follows: (i) approximately $56.8 million was deposited in escrow to pay
10
<PAGE> 12
the first four semi-annual interest payments on the Notes, (ii) approximately
$11.0 million was used to refinance indebtedness owed by the Company to Linsang,
(iii) approximately $1.5 million was used to repay debt owed to a supplier, and
(iv) the remainder will be used to finance capital expenditures to complete the
Phase II Expansion (as defined) of the Splitrock Network (as defined), expected
to be approximately $139.6 million, and for general corporate purposes. In
addition, a portion of the net proceeds may be used to make investments in or
acquisitions of certain businesses or assets. See "Use of Proceeds." The
Warrants have an exercise price of $.01 per share, and are exercisable at any
time on or after the first anniversary of the date of original issuance of the
Warrants and prior to the maturity date of the Notes. The Warrants are not being
registered in the Exchange Offer, but are entitled to registration rights under
the Warrant Agreement. See "Capitalization," "Description of Capital Stock" and
"Description of the Warrants."
THE EXCHANGE OFFER
The Exchange Offer, the consummation of which is required by the Indenture
and the Exchange and Registration Rights Agreement described in the Offering
Memorandum, relates to the exchange of up to $250.0 million in principal amount
of Exchange Notes for up to $250.0 million in principal amount of Original
Notes. The form and terms of the Exchange Notes are identical in all material
respects to the form and terms of the Original Notes except that the Exchange
Notes have been registered under the Securities Act and will not contain certain
transfer restrictions, registration rights or liquidated damages provisions. The
Exchange Notes will evidence the same debt as the Original Notes and will be
issued under and be entitled to the benefits of the Indenture governing the
Original Notes. See "Description of the Notes."
The Exchange Offer......... The Company is offering to exchange an Exchange
Note in the principal amount of $1,000 for each
Original Note in the principal amount of $1,000,
other than Original Notes held by affiliates of the
Company, that is properly tendered and accepted.
The Company will issue Exchange Notes on or
promptly after the Expiration Date. The Exchange
Offer covers Original Notes in an aggregate
principal amount of $250.0 million, not including
11,000 Original Notes in an aggregate principal
amount of $11.0 million held by Linsang, an
affiliate of the Company. Such $11.0 million of
Original Notes will be exchanged for $11.0 million
of Exchange Notes in a private offering and such
Exchange Notes are expected to be registered for
resale under the Securities Act. See "The Exchange
Offer."
Expiration Date; Right to
Withdraw................. The Exchange Offer will expire at 5:00 p.m., New
York City time, on , 1998 (30 days
after the registration statement covering this
Exchange Offer has been declared effective by the
Commission), unless the Exchange Offer is extended
by the Company in its sole discretion, to a date
not later than , 1998, in which case
the term "Expiration Date" shall mean the latest
date and time to which the Exchange Offer is
extended. The tender of Original Notes pursuant to
the Exchange Offer may be withdrawn at any time
before the earlier of acceptance for exchange or
the Expiration Date. Any Original Notes not
accepted for any reason will be returned without
expense to the tendering holder thereof as promptly
as practicable after the expiration or termination
of the Exchange Offer. See "The Exchange
Offer -- Withdrawal of Tenders."
Conditions to the Exchange
Offer...................... The Exchange Offer is subject to certain customary
conditions, which may be waived by the Company. See
"The Exchange Offer -- Certain Conditions to The
Exchange Offer." The Exchange Offer is not condi-
11
<PAGE> 13
tioned upon any minimum aggregate principal amount
of Original Notes being tendered for exchange.
Procedures for Tendering
Notes...................... Each holder of Original Notes wishing to accept the
Exchange Offer must complete, sign and date the
Letter of Transmittal, or a facsimile thereof, in
accordance with the instructions contained herein
and therein, and mail or otherwise deliver such
Letter of Transmittal, or such facsimile, together
with such Original Notes and any other required
documentation to Bank of Montreal Trust Company, as
Exchange Agent, at the address set forth herein. By
executing the Letter of Transmittal, each holder
will represent to the Company that, among other
things, (i) the Exchange Notes to be acquired by
the holder of the Original Notes in connection with
the Exchange Offer are being acquired by the holder
in the ordinary course of business of the holder,
(ii) the holder has no arrangement or understanding
with any person to participate in the distribution
of Exchange Notes, (iii) the holder acknowledges
and agrees that any person who is a broker-dealer
registered under the Exchange Act or is
participating in the Exchange Offer for the
purposes of distributing the Exchange Notes must
comply with the registration and prospectus
delivery requirements of the Securities Act in
connection with a secondary resale transaction of
the Exchange Notes acquired by such person and
cannot rely on the position of the staff of the
Commission set forth in no-action letters (see "The
Exchange Offer -- Resale of Exchange Notes"), (iv)
the holder understands that a secondary resale
transaction described in clause (iii) above and any
resales of Exchange Notes obtained by such holder
in exchange for Original Notes acquired by such
holder directly from the Company should be covered
by an effective registration statement containing
the selling security holder information required by
Item 507 or Item 508, as applicable, of Regulation
S-K of the Commission, and (v) the holder is not an
"affiliate," as defined in Rule 405 under the
Securities Act, of the Company. If the holder is a
broker-dealer that will receive Exchange Notes for
its own account in exchange for Original Notes that
were acquired as a result of market-making
activities or other trading activities, the holder
is required to acknowledge in the Letter of
Transmittal that it will deliver a Prospectus in
connection with any resale of such Exchange Notes;
however, by so acknowledging and by delivering a
Prospectus, the holder will not be deemed to admit
that it is an "underwriter" within the meaning of
the Securities Act. See "The Exchange
Offer -- Procedures for Tendering."
Exchange and Registration
Rights Agreement......... The Exchange and Registration Rights Agreement
grants the holders of the Original Notes certain
exchange and registration rights. See "The Exchange
Offer -- Termination of Certain Rights." This
Exchange Offer is intended to satisfy such rights,
which terminate upon the consummation of the
Exchange Offer. The holders of the Exchange Notes
are not entitled to any exchange or registration
rights with respect to the Exchange Notes. If the
Company fails to consummate the Exchange Offer on
or before 135 days after the date of the issuance
of the Original Notes or is otherwise not in
compliance with certain obligations under the
Exchange and Registration Rights Agreement, the
Company will be obligated to pay liquidated damages
to the holders of the Original Notes.
12
<PAGE> 14
Accrued Interest on the
Exchange Notes and
Original Notes........... Interest on the Exchange Notes will accrue from the
Exchange Date at the rate of 11 3/4% annually and
will be payable semiannually in arrears on January
15 and July 15 of each year, commencing on January
15, 1999. Holders of Exchange Notes will also, on
January 15, 1999, receive an amount equal to the
accrued interest on the Original Notes exchanged
therefor. Interest on the Original Notes accepted
for exchange will cease to accrue on the Exchange
Date.
Special Procedures for
Beneficial Owners.......... Any beneficial owner whose Original Notes are
registered in the name of a broker, dealer,
commercial bank, trust company or other nominee and
who wishes to tender such Original Notes in the
Exchange Offer should contact such registered
holder promptly and instruct such registered holder
to tender on such beneficial owner's behalf. See
"The Exchange Offer -- Procedures for Tendering."
If such beneficial owner wishes to tender on such
owner's own behalf, such owner must, prior to
completing and executing the Letter of Transmittal
and delivering such owner's Original Notes, either
make appropriate arrangement to register ownership
of the Original Notes in such owner's name or
obtain a properly completed bond power from the
registered holder. The transfer of registered
ownership may take considerable time and may not be
able to be completed prior to the Expiration Date.
Guaranteed Delivery
Procedures................. Holders of Original Notes who wish to tender their
Original Notes and whose Original Notes are not
immediately available or who cannot deliver their
Original Notes, the Letter of Transmittal or any
other documents required by the Letter of
Transmittal to the Exchange Agent, prior to the
Expiration Date, must tender their Original Notes
according to the guaranteed delivery procedures set
forth in "The Exchange Offer -- Guaranteed Delivery
Procedures."
Acceptance of the Original
Notes and Delivery of the
Exchange Notes........... Subject to the satisfaction or waiver of the
conditions to the Exchange Offer, the Company will
accept for exchange any and all Original Notes
which are properly tendered in the Exchange Offer
prior to the Expiration Date. The Exchange Notes
issued pursuant to the Exchange Offer will be
delivered on the earliest practicable date
following the Expiration Date. See "The Exchange
Offer -- Terms of the Exchange Offer."
Certain Federal Income Tax
Considerations........... For a discussion of certain federal income tax
considerations relating to the exchange of the
Exchange Notes for the Original Notes, see "Certain
Federal Income Tax Considerations."
Exchange Agent............. Bank of Montreal Trust Company is serving as the
exchange agent (the "Exchange Agent") in connection
with the Exchange Offer.
Consequences of Failure to
Exchange................. The Original Notes that are not exchanged pursuant
to the Exchange Offer will remain restricted
securities. Accordingly, such Original Notes may be
resold only (i) to the Company, (ii) pursuant to
Rule 144A or Rule 144 under the Securities Act or
pursuant to some other exemption
13
<PAGE> 15
under the Securities Act, or (iii) pursuant to an
effective registration statement under Securities
Act. See "The Exchange Offer -- Consequences of
Failure to Exchange."
THE NOTES
The Exchange Notes......... The Exchange Offer applies to Original Notes in the
aggregate principal amount of $250.0 million. The
form and terms of the Exchange Notes are the same
as the form and terms of the Original Notes except
that (i) the exchange will have been registered
under the Securities Act and, therefore, the
Exchange Notes will not bear legends restricting
their transfer pursuant to the Securities Act and
(ii) holders of the Exchange Notes will not be
entitled to certain rights of holders of the
Original Notes under the Exchange and Registration
Rights Agreement. Such rights will terminate upon
consummation of the Exchange Offer. The Exchange
Notes will represent the same debt as the Original
Notes (which they replace) and will be issued
under, and be entitled to the benefits of, the
Indenture. See "Description of the Notes."
Maturity................... July 15, 2008.
Interest Payment Dates..... January 15 and July 15 of each year, commencing on
January 15, 1999.
Escrow Proceeds............ The Company has deposited with the Escrow Agent an
amount of Temporary Cash Investments (approximately
$56.8 million), that, together with the interest
received thereon, will be sufficient to pay when
due the first four semi-annual interest payments on
the Notes, with any remaining balance to be
retained by the Company. The Notes will be
collateralized by a first priority and exclusive
security interest in the Escrow Account. See
"Description of the Notes -- Disbursement of Funds;
Escrow Account."
Sinking Fund............... None.
Guarantees................. The Notes will be fully and unconditionally
guaranteed on a senior, unsecured basis by each of
the Company's future Restricted Subsidiaries that
incurs indebtedness. See "Description of the
Notes -- Certain Covenants -- Future Subsidiary
Guarantors." The Company does not currently have
any subsidiaries.
Optional Redemption........ Except as described below, the Company may not
redeem the Notes prior to July 15, 2003. On or
after such date, the Company may redeem the Notes,
in whole or in part, at the redemption prices set
forth herein, together with accrued and unpaid
interest and liquidated damages, if any, to the
date of redemption. In addition, at any time and
from time to time prior to July 15, 2001, the
Company may, subject to certain requirements,
redeem up to 35% of the original aggregate
principal amount of the Notes (calculated after
giving effect to any issuance of Additional Notes,
as defined) with the Net Cash Proceeds of one or
more Equity Offerings by the Company, at a
redemption price equal to 111.75% of the principal
amount thereof, plus accrued and unpaid interest
and liquidated damages, if any, to the date of
redemption; provided, however, that at least 65% of
the original aggregate principal amount of the
Notes remains outstanding immediately after each
such redemption (calculated after giving effect to
any issuance of Additional Notes). See "Description
of the Notes -- Optional Redemption."
14
<PAGE> 16
Change of Control.......... Upon the occurrence of a Change of Control, each
holder of the Notes will have the right to require
the Company to repurchase all or any part of such
holder's Notes at a price equal to 101% of the
aggregate principal amount of the Notes plus
accrued and unpaid interest and liquidated damages
thereon, if any, to the date of repurchase. There
can, however, be no assurance that upon any such
Change of Control the Company will be able to fund
the repurchase obligation. Failure to fund such
repurchase obligation will constitute an Event of
Default under the Notes. See "Description of the
Notes -- Change of Control."
Ranking.................... The Notes will be Senior Indebtedness of the
Company, will rank pari passu with all existing and
future Senior Indebtedness of the Company and will
rank senior to all future Subordinated Obligations
of the Company. The Notes will be unsecured (except
that the Trustee will have a security interest in
the Escrow Account for the benefit of the Holders
of the Notes) and will therefore be effectively
subordinated to all secured indebtedness of the
Company. At June 30, 1998, after giving pro forma
effect to the offering of the Notes and the
application of the proceeds therefrom, the Company
would have had $21.2 million of indebtedness
outstanding (other than the Notes), all of which
would have been Senior Indebtedness and all of
which would have been secured. See "Description of
the Notes -- Ranking."
Prospective investors in the Exchange Notes should carefully consider all
of the information set forth in this Prospectus and, in particular, should
evaluate the specific factors under "Risk Factors" for risks involved with an
investment in the Exchange Notes.
---------------------
The Company's principal executive offices are located at 8665 New Trails
Drive, Suite 200, The Woodlands, Texas 77381. The Company's telephone number is
(281) 465-1200.
15
<PAGE> 17
SUMMARY HISTORICAL AND UNAUDITED PRO FORMA FINANCIAL DATA
The following table sets forth summary historical and unaudited pro forma
financial data of the Company. The historical statement of operations and other
financial data for the period from inception (March 5, 1997) through December
31, 1997 and the historical balance sheet data as of December 31, 1997 have been
derived from, should be read in conjunction with and are qualified in their
entirety by reference to the audited financial statements, including the notes
thereto, included elsewhere in this Prospectus. The historical statement of
operations and other financial data for the period from inception (March 5,
1997) through June 30, 1997 and for the six months ended June 30, 1998 and the
historical balance sheet data as of June 30, 1998 have been derived from, should
be read in conjunction with and are qualified in their entirety by reference to
the unaudited condensed financial statements, including the notes thereto,
included elsewhere in this Prospectus which have been prepared on a basis
consistent with the audited financial statements and in the opinion of
management include all adjustments, consisting solely of normal, recurring
adjustments, necessary to present fairly the information contained therein. The
historical quarterly statement of operations data for the three months ended
June 30, 1997, September 30, 1997, December 31, 1997, March 31, 1998 and June
30, 1998 have been derived from the Company's accounting records and have been
prepared on a basis consistent with the audited financial statements and in the
opinion of management include all adjustments, consisting solely of normal,
recurring adjustments, necessary to present fairly the information contained
therein. The summary historical financial data are not necessarily indicative of
the operating results to be expected in future periods.
The following table also presents certain summary unaudited pro forma
financial data of the Company for the period from inception (March 5, 1997) to
December 31, 1997 and the six months ended and as of June 30, 1998, which give
effect to the Unit Offering and the application of the proceeds therefrom as if
they had occurred on March 5, 1997 in the case of the statement of operations
data, and June 30, 1998, in the case of the balance sheet data. The summary
unaudited pro forma financial data do not purport to be indicative of the
results that actually would have been obtained had the Unit Offering been
consummated on the assumed dates and they are not necessarily indicative of
operating results to be expected in future periods.
The following summary historical and unaudited pro forma financial data
should be read in conjunction with the historical financial statements of the
Company and the notes thereto included elsewhere in this Prospectus, "Selected
Historical and Unaudited Pro Forma Financial Data" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
16
<PAGE> 18
SUMMARY HISTORICAL AND UNAUDITED PRO FORMA FINANCIAL DATA
<TABLE>
<CAPTION>
PERIOD FROM INCEPTION PERIOD FROM INCEPTION SIX MONTHS
(MARCH 5, 1997) (MARCH 5, 1997) ENDED
THROUGH THROUGH JUNE 30,
DECEMBER 31, 1997 JUNE 30, 1997 1998
--------------------- --------------------- -----------
(UNAUDITED) (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue...................................... $ 22,708 $ -- $ 32,214
Operating expenses:
Network personnel costs.................... 437 -- 2,156
Network operating costs.................... 1,925 -- 9,402
Legacy Network costs....................... 25,341 -- 27,090
Severance costs(1)......................... 463 -- --
Selling, general and administrative........ 1,276 125 1,628
Depreciation and amortization.............. 3,500 -- 4,907
-------- ------- --------
Total operating expenses........... 32,942 125 45,183
-------- ------- --------
Loss from operations......................... (10,234) (125) (12,969)
Other income (expense):
Interest income............................ 348 30 183
Interest expense........................... (235) -- (842)
-------- ------- --------
Loss before income taxes..................... (10,121) (95) (13,628)
Provision for income taxes................... -- -- --
-------- ------- --------
Net loss..................................... $(10,121) $ (95) $(13,628)
======== ======= ========
Loss per share -- basic and diluted.......... $ (0.24) $ (0.01) $ (0.18)
======== ======= ========
Weighted average shares -- basic and
diluted.................................... 42,824 11,525 76,888
======== ======= ========
</TABLE>
<TABLE>
<CAPTION>
AS OF
DECEMBER 31, AS OF
1997 JUNE 30, 1998
------------ ----------------------
ACTUAL ACTUAL PRO FORMA(2)
------------ ------- ------------
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents(3).............................. $ 7,710 $ 5,177 $187,308
Restricted cash(4)........................................ 3,472 -- 56,752
Property and equipment, net............................... 38,504 43,148 43,148
Total assets.............................................. 54,388 57,630 306,183
Short term note payable(3)................................ -- 1,477 --
Long term debt and capital lease obligations (including
current portion)(3)..................................... 25,120 32,219 279,339
Stockholders' equity(5)................................... 20,407 7,879 10,759
</TABLE>
<TABLE>
<CAPTION>
PERIOD FROM INCEPTION PERIOD FROM INCEPTION SIX MONTHS
(MARCH 5, 1997) (MARCH 5, 1997) ENDED
THROUGH THROUGH JUNE 30,
DECEMBER 31, 1997 JUNE 30, 1997 1998
--------------------- --------------------- -----------
(UNAUDITED) (UNAUDITED)
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
OTHER FINANCIAL DATA:
Capital expenditures(6)...................... $ 42,004 $ 2,078 $ 9,379
EBITDA(7).................................... (6,271) (125) (8,062)
Cash provided by (used in):
Operating activities....................... (2,233) (3) (3,712)
Investing activities....................... (17,198) (2,078) (7,714)
Financing activities....................... 27,141 10,778 8,893
PRO FORMA DATA:(8)
Interest expense............................. $ 26,422 N/A $ 16,349
</TABLE>
17
<PAGE> 19
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------------------
JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1997 1997 1997 1998 1998
-------- ------------- ------------ --------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
QUARTERLY STATEMENT OF OPERATIONS
DATA:
Revenue............................... $ -- $ 10,729 $11,979 $16,494 $15,720
Operating expenses:
Network personnel costs............. -- 95 342 1,051 1,105
Network operating costs............. -- 561 1,364 3,127 6,275
Legacy Network costs................ -- 13,119 12,222 12,295 14,795
Severance costs(1).................. -- -- 463 -- --
Selling, general and
administrative................... 125 471 680 657 971
Depreciation and amortization....... -- 1,708 1,792 2,820 2,087
------- ---------- ------- ------- -------
Total operating expenses.... 125 15,954 16,863 19,950 25,233
------- ---------- ------- ------- -------
Loss from operations.................. (125) (5,225) (4,884) (3,456) (9,513)
Other income (expense):
Interest income..................... 30 137 181 107 76
Interest expense.................... -- (113) (122) (349) (493)
------- ---------- ------- ------- -------
Loss before income tax................ (95) (5,201) (4,825) (3,698) (9,930)
Provision for income tax.............. -- -- -- -- --
------- ---------- ------- ------- -------
Net loss.............................. $ (95) $ (5,201) $(4,825) $(3,698) $(9,930)
------- ---------- ------- ------- -------
Loss per share -- basic and diluted... $ (0.01) $ (0.11) $ (0.06) $ (0.05) $ (0.13)
======= ========== ======= ======= =======
Weighted average shares -- basic and
diluted............................. 14,648 48,991 76,800 76,800 76,976
======= ========== ======= ======= =======
OTHER QUARTERLY DATA:
EBITDA(7)............................. $ (125) $ (3,517) $(2,629) $ (636) $(7,426)
======= ========== ======= ======= =======
Cash provided by (used in):
Operating activities................ $(1,554) $ 103 $(2,333) $(4,874) $ 1,162
Investing activities................ (377) (12,242) (2,878) (2,740) (4,974)
Financing activities................ 10,026 19,750 (3,387) 3,253 5,640
</TABLE>
- ---------------
(1) Prior to January 1998, certain staffing positions were filled by Prodigy
employees who were subcontracted to the Company. In the fourth quarter of
1997, the Company recorded a severance charge related to the elimination of
13 of these positions.
(2) Pro forma balance sheet data assumes the Unit Offering and the application
of the net proceeds therefrom had occurred on June 30, 1998.
(3) As of June 30, 1998, the Company owed Ericsson $1.5 million, which was
repaid with the proceeds of the Unit Offering, and Linsang, a stockholder of
the Company, $11.0 million, which was refinanced in connection with the Unit
Offering. After giving effect to such repayment and refinancing, pro forma
cash and cash equivalents would have been $187.3 million. Pro forma long
term debt and capital lease obligations is net of $2.9 million discount to
the principal amount of the Notes attributable to the Company's estimate of
the value of the Warrants issued in connection with the Unit Offering.
(4) As of December 31, 1997, the Company had an outstanding letter of credit in
the amount of $3.5 million. This letter of credit was secured by the amount
in the restricted cash account. In the first quarter of 1998, the Company
exercised its early purchase option with regard to the related capital lease
and the letter of credit was retired. Pro forma amount represents escrowed
funds that, together with interest received thereon, will be sufficient to
pay when due the first four semi-annual interest payments on the Notes.
(5) Includes $2.9 million attributable to the Company's estimate of the value of
the Warrants issued in connection with the Unit Offering. Such estimate was
based on a valuation of the Common Stock as of
18
<PAGE> 20
December 31, 1997 by a third party valuation firm. See
"Management -- Aggregated Fiscal Year-End Option Values." No assurance can
be given that the value allocated to the Warrants is indicative of the price
at which the Warrants may actually trade. The June 30, 1998 actual and pro
forma stockholders' equity does not include the exercise by Orient Star of
its warrant to purchase an additional 5.0 million shares of the Company for
$0.625 per share, which occurred on September 14, 1998.
(6) Capital expenditures include equipment purchased through capital leases of
$26.2 million and $4.1 million for the period from inception (March 5, 1997)
through December 31, 1997 and for the six months ended June 30, 1998,
respectively. These capital leases include $5.3 million of equipment leases
assumed from Prodigy and $3.5 million of equipment leases subsequently
liquidated through an early purchase option.
(7) EBITDA is defined as net income (loss) plus net interest expense, provision
for income taxes, depreciation and amortization and severance costs. EBITDA
is presented as it is commonly used by certain investors to analyze and
compare operating performance and to determine a company's ability to
service and/or incur debt. However, EBITDA should not be considered in
isolation or as a substitute for net income, cash flows or other income or
cash flow data or as a measure of a company's profitability or liquidity and
is not a measure in accordance with generally accepted accounting
principles. EBITDA is not necessarily comparable with similarly titled
measures reported by other companies.
(8) Pro forma interest expense assumes that the Unit Offering and the
application of the net proceeds therefrom had occurred on the first day of
the period presented. In addition to the stated interest rate on the Notes,
pro forma interest expense includes amortization of deferred issuance costs
and discount on the Notes related to the Warrants. Pro forma interest
expense does not include the pro forma effect of interest income which would
have been earned on excess cash for the period from inception (March 5,
1997) through December 31, 1997 and for the six months ended June 30, 1998.
19
<PAGE> 21
RISK FACTORS
An investment in the Exchange Notes involves a high degree of risk. In
addition to the other information set forth elsewhere in this Prospectus, the
following factors relating to the Company and this Exchange Offer should be
considered carefully by prospective investors when evaluating an investment in
the Exchange Notes.
LIMITED OPERATING HISTORY; OPERATING LOSSES
The Company was formed in March 1997 and has a limited history of
operations. Thus, historical information set forth herein may not be indicative
of the Company's future operating results and financial condition. In view of
the limited operating history of the Company, the Company remains vulnerable to
a variety of business risks generally associated with start-up companies, some
of which are beyond the control of the Company. Failure to continue to upgrade
operating and financial controls or systems or unexpected difficulties
encountered during expansion could adversely affect the Company's business,
financial condition and results of operation. Since June 1997, the Company has
recruited and hired key members of management in the areas of operations and
administration. As a result, the key members of the Company's management team
have worked together for only a short time. See "Management."
The Company reported EBITDA (as defined) of approximately $(6.3) million
and $(8.1) million for the period from inception (March 5, 1997) to December 31,
1997 and the six months ended June 30, 1998, respectively (net losses amounted
to $10.1 million and $13.6 million for the same periods). Net cash used in
operating activities was $2.2 million and $3.7 million, net cash used in
investing activities was $17.2 million and $7.7 million and net cash provided by
financing activities was $27.1 and $8.9 million for the period from inception
(March 5, 1997) to December 31, 1997 and for the six months ended June 30, 1998,
respectively. On a pro forma basis after giving effect to the Unit Offering and
the application of the net proceeds therefrom, the Company would have reported
net losses of $36.3 million and $29.1 million for the period from inception
(March 5, 1997) to December 31, 1997 and the six months ended June 30, 1998,
respectively. The Company expects such net losses to continue as the Company
focuses on increasing its customer base, implementing its business strategy and
developing new services which will require it to incur significantly increased
expenses for marketing, network infrastructure, accounting, billing and other
financial control systems and personnel. Such expenses are expected to adversely
impact cash flow and operating performance. See "Summary -- Recent
Developments." There can be no assurance that the Company will generate
sufficient revenues such that the Company's operations will become profitable or
generate positive cash flows in the future. If the Company cannot achieve
operating profitability or positive cash flows from operating activities, it may
not be able to meet its working capital or debt service requirements, including
its obligations under the Notes, which would cause an event of default under the
Indenture. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
DIFFICULTIES IN EXPANDING AND OPERATING THE SPLITROCK NETWORK
The Company's ability to generate positive cash flows from operations will
depend upon the successful, timely and cost-effective expansion of the Splitrock
Network, the successful operation of the Splitrock Network and the Company's
ability to continue to attract customers. The expansion of the Splitrock Network
is subject to a variety of uncertainties and contingencies, including site and
facility acquisitions, the purchase and installation of network equipment, the
timely performance by its suppliers and third-party contractors of their
obligations, obtaining local telecommunications connections, and network
testing. Although the Company believes that its cost estimates and the expansion
schedule are reasonable, there can be no assurance that the actual construction
costs or time required to expand the Splitrock Network will not substantially
exceed current estimates. The inability of the Company to complete the Phase II
Expansion or obtain the necessary third-party telecommunication connections on a
timely or cost-efficient basis would have a material adverse effect on the
Company's financial condition and results of operations.
The Company has limited experience managing a telecommunications network.
The operation of the Splitrock Network is a significant undertaking.
Administrative, technical, operational and other problems that could arise,
including as a result of increasing traffic volume and equipment and software
failures, may be
20
<PAGE> 22
more difficult to address and solve due to the significant size and complexity
of the Network. The Company has experienced technical problems which have led to
significant service interruptions and failures. See "-- Reliance on Prodigy;
Recent Discussions with Prodigy." The inability of the Company to effectively
operate the Network and to quickly respond to problems as they occur would have
a material adverse effect on the Company's financial condition and results of
operations.
The Company's financial performance will further depend on its ability to
generate significant customer traffic. The Company currently derives
substantially all of its revenues from Prodigy. Although the Company has begun
receiving revenues from two additional customers, the Company expects that for
the foreseeable future Prodigy will remain its dominant customer and a small
number of customers will continue to account for all the Company's revenue. See
"Business -- Customers." In order to broaden its customer base, the Company will
need to expand its marketing and sales efforts and staff. See "-- Ability to
Manage Growth." The inability to significantly increase customer traffic would
have a material adverse effect on the Company.
The Company anticipates that even after the Phase II Expansion, future
expansions and adaptations of the Network's infrastructure, including the
electronic and software components used therein, will be necessary in order to
respond to growth in the number of customers served, increased demands to
transmit larger amounts of data, changes in its customers' service requirements
and technological advances by competitors. The expansion and adaptation of the
Splitrock Network will require substantial financial, operational and managerial
resources. There can be no assurance that the Company will be able to expand or
adapt the Splitrock Network to meet the evolving standards, demands and
requirements of its customers or technological advances of its competitors on a
timely basis and at a commercially reasonable cost, if at all, or that the
Company will be able to deploy successfully any expanded and adapted Network
infrastructure. The Company believes, based on current plans and assumptions
relating to its operations, that the net proceeds of the Unit Offering, together
with its existing financial resources and future borrowings from a stockholder,
if any, will be sufficient to fund the Company's growth and operations. In the
event that the Company's plans or assumptions change or prove to be inaccurate,
the Company may be required to seek alternative sources of financing. There can
be no assurance that the Company would be able to obtain additional financing on
acceptable terms, or at all. Any failure by the Company to expand or adapt the
Splitrock Network to the needs of its customers could have a material adverse
effect on the Company's financial condition and results of operations.
RELIANCE ON PRODIGY; RECENT DISCUSSIONS WITH PRODIGY
Pursuant to the Prodigy Agreement (as defined), the Company currently
provides certain network and related services, including Internet dial access
services, to Prodigy for its subscribers. For the period from inception (March
5, 1997) to December 31, 1997, the Company generated $22.7 million (100%) of
total revenue from Prodigy under this agreement. For the six months ended June
30, 1998, the Company generated $32.2 million (99%) of total revenue from
Prodigy under this agreement. Although the Company has recently begun providing
services to two additional customers and expects to attract additional customers
in the short-term, the Company expects that for the foreseeable future Prodigy
will remain its dominant customer and a small number of customers will continue
to account for all the Company's revenue.
Prodigy is currently the third largest U.S. ISP measured in minutes
on-line. Launched in 1984 as a joint venture between IBM and Sears, Prodigy is
currently controlled by Carso, which indirectly owns 25.0 million shares, or
30.2%, of the Common Stock of the Company. Samer Salameh, the President and
Chief Executive Officer of Prodigy, is a member of the Board of Directors of the
Company. See "Principal Stockholders". Since Prodigy is a private company,
limited financial or other information regarding Prodigy is publicly available.
In addition, the Prodigy Agreement provides for only very limited information
regarding Prodigy to be provided to the Company. Therefore, the Company is
unable to assess with any certainty the financial condition or results of
operations of Prodigy or whether Prodigy will continue to operate as a
financially solvent company or remain able to pay amounts owed under the Prodigy
Agreement. Furthermore, Prodigy operates in a highly competitive environment.
Prodigy competes with a wide range of national, regional and local ISPs. Due to
the limited available information regarding Prodigy, the Company is unable to
predict whether Prodigy will remain competitive in the ISP marketplace. If
competitive or other factors were to result in a reorganization, bankruptcy,
liquidation or similar proceeding with respect to Prodigy or otherwise result in
21
<PAGE> 23
Prodigy being unable to pay amounts due under the Prodigy Agreement the
Company's financial position, results of operations and ability to pay principal
and interest on the Notes would be materially adversely affected. Furthermore,
if due to competitive or other factors the number of Prodigy subscribers or
usage by subscribers were to decrease, the Company would receive less revenue
under the Prodigy Agreement, which could have a material adverse effect on the
Company's financial position and results of operations. In addition, Prodigy is
operating in an industry undergoing rapid consolidation. Any acquisition or
merger involving Prodigy and a company with an alternative source of network
services could result in Prodigy exercising its option to terminate the Prodigy
Agreement and therefore have a material adverse effect on the Company. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Prodigy Transactions."
The Prodigy Agreement allows Prodigy to terminate its arrangement with the
Company on twelve months notice upon the payment of a termination charge. The
Prodigy Agreement also allows Prodigy to terminate its arrangement with the
Company on 45 days notice without payment if the Company defaults, following a
cure period, with respect to certain performance standards contained in the
Prodigy Agreement. In addition, the Prodigy Agreement provides for arbitration
to resolve certain other disputes including a default by the Company with
respect to certain financial covenants. Such arbitration could lead to a
termination of the Prodigy Agreement. The Company believes that, based on
current market conditions, if the relationship with Prodigy were terminated, it
could find new customers to replace the resulting loss of traffic. There can be
no assurance that there will not be a change in market conditions or that the
Company will be able to secure additional traffic should the relationship with
Prodigy be terminated. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business -- Customers."
The Company is currently Prodigy's sole supplier of network services. As a
result, Prodigy is dependent on the Company to provide local Internet dial
access services to its subscribers. As such, Prodigy closely monitors the
quality of the services provided by the Company since it directly impacts
Prodigy's business and financial performance.
As part of its expansion plan, in January 1998 the Company began migrating
Prodigy subscribers from the Legacy Network to the Splitrock Network. In
addition to technical problems and network failures which occur from time to
time in the ordinary course of operating a telecommunications network, in
connection with the rapid migration of Prodigy subscribers from the Legacy
Network to the Splitrock Network during the first quarter of 1998, the Company,
and therefore Prodigy, experienced significant service interruptions and
failures, the most prolonged and serious of which occurred in February, March
and April of 1998. These service interruptions and failures were primarily due
to a faulty modem code that, among other things, resulted in a significant
number of Prodigy subscribers who called into the Splitrock Network receiving
busy signals when, in fact, there was sufficient capacity available to handle
the calls. At the time of these service interruptions, the Company had
inadequate staffing levels and procedures in place to detect or respond to the
situation in a timely manner. As a result, the modem related problems resulted
in an unfavorable call failure rate compared to industry norms. The Company
believes that it and its third-party modem vendor have corrected the faulty
modem code, although no assurance can be given in this regard. In addition, the
Company believes that it has achieved staffing levels in its NOCs adequate to
detect and address any such future service interruptions or failures.
Since February 1998 Prodigy has expressed repeated and serious concerns
regarding the Company's ability to deliver network services at a level of
quality and reliability necessary to sustain Prodigy's business and expected
growth. In particular, Prodigy has indicated that it believes that, due to the
Company's Network problems during the first quarter of 1998, Prodigy lost a
significant number of subscribers and the associated revenues and incurred
substantial costs. In addition, Prodigy has expressed serious concern about the
impact the Company's Network problems have had on the perception of Prodigy in
the industry. In May 1998, Prodigy notified the Company that unless the Company
was able to improve Network quality and access availability, it would be forced
to use alternate network service providers.
In connection with these discussions Prodigy raised a number of service and
technology related issues that it believes require prompt resolution. These
issues include, among other things, providing backup capacity
22
<PAGE> 24
to the Splitrock Network (including through other providers' networks),
automatic rollover services to alternate access phone numbers, methods for
limiting service abusers, and network time-out circumventions. In addition,
Prodigy has proposed a number of amendments to the Prodigy Agreement including,
among other things, modifying the current fee structure to a monthly fee based
on utilization of the Network, imposing more stringent financial penalties on
the Company in the event of Network interruptions, and exclusivity until the
Network is stable (i.e., a prohibition on the Company providing Internet dial
access services to Prodigy's large consumer-oriented ISP competitors).
Prodigy and the Company have had several meetings with regard to these
issues and have agreed to continue to have frequent periodic meetings. As a
result of these meetings, the Company has implemented a number of additional
procedures and business support systems. For example, the Company has
implemented network management systems that enable real time monitoring of the
Network and has established more frequent access to Prodigy subscriber-related
data on Network performance. Certain issues, however, remain under discussion.
Although the Company believes that it will resolve the outstanding issues
between the Company and Prodigy, until these issues are resolved, the future of
the Company's relationship with Prodigy is uncertain and there can be no
assurance that further discussions with Prodigy will not result in a termination
of the relationship, increased costs to the Company or amendments to the Prodigy
Agreement that are unfavorable to the Company. The loss of Prodigy as a customer
or any such increased costs or amendments to the Prodigy Agreement could have a
material adverse effect on the Company.
Prior to solutions implemented by the Company and its third-party modem
vendor, in April 1998 Inverse, an independent Internet testing group, indicated
that Prodigy had a call failure rate for the March 1998 reporting period that
was almost double that of Inverse's reported industry average, an 18.3% call
failure rate versus 9.4%, respectively, during the evening hours in which most
Prodigy traffic occurs. In June 1998, Inverse indicated that for the May
reporting period Prodigy had a call failure rate that was lower than the Inverse
industry average during such evening hours. The Company believes that its
improvement was primarily due to the solutions implemented by it and its
third-party modem vendor. In July 1998, Inverse indicated that for the June
reporting period Prodigy had a call failure rate above the Inverse industry
average during such evening hours. Prodigy's higher rate was in part due to
problems Prodigy experienced with certain log-on software during four evenings
during the Inverse testing period. The Company believes that Prodigy has
corrected these software problems. In all other call failure rating categories
tested by Inverse during June, the Company's measurements were better than the
Inverse industry average. Investors should not place undue reliance on the
Inverse report as a measure of the Company's Network performance because it does
not measure and report on all the factors that may affect the quality of
Splitrock's services to Prodigy and Inverse's findings are based on tests
conducted on a sampling of only 42 POPs. Furthermore, the most recent Inverse
data reflect only two months of operations and there can be no assurance that
the Company will be able to sustain such a level of Network performance.
ESTABLISHMENT AND MAINTENANCE OF TRANSMISSION SERVICES AND PEERING RELATIONSHIPS
The Company's success will depend upon its ability to complete the Phase II
Expansion and develop adequate support systems and services at an acceptable
cost. In order to complete the Phase II Expansion and continue operating the
existing POPs, the Company has entered into and will continue to enter into
agreements with various providers of infrastructure capacity.
The Company currently maintains transmission services agreements primarily
with WorldCom Communications, Inc. ("WorldCom") for long distance and with
competitive local exchange carriers ("CLECs") and various regional Bell
operating companies ("RBOCs") for local connections. In the future, the Company
will be required to negotiate new transmission services agreements, or
renegotiate existing transmission services agreements, as the Company expands
the Network. There can be no assurance that the Company will successfully
negotiate or renegotiate such agreements. The failure to negotiate or
renegotiate required transmission services agreements could have a material
adverse effect on the Company's financial condition and results of operations.
See "Business -- Splitrock's Network -- Transmission Services."
23
<PAGE> 25
The Company has established peering arrangements with several ISPs and
intends to negotiate further agreements. The establishment and maintenance of
peering relationships with other network service providers is necessary in order
to exchange traffic with other network service providers without having to pay
transit costs. The basis on which network service providers make peering
available or impose settlement charges is evolving as the provision of Internet
access and related services has expanded and the dominance of a small group of
national network service providers has driven corporate peering policies.
Recently, companies that have previously offered peering have cut back or
eliminated peering relationships and are establishing new, more restrictive
criteria for peering. Furthermore, if increasing requirements associated with
maintaining peering with the major national network service providers develop,
the Company may have to comply with those additional requirements in order to
establish peering relationships. Failure to maintain peering relationships or
establish new ones, if necessary, would cause the Company to incur additional
operating expenditures which would have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Business -- Splitrock's Network -- Peering."
LEVERAGE AND RESTRICTIONS IMPOSED BY INDEBTEDNESS
The Company is highly leveraged. At June 30, 1998, on a pro forma basis
after giving effect to the Unit Offering and the application of the net proceeds
therefrom, the Company would have had $279.3 million of total indebtedness,
representing approximately 96.3% of the Company's total capitalization. See
"Capitalization." Approximately $1.9 million of the Company's indebtedness other
than the Notes would be in default upon the occurrence of a default with respect
to the Notes. In addition, the terms of the Notes permit the Company to incur
certain other indebtedness. None of the Company's other current indebtedness
prohibits the Company from making the required payments under the Notes. There
can, however, be no assurance that the Company will have sufficient cash flow to
pay the interest expense or the principal associated with the Notes or such
additional indebtedness. See "Use of Proceeds," "Selected Historical and
Unaudited Pro Forma Financial Data," "Capitalization," and "Description of the
Notes."
The historical earnings of the Company were insufficient to cover its fixed
charges for the period from inception (March 5, 1997) to December 31, 1997 and
the six months ended June 30, 1998 by approximately $10.1 million and $13.6
million, respectively. On a pro forma basis after giving effect to the Unit
Offering and the application of the net proceeds therefrom, the earnings of the
Company would have been insufficient to cover its fixed charges for the period
from inception (March 5, 1997) to December 31, 1997 and the six months ended
June 30, 1998 by approximately $36.3 million and $29.1 million, respectively.
See "Selected Historical and Unaudited Pro Forma Financial Data."
The degree to which the Company will be leveraged could have several
important consequences to the holders of the Notes, including, but not limited
to, the following: (i) a substantial portion of the Company's cash flow from
operations will be required to be dedicated to service the Company's
indebtedness, and the failure of the Company to generate sufficient cash flow to
service such indebtedness could result in a default under such indebtedness,
including under the Notes; (ii) the Company's ability to obtain additional
financing in the future for working capital, capital expenditures, acquisitions
or for other purposes may be impaired; (iii) the Company's flexibility to
expand, make capital expenditures and respond to changes in the industry and
economic conditions may be limited; (iv) the Indenture will contain, and future
agreements relating to the Company's indebtedness (including any credit
facilities, to the extent permitted by the Indenture) may contain, numerous
financial and other restrictive covenants, including, among other things,
limitations on the ability of the Company to incur additional indebtedness, to
create liens and other encumbrances, to make certain payments and investments,
to pay dividends, to sell or otherwise dispose of assets or to merge or
consolidate with another entity, the failure to comply with which may result in
an event of default, which, if not cured or waived, could have a material
adverse effect on the Company; and (v) the Company will be more leveraged than
certain of its competitors, which might place the Company at a competitive
disadvantage. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
The Company's ability to meet its debt service obligations, to finance
planned capital expenditures, lease payments or acquisitions or to comply with
the covenants contained in the Indenture will depend upon the Company's future
performance, which will be subject to general economic conditions and to
financial,
24
<PAGE> 26
business, competitive, legislative, regulatory and other factors affecting its
operations, many of which are beyond the control of the Company. There can be no
assurance that the Company's business will be able to generate cash flow at
levels sufficient to satisfy its debt service and other requirements. If in the
future the Company is unable to generate sufficient cash from its operations to
make scheduled interest payments on the Notes, to pay the Notes at maturity, or
to meet other obligations and commitments, the Company may be required to adopt
one or more alternatives, such as refinancing or restructuring its indebtedness,
reducing or delaying planned expansion, selling assets or seeking to raise
additional debt or equity. There can be no assurance that the Company will be
able to implement any of these alternatives on satisfactory terms or at all. In
addition, the terms of existing or future debt agreements, including the
Indenture, may prohibit the Company from adopting some of these alternatives.
See "Description of the Notes."
ASSET ENCUMBRANCE
The Exchange Notes will be senior obligations of Splitrock ranking pari
passu in right of payment with all existing and future Senior Indebtedness of
Splitrock. The Exchange Notes will be unsecured except with respect to the
security interest held by the Trustee in the Escrow Account for the benefit of
holders of the Exchange Notes. The Indenture will permit the Company to incur
certain indebtedness, including secured indebtedness. Holders of secured
indebtedness of the Company will have claims with respect to the assets
constituting collateral for such indebtedness that are prior to the claims of
holders of Exchange Notes.
In the event of a default on the Exchange Notes, or a bankruptcy,
liquidation or reorganization of the Company, assets securing indebtedness of
the Company and its subsidiaries other than the Exchange Notes will be available
to satisfy obligations with respect to the indebtedness secured thereby before
any payment therefrom could be made on the Exchange Notes. Accordingly, the
Exchange Notes will be effectively subordinated to claims of secured creditors
of the Company to the extent of such pledged collateral. At June 30, 1998, after
giving pro forma effect to the Unit Offering and the application of the net
proceeds therefrom, the Company would have had $21.2 million of secured
indebtedness outstanding (other than the Notes). See "Description of the Notes,"
"Selected Historical and Unaudited Pro Forma Financial Data," "Description of
Certain Indebtedness" and the Company's historical financial statements and
notes thereto included elsewhere in this Prospectus.
SUBSIDIARIES
The Company is an operating entity that may in the future conduct a portion
of its business through subsidiaries, although it does not currently have any
subsidiaries. The Company's cash flow from operations and consequent ability to
service its debt, including the Exchange Notes, may therefore in the future
become in part dependent upon the earnings of such subsidiaries, if any, and the
distribution (through dividends or otherwise) of those earnings to the Company,
or upon loans, advances or other payments of funds by any such subsidiaries to
the Company. It is not anticipated that such subsidiaries will have any
obligation, contingent or otherwise, to make any funds available to the Company
for payment of the principal of or interest on the Exchange Notes. The ability
of any such subsidiaries to make such payments will be subject to, among other
things, the availability of sufficient surplus funds, the terms of such
subsidiaries' indebtedness and applicable laws.
Claims of creditors of any such subsidiaries and holders of preferred
stock, if any, of any such subsidiaries will have priority as to the assets of
such subsidiaries over the claims of the Company and the holders of the
Company's indebtedness, except to the extent that such subsidiaries have
provided guarantees of the Company's indebtedness and to the extent that loans
made by the Company to its subsidiaries are recognized as indebtedness.
Therefore, the Exchange Notes will be effectively subordinated in right of
payment to all existing and future indebtedness and other liabilities of the
Company's subsidiaries, including trade payables. Under the terms of the
Indenture, certain subsidiaries of the Company will be restricted in their
ability to incur debt in the future. See "Description of the Notes -- Certain
Covenants."
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ABILITY TO MANAGE GROWTH
To date, the Company's operations have been limited to one primary customer
and rapid growth may place a significant strain on the Company's Network and
management, administrative, operational and financial resources. The Company's
ability to manage its growth successfully will require the Company to further
enhance its operational, management, administrative, financial and information
systems and controls. There can be no assurance that the Company will have the
resources available to successfully enhance such systems and controls.
Since June 1997, the Company has recruited and hired key members of
management in the areas of operations and administration. As a result, the key
members of the Company's management team have worked together for only a short
time. See "Management." Currently, the Company has limited personnel. In
accordance with the Company's growth strategy, it is seeking to hire additional
sales, marketing, administrative, operating and technical personnel. See
"Business -- Employees." Successful implementation of the Company's strategy
will depend on its ability to attract and retain such employees. The process of
locating, training and successfully integrating qualified personnel into the
Company's operations is often lengthy and expensive, and as a result of the
recent growth in the industry, the Company has experienced significant
competition in the attraction and retention of personnel that possess the skill
sets that the Company is seeking. There can be no assurance that the Company
will be successful in attracting, integrating and retaining such personnel. The
loss of the services of key personnel, or the inability to attract additional
qualified personnel, could have a material adverse effect on the Company's
results of operations, product development efforts, ability to attract customers
and ability to expand the Network.
In addition, as the Company increases its service offerings and number of
customers, there will be additional demands on the Company's customer support,
sales, marketing and administrative resources and personnel as well as on the
Splitrock Network infrastructure. While the Company's Network is operational, it
has experienced significant recent interruptions and failures and has not been
tested under circumstances consistent with the more significant volume of
activity anticipated as the Company grows its business and continues to migrate
Prodigy traffic from the Legacy Network and the IBM Global Services Network to
the Splitrock Network. See "-- Difficulties in Expanding and Operating the
Splitrock Network" and "-- Reliance on Prodigy; Recent Discussions with
Prodigy." The Company's inability to effectively manage its growth could have a
material adverse effect on the Company.
DEVELOPMENT OF EFFECTIVE PROCESSES AND SYSTEMS
Sophisticated processes and systems are vital to the Company's growth and
its ability to monitor costs, bill customers, record and manage customer orders
and record taxes due. The Company utilizes information management, equipment
monitoring, tracking and other software systems provided by third party vendors
and intends to implement a billing system based on third party software late in
1998. As the Company's strategy provides for growth in the number and volume of
products and services offered by the Company, such systems will be required to
expand with and adapt to the Company's growth. Failure of third party vendors to
deliver proposed products and services in a timely and effective manner and at
acceptable costs, failure of the Company to adequately identify all of its
information and processing needs, failure of the Company's processing or
information systems or failure of the Company to upgrade systems as necessary
would have a material adverse effect on the ability of the Company to implement
its strategy and on its financial condition and results of operations.
COMPETITION
The industry in which the Company competes is extremely competitive. The
Company expects that competition will continue to intensify as customers seek
additional capacity to satisfy continued growth of the Internet industry. In
addition, numerous competitors, including major telecommunications carriers, are
rapidly expanding their network capabilities. The Company believes that the
primary competitive factors for the provision of network services are quality of
service, network coverage, reliability, price, and product innovation.
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Management believes it can compete effectively on these factors based on the
design of the Splitrock Network and industry experience at top management
levels, although there can be no assurance in this regard.
The Company's current and prospective competitors generally may be divided
into two groups: (i) companies that provide Internet access services to ISPs
with both residential and small business customers, including Verio Inc.
("Verio"), Concentric Network Corporation ("Concentric"), PSINet Inc. ("PSINet")
and NETCOM On-Line Communications Services, Inc. ("Netcom") and (ii) companies
that provide Internet access (including Internet dial access and transit), VPN
and other value added services to medium and large business customers, including
UUNet Technologies, Inc., a subsidiary of WorldCom ("UUNet"), GTE
Internetworking (formerly Bolt, Beranek & Newman, Inc. ("BBN")) and DIGEX, a
subsidiary of Intermedia Communications Inc. ("DIGEX"), as well as most of the
major long distance companies. Many of these competitors, in addition to their
substantially greater market presence and financial, technical and personnel
resources, also have large existing commercial customer bases. Furthermore, many
of these competitors have the ability to bundle Internet access and VPN services
with other services such as Web browsing or, in the case of long distance
companies, telephony. Such bundling of services may have a material adverse
effect on the Company's ability to compete effectively and thus could have an
adverse effect on the Company's business, financial condition and results of
operations.
The Company believes that significant new competitors will enter the
network services market. The Company is aware that other companies, including
IXC Communications Inc. ("IXC Comm.") and Level 3 Communications Inc. ("Level
3"), are in the process of building or expanding networks that will have the
ability to provide services comparable to those of the Company. In addition,
many of the Company's competitors have the financial and operational resources
to construct networks similar to the Splitrock Network. For example, Sprint
Communications Corp. ("Sprint") recently announced that it is in the process of
designing a network which will contain ATM switches at every core, hub and
remote site. There can be no assurance that the Company will be able to compete
effectively with such companies.
Recent reforms in the federal regulation of the telecommunications industry
have also created greater opportunities for local exchange carriers ("LECs"),
including the RBOCs, to enter the Internet network services market and therefore
compete with the Company. Such increased competition could have a material
adverse effect on the Company. In order to address the Internet network service
requirements of the current business customers of long distance and local
carriers, the Company believes that there is a trend toward horizontal
integration through acquisitions of, joint ventures with, and the wholesale
purchase of connectivity from, ISPs. The WorldCom/MFS Communications Company,
Inc. ("MFS")/UUNet consolidation (as well as the pending WorldCom/MCI
Communications Corporation ("MCI") merger), the Netcom/ICG Communications Inc.
merger, the Intermedia Communications Inc. ("Intermedia")/DIGEX merger and the
GTE Corporation's ("GTE") acquisition of BBN are indicative of this trend. Such
consolidations may result in the Company competing with larger companies with
greater resources to devote to the development of new competitive products and
services and the marketing of existing competitive products and services.
As a result of increased competition and integration in the industry, the
Company could encounter significant pricing pressure, which in turn could result
in significantly lower average selling prices of the Company's services. There
can be no assurance that the Company will be able to offset the effects of any
such lower prices with an increase in the number of its customers, growth in
sales to its customers base, higher revenue from enhanced services, cost
reductions or otherwise. In addition, the Company believes that the Internet
access and related services industry is likely to undergo further consolidation
in the near future, which could result in increased price and other competition
in these industries and, potentially, other portions of the industry, including
the market for VPN services. Increased price or other competition could have a
material adverse effect on the Company's business, financial condition and
results of operations. There can be no assurance that the Company will have the
financial resources, technical expertise or marketing and support capabilities
to continue to compete successfully.
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DEPENDENCE ON SUPPLIERS
The Company is dependent on third parties for key components of its network
infrastructure, including for leased lines, transmission services and networking
equipment, such as routers, switches and modems. The quantities and quality of
such networking equipment required by the Company are available only from
limited sources. The Company currently utilizes Lucent for ATM switching
products, including the Lucent LDR200 switch, Bay Networks, Inc. ("Bay
Networks") for its Internet dial access platform, Cisco Systems, Inc. ("Cisco")
for routers and Sun Microsystems, Inc. ("Sun") for servers. The Company also
depends upon a variety of LECs and interexchange carriers ("IXCs") to provide
telecommunication services, including leased line and collocation facilities.
The Company currently has limited alternative suppliers for many of the
products or services it employs in its Network. In particular, Lucent is the
sole producer of the LDR200 switch, which the Company believes is a key
component of the Network. The Company has entered into a Purchase Agreement with
Yurie (which was acquired by Lucent in May 1998) pursuant to which the Company
agreed to purchase and Yurie agreed to provide a minimum of $20.0 million of
Yurie equipment and related products prior to January 1, 1999. As of August 31,
1998 the Company had purchased $11.0 million of equipment and products under
this agreement. Should the Company require additional Lucent LDR200 switches
beyond the quantity covered by the agreement (which the Company does not expect
to be the case), there can be no assurance that the Company will be able to
acquire them on acceptable terms, or at all. See "Business -- Suppliers." In
addition, expansion of network infrastructures by the Company and others is
placing, and will continue to place, a significant demand on the Company's other
suppliers, some of which have limited resources and production capacity. Certain
of the Company's suppliers, in turn, rely on sole or limited sources of supply
of components included in their products. These constraints may limit such
suppliers' ability to deliver products of the quality or within the time frame
demanded by the Company. The Company has experienced significant service
interruptions caused, in part, by faulty modem software code provided by one of
its suppliers. See "-- Reliance on Prodigy; Recent Discussions with Prodigy."
The Company is also dependent upon third party suppliers for its data
communications facilities and capacity. Certain of these suppliers are or may
become competitors of the Company, and such suppliers are not subject to any
contractual restrictions upon their ability to compete with the Company. The
Company currently uses WorldCom for the majority of its long distance
connections and backbone long distance transmission facilities. In addition, the
Company obtains bandwidth capacity under leased line connection agreements with
LECs, including RBOCs, or is provided telecommunications services and leased
physical space under local access/collocation agreements with various CLECs,
such as Focal Communications Corp. ("Focal"), Intermedia, Brooks Fiber
Communications and others. Since its inception, the Company has actively pursued
agreements with additional CLECs in an effort to establish relationships with a
variety of telecommunication providers and thereby reduce the cost of leased
connectivity. There can be no assurance that the Company will be able to
continue to obtain services from such suppliers on the scale and within the time
frames required by the Company at commercially reasonable cost, or at all. See
"Business -- Splitrock's Network -- Transmission Services." Any difficulties in
receiving adequate equipment, services or additional capacity on a timely basis
could have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company has an agreement with IBM to use the IBM Global Services
Network to cover market areas that are neither served by the Splitrock Network
nor the Legacy Network. The usage from these POPs currently accounts for
approximately 30% of all Prodigy-related traffic. The terms of the agreement
provide that either party may, upon 60 days prior notice, terminate its
respective obligations under the contract for the remaining POP sites. In
addition, under the terms of the agreement with IBM services at certain of the
POPs in the IBM Global Services Network are scheduled to be discontinued on
September 30, 1998. The usage from these POPs currently represents less than 2%
of the Company's Prodigy-related traffic. As part of the Phase II Expansion, the
Company plans to deploy POPs to those locations. The Company has also formulated
contingency plans, including providing toll free Internet dial access to users
in these areas, should the Company be unable to timely deploy POPs in those
areas or IBM be unwilling to continue to provide service to those POPs after
September 30, 1998. The inability to provide coverage to those cities terminated
on
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September 30, 1998 or any termination of IBM's other obligations under the
contract could have a material adverse effect on the Company's relationship with
Prodigy, and, consequently, the Company's business, financial condition and
results of operations.
As part of the Company's strategy to replace remaining POPs covered by the
IBM Global Services Network and to complete the expansion of the Splitrock
Network, the Company will rely significantly upon third parties to provide
equipment and services and to deploy the remainder of the Splitrock Network. The
Company has an agreement with Ericsson under which Ericsson will provide certain
equipment and services for, and deploy, 99 additional POP sites (the "Ericsson
Agreement"). In April 1998, Ericsson provided the Company with a $5.0 million
credit facility to be used to pay amounts due under the Ericsson Agreement. All
amounts drawn under the facility ($1.5 million) were repaid upon consummation of
the Unit Offering. The Company is in negotiations with Ericsson for the
deployment of the additional 231 POPs needed to complete the Phase II Expansion.
The Company expects that such negotiations will lead to an agreement on similar
terms and conditions as the Ericsson Agreement. There can be no assurance that
the Company and Ericsson will come to an agreement on the deployment of the
remaining 231 POPs required to complete the Network's expansion. Should the
Company and Ericsson fail to reach such an agreement, there can be no assurance
that the Company will be able to secure an alternative vendor to complete the
Network's expansion. The inability of Ericsson to complete its obligations under
the Ericsson Agreement or the failure of the Company to reach an agreement for
the deployment of additional POPs would have a material adverse effect on the
Company's business, results of operations and financial condition. See
"Business -- Suppliers" and "Description of Certain Indebtedness."
The Company also engages third party vendors for routine maintenance,
on-call repair and certain related services. In addition to nine employees and
six individual contractors designated, trained and engaged by the Company as
field operation personnel, the Company has an agreement with IBM designed to
provide additional on-call field support personnel for maintenance, part
replacement and repairs for the Legacy Network until that network is
substantially decommissioned. In addition, during and following the Phase I
Buildout, WilTel has performed on-call services for replacement parts,
maintenance and repair services for the Splitrock Network. The agreement with
WilTel will expire on September 30, 1998. The Company is currently evaluating
and negotiating maintenance service proposals that are designed to replace the
existing agreements with IBM and WilTel and expand as the network infrastructure
grows. There can be no assurance that the Company will be able to enter into a
replacement maintenance agreement on acceptable terms, or at all. See
"Business -- Suppliers."
DEPENDENCE ON KEY PERSONNEL
The Company's business is managed by key executive officers, particularly
Mr. Kwok L. Li, Chairman of the Board and Chief Technical Officer, and Mr.
William R. Wilson, President and Chief Executive Officer. In addition, the
Company is currently in the process of recruiting additional key personnel,
including a Chief Operating Officer. The loss of one or more members of senior
management or the failure to recruit such personnel in the future could
significantly impede attainment of the Company's financial objectives. See "--
Ability to Manage Growth." The Company does not currently maintain key man life
insurance on the life of any of its officers or employees but intends to acquire
such insurance for Mr. Li and Mr. Wilson in the near future. Although the
Company substantially relies on the efforts of Mr. Li, Mr. Li currently acts as
a consultant for Lucent and is the majority owner of Linsang Partners L.L.C.
("Linsang"), to which companies he devotes a portion of his work time. Mr. Li
does not, therefore, devote his time exclusively to the affairs of the Company.
The Company's operations may be adversely affected to the extent Mr. Li does not
devote full-time efforts to the Company.
CHANGE OF CONTROL
The Indenture provides that upon the occurrence of a Change of Control each
holder of Notes will have the right to require the Company to repurchase all or
any part of such holder's Notes at a price in cash equal to 101% of the
aggregate principal amount thereof plus accrued and unpaid interest and
liquidated damages, if any, to the date of repurchase. The Indenture allows the
Company to incur certain indebtedness, including
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Senior Indebtedness. The terms of such indebtedness may prohibit the repurchase
of the Notes by the Company in the event of a Change of Control, unless and
until such time as it is repaid in full. In such case, the Company, in order to
repurchase the Notes, would need to obtain the consent of the requisite lenders
under such indebtedness or to repay such indebtedness in full. The Company's
failure to repurchase the Notes would result in a default under the Indenture.
The inability to repay any future indebtedness, if accelerated, would also
constitute an event of default under the Indenture. There can be no assurance
that the Company will have the financial resources necessary to repurchase the
Notes or any other indebtedness upon a Change of Control. See "Description of
the Notes -- Change of Control."
RISKS ASSOCIATED WITH STRATEGIC ALLIANCES AND ACQUISITIONS
The Company intends to evaluate strategic alliances and acquisitions both
domestically and internationally as they present themselves. The Company
believes that an attractive strategic alliance or acquisition candidate should
provide additional traffic over the Network, service enabling technology, or
management or employee expertise. Any future strategic alliances or acquisitions
which the Company pursues would be accompanied by the risks commonly encountered
in strategic alliances with or acquisitions of companies. Such risks include,
among other things, the difficulty of integrating the operations and personnel
of the companies, the potential disruption of the Company's ongoing business,
the inability of management to maximize the financial and strategic position of
the Company by the successful incorporation of licensed or acquired technology
and rights into the Company's service offerings, the maintenance of uniform
standards, controls, procedures and policies and the impairment of relationships
with employees and customers as a result of changes in management. Any
international alliance or acquisition would be accompanied by the additional
risks of doing business abroad, including unexpected changes in the regulatory
environments, export controls, tariffs, fluctuations in currency exchange rates
and potentially adverse tax consequences. There can be no assurance that the
Company would be successful in overcoming these risks or any other problems
encountered in connection with such strategic alliances or acquisitions. In
connection with any strategic alliance or acquisition, the Company could incur
substantial expenses, including the expenses of integrating the business of the
strategic alliance or the acquired company with the Company's business. Such
expenses, in addition to the financial impact of such strategic alliances or
acquisitions, could have a material adverse effect on the Company's business,
financial condition and results of operations.
CONTROL BY PRINCIPAL STOCKHOLDERS AND MANAGEMENT; TRANSACTIONS WITH RELATED
PARTIES
Mr. Kwok L. Li, one of the founders and Chairman of the Board of the
Company, and Linsang, a company controlled by Mr. Li, collectively own
approximately 47.1% of the Company's outstanding shares. In addition, William R.
Wilson, the other founder and the President and Chief Executive Officer of the
Company, owns approximately 20.5% of the Company's outstanding shares. As a
result of this direct and indirect ownership, Mr. Li, individually, and Mr. Li
and Mr. Wilson, collectively, are able to elect the entire Board of Directors of
the Company, to direct the affairs of the Company, to appoint new management and
to approve any action requiring the approval of the holders of the Company's
capital stock, including the adoption of amendments to the Company's certificate
of incorporation and approval of mergers or sales of substantially all of the
Company's assets. There can be no assurance that the interests of Mr. Li and Mr.
Wilson will not conflict with the interests of the holders of the Notes. See
"Principal Stockholders."
Certain of the directors of the Company also serve as directors and/or
officers of other companies with which the Company conducts business and,
consequently, there exists the possibility that such directors will have a
conflict of interest. Until its sale to Lucent, Mr. Li was Director, Vice
Chairman, Chief Technology Officer and owner of 12.4% of the Common stock of
Yurie, one of the Company's principal suppliers. In connection with the sale of
Yurie to Lucent, Linsang has agreed to make the services of Mr. Li available to
Lucent to provide technical guidance for both the Lucent LDR200 and Lucent's
entire line of other ATM switches. The agreement has a term of three years and
terminates on May 29, 2001. Mr. Li has been named Chief Technical Officer of the
Carrier Network division of Lucent and has agreed to not participate in
designing, developing, producing, manufacturing or marketing multi-service
access equipment other than for Lucent. See "-- Dependence on Suppliers" and
"-- Dependence on Key Personnel.". Furthermore, Mr. Samer Salameh is President
and Chief Executive Officer of Prodigy and is a member of the Company's Board of
Directors. In addition, certain stockholders may have conflicting interests.
Orient Star, a wholly
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owned subsidiary of Carso, owns 25.0 million shares, or approximately 30.2%, of
the outstanding shares of Common Stock of the Company. Carso is a controlling
stockholder of Prodigy and a significant stockholder of Telmex.
Any decision made by directors is required by law to be made in accordance
with their duties and obligations to deal fairly and in good faith with a view
to the best interests of the Company and its shareholders. Directors may owe
similar duties to the other companies for which they serve as directors or
officers. Due in part to the nature of the potential conflicts presented on an
ongoing basis by certain of the Company's suppliers, customers and others, there
can be no assurance that the directors involved in such a conflict will act in
the best interests of the Company. See "Management -- Certain Relationships and
Related Transactions" and "Description of the Notes -- Certain Covenants
Limitation on Transactions with Affiliates."
RISKS OF TECHNOLOGY TRENDS AND EVOLVING INDUSTRY STANDARDS
The markets for Internet access, transit services, VPNs and related
services provided by the Company are relatively new and characterized by rapidly
changing technology, evolving industry standards, changes in customer needs and
frequent new product and service introductions. The Company's future success
will depend, in part, on its ability to effectively use leading technologies, to
continue to develop its technical expertise, to enhance its current services, to
develop new products and services that meet changing customer needs, and to
influence and respond to emerging industry standards and other technological
changes on a timely and cost-effective basis. There can be no assurance that the
Company will be successful in effectively using new technologies, developing new
services and technical expertise or enhancing its current services on a timely
basis or that such new technologies or enhancements will achieve market
acceptance. The Company believes that its ability to compete successfully is
also dependent upon the continued compatibility of its services with products
and architectures offered by various vendors. There can be no assurance that the
Company will be able to effectively address the compatibility issues raised by
technological changes or new industry standards. In addition, there can be no
assurance that services or technologies developed by others will not render the
services or technology of the Company or its vendors uncompetitive or obsolete.
In addition, issues concerning the commercial use of the Internet and other
services remain unresolved and may impact the growth of Internet use, especially
in the business market targeted by the Company. Despite growing interest in the
many commercial uses of the Internet, many businesses have been deterred from
purchasing Internet access services for a number of reasons, including, among
others, inconsistent quality of service, the lack of availability of
cost-effective, high-speed options, a limited number of local access points for
corporate users, inability to integrate business applications on the Internet,
the need to deal with multiple and frequently incompatible vendors, inadequate
protection of the confidentiality of stored data and information moving across
the Internet, and a lack of tools to simplify Internet access and use. In
particular, there is a perceived lack of security of commercial data, such as
credit card numbers, that has significantly impeded commercial exploitation of
the Internet to date, and there can be no assurance that encryption or other
technologies will be developed that satisfactorily address these security
concerns. Capacity constraints caused by growth in the use of the Internet may,
unless resolved, also impede further development of the Internet to the extent
that users experience delays, transmission errors and other difficulties. The
failure of the Internet industry to address these concerns and introduce viable
solutions could limit the growth of the Internet and other telecommunications
services. Any such failure would have a material adverse effect on the Company's
ability to rapidly grow its business and attain its financial objectives.
NETWORK SECURITY RISKS
Despite the implementation of network security measures by the Company,
such as limiting physical and network access to its equipment, its
infrastructure is potentially vulnerable to computer viruses, break-ins and
similar disruptive problems caused by others. Computer viruses, break-ins or
other problems caused by third parties could lead to interruptions, delays or
cessation in service to the Company's customers. Furthermore, inappropriate use
of the Internet by third parties could also potentially jeopardize the security
of confidential information stored in the computer systems of the Company's
customers, which may deter potential customers
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and adversely affect existing customer relationships. Security problems
represent an ongoing threat to public and private data networks. Addressing
problems caused by computer viruses, break-ins or other problems caused by third
parties could have a material adverse effect on the Company.
The security measures employed by the Company cannot assure complete
protection from computer viruses, break-ins and other disruptive problems. The
occurrence of such problems may result in claims against or liability on the
part of the Company. Such claims, regardless of their ultimate outcome, could
result in costly litigation and could have a material adverse effect on the
Company's business or reputation or on its ability to attract and retain
customers for its services.
RISK OF SYSTEM FAILURE; INSURANCE
The success of the Company is dependent upon its ability to protect its
network infrastructure against damage from fire, earthquakes, floods, power
loss, telecommunications failures and similar events. Despite precautions taken
by and planned by the Company, the occurrence of a natural disaster or other
unanticipated problems at one of the Company's NOCs or at a number of the
Company's core sites, hub sites or remote access sites could cause significant
interruptions in the services provided by the Company. Additionally, failure of
the Company's telecommunications providers to provide the communications
capacity required by the Company as a result of natural disaster, operational
disruption or for any other reason could cause significant interruptions in the
services provided by the Company. While the Company believes it has insurance
adequate to cover such risks, the occurrence of a significant loss not fully
covered by insurance could have a material adverse effect on the Company. In
addition, there can be no assurance that the Company will be able to maintain
adequate insurance coverage at rates it believes reasonable.
REGULATORY MATTERS; POTENTIAL LIABILITY FOR INFORMATION DISSEMINATED OVER THE
INTERNET
Although the Company is not currently subject to direct regulation by the
Federal Communications Commission ("FCC") or any other federal or state agency,
it operates in a highly regulated industry and therefore changes in the
regulatory environment relating to Internet services and traditional
telecommunications services, including regulatory changes which directly or
indirectly affect telecommunications costs or increase the likelihood or scope
of competition from RBOCs or other telecommunication companies, could have a
material adverse effect on the Company's financial position or results of
operations, including by affecting the prices at which the Company offers its
services or imposing regulatory compliance and other costs on the Company. There
can be no assurance that future service offerings of the Company will not be
subject to regulation or that the current regulatory environment will not evolve
in ways which impose requirements on the Company or its customers that would
materially adversely affect the Company. Various existing federal and state
regulations are currently the subject of judicial proceedings, legislative
hearings and administrative proposals which could change, in varying degrees,
the manner in which the industry operates. For example, the FCC is considering
whether Internet related service providers should be required to pay into
Universal Service subsidy pools. The imposition of such regulatory charges or
similar regulatory constraints would affect the Company's costs of serving its
customers and could have a material adverse effect on the Company's business and
results of operations. Furthermore, the FCC has indicated that it may consider
regulating ISPs, which could have a material adverse effect on the Company. In
addition, Internet telephony may become subject to some form of regulation in
the future. See "Business -- Regulation".
The law in the United States relating to the liability of ISPs and
providers of transmission capacity for information carried on, disseminated
through, or hosted on their systems is currently unsettled. The
Telecommunications Act of 1996 (the "Communications Act") and statutes enacted,
or under consideration in some states, impose civil and criminal liability upon
ISPs, or providers of transmission capacity to ISPs, for the transmission or
dissemination of certain types of information and materials. The imposition of
such liability may require the Company to implement measures to reduce its
exposure to such liability, which may require the expenditure of substantial
resources. Regulations, litigation, or legislation could affect the demand for
the Company's services.
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BANKRUPTCY RISKS RELATED TO ESCROW ACCOUNT
The right of the Trustee under the Indenture and the Escrow and
Disbursement Agreement (as defined) to foreclose upon and sell Escrow Collateral
(as defined) upon the occurrence of an Event of Default on the Notes is likely
to be significantly impaired by applicable bankruptcy law if a bankruptcy or
reorganization case were to be commenced by or against the Company. Under
applicable bankruptcy law, secured creditors such as the holders of the Notes
are prohibited from foreclosing upon or disposing of a debtor's property without
prior bankruptcy court approval. See "Description of Notes -- Disbursement of
Funds; Escrow Account."
FRAUDULENT CONVEYANCE; PREFERENTIAL TRANSFER
If, in a bankruptcy or reorganization case or a lawsuit by or on behalf of
unpaid creditors of the Company, a court were to find that, at the time the
Company incurred indebtedness under the Notes, (i) the Company incurred such
indebtedness with the intent of hindering, delaying or defrauding current or
future creditors or (ii)(a) the Company received less than reasonably equivalent
value or fair consideration for incurring such indebtedness and (b) the Company
(1) was insolvent or was rendered insolvent by reason of such incurrence, (2)
was engaged, or about to engage, in a business or transaction for which its
assets constituted unreasonably small capital, (3) intended to incur, or
believed that it would incur, debts beyond its ability to pay such debts as they
matured (as all of the foregoing terms are defined in or interpreted under the
relevant fraudulent transfer or conveyance statutes) or (4) was a defendant in
an action for money damages, or had a judgment for money damages docketed
against it (if, in either case, after final judgment, the judgment is
unsatisfied), then such court could avoid or subordinate the Company's
obligations under the Notes to presently existing and future indebtedness of the
Company and take other actions detrimental to the holders of the Notes.
For purposes of the foregoing, the measure of insolvency varies depending
upon the law of the jurisdiction which is being applied. Generally, however, the
Company would be considered to have been insolvent at the time the Notes were
issued if the sum of its debts was, at that time, greater than the sum of the
value of all of its property at a fair valuation, or if the then fair saleable
value of its assets was less than the amount that was then required to pay its
probable liability on its existing debts as they became absolute and matured.
There can be no assurance as to what standard a court would apply in order to
determine whether the Company was insolvent as of the date the Notes were
issued, or that, regardless of the method of valuation, a court would not
determine that the Company was insolvent on that date, or that, regardless of
whether the Company was insolvent on the date the Notes were issued, that the
issuance constituted a fraudulent transfer for the grounds summarized above.
Additionally, under federal bankruptcy law or applicable state insolvency
law, if certain bankruptcy or insolvency proceedings were initiated by or
against the Company within 90 days after any payment by the Company with respect
to the Notes or if the Company anticipated becoming insolvent at the time of
such payment or incurrence, all or a portion of such payment could be avoided as
a preferential transfer and the recipient of such payment could be required to
return such payment.
ABSENCE OF PUBLIC MARKET
Before the Exchange Offer, there has not been any public market for the
Original Notes. The Original Notes have not been registered under the Securities
Act and are subject to restrictions on transferability to the extent that they
are not exchanged for Exchange Notes by holders who are entitled to participate
in the Exchange Offer. The Exchange Notes will constitute a new issue of
securities with no established trading market. The Company does not intend to
list the Exchange Notes on any national securities exchange or to seek approval
for quotation through any automated quotation system. The Initial Purchaser of
the Original Notes currently makes a market in the Notes, but is not obligated
to do so and may discontinue such market making at any time. In addition, such
market making activity will be subject to the limits imposed by the Securities
Act and the Exchange Act and may be limited during the Exchange Offer.
Accordingly, no assurance can be given that an active public or other market
will develop for the Exchange Notes or as to the liquidity of the trading market
for the Exchange Notes. If a trading market does not develop or is not
maintained, holders of the Exchange Notes may experience difficulty in reselling
the Exchange Notes or may
33
<PAGE> 35
be unable to sell them at all. If a market for the Exchange Notes develops, any
such market may be discontinued at any time.
If a public trading market develops for the Exchange Notes, future trading
prices of such securities will depend on many factors, including, among other
things, prevailing interest rates, the Company's results of operations and the
market for similar securities. Depending on prevailing interest rates, the
market for similar securities and other factors, including the financial
condition of the Company, the Exchange Notes may trade at a discount from their
principal amount. Historically, the market for securities similar to the
Exchange Notes, including non-investment grade debt, has been subject to
disruptions that have caused substantial volatility in the prices of such
securities. There can be no assurance that any market for the Exchange Notes, if
such market develops, will not be subject to similar disruptions.
CONSEQUENCES OF FAILURE TO EXCHANGE
Holders of Original Notes who do not exchange their Notes for Exchange
Notes pursuant to the Exchange Offer will continue to be subject to the
restrictions on transfer of such Notes as set forth in the legend thereon and in
the Offering Memorandum, dated July 21, 1998, because the Original Notes were
issued pursuant to exemptions from, or in transactions not subject to, the
registration requirements of the Securities Act and applicable state securities
laws. In general, the Original Notes may not be offered or sold unless
registered under the Securities Act and applicable state securities laws, or
pursuant to an exemption therefrom, or in a transaction not subject to the
Securities Act and applicable state securities laws. The Company does not intend
to register the Original Notes under the Securities Act, and after consummation
of the Exchange Offer will not be obligated to do so except under limited
circumstances. To the extent Original Notes are tendered and accepted in the
Exchange Offer, the trading market for untendered and tendered but unaccepted
Original Notes could be adversely affected. See "The Exchange Offer."
EXCHANGE OFFER PROCEDURES
The Exchange Notes will be issued in exchange for Original Notes only after
timely receipt by the Exchange Agent of such Original Notes, a properly
completed and duly executed Letter of Transmittal and all other required
documents. Therefore, holders of Original Notes desiring to tender such Original
Notes in exchange for Exchange Notes should allow sufficient time to ensure
timely delivery. Neither the Exchange Agent nor the Company is under any duty to
give notification of defects or irregularities with respect to tenders of
Original Notes for exchange. Original Notes that are not tendered or are
tendered but not accepted will, following consummation of the Exchange Offer,
continue to be subject to the existing restrictions upon transfer thereof. In
addition, any holder of Original Notes who tenders in the Exchange Offer for the
purpose of participating in a distribution of the Exchange Notes will be
required to comply with the registration and prospectus delivery requirements of
the Securities Act in connection with any resale transaction. Based on an
interpretation by the staff of the Commission set forth in no-action letters
issued to third parties, the Company believes that the Exchange Notes issued
pursuant to the Exchange Offer in exchange for Original Notes may be offered for
resale, resold or otherwise transferred by holders thereof (other than any such
holder which is an "affiliate" of the Company within the meaning of Rule 405
under the Securities Act) without compliance with the registration and
prospectus delivery provisions of the Securities Act, if such Exchange Notes are
acquired in the ordinary course of such holder's business, such holders have no
arrangement with any person to participate in the distribution of such Exchange
Notes and neither such holders nor any such other person is engaging in or
intends to engage in a distribution of such Exchange Notes. Any holder of
Original Notes who tenders in the Exchange Offer for the purpose of
participating in a distribution of the Exchange Notes may be deemed to have
received restricted securities and, if so, will be required to comply with the
registration and prospectus delivery requirements of the Securities Act in
connection with any resale transaction. Each broker-dealer that receives
Exchange Notes for its own account in exchange for Original Notes, where such
Original Notes were acquired by such broker-dealer as a result of market-making
activities or any other trading activities, must acknowledge that it will
deliver a prospectus in connection with any resale of such Exchange Notes. See
"Plan of Distribution" and "The Exchange Offer."
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<PAGE> 36
YEAR 2000
The year-2000 issue is the result of computer programs being written using
two digits, rather than four digits, to define the applicable year. Programs
that have time-sensitive software may recognize a date using "00" as the year
1900 rather than the year 2000 (the "year-2000 issue"). This could result in a
major system failure or miscalculations, including an inability to process
transactions, send invoices or engage in similar normal business activities. Due
to its reliance on computer hardware and software, the Internet and related
service industries are highly susceptible to the year-2000 issue. If the
year-2000 issue should cause widespread problems across the Internet, usage can
be expected to decline dramatically. Such an event would have a material adverse
effect on the Company's financial condition and results of operations, the
nature and extent of which cannot reasonably be determined by the Company on the
basis of information currently available to it. The Company has not prepared a
contingency plan and does not expect to do so in light of the uncertainty of the
impact of year-2000 issues on the Internet as a whole and the Company's
anticipated schedule to be year-2000 compliant before the end of 1999.
The Company is currently in the process of evaluating its operations and
both its information technology systems and its non-information technology
systems to determine its own vulnerability to the year-2000 issue. The Company
relies heavily on non-information technology systems in the conduct of its
operations and has determined that substantially all of such systems are
year-2000 compliant. Certain network-monitoring software, which is used by the
Company to monitor network equipment (POPs) on the Legacy Network, is not
year-2000 compliant, but as part of the Company's Phase II Expansion,
substantially all of the Legacy Network POPs are scheduled to be decommissioned
by the end of 1998 and such network-monitoring software will no longer be used
by the Company. With respect to the Company's database inventory software, used
to capture data about the network configuration, including location of equipment
and maintenance, the Company has purchased and is currently installing year-2000
compliant software to replace its existing software. Installation is scheduled
to be completed by the end of 1998, and the cost of such purchase and
installation is not material. The Company has also determined that certain other
of its software systems are not year-2000 compliant. The Company believes that,
with modifications and upgrades to such software, which are scheduled to occur
in the ordinary course of business, it will be fully year-2000 compliant by the
end of 1999. The Company is continuing its evaluation of the remaining areas
impacted by year-2000 issues, including Internet interfaces, facility matters
and equipment vendors, but does not expect to incur material costs in connection
with making its software year-2000 compliant. To date the Company has not
incurred material costs in ensuring year-2000 compliance.
The Company is also dependent upon the ability of its customers to ensure
that their software and equipment is year-2000 compliant. The Company has
initiated formal communications with Prodigy to determine the extent to which
the Company is vulnerable to Prodigy's own year-2000 issues, if any. Prodigy has
informed the Company that Prodigy Classic may not be year-2000 compliant.
Prodigy is in the process of migrating users to Prodigy Internet, which is
year-2000 compliant, and plans to discontinue Prodigy Classic service by the end
of 1999. However, there can be no guarantee that Prodigy Classic or systems of
future customers on which the Company may rely will be timely converted, or that
a failure to convert, or a conversion that is incompatible with the Company's
systems, would not have a material adverse effect on the Company.
USE OF PROCEEDS
The Company will not receive any cash proceeds from the issuance of the
Exchange Notes offered hereby. In consideration for issuing the Exchange Notes
as contemplated in this Prospectus, the Company will receive in exchange
Original Notes in like principal amount, the terms of which are substantially
identical to the Exchange Notes. The Original Notes surrendered in exchange for
Exchange Notes will be retired and cancelled and cannot be reissued.
Accordingly, issuance of the Exchange Notes will not result in any increase in
the outstanding indebtedness of the Company. The Company believes the net
proceeds of the Unit Offering, pursuant to which the Original Notes were issued,
will be sufficient to fund the Company's expected capital expenditures, working
capital, lease obligations and debt service requirements for at least the next
twelve months.
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<PAGE> 37
CAPITALIZATION
The following table sets forth the Company's capitalization as of June 30,
1998 (i) on an actual basis and (ii) on an as adjusted basis after giving effect
to the Unit Offering and the application of net proceeds therefrom as if they
had occurred on June 30, 1998. This table should be read in conjunction with
"Selected Historical and Unaudited Pro Forma Financial Data," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the historical financial statements of the Company, including the notes thereto,
included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
AS OF JUNE 30, 1998
-----------------------
ACTUAL AS ADJUSTED
-------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Cash and cash equivalents................................... $ 5,177 $187,308
======== ========
Restricted cash(1).......................................... $ -- $ 56,752
======== ========
Total debt (including current portion)(2):
Short term note payable(2)................................ $ 1,477 $ --
Capital leases............................................ 21,219 21,219
Senior Notes due 2008(3).................................. -- 258,120
Notes payable to stockholder(4)........................... 11,000 --
-------- --------
Total debt........................................ 33,696 279,339
Stockholders' equity:
Common stock.............................................. 78 78
Common Stock Warrants(5).................................. -- 2,880
Additional paid-in capital(6)............................. 31,550 31,550
Accumulated deficit....................................... (23,749) (23,749)
-------- --------
Total stockholders' equity........................ 7,879 10,759
-------- --------
Total capitalization.............................. $41,575.. $290,098
======== ========
</TABLE>
- ---------------
(1) As adjusted amount represents escrowed funds that, together with interest
received thereon, will be sufficient to pay when due the first four
semi-annual payments on the Notes.
(2) As of June 30, 1998 the Company owed Ericsson $1.5 million. This
indebtedness was repaid with the net proceeds of the Unit Offering.
(3) Net of discount to the principal amount of the Notes attributable to the
Company's estimate of the value of the Warrants issued together with the
Original Notes as the Units in the Unit Offering.
(4) This amount was refinanced in connection with the Unit Offering. In
connection with such refinancing, the stockholder, Linsang, purchased $11.0
million of the Original Notes.
(5) Includes $2.9 million attributable to the Company's estimate of the value of
the Warrants issued as part of the Units. Such estimate was based on a
valuation of the Common Stock as of December 31, 1997 by a third party
valuation firm. See "Management -- Aggregated Fiscal Year-End Option
Values." No assurance can be given that the value allocated to the Warrants
is indicative of the price at which the Warrants may actually trade.
(6) Includes a $10.0 million convertible note that was converted into equity on
August 9, 1997. The June 30, 1998 actual and pro forma stockholders' equity
does not include the exercise by Orient Star of its warrant to purchase an
additional 5.0 million shares of the Company for $0.625 per share, which
occurred on September 14, 1998.
36
<PAGE> 38
THE EXCHANGE OFFER
EXCHANGE OFFER PURSUANT TO EXCHANGE AND REGISTRATION RIGHTS AGREEMENT
The Original Notes were sold by the Company on July 24, 1998 (the "Issue
Date"). The Initial Purchaser purchased $261.0 million in aggregate principal
amount of the Original Notes, of which $11.0 million in aggregate principal
amount of the Original Notes were sold to Linsang, an affiliate of the Company.
Such $11.0 million of Original Notes will be exchanged for $11.0 million of
Exchange Notes in a private offering, and such Exchange Notes will be registered
and are expected to be offered for resale under the Securities Act. As a
condition to the sale of the Original Notes, the Company and the Initial
Purchaser entered into the Exchange and Registration Rights Agreement on the
Issue Date. Pursuant to the Exchange and Registration Rights Agreement, the
Company agreed that, unless the Exchange Offer is not permitted by applicable
law or Commission policy, it would (i) file with the Commission a Registration
Statement under the Securities Act with respect to the Exchange Notes within 45
days after the Issue Date, (ii) use its reasonable best efforts to cause such
Registration Statement to become effective under the Securities Act within 105
days after the Issue Date and (iii) upon effectiveness of the Registration
Statement, commence the Exchange Offer, keep the Exchange Offer open for at
least 30 days (or a longer period if required by law) and deliver to the
Exchange Agent Exchange Notes in the same aggregate principal amount at maturity
as the Original Notes that were tendered by holders thereof pursuant to the
Exchange Offer. A copy of the Exchange and Registration Rights Agreement has
been filed as an exhibit to the Registration Statement of which this Prospectus
is a part. The Registration Statement of which this Prospectus is a part is
intended to satisfy certain of the Company's obligations under the Exchange and
Registration Rights Agreement.
If (i) because of any change in law or applicable interpretations thereof
by the staff of the Commission, the Company is not permitted to effect the
Exchange Offer as contemplated hereby, (ii) any Original Notes validly tendered
pursuant to the Exchange Offer are not exchanged for Exchange Notes within 135
days after the Issue Date, (iii) the Initial Purchaser so requests with respect
to Original Notes not eligible to be exchanged for Exchange Notes in the
Exchange Offer, (iv) any applicable law or interpretations do not permit any
holder of Original Notes to participate in the Exchange Offer, (v) any holder of
Original Notes that participates in the Exchange Offer does not receive freely
transferable Exchange Notes in exchange for tendered Original Notes, or (vi) the
Company so elects, the Company has agreed to file with the Commission a shelf
registration statement (the "Shelf Registration Statement") to cover resales of
each Original Note that (i) has not been exchanged for a freely transferable
Exchange Note in the Exchange Offer; (ii) has not been effectively registered
under the Securities Act and disposed of in accordance with the Shelf
Registration Statement or (iii) has not been nor is eligible to be distributed
to the public pursuant to Rule 144 under the Securities Act or Rule 144(k) under
the Securities Act (each such Original Note being a "Restricted Note").
RESALE OF THE EXCHANGE NOTES
With respect to the Exchange Notes, based upon an interpretation by the
staff of the Commission and subject to the terms and conditions set forth in the
Morgan Stanley No-Action Letter (Morgan Stanley and Co., Inc., available June 5,
1991) and the Exxon Capital No-Action Letter (Exxon Capital Holdings
Corporation, available May 13, 1989), as interpreted in the Commission's letter
to Shearman & Sterling dated July 2, 1993 and other no-action letters issued to
third parties, the Company believes that a holder (other than (i) a
broker-dealer who purchases such Exchange Notes directly from the Company to
resell pursuant to Rule 144A or any other available exemption under the
Securities Act or (ii) any such holder which is an "affiliate" of the Company
within the meaning of Rule 405 under the Securities Act) who exchanges the
Original Notes for the Exchange Notes in the ordinary course of business and who
is not participating, does not intend to participate, and has no arrangement
with any person to participate, in the distribution of the Exchange Notes, will
be allowed to resell the Exchange Notes to the public without further
registration under the Securities Act and without delivering to the purchasers
of the Exchange Notes a prospectus that satisfies the requirements of Section 10
of the Securities Act. However, if any holder acquires the Exchange Notes in the
Exchange Offer for the purposes of distributing or participating in the
distribution of the Exchange Notes or is a broker-dealer, such holder cannot
rely on the position of the staff of the Commission enumerated in
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<PAGE> 39
certain no-action letters issued to third parties and must comply with the
registration and prospectus delivery requirements of the Securities Act in
connection with any resale transaction, unless an exemption from registration is
otherwise available. Each broker-dealer that receives Exchange Notes for its own
account in exchange for Original Notes, where such Original Notes were acquired
by such broker-dealer as a result of market-making activities or other trading
activities, must acknowledge that it will deliver a prospectus in connection
with any resale of such Exchange Notes. The Company has agreed to make available
a Prospectus meeting the requirements of the Securities Act to any broker-dealer
for use in connection with any resale of any such Exchange Notes acquired as
described below for such period as such broker-dealers must comply with such
requirements. A broker-dealer that delivers such a Prospectus to purchasers in
connection with such resales will be subject to certain of the civil liability
provisions under the Securities Act, and will be bound by the Exchange and
Registration Rights Agreement (including certain indemnification rights and
obligations). The Letter of Transmittal states that by so acknowledging and by
delivering a prospectus, a broker-dealer will not be deemed to admit that it is
an "underwriter" within the meaning of the Securities Act. This Prospectus, as
it may be amended or supplemented from time to time, may be used by a
broker-dealer in connection with resales of Exchange Notes received in exchange
for Original Notes where such Original Notes were acquired by such broker-dealer
as a result of market-making or other trading activities. Pursuant to the
Registration Rights Agreement, the Company has agreed to make this Prospectus,
as it may be amended or supplemented from time to time, available to
broker-dealers for us in connection with any resale for a period of 180 days
after the Expiration Date. See "Plan of Distribution."
TERMS OF THE EXCHANGE OFFER
Upon the terms and subject to the conditions set forth in this Prospectus
and in the Letter of Transmittal, the Company will accept any and all Original
Notes validly tendered and not withdrawn prior to the Expiration Date. The
Company will issue $1,000 principal amount of Exchange Notes in exchange for
each $1,000 principal amount of outstanding Original Notes surrendered pursuant
to the Exchange Offer. Notes may be tendered only in integral multiples of
$1,000.
The form and terms of the Exchange Notes are the same as the form and terms
of the Original Notes except that (i) the exchange will be registered under the
Securities Act and hence the Exchange Notes will not bear legends restricting
their transfer and (ii) holders of the Exchange Notes will not be entitled to
the certain rights of holders of the Original Notes under the Exchange and
Registration Rights Agreement, which rights will terminate upon the consummation
of the Exchange Offer. The Exchange Notes will evidence the same debt as the
Original Notes (which they replace) and will be issued under, and be entitled to
the benefits of, the Indenture, which also authorized the issuance of the
Original Notes, such that all outstanding Notes will be treated as a single
class of debt securities under the Indenture.
As of the date of this Prospectus, $250.0 million aggregate principal
amount of the Original Notes are outstanding and registered in the name of Cede
& Co., as nominee for The Depository Trust Company (the "Depositary"). In
addition, Original Notes in the aggregate principal amount of $11.0 million,
also outstanding and registered in the name of Cede & Co. (which are not
eligible to be exchanged under this Exchange Offer) are held by Linsang, an
affiliate of the Company. Such $11.0 million of Original Notes will be exchanged
for $11.0 million of Exchange Notes in a private offering and the Exchange Notes
are expected to be registered for resale under the Securities Act. Only a
registered holder of the Original Notes (or such holder's legal representative
or attorney-in-fact) as reflected on the records of the Trustee under the
Indenture may participate in the Exchange Offer. There will be no fixed record
date for determining registered holders of the Original Notes entitled to
participate in the Exchange Offer.
Holders of the Original Notes do not have any appraisal or dissenter's
rights under the Indenture in connection with the Exchange Offer. The Company
intends to conduct the Exchange Offer in accordance with the provisions of the
Exchange and Registration Rights Agreement and the applicable requirements of
the Securities Act, the Exchange Act and the rules and regulations of the
Commission thereunder.
The Company shall be deemed to have accepted validly tendered Original
Notes when, as and if the Company has given oral or written notice thereof to
the Exchange Agent. The Exchange Agent will act as
38
<PAGE> 40
agent for the tendering holders of Original Notes for the purposes of receiving
the Exchange Notes from the Company.
Holders who tender Original Notes in the Exchange Offer will not be
required to pay brokerage commissions or fees or, subject to the instructions in
the Letter of Transmittal, transfer taxes with respect to the exchange of Notes
pursuant to the Exchange Offer. The Company will pay all charges and expenses,
other than certain applicable taxes described below, in connection with the
Exchange Offer. See " Fees and Expenses."
EXPIRATION DATE; EXTENSIONS; AMENDMENTS
The term "Expiration Date" shall mean 5:00 p.m., New York City time on
, 1998 (30 days after the registration statement covering this
Exchange Offer has been declared effective by the Commission) unless the
Company, in its sole discretion, extends the Exchange Offer to a date not later
than , 1998, in which case the term "Expiration Date" shall mean the
latest date and time to which the Exchange Offer is extended.
In order to extend the Exchange Offer, the Company will (i) notify the
Exchange Agent of any extension by oral or written notice, (ii) will mail to the
registered holders of Original Notes an announcement thereof, (iii) will issue a
press release or other public announcement which shall include disclosure of the
approximate number of Original Notes deposited to date, each prior to 9:00 a.m.,
New York City time, on the next business day after the previously scheduled
Expiration Date. Without limiting the manner in which the Company may choose to
make a public announcement of any delay, extension, amendment or termination of
the Exchange Offer, the Company shall have no obligation to publish, advertise
or otherwise communicate any such public announcement, other than by making a
timely release to an appropriate news agency.
The Company reserves the right, in its sole discretion, (i) to delay
accepting any Original Notes, (ii) to extend the Exchange Offer, or (iii) if any
conditions set forth below under "-- Certain Conditions to the Exchange Offer"
shall not have been satisfied, to terminate the Exchange Offer by giving oral or
written notice of such delay, extension or termination to the Exchange Agent.
Any such delay in acceptance, extension, termination or amendment will be
followed as promptly as practicable by oral or written notice thereof to the
registered holders. If the Exchange Offer is amended in a manner determined by
the Company to constitute a material change, the Company will promptly disclose
such amendment by means of a prospectus supplement that will be distributed to
the registered holders of Original Notes, and the Company will extend the
Exchange Offer for a period of five to 10 business days, depending upon the
significance of the amendment and the manner of disclosure to such registered
holders, if the Exchange Offer would otherwise expire during such five to 10
business day period.
INTEREST ON THE EXCHANGE NOTES
The Exchange Notes bear interest at a rate equal to 11 3/4% per annum.
Interest on the Exchange Notes is payable semi-annually on each January 15 and
July 15, commencing on January 15, 1999. Holders of Exchange Notes will receive
interest on January 15, 1999 from the date of initial issuance of the Original
Notes plus an amount equal to the interest accrued on the Original Notes.
Interest on the Original Notes accepted for exchange will cease to accrue upon
issuance of the Exchange Notes.
PROCEDURES FOR TENDERING
Only a registered holder of Original Notes may tender such Original Notes
in the Exchange Offer. To tender in the Exchange Offer, a holder must complete,
sign and date the Letter of Transmittal, or facsimile thereof, have the
signatures thereon guaranteed if required by the Letter of Transmittal, and mail
or otherwise deliver such Letter of Transmittal or such facsimile to the
Exchange Agent at the address set forth below under "-- Exchange Agent" for
receipt prior to the Expiration Date. In addition, either (i) certificates for
such Original Notes must be received by the Exchange Agent along with the Letter
of Transmittal, or (ii) a timely confirmation of a book-entry transfer (a
"Book-Entry Confirmation") of such Original Notes, if such procedure is
available, into the Exchange Agent's account at the Depositary pursuant to the
procedure for
39
<PAGE> 41
book-entry transfer described below, must be received by the Exchange Agent
prior to the Expiration Date, or (iii) the holder must comply with the
guaranteed delivery procedures described below.
The tender by a holder which is not withdrawn prior to the Expiration Date
will constitute an agreement between such holder and the Company in accordance
with the terms and subject to the conditions set forth herein and in the Letter
of Transmittal.
THE METHOD OF DELIVERY OF ORIGINAL NOTES AND THE LETTER OF TRANSMITTAL AND
ALL OTHER REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT THE ELECTION AND RISK
OF THE HOLDER. INSTEAD OF DELIVERY BY MAIL, IT IS RECOMMENDED THAT HOLDERS USE
AN OVERNIGHT OR HAND DELIVERY SERVICE, PROPERLY INSURED. IN ALL CASES,
SUFFICIENT TIME SHOULD BE ALLOWED TO ASSURE DELIVERY TO THE EXCHANGE AGENT
BEFORE THE EXPIRATION DATE. NO LETTER OF TRANSMITTAL OR ORIGINAL NOTES SHOULD BE
SENT TO THE COMPANY. HOLDERS MAY REQUEST THEIR RESPECTIVE BROKERS, DEALERS,
COMMERCIAL BANKS, TRUST COMPANIES OR NOMINEES TO EFFECT THE ABOVE TRANSACTIONS
FOR SUCH HOLDERS.
Any beneficial owner(s) of the Original Notes whose Original Notes are
registered in the name of a broker, dealer, commercial bank, trust company or
other nominee and who wishes to tender should contact the registered holder
promptly and instruct such registered holder to tender on such beneficial
owner's behalf. If such beneficial owner wishes to tender on such owner's own
behalf, such owner must, prior to completing and executing the Letter of
Transmittal and delivering such owner's Original Notes, either make appropriate
arrangements to register ownership of the Original Notes in such owner's name
(to the extent permitted by the Indenture) or obtain a properly completed bond
power from the registered holder. The transfer of registered ownership may take
considerable time.
Signatures on a Letter of Transmittal or a notice of withdrawal described
below (see "-- Withdrawal of Tenders"), as the case may be, must be guaranteed
by an Eligible Institution (as defined below) unless the Original Notes tendered
pursuant thereto are tendered (i) by a registered holder who has not completed
the box entitled "Special Delivery Instructions" on the Letter of Transmittal or
(ii) for the account of an Eligible Institution. If signatures on a Letter of
Transmittal or a notice of withdrawal, as the case may be, are required to be
guaranteed, such guarantee must be made by a member firm of a registered
national securities exchange or of the National Association of Securities
Dealers, Inc., a commercial bank or trust company having an office or
correspondent in the United States, or an "eligible guarantor institution"
within the meaning of Rule 17Ad-15 under the Exchange Act which is a member of
one of the recognized signature guarantee programs identified in the Letter of
Transmittal (an "Eligible Institution").
If the Letter of Transmittal is signed by a person other than the
registered holder of any Original Notes listed therein, such Original Notes must
be endorsed or accompanied by a properly completed bond power, signed by such
registered holder as such registered holder's name appears on such Original
Notes.
If the Letter of Transmittal or any Original Notes or bond powers are
signed by trustees, executors, administrators, guardians, attorneys-in-fact,
officers of corporations or others acting in a fiduciary or representative
capacity, such persons should so indicate when signing, and unless waived by the
Company, evidence satisfactory to the Company of their authority to so act must
be submitted with the Letter of Transmittal.
The Exchange Agent and the Depositary have confirmed that any financial
institution that is a participant in the Depositary's system may utilize the
Depositary's Automated Tender Offer Program to tender Original Notes.
All questions as to the validity, form, eligibility (including time of
receipt), acceptance and withdrawal of tendered Original Notes will be
determined by the Company in its sole discretion, which determination will be
final and binding. The Company reserves the absolute right to reject any and all
Original Notes not properly tendered or any Original Notes the Company's
acceptance of which would, in the opinion of counsel for the Company, be
unlawful. The Company also reserves the right to waive any defects,
irregularities or conditions
40
<PAGE> 42
of tender as to particular Original Notes. The Company's interpretation of the
terms and conditions of the Exchange Offer (including the instructions in the
Letter of Transmittal) will be final and binding on all parties. Unless waived,
any defects or irregularities in connection with tenders of Original Notes must
be cured within such time as the Company shall determine. Although the Company
intends to notify holders of defects or irregularities with respect to tenders
of Original Notes, neither the Company, the Exchange Agent nor any other person
shall incur any liability for failure to give such notification. Tenders of
Original Notes will not be deemed to have been made until such defects or
irregularities have been cured or waived.
While the Company has no present plan to acquire any Original Notes which
are not tendered in the Exchange Offer or to file a registration statement to
permit resales of any Original Notes which are not tendered pursuant to the
Exchange Offer (other than the Shelf Registration Statement in connection with
the Original Notes in the aggregate principal amount of $11.0 million held by an
affiliate of the Company), the Company reserves the right in its sole discretion
to purchase or make offers for any Original Notes that remain outstanding after
the Expiration Date or, as set forth below under "-- Certain Conditions to the
Exchange Offer," to terminate the Exchange Offer and, to the extent permitted by
applicable law, purchase Original Notes in the open market, in privately
negotiated transactions or otherwise. The terms of any such purchases or offers
could differ from the terms of the Exchange Offer.
By tendering, each holder will represent to the Company that, among other
things, (i) the Exchange Notes to be acquired by the holder of the Original
Notes in connection with the Exchange Offer are being acquired by the holder in
the ordinary course of business of the holder, (ii) the holder has no
arrangement or understanding with any person to participate in the distribution
of Exchange Notes, (iii) the holder acknowledges and agrees that any person who
is a broker-dealer registered under the Exchange Act or is participating in the
Exchange Offer for the purposes of distributing the Exchange Notes must comply
with the registration and prospectus delivery requirements of the Securities Act
in connection with a secondary resale transaction of the Exchange Notes acquired
by such person and cannot rely on the position of the staff of the Commission
set forth in certain no-action letters, (iv) the holder understands that a
secondary resale transaction described in clause (iii) above and any resales of
Exchange Notes obtained by such holder in exchange for Original Notes acquired
by such holder directly from the Company should be covered by an effective
registration statement containing the selling securityholder information
required by Item 507 or Item 508, as applicable, of Regulation S-K of the
Commission, and (v) the holder is not an "affiliate," as defined in Rule 405 of
the Securities Act, of the Company. If the holder is a broker-dealer that will
receive Exchange Notes for its own account in exchange for Original Notes that
were acquired as a result of market-making activities or other trading
activities, the holder is required to acknowledge in the Letter of Transmittal
that it will deliver a prospectus in connection with any resale of such Exchange
Notes; however, by so acknowledging and by delivering a prospectus, the holder
will not be deemed to admit that it is an "underwriter" within the meaning of
the Securities Act.
RETURN OF NOTES
If any tendered Original Notes are not accepted for any reason set forth in
the terms and conditions of the Exchange Offer or if Original Notes are
withdrawn or are submitted for a greater principal amount than the holders
desire to exchange, such unaccepted, withdrawn or non-exchanged Original Notes
will be returned without expense to the tendering holder thereof (or, in the
case of Original Notes tendered by book-entry transfer into the Exchange Agent's
account at the Depositary pursuant to the book-entry transfer procedures
described below, such Original Notes will be credited to an account maintained
with the Depositary) as promptly as practicable.
BOOK-ENTRY TRANSFER
The Exchange Agent will make a request to establish an account with respect
to the Original Notes at the Depositary for purposes of the Exchange Offer
within two business days after the date of this Prospectus, and any financial
institution that is a participant in the Depositary's systems may make
book-entry delivery of Original Notes by causing the Depositary to transfer such
Original Notes into the Exchange Agent's account at the Depositary in accordance
with the Depositary's procedures for transfer. Although delivery of Original
41
<PAGE> 43
Notes may be effected through book-entry transfer at the Depositary, the Letter
of Transmittal or facsimile thereof, with any required signature guarantees and
any other required documents, must, in any case, be transmitted to and received
by the Exchange Agent at the address set forth below under " Exchange Agent" on
or prior to the Expiration Date or pursuant to the guaranteed delivery
procedures described below.
GUARANTEED DELIVERY PROCEDURES
Holders who wish to tender their Original Notes and (i) whose Original
Notes are not immediately available or (ii) who cannot deliver their Original
Notes, the Letter of Transmittal or any other required documents to the Exchange
Agent prior to the Expiration Date, may effect a tender if:
(a) The tender is made through an Eligible Institution;
(b) Prior to the Expiration Date, the Exchange Agent receives from
such Eligible Institution a properly completed and duly executed Notice of
Guaranteed Delivery substantially in the form provided by the Company (by
facsimile transmission, mail or hand delivery) setting forth the name and
address of the holder, the certificate number(s) of such Original Notes and
the principal amount of Original Notes tendered, stating that the tender is
being made thereby and guaranteeing that, within five New York Stock
Exchange trading days after the Expiration Date, the Letter of Transmittal
(or a facsimile thereof) together with the certificate(s) representing the
Original Notes in proper form for transfer or a Book-Entry Confirmation, as
the case may be, and any other documents required by the Letter of
Transmittal will be deposited by the Eligible Institution with the Exchange
Agent; and
(c) Such properly executed Letter of Transmittal (or facsimile
thereof), as well as the certificate(s) representing all tendered Original
Notes in proper form for transfer and all other documents required by the
Letter of Transmittal are received by the Exchange Agent within five New
York Stock Exchange trading days after the Expiration Date.
Upon request to the Exchange Agent, a Notice of Guaranteed Delivery will be
sent to holders who wish to tender their Original Notes according to the
guaranteed delivery procedures set forth above.
WITHDRAWAL OF TENDERS
Except as otherwise provided herein, tenders of Original Notes may be
withdrawn at any time prior to the Expiration Date.
To withdraw a tender of Original Notes in the Exchange Offer, a written or
facsimile transmission notice of withdrawal must be received by the Exchange
Agent at its address set forth herein prior to the Expiration Date. Any such
notice of withdrawal must (i) specify the name of the person having deposited
the Original Notes to be withdrawn (the "Depositor"), (ii) identify the Original
Notes to be withdrawn (including the certificate number or numbers and principal
amount of such Original Notes), and (iii) be signed by the holder in the same
manner as the original signature on the Letter of Transmittal by which such
Original Notes were tendered (including any required signature guarantees). All
questions as to the validity, form and eligibility (including time of receipt)
of such notices will be determined by the Company in its sole discretion, whose
determination shall be final and binding on all parties. Any Original Notes so
withdrawn will be deemed not to have been validly tendered for purposes of the
Exchange Offer and no Exchange Notes will be issued with respect thereto unless
the Original Notes so withdrawn are validly retendered. Properly withdrawn Notes
may be retendered by following one of the procedures described above under
"Procedures for Tendering" at any time before the Expiration Date.
CERTAIN CONDITIONS TO THE EXCHANGE OFFER
Notwithstanding any other term of the Exchange Offer, the Company shall not
be required to accept for exchange, or exchange the Exchange Notes for, any
Original Notes not theretofore accepted for exchange, and
42
<PAGE> 44
may terminate or amend the Exchange Offer as provided herein before the
acceptance of such Original Notes, if any of the following conditions exist:
(a) any action or proceeding is instituted or threatened in any court
or by or before any governmental agency with respect to the Exchange Offer
which, in the reasonable judgment of the Company, might impair the ability
of the Company to proceed with the Exchange Offer or have a material
adverse effect on the contemplated benefits of the Exchange Offer to the
Company or there shall have occurred any material adverse development in
any existing action or proceeding with respect to the Company; or
(b) there shall have been any material change, or development
involving a prospective change, in the business or financial affairs of the
Company which, in the reasonable judgment of the Company, would materially
impair the contemplated benefits of the Exchange Offer to the Company; or
(c) there shall have been proposed, adopted or enacted any law,
statute, rule or regulation which, in the reasonable judgment of the
Company, might materially impair the ability of the Company to proceed with
the Exchange Offer or materially impair the contemplated benefits of the
Exchange Offer to the Company; or
(d) any governmental approval which the Company shall, in its
reasonable discretion, deem necessary for the consummation of the Exchange
Offer as contemplated hereby has not been obtained.
If the Company determines in its sole discretion that any of these
conditions are not satisfied, the Company may (i) refuse to accept any Original
Notes and return all tendered Original Notes to the tendering holders, (ii)
extend the Exchange Offer and retain all Original Notes tendered prior to the
expiration of the Exchange Offer, subject, however, to the rights of holders to
withdraw such Original Notes (see "Withdrawal of Tenders"), or (iii) waive such
unsatisfied conditions with respect to the Exchange Offer and accept all
properly tendered Original Notes which have not been withdrawn. If such waiver
constitutes a material change to the Exchange Offer, the Company will promptly
disclose such waiver by means of a prospectus supplement that will be
distributed to the registered holders of the Original Notes, and the Company
will extend the Exchange Offer for a period of five to 10 business days,
depending upon the significance of the waiver and the manner of disclosure to
the registered holders, if the Exchange Offer would otherwise expire during such
five to 10 business day period.
Holders may have certain rights and remedies against the Company under the
Exchange and Registration Rights Agreement if the Company fails to consummate
the Exchange Offer, notwithstanding a failure of the conditions stated above.
Such conditions are not intended to modify those rights or remedies in any
respect.
The foregoing conditions are for the sole benefit of the Company and may be
asserted by the Company regardless of the circumstances giving rise to such
condition or may be waived by the Company in whole or in part at any time and
from time to time in the Company's sole discretion. The failure by the Company
at any time to exercise the foregoing rights shall not be deemed a waiver of
such right and each such right shall be deemed an ongoing right which may be
asserted at any time and from time to time.
TERMINATION OF CERTAIN RIGHTS
All rights under the Exchange and Registration Rights Agreement (including
registration rights) of holders of the Original Notes eligible to participate in
this Exchange Offer will terminate upon consummation of the Exchange Offer
except with respect to the Company's continuing obligations (i) to indemnify the
holders (including any broker-dealers) and certain parties related to the
holders against certain liabilities (including liabilities under the Securities
Act), (ii) to provide, upon the request of any holder of a transfer-restricted
Original Note, the information required by Rule 144(d)(4) under the Securities
Act in order to permit resales of such Original Notes pursuant to Rule 144A,
(iii) to use its best efforts to keep the Registration Statement effective to
the extent necessary to ensure that it is available for resales of transfer-
restricted Notes by broker-dealers for a period of 180 days from the date on
which the Registration Statement
43
<PAGE> 45
is declared effective, and (iv) to provide copies of the latest version of the
Prospectus to broker-dealers upon their request for a period of 180 days from
the date on which the Registration Statement is declared effective.
LIQUIDATED DAMAGES
If (i) the Registration Statement or Shelf Registration Statement is not
filed with the Commission on or prior to 45 days after the Issue Date; (ii)
Registration Statement or the Shelf Registration Statement is not declared
effective within 105 days after the Issue Date; (iii) the Exchange Offer is not
consummated on or prior to 135 days after the Issue Date or (iv) the Shelf
Registration Statement is filed and declared effective within 135 days after the
Issue Date but shall thereafter cease to be effective (at any time that the
Company is obligated to maintain the effectiveness thereof) without being
succeeded within 30 days by an additional registration statement filed and
declared effective (each such event referred to in clauses (i) through (iv), a
"Registration Default"), the Company will be obligated to pay liquidated damages
to each holder of Restricted Notes, during the period of one or more such
Registration Defaults, in an amount equal to $0.192 per week per $1,000
principal amount of the Notes constituting Restricted Notes held by such holder
until the Registration Statement, the Shelf Registration Statement or other
applicable registration statement is filed, the Exchange Offer Registration
Statement is declared effective and the Exchange Offer is consummated or the
Shelf Registration Statement is declared effective or again becomes effective,
as the case may be. All accrued liquidated damages shall be paid to holders in
the same manner as interest payments on the Notes on semi-annual payment dates
which correspond to interest payment dates for the Notes. Following the cure of
all Registration Defaults, the accrual of liquidated damages will cease.
EXCHANGE AGENT
Bank of Montreal Trust Company has been appointed as Exchange Agent of the
Exchange Offer. Questions and requests for assistance, requests for additional
copies of this Prospectus or of the Letter of Transmittal and requests for
Notice of Guaranteed Delivery should be directed to the Exchange Agent addressed
as follows:
<TABLE>
<S> <C>
By Registered or Certified Mail: By Hand Delivery:
Bank of Montreal Trust Company Bank of Montreal Trust Company
Wall Street Plaza Wall Street Plaza
88 Pine Street, 19th Floor 88 Pine Street, 19th Floor
New York, NY 10005 New York, NY 10005
By Overnight Delivery: By Facsimile:
Bank of Montreal Trust Company 212/701-7664
Wall Street Plaza
88 Pine Street, 19th Floor
New York, NY 10005
</TABLE>
FEES AND EXPENSES
All fees and expenses incident to compliance with the Exchange and
Registration Rights Agreement regarding this Exchange Offer shall be borne by
the Company whether or not the Exchange Offer or a Shelf Registration becomes
effective.
The Company has not retained any dealer-manager in connection with the
Exchange Offer and will not make any payments to brokers, dealers or others
soliciting acceptances of the Exchange Offer. The Company, however, will pay the
Exchange Agent reasonable and customary fees for its services and will reimburse
it for its reasonable out-of-pocket expenses in connection therewith.
The cash expenses to be incurred in connection with the Exchange Offer will
be paid by the Company and are estimated in the aggregate to be approximately
$350,000. Such expenses include registration fees, fees and expenses of the
Exchange Agent and Trustee, accounting and legal fees and printing costs, among
others.
44
<PAGE> 46
The Company will pay all transfer taxes, if any, applicable to the exchange
of Original Notes pursuant to the Exchange Offer. If, however, a transfer tax is
imposed for any reason other than the exchange of the Original Notes pursuant to
the Exchange Offer, then the amount of any such transfer taxes (whether imposed
on the registered holder or any other persons) will be payable by the tendering
holder. If satisfactory evidence of payment of such taxes or exemption therefrom
is not submitted with the Letter of Transmittal, the amount of such transfer
taxes will be billed directly to such tendering holder.
CONSEQUENCES OF FAILURE TO EXCHANGE
Participation in the Exchange Offer is voluntary. Holders of the Original
Notes are urged to consult their financial and tax advisors in making their own
decisions on what action to take.
The Original Notes which are not exchanged for the Exchange Notes pursuant
to the Exchange Offer will remain restricted securities. Accordingly, such Notes
may be resold only (i) to a person whom the seller reasonably believes is a
qualified institutional buyer (as defined in Rule 144A under the Securities Act)
in a transaction meeting the requirements of Rule 144A, (ii) in a transaction
meeting the requirements of Rule 144 under the Securities Act, (iii) outside the
United States to a foreign person in a transaction meeting the requirements of
Rule 904 under the Securities Act, (iv) in accordance with another exemption
from the registration requirements of the Securities Act (and based upon an
opinion of counsel if the Company so requests), (v) to the Company, or (vi)
pursuant to an effective registration statement and, in each case, in accordance
with any applicable securities laws of any state of the United States or any
other applicable jurisdiction.
ACCOUNTING TREATMENT
For accounting purposes, the Company will recognize no gain or loss as a
result of the Exchange Offer. The expenses of the Exchange Offer will be
amortized over the term of the Exchange Notes.
45
<PAGE> 47
SELECTED HISTORICAL AND UNAUDITED PRO FORMA FINANCIAL DATA
The following table sets forth selected historical and unaudited pro forma
financial data of the Company. The historical statement of operations and other
financial data for the period from inception (March 5, 1997) through December
31, 1997 and the historical balance sheet data as of December 31, 1997 have been
derived from, should be read in conjunction with and are qualified in their
entirety by reference to the audited financial statements, including the notes
thereto, included elsewhere in this Prospectus. The historical statement of
operations and other financial data for the period from inception (March 5,
1997) through June 30, 1997 and for the six months ended June 30, 1998 and the
historical balance sheet data as of June 30, 1998 have been derived from, should
be read in conjunction with and are qualified in their entirety by reference to
the unaudited condensed financial statements, including the notes thereto,
included elsewhere in this Prospectus which have been prepared on a basis
consistent with the audited financial statements and in the opinion of
management include all adjustments, consisting solely of normal, recurring
adjustments, necessary to present fairly the information contained therein. The
historical quarterly statement of operations data for the three months ended
June 30, 1997, September 30, 1997, December 31, 1997, March 31, 1998 and June
30, 1998 have been derived from the Company's accounting records and have been
prepared on a basis consistent with the audited financial statements and in the
opinion of management include all adjustments, consisting solely of normal,
recurring adjustments, necessary to present fairly the information contained
therein. The selected historical financial data are not necessarily indicative
of the operating results to be expected in future periods.
The following table also presents certain selected unaudited pro forma
financial data of the Company for the period from inception (March 5, 1997) to
December 31, 1997 and for the six months ended and as of June 30, 1998, which
give effect to the Unit Offering and the application of the proceeds therefrom
as if they had occurred on March 5, 1997, in the case of the statement of
operations data, and June 30, 1998, in the case of the balance sheet data. The
selected unaudited pro forma financial data do not purport to be indicative of
the results that actually would have been obtained had the Unit Offering been
consummated on the assumed dates and they are not necessarily indicative of
operating results to be expected in future periods.
The following selected historical and unaudited pro forma financial data
should be read in conjunction with the historical financial statements of the
Company and the notes thereto included elsewhere in this Prospectus and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
46
<PAGE> 48
SELECTED HISTORICAL AND UNAUDITED PRO FORMA FINANCIAL DATA
<TABLE>
<CAPTION>
PERIOD FROM INCEPTION PERIOD FROM INCEPTION SIX MONTHS
(MARCH 5, 1997) (MARCH 5, 1997) ENDED
THROUGH THROUGH JUNE 30,
DECEMBER 31, 1997 JUNE 30, 1997 1998
--------------------- --------------------- ----------
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue........................................ $ 22,708 $ -- $ 32,214
Operating expenses:
Network personnel costs...................... 437 -- 2,156
Network operating costs...................... 1,925 -- 9,402
Legacy Network costs......................... 25,341 -- 27,090
Severance costs(1)........................... 463 -- --
Selling, general and administrative.......... 1,276 125 1,628
Depreciation and amortization................ 3,500 -- 4,907
-------- ------- --------
Total operating expenses............. 32,942 125 45,183
-------- ------- --------
Loss from operations........................... (10,234) (125) (12,969)
Other income (expense):
Interest income.............................. 348 30 183
Interest expense............................. (235) -- (842)
-------- ------- --------
Loss before income taxes....................... (10,121) (95) (13,628)
Provision for income taxes..................... -- -- --
-------- ------- --------
Net loss....................................... $(10,121) $ (95) $(13,628)
======== ======= ========
Loss per share -- basic and diluted............ $ (0.24) $ (0.01) $ (0.18)
======== ======= ========
Weighted average shares -- basic and diluted... 42,824 11,525 76,888
======== ======= ========
</TABLE>
<TABLE>
<CAPTION>
AS OF
DECEMBER 31, AS OF
1997 JUNE 30, 1998
------------ ----------------------
ACTUAL ACTUAL PRO FORMA(2)
------------ ------- ------------
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents(3).............................. $ 7,710 $ 5,177 $187,308
Restricted cash(4)........................................ 3,472 -- 56,752
Property and equipment, net............................... 38,504 43,148 43,148
Total assets.............................................. 54,388 57,630 306,183
Short term note payable(3)................................ -- 1,477 --
Long term debt and capital lease obligations (including
current portion)(3)..................................... 25,120 32,219 279,339
Stockholders' equity(5)................................... 20,407 7,879 10,759
</TABLE>
47
<PAGE> 49
<TABLE>
<CAPTION>
PERIOD FROM INCEPTION PERIOD FROM INCEPTION SIX MONTHS
(MARCH 5, 1997) (MARCH 5, 1997) ENDED
THROUGH THROUGH JUNE 30,
DECEMBER 31, 1997 JUNE 30, 1997 1998
--------------------- --------------------- -----------
(UNAUDITED) (UNAUDITED)
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
OTHER FINANCIAL DATA:
Capital expenditures(6)........................ $ 42,004 $ 2,078 $ 9,379
EBITDA(7)...................................... (6,271) (125) (8,062)
Cash provided by (used in):
Operating activities......................... (2,233) (3) (3,712)
Investing activities......................... (17,198) (2,078) (7,714)
Financing activities......................... 27,141 10,778 8,893
Ratio of earnings to fixed charges(8).......... -- -- --
PRO FORMA DATA:(9)
Interest expense............................... $ 26,422 N/A $ 16,349
Ratio of earnings to fixed charges(8).......... -- -- --
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------------------
JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1997 1997 1997 1998 1998
-------- ------------- ------------ --------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
QUARTERLY STATEMENT OF OPERATIONS
DATA:
Revenue............................... $ -- $ 10,729 $11,979 $16,494 $15,720
Operating expenses:
Network personnel costs............. -- 95 342 1,051 1,105
Network operating costs............. -- 561 1,364 3,127 6,275
Legacy Network costs................ -- 13,119 12,222 12,295 14,795
Severance costs(1).................. -- -- 463 -- --
Selling, general and
administrative................... 125 471 680 657 971
Depreciation and amortization....... -- 1,708 1,792 2,820 2,087
------- -------- ------- ------- -------
Total operating expenses.... 125 15,954 16,863 19,950 25,233
------- -------- ------- ------- -------
Loss from operations.................. (125) (5,225) (4,884) (3,456) (9,513)
Other income (expense):
Interest income..................... 30 137 181 107 76
Interest expense.................... -- (113) (122) (349) (493)
------- -------- ------- ------- -------
Loss before income tax................ (95) (5,201) (4,825) (3,698) (9,930)
Provision for income tax.............. -- -- -- -- --
------- -------- ------- ------- -------
Net loss.............................. $ (95) $ (5,201) $(4,825) $(3,698) $(9,930)
======= ======== ======= ======= =======
Loss per share -- basic and diluted... $ (0.01) $ (0.11) $ (0.06) $ (0.05) $ (0.13)
======= ======== ======= ======= =======
Weighted average shares -- basic and
diluted............................. 14,648 48,991 76,800 76,800 76,976
======= ======== ======= ======= =======
OTHER QUARTERLY DATA:
EBITDA(7)............................. $ (125) $ (3,517) $(2,629) $ (636) $(7,426)
======= ======== ======= ======= =======
Cash provided by (used in):
Operating activities................ (1,554) 103 (2,333) (4,874) 1,162
Investing activities................ (377) (12,242) (2,878) (2,740) (4,974)
Financing activities................ 10,026 19,750 (3,387) 3,253 5,640
</TABLE>
- ---------------
(1) Prior to January 1998, certain staffing positions were filled by Prodigy
employees who were subcontracted to the Company. In the fourth quarter of
1997, the Company recorded a severance charge related to the elimination of
13 of these positions.
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<PAGE> 50
(2) Pro forma balance sheet data assumes the Unit Offering and the application
of the net proceeds therefrom had occurred on June 30, 1998.
(3) As of June 30, 1998, the Company owed Ericsson $1.5 million, which was
repaid with the proceeds of the Unit Offering, and Linsang, a stockholder of
the Company, $11.0 million which was refinanced in connection with the Unit
Offering. After giving effect to such repayment and refinancing, pro forma
cash and cash equivalents would have been $187.3 million. Pro forma long
term debt and capital lease obligations is net of $2.9 million discount to
the principal amount of the Notes attributable to the Company's estimate of
the value of the Warrants issued in connection with the Unit Offering.
(4) As of December 31, 1997, the Company had an outstanding letter of credit in
the amount of $3.5 million. This letter of credit was secured by the amount
in the restricted cash account. In the first quarter of 1998, the Company
exercised its early purchase option with regard to the related capital lease
and the letter of credit was retired. Pro forma amount represents escrowed
funds that, together with interest received thereon, will be sufficient to
pay when due the first four semi-annual interest payments on the Notes.
(5) Includes $2.9 million attributable to the Company's estimate of the value of
the Warrants issued in connection with the Unit Offering. Such estimate was
based on a valuation of the Common Stock as of December 31, 1997 by a third
party valuation firm. See "Management -- Aggregated Fiscal Year-End Option
Values." No assurance can be given that the value allocated to the Warrants
is indicative of the price at which the Warrants may actually trade. The
June 30, 1998 actual and pro forma stockholders' equity does not include the
exercise by Orient Star of its warrant to purchase an additional 5.0 million
shares of the Company for $0.625 per share, which occurred on September 14,
1998.
(6) Capital expenditures include equipment purchased through capital leases of
$26.2 million and $4.1 million for the period from inception (March 5, 1997)
through December 31, 1997 and for the six months ended June 30, 1998,
respectively. These capital leases include $5.3 million of equipment leases
assumed from Prodigy and $3.5 million of equipment leases subsequently
liquidated through an early purchase option.
(7) EBITDA is defined as net income (loss) plus net interest expense, provision
for income taxes, depreciation and amortization and severance costs. EBITDA
is presented as it is commonly used by certain investors to analyze and
compare operating performance and to determine a company's ability to
service and/or incur debt. However, EBITDA should not be considered in
isolation or as a substitute for net income, cash flows or other income or
cash flow data or as a measure of a company's profitability or liquidity and
is not a measure in accordance with generally accepted accounting
principles. EBITDA is not necessarily comparable with similarly titled
measures reported by other companies.
(8) The historical earnings of the Company were insufficient to cover its fixed
charges for the period from inception (March 5, 1997) through December 31,
1997 and for the period from inception (March 5, 1997) through June 30, 1997
and the six months ended June 30, 1998 by approximately $10.1 million and
$13.6 million, respectively. On a pro forma basis after giving effect to the
offering of the Original Notes and the application of the net proceeds
therefrom, the earnings of the Company would have been insufficient to cover
its fixed charges for the period from inception (March 5, 1997) to December
31, 1997 and the six months ended June 30, 1998 by approximately $36.3
million and $29.1 million, respectively. Fixed charges consist of interest
expense and that portion of rent expense the Company believes to be
representative of interest (i.e., one-third of rent expense).
(9) Pro forma interest expense assumes that the Unit Offering and the
application of the net proceeds therefrom had occurred on the first day of
the period presented. In addition to the stated interest rate on the Notes,
pro forma interest expense includes amortization of deferred issuance costs
and discount on the Notes related to the Warrants. Pro forma interest
expense does not include the pro forma effect of interest income which would
have been earned on excess cash for the period from inception (March 5,
1997) through December 31, 1997 and for the six months ended June 30, 1998.
49
<PAGE> 51
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company was formed in March 1997, and has a limited history of
operations. Thus, historical information set forth herein may not be indicative
of the Company's future operating results and financial condition.
The Company is a provider of telecommunications services, including high
speed Internet access services, on an advanced nationwide network based on ATM
switching technology, which will be deployed in every POP of the network being
constructed by the Company (the "Splitrock Network" or the "Network"). The
Company is currently providing Internet dial access and related services to
Prodigy for its subscribers. The Network currently reaches more than 55% of U.S.
households by a local call with 56k modem access (currently the fastest modem
speed commercially available over residential phone lines), including households
in every market with a population of at least 100,000 as well as several second
tier markets. The Company has deployed POPs in 70 metropolitan areas across the
nation, and is currently constructing 330 additional POPs. Upon completion of
the Phase II Expansion, the Network will have approximately 400 active POPs with
a physical presence in all 50 states, reaching over 90% of U.S. households with
a local call.
From the formation of the Company until July 1, 1997 the Company did not
generate any revenue. On July 1, 1997 the Company consummated the Prodigy
Transactions (as defined) following which the Company began providing Internet
dial access and related services to Prodigy for its subscribers. To date, the
Company has generated substantially all of its revenue under its agreement with
Prodigy. See "-- Prodigy Transactions" and "Risk Factors -- Reliance on Prodigy;
Recent Discussions with Prodigy."
The Company recently began generating revenue from two additional
customers. The Company has provided transit services to Orbis, an Internet
connection service provider to businesses, on a month-to-month basis since May
1998. In addition, the Company has signed an agreement with NetworkTwo, a value
added network service provider, to provide VPN services to NetworkTwo's business
customers. Under this agreement, the Company installed co-location space in June
1998 and anticipates delivering VPN services beginning in the fourth quarter
1998. Until the Company's customer base is broadened, its results of operations
will be substantially dependent on its relationship with Prodigy.
PRODIGY TRANSACTIONS
On June 24, 1997, the Company and Prodigy entered into the Splitrock Full
Service Agreement (the "Prodigy Agreement") pursuant to which the Company agreed
to provide certain network services to Prodigy for its subscribers. The Prodigy
Agreement became effective on July 1, 1997. In order to provide these services
to Prodigy for its subscribers prior to the completion of the Splitrock Network,
on July 1, 1997 the Company acquired, for temporary use, the Legacy Network from
Prodigy, which consisted of substantially all network assets and related
communications equipment owned or leased by Prodigy. Consideration for the
acquisition of the Legacy Network was in the form of the assumption of $5.9
million of liabilities. The foregoing transactions are collectively referred to
herein as the "Prodigy Transactions."
Prodigy Agreement. Under the Prodigy Agreement, the Company provides
Prodigy with network services, including Internet dial access services and other
network connections, and Prodigy pays the Company monthly usage-based or
subscriber-based service charges equal to the lower of: (i) total subscriber
hours for the month multiplied by the contracted hourly usage rate (the
"Usage-Based Rate") or (ii) total subscribers for the month, as measured by a
"Subscriber Count," as defined in the Prodigy Agreement, multiplied by the fixed
monthly charge per subscriber (the "Subscriber-Based Rate"). The contracted
hourly Usage-Based Rate increased by 9.5% on January 1, 1998 and will increase
by 8.7% on January 1, 1999. The fixed monthly Subscriber-Based Rate does not
increase over time. The Prodigy Agreement imposes certain minimum monthly
service charges on Prodigy in the event that the lower of the Usage-Based Rate
or Subscriber-Based Rate calculation is below defined levels. The minimum
monthly service charges are $3.5 million through
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June 30, 1999 and will increase by $500,000 beginning each subsequent July 1.
Additionally, in the event the average monthly hours per subscriber (calculated
as the total subscriber hours for the month divided by the total subscribers at
the month end) exceeds 30 hours, the Prodigy Agreement provides that Prodigy
will be subject to additional fees ("Additional Fees") equal to (a) $1.00,
multiplied by (b) the number of average monthly hours per subscriber in excess
of 30 hours, multiplied by (c) the total subscribers at the month end. Through
March 31, 1998 amounts paid by Prodigy under the Prodigy Agreement were based on
the Usage-Based Rate. Since April 1998 such amounts have been based on the
Subscriber-Based Rate. Over the long-term the Company expects to receive amounts
from Prodigy based on the Subscriber-Based Rate, although there may be
short-term periods when the Usage-Based Rate applies. As a result, amounts
received by the Company from Prodigy since April 1998 have been, and over the
long-term (except for any Additional Fees) are expected to be, a function of the
total number of Prodigy subscribers as opposed to total subscriber hours.
Depending on the relative growth rates of the number of Prodigy subscribers and
total subscriber hours, the amount of the Company's revenues and the Company's
operating margins could be negatively affected.
The initial term of the Prodigy Agreement expires on June 30, 2001. After
the initial term either party may terminate the Prodigy Agreement upon twelve
months prior written notice. If no notice is received, the term of the Prodigy
Agreement is automatically extended for successive twelve month terms. Under the
Prodigy Agreement the Company is required, among other things, to provide
Prodigy with certain financial and other information, meet certain financial
covenants and meet certain network performance standards. The financial
covenants under the Agreement require the Company to furnish certain financial
statements on an annual and quarterly basis prepared in accordance with
generally accepted accounting principles and audited by independent certified
public accountants (annual financial reports) or prepared consistent with normal
accounting practices certified as true by a designated officer of the Company
(quarterly reports). Additional covenants include furnishing a quarterly report
of payables if not timely paid, furnishing evidence of payment of taxes and
similar assessments, giving notice of liens and litigation with respect to
claims in excess of a certain amount, provision of financial projections for the
immediately succeeding fifteen (15) months based on capacity planning forecasts
for network usage and maintenance of insurance coverage customary to the
industry. Network performance standards contain four service level objectives,
three of which are measured on a monthly basis, and one on a weekly basis. The
Company is required to provide certain credits to Prodigy in the event it fails
to meet such network performance standards. Prodigy has the right to terminate
the Prodigy Agreement following a cure period in the event of the Company's
failure to comply with certain provisions thereof, including certain network
performance standards. In addition, Prodigy has the right to terminate the
Prodigy Agreement during the initial term without cause by providing twelve
months prior written notice and paying a termination charge of $5.0 million
until July 1, 1999 and $3.0 million thereafter. In the event of certain
prolonged network failures, Prodigy also has the right to enter the Company's
premises and cure such failures.
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RESULTS OF OPERATIONS
The following table sets forth selected quarterly statement of operations
data that are the basis of discussion below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------------------
JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1997 1997 1997 1998 1998
-------- ------------- ------------ --------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
QUARTERLY STATEMENT OF OPERATIONS
DATA:
Revenue............................... $ -- $ 10,729 $11,979 $16,494 $15,720
Operating expenses:
Network personnel costs............. -- 95 342 1,051 1,105
Network operating costs............. -- 561 1,364 3,127 6,275
Legacy Network costs................ -- 13,119 12,222 12,295 14,795
Severance costs..................... -- -- 463 -- --
Selling, general and
administrative................... 125 471 680 657 971
Depreciation and amortization....... -- 1,708 1,792 2,820 2,087
------- -------- ------- ------- -------
Total operating expenses.... 125 15,954 16,863 19,950 25,233
------- -------- ------- ------- -------
Loss from operations.................. (125) (5,225) (4,884) (3,456) (9,513)
Other income (expense):
Interest income..................... 30 137 181 107 76
Interest expense.................... -- (113) (122) (349) (493)
------- -------- ------- ------- -------
Loss before income tax................ (95) (5,201) (4,825) (3,698) (9,930)
Provision for income tax.............. -- -- -- -- --
------- -------- ------- ------- -------
Net loss.............................. $ (95) $ (5,201) $(4,825) $(3,698) $(9,930)
======= ======== ======= ======= =======
Loss per share -- basic and diluted... $ (0.01) $ (0.11) $ (0.06) $ (0.05) $ (0.13)
======= ======== ======= ======= =======
Weighted average shares -- basic and
diluted............................. 14,648 48,991 76,800 76,800 76,976
======= ======== ======= ======= =======
OTHER QUARTERLY DATA:
EBITDA (as defined)................... $ (125) $ (3,517) $(2,629) $ (636) $(7,426)
======= ======== ======= ======= =======
Cash provided by (used in):
Operating activities................ $(1,554) $ 103 $(2,333) $(4,874) $ 1,162
Investing activities................ (377) (12,242) (2,878) (2,740) (4,974)
Financing activities................ 10,026 19,750 (3,387) 3,253 5,640
</TABLE>
Net Loss. The Company has incurred net losses since its inception in March
1997. Net losses of $0.1 million, $5.2 million, $4.8 million, $3.7 million and
$9.9 million were recorded for the second quarter of 1997, third quarter of
1997, fourth quarter of 1997, first quarter of 1998 and second quarter of 1998,
respectively. Cumulative losses from inception total $23.7 million. The Company
anticipates that losses will continue for the immediate future.
Revenue. Prior to July 1, 1997, the Company did not generate any revenues.
Since July 1, 1997, pursuant to the Prodigy Agreement, the Company has provided
certain network and related services, including Internet dial access services,
to Prodigy for its subscribers. For the period from inception (March 5, 1997) to
December 31, 1997, the Company generated $22.7 million (100%) of total revenue
from Prodigy. For the six months ended June 30, 1998, the Company generated
$32.2 million (99%) of total revenue from Prodigy.
Prodigy currently offers two services to its subscribers: Prodigy Classic
and Prodigy Internet. Prodigy Internet subscribers generally have higher average
usage, and therefore when Prodigy pays the Company based on the Usage-Based Rate
such subscribers generate greater revenues for the Company. Since April 1998
amounts paid by Prodigy have been based on the Subscriber-Based Rate, which the
Company
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expects to continue over the long-term. The Subscriber-Based Rate measures
subscribers on the basis of a "Subscriber Count" as defined in the Prodigy
Agreement. For the quarter ended June 30, 1998, the average "Subscriber Count"
was approximately 750,000. Prodigy Classic subscribers are expected to continue
to decline as Prodigy seeks to migrate such subscribers to Prodigy Internet and
discontinues Prodigy Classic service by the end of 1999. Most of those
subscribers are expected to become Prodigy Internet subscribers, although there
can be no assurances in that regard.
During the third quarter of 1997, the first quarter following the
consummation of the Prodigy Transactions, the Company had revenue of $10.7
million. Revenue calculations were based on the Usage-Based Rate.
During the fourth quarter of 1997, the Company had revenue, calculated
based on the Usage-Based Rate, of $12.0 million, an increase of 11.7% from the
prior quarter. The increase in revenue was due primarily to a 12.1% increase in
total subscriber usage. While the average number of total Prodigy subscribers
for the fourth quarter decreased by approximately 3.3%, average subscriber usage
increased 15.8% due to a 30.2% increase in the average number of total Prodigy
Internet subscribers, with a partially offsetting 19.3% decrease in the average
number of total Prodigy Classic subscribers, which traditionally have lower
monthly usage than Prodigy Internet subscribers. Such decrease in Prodigy
Classic subscribers was in line with expectations.
During the first quarter of 1998, the Company had revenue, calculated based
on the Usage-Based Rate, of $16.5 million, an increase of 37.7% from the prior
quarter. The increase in revenue was due primarily to a 25.4% increase in total
Prodigy subscriber usage, as the average number of total Prodigy subscribers
increased by 6.4% for the first quarter. In addition, the 9.5% increase in the
contracted hourly Usage-Based Rate effective January 1, 1998 contributed to the
revenue growth. Average subscriber usage increased 17.9% due to a 36.4% increase
in the average number of total Prodigy Internet subscribers during the quarter,
which was partially offset by an 16.7% decrease in the average number of total
Prodigy Classic subscribers. Such decrease in Prodigy Classic subscribers was in
line with expectations.
During the second quarter of 1998, the Company had revenue of $15.7
million, a decrease of 4.7% from the first quarter 1998. Revenue calculations
were based on the Subscriber-Based Rate versus the Usage-Based Rate used in
previous quarters. See "-- Prodigy Transactions." The decrease was attributable
to the continued increase in Prodigy Internet subscribers relative to Prodigy
Classic subscribers creating higher usage and a decline in total subscriber
counts by 8% from the previous quarter. Average subscriber usage increased 10.7%
due to a 3.3% increase in the average number of total Prodigy Internet
subscribers during the quarter, which was offset by a 22.2% decrease in the
average number of total Prodigy Classic subscribers. Such decrease in Prodigy
Classic subscribers was in line with expectations. Based on information prepared
by Prodigy, there has been a trend in the first and second quarters of 1998 of
decreases in the number of total Prodigy subscribers. The average number of
subscribers decreased by 2.0% from the fourth quarter of 1997 to the second
quarter of 1998. The decrease in the number of Classic subscribers discussed
above was anticipated. The increase in the number of new Prodigy Internet
subscribers was not, however, as great as was anticipated. During the second
quarter of 1998, Prodigy Internet and Prodigy Classic comprised 62.7% and 37.3%
of Prodigy's subscribers, respectively, as compared to 55.8% and 44.2% of
Prodigy's subscribers in the first quarter of 1998. The Company anticipates this
change in the mix between Prodigy Internet and Prodigy Classic subscribers will
continue as Prodigy currently plans for the Prodigy Classic user to be migrated
to Prodigy Internet by the end of 1999. Prodigy has informed the Company that it
intends to begin a widespread major U.S. market advertising campaign in the
latter part of 1998. In addition, the Company expects the number of Prodigy
Internet subscribers to continue to increase relative to the number of Prodigy
Classic subscribers, and thereby continue to increase average hourly usage per
subscriber, which could result in Additional Fees becoming due to the Company.
The Company is unable to predict when or whether it will receive any Additional
Fees from Prodigy in the future.
Network Costs -- Overview. The Company was formed on March 5, 1997 to build
the Splitrock Network. From that time through the end of the second quarter of
1997, the Company had not yet begun deploying the Splitrock Network nor had it
consummated the Prodigy Transactions. As a result, it incurred
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limited operating expenses prior to the third quarter of 1997. Network related
operating expenses include all of the direct costs incurred in connection with
designing, deploying and expanding the Splitrock Network, operating the
Splitrock Network and the Legacy Network, and accessing the IBM Global Services
Network.
The Company accounts for its direct Network-related operating expenses in
three line items, Network personnel costs, Network operating costs and Legacy
Network costs. Under a transition services agreement with Prodigy entered into
as part of the Prodigy Transactions, certain of these expenses which were
incurred by Prodigy prior to the consummation of the Prodigy Transactions
continued to be paid by Prodigy and the Company reimbursed Prodigy for such
charges or netted such charges against amounts due from Prodigy. The transition
services agreement expired on January 1, 1998, although the Company continues to
reimburse Prodigy for occupancy expenses, telecommunications line charges and
equipment lease payments relating to Legacy Network POPs that have not yet been
decommissioned. The Company assumed no contractual liability for facility or
telecommunications lines as part of the transition services agreement. Under an
agreement with Prodigy in June 1998, all Legacy Network expenses payable except
for contractual facility leases after July 1, 1998 will be paid directly by the
Company.
Network Personnel Costs. Network personnel costs include all internal
personnel expenses incurred in connection with deploying, operating and
expanding the Splitrock Network. During the third quarter of 1997, the Company
incurred approximately $95,000 of Network personnel costs, primarily
representing engineering personnel located at the Company's headquarters in The
Woodlands, TX.
During the fourth quarter of 1997, the Company incurred approximately
$342,000 of Network personnel costs, primarily due to the hiring of
approximately 20 technical and accounting employees for The Woodlands, TX
headquarters location.
During the first quarter of 1998, the Company incurred $1.1 million of
Network personnel costs due to continued hiring for The Woodlands, TX operations
and the change in recording the personnel costs for Yorktown, NY employees
(approximately $500,000) as Network personnel costs rather than Legacy Network
costs.
During the second quarter of 1998, Network personnel costs remained flat
while the Company secured additional financing and executed agreements related
to the Phase II Expansion. Network personnel costs are expected to increase due
to the expansion of the Network facilities during the Phase II Expansion.
Network Operating Costs. Network operating costs include all other expenses
incurred in connection with deploying, operating and expanding the Splitrock
Network, including assembly costs, line charges, maintenance costs, travel
costs, auxiliary equipment costs and collocate charges. In the third quarter of
1997, the Company incurred approximately $561,000 of Network operating costs.
The Network operating costs were comprised primarily of approximately $470,000
of assembly and engineering design charges paid to Yurie in connection with the
Phase I Buildout.
During the fourth quarter of 1997, the Company incurred $1.4 million of
Network operating costs. The increase in Network operating costs reflected the
beginning of the Splitrock Network deployment. During this period, the Company
deployed 29 POPs, of which 16 were operational by the end of the period, and
completed its backbone installation. The Network operating costs during this
period primarily consisted of approximately $514,000 of assembly and engineering
design charges paid to Yurie in connection with the Phase I Buildout and
approximately $551,000 of leased transmission and local access line charges.
During the first quarter of 1998, the Company incurred $3.1 million of
Network operating costs. The increase in Network operating costs reflected the
continued deployment of the Splitrock Network. By the end of this period, the
Company had deployed 58 POPs, of which 51 were operational. Approximately 77% of
the increase in Network operating costs was due to increased line and backbone
circuit charges. Network operating costs also included assembly and engineering
design charges paid to Yurie in connection with the Phase I Buildout in the
amount of $470,000.
The Company incurred $6.3 million of Network operating costs during the
second quarter of 1998. The increase in Network operating costs reflected the
continued deployment of the Splitrock Network. By the end
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<PAGE> 56
of this period, the Company had deployed 70 POPs, all of which were operational.
Approximately 85% of the increase in Network operating costs was due to
increased line charges. The remaining increase relates to adding a second NOC in
The Woodlands, TX during the second quarter of 1998, increase in field
operations to support added capacity and the start of the customer support
program. These increases were offset by decreases in the engineering charges
incurred for the Phase I Buildout as it was completed at the beginning of the
quarter. The Phase II Expansion began in the middle of the second quarter of
1998. As the Company continues to deploy Phase II Expansion, the Network
operating costs will continue to increase. Typically, telecommunication lines
are installed and thus charges are incurred prior to the POP site being in
productive use. This results in higher expenses during the startup of a new POP
site.
To date, the Company has substantially performed its own maintenance of
equipment deployed in the Phase I Buildout and has relied on initial warranties
at no costs from its vendors. The Company is currently in discussions with
various vendors in regard to equipment maintenance contracts for current and
future operations. These maintenance contracts will significantly increase the
cost of Network operations. See "Risk Factors -- Dependence On Suppliers."
Legacy Network Costs. Legacy Network costs include all expenses incurred in
connection with operating and decommissioning the Legacy Network, including
facility leases, line charges, personnel costs, occupancy costs, equipment
maintenance costs and access fees for the IBM Global Services Network.
As the expansion of the Splitrock Network progresses, the Legacy Network is
being decommissioned and usage of the IBM Global Services Network is declining.
As POPs are decommissioned, all occupancy and telecommunication line charges are
terminated. The Company has fully decommissioned 90 of the original Legacy
Network POPs through August 31, 1998. Fewer than 20 Legacy Network POPs are
expected to remain in operation as of the end of 1998. There is typically a lag
time of two to three months between the time the Splitrock Network is
operational in any given area and either the Legacy Network infrastructure for
such area is decommissioned or the IBM Global Services Network is no longer
used. As a result, transition to the Splitrock Network involves a temporary
duplication of costs.
During the third quarter of 1997, the Company incurred $13.1 million of
Legacy Network costs. The Legacy Network costs incurred in this period included
operating costs to operate the Legacy Network as well as $5.6 million of usage
charges paid relating to the IBM Global Services Network.
During the fourth quarter of 1997, the Company incurred $12.2 million of
Legacy Network costs. The decrease in Legacy Network costs from the prior
quarter primarily resulted from disconnecting underutilized lines and reduced
occupancy and personnel costs, offset in part by expenses incurred related to
new lines installed for the Legacy Network in certain geographic areas to
address capacity issues and increased access charges relating to the IBM Global
Services Network. The Company paid $6.3 million of usage charges related to the
IBM Global Services Network in the fourth quarter of 1997. During this quarter
the Company incurred certain duplicative expenses as a result of the lag between
moving Splitrock Network POPs into production and decommissioning the
corresponding Legacy Network infrastructure.
During the first quarter of 1998, the Company incurred $12.3 million of
Legacy Network costs. The slight increase in Legacy Network costs was primarily
due to increased usage charges relating to the IBM Global Services Network as
well as expenses incurred related to new lines installed for the Legacy Network
in certain geographic areas to address capacity issues, offset by the
decommissioning of Legacy Network lines (although during this period duplicative
costs were incurred in certain areas as a result of the lag of such
decommissioning) and the change in accounting for the Yorktown, NY employees
described above. During this quarter the Company paid $7.3 million of usage
charges related to the IBM Global Services Network.
During the second quarter of 1998, the Company incurred $14.8 million of
Legacy Network costs. The 20% net increase in Legacy Network costs was due
primarily to an increase in rates for access to the IBM Global Services Network.
Additionally, the Company continued to add new lines to the Legacy Network in
certain geographic areas to address capacity issues. These increases were offset
by the decommissioning of Legacy Network lines (although during this period
duplicative costs were incurred in certain areas as a result of the lag of such
decommissioning). Prior to April 1, 1998, the Company accessed the IBM Global
Services
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Network under Prodigy's contract with IBM. During the period from July 1, 1997
to March 31, 1998, Prodigy incurred usage charges to IBM and was reimbursed by
the Company for $19.2 million of these expenses. Effective April 1, 1998, the
Company entered into a new contract with IBM to continue to provide these access
services. The increase in rates was due to the implementation of this new
contract between the Company and IBM Global Services Network. This new contract
provides for significantly higher hourly usage charges due to the Company's
expected short-term use of the IBM Global Services Network as well as the
Company's lack of a long-term relationship with IBM.
During this quarter, the Company paid $11.0 million of usage charges
related to the IBM Global Services Network. This represents a 51% increase in
IBM Global Services charges between the first and second quarter of 1998. The
Company anticipates that aggregate IBM charges will decline through mid-1999 as
the Splitrock Network is further expanded and traffic migrates from the IBM
Global Services Network to the Splitrock Network, although hourly usage charges
may increase due to the lower volume of use. If the Company is unable to meet
certain POP build out schedules, the Company may be required to move traffic
from the Legacy Network to the IBM Global Services Network until the Splitrock
Network is completed. This would result in higher charges in the interim. See
"Risk Factors -- Dependence on Suppliers."
Severance Costs. Prior to January 1, 1998, the Yorktown, NY staff remained
employed by Prodigy and were made available to the Company by Prodigy. The
Company reimbursed Prodigy for the costs related to such employees and recorded
them as Legacy Network expenses. In the fourth quarter of 1997, as part of a
downsizing program in Yorktown, NY, the Company eliminated the need for 13
Prodigy employees. The Company recorded a charge of approximately $463,000
related to severance pay for these Prodigy employees. This charge was recorded
as a severance cost in the fourth quarter of 1997. As of January 1, 1998, the
remaining employees at the Yorktown, NY facility and NOC were transferred from
Prodigy's payroll to the Company's payroll. As these remaining employees are
expected to be retained after the Legacy Network is fully decommissioned,
effective January 1, 1998 the Company began recording the personnel expenses
related to such employees as Network personnel expenses rather than Legacy
Network expenses.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses consist of personnel and operating costs relating to
executive management, accounting and finance, human resources, sales and
marketing and administrative employees. In the second quarter of 1997 the
Company incurred limited selling, general and administrative expenses, which
primarily consisted of consulting and legal fees incurred in connection with the
Prodigy Transactions. The Company incurred approximately $125,000, $471,000,
$680,000 and $657,000 of selling, general and administrative expenses in the
second quarter of 1997, the third quarter of 1997, the fourth quarter of 1997
and the first quarter of 1998, respectively. This gradual increase reflects the
development of the Company's executive, accounting and administrative support
departments. The decrease in selling, general and administrative expenses in the
first quarter of 1998 compared to the fourth quarter of 1997 was due to certain
non-recurring expenses incurred in the fourth quarter of 1997, primarily
increased travel costs, bonuses paid to employees and other miscellaneous costs.
In the second quarter of 1998, selling, general and administrative expenses
increased by $314,000 to $971,000, in line with expectations, as the Company
continues to add staff in these areas and has experienced increases in legal and
other fees incurred in connection with the continued expansion of the Splitrock
Network. The Company believes that selling, general and administrative expenses
will begin increasing at a greater rate in the third and fourth quarters of
1998, as the Company (i) plans to begin hiring additional sales and marketing
personnel, (ii) continues the implementation of its advanced business support
systems, (iii) realizes the full quarter cost of its new facility in The
Woodlands, TX, which more than doubled the Company's occupancy costs, and (iv)
incurs the fees and expenses resulting from the obligations incident to the sale
of the Units.
Depreciation and Amortization. Depreciation and amortization in the third
and fourth quarter of 1997 consisted almost exclusively of depreciation of
Legacy Network equipment acquired as part of the Prodigy Transactions. Legacy
Network equipment was recorded at approximately $5.9 million based on the fair
value of the consideration paid. Approximately 80% of the equipment acquired was
depreciated over nine months, the expected useful life of the Legacy Network,
with the remaining 20% depreciated over 36 months.
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Therefore, on March 31, 1998, 80% of Prodigy equipment acquired was fully
depreciated. All Splitrock Network-related equipment begins to be depreciated as
it is placed into service using a straight-line basis over three years from the
date of installation. Depreciation will increase as the Phase II Expansion
progresses. The Company incurred depreciation expenses of $1.7 million, $1.8
million and $2.8 million in the third quarter of 1997, the fourth quarter of
1997 and the first quarter of 1998, respectively.
In the second quarter of 1998, depreciation expense decreased to $2.1
million primarily due to the end of the accelerated depreciation of Legacy
Network equipment purchased from Prodigy by the end of the first quarter of
1998. This was offset by increases in depreciation of new Splitrock Network
equipment during the second quarter of 1998. Depreciation is expected to
increase as new POPs and equipment are installed to support the expansion of the
Splitrock Network.
Interest Expense. Historical interest expense is related to capital leases
on equipment and loans from a stockholder of the Company. The Company incurred
interest expense of approximately $113,000, $122,000 and $349,000 in the third
quarter of 1997, the fourth quarter of 1997 and the first quarter of 1998,
respectively. Interest expense increased to $493,000 for the second quarter of
1998 due to the receipt of additional working capital loans from Linsang, a
stockholder of the Company, during the quarter. Such loans were refinanced in
July 1998 in connection with the Unit Offering. Interest expense is expected to
increase significantly in the third quarter due to the interest on the Notes.
Interest Income. Interest income relates to the interest earned on
investments of cash on hand in commercial paper and money market accounts. The
Company recorded interest income of approximately $30,000, $137,000, $181,000
and $107,000 in the second quarter of 1997, in the third quarter of 1997, in the
fourth quarter of 1997 and in the first quarter of 1998, respectively. The
Company recorded interest income of $76,000 in the second quarter of 1998.
Interest income is expected to increase in the third quarter of 1998 due to the
investment of a portion of the proceeds from the Notes.
Provision for Income Taxes. No provision for income taxes has been
recognized as the Company had operating losses for both tax and financial
reporting purposes for the period from inception (March 5, 1997) to December 31,
1997 and for the six months ended June 30, 1998.
LIQUIDITY AND CAPITAL RESOURCES
Historical. From the Company's inception (March 5, 1997), the Company has
satisfied the majority of its working capital requirements through the issuance
of equity or debt financing. The Company's capital purchases have been primarily
financed through lease financing with the exception of capital purchases from
Yurie, which were financed out of working capital.
Cash Flow Related to Operations. Cash flow used or provided in the
Company's operations approximated $1.6 million used, $103,000 provided, $2.3
million used, $4.9 million used and $1.2 million provided in the second, third
and fourth quarters of 1997 and the first and second quarters of 1998,
respectively. Cash flow used in operating activities can vary significantly from
period to period depending upon the timing of operating cash receipts from
Prodigy and the payments to large vendors. The Company expects this variation to
continue until the Phase II Expansion is completed and the Company's base of
customers has increased.
Cash Flow Related to Financings. The Company was founded in March 1997 by
Mr. Kwok L. Li and Mr. William R. Wilson. Since its inception, the Company has
raised approximately $263.3 million (excluding a $10.0 million note that was
converted into equity) through private sales of debt (of which $0.8 million has
been repaid) and $31.6 million through private sales of equity (including the
conversion into equity of such $10.0 million convertible note). The Notes issued
in the Unit Offering represent $261.0 million of the debt financing.
Through various transactions since March 1997, Mr. Li and Linsang, a
technology investment company controlled by Mr. Li, have invested approximately
$21.8 million in debt (including the convertible note described above) and $7.5
million in equity in the Company. Of the amount that Mr. Li and Linsang have
loaned to the Company, $0.8 million has been repaid and the $10.0 million
convertible note was converted into 16.0 million shares of Common Stock of the
Company. The remaining $11.0 million debt outstanding was
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represented by demand notes bearing annual interest of 9.75% and maturing on the
earlier of written demand or December 1, 2002. The entire amount of such
indebtedness ($11.0 million) was refinanced in connection with the Unit
Offering, pursuant to which Linsang purchased 11,000 Units by surrendering the
demand notes in the principal amount of $11.0 million in exchange for the 11,000
Units.
On August 18, 1997, Roy Wilkens and Sandra Wilkens purchased 800,000 shares
of the Common Stock of the Company for $0.5 million. Mr. Wilkens became a member
of the Board of Directors of the Company in April 1998.
On September 22, 1997, Orient Star, a wholly owned subsidiary of Carso (the
controlling stockholder of Prodigy), purchased 20.0 million shares of Common
Stock of the Company for $12.5 million. Orient Star subsequently acquired,
pursuant to a warrant agreement, an additional 5.0 million shares of Common
Stock of the Company for $3.1 million. Orient Star currently holds approximately
30.2% of the Common Stock of the Company. Samer Salameh, the President of
Prodigy, an affiliate of Carso, became a member of the Board of Directors of the
Company in April 1998.
In June 1998, Clark McLeod, CEO of McLeodUSA, Incorporated ("McLeodUSA"), a
regional telecommunications firm in the Midwest, exercised in full a stock
option previously granted to him and purchased 1.0 million shares of Common
Stock of the Company for $1.1 million. Mr. McLeod became a member of the Board
of Directors of the Company in May 1998.
In addition, through June 30, 1998 the Company had arranged $24.4 million
in equipment financing, including $23.8 million related to network-related
equipment primarily from equipment vendors and $0.6 million related to office
equipment from vendors and leasing companies. This financing includes $3.5
million of equipment leases subsequently liquidated through an early purchase
option, In addition, the Company assumed approximately $5.9 million in
liabilities pursuant to the Prodigy Transactions. The Company does not
anticipate the continued use of leasing to fund capital purchases as the Company
anticipates that the proceeds from the sale of Notes will be adequate to cover
such purchases for the Phase II Expansion and the business support systems
anticipated.
On July 24, 1998, the Company issued and sold $261.0 million aggregate
principal amount of 11 3/4% Notes due 2008 with interest to be paid
semi-annually each January 15 and July 15 commencing with the January 15, 1999
payment. The Initial Purchaser of the Notes resold $250.0 million to qualified
institutional buyers and $11.0 million to Linsang, a stockholder of the Company
in connection with the refinancing of Linsang's outstanding notes to the
Company. The Notes are senior obligations of the Company ranking pari passu with
all existing and future Senior Indebtedness of the Company and will rank senior
to all future Subordinated Obligations of the Company. The Notes will be
unsecured (except that the Trustee will have a security interest in an Escrow
Account for the benefit of the holders) and will therefore be subordinate to all
secured indebtedness. An amount that, together with the interest received
thereon, will be sufficient to pay when due the first four semi-annual payments
of interest beginning with the January 15, 1999 payment has been escrowed from
the proceeds received upon consummation of the Unit Offering in the Escrow
Account. See "Description of the Notes."
As of August 31, 1998, the Company had incurred approximately $9.2 million
in costs associated with the Unit Offering. The Company anticipates the total
costs including underwriting fees will approximate $9.7 million.
Cash Flow Related to Investing. As of June 30, 1998, the Company's
investing activities are almost entirely composed of purchases of capital
equipment.
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Capital Expenditures. As of June 30, 1998 the Company had recorded capital
expenditures (exclusive of depreciation) of approximately $51.4 million, of
which $5.9 million represents assets acquired from Prodigy. The following table
sets forth such capital expenditures by category:
<TABLE>
<S> <C>
Network Equipment for Phase I Buildout...................... $25.0
Network Equipment for Phase II Expansion.................... 14.2
Network Operating Center and Other.......................... 4.4
Assets Acquired from Prodigy................................ 5.9
Office Equipment and Furniture Purchased.................... 1.9
-----
$51.4
</TABLE>
Of this amount, approximately $30.3 million was financed through capital
leases (including $5.3 million of equipment leases assumed from Prodigy and $3.5
million of equipment leases subsequently liquidated through an early purchase
option). Additionally, the Company has expended approximately $2.4 million in
deposits and other intangibles in connection with the Phase II Expansion.
Commitments. The Company has utilized contractual pricing in exchange for
volume commitments on certain Network activities, lease lines and equipment.
The Company has agreed to purchase a minimum of $20.0 million of standard
Yurie products during the 18-month period ended December 31, 1998. As of June
30, 1998, the Company had purchased approximately $11.0 million of products
under this arrangement.
The Company has an agreement with a telecommunication supplier to provide
certain installation services for the Company. The minimum amount of services
for which the Company is required to pay is $1.3 million. The Company estimates
that as of April 1998 it has approximately $700,000 remaining to be paid on this
agreement.
The Company has commitments to certain telecommunication vendors to meet
certain minimum monthly usage volumes over periods of two to three years. The
Company is currently meeting its minimum monthly usage volumes. Additionally,
the Company is subject to certain cancellation penalties should the Company need
to terminate its line contracts. The cancellation penalties typically require
the payment of a certain percentage of the remaining amounts due under the
contract depending on the year in which the cancellation occurs.
In addition, as of June 30, 1998, the Company had aggregate operating and
capital lease payments of $5.5 million, $9.6 million, $7.2 million, $1.0
million, $0.3 million and $0.2 million due in the last six months of 1998,
calendar 1999, 2000, 2001, 2002 and 2003, respectively.
Future. The Company's future liquidity and capital requirements will result
primarily from its debt service and principal repayment obligations, lease
obligations, capital expenditures and other expenses to be incurred in
connection with the expansion of the Splitrock Network, acquisitions and joint
ventures and general working capital purposes. Through June 30, 1998, the
Company had spent approximately $25.0 million on the Phase I Buildout, which was
substantially completed in April 1998, and $14.2 million on the Phase II
Expansion. The Company anticipates making an additional $139.6 million of
capital expenditures in connection with the Phase II Expansion. The Company
expects to spend approximately $45.9 to construct approximately 330 additional
POPs, approximately $81.5 million to deploy advanced processing equipment and
software to enhance and accelerate the Company's ability to provide value added
services, such as ISDN video, web hosting and VPN, and approximately $12.2
million to support the Company's network management infrastructure. Of these
amounts, the Company has spent $3.2 million since June 30, 1998. The Company has
a commitment to purchase $9.0 million of additional equipment from Yurie prior
to January 1, 1999. The Company currently believes that the net proceeds of the
Notes will be sufficient to fund the Company's expected capital expenditures,
working capital, lease obligations and debt service requirements for at least
the next twelve months. Linsang has not committed to make any additional credit
available to the Company.
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Any future acquisitions, joint ventures or similar transactions may require
additional financings and there can be no assurance that such financings will be
available to the Company on acceptable terms or at all.
The Company is highly leveraged. At June 30, 1998, on a pro forma basis
after giving effect to the offering of the Notes and the application of the net
proceeds therefrom, the Company would have had $279.3 million of total
indebtedness, representing approximately 96.3% of the Company's total
capitalization. See "Capitalization." In addition, the terms of the Notes permit
the Company to incur certain other indebtedness. While there can be no assurance
that the Company will have sufficient cash flow to pay the interest expense or
the principal associated with the Notes or such indebtedness, the Company has
placed funds in escrow that, together with the interest received thereon, will
be sufficient to pay when due the first four semi-annual interest payments on
the Notes. The highly leveraged position of the Company could have a material
adverse effect on its ability to obtain financing for acquisitions, joint
ventures or other purposes and the Company's ability to borrow is also
restricted by covenants contained in the Notes.
The Company recorded EBITDA (as defined) of approximately $(6.3) million
and $(8.1) million for the period from inception (March 5, 1997) to December 31,
1997 and the six months ended June 30, 1998, respectively (net losses amounted
to $10.1 million and $13.6 million for the same periods). On a pro forma basis
after giving effect to the Offering and the application of the net proceeds
therefrom, the Company would have reported net losses of $36.3 million and $29.1
million for the period from inception (March 5, 1997) to December 31, 1997 and
the six months ended June 30, 1998, respectively. The Company expects such net
losses to continue as the Company focuses on increasing its customer base,
implementing its business strategy and developing new services. See "Summary --
Recent Developments." The historical earnings of the Company were insufficient
to cover its fixed charges for the period from inception (March 5, 1997) to
December 31, 1997 and the six months ended June 30, 1998 by approximately $10.1
million and $13.6 million, respectively. On a pro forma basis after giving
effect to the offering of the Notes and the application of the net proceeds
therefrom, the earnings of the Company would have been insufficient to cover its
fixed charges for the period from inception (March 5, 1997) to December 31, 1997
and the six months ended June 30, 1998 by approximately $36.3 million and $29.1
million, respectively.
Net cash used in operating activities was $2.2 million and $3.7 million for
the period from inception (March 5, 1997) to December 31, 1997 and for the six
months ended June, 30, 1998, respectively. There can be no assurance that the
Company will generate sufficient revenue such that the Company's operations will
become profitable or generate positive cash flows from operating activities. Net
cash used in investing activities was $17.2 million and $7.7 million for the
period from inception (March 5, 1997) to December 31, 1997 and for the six
months ended June 30, 1998, respectively. The Company expects investment in
capital expenditures to increase as the Company expands its Network. Net cash
provided by financing activities was $27.1 million and $8.9 million for the
period from inception (March 5, 1997) to December 31, 1997 and for the six
months ended June 30, 1998, respectively. On July 24, 1998, in connection with
the Unit Offering, the Company sold 261,000 Units consisting of $261.0 million
principal amount of Original Notes and Warrants to purchase 2.6 million shares
of Common Stock. In connection with the Unit Offering, the Company repaid the
amount outstanding, $1.5 million, under a credit facility and refinanced $11.0
million of indebtedness owed to Linsang, a stockholder. The net proceeds to the
Company, after Unit Offering expenses, approximated $240.0 million.
The Company's ability to meet its debt service obligations, to finance
planned capital expenditures, lease payments or acquisitions or to comply with
certain covenants contained in the Indenture will depend upon the Company's
future performance, which will be subject to general economic conditions and to
financial, business, competitive, legislative, regulatory and other factors
affecting its operations, many of which are beyond the Company's control. In
addition, for the foreseeable future the Company's financial performance will be
dependent on Prodigy. There can be no assurance that the Company's business will
be able to generate cash flow at levels sufficient to satisfy its debt service
and other requirements. If in the future the Company is unable to generate
sufficient cash from its operations to make scheduled interest payments on the
Notes, to pay the Notes at maturity, or to meet other obligations and
commitments, the Company may be required to adopt one or more alternatives, such
as refinancing or restructuring its indebtedness, reducing or delaying planned
expansion, selling assets or raising additional debt or equity. There can be no
assurance that the
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Company will be able to implement any of these alternatives on satisfactory
terms or at all. In addition, the terms of existing or future debt agreements,
including the Indenture, may prohibit the Company from adopting some of these
alternatives. See "Description of the Notes."
YEAR 2000
The year-2000 issue is the result of computer programs being written using
two digits, rather than four digits, to define the applicable year. Programs
that have time-sensitive software may recognize a date using "00" as the year
1900 rather than the year 2000. This could result in a major system failure or
miscalculations, including an inability to process transactions, send invoices
or engage in similar normal business activities. Due to its reliance on computer
hardware and software, the Internet and related service industries are highly
susceptible to the year-2000 issue. If the year-2000 issue should cause
widespread problems across the Internet, usage can be expected to decline
dramatically. Such an event would have a material adverse effect on the
Company's financial condition and results of operations, the nature and extent
of which cannot reasonably be determined by the Company on the basis of
information currently available to it. The Company has not prepared a
contingency plan and does not expect to do so in light of the uncertainty of the
impact of year-2000 issues on the Internet as a whole and the Company's
anticipated schedule to be year-2000 compliant before the end of 1999.
The Company is currently in the process of evaluating its operations and
both its information technology systems and its non-information technology
systems to determine its own vulnerability to the year-2000 issue. The Company
relies heavily on non-information technology systems in the conduct of its
operations and has determined that substantially all of such systems are
year-2000 compliant. Certain network-monitoring software, which is used by the
Company to monitor network equipment (POPs) on the Legacy Network, is not
year-2000 compliant, but as part of the Company's Phase II Expansion,
substantially all of the Legacy Network POPs are scheduled to be decommissioned
by the end of 1998 and such network-monitoring software will no longer be used
by the Company. With respect to the Company's database inventory software, used
to capture data about the network configuration, including location of equipment
and maintenance, the Company has purchased and is currently installing year-2000
compliant software to replace its existing software. Installation is scheduled
to be completed by the end of 1998, and the cost of such purchase and
installation is not material. The Company has also determined that certain other
of its software systems are not year-2000 compliant. The Company believes that,
with modifications and upgrades to such software, which are scheduled to occur
in the ordinary course of business, it will be fully year-2000 compliant by the
end of 1999. The Company is continuing its evaluation of the remaining areas
impacted by year-2000 issues, including Internet interfaces, facility matters
and equipment vendors, but does not expect to incur material costs in connection
with making its software year-2000 compliant. To date, the Company has not
incurred material costs in ensuring year-2000 compliance.
The Company is also dependent upon the ability of its customers to ensure
that their software and equipment is year-2000 compliant. The Company has
initiated formal communications with Prodigy to determine the extent to which
the Company is vulnerable to Prodigy's own year-2000 issues, if any. Prodigy has
informed the Company that Prodigy Classic may not be year-2000 compliant.
Prodigy is in the process of migrating users to Prodigy Internet, which is
year-2000 compliant, and plans to discontinue Prodigy Classic service by the end
of 1999. However, there can be no guarantee that Prodigy Classic or systems of
future customers on which the Company may rely will be timely converted, or that
a failure to convert, or a conversion that is incompatible with the Company's
systems, would not have a material adverse effect on the Company.
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INDUSTRY OVERVIEW
The Company believes that it is well-positioned to capture revenue
opportunities in the growing Internet services market. As a broad-based ISP, the
Company utilizes an advanced ATM-to-the-edge Network to offer services that
either directly address Internet connectivity (dial access and transit) or which
leverage Internet technology to provide cost-effective alternatives to
traditional corporate network solutions (VPN). While the Company is considering
broadening its service offerings to optimize Network utilization, the Company
believes that a significant amount of its revenues for the foreseeable future
will continue to be derived from Internet related applications.
The Internet. The Internet is a global collection of interconnected
computer networks that allows commercial organizations, educational
institutions, government agencies and individuals to communicate electronically,
access and share information and conduct business. The networks that comprise
the Internet are connected in a variety of ways, including by the public
switched telephone network ("PSTN") and by high speed, dedicated leased lines.
Over time, as businesses have begun to utilize e-mail, file transfer and, more
recently, intranet and extranet services, commercial usage has become a major
component of Internet traffic.
In order for an end-user to access the Internet, a local network connection
is required to an ISP's local facilities. For large, communication-intensive
users and for content providers, these connections are typically unswitched,
dedicated connections provided by incumbent local exchange carriers ("ILECs") or
competitive local exchange carriers ("CLECs"), either as independent service
providers or, in some cases, by a company which is both a CLEC and an ISP. For
residential and small and medium business users, these connections are generally
PSTN connections obtained on a dial-up access basis as a local exchange
telephone call. This collection of interconnected networks makes up the
Internet. A key feature of Internet architecture is that a single dedicated
channel between communication points is never established, which distinguishes
Internet-based services from the PSTN.
Internet Market Size and Growth. The Internet services industry is one of
the fastest growing segments of the global telecommunications market. Forrester
estimates that the U.S. market for Internet and related services, including
advanced Internet applications such as VPN, voice communications, fax and video
conferencing, was approximately $6.2 billion in 1997 and will grow to
approximately $49.7 billion in 2002, reflecting a compound annual growth rate of
over 50%. The Company believes that Internet dial access and transit services,
VPN services and enhanced business services represent three of the fastest
growing segments of the industry.
Internet Access. Internet access services represent the means by which ISPs
interconnect either businesses or individual consumers to the Internet's
resources or to corporate intranets and extranets. Access services include
dial-up access for individuals and small businesses and high-speed dedicated
access (transit services) used primarily by mid-sized and larger organizations.
According to Forrester, business access services are projected to grow at a
compound annual growth rate of approximately 75%, from approximately $1.0
billion in 1997 to approximately $16.0 billion in 2002.
The demand for access services is driven by the end-user's ability and
desire to gather data and communicate or interact with others. Over the past few
years, many organizations have established Web pages on the Internet in order to
convey a variety of information to end-users. Compounding this growth in
information available over the Internet has been a dramatic increase in the
number of ISPs providing access and related services to end-users. According to
IDC, there are currently over 4,000 ISPs in the U.S., consisting of national,
regional and local providers, of which the Company believes only a small
percentage have access to their own nationwide backbone network infrastructure.
These ISPs have exposed a broad population of users to the opportunities
available over the Internet, resulting in a large and growing group of people
who are accustomed to using networked computers for a variety of purposes,
including e-mail, electronic file transfers, on-line computing and electronic
financial transactions. According to IDC, the number of Internet users worldwide
reached approximately 60.0 million in 1997 and is forecasted to grow to 173.0
million by the year 2000.
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The ISP market is segmented into large national or multinational ISPs
("Tier 1 ISPs"), which are typically full-service providers that offer a broad
range of Internet access and value-added services to businesses and regional and
local ISPs ("Tier 2 ISPs" and "Tier 3 ISPs"), which typically offer a smaller
range of products and services to both individuals and business customers. Tier
1 ISPs also provide wholesale services by reselling capacity on their networks
to smaller regional and local ISPs, thereby enabling these smaller ISPs to
provide Internet services on a private label basis without building their own
facilities. The Company believes that the top six Tier 1 ISPs represented
approximately 50% of the market for business connectivity and value-added
services. Tier 1 ISPs exchange Internet traffic at multiple public peering
points known as network access points ("NAPs") and through private peering
arrangements.
VPNs. The Company believes that many businesses desire to utilize VPNs as a
lower-cost alternative to certain traditional telecommunications services.
Historically, many corporations established and maintained their own private
wide-area networks to provide network-based services, such as transaction
processing, to their customers and to coordinate operations between employees,
suppliers and business partners. Despite the attractive capabilities of private
networks, however, limitations of many private WANs have impeded or reduced the
effectiveness of their use. These networks, which traditionally have required
the use of leased telephone lines with dedicated bandwidth and the purchase of
vendor-specific networking equipment and software, are inherently expensive to
set up, operate and maintain. The Company believes that VPNs present a
cost-effective alternative to WANs since VPNs (i) eliminate the need to invest
significant amounts in proprietary equipment and software, (ii) securely and
efficiently connect multiple, geographically dispersed locations, (iii) provide
global remote access capabilities and (iv) offer a full range of value added
services, such as videoconferencing, that meet a company's particular networking
needs.
Enhanced Business Services. In addition to Internet access and VPN
services, business customers increasingly are seeking a variety of enhanced
products and applications to take full advantage of the Internet. The principal
enhanced services currently available to companies are Web hosting, including
hosting of intranet sites, e-mail outsourcing, e-mail broadcast and security.
Forrester forecasts that enhanced business services revenues will grow from
approximately $0.4 billion in 1997 to approximately $10.5 billion in 2002,
representing a compound annual growth rate of 92%.
Development of Network Technology. The Company has designed, deployed and
is in the process of expanding an advanced nationwide telecommunications network
based on ATM-to-the-edge switching technology. The pervasive deployment of ATM
switches throughout the Network enables the Company to create a multi-service
platform by which to expand its service offerings to provide fully integrated
data, video and voice services and to incorporate future technological
innovations into its architecture with a lower incremental investment than that
required by other, less flexible, networks.
Most networks currently in operation use either circuit switching or packet
switching. Circuit switching operates by dedicating a circuit, or fixed amount
of bandwidth, to each end device. Circuit switching's use of dedicated circuits
provides high quality service for all network traffic, but, since information is
not continuously transmitted, the dedicated circuits are often inefficiently and
expensively idle.
Frame relay, a packet switching technology, was introduced in 1990 as a
method of connecting local area networks ("LANs") over WANs by using flexible
bandwidth allocation to lower the cost of transmission. Frame relay uses
"packets' or "frames" to transmit traffic, thereby allowing the same bandwidth
to be shared by many users, each using the bandwidth only for the time required
to transmit a packet. Designed primarily for data transmission, frame relay
cannot guarantee high quality transmission of voice and video. Currently, frame
relay is widely used to transmit data over WANs, including the Internet. Due to
the substantial increase in data traffic, however, today's frame relay networks
are being used to transmit more traffic than they were designed to support,
resulting in network congestion.
To increase a frame relay network's switching capacity to meet increased
data demands and alleviate congestion, sophisticated software is required. To
run this software, the network must be upgraded with powerful, intelligent
processors. The costs of these high-end processors required to switch frame
relay traffic at the speeds needed in today's data network backbones are very
high. Therefore, as data traffic increases, upgrading a frame relay network
becomes more costly and inefficient and ultimately impractical.
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Faced with the limitations of frame relay, telecommunications service
providers are installing ATM switches, a newer packet switching technology, in
the backbones of their existing networks. ATM segments data, video and voice
traffic into small, uniform-sized "cells," rather than the larger, variable-size
"packets" or "frames" used in frame relay. The addition of ATM backbone switches
upgrades a network's performance by increasing switching capabilities at the
network's core. ATM's cell-based architecture increases bandwidth utilization
and seeks to provide consistent quality of service and predictability for all
traffic types.
ATM is the first standard protocol to permit reliable service for all
traffic types, allowing the consolidation of circuit switching and packet
switching networks into a single ATM network for data, video and voice. A single
ATM network offers the potential for economies of scale and streamlining of
network operations. The standardization of ATM has allowed for compatibility of
ATM equipment and interoperability of ATM among a wide variety of interfaces and
vendors.
The U.S. government was among the first to deploy ATM technology. Its
initial decision to use ATM was motivated by its desire to consolidate many
discrete networks onto a single network, thus significantly reducing cost. The
U.S. government was able to deploy ATM across geographic boundaries because ATM
was quickly accepted as an international standard, and the government soon
discovered the effectiveness and efficiency of ATM as a global networking
technology.
Several telecommunications service providers began offering trial ATM
services in the early 1990s. These services were available only for high speed
traffic and at high prices and, therefore, made ATM attractive only to users
with significant bandwidth needs. Driven by increasing competition and the rapid
growth of data traffic on frame relay systems, a number of telecommunications
service providers began deploying ATM for use in their network backbones to
manage heavy loads of user traffic and thereby relieve network congestion. Until
recently, providers have continued to install ATM primarily in their network
backbones and typically have not offered ATM service directly to end users.
In 1996, certain telecommunications service providers announced plans to
begin offering ATM services directly to end users at prices competitive with
similar packet switching and circuit switching access services. To utilize these
direct ATM services, an end user needs ATM access products either located at the
local office of a telecommunications service provider (in close proximity to the
end user) or deployed by the end user in its private network. Access products
provide the end user with network access through multiple network interfaces,
traffic concentration and data protocol translation.
ATM access products are well suited to provide efficient connectivity to
ATM networks, facilitate transmission of a variety of traffic types at varying
speeds and accommodate a mix of end user applications on a single network. In
addition, ATM access products have the potential to lower the cost to end users
of transmitting data, video and voice communications. Management believes that
the Splitrock Network contains more ATM-based switches than that of any other
commercial network.
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BUSINESS
GENERAL
The Company is a provider of telecommunications services, including high
speed Internet access services, on an advanced nationwide network based on ATM
switching technology which is deployed in every POP of the network. The
pervasive deployment of ATM switches throughout the Network enables the Company
to serve as a broad-based ISP through the creation of a multi-service platform
which efficiently delivers IP, frame relay and other Internet services. This
flexibility will allow the Company to expand its service offerings to provide
fully integrated data, video and voice services and to incorporate future
technological innovations into its Network architecture with a lower incremental
investment than that required by other, less flexible, networks. The Company
currently provides nationwide Internet dial access and related services to
Prodigy, the third largest U.S. ISP measured in minutes on-line, for its
subscribers. In addition, the Company has begun providing Internet transit
services to Orbis, an Internet connection service provider to businesses, and
expects to begin providing VPN services to NetworkTwo, a value added network
service provider during the fourth quarter of 1998. For the six months ended
June 30, 1998, the Company had revenues of $32.2 million.
The Splitrock Network currently reaches more than 55% of U.S. households by
a local call with 56k modem access (currently the fastest modem speed
commercially available over residential phone lines), including households in
every market with a population of at least 100,000 as well as several second
tier markets. From September 1997 to April 1998, the Company engaged in the
Phase I Buildout which resulted in the deployment of the nationwide ATM backbone
portion of the Splitrock Network and POPs in 70 metropolitan areas across the
nation. Upon completion of the Phase II Expansion, the Network will have
approximately 400 active POPs with a physical presence in all 50 states,
reaching over 90% of U.S. households with a local call.
In order to provide services to Prodigy while the Splitrock Network was
being deployed, on July 1, 1997 the Company acquired the Legacy Network and
began immediately providing Internet dial access and related services to Prodigy
for its subscribers. Additionally, the Company has an agreement with IBM to use
the IBM Global Services Network to cover market areas that are served neither by
the Splitrock Network nor the Legacy Network. The Company currently handles more
than 800 million minutes of Internet traffic per month for Prodigy (currently
the Company's only Internet dial access customer), with over 60% of the traffic
flowing on the Splitrock Network, approximately 30% on the IBM Global Services
Network and the remainder on the Legacy Network. As the Phase II Expansion
progresses, Legacy Network POPs will be decommissioned and access to specific
IBM Global Services Network POPs will be terminated when appropriate.
Substantially all Legacy Network POPs are expected to be decommissioned by the
end of 1998 and usage of the IBM Global Services Network is expected to be
terminated by the end of the second quarter of 1999.
COMPETITIVE ADVANTAGES
Since July 1997, the Company has provided Internet dial access services to
Prodigy for its subscribers. The Company believes it benefits from the following
competitive advantages which will assist it in implementing its business
strategy:
Flexible and Efficient New Network Infrastructure. The Splitrock
Network is designed to provide reliable, flexible and efficient services to
the Company's current and future customers. Since the Splitrock Network is
newly-designed (and not based on or an upgrade to an older network), the
Company believes the Network contains many features that are not present in
older networks and is able to flexibly incorporate future developments and
innovations. Older networks were typically designed to provide one type of
service, such as voice or data, and are less efficient at carrying other
traffic. Unlike many networks which deploy ATM technology only along the
core sites in the backbone, the Splitrock Network deploys ATM-to-the-edge
at every core site, hub site and remote site. See "Business -- Splitrock's
Network." Each POP is supported by the Lucent LDR200 switch which the
Company believes provides significant quality of service advantages over
typical ATM backbone switches. Management believes that the Network
contains more ATM-based switches than that of any other commercial network.
This pervasive
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use of ATM technology and the Lucent LDR200 switch enables the Company to
create a multi-service platform which delivers IP, frame relay and other
Internet services. In addition, ATM-to-the-edge provides additional
capabilities to expand the Company's service offerings to provide fully
integrated data, video and voice services and to incorporate future
technological innovations into the Splitrock Network architecture with a
lower incremental investment than that required by other, less flexible,
networks.
Providing of Wholesale Internet Dial Access and International
Services. The Company currently provides wholesale Internet data access
services to Prodigy for its subscribers. The Company intends to market
Internet dial access services directly to ISPs rather than to individual
end-users. As a result, unlike many providers of network services, the
Company does not intend to compete against its ISP customers, thereby
broadening the potential customer base to include those ISPs unwilling to
strengthen their competitors with their own network business. Furthermore,
the Company believes it will be viewed as a non-competing vendor and, thus
a potential partner, by major foreign and regional telecommunications
carriers, providing an alternative to their primary U.S. competitors for
delivering data, video and voice services.
Experienced Management Team. The Company's co-founders, Kwok L. Li,
Chairman of the Board and Chief Technical Officer, and William R. Wilson,
President and Chief Executive Officer, have assembled a management team
with significant data and voice communications experience. The 10 most
senior executives and managers of the Company have an average of over 12
years experience in the data and voice communications industry. Previously,
Mr. Li and Mr. Wilson were both senior executives at the predecessor
corporation of WilTel, a wholesale provider of telecommunications services.
During their tenure WilTel designed, constructed, developed and managed
modern packet switched networks (including frame relay and ATM) and
marketed related services. At the time of the sale of Yurie to Lucent in
May 1998, Mr. Li was a Director, Vice Chairman and Chief Technical Officer
at Yurie, where he created and designed the Lucent LDR200 switch which is a
key component of the Splitrock Network.
BUSINESS STRATEGY
Key elements of the Company's business strategy include:
Complete the Expansion of the Advanced Network Infrastructure. The
Company has designed, deployed and is in the process of expanding the
Splitrock Network, an advanced nationwide telecommunications network based
on ATM-to-the-edge switching technology. Through June 30, 1998, the Company
had spent approximately $25.0 million on the Phase I Buildout, which was
substantially completed in April 1998, and $14.2 million on the Phase II
Expansion. The Company anticipates that completion of the Phase II
Expansion will require an additional $139.6 million of capital
expenditures. The Company expects to spend approximately $45.9 million to
construct approximately 330 additional POPs, approximately $81.5 million to
deploy advanced processing equipment and software to enhance and accelerate
the Company's ability to provide value added services, such as ISDN video,
web hosting and VPN, and approximately $12.2 million to augment the
Company's network management infrastructure. Of these amounts, the Company
has spent $3.2 million since June 30, 1998. The Company believes that
having ATM-to-the-edge results in: (i) a more easily upgradeable network;
(ii) the ability to efficiently add new services at a lower incremental
investment; (iii) improved network reliability; (iv) interoperability with
other network platforms; and (v) improved network manageability.
Offer a Comprehensive Range of Services to Optimize Network
Utilization. Given the fixed cost nature of the Splitrock Network's
infrastructure, the Company seeks to increase total network utilization
primarily by targeting providers of business services (daytime intensive
traffic) and, to a lesser extent, providers of consumer services (evening
intensive traffic) to balance the Network's usage throughout a 24-hour
period. The Network's flexibility will provide for service innovation
(including data, video and voice services) with lower incremental
investment than less flexible networks. To offer new services, the Company
will only need to add the appropriate protocol processors and billing and
service management systems without changes to the core ATM switching
platform. Therefore, the Company believes it will be able to maximize
Network utilization by offering both daytime business-oriented services
(such as video
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conferencing and VPN services) and evening-time consumer-oriented services
(such as Internet dial access services). The ability of the Company to
offer a wide range of services will enhance its ability to optimize traffic
at all times of the day, thereby increasing revenue and profitability. As
its business strategy is implemented, the Company will evaluate offering
complementary services as they are required by its customer base.
Development of Advanced Business Support Systems. Through the
development of scalable business support systems, the Company believes that
it has the opportunity to establish a competitive advantage relative to
traditional network service providers. Traditional network service
providers typically operate extensive legacy business support systems with
compartmentalized architectures that limit their ability to scale rapidly
and introduce enhanced services and features. In connection with the
expansion of the Splitrock Network the Company is creating business support
systems with an architecture designed to maximize both reliability and
scalability. All database and billing systems will run on a PC or UNIX
distributed architecture rather than centralized mainframe systems.
Expand Target Market Opportunities. IDC estimates that the total
number of U.S. companies with Internet access will grow from an estimated
1.5 million, or 20.0% of total U.S. companies, in 1996 to 4.1 million, or
53.0% of total U.S. companies, in 2000. IDC also estimates that the number
of U.S. households with a personal computer and a modem will grow from an
estimated 8.8 million, or 24.0% of all U.S. households with a personal
computer in 1996, to 39.4 million, or 58.0% of all U.S. households with a
personal computer in 2000. IDC estimates that there are currently over
4,000 ISPs in the U.S., consisting of national, regional and local
providers, of which the Company believes only a small percentage have
access to their own nationwide backbone network infrastructure. The Company
intends to capitalize on this expected growth in demand for network
services by aggressively marketing its services through a variety of
distribution channels and evaluating strategic alliances and acquisitions
as they present themselves. The Company believes that utilizing a range of
distribution channels will enable it to cost-effectively reach a broad base
of potential customers. The Company currently intends to develop and use a
direct sales force (which it expects to begin hiring in the second half of
1998) to attract ISPs, carriers, value added service providers and medium
and large businesses. In addition, the Company intends to use alternative
distribution channels, including agents, resellers and wholesalers, to gain
access to a substantially larger base of potential customers than the
Company could otherwise initially address through its direct sales force.
Through the combination of a direct sales force and alternative
distribution channels, the Company will seek to rapidly increase
revenue-producing traffic on its Network.
The Company also intends to evaluate strategic alliances and
acquisitions that could provide additional traffic over the Splitrock
Network. While the Company is primarily focused on the domestic services
market, it believes the demand for Internet services outside the U.S. will
grow over the next few years. As a result, the Company will evaluate
opportunities, primarily in Latin America, to partner with strong,
established telecommunications service providers. For example, the Company
will consider entering into international alliances to originate and
terminate international traffic on the Splitrock Network.
Provide Superior Comprehensive Customer Service. Splitrock believes
that superior customer service is a critical element in attracting and
retaining customers, and expanding value added services to existing
customers. In particular, the Company believes it is critical to maintain
two geographically dispersed NOCs, each of which is able to monitor the
entire Network and provide rapid problem resolution. The Company has
established a 24-hours per day, seven days per week NOC at its Yorktown, NY
facility. In addition, a new 24-hours per day, seven days per week NOC
recently became fully operational at The Woodlands, TX facility.
SPLITROCK'S NETWORK
Overview. The Splitrock Network is a facilities-based nationwide ATM-based
commercial telecommunications network. The Network currently reaches more than
55% of U.S. households by a local call with 56k modem access (currently the
fastest modem speed commercially available over residential phone lines),
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including every market with a population of at least 100,000 as well as several
second-tier markets. Upon completion of the Phase II Expansion, the Splitrock
Network will have approximately 400 active POPs with a physical presence in all
50 states, reaching over 90% of U.S. households with a local call.
On June 24, 1997, the Company entered into the Prodigy Agreement to provide
nationwide Internet dial access and related services to Prodigy for its
subscribers on the new Splitrock Network. In order to provide Internet access
services to Prodigy while the Splitrock Network was being deployed, on July 1,
1997 the Company acquired the Legacy Network and began immediately providing
Internet dial access and related services to Prodigy for its subscribers.
Additionally, the Company uses the IBM Global Services Network to cover market
areas that are served neither by the Splitrock Network nor the Legacy Network.
The Company currently handles more than 800 million minutes of Internet traffic
per month for Prodigy (currently the Company's only Internet dial access
customer), with over 60% of the traffic flowing on the Splitrock Network,
approximately 30% on the IBM Global Services Network and the remainder on the
Legacy Network. As the Phase II Expansion progresses, Legacy Network POPs will
be decommissioned and access to specific IBM Global Services Network POPs will
be terminated when appropriate. Substantially all Legacy Network POPs are
expected to be decommissioned by the end of 1998 and usage of the IBM Global
Services Network is expected to terminate by the end of the second quarter of
1999. In addition to providing Internet dial access and related services to
Prodigy, the Company has recently launched two new data services, transit
services and VPN services, and has begun providing transit services to Orbis, an
Internet connection service provider to businesses, and expects to begin
delivering VPN services to NetworkTwo, a value added network service provider,
in the fourth quarter of 1998.
The Splitrock Network Architecture. The Splitrock Network, through its
ATM-to-the-edge architecture, will allow the Company to concurrently provide
multiple services such as data, video and voice to its customers and to
incorporate future technology changes at relatively low incremental investments.
As a result, the Company believes it has created a more efficient network than
its competitors, thereby reducing its own costs and concurrently improving
reliability to the end user.
Communication service providers have typically provided services using two
predominant types of infrastructure, one geared towards voice service and the
other designed to optimize data communications. These infrastructures are based
on (i) telecommunications switches designed primarily for voice grade services
or (ii) data telecommunications routers and switches designed primarily for
communications between computers. Practical considerations and equipment
constraints have lead to the development of these two types of distinct network
infrastructures. Voice telecommunications service providers historically have
needed to provide a high level of reliability because of the need for life
dependent emergency services such as 911 calls. Since telephone services use
relatively simple handsets that cannot redial or re-transmit automatically if
disconnected, telephone network providers depend upon equipment reliability,
network architecture design, network management and maintenance to meet their
service needs and reliability constraints. Data telecommunications service
providers, on the other hand, have the benefit of highly intelligent terminals
at the end-user. These terminals usually can determine if a transmission error
has occurred and automatically re-transmit data and even reconnect a session if
necessary. With the help of intelligent terminals, data telecommunication
service equipment run complex routing algorithms that allow them to locate and
find the best route to transmit data. While providing a high degree of
flexibility, data telecommunication service equipment is generally plagued with
system reliability issues and often unpredictable performance. This attribute
has historically differentiated data telecommunication service equipment from
voice telecommunication service equipment.
In order to create a network which efficiently supplies multiple types of
services, such as data, video and voice, a company must make the platform
reliable enough to support voice, yet flexible enough to support data. To date,
all companies successfully providing voice and data concurrently have
partitioned their network's bandwidth to support two separate service
infrastructures. Part of their bandwidth is used for voice, employing voice
telecommunications service switches, and the other part is used for data,
employing standard data telecommunication equipment in the network.
Separating bandwidth use is a very practical way to provide multiple
services. Particularly today, when voice traffic still dominates the majority of
bandwidth transferred over most networks, all major networks have
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partitioned their bandwidth into two separate components, one to carry voice and
the other to carry data. As long as data represents a small portion of network
traffic, this partitioning remains practical. However, it is expected that the
rapid growth of data will soon cause data to consume more bandwidth than voice.
When that occurs, partitioning will make network bandwidth utilization very
difficult to optimize while creating significant management complexity.
The Splitrock Network was designed to address these and other constraints
facing older networks by not requiring the separation of bandwidth for different
types of services. In the process of designing the Network the Company sought to
create a Network infrastructure which could (i) efficiently offer data, video,
and voice services concurrently, (ii) reduce operating costs by more efficient
utilization of network resources and (iii) provide high quality service for all
services offered on the Network.
The Company believes that three features distinguish the Splitrock Network
from other telecommunications networks. First, Splitrock uses the Lucent LDR200
switch which supports multiple services at every POP of the Network. The Company
believes that this "intelligent" ATM switch differs from typical ATM backbone
switch engines in two important ways. First, the Lucent LDR200 supports many
access protocols to the Network whereby an array of data, video and voice
services can be sent and/or received, such as IP, frame relay, ATM, ethernet,
T-1, T-3, OC-3 and many other digital as well as analog interfaces. The Lucent
LDR200 is also scalable with up to fourteen interface module slots designed to
house interface cards supporting these various services. The Lucent LDR200
translates these native service protocols into standard ATM format and
transports any service as an ATM connection. In addition, the Lucent LDR200
implements a patented queuing algorithm, allowing simultaneous support of data,
video and voice services on a unified platform without loss of quality of
service even during periods of high network utilization. The queuing algorithm
eliminates the need for bandwidth allocation to different kinds of services.
Second, to manage the large number of ATM switches in the Network, the
Company organized the Network architecture into classes and regions. This
architecture allows the Company to more quickly introduce new services because
all new services can be layered on the Network's ATM switching fabric without
alterations being made to the fabric itself. A new network service has two
components, the protocol that defines the format of the information payload and
the signaling or routing instructions required to direct the information to its
destination in the network. The Splitrock Network ATM switching platform
streamlines the signaling process because routing information is concentrated in
a limited number of central sites in the Network (known as core sites) rather
than having signaling or routing information interpreted by switches or routers
at every point of the network as occurs, for example, in a typical IP-based
network. Therefore, to introduce a new service, the Company only needs to deploy
the proper signaling or routing processors at a few core sites instead of
hundreds of switch or router sites distributed around the network. This reduced
number of routing decisions also allows for better management and typically
faster throughput than other networks.
Third, most modern networks achieve transmission efficiencies by deploying
ATM switching engines in three to twenty access sites only in the core backbone
of their network. In contrast, Splitrock has created an ATM-to-the-edge
switching fabric that blankets the entire network (i.e., ATM switches are
located in all POPs throughout the Splitrock Network). As of June 1, 1998,
Splitrock had installed 70 ATM switches, and expects to deploy an additional 330
ATM switches during the Phase II Expansion. ATM-to-the-edge forms the basic
platform for Splitrock to offer multiple services to all users on the Network.
The Splitrock Network is organized into three classes of access sites: core
sites, hub sites and remote sites. The architecture partitions the entire
Network into 21 regions, with a core site in each region. The core site is
generally located in the city with the most traffic in that region. Users access
the Network within a region by connecting to either a core, a hub or a remote
access site. The core sites form the backbone of the Splitrock Network, with the
hub and remote access sites extending the reach of the backbone.
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The following diagram is a simplified illustration of the Company's
ATM-to-the-edge Network architecture, and is designed for illustrative purposes
only. It does not represent the actual number or location of POPs.
[NETWORK ARCHITECTURE GRAPHIC]
The 21 core sites, all of which were completed by June 1, 1998, are
equipped with Lucent LDR200 switches. Using ATM technology, these core sites are
logically fully meshed, allowing traffic to pass directly from any one region to
any other region. The core sites are interconnected by standard transmission
links such as DS-3 or OC-3, which are available from IXCs such as WorldCom, MCI
and Qwest Communications International Inc. ("Qwest"). Because the Lucent LDR200
conforms to standard transmission specifications, the Company can purchase
bandwidth on an actual need basis between each site and upgrade these links as
the bandwidth demand increases.
In addition, each core site is equipped with special protocol processors to
enable the Network to accommodate demand for a wide variety of services. For
example, to support IP protocol for Internet services, standard Cisco IP routers
are installed, one per core site. These are the only routers installed in the
Network as opposed to other networks which have routers installed throughout the
network. Since a router has direct connections to every other router in the
Splitrock Network, the routers have very simple routing tables and can forward
packets from region to region efficiently and directly.
Hub sites service the major cities within a region. Upon completion of the
Network expansion, there will be approximately 60 hub sites in the Network, of
which 49 were completed by June 1, 1998. Each hub site is equipped with a Lucent
LDR200 switch and all other user access equipment, including Bay Network modems,
necessary for Internet dial access service. A Splitrock user connected to any
hub site can access the complete array of services. Hub sites connect to core
sites over a DS-3 line or multiple T-1 lines depending on the traffic
requirements. Hub sites can be connected redundantly to other hub sites or to
other core sites to increase network reliability. For IP traffic, all packets
from a hub site are forwarded directly to the region's core site, and then
forwarded to their destination region by the core site router.
Upon completion of the Phase II Expansion, the Network will have more than
300 remote sites to reach the smaller cities within a region. None of such sites
were in place by June 1, 1998. These sites are also fully equipped with Lucent
LDR200 switches and other equipment to allow user access to the same services as
elsewhere in the Network. Remote access sites connect to a hub site, usually
with a T-1 line. The remote sites
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can also be protected from transmission failures by being connected redundantly
to other access or hub sites in the region. The Company has not added a material
number of POPs since June 1, 1998.
The following diagram is a simplified illustration of how the Splitrock
Network is designed to deliver data (including Internet), video and voice
services.
[FLOW CHART
Network Infrastructure. The Company believes that it has provided for
future growth by ensuring that the Splitrock Network is scalable, flexible,
fault tolerant, open standards and interoperable and manageable from remote
locations.
- Scalable. Splitrock's flexible, multi-layer network architecture utilizes
a high-speed switching fabric enabling the Company to grow the number of
POPs and the number of users served in an incremental manner that matches
investment with demand. The Splitrock Network's scalability extends
beyond the currently installed base of POPs to allow for growth without
fundamental design changes.
- Flexible. The Company believes that the Splitrock Network will adapt to
new services and manages network resources according to each service's
needs, permitting the Network to efficiently offer data, video and voice
services concurrently. On the switching level, the switching elements
(Lucent LDR200 switches) adjust Network responses based on the traffic's
delay and loss sensitivities. On the protocol level, the Network
architecture is able to sort and direct various protocols to its
designated protocol processors, including Internet packets to Cisco
routers, ISDN signaling to workstations with ISDN software, and
traditional voice network signaling to workstations with SS7 software.
- Fault Tolerant. Redundancy and adaptive technology in the Splitrock
Network reduces the impact of isolated failures. For example, all core
sites are interconnected, allowing traffic to be transferred among sites
in case of a failure. In addition, key switching, routers and
workstations are configured to search for alternate paths in the event of
individual component or transmission line failure. The Company also has
an uninterruptible power supply at each POP, limiting the impact of local
power outages on the Network.
- Open Standards and Interoperable. The Splitrock Network is entirely based
on standards compliant architecture supporting various protocols,
including IP, ATM, frame relay, ISDN video and SS7. This architecture
allows Splitrock to interconnect freely with other carrier networks or
customer networks. As a result, Splitrock can extend services of another
carrier outside of that carrier's own region. In addition, potential VPN
clients that use standards based protocols can easily access the Network
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without having to purchase special equipment that would otherwise be
necessary with a proprietary network.
- Manageable. From its NOCs, the Company is able to monitor the Network
remotely, perform network diagnostics and equipment surveillance, and
inform customers when a network problem occurs. As a result of the
Company's network architecture, these tasks may be performed remotely
regardless of POP location or network status. This capability allows the
Company to control costs associated with on-site network configuration
and repair.
Network Management. The Company believes that superior customer service is
a critical element in attracting and retaining customers, and expanding value
added services to existing customers. In particular, the Company believes it is
critical to maintain two geographically dispersed NOCs, each of which is able to
monitor the entire Network and provide rapid problem resolution. The Company has
established a 24-hours per day, seven days per week NOC at its Yorktown, NY
facility. In addition, a new 24-hours per day, seven days per week NOC recently
became fully operational at The Woodlands, TX facility.
Peering. Peering arrangements between the Company and ISPs are necessary to
exchange traffic destined for other networks and to allow external traffic
access to the Splitrock Network. With Prodigy as a customer, the Company is now
carrying a significant amount of Internet traffic. The Company is building an
infrastructure equivalent to other Tier 1 providers and it has sought peering
relationships with many Tier 1 and Tier 2 ISPs. Peering arrangements have been
established with six ISPs, including Sprint and PSINet, and the Company is
currently in discussions with other ISPs in order to broaden its peering
capabilities. The Company peers with other networks from a core site through an
industrial standard Cisco router, which promotes proper protocol exchange
between Splitrock and other ISPs. The Company currently maintains private
peering connections at its Los Angeles, California; New York, New York; Atlanta,
Georgia; Phoenix, Arizona; and Dallas, Texas facilities. In addition, the
Company currently has access to one public peering location in Chicago, Illinois
and expects that access to two additional public peering locations will be
established in the third quarter of 1998. The Company expects that it will
substantially increase the number of ISPs with which it peers over the next two
years. The Company believes that by entering into direct peering relationships
with a large number of ISPs, the Company's business customers receive better
service and higher quality network performance. See "Risk Factors Establishment
and Maintenance of Transmission Services and Peering Relationships."
Transmission Services. The Company leases long distance connections of
various bandwidths to connect sites in the Network. The choice of long distance
carriers is based on their network reliability, bandwidth availability,
responsiveness and pricing. The Company currently leases a majority of its long
distance connections from WorldCom and is also reviewing other suppliers such as
Sprint and Qwest.
The Company leases local connections (DS-1, T-1 or ISDN PRI) to access the
end-user. The local service providers are selected based on their reliability,
service availability, responsiveness, pricing and minimum switch congestion
during busy hours. Based on these criteria, the Company has relationships with
21 CLECs and all major ILECs in the country. The Company has also established
approximately 60 collocations with various CLECs.
PRODUCTS AND SERVICES
General. The pervasive deployment of ATM switching technology throughout
the Network enables the Company to offer new services with lower incremental
investment than that required by less flexible networks. Currently, the Company
provides Internet access options and related-services, including Internet dial
access services and transit services, as well as enhanced VPN services. The
Company is seeking to increase total network utilization primarily by targeting
providers of business services (daytime intensive traffic) and, to a lesser
extent, providers of consumer services (evening intensive traffic).
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Internet Access Options. The Company provides the following Internet access
options and related services to its customers:
- Internet Dial Access Services. The Company's Internet dial access
services offer a cost effective Internet solution that provides 56k dial
access to the Company's advanced ATM-to-the-edge network via ordinary
telephone lines. The Company's Internet dial access services provide
smaller ISPs with the opportunity to increase their user base over time
while at the same time providing larger ISPs the opportunity to cost
effectively manage their growth. The Company currently provides Internet
dial access services to Prodigy for its subscribers. The Company intends
to primarily target business focused ISPs and businesses and, to a lesser
extent, ISPs with residential customers to maximize traffic throughout
the Network. As of August 31, 1998, Prodigy was the Company's only
Internet dial access service customer and provided $22.7 million (100%)
of total revenue for the period from inception (March 5, 1997) to
December 31, 1997 and $32.2 million (99%) of total revenue during the six
months ended June 30, 1998.
- Transit Service. The Company offers high speed transit services, which
provide businesses with direct access, via dedicated capacity, to a full
range of Internet applications and allows an ISP to transfer traffic
through the Company's Network to another ISP. The Company's transit
services provide full-time dedicated Internet connectivity at a range of
access speeds from 56 Kbps to 155 Mbps. This service is designed to offer
comprehensive network security and to help ensure bandwidth availability
for priority business applications. Transit services enable businesses to
reduce their data communications expenses by leasing network utilization
from the Company in lieu of leasing point-to-point circuits from other
telecommunications providers. The Company has initially begun to target
carriers (i.e. ISPs, ILECs, CLECs, regional long distance providers and
wireless providers) as potential customers for this service. As the
Company's carrier transit service business grows, the Company will target
other businesses. Since May 1998, the Company has provided transit
services on a month-to-month basis to Orbis, an Internet connection
service provider to businesses, which is currently the Company's only
transit service customer, providing less than 1% of total revenue during
the six months ended June 30, 1998.
Virtual Private Network Services. Many companies today have private data
communication networks (often referred to as WANs) built on expensive leased
lines designed to transfer proprietary data between office locations. The
Splitrock Network offers companies a cost-effective alternative to WANs through
VPNs, which are designed to provide secure transmission of private IP traffic
through the Internet. Additionally, many companies require that their employees
have remote access to these private networks from home or while traveling, which
is a function that VPNs provide. VPN products are also the vehicle for offering
intranet and extranet services. Intranets are corporate/organizational networks
that rely on Internet-based technologies to provide secure links between
corporate offices. Extranets expand the network to selected business partners
through secured links on the Internet. Increasingly, companies are finding that
intranets and extranets can enhance corporate productivity more easily and less
expensively than proprietary systems. The Company currently offers VPN
solutions, and is in the process of evaluating additional products to meet the
needs of customers. For example, the Company is in the process of testing ISDN
software and expects to offer video conferencing services to customers by the
end of 1998. Such services will be point-to-point, targeted primarily at the
communications needs of companies using PictureTel, VTEL or other standards
based video conferencing, and will allow the business customer to conduct video
conferencing with other on-network or off-network users with compatible video
conferencing equipment. The Company has initially begun to target carriers (e.g.
ISPs, ILECs, CLECs, regional long distance providers and wireless providers),
which the Company expects to distribute the Company's VPN services to end-users.
As the Company's VPN service business grows, the Company will also target
businesses as potential VPN customers. The Company has signed an agreement with
NetworkTwo, a value added network service provider, and expects to begin
delivering VPN services pursuant to this agreement in the fourth quarter of
1998. NetworkTwo is currently the Company's only VPN customer, providing less
than 1% of total revenue during the six months ended June 30, 1998.
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DISTRIBUTION STRATEGY
Through the combination of a direct sales force and alternative
distribution channels, the Company believes that it will be able to access
markets and increase revenue-producing traffic on the Splitrock Network. To
implement its distribution strategy, the Company intends to develop an in-house
direct sales force and has identified a variety of possible alternative
distribution channels. The Company expects to begin hiring sales employees in
the second half of 1998.
The Company intends to utilize its direct sales force to market its
products and services directly to ISPs, carriers, value added service providers
and medium and large businesses. The Company intends to utilize alternate
distribution channels to market its products and services to medium and small
businesses. These alternate distribution channels include agents, resellers and
wholesalers.
- Agents are independent organizations that would sell the Company's
products and services under the Splitrock brand name to end-users in
exchange for revenue based commissions. The Company intends to identify
agents that generally would be focused on specific market segments (such
as medium and small businesses) and have existing customer bases. Sales
through this alternative distribution channel would require the Company
to provide the same type of services that would be provided in the case
of sales through its own direct sales force, such as order fulfillment,
billing and collections, customer service and direct sales management.
- Resellers are independent companies that would purchase the Company's
products and services and then "repackage" these services for sale to
their customers under their own brand name. The Company believes that
resellers would require access to certain of the Company's business
operating systems in connection with the sale of the Company's services
to the resellers' customers. Sales through this distribution channel
generally would not require the Company to provide order fulfillment,
billing and collection and customer service.
- Wholesalers are independent companies that would purchase from the
Company unbundled network and service capabilities in large quantities in
order to market their own products and services under a brand name other
than Splitrock. The Company believes that wholesalers would have minimal
dependence on the Company's business support systems in connection with
the sale of services to their customers.
The Company anticipates that participants in its alternative distribution
channels will sell services directly to medium and small businesses. The Company
expects these medium and small businesses to access the Splitrock Network by
using local switched services that are provided by CLECs or ILECs.
CUSTOMERS
The Company currently provides Internet dial access, transit and VPN
services to its customers. To date, Internet dial access services have provided
substantially all of the Company's revenue. The Company expects this percentage
to decrease as the Company continues to add new customers.
Internet dial access customers. Prodigy has been the Company's customer
since July 1997 and has provided $22.7 million (100% of total revenues) of
Internet dial access revenue during the period from inception (March 5, 1997) to
December 31, 1997 and $32.2 million (99% of total revenues) of Internet dial
access revenue during the six months ended June 30, 1998. Pursuant to the
Prodigy Agreement, the Company currently provides certain network and related
services, including Internet dial access services, to Prodigy for its
subscribers. Launched in 1984 as a joint venture between IBM and Sears, Prodigy
developed a nationwide on-line service that reached more than 85% of U.S.
households with a local call. Along with America Online, Inc. and CompuServe
Corp., Prodigy helped pioneer the concept of e-mail and on-line services to
consumers in the U.S.
In 1996, Prodigy was spun off from IBM and Sears. In 1997, Carso obtained
control of Prodigy. Carso introduced a new management team which has focused on
growing and expanding the business, modernizing infrastructure, and reducing
costs. In early 1997, Prodigy launched a new Internet-based service, Prodigy
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Internet, separate from the original proprietary on-line service, Prodigy
Classic, priced at $19.95 per month for unlimited service. Prodigy is in the
process of migrating Prodigy Classic subscribers to Prodigy Internet. The
average number of total Prodigy Internet subscribers grew 36.4% during the first
quarter of 1998 compared to the fourth quarter of 1997 and 3.3% during the
second quarter of 1998 when compared to the first quarter of 1998.
In 1998, as a result of its continued focus on marketing and customer
service, Prodigy outsourced its content management to Excite Communications,
Inc. Additionally, Prodigy has started aggressive marketing programs which are
intended to rebuild its brand name recognition. Since July 1997, Prodigy has
almost doubled the number of subscribers to its Prodigy Internet service
partially as a result of a migration of Prodigy Classic subscribers to Prodigy
Internet. The Prodigy customer base and associated revenue has enabled the
Company to support the deployment of the Splitrock Network. See "Risk
Factors -- Reliance on Prodigy; Recent Discussions with Prodigy."
Transit customers. There are approximately 4,000 ISPs in the U.S. today.
Most of these do not have their own nationwide network and thus require transit
service to the Internet. Commencing in May 1998, the Company has provided
transit services to Orbis on a month-to-month basis. Orbis is the leading
provider of local Internet connection services for businesses in Minneapolis and
St. Paul, Minnesota. Orbis offers business critical connectivity featuring
redundant, high-speed (T-1, T-3) backbone connections, 24-hour operational and
environmental monitoring, and Web hosting services. At the beginning of each
month, Orbis requests a certain amount of dedicated bandwidth and the Company
then charges a monthly fee based on the amount of bandwidth requested. The
Company began generating revenue from Orbis in May 1998, such revenue
constituting less than 1% of total revenue during the six months ended June 30,
1998. The Company does not expect that revenues from Orbis will be material for
the foreseeable future.
VPN customers. The Company has entered into a three-year agreement to
provide VPN services to NetworkTwo. NetworkTwo, formerly known as ADP AutoNet
Communications Group, supplies high quality, reliable and fully supported
network services and operates a national wide area network delivering both
dedicated and dial-up connectivity to business clients. NetworkTwo also manages
VPNs, enterprise-wide intranets and extranets. NetworkTwo moves more than $2.0
billion over its network each day as a function of its cash management and funds
transfer service for ADP Financial Services. Other Network Two users include Dow
Jones' News Retrieval service; State Farm and Allstate insurance companies; and
60 of the top 100 U.S. banks. Under the agreement, NetworkTwo will be billed
depending on the type of modem port used (i.e. 612 Kbps, 768 Kbps, etc.) and the
amount of bandwidth consumed, with certain discounts available based on volume.
The agreement provides for a minimum aggregate payment by NetworkTwo of $7.0
million over the three year contract period, but no minimum monthly payment is
required in 1998. The Company began generating revenue from NetworkTwo in June
1998, such revenue constituting less than 1% of total revenue during the six
months ended June 30, 1998, and expects to begin providing VAN services to
NetworkTwo in the fourth quarter of 1998.
CUSTOMER SERVICE
Splitrock believes that superior customer service is a critical element in
attracting and retaining customers and expanding value added services to
existing customers. In particular, the Company believes it is critical to
maintain two geographically dispersed NOCs, each of which is able to monitor the
entire Network and provide rapid problem resolution. Since the first quarter of
1998, the Company believes that it has developed a customer service platform
which will minimize the impact of future service interruptions and provide
superior customer service. Specifically, the Company has established a 24-hours
per day, seven days per week NOC at its Yorktown, NY facility and a new 24-hours
per day, seven days per week NOC recently became fully operational at The
Woodlands, TX facility. Each of these NOCs has the capability to manage traffic,
monitor system status and remotely implement solutions to system interruptions.
As of May 1998, the Company had implemented a number of other systems and
procedures to provide superior customer service. The Company has installed a
leading customer support trouble ticketing and workflow management system from
Remedy Corporation ("Remedy") to track, route and report on customer
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service issues. In addition, software installed at the NOCs now enables the
Company to remotely service customer connections to the Splitrock Network. In
addition, field service personnel from the Company or third party vendors are
dispatched in the event of an equipment failure that cannot be serviced
remotely. See "-- Suppliers." In the first quarter of 1998 the Network
experienced significant service interruptions and failures. See "Risk
Factors -- Reliance on Prodigy; Recent Discussions with Prodigy."
BUSINESS SUPPORT SYSTEMS
General. Through the development of scalable business support systems, the
Company believes that it has the opportunity to establish a competitive
advantage relative to traditional network service providers. Traditional network
service providers typically operate extensive legacy business support systems
with compartmentalized architectures that limit their ability to scale rapidly
and introduce enhanced services and features. In connection with the expansion
of the Splitrock Network, the Company is creating business support systems with
an architecture designed to maximize both reliability and scalability.
Furthermore, in establishing its business support systems, the Company has
attempted to develop Company-wide standardization of hardware, software,
database platforms and problem solving in order to maximize system automation
and minimize employee manual processing. Business support systems are, or will
be, distributed throughout the Splitrock Network, rather than located at central
sites, which improves network performance, recovery and reliability, while also
providing real-time capture of statistical and accounting data. Splitrock
utilizes, when available, industry standard software systems developed and
maintained by third party vendors but customized for the Company's specific
needs.
Network Management. The Company believes that an up-to-date management
platform is critical for the Company to be competitive and provide customers
with quality services. The Company has put in place a modern management platform
to manage the extensive Splitrock Network. The new management platform performs
operations, administration and management tasks. The Company has selected UNIX
and Windows NT based computing systems for network management to ensure ease of
upgrades in the future. Key features of the system are provided by third party
vendors, including an SQL database for information management, NetExpert from
Objective Systems, Inc. for equipment monitoring, Remedy for trouble request
tracking, and other software running tasks that monitor network utilization. The
Company has customized most of these platforms to ensure maximum Network
flexibility and efficiency. The systems also have sufficient capacity to expand
without significant design changes.
Billing. The Company has reviewed billing systems, selected an
industry-standard billing system and begun implementation. The Company believes
that billing requirements prior to full implementation, expected in the first
quarter of 1999, can be addressed with existing systems. In order to support the
third party system that the Company plans to utilize, the Company has adopted
Radius Authentication software to capture Internet session activity in order to
feed the billing system for usage-based services. The Company believes that this
software offers the flexibility and scalability necessarily to provide high
quality Network billing services. For example, the Company believes that this
software will have the ability to process 1 million records per hour to capture
all relevant billing information. While this software has been purchased and
customized, it has yet to be tested at production levels but is expected to be
fully deployed by the end of October 1998.
SUPPLIERS
The Company is dependent on third parties for key components of its network
infrastructure, including for leased lines, transmission services and networking
equipment, such as routers, switches and modems. The quantities and quality of
such networking equipment required by the Company are available only from
limited sources. The Company currently utilizes Lucent for ATM switching
products, including the Lucent LDR200 switch, Bay Networks for its Internet dial
access platform, Cisco for routers and Sun for servers. The Company has entered
into a Purchase Agreement with Yurie (which was acquired by Lucent in May 1998)
pursuant to which the Company agreed to purchase and Yurie agreed to provide a
minimum of $20.0 million of Yurie equipment and related products prior to
January 1, 1999. As of August 31, 1998 the Company had purchased $11.0 million
of equipment and products under this agreement. The Company also depends upon a
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variety of LECs and IXCs to provide telecommunication services, including leased
line and collocation facilities. For long distance connections and backbone long
distance transmission facilities, the Company currently uses WorldCom. In
addition, the Company obtains bandwidth capacity under leased line connection
agreements with LECs, including RBOCs, or is provided telecommunications
services and leased physical space under local access/collocation agreements
with various CLECs, such as Focal, Intermedia, and others. The Company is also
actively pursuing agreements with additional CLECs in an effort to establish
relationships with a variety of telecommunication providers and thereby reduce
the cost of lease connectivity. See "Risk Factors -- Dependence on Suppliers"
and "-- Splitrock's Network -- Transmission Services."
The Company has an agreement with IBM to use the IBM Global Services
Network to cover market areas that are neither served by the Splitrock Network
nor the Legacy Network. These POPs currently account for approximately 30% of
all Prodigy-related traffic. The terms of the agreement provide that either
party may, upon 60 days prior notice, terminate its respective obligations under
the contract for the remaining POP sites. In addition, under the terms of the
agreement with IBM, services at certain of the POPs in the IBM Global Services
Network are scheduled to be discontinued on September 30, 1998. These POPs
currently represent less than 2% of the Company's Prodigy-related traffic. As
part of the Phase II Expansion, the Company plans to deploy POPs to those
locations. The Company has also formulated contingency plans, including
providing toll free Internet dial access to users in these areas, should the
Company be unable to timely deploy POPs in those areas or IBM be unwilling to
continue to provide service to those POPs after September 30, 1998. See "Risk
Factors -- Dependence on Suppliers."
As part of the Company's strategy to replace remaining POPs covered by the
IBM Global Services Network and to complete the expansion of the Splitrock
Network, the Company will rely significantly upon third parties to provide
equipment and services and to deploy the remainder of the Splitrock Network.
Under the Ericsson Agreement, Ericsson will provide certain equipment and
services for, and deploy, 99 additional POP sites. In April 1998, Ericsson
provided the Company with a $5.0 million credit facility to be used to pay
amounts due under the Ericsson Agreement. The amount borrowed, $1.5 million,
under the Ericsson Agreement was repaid upon consummation of the Unit Offering.
The Company has had negotiations with Ericsson for the deployment of the
additional 231 POPs needed to complete the Phase II Expansion. The Company
expects that such negotiations will lead to an agreement on similar terms and
conditions as the Ericsson Agreement. There can be no assurance that the Company
and Ericsson will come to an agreement on the deployment of the remaining 231
POPs required to complete the Network's expansion. See "Risk
Factors -- Suppliers" and "Description of Certain Indebtedness."
The Company also engages third party vendors for routine maintenance,
on-call repair and certain related services. In addition to nine employees and
six individual contractors designated, trained and engaged by the Company as
field operation personnel, the Company has an agreement with IBM designed to
provide additional on-call field support personnel for maintenance, part
replacement and repairs for the Legacy Network until that network is
substantially decommissioned. In addition, during and following the Phase I
Buildout, WilTel has performed on-call services for replacement parts,
maintenance and repair services for the Splitrock Network. The agreement with
WilTel will expire on September 30, 1998. The Company is currently evaluating
and negotiating maintenance service proposals that are designed to replace the
agreements with IBM and WilTel and expand as the network infrastructure grows.
There can be no assurance that the Company will be able to enter into a
replacement maintenance agreement on acceptable terms, or at all. See "Risk
Factors -- Dependence on Suppliers."
COMPETITION
The industry in which the Company competes is extremely competitive. The
Company expects that competition will continue to intensify as customers seek
additional capacity to satisfy the continued growth of the Internet industry. In
addition, numerous competitors, including major telecommunications carriers, are
rapidly expanding their network capabilities. The Company believes that the
primary competitive factors for the provision of network services are quality of
service, network coverage, reliability, price, and product innovation.
Management believes it can compete effectively on these factors based on the
design of the Splitrock Network and industry experience at top management
levels.
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The Company's current and prospective competitors generally may be divided
into two groups: (i) companies that provide Internet access services to ISPs
with both residential and small business customers and (ii) companies that
provide Internet access (including Internet dial access and transit), VPN and
other value added services to medium and large business customers.
ISP Internet Access Service. According to IDC, there are over 4,000 ISPs in
the United States, consisting of national, regional and local providers. The
Company intends to market Internet dial access services to these ISPs. The
Company's competitors in this market will be other companies that provide
Internet access service to ISPs as well as ISPs which possess backbone networks
thereby enabling them to provide capacity to other ISPs. Competitors in this
segment include Verio, Concentric, PSINet and Netcom. While the Company believes
that its status as an independent service provider distinguishes it from many of
these competitors, some of these competitors have significantly greater market
presence, brand recognition and financial, technical and personnel resources
than the Company.
Corporate Internet Access and VPN. In the corporate Internet access
(including Internet dial access and transit) and VPN markets, competitors will
be comprised of network service providers that focus on medium and large
business customers as well as telecommunications carriers. Competitors will
include UUNet, GTE Internetworking (formally BBN)) and DIGEX. Many of the
network service providers that primarily focus on small business, including
Verio and Concentric, also have capabilities in these markets. In addition, all
of the major long distance companies, including AT&T Corporation ("AT&T"), MCI,
and Sprint, offer Internet access and VPN services and compete with the Company.
Many of these competitors, in addition to their substantially greater market
presence and financial, technical and personnel resources, also have large
existing commercial customer bases. Furthermore, many of these competitors have
the ability to bundle Internet access and VPN services with other services such
as Web browsing or, in the case of long distance companies, telephony. Such
bundling of services may have a material adverse effect on the Company's ability
to compete effectively and thus could have an adverse effect on the Company's
business, financial condition and results of operations.
The Company believes that significant new competitors will enter the
network services market. The Company is aware that other companies, including
IXC Comm. and Level 3, are in the process of building or expanding networks that
will have the ability to provide services comparable to those of the Company. In
addition, many of the Company's competitors have the financial and operational
resources to construct networks similar to the Splitrock Network. For example,
Sprint recently announced that it is in the process of designing a network which
will contain ATM switches at every core, hub and remote site. There can be no
assurance that the Company will be able to compete effectively with such
companies.
Recent reforms in the federal regulation of the telecommunications industry
have also created greater opportunities for LECs, including the RBOCs, to enter
the Internet network services market and therefore compete with the Company.
Such increased competition could have a material adverse effect on the Company.
In order to address the Internet network service requirements of the current
business customers of long distance and local carriers, the Company believes
that there is a trend toward horizontal integration through acquisitions of,
joint ventures with, and the wholesale purchase of connectivity from, ISPs. The
WorldCom/MFS/UUNet consolidation (as well as the pending WorldCom/ MCI merger),
the Netcom/ ICG Communications Inc. merger, the Intermedia/DIGEX merger and
GTE's acquisition of BBN are indicative of this trend. Such consolidations may
result in the Company competing with larger companies with greater resources to
devote to the development of new competitive products and services and the
marketing of existing competitive products and services.
As a result of increased competition and integration in the industry, the
Company could encounter significant pricing pressure, which in turn could result
in significantly lower average selling prices of the Company's services. There
can be no assurance that the Company will be able to offset the effects of any
such lower prices with an increase in the number of its customers, growth in
sales to its customer base, higher revenue from enhanced services, cost
reductions or otherwise. In addition, the Company believes that the Internet
access and related services industry is likely to undergo further consolidation
in the near future, which could result in increased price and other competition
in these industries and, potentially, other portions of the
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industry, including the market for VPN services. Increased price or other
competition could have a material adverse effect on the Company's business,
financial condition and results of operations. There can be no assurance that
the Company will have the financial resources, technical expertise or marketing
and support capabilities to continue to compete successfully.
REGULATION
Overview. Although the Company is not currently subject to direct
regulation by the FCC or any other federal or state agency, it operates in a
highly regulated industry and therefore changes in the regulatory environment
relating to Internet related and other telecommunications services, including
regulatory changes which directly or indirectly affect telecommunications costs
or increase the likelihood or scope of competition from RBOCs or other
telecommunication companies, could have a material adverse effect on the
Company's financial position or results of operations, including by affecting
the prices at which the Company offers it services or imposing regulatory
compliance and other costs on the Company.
Various existing federal and state regulations are currently the subject of
judicial proceedings, legislative hearings and administrative proposals which
could change, in varying degrees, the manner in which the industry operates.
Neither the outcome of these proceedings, nor their impact upon the
telecommunications industry generally, or on the Company particularly, can be
predicted at this time. In addition, over the past several years both the
federal and state governments have adopted new legislation and rules profoundly
affecting the telecommunications industry. No assurance can be given that the
changes in current legislation or new legislation, and the regulations adopted
by the FCC or state regulators pursuant to such legislation, would not have a
material adverse impact on the Company.
The Company Operates as an Unregulated Private Carrier. Unlike most
providers of telecommunications services, the Company does not offer services
indiscriminately to the public or to a broad class of customers, but instead
negotiates individual service contracts with a small number of select carriers.
As a result, it is classified as a "private carrier" as opposed to a "common
carrier" and is not subject to most federal and state regulations. If, in the
future, the Company broadens its customer base and/or provides services
according to standardized service arrangements instead of individually
negotiated contracts, it may become subject to common carrier regulation. If
this occurs, the Company may incur additional regulatory costs to which it is
not now subject.
Regulation of Internet Communications. To date, the FCC has exempted
Enhanced Service Providers ("ESPs"), including ISPs, from federal and state
regulations governing common carriers, including the obligation to pay access
charges and regulatory fees, including contributions to the Universal Services
Fund. Thus, to the extent that the Company provides Internet services and other
services employing Internet protocols, it is not currently subject to
regulation.
Some recent regulatory action indicates that ISPs may be subject to some
form of regulation in the future. The regulatory status of communications
services over the Internet is presently uncertain. For example, in an April 10,
1998 Report to Congress regarding Universal Service (the "Report"), the FCC
concluded that the provision of transmission capacity to ISPs constitutes
"telecommunications" under the Communications Act. The FCC has also indicated in
the Report that it would consider, in an upcoming proceeding, issues related to
whether ISPs that own transmission facilities and engage in data transport over
those facilities in order to provide information services are providing
telecommunications to themselves, and therefore ought to be required to
contribute to the Universal Service Fund. While the Report containing this
conclusion does not have the force of law, it provides a strong indication of
regulatory action that may be taken by the FCC in the future. A finding by the
FCC that ISPs and carriers providing service to ISPs must pay Universal Service
contributions could increase the Company's cost of doing business and have a
material adverse affect on the Company.
To the extent that the Company provides Internet telephony (i.e., a service
in which a voice transmission is made over a packet-switched interactive data
network), such service is deemed an enhanced service and is not currently
subject to federal or state regulation. There is no guarantee, however, that the
regulatory status of Internet telephony will not change in the future. If
Internet telephony does become subject to federal or
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state regulation in the future, such a development could impose substantial new
costs on the Company. Therefore, there can be no assurance that new laws or
regulations relating to these services, or determinations that existing laws are
applicable to them, will not have a material adverse effect on the Company's
business.
Potential Liability of ISPs. The law in the United States relating to the
liability of ISPs and providers of transmission capacity for information carried
on, disseminated through or hosted on their systems is currently unsettled. The
Communications Act and statutes enacted, or under consideration in some states,
impose civil and criminal liability upon ISPs, or providers of transmission
capacity to ISPs, for the transmission or dissemination of certain types of
information and materials. The imposition of such liability may require the
Company to implement measures to reduce its exposure to such liability, which
may require the expenditure of substantial resources. Regulations, litigation,
or legislation could affect the demand for the Company's services. See "Risk
Factors Regulatory Matters; Potential Liability for Information Disseminated
over the Internet."
TRADEMARKS AND TRADE NAMES
The Company filed federal trademark applications for the words "Splitrock"
and "A Carrier of Wisdom" on September 18, 1997, and its domain name
"splitrock.net" on March 6, 1998. The Company also filed separate federal
trademark applications for logos on the above dates, for a logo on June 16, 1998
and for the domain name "splitrock.com" on July 27, 1998. These applications are
pending and the Company has no assurance that they will be granted. Trademark
applications for the "Splitrock" mark also have been applied for in numerous
foreign countries including Mexico, twelve Central and South American countries,
Canada, the European Community, Japan, South Korea, Taiwan, China, Thailand, the
Russian Federation, Poland and Australia. "Splitrock Services, Inc." is a trade
name of the Company.
EMPLOYEES
As of August 31, 1998, the Company had 82 full-time employees and 31
independent contract workers. None of the Company's employees are represented by
a union. The Company has experienced no strikes or work stoppages and considers
its relations with its employees to be satisfactory.
The Company believes that its ability to successfully implement its
business strategies will depend on its ability to attract and retain qualified
employees. The Company expects to hire approximately 24 and 70 additional
employees by the end of 1998 and the Phase II Expansion, respectively. In
addition, the Company expects to utilize additional independent contractors.
Independent contractors are expected to continue to represent approximately
20-25% of the Company's total workforce. While the Company is expecting to add
employees throughout its organization, the Company will focus on recruiting new
technical and sales and marketing employees. The Company expects to employ over
175 employees and independent contractors upon completion of the Phase II
Expansion in the second quarter of 1999. In order to attract and retain highly
qualified employees, the Company believes that it is important to provide a
competitive compensation program that aligns employees' interests with the
Company's. The Company's noncash benefit programs are designed to be comparable
to those offered by its competitors. See "Management." There can be no assurance
that the Company will be able to attract and retain the personnel necessary to
implement its strategies. See "Risk Factors -- Ability to Manage Growth".
INSURANCE
The Company has insurance coverage it believes to be adequate for the risks
of the businesses in which it is engaged. The Company carries property, general
liability and directors and officers insurance with basic policy limitations of
$5.0 million, $2.0 million and $5.0 million, respectively, subject to
deductibles, exclusions and self-insurance retention amounts. In addition, the
Company has a $5.0 million umbrella policy. Such coverage may not be adequate or
available to compensate the Company for all losses that may occur. The
occurrence of a significant loss not fully covered by insurance could have a
material adverse effect on the Company. See "Risk Factors -- Risk of System
Failure; Insurance."
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PROPERTIES
Until recently the Company leased approximately 8,000 square feet of space
in The Woodlands, TX for its headquarters and administrative facilities. In
early July 1998 the Company moved its headquarters and administrative facilities
to a new facility containing approximately 25,000 square feet in The Woodlands,
TX. The lease on the new facility expires in 2003. The Woodlands, TX NOC is also
housed in the new facility.
The Company also subleases from Prodigy a facility of approximately 12,500
square feet in Yorktown, NY for the Company's Yorktown office and NOC. This
lease expires on February 28, 2001 but is subject to early termination on
December 31, 1999 upon three months written notice. The Company plans to move
its Yorktown, NY facility to another location in the New York metropolitan area.
In connection with its network operations, the Company leases space for
installed telecommunications equipment throughout the U.S. for those POPs
deployed in over 70 metropolitan markets. These leases have an average term of
three years and average monthly payments ranging up to several thousand dollars.
In many cases, the Company has the option to renew such leases. The Company
considers these facilities and properties to be suitable for its present needs.
The Company did not assume leases related to the Prodigy POPs in connection with
the Prodigy Transactions. The Company expects to enter additional leases as the
Phase II Expansion progresses.
LEGAL PROCEEDINGS
The Company is not currently involved in any legal proceedings, nor are any
legal proceedings threatened by or against the Company.
MANAGEMENT
Directors are elected annually and hold office until the next shareholders
meeting unless removed because of death, disability, or removal from the Board
of Directors, in conformance with the provisions of the Company's Certificate of
Incorporation. All officers are elected by the Board of Directors, and serve
until removed by the Board of Directors. The following is information concerning
the Board of Directors, executive officers and other key employees of the
Company:
<TABLE>
<CAPTION>
Name Age Principal Position With the Company
---- --- -----------------------------------
<S> <C> <C>
Kwok L. Li............................. 41 Chairman of the Board of Directors and Chief
Technical Officer
William R. Wilson...................... 50 President, Chief Executive Officer and
Director
James D. Long.......................... 44 Senior Vice President, Chief Financial Officer
and Director
Patrick J. McGettigan, Jr.............. 45 Senior Vice President, Secretary and General
Counsel
Clark McLeod........................... 51 Director
Samer Salameh.......................... 33 Director
Roy A. Wilkens......................... 55 Director
Todd Wilkens........................... 31 Vice President -- Engineering
Tracy Hammond.......................... 38 Controller
</TABLE>
Kwok L. Li has served as a Chairman of the Board since July 1997 and has
served as Chief Technical Officer of the Company since April 1998. Mr. Li is a
co-founder of the Company. Mr. Li has also been the Chairman and managing member
of Linsang since July 1997. Linsang is a technology investment company in which
Mr. Li owns a controlling interest. Mr. Li was a director of Yurie from 1995
until the consummation of the sale of Yurie to Lucent. Mr. Li also served as
Vice Chairman of Yurie from June 1997 until its sale to Lucent, as President and
Chief Operating Officer of Yurie from March 1996 to June 1997, and as Executive
Vice President and Chief Technical Officer of Yurie from August 1994 through
March 1996. From 1991 to
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1994, Mr. Li was Director of Strategic Planning at WilTel an interexchange
carrier. From 1988 to 1991, he was Manager of Fiber Access Systems Development
for Bell Northern Research, Inc., a subsidiary conducting technological research
and development for Northern Telecom Limited. Mr. Li is the primary technical
architect of the Lucent LDR200 switch technology. Mr. Li received a B.E.S. in
electrical engineering from The Johns Hopkins University in 1979. Mr. Li does
not maintain time records, and although he is Chairman of the Company, he is not
involved in its day-to-day affairs. Mr. Li is, however, committed to devoting
whatever time may be necessary to assure the success of the Company, whether
full-time or otherwise. As a result of Mr. Li's relationship with Lucent and
with Linsang, each of which has business relationships with the Company, there
may be conflicts of interest that arise including conflicts relating to
potential corporate opportunities. If any such possible conflict arises the
Company will have the non-interested members of the Board of Directors pass on
the appropriateness of any particular matter. See "Risk Factors-- Control by
Principal Stockholders and Management; Transactions with Related Parties."
William R. Wilson has served as President of the Company since its
formation and Chief Executive Officer of the Company since April 1998. Mr.
Wilson is a co-founder of the Company. Prior to assuming his position at the
Company, Mr. Wilson was the Chief Executive Officer of OneLine Management, a
telecommunications consulting firm specializing in strategic positioning founded
by Mr. Wilson in 1995. In that capacity, Mr. Wilson advised Carso and Telmex on
strategic matters. From 1988 to 1995, Mr. Wilson was Vice President of Strategic
Planning at WilTel. Previously, Mr. Wilson taught at Rice University, The
University of Texas at Austin, and The University of Michigan. Mr. Wilson holds
a Ph.D. in Social Psychology from The University of Michigan and an MBA from The
University of Texas at Austin.
James D. Long has served as Senior Vice President and Chief Financial
Officer of the Company since March 1998. From 1995 to 1997, Mr. Long was Senior
Vice President and Chief Financial Officer of CoreSource, Inc., a venture
capital backed healthcare services company, with responsibilities for general
management, financial management and corporate finance. From 1993 to 1995, Mr.
Long was a principal in Nightingale & Associates, a management consulting firm.
Mr. Long has experience with several other management consulting firms including
Deloitte & Touche and Price Waterhouse. Mr. Long holds a BA in Latin American
Economics and an MBA from the University of Texas.
Patrick J. McGettigan, Jr., has served as General Counsel of the Company
since September 1997, as Secretary since March 1998, and as Senior Vice
President since April 1998. Prior to joining the Company, Mr. McGettigan was in
the private practice of law, having been a partner in the firm he founded in the
early 1980s. Mr. McGettigan served as outside counsel to the Company when it was
formed in March 1997. While in private practice for 19 years, Mr. McGettigan
primarily represented closely held businesses in commercial litigation and
transactional matters. Mr. McGettigan received a Bachelor of Arts degree from
The University of Texas and his JD degree from South Texas College of Law, and
is a member of the State Bar of Texas.
Clark McLeod has served as a director of the Company since May 1998. Mr.
McLeod founded McLeodUSA, and has served as its Chairman of the Board and Chief
Executive Officer since its inception in 1991. McLeodUSA is a fully integrated
provider of telecommunications services in the Midwest region. Mr. McLeod's
previous business venture, Teleconnect, a long distance telecommunications
company, was founded in January 1980. This company later merged with
SouthernNet, Inc., forming Telecom*USA. The company grew to become the fourth
largest long distance telecommunications company in the U.S., and was purchased
by MCI in 1990 for $1.3 billion.
Samer Salameh has served as a director of the Company since April 1998.
Since September 1997, Mr. Salameh has been President, Chief Executive Officer,
and a director of Prodigy. From July 1994 until joining Prodigy, Mr. Salameh
served as Director, Long Distance Division of SBC Communications (formerly
Southwestern Bell), responsible for marketing, strategy, positioning, product
management and product development for Telmex, the leading provider of local and
long distance telephone services in Mexico. Before that, Mr. Salameh was
employed by MCI as a Product Manager in 1994 and as a Strategic Marketing
Manager from 1991 to 1993, and he was employed by Merl Industries, a management
consulting firm, as Vice President of Finance during 1993. Mr. Salameh holds a
Masters degree from the Fletcher School of Law and Diplomacy, a B.S. degree in
Management and Technology Transfer from Polytechnic University of New York
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and a Baccalaureate degree with concentration in Math and Physics from Lycee
Fenelon in Paris. As a result of Mr. Salameh's relationship with Prodigy,
conflicts of interest may arise, including conflicts relating to potential
corporate opportunities. See "Summary -- Recent Developments; Risk
Factors -- Reliance on Prodigy; Recent Discussions with Prodigy; -- Control by
Principal Stockholders and Management; Transactions with Related Parties."
Roy A. Wilkens has served as a director of the Company since April 1998.
Mr. Wilkens was President of The Williams Pipeline Company when he founded
WilTel Network Services as an operating unit of The Williams Companies, Inc. in
1985. He was Founder/Chief Executive Officer of WilTel Network Services from
1985 to 1997. In 1995, WilTel Network Services was acquired by LDDS
Communications, which now operates under the name WorldCom. Mr. Wilkens served
as Vice Chairman of WorldCom until his retirement in 1997. In 1992, Mr. Wilkens
was appointed by President George Bush to the National Security
Telecommunications Advisory Council. He has also served as chairman of both the
Competitive Telecommunications Association (CompTel) and the National
Telecommunications Network. Mr. Wilkens is a member of the board of directors of
Paging Network, Inc., UniDial Inc., Invensys Corporation Inc., and Qwest. Mr.
Wilkens is the father of Todd Wilkens, the Company's Vice
President -- Engineering.
Todd Wilkens has served as Vice President -- Engineering of the Company
since July 1997. From 1996 to 1997, Mr. Wilkens was Vice President, Engineering
and Operations, at Gridnet International, where he helped Gridnet, a start-up
Internet services company, implement a nationwide frame relay/ATM network. From
1993 to 1996, Mr. Wilkens was Senior Manager, Advanced Products Support, at
WorldCom where he helped build the Internet Support Organization which
specialized in building and operating ISP backbones. Prior to that, Mr. Wilkens
supported offshore communications in the Gulf of Mexico for Conoco/Dupont. Mr.
Wilkens holds a BSEE from Oklahoma State University. Mr. Wilkens is the son of
Roy A. Wilkens, a director of the Company.
Tracy Hammond joined the Company as Controller in September 1997. From 1995
to 1997, Ms. Hammond served as Vice President -- Finance and Administration of
Comsul, Ltd., a privately held national communications consulting firm. From
1992 to 1995, Ms. Hammond was Principal Financial Officer at Optex Biomedical, a
high-tech biomedical start-up company. Previously, Ms. Hammond worked for seven
years in Arthur Andersen's emerging business practice group, achieving the level
of audit manager. Ms. Hammond is a CPA, and holds a BS in Accountancy from The
University of Missouri.
COMMITTEES OF THE BOARD OF DIRECTORS
The Company's Board of Directors has established a compensation and an
audit committee. The audit committee is composed of Messrs. Long, Wilkens and
McLeod. The audit committee is responsible for recommending the firm to be
appointed as independent accountants to audit the Company's financial
statements, discussing the scope and results of the audit with the independent
accountants, reviewing the functions of the Company's management and independent
accountants with respect to the Company's financial statements and performing
such other related duties and functions as are deemed appropriate by the audit
committee and the board. The compensation committee is responsible for reviewing
and establishing the compensation structure for the Company's officers and
directors, including salary rates, participation in incentive, compensation and
benefit plans, stock options and other forms of compensation. The compensation
committee is composed of Messrs. Li, Wilson, Wilkens and Salameh.
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<PAGE> 85
EXECUTIVE COMPENSATION
The following table sets forth certain information regarding the
compensation earned by or awarded to the chief executive officer of the Company
and each other executive officer of the Company for the first fiscal year of the
Company from inception (March 5, 1997) through December 31, 1997.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
ANNUAL COMPENSATION ------------
------------------------------------ SECURITIES
OTHER ANNUAL UNDERLYING
NAME AND PRINCIPAL POSITION YEAR SALARY ($) COMPENSATION ($) OPTIONS (#)
- --------------------------- ---- ---------- ---------------- ------------
<S> <C> <C> <C> <C>
Kwok L. Li..................................... 1997 -0- 10,600(1) -0-
Chairman of the Board and Chief
Technical Officer
William R. Wilson.............................. 1997 62,980 16,400(1) -0-
President and Chief Executive Officer
James D. Long.................................. 1997 -0- -0- -0-
Senior Vice President and
Chief Financial Officer(2)
Patrick J. McGettigan, Jr...................... 1997 46,933 65,000(4) 250,000
Senior Vice President, Secretary and
General Counsel(3)
</TABLE>
- ---------------
(1) The compensation for services rendered was paid in the form of shares of
Common Stock in May 1997.
(2) Mr. Long became an employee of the Company in March 1998.
(3) Mr. McGettigan became an employee of the Company in September 1997. Prior to
being employed by the Company, Mr. McGettigan performed legal services on
behalf of the Company. In 1997, Mr. McGettigan's former law firm received
approximately $18,000 from the Company.
(4) Granted as a bonus upon Mr. McGettigan becoming an employee of the Company.
OPTION GRANTS IN FISCAL YEAR 1997
The following table sets forth information concerning the grant of stock
options during the fiscal year ended December 31, 1997 to the executive officers
named in the Summary Compensation Table.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZABLE
----------------------------------------------------- VALUE AT ASSUMED
PERCENT OF ANNUAL RATES OF
NUMBER OF TOTAL STOCK PRICE
SECURITIES OPTIONS EXERCISE OR APPRECIATION FOR
UNDERLYING GRANTED TO BASE PRICES OPTION TERM(1)
OPTIONS EMPLOYEES IN PER SHARE EXPIRATION --------------------
NAME GRANTED (#) FISCAL YEAR ($/SHARE) DATE 5% ($) 10% ($)
- ---- ----------- ------------ ----------- ---------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
Kwok L. Li................... -0- * * * * *
William R. Wilson............ -0- * * * * *
James D. Long(2)............. -0- * * * * *
Patrick J. McGettigan, Jr.... 250,000 13.3% .625 9/07 98,268 249,022
</TABLE>
- ---------------
* Not applicable.
(1) The potential realizable value through the expiration date of options has
been determined on the basis of a per share price at the time the options
were granted of $.625, compounded annually over ten years, net of the
exercise price. These values have been determined based upon assumed rates
of appreciation and are not intended to forecast the possible future
appreciation, if any, of the price or value of the Company's Common Stock.
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<PAGE> 86
(2) Mr. Long was granted an option to acquire 250,000 shares of Common Stock at
a price of $.625 per share upon his employment with the Company in 1998. The
Company will recognize compensation expense of $118,750 over the vesting
period of these options as they were granted at a discount from the then
fair market value of the Company's common stock.
AGGREGATED FISCAL YEAR-END OPTION VALUES
The following table shows information with respect to unexercised options
held by the executive officers named in the Summary Compensation Table as of
December 31, 1997. No stock options were exercised by any executive officers
during the fiscal year ended December 31, 1997.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS HELD AT IN-THE-MONEY OPTIONS AT
DECEMBER 31, 1997 (#) DECEMBER 31, 1997(1) ($)
--------------------------- ---------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Kwok L. Li.................................... * * * *
William R. Wilson............................. * * * *
James D. Long................................. * * * *
Patrick J. McGettigan, Jr..................... 80,000 170,000 38,000 80,750
</TABLE>
- ---------------
* Not applicable.
(1) Options are "in-the-money" if the price of the Company's Common Stock
exceeds the exercise price of the options. The value of unexercised options
represents the difference between the exercise price of such options and the
value of the Company's Common Stock on December 31, 1997, which is based on
a valuation made by an independent firm and which was determined to be $1.10
per share.
1997 INCENTIVE SHARE PLAN
On June 16, 1997, the Company's 1997 Incentive Share Plan (the "Plan")
became effective. On April 1, 1998, the Board of Directors of the Company
approved and adopted an amendment and restatement of the Plan which was
subsequently approved and adopted by the stockholders of the Company on April
27, 1998. The purpose of the Plan is to provide employees, and certain
non-employee directors, and consultants with additional incentives by increasing
their ownership interests in the Company.
Individual awards under the Plan may take the form of one or more of (i)
either incentive or non-qualified stock options, (ii) stock appreciation rights,
(iii) restricted stock and (iv) other awards, the value of which is based in
whole or in part upon the value of the Common Stock. Options under the Plan have
a term of ten years and are generally granted with an exercise price equivalent
to market value at the date of grant. Individual option grants vest over time,
based upon a schedule approved by the Board of Directors, which is generally
four years. All of the Company's Common Stock options vest automatically upon a
change in control of the Company, as defined.
The Compensation Committee administers the Plan, determines the persons who
will receive awards and establishes the terms and conditions of those awards.
The President of the Company is also authorized, subject to certain limitations,
to grant awards to other employees. The maximum number of shares of Common Stock
that may be subject to outstanding awards is 20.0 million. As of July 15, 1998,
options for 3,404,500 shares had been granted. No options have been exercised
other than the option to purchase 1,000,000 shares granted to Mr. McLeod in May
1998, which was exercised in June 1998. See "-- Certain Relationships and
Related Transactions -- Financings." Shares of Common Stock which are
attributable to awards which have expired, terminated or been canceled or
forfeited are available for issuance or use in connection with future awards.
Awards under the Plan may be made until January 1, 2007. The Plan may be
amended by the Board of Directors without the consent of the stockholders of the
Company.
85
<PAGE> 87
DIRECTOR COMPENSATION
The directors of the Company who are not also employees of the Company are
entitled to receive an annual fee of $10,000 and a fee of $500 for attending
each committee meeting not held on the same date as a regular meeting of
Directors (Mr. Wilkens and Mr. Salameh have waived all such cash compensation
for 1998), plus reimbursement for reasonable expenses incurred in conjunction
with attending meetings. Directors are also eligible for grants of awards under
the Plan. On May 28, 1998, each of the three outside directors was granted
options to purchase 80,000 shares of the Common Stock at $1.10 per share, with
options to purchase 20,000 of such shares vesting on each of the first four
anniversaries of the date of grant.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
In 1997, the compensation of the Company's executive officers was
determined by the Board of Directors. In 1998, the Board of Directors of the
Company appointed a compensation committee consisting of Kwok L. Li, William R.
Wilson, Samer Salameh and Roy Wilkens, who will determine the compensation of
the Company's executive officers consistent with guidelines established by the
Board of Directors. Mr. Li and Mr. Wilson are executive officers of the Company.
For information concerning the Company's relationship with Mr. Li and Mr.
Salameh and certain of their related entities, reference is made to
"Summary -- The Private Placement and Use of Proceeds," "-- Recent
Developments," "Risk Factors -- Reliance on Prodigy; Recent Discussions with
Prodigy," "-- Dependence on Suppliers," "-- Dependence on Key Personnel,"
"-- Control by Principal Stockholders and Management; Transactions with Related
Parties," "Business -- Customers" and "-- Suppliers."
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Employment Agreements. The Company has entered into employment agreements
with William R. Wilson (the "Wilson Agreement") and Patrick J. McGettigan, Jr.
(the "McGettigan Agreement"). The Wilson Agreement terminates on March 15, 2002,
and provides for the payment of an initial base salary at an annual rate of not
less than $150,000 and entitles him to participate in employee benefit plans
offered to senior executives. The McGettigan Agreement terminates on August 31,
1999, and provides for the payment of an initial base salary at an annual rate
of not less than $140,000 and entitles him to participate in employee benefit
plans offered to senior executives. The base salaries are subject to adjustment
by the Board of Directors or the Compensation Committee.
The Wilson Agreement contains certain confidentiality provisions and
provides for termination (a) for cause (i.e., final conviction of a felony or
crime involving moral turpitude or willful or grossly negligent violation of the
terms regarding confidentiality), (b) upon death or disability or (c) without
cause. If Mr. Wilson is terminated upon death or disability or without cause,
the Company is required to pay the base salary for the remaining term of the
Wilson Agreement. The Company has also indemnified Mr. Wilson pursuant to the
Wilson Agreement for actions taken as an officer and director. The Wilson
Agreement further provides that Mr. Wilson may engage in other business
endeavors without violating any of provisions of the agreement and allows Mr.
Wilson to terminate all obligations under the agreement with 30 days written
notice.
The McGettigan Agreement provides for termination for cause (i.e., willful
and material breach of the McGettigan Agreement, intentional nonperformance,
willful dishonesty, fraud or misconduct with respect to the business or
conviction of a felony). If Mr. McGettigan is terminated by the Company for any
reason other than cause, the Company is required to pay the base salary for the
remaining term of the McGettigan Agreement. In addition, Mr. McGettigan can
terminate all obligations under the McGettigan Agreement upon 60 days written
notice.
Financings. In March 1997, the Company issued to its founders, Kwok L. Li
and William R. Wilson, 400,000 and 600,000 shares, respectively, of its Common
Stock for $0.00167 per share. In May 1997, the Company approved the issuance to
Mr. Li and Mr. Wilson of 10.6 million and 16.4 million shares, respectively, of
the Company's Common Stock in consideration of services performed since March
1997.
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<PAGE> 88
In March 1997, Mr. Li loaned to the Company an aggregate of $750,000. Such
loans were repaid with interest on July 7, 1997. On June 6, 1997, Mr. Li
advanced $3.0 million to the Company and on June 19, 1997, Mr. Li advanced an
additional $7.0 million to the Company. Such advances were evidenced by a $10.0
million convertible note. On August 9, 1997, Linsang, the assignee of Mr. Li,
converted such note into 16.0 million shares of the Common Stock of the Company.
In December 1997, Linsang loaned $1.0 million to the Company. Such loan is
repayable 30 days after written demand or, if no demand is made, on December 1,
2002 and bears interest at the rate of 9.75% per annum beginning in February
1998. In January, March and June 1998, Linsang advanced an additional $3.0
million, $2.0 million and $5.0 million, respectively, to the Company on similar
terms. Such indebtedness was refinanced in connection with the Unit Offering. In
connection with such refinancing, Linsang purchased 11,000 Units in the Unit
Offering.
In August 1997, Linsang purchased 800,000 shares of the Common Stock for
$0.5 million. In addition, in August 1997, Linsang acquired 11.2 million shares
of Common Stock of the Company for $7.0 million pursuant to a subscription
agreement previously executed by Mr. Li and assigned to Linsang.
In August 1997, Roy Wilkens and Sandra Wilkens purchased 800,000 shares of
the Common Stock of the Company for $0.5 million. Mr. Wilkens became a member of
the Board of Directors of the Company in April 1998.
In September 1997, Orient Star, a wholly owned subsidiary of Carso,
purchased 20.0 million shares of Common Stock of the Company for $12.5 million.
Orient Star subsequently acquired, pursuant to an option, an additional 5.0
million shares for $3.1 million. Orient Star currently holds approximately 30.2%
of the Common Stock of the Company. Samer Salameh, the President of Prodigy, an
affiliate of Carso, became a member of the Board of Directors of the Company in
April 1998. Carso is a controlling stockholder of Prodigy and a significant
stockholder of TelMex.
In June 1998, Clark McLeod, CEO of McLeodUSA, a regional telecommunications
firm in the Midwest, exercised in full a stock option previously granted to him
and purchased 1.0 million shares of Common Stock of the Company for $1.1
million. Mr. McLeod became a member of the Board of Directors of the Company in
May 1998.
Other. Kwok L. Li, the Chairman and Chief Technical Officer of the Company,
was also the Vice Chairman and a Director of Yurie, a principal supplier of the
Company, until its acquisition by Lucent. Mr. Li acts as a consultant to Lucent.
As of August 31, 1998, the Company has purchased approximately $11.0 million of
products and services from Yurie. The Company has agreed to purchase and Yurie
has agreed to supply a minimum of $20.0 million of standard Yurie products
during the 18-month period commencing on July 1, 1997. See
"Business -- Suppliers."
Samer Salameh, a Director of the Company, is President, Chief Executive
Officer, and a Director of Prodigy, the principal customer of the Company. See
"Management" and "Business -- Customers" for further discussion of the
relationships between the Company and Prodigy. During the fiscal year ended
December 31, 1997, the Company charged Prodigy approximately $22.7 million under
the agreements between the Company and Prodigy. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Prodigy
Transactions" for a discussion of the terms of these agreements.
87
<PAGE> 89
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information with respect to the
beneficial ownership of the Company's common stock as of September 15, 1998 by
(i) each executive officer and director of the Company, (ii) each stockholder
known by the Company to own beneficially 5% or more of the Company's common
stock and (iii) all directors and executive officers of the Company as a group.
As of September 15, 1998 the Company had 82.8 million shares of Common Stock
outstanding. The Company effected a 100-for-1 stock split on June 3, 1997 and a
10-for-1 stock split on August 8, 1997. All share amounts included in this
Prospectus have been adjusted to reflect the effect of these stock splits. All
information contained in this Prospectus relating to percentage ownership of the
Common Stock does not take into account the 2,642,613 shares of Common Stock
issuable upon exercise of the Warrants.
<TABLE>
<CAPTION>
NUMBER OF
NAME SHARES PERCENTAGE
---- ---------- ----------
<S> <C> <C>
Kwok L. Li.................................................. 39,000,000(1) 47.1%
Linsang Partners, L.L.C. ................................... 28,000,000(2) 33.8%
William R. Wilson........................................... 17,000,000 20.5%
Clark McLeod................................................ 1,000,000 1.2%
Roy A. Wilkens.............................................. 800,000(3) 1.0%
James D. Long............................................... 80,000(4) *
Samer Salameh............................................... -0-(5) -0-
Patrick J. McGettigan, Jr. ................................. 122,500(4) *
Orient Star................................................. 25,000,000 30.2%
Paseo de las Palmas #736
Col Lomas de Chapultepec
Mexico DF CP 11000
Directors and executive officers as a group (7 people)...... 57,960,000(7) 69.9%
</TABLE>
- ---------------
* Less than 1%.
(1) Includes 28.0 million shares owned beneficially and of record by Linsang, a
limited liability company controlled by Mr. Li. Excludes 111,375 shares
issuable upon exercise of Warrants included as part of Units purchased by
Linsang in the Offering.
(2) Such shares are included in the shares shown as beneficially owned by Kwok
L. Li. Excludes 111,375 shares issuable upon exercise of Warrants included
as part of Units purchased by Linsang in the Offering.
(3) Such shares are held by Mr. Wilkens and Sandra L. Wilkens in joint tenancy.
(4) Consists of shares subject to stock options granted under the Plan that are
exercisable within 60 days of the date of this Offering.
(5) Excludes stock owned by Orient Star, a wholly owned subsidiary of Carso.
Carso is a controlling shareholder of Prodigy and Mr. Salameh is President
and Chief Executive Officer of Prodigy. Mr. Eduardo Valdes Acra, as
attorney-in-fact, exercises sole voting and dispositive powers over the
holdings of Orient Star.
(6) See notes 1 through 5 above.
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<PAGE> 90
DESCRIPTION OF CERTAIN INDEBTEDNESS
The following is a summary of the material terms of certain indebtedness of
the Company.
In connection with the Company's agreement with Ericsson, Ericsson provided
a $5.0 million credit facility to the Company. See "Business -- Suppliers". Such
credit facility is evidenced by a Secured Promissory Note and Agreement dated
April 30, 1998, providing for interest at the rate of 11% per annum on the
outstanding balance thereunder, payable monthly in arrears on the first business
day of each calendar month commencing on June 1, 1998. The Secured Promissory
Note and Agreement provided that all principal and accrued and unpaid interest
under such Secured Promissory Note and Agreement would become due and payable in
full upon the earlier of (i) the date the Company sells any of its equity
securities or debt instruments or securities (other than issuances of equities
securities to officers, directors, employees, or consultants in the ordinary
course of business) in an aggregate amount equal to or greater than the then
outstanding principal amount thereunder, and (ii) October 30, 1998. Thus, all
outstanding principal and accrued and unpaid interest under such Secured
Promissory Note and Agreement became due upon consummation of the Unit Offering.
Such Secured Promissory Note and Agreement was secured by a security interest in
the Company's Yurie ATM switches (with certain exceptions), Ericsson power
equipment, and concrete shelters. As of June 30, 1998, the outstanding principal
balance due under such Secured Promissory Note and Agreement was $1.5 million.
Such indebtedness was repaid with the proceeds of the Unit Offering.
The Company is indebted to Linsang, a stockholder of the Company controlled
by the Company's Chairman of the Board and Chief Technical Officer, Kwok L. Li,
for an aggregate of $11.0 million in principal, plus accrued interest, as a
result of advances made by Linsang to the Company. See "Management -- Certain
Relationships and Related Transactions." Such indebtedness, initially
represented by demand notes bearing annual interest of 9.75% and maturing on the
earlier of written demand or December 1, 2002, was exchanged for 11,000 Units in
connection with the Unit Offering.
As of June 30, 1998, the Company had outstanding total future commitments
relating to noncancelable capital and operating leases of $21.5 million and $2.3
million, respectively. Operating leases primarily relate to leases of the NOCs
and the Company's corporate offices. Capital leases primarily relate to Network
equipment and require payments on a monthly basis over periods ranging from 24
to 48 months, with implicit interest rates of 9.0% to 12.0%. As of June 30, 1998
the Company was required to make minimum capital and operating lease payments of
$5.5 million, $9.6 million, $7.2 million, $1.0 million, $0.3 million and $0.2
million in the last six months of 1998, 1999, 2000, 2001, 2002 and 2003,
respectively.
On July 24, 1998, the Company offered and sold 261,000 Units to the Initial
Purchaser pursuant to the Unit Offering, of which 250,000 Units were resold to
"qualified institutional buyers" (as defined in Rule 144A under the Securities
Act) and 11,000 Units to Linsang. As a result, the Company incurred $261.0
million of Senior Debt.
DESCRIPTION OF CAPITAL STOCK
GENERAL
The authorized capital stock of the Company presently consists of 150.0
million shares of Common Stock and 25.0 million shares of Preferred Stock, $.001
par value per share ("Preferred Stock"). At September 15, 1998, there were 82.8
million outstanding shares of Common Stock and no shares of Preferred Stock
outstanding.
The following are summaries of the terms of the Common Stock and the
Preferred Stock. Such summaries do not purport to be complete and are subject in
all respects to the Certificate of Incorporation and By-laws of the Company.
COMMON STOCK
The holders of Common Stock are entitled to receive dividends when and as
declared by the Board of Directors of the Company out of funds legally available
therefor. See "Risk -- Factors Dividend Policy."
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<PAGE> 91
The holders of Common Stock are entitled to one vote for each share on all
matters voted upon by stockholders, including the election of directors. Shares
of Common Stock do not have cumulative voting rights, which means that the
holders of more than 50% of such shares voting for the election of directors can
elect 100% of the directors if they choose to do so and, in such event, the
holders of the remaining shares so voting will not be able to elect any
directors. See "Risk Factors -- Control by Principal Stockholders and
Management; Transactions with Related Parties." Holders of Common Stock do not
have any conversion, redemption or preemptive rights. In the event of the
dissolution, liquidation or winding up of the Company, holders of Common Stock
will be entitled to share ratably in any assets remaining after the satisfaction
in full of the prior rights of creditors, including holders of the Company's
indebtedness, and the liquidation preference of any Preferred Stock then
outstanding.
PREFERRED STOCK
Under Delaware law and the Company's Certificate of Incorporation, the
Company's Board of Directors has authority to issue, without further action by
stockholders, one or more series of Preferred Stock, and to determine at the
time of issuance of each such series the rights and preferences thereof
(including dividend rate, liquidation priority, benefit of a sinking fund,
redemption and conversion and voting rights, if any). The issuance of Preferred
Stock, while providing flexibility in connection with possible acquisitions and
other corporate purposes, could, among other things, adversely affect the voting
power or other rights of the holders of Common Stock.
Holders of the Preferred Stock would be entitled to receive dividends, as
specifically provided with respect to each series, prior to the payment or
declaration of any dividends for the Common Stock.
CERTAIN BY-LAW PROVISIONS
The Company's By-laws provide additional notice requirements for
stockholder nominations of candidates for election to the Board of Directors and
proposals for other business that may be properly brought before a meeting of
stockholders.
DESCRIPTION OF THE NOTES
GENERAL
The Original Notes were issued, and the Exchange Notes are issuable, under
the Indenture dated as of July 24, 1998, between the Company and Bank of
Montreal Trust Company, as trustee (the "Trustee"), a copy of which has been
filed as an exhibit to the Registration Statement. The form and terms of the
Exchange Notes will be identical in all material respects to the form and terms
of the Original Notes, except that the Exchange Notes will have been registered
under the Securities Act and, therefore, will not bear legends restricting
transfer thereof. The Exchange Notes and the Original Notes are deemed the same
class of notes under the Indenture and are both entitled to the benefits
thereof. Whenever particular sections or defined terms of the Indenture not
otherwise defined herein are referred to, such sections or defined terms are
incorporated herein by reference.
The following summary of certain provisions of the Indenture, the Notes and
the Escrow and Disbursement Agreement does not purport to be complete and is
subject to, and is qualified in its entirety by reference to, all the provisions
of the Indenture, including the definitions of certain terms therein and those
terms made a part thereof by the Trust Indenture Act of 1939, as amended, and
the Escrow Agreement. Capitalized terms used herein and not otherwise defined
have the meanings set forth in the section "Certain Definitions."
The Indenture provides for the issuance of up to $50.0 million aggregate
principal amount of additional Notes having identical terms and conditions to
the Notes offered hereby (the "Additional Notes"), subject to compliance with
the covenants contained in the Indenture. Any Additional Notes will be part of
the same issue as the Notes offered hereby and will vote on all matters with the
Notes offered hereby.
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<PAGE> 92
Principal of, premium, if any, and interest on the Notes is payable, and
the Notes may be exchanged or transferred, at the office or agency of the
Company in the Borough of Manhattan, The City of New York (which initially shall
be the corporate trust office of the Trustee, at 88 Pine Street, 19th Floor, New
York, New York 10005), except that, at the option of the Company, payment of
interest may be made by check mailed to the registered holders of the Notes at
their registered addresses.
The Notes will be issued only in fully registered form, without coupons, in
denominations of $1,000 and any integral multiple of $1,000. No service charge
will be made for any registration of transfer or exchange of Notes, but the
Company may require payment of a sum sufficient to cover any transfer tax or
other similar governmental charge payable in connection therewith.
TERMS OF THE NOTES
The Original Notes are and the Exchange Notes will be senior obligations of
the Company and will mature on July 15, 2008. Each Note will bear interest at a
rate per annum shown on the front cover of this Prospectus from July 24, 1998,
or from the most recent date to which interest has been paid or provided for,
payable semiannually to Holders of record at the close of business on the
January 1 or July 1 immediately preceding the interest payment date on January
15 and July 15 of each year, commencing January 15, 1999.
DISBURSEMENT OF FUNDS; ESCROW ACCOUNT
The Company has deposited $56.8 million in Temporary Cash Investments, an
amount that, together with the interest received thereon, is sufficient to pay
when due the first four semi-annual interest payments on the Notes. Such amounts
will be deposited in an escrow account (the "Escrow Account") held by the Escrow
Agent for the benefit of the Trustee under the Indenture in accordance with the
Escrow and Disbursement Agreement. The Company will enter into the Escrow and
Disbursement Agreement, which will provide, among other things, that funds may
be disbursed from the Escrow Account only to pay interest on the Notes (or, if a
portion of the Notes has been retired by the Company, funds representing the
interest payment on the retired Notes may be paid to the Company). Pending such
disbursement, the Company will cause all funds contained in the Escrow Account
to be invested in Temporary Cash Investments. Interest earned on these Temporary
Cash Investments will be added to the Escrow Account.
Under the Escrow and Disbursement Agreement, the Company will grant to the
Trustee, for the benefit of the holders, a first priority and exclusive security
interest in the Escrow Account (the "Escrow Collateral"). The Escrow and
Disbursement Agreement will provide that the Trustee may foreclose on the Escrow
Collateral upon acceleration of the maturity of the Notes. Under the terms of
the Indenture, the proceeds of the Escrow Collateral will be applied, first, to
amounts owing to the Escrow Agent in respect of fees and expenses of the Escrow
Agent, and second, to the obligations of the Company to the holders under the
Notes and the Indenture. The ability of holders to realize upon the Escrow
Collateral may be subject to certain bankruptcy law limitations in the event of
the bankruptcy of the Company.
Upon payment in full of the first four scheduled semi-annual payments on
the Notes, if no Default or Event of Default has occurred and is continuing, the
Escrow Collateral, if any, then remaining will be released to the Company.
OPTIONAL REDEMPTION
Except as set forth in the following paragraph, the Notes will not be
redeemable at the option of the Company prior to July 15, 2003. On or after such
date, the Notes will be redeemable at the option of the Company, in whole or in
part, on not less than 30 nor more than 60 days prior notice, at the following
redemption prices (expressed as percentages of principal amount), plus accrued
and unpaid interest and liquidated damages (if any) to the redemption date
(subject to the right of holders of record on the relevant
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record date to receive interest due on the relevant interest payment date), if
redeemed during the 12-month period commencing on July 15 of the years set forth
below:
<TABLE>
<CAPTION>
REDEMPTION
YEAR PRICE
---- ----------
<S> <C>
2003........................................................ 105.875%
2004........................................................ 103.917%
2005........................................................ 101.958%
2006 and thereafter......................................... 100.000%
</TABLE>
In addition, at any time and from time to time prior to July 15, 2001, the
Company may redeem up to a maximum of 35% of the original aggregate principal
amount of the Notes (calculated giving effect to any issuance of Additional
Notes) with the Net Cash Proceeds of one or more Equity Offerings by the
Company, at a redemption price equal to 111.75% of the principal amount thereof,
plus accrued and unpaid interest and liquidated damages, if any, to date of
redemption (subject to the right of holders of record on the relevant record
date to receive interest due on the relevant interest payment date); provided,
however, that at least 65% of the original aggregate principal amount of the
Notes remains outstanding immediately after each such redemption (calculated
giving effect to any issuance of Additional Notes). Any such redemption shall be
made within 60 days of such Equity Offering upon not less than 30 nor more than
60 days notice mailed to each holder of Notes being redeemed and otherwise in
accordance with the procedures set forth in the Indenture.
SELECTION
In the case of any partial redemption, selection of the Notes for
redemption will be made by the Trustee on a pro rata basis, by lot or by such
other method as the Trustee in its sole discretion shall deem to be fair and
appropriate, although no Note of $1,000 in original principal amount or less
will be redeemed in part. If any Note is to be redeemed in part only, the notice
of redemption relating to such Note shall state the portion of the principal
amount thereof to be redeemed. A new Note in principal amount equal to the
unredeemed portion thereof will be issued in the name of the Holder thereof upon
cancellation of the original Note.
RANKING
The indebtedness evidenced by the Notes will be unsecured Senior
Indebtedness of the Company, will rank pari passu in right of payment with all
existing and future Senior Indebtedness of the Company and will be senior in
right of payment to all existing and future Subordinated Obligations of the
Company. The Notes will also be effectively subordinated to any Secured
Indebtedness of the Company and its subsidiaries to the extent of the value of
the assets securing such Indebtedness.
At June 30, 1998, after giving pro forma effect to the Unit Offering and
the application of the proceeds therefrom, the Company would have had $21.2
million of Indebtedness outstanding (other than the Notes), all of which would
have been Senior Indebtedness and all of which would have been Secured
Indebtedness. The Company currently does not have any Subsidiaries.
Although the Indenture contains limitations on the amount of additional
Indebtedness that the Company may incur, under certain circumstances the amount
of such Indebtedness could be substantial and, in any case, such Indebtedness
may be Senior Indebtedness. See "-- Certain Covenants Limitation on
Indebtedness".
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CHANGE OF CONTROL
Upon the occurrence of any of the following events (each a "Change of
Control"), each Holder will have the right to require the Company to repurchase
all or any part of such Holder's Notes at a purchase price in cash equal to 101%
of the principal amount thereof plus accrued and unpaid interest and liquidated
damages, if any, to the date of repurchase (subject to the right of Holders of
record on the relevant record date to receive interest due on the relevant
interest payment date); provided, however, that notwithstanding the occurrence
of a Change of Control, the Company shall not be obligated to repurchase the
Notes pursuant to this section in the event that it has exercised its right to
redeem all the Notes under the terms of the section titled "Optional
Redemption":
(i) prior to the first public offering of common stock of the Company,
the Permitted Holders cease to be the "beneficial owner" (as defined in
Rules 13d-3 and 13d-5 under the Exchange Act), directly or indirectly, of a
majority in the aggregate of the total voting power of the Voting Stock of
the Company, whether as a result of issuance of securities of the Company,
any merger, consolidation, liquidation or dissolution of the Company, any
direct or indirect transfer of securities by any Permitted Holder or
otherwise (for purposes of this clause (i) and clause (ii) below, the
Permitted Holders shall be deemed to beneficially own any Voting Stock of
an entity (the "specified entity") held by any other entity (the "parent
entity") so long as the Permitted Holders beneficially own (as so defined),
directly or indirectly, in the aggregate a majority of the voting power of
the Voting Stock of the parent entity);
(ii) on the date of or after the first public offering of common stock
of the Company referred in clause (i), (A) any "person" (as such term is
used in Sections 13(d) and 14(d) of the Exchange Act), other than one or
more Permitted Holders, is or becomes the beneficial owner (as defined in
clause (i) above, except that for purposes of this clause (ii) such person
shall be deemed to have "beneficial ownership" of all shares that any such
person has the right to acquire, whether such right is exercisable
immediately or only after the passage of time), directly or indirectly, of
more than 35% of the total voting power of the Voting Stock of the Company
and (B) the Permitted Holders "beneficially own" (as defined in clause (i)
above), directly or indirectly, in the aggregate a lesser percentage of the
total voting power of the Voting Stock of the Company than such other
person and do not have the right or ability by voting power, contract or
otherwise to elect or designate for election a majority of the Board of
Directors (for the purposes of this clause (ii), such other person shall be
deemed to beneficially own any Voting Stock of a specified entity held by a
parent entity, if such other person is the beneficial owner (as defined in
this clause (ii)), directly or indirectly, of more than 35% of the voting
power of the Voting Stock of such parent entity and the Permitted Holders
"beneficially own" (as defined in clause (i) above), directly or
indirectly, in the aggregate a lesser percentage of the voting power of the
Voting Stock of such parent entity and do not have the right or ability by
voting power, contract or otherwise to elect or designate for election a
majority of the board of directors of such parent entity);
(iii) during any period of two consecutive years, individuals who at
the beginning of such period constituted the Board of Directors (together
with any new directors whose election by such Board of Directors or whose
nomination for election by the stockholders of the Company was approved by
a vote of 66 2/3% of the directors of the Company then still in office who
were either directors at the beginning of such period or whose election or
nomination for election was previously so approved) cease for any reason to
constitute a majority of the Board of Directors of the Company then in
office;
(iv) the adoption of a plan relating to the liquidation or dissolution
of the Company; or
(v) the merger or consolidation of the Company with or into another
Person or the merger of another Person with or into the Company, or the
sale of all or substantially all the assets of the Company to another
Person (other than a Person that is controlled by the Permitted Holders),
and, in the case of any such merger or consolidation, the securities of the
Company that are outstanding immediately prior to such transaction and
which represent 100% of the aggregate voting power of the Voting Stock of
the Company are changed into or exchanged for cash, securities or property,
unless pursuant to such transaction such securities are changed into or
exchanged for, in addition to any other consideration,
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securities of the surviving Person or transferee that represent immediately
after such transaction, at least a majority of the aggregate voting power
of the Voting Stock of the surviving Person or transferee.
Within 30 days following any Change of Control, the Company shall mail a
notice to each Holder with a copy to the Trustee (the "Change of Control Offer")
stating: (1) that a Change of Control has occurred and that such Holder has the
right to require the Company to purchase such Holder's Notes at a purchase price
in cash equal to 101% of the principal amount thereof, plus accrued and unpaid
interest and liquidated damages, if any, to the date of repurchase (subject to
the right of Holders of record on the relevant record date to receive interest
on the relevant interest payment date); (2) the circumstances and relevant facts
and financial information regarding such Change of Control; (3) the repurchase
date (which shall be no earlier than 30 days nor later than 60 days from the
date such notice is mailed); and (4) the instructions determined by the Company,
consistent with this covenant, that a Holder must follow in order to have its
Notes purchased.
The Company will not be required to make a Change of Control Offer upon a
Change of Control if a third party makes the Change of Control Offer in the
manner, at the times and otherwise in compliance with the requirements set forth
in the Indenture applicable to a Change of Control Offer made by the Company and
purchases all Notes validly tendered and not withdrawn under such Change of
Control Offer.
The Company will comply, to the extent applicable, with the requirements of
Section 14(e) of the Exchange Act and any other securities laws or regulations
in connection with the repurchase of Notes pursuant to this covenant. To the
extent that the provisions of any securities laws or regulations conflict with
provisions of this covenant, the Company will comply with the applicable
securities laws and regulations and will not be deemed to have breached its
obligations under this paragraph by virtue thereof.
The Change of Control purchase feature is a result of negotiations between
the Company and the Initial Purchaser. Management has no present intention to
engage in a transaction involving a Change of Control, although it is possible
that the Company would decide to do so in the future. Subject to the limitations
discussed below, the Company could, in the future, enter into certain
transactions, including acquisitions, refinancings or other recapitalizations,
that would not constitute a Change of Control under the Indenture, but that
could increase the amount of indebtedness outstanding at such time or otherwise
affect the Company's capital structure or credit ratings. Restrictions on the
ability of the Company to incur additional Indebtedness are contained in the
covenants described under "Certain Covenants -- Limitation on Indebtedness",
"Certain Covenants -- Limitation on Liens" and "Certain Covenants -- Limitation
on Sale/Leaseback Transactions". Such restrictions can only be waived with the
consent of the holders of a majority in principal amount of the Notes then
outstanding. Except for the limitations contained in such covenants, however,
the Indenture will not contain any covenants or provisions that may afford
holders of the Notes protection in the event of a highly leveraged transaction.
Future Senior Indebtedness of the Company may contain prohibitions of
certain events which would constitute a Change of Control or require such Senior
Indebtedness to be repurchased upon a Change of Control. Moreover, the exercise
by the Holders of their right to require the Company to repurchase the Notes
could cause a default under such Senior Indebtedness, even if the Change of
Control itself does not, due to the financial effect of such repurchase on the
Company. Finally, the Company's ability to pay cash to the Holders upon a
repurchase may be limited by the Company's then existing financial resources.
There can be no assurance that sufficient funds will be available when necessary
to make any required repurchases. The provisions under the Indenture relative to
the Company's obligation to make an offer to repurchase the Notes as a result of
a Change of Control may be waived or modified with the written consent of the
holders of a majority in principal amount of the Notes.
CERTAIN COVENANTS
The Indenture contains covenants including, among others, the following:
Limitation on Indebtedness. (a) The Company will not, and will not permit
any Restricted Subsidiary to, Incur, directly or indirectly, any Indebtedness;
provided, however, that the Company may Incur Indebtedness if on the date of
such Incurrence and after giving effect thereto the Debt to Annualized
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<PAGE> 96
Operating Cash Flow Ratio would be less than or equal to 6.0:1.0 if such
Indebtedness is Incurred prior to July 15, 2001 and less than or equal to
5.5:1.0 if such Indebtedness is Incurred on or after such date.
(b) Notwithstanding the foregoing paragraph (a), the Company and its
Restricted Subsidiaries may Incur the following Indebtedness:
(i) Bank Indebtedness in an aggregate principal amount not to exceed
$75.0 million less the aggregate amount of all repayments of principal
applied to permanently reduce any such Indebtedness;
(ii) Indebtedness of the Company owed to and held by any Wholly Owned
Subsidiary or Indebtedness of a Restricted Subsidiary owed to and held by
the Company or any Wholly Owned Subsidiary; provided, however, that (i) any
subsequent issuance or transfer of any Capital Stock or any other event
that results in any such Wholly Owned Subsidiary ceasing to be a Wholly
Owned Subsidiary or any subsequent transfer of any such Indebtedness
(except to the Company or a Wholly Owned Subsidiary) shall be deemed, in
each case, to constitute the Incurrence of such Indebtedness by the issuer
thereof and (ii) if the Company is the obligor on such Indebtedness, such
Indebtedness is expressly subordinated to the prior payment in full in cash
of all obligations with respect to the Notes;
(iii) Indebtedness (A) represented by the Notes (not including any
Additional Notes), (B) outstanding on the Closing Date (other than the
Indebtedness described in clauses (i) and (ii) above), (C) consisting of
Refinancing Indebtedness Incurred in respect of any Indebtedness described
in this clause (iii) (including Indebtedness Refinancing) or the foregoing
paragraph (a), (D) consisting of Guarantees of any Indebtedness permitted
under clauses (i) and (ii) of this paragraph (b) and (E) consisting of any
Guarantees of the Notes;
(iv) (A) Indebtedness of a Restricted Subsidiary Incurred and
outstanding on or prior to the date on which such Restricted Subsidiary was
acquired by the Company (other than Indebtedness Incurred as consideration
in, or to provide all or any portion of the funds or credit support
utilized to consummate, the transaction or series of related transactions
pursuant to which such Restricted Subsidiary became a Subsidiary of or was
otherwise acquired by the Company); provided, however, that on the date
that such Restricted Subsidiary is acquired by the Company, the Company
would have been able to Incur $1.00 of additional Indebtedness pursuant to
the foregoing paragraph (a) after giving effect to the Incurrence of such
Indebtedness pursuant to this clause (iv) and (B) Refinancing Indebtedness
Incurred by a Restricted Subsidiary in respect of Indebtedness Incurred by
such Restricted Subsidiary pursuant to this clause (iv);
(v) Indebtedness (A) in respect of performance bonds, bankers'
acceptances, letters of credit and surety or appeal bonds provided by the
Company and the Restricted Subsidiaries in the ordinary course of their
business, and (B) under Hedging Obligations entered into for bona fide
hedging purposes of the Company in the ordinary course of business;
provided, however, that such Hedging Obligations do not increase the
Indebtedness of the Company outstanding at any time other than as a result
of fluctuations in interest rates or currency exchange rates or by reason
of fees, indemnities and compensation payable thereunder;
(vi) Purchase Money Indebtedness, provided that the amount of such
Purchase Money Indebtedness does not exceed the lesser of 80% of (a) the
Fair Market Value of or (b) the cost of the construction, installation,
acquisition, lease, development or improvement of, the applicable
Telecommunications Assets;
(vii) Contribution Indebtedness; or
(viii) Indebtedness (other than Indebtedness permitted to be Incurred
pursuant to the foregoing paragraph (a) or any other clause of this
paragraph (b)) in an aggregate principal amount on the date of Incurrence
that, when added to all other Indebtedness Incurred pursuant to this clause
(viii) and then outstanding, shall not exceed $40.0 million.
(c) Notwithstanding the foregoing, the Company may not Incur any
Indebtedness pursuant to paragraph (b) above if the proceeds thereof are used,
directly or indirectly, to repay, prepay, redeem, defease,
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retire, refund or refinance any Subordinated Obligations unless such
Indebtedness will be subordinated to the Notes to at least the same extent as
such Subordinated Obligations.
(d) Notwithstanding any other provision of this covenant, the maximum
amount of Indebtedness that the Company or any Restricted Subsidiary may Incur
pursuant to this covenant shall not be deemed to be exceeded solely as a result
of fluctuations in the exchange rates of currencies. For purposes of determining
the outstanding principal amount of any particular Indebtedness Incurred
pursuant to this covenant, (i) Indebtedness permitted by this covenant need not
be permitted solely by reference to one provision permitting such Indebtedness
but may be permitted in part by one such provision and in part by one or more
other provisions of this covenant permitting such Indebtedness and (ii) in the
event that Indebtedness meets the criteria of more than one of the types of
Indebtedness described in this covenant, the Company, in its sole discretion,
shall classify such Indebtedness and only be required to include the amount of
such Indebtedness in one of such clauses. Once so classified, such Indebtedness
shall retain such classification until repaid.
Limitation on Restricted Payments. (a) The Company will not, and will not
permit any Restricted Subsidiary, directly or indirectly, to (i) declare or pay
any dividend or make any distribution on or in respect of its Capital Stock
(including any payment in connection with any merger or consolidation involving
the Company) or similar payment to the direct or indirect holders of its Capital
Stock except dividends or distributions payable solely in its Capital Stock
(other than Disqualified Stock) and except dividends or distributions payable to
the Company or another Restricted Subsidiary (and, if such Restricted Subsidiary
has stockholders other than the Company or other Restricted Subsidiaries, to its
other stockholders on a pro rata basis), (ii) purchase, redeem, retire or
otherwise acquire for value any Capital Stock of the Company or any Restricted
Subsidiary held by Persons other than the Company or another Restricted
Subsidiary, (iii) purchase, repurchase, redeem, defease or otherwise acquire or
retire for value, prior to scheduled maturity, scheduled repayment or scheduled
sinking fund payment any Subordinated Obligations (other than the purchase,
repurchase or other acquisition of Subordinated Obligations purchased in
anticipation of satisfying a sinking fund obligation, principal installment or
final maturity, in each case due within one year of the date of acquisition) or
(iv) make any Investment (other than a Permitted Investment) in any Person (any
such dividend, distribution, purchase, redemption, repurchase, defeasance, other
acquisition, retirement or Investment being herein referred to as a "Restricted
Payment") if at the time the Company or such Restricted Subsidiary makes such
Restricted Payment: (1) a Default will have occurred and be continuing (or would
result therefrom); (2) the Company could not Incur at least $1.00 of additional
Indebtedness under paragraph (a) of the covenant described under "-- Limitation
on Indebtedness"; or (3) the aggregate amount of such Restricted Payment and all
other Restricted Payments (the amount so expended, if other than in cash, to be
determined in good faith by the Board of Directors, whose determination will be
conclusive and evidenced by a resolution of the Board of Directors) declared or
made subsequent to the Closing Date would exceed the sum of: (A)(i) 100% of
Consolidated Operating Cash Flow accrued during the period (treated as one
accounting period) from the beginning of the fiscal quarter immediately
following the fiscal quarter during which the Closing Date occurs to the end of
the most recent fiscal quarter ending at least 45 days prior to the date of such
Restricted Payment (or, in case such Consolidated Operating Cash Flow during
such period is a deficit, minus 100% of such deficit), minus (ii) 150% of
Consolidated Interest Expense accrued during the period (treated as one
accounting period) from the beginning of the fiscal quarter immediately
following the fiscal quarter during which the Closing Date occurs to the end of
the most recent fiscal quarter ending at least 45 days prior to the date of such
Restricted Payment; plus, (B) the aggregate Net Cash Proceeds received by the
Company from the issue or sale of its Capital Stock (other than Disqualified
Stock) subsequent to the Closing Date (other than an issuance or sale to (x) a
Subsidiary of the Company or (y) an employee stock ownership plan or other trust
established by the Company or any of its Subsidiaries); plus, (C) the amount by
which Indebtedness of the Company or its Restricted Subsidiaries is reduced on
the Company's balance sheet upon the conversion or exchange (other than by a
Subsidiary of the Company) subsequent to the Closing Date of any Indebtedness of
the Company or its Restricted Subsidiaries issued after the Closing Date which
is convertible or exchangeable for Capital Stock (other than Disqualified Stock)
of the Company (less the amount of any cash or the fair market value of other
property distributed by the Company or any Restricted Subsidiary upon such
conversion or exchange); plus, (D) the amount equal to the net reduction in
Investments in Unrestricted Subsidiaries resulting from (i) payments of
dividends, repayments of the
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principal of loans or advances or other transfers of assets to the Company or
any Restricted Subsidiary from Unrestricted Subsidiaries or (ii) the
redesignation of Unrestricted Subsidiaries as Restricted Subsidiaries (valued in
each case as provided in the definition of "Investment") not to exceed, in the
case of any Unrestricted Subsidiary, the amount of Investments previously made
by the Company or any Restricted Subsidiary in such Unrestricted Subsidiary,
which amount was included in the calculation of the amount of Restricted
Payments; and less, (E) the aggregate principal amount of any outstanding
Contribution Indebtedness or, if less, the Cash Contribution Amount.
(b) The provisions of the foregoing paragraph (a) will not prohibit: (i)
any purchase, repurchase, retirement or other acquisition or retirement for
value of Capital Stock of the Company made by exchange for, or out of the
proceeds of the substantially concurrent sale of, Capital Stock of the Company
(other than Disqualified Stock and other than Capital Stock issued or sold to a
Subsidiary of the Company or an employee stock ownership plan or other trust
established by the Company or any of its Subsidiaries); provided, however, that
such purchase, repurchase, retirement or other acquisition or retirement for
value will be excluded in the calculation of the amount of Restricted Payments;
(ii) any purchase, repurchase, redemption, defeasance or other acquisition or
retirement for value of Subordinated Obligations of the Company made by exchange
for, or out of the proceeds of the substantially concurrent sale of,
Indebtedness of the Company that is permitted to be Incurred pursuant to
paragraph (b) of the covenant described under "-- Limitation on Indebtedness" or
Capital Stock of the Company (other than Disqualified Stock and other than
Capital Stock issued or sold to a Subsidiary of the Company or an employee stock
ownership plan or other trust established by the Company or any of its
Subsidiaries); provided, however, that such purchase, repurchase, redemption,
defeasance or other acquisition or retirement for value will be excluded in the
calculation of the amount of Restricted Payments; (iii) any purchase or
redemption of Subordinated Obligations from Net Available Cash to the extent
permitted by the covenant described under "-- Limitation on Sales of Assets and
Subsidiary Stock"; provided, however, that such purchase or redemption will be
included in the calculation of the amount of Restricted Payments; (iv) dividends
paid within 60 days after the date of declaration thereof if at such date of
declaration such dividend would have complied with this covenant; provided,
however, that such dividend will be included in the calculation of the amount of
Restricted Payments; or (v) the repurchase or other acquisition of shares of, or
options to purchase shares of, common stock of the Company or any of its
Subsidiaries from employees, former employees, directors or former directors of
the Company or any of its Subsidiaries (or permitted transferees of such
employees, former employees, directors or former directors), pursuant to the
terms of agreements (including employment agreements) or plans (or amendments
thereto) approved by the Board of Directors under which such individuals
purchase or sell or are granted the option to purchase or sell, shares of such
common stock; provided, however, that the aggregate amount of such repurchases
shall not exceed $1.0 million in any calendar year and $3.0 million in the
aggregate; provided further, that such repurchases and other acquisitions shall
be included in the calculation of the amount of Restricted Payments.
Limitation on Restrictions on Distributions from Restricted
Subsidiaries. The Company will not, and will not permit any Restricted
Subsidiary to, create or otherwise cause or permit to exist or become effective
any consensual encumbrance or restriction on the ability of any Restricted
Subsidiary to (i) pay dividends or make any other distributions on its Capital
Stock or pay any Indebtedness or other obligations owed to the Company, (ii)
make any loans or advances to the Company or (iii) transfer any of its property
or assets to the Company, except: (1) any encumbrance or restriction pursuant to
(A) an agreement in effect at or entered into on the Closing Date or (B) an
agreement entered into in connection with the Incurrence of Indebtedness
permitted under clause (b)(i) or (b)(vi) of the covenant described under
"-- Limitation on Indebtedness", provided that the chief financial officer of
the Company has determined in good faith that any restriction incurred pursuant
to this clause (B) is customary for similar Incurrences of Indebtedness; (2) any
encumbrance or restriction with respect to a Restricted Subsidiary pursuant to
an agreement relating to any Indebtedness Incurred by such Restricted Subsidiary
prior to the date on which such Restricted Subsidiary was acquired by the
Company (other than Indebtedness Incurred as consideration in, in contemplation
of, or to provide all or any portion of the funds or credit support utilized to
consummate the transaction or series of related transactions pursuant to which
such Restricted Subsidiary became a Restricted Subsidiary or was otherwise
acquired by the Company) and outstanding on such date; (3) any encumbrance or
restriction
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pursuant to an agreement effecting a Refinancing of Indebtedness Incurred
pursuant to an agreement referred to in clause (1) or (2) of this covenant or
this clause (3) or contained in any amendment to an agreement referred to in
clause (1) or (2) of this covenant or this clause (3); provided, however, that
the encumbrances and restrictions contained in any such refinancing agreement or
amendment are no less favorable to the Noteholders than the encumbrances and
restrictions contained in such predecessor agreements; (4) in the case of clause
(iii), any encumbrance or restriction (A) that restricts in a customary manner
the subletting, assignment or transfer of any property or asset that is subject
to a lease, license or similar contract, or (B) contained in security agreements
securing Indebtedness of a Restricted Subsidiary to the extent such encumbrance
or restriction restricts the transfer of the property subject to such security
agreements; and (5) with respect to a Restricted Subsidiary, any restriction
imposed pursuant to an agreement entered into for the sale or disposition of all
or substantially all the Capital Stock or assets of such Restricted Subsidiary
pending the closing of such sale or disposition.
Limitation on Sales of Assets and Subsidiary Stock. (a) The Company will
not, and will not permit any Restricted Subsidiary to, make any Asset
Disposition unless (i) the Company or such Restricted Subsidiary receives
consideration (including by way of relief from, or by any other Person assuming
sole responsibility for, any liabilities, contingent or otherwise) at the time
of such Asset Disposition at least equal to the Fair Market Value of the shares
and assets subject to such Asset Disposition, (ii) at least 75% of the
consideration thereof received by the Company or such Restricted Subsidiary is
in the form of cash or cash equivalents and (iii) an amount equal to 100% of the
Net Available Cash from such Asset Disposition is applied by the Company (or
such Restricted Subsidiary, as the case may be) (A) first, to the extent the
Company elects (or is required by the terms of any Bank Indebtedness) to (x)
reinvest in Telecommunications Assets (including by means of an Investment in
Telecommunications Assets by a Restricted Subsidiary with Net Available Cash
received by the Company or another Restricted Subsidiary) or (y) prepay, repay,
redeem or purchase Bank Indebtedness of the Company Incurred pursuant to clause
(b)(i) of the covenant described under "-- Limitation on Indebtedness", in each
case within 180 days after the later of the date of such Asset Disposition or
the receipt of such Net Available Cash; (B) second, to the extent of the balance
of such Net Available Cash after application in accordance with clause (A), to
make an Offer (as defined below) to purchase Notes pursuant to and subject to
the conditions set forth in section (b) of this covenant within 365 days after
the later of such Asset Disposition or the receipt of such Net Available Cash;
provided, however, that if the Company elects (or is required by the terms of
any other Senior Indebtedness), such Offer may be made ratably to purchase the
Notes and other Senior Indebtedness of the Company, and (C) third, to fund (to
the extent consistent with any other applicable provision in the Indenture) any
corporate purpose. Notwithstanding the foregoing provisions of this covenant,
the Company and the Restricted Subsidiaries will not be required to apply any
Net Available Cash in accordance with this covenant except to the extent that
the aggregate Net Available Cash from all Asset Dispositions that is not applied
in accordance with this covenant exceeds $5.0 million.
For the purposes of this covenant, the following are deemed to be cash: (x)
the assumption of Indebtedness of the Company (other than Disqualified Stock of
the Company) or any Restricted Subsidiary and the release of the Company or such
Restricted Subsidiary from all liability on such Indebtedness in connection with
such Asset Disposition and (y) securities received by the Company or any
Restricted Subsidiary from the transferee that are converted by the Company or
such Restricted Subsidiary into cash within 60 days of such receipt.
(b) In the event of an Asset Disposition that requires the purchase of
Notes (and other Senior Indebtedness) pursuant to clause (a)(iii)(B) of this
covenant, the Company will be required to purchase Notes (and other Senior
Indebtedness) tendered pursuant to an offer by the Company for the Notes (and
other Senior Indebtedness) (the "Offer") at a purchase price of 100% of their
principal amount plus accrued and unpaid interest and liquidated damages, if
any, to the date of purchase in accordance with the procedures (including
prorating in the event of oversubscription), set forth in the Indenture. If the
aggregate purchase price of Notes (and other Senior Indebtedness) tendered
pursuant to the Offer is less than the Net Available Cash allotted to the
purchase of the Notes (and other Senior Indebtedness), the Company may apply the
remaining Net Available Cash in accordance with clause (a)(iii)(C) of this
covenant. The Company will not be required to make an Offer for Notes (and other
Senior Indebtedness) pursuant to this covenant if the Net
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Available Cash available therefor (after application of the proceeds as provided
in clause (a)(iii)(A)) is less than $5.0 million for any particular Asset
Disposition (which lesser amount will be carried forward for purposes of
determining whether an Offer is required with respect to the Net Available Cash
from any subsequent Asset Disposition).
(c) The Company will comply, to the extent applicable, with the
requirements of Section 14(e) of the Exchange Act and any other securities laws
or regulations in connection with the repurchase of Notes pursuant to this
covenant. To the extent that the provisions of any securities laws or
regulations conflict with provisions of this covenant, the Company will comply
with the applicable securities laws and regulations and will not be deemed to
have breached its obligations under this covenant by virtue thereof.
Limitation on Transactions with Affiliates. (a) The Company will not, and
will not permit any Restricted Subsidiary to, directly or indirectly, enter into
or conduct any transaction (including the purchase, sale, lease or exchange of
any property or the rendering of any service) with any Affiliate of the Company
(an "Affiliate Transaction") unless such transaction is on terms (i) that are no
less favorable to the Company or such Restricted Subsidiary, as the case may be,
than those that could be obtained at the time of such transaction in
arm's-length dealings with a Person who is not such an Affiliate, (ii) that, in
the event such Affiliate Transaction involves an aggregate amount in excess of
$1.0 million, (1) are set forth in writing and (2) have been approved by a
majority of the members of the Board of Directors having no personal stake in
such Affiliate Transaction and (iii) that, in the event such Affiliate
Transaction involves an amount in excess of $20.0 million, have been determined
by a nationally recognized appraisal or investment banking firm to be fair, from
a financial standpoint, to the Company and its Restricted Subsidiaries.
(b) The provisions of the foregoing paragraph (a) will not prohibit (i) any
Restricted Payment permitted to be paid pursuant to the covenant described under
"-- Limitation on Restricted Payments", (ii) any issuance of securities, or
other payments, awards or grants in cash, securities or otherwise pursuant to,
or the funding of, employment arrangements, stock options and stock ownership
plans approved by the Board of Directors, (iii) the grant of stock options or
similar rights to employees and directors of the Company pursuant to plans
approved by the Board of Directors, (iv) loans or advances to employees in the
ordinary course of business in accordance with past practices of the Company,
but in any event not to exceed $2.0 million in the aggregate outstanding at any
one time, (v) the payment of reasonable fees to directors of the Company and its
Subsidiaries who are not employees of the Company or its Subsidiaries, (vi) any
transaction between the Company and a Wholly Owned Subsidiary or between Wholly
Owned Subsidiaries or (vii) any transaction pursuant to, and on the terms set
forth in, the Prodigy Agreement.
Limitation on the Sale or Issuance of Capital Stock of Restricted
Subsidiaries. The Company will not permit (a) any Restricted Subsidiary of the
Company to issue any Capital Stock except for (i) Capital Stock issued or sold
to, held by or transferred to the Company or a Wholly Owned Subsidiary, (ii)
Capital Stock issued by a Person prior to the time (A) such Person becomes a
Restricted Subsidiary of the Company, (B) such Person merges with or into a
Restricted Subsidiary of the Company or (C) a Restricted Subsidiary of the
Company merges with or into such Person; provided that such Capital Stock was
not issued or Incurred by such Person in anticipation of the type of transaction
contemplated by subclause (A), (B) or (C) (excluding for purposes of this
proviso, shares of Capital Stock issued in connection with customary accelerated
vesting provisions contained in option or similar plans or agreements which are
accelerated as a result of a change of control of such Person and which option
or similar plans or agreements were not adopted or implemented solely in
anticipation of or in connection with such transaction) or (b) any person (other
than the Company or a Wholly Owned Subsidiary) to acquire Capital Stock of any
Restricted Subsidiary of the Company from the Company or any Restricted
Subsidiary of the Company, except, in the case of each of clause (a) or (b), (1)
upon the acquisition of all the outstanding Capital Stock of such Restricted
Subsidiary in accordance with the covenant described under "-- Limitation on
Sales of Assets and Subsidiary Stock", (2) if, immediately after giving effect
to such issuance or sale, such Restricted Subsidiary would no longer constitute
a Restricted Subsidiary, and any Investment in such Person remaining after
giving effect to such issuance or sale would have been permitted to be made
pursuant to the covenant described under "-- Limitation on Restricted Payments"
if made on the date of such issuance or sale, and (3) if required, the issuance,
transfer, conveyance, sale or other disposition of directors' qualifying shares.
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Limitation on Liens. The Company will not, and will not permit any
Restricted Subsidiary to, directly or indirectly, Incur or permit to exist any
Lien of any nature whatsoever on any of its property or assets (including
Capital Stock of a Restricted Subsidiary), whether owned at the Closing Date or
thereafter acquired, other than Permitted Liens, without effectively providing
that the Notes shall be secured equally and ratably with (or prior to) the
obligations so secured for so long as such obligations are so secured; provided,
that if such obligations are expressly subordinated to the Notes or the
Subsidiary Guarantees the Lien securing such obligations will be subordinated
and junior to the Lien securing the Notes with the same relative priority as
such obligations have with respect to the Notes or the Subsidiary Guarantees.
Commission Reports. Notwithstanding that the Company may not be subject to
the reporting requirements of Section 13 or 15(d) of the Exchange Act the
Company will file with the Commission and provide the Trustee and Noteholders
and prospective Noteholders (upon request) within 15 days after it files them
with the Commission, copies of its annual report and the information, documents
and other reports that are specified in Sections 13 and 15(d) of the Exchange
Act. In addition, following a public offering of the common stock of the
Company, the Company shall furnish to the Trustee and the Noteholders, promptly
upon their becoming available, copies of the annual report to stockholders and
any other information provided by the Company to its public stockholders
generally. The Company also will comply with the other provisions of Section
314(a) of the TIA.
Future Subsidiary Guarantors. The Company will cause each Restricted
Subsidiary that Incurs Indebtedness to become a Subsidiary Guarantor, and
execute and deliver to the Trustee a supplemental indenture pursuant to which
such Restricted Subsidiary will Guarantee payment of the Notes. Each Subsidiary
Guarantee will be limited to an amount not to exceed the maximum amount that can
be Guaranteed by that Restricted Subsidiary without rendering the Subsidiary
Guarantee, as it relates to such Restricted Subsidiary, voidable under
applicable law relating to fraudulent conveyance or fraudulent transfer or
similar laws affecting the rights of creditors generally.
Limitation on Lines of Business. The Company will not, and will not permit
any Restricted Subsidiary to, engage in any business other than a
Telecommunications Business.
Limitation on Sale/Leaseback Transactions. The Company will not, and will
not permit any Restricted Subsidiary to, enter into any Sale/Leaseback
Transaction with respect to any property unless (a) the Company or such
Restricted Subsidiary would be entitled to (i) Incur Indebtedness in an amount
equal to the Attributable Debt with respect to such Sale/Leaseback Transaction
pursuant to the covenant described under "-- Limitation on Indebtedness" and
(ii) create a Lien on such property securing such Attributable Debt without
equally and ratably securing the Notes pursuant to the covenant described under
"-- Limitation on Liens", (b) the net proceeds received by the Company or such
Restricted Subsidiary in connection with such Sale/Leaseback Transaction are at
least equal to the fair market value (as determined in good faith by the Board
of Directors) of such property and (c) the transfer of such property is
permitted by, and the Company applies the proceeds of such transaction in
compliance with, the covenant described under "-- Limitation on Sale of Assets
and Subsidiary Stock".
MERGER AND CONSOLIDATION
The Company will not consolidate with or merge with or into, or convey,
transfer or lease all or substantially all its assets to, any Person, unless:
(i) the resulting, surviving or transferee Person (the "Successor Company") will
be a corporation organized and existing under the laws of the United States of
America, any State thereof or the District of Columbia and the Successor Company
(if not the Company) will expressly assume, by a supplemental indenture and
other appropriate documents, executed and delivered to the Trustee, in form
satisfactory to the Trustee, all the obligations of the Company under the Notes,
the Indenture and the Escrow and Disbursement Agreement; (ii) immediately after
giving effect to such transaction (and treating any Indebtedness which becomes
an obligation of the Successor Company or any Restricted Subsidiary as a result
of such transaction as having been Incurred by the Successor Company or such
Restricted Subsidiary at the time of such transaction), no Default shall have
occurred and be continuing; (iii) immediately after giving effect to such
transaction, the Successor Company would be able to Incur an
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additional $1.00 of Indebtedness under paragraph (a) of the covenant described
under "-- Certain Covenants -- Limitation on Indebtedness"; (iv) the Company
shall have delivered to the Trustee an Officers' Certificate and an Opinion of
Counsel, each stating that such consolidation, merger or transfer and such
supplemental indenture and other appropriate documents (if any) comply with the
Indenture and the Escrow and Disbursement Agreement; (v) the Company shall have
delivered to the Trustee an Opinion of Counsel to the effect that the Holders
will not recognize income, gain or loss for Federal income tax purposes as a
result of such transaction and will be subject to Federal income tax on the same
amounts, in the same manner and at the same times as would have been the case if
such transaction had not occurred; and (vi) the Company shall have delivered to
the Trustee an Opinion of Counsel (subject to customary exceptions) to the
effect that any Subsidiary Guarantee shall remain in full force and effect after
such transaction.
The Successor Company will succeed to, and be substituted for, and may
exercise every right and power of, the Company under the Indenture and the
Escrow and Disbursement Agreement, but the predecessor Company in the case of a
conveyance, transfer or lease of all or substantially all its assets will not be
released from the obligation to pay the principal of and interest on the Notes.
The Company will not permit any Subsidiary Guarantor to consolidate with or
merge with or into, or convey, transfer or lease, all or substantially all of
its assets to any Person unless: (i) the resulting, surviving or transferee
Person will be a corporation organized and existing under the laws of the United
States of America, any State thereof or the District of Columbia, and such
Person (if not a Subsidiary Guarantor) will expressly assume, by a supplemental
indenture, executed and delivered to the Trustee, in form satisfactory to the
Trustee, all the obligations of such Subsidiary Guarantor under its Subsidiary
Guarantee; (ii) immediately after giving effect to such transaction (and
treating any Indebtedness which becomes an obligation of the resulting,
surviving or transferee Person as a result of such transaction as having been
incurred by such Person at the time of such transaction), no Default shall have
occurred and be continuing; and (iii) the Company shall have delivered to the
Trustee an Officers' Certificate and an Opinion of Counsel, each stating that
such consolidation, merger or transfer and such supplemental indenture (if any)
comply with the Indenture.
Notwithstanding the foregoing, (a) any Restricted Subsidiary may
consolidate with, merge into or transfer all or part of its properties and
assets to the Company and (b) the Company may merge with an Affiliate
incorporated solely for the purpose of reincorporating the Company in another
jurisdiction to realize tax or other benefits.
DEFAULTS
An Event of Default is defined in the Indenture as (i) a default in any
payment of interest on any Note when due and payable, continued for 30 days,
(ii) a default in the payment of principal of any Note when due and payable at
its Stated Maturity, upon required redemption or repurchase, upon declaration or
otherwise, (iii) the failure by the Company to comply with its obligations under
the covenant described under "-- Merger and Consolidation", (iv) the failure by
the Company to comply for 30 days after notice with any of its obligations under
the covenants described under "-- Change of Control" or "-- Certain Covenants"
(in each case, other than a failure to purchase Notes) or any of its agreements
contained in the Escrow and Disbursement Agreement, (v) the failure by the
Company to comply for 60 days after notice with its other agreements contained
in the Notes or the Indenture, (vi) the failure by the Company or any Subsidiary
to pay any Indebtedness within any applicable grace period after final maturity
or the acceleration of any such Indebtedness by the holders thereof because of a
default if the total amount of such Indebtedness unpaid or accelerated exceeds
$5.0 million or its foreign currency equivalent (the "cross acceleration
provision") and such failure continues for 10 days after receipt of the notice
specified in the Indenture, (vii) certain events of bankruptcy, insolvency or
reorganization of the Company or a Significant Subsidiary (the "bankruptcy
provisions"), (viii) the rendering of any judgment or decree for the payment of
money in excess of $5.0 million or its foreign currency equivalent against the
Company or a Significant Subsidiary if (A) an enforcement proceeding thereon is
commenced by any creditor or (B) such judgment or decree remains outstanding for
a period of 60 days following such judgment and is not discharged, waived or
stayed (the "judgment default provision"), (ix) any Subsidiary Guarantee ceases
to be in full force and effect (except as contemplated by the terms thereof) or
any Subsidiary Guarantor or Person acting by or on behalf of such
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Subsidiary Guarantor denies or disaffirms such Subsidiary Guarantor's
obligations under the Indenture or any Subsidiary Guarantee and such Default
continues for 10 days after receipt of the notice specified in the Indenture, or
(x) the Company challenging the Lien on the Escrow Collateral under the Escrow
and Disbursement Agreement prior to the time that the Escrow Collateral is to be
released to the Company, the Escrow Collateral becoming subject to any lien
other than liens under the Escrow Agreement or the Escrow and Disbursement
Agreement becomes, or the Company asserts that the Escrow and Disbursement
Agreement is, invalid and unenforceable, other than in accordance with its
terms.
The foregoing will constitute Events of Default whatever the reason for any
such Event of Default and whether it is voluntary or involuntary or is effected
by operation of law or pursuant to any judgment, decree or order of any court or
any order, rule or regulation of any administrative or governmental body.
However, a default under clauses (iv), (v), (vi) or (ix) will not
constitute an Event of Default until the Trustee or the Holders of at least 25%
in principal amount of the outstanding Notes notify the Company of the default
and the Company does not cure such default within the time specified in clauses
(iv), (v), (vi) or (ix) hereof after receipt of such notice.
If an Event of Default (other than an Event of Default relating to certain
events of bankruptcy, insolvency or reorganization of the Company) occurs and is
continuing, the Trustee or the Holders of at least 25% in principal amount of
the outstanding Notes by notice to the Company may declare the principal of and
accrued but unpaid interest on all the Notes to be due and payable. Upon such a
declaration, such principal and interest will be due and payable immediately. If
an Event of Default relating to certain events of bankruptcy, insolvency or
reorganization of the Company occurs, the principal of and interest on all the
Notes will become immediately due and payable without any declaration or other
act on the part of the Trustee or any Holders. Under certain circumstances, the
Holders of a majority in principal amount of the outstanding Notes may rescind
any such acceleration with respect to the Notes and its consequences.
Subject to the provisions of the Indenture relating to the duties of the
Trustee, in case an Event of Default occurs and is continuing, the Trustee will
be under no obligation to exercise any of the rights or powers under the
Indenture at the request or direction of any of the Holders unless such Holders
have offered to the Trustee reasonable indemnity or security against any loss,
liability or expense. Except to enforce the right to receive payment of
principal, premium (if any) or interest when due, no Holder may pursue any
remedy with respect to the Indenture or the Notes unless (i) such Holder has
previously given the Trustee notice that an Event of Default is continuing, (ii)
Holders of at least 25% in principal amount of the outstanding Notes have
requested the Trustee in writing to pursue the remedy, (iii) such Holders have
offered the Trustee reasonable security or indemnity against any loss, liability
or expense, (iv) the Trustee has not complied with such request within 60 days
after the receipt of the request and the offer of security or indemnity and (v)
the Holders of a majority in principal amount of the outstanding Notes have not
given the Trustee a direction inconsistent with such request within such 60-day
period. Subject to certain restrictions, the Holders of a majority in principal
amount of the outstanding Notes are given the right to direct the time, method
and place of conducting any proceeding for any remedy available to the Trustee
or of exercising any trust or power conferred on the Trustee. The Trustee,
however, may refuse to follow any direction that conflicts with law or the
Indenture or that the Trustee determines is unduly prejudicial to the rights of
any other Holder or that would involve the Trustee in personal liability. Prior
to taking any action under the Indenture, the Trustee will be entitled to
indemnification satisfactory to it in its sole discretion against all losses and
expenses caused by taking or not taking such action.
The Indenture provides that if a Default occurs and is continuing and is
known to the Trustee, the Trustee must mail to each Holder notice of the Default
within the earlier of 90 days after it occurs or 30 days after it is known to a
Trust Officer or written notice of it is received by the Trustee. Except in the
case of a Default in the payment of principal of, premium (if any) or interest
on any Note (including payments pursuant to the redemption provisions of such
Note), the Trustee may withhold notice if and so long as a committee of its
Trust Officers in good faith determines that withholding notice is in the
interests of the Noteholders. In addition, the Company is required to deliver to
the Trustee, within 120 days after the end of each fiscal year, a certificate
indicating whether the signers thereof know of any Default that occurred during
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the previous year. The Company also is required to deliver to the Trustee,
within 30 days after the occurrence thereof, written notice of any event which
would constitute certain Events of Default, their status and what action the
Company is taking or proposes to take in respect thereof.
AMENDMENTS AND WAIVERS
Subject to certain exceptions, the Indenture or the Notes may be amended
with the written consent of the Holders of a majority in principal amount of the
Notes then outstanding and any past default or compliance with any provisions
may be waived with the consent of the Holders of a majority in principal amount
of the Notes then outstanding. However, without the consent of each Holder of an
outstanding Note affected, no amendment may, among other things, (i) reduce the
amount of Notes whose Holders must consent to an amendment, (ii) reduce the rate
of or extend the time for payment of interest or any liquidated damages on any
Note, (iii) reduce the principal of or extend the Stated Maturity of any Note,
(iv) reduce the premium payable upon the redemption of any Note or change the
time at which any Note may be redeemed as described under "-- Optional
Redemption", (v) make any Note payable in money other than that stated in the
Note, (vi) impair the right of any Holder to receive payment of principal of and
interest or any liquidated damages on such Holder's Notes on or after the due
dates therefor or to institute suit for the enforcement of any payment on or
with respect to such Holder's Notes, (vii) make any change in the amendment
provisions which require each Holder's consent or in the waiver provisions,
(viii) modify the Subsidiary Guarantees in any manner adverse to the Holders, or
(ix) modify the provisions of the Escrow and Disbursement Agreement or the
Indenture relating to the Escrow Collateral in any manner adverse to the Holders
or release any of the Escrow Collateral from the Lien under the Escrow and
Disbursement Agreement or permit any other obligation to be secured by the
Escrow Collateral.
Without the consent of any Holder, the Company and Trustee may amend the
Indenture to cure any ambiguity, omission, defect or inconsistency, to provide
for the assumption by a successor corporation of the obligations of the Company
under the Indenture, to provide for uncertificated Notes in addition to or in
place of certificated Notes (provided that the uncertificated Notes are issued
in registered form for purposes of Section 163(f) of the Code, or in a manner
such that the uncertificated Notes are described in Section 163(f)(2)(B) of the
Code), to add additional Guarantees with respect to the Notes, to secure the
Notes, to add to the covenants of the Company for the benefit of the Noteholders
or to surrender any right or power conferred upon the Company, to make any
change that does not adversely affect the rights of any Holder, subject to the
provisions of the Indenture, to provide for the issuance of the Exchange Notes,
or Additional Notes or to comply with any requirement of the Commission in
connection with the qualification of the Indenture under the TIA.
The consent of the Noteholders is not necessary under the Indenture to
approve the particular form of any proposed amendment. It is sufficient if such
consent approves the substance of the proposed amendment.
After an amendment under the Indenture becomes effective, the Company is
required to mail to the Noteholders a notice briefly describing such amendment.
However, the failure to give such notice to all Noteholders, or any defect
therein, will not impair or affect the validity of the amendment.
TRANSFER AND EXCHANGE
A Noteholder may transfer or exchange Notes in accordance with the
Indenture. Upon any transfer or exchange, the registrar and the Trustee may
require a Noteholder, among other things, to furnish appropriate endorsements
and transfer documents and the Company may require a Noteholder to pay any taxes
required by law or permitted by the Indenture. The Company is not required to
transfer or exchange any Note selected for redemption or to transfer or exchange
any Note for a period of 15 days prior to a selection of Notes to be redeemed.
The Notes will be issued in registered form and the registered holder of a Note
will be treated as the owner of such Note for all purposes.
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DEFEASANCE
The Company at any time may terminate all its obligations under the Notes
and the Indenture ("legal defeasance"), except for certain obligations,
including those respecting the defeasance trust and obligations to register the
transfer or exchange of the Notes, to replace mutilated, destroyed, lost or
stolen Notes and to maintain a registrar and paying agent in respect of the
Notes. The Company at any time may terminate its obligations under the covenants
described under "-- Certain Covenants", the operation of the cross acceleration
provision, the bankruptcy provisions with respect to Significant Subsidiaries
and the judgment default provision described under "-- Defaults", the provisions
described under "Change of Control" and the limitations contained in clause
(iii) under the first paragraph of "-- Merger and Consolidation" ("covenant
defeasance").
The Company may exercise its legal defeasance option notwithstanding its
prior exercise of its covenant defeasance option. If the Company exercises its
legal defeasance option, payment of the Notes may not be accelerated because of
an Event of Default with respect thereto. If the Company exercises its covenant
defeasance option, payment of the Notes may not be accelerated because of an
Event of Default specified in clause (iv), (vi), (vii) (with respect only to
Significant Subsidiaries) or (viii) under "-- Defaults" or because of the
failure of the Company to comply with clause (iii) under the first paragraph of
"-- Merger and Consolidation".
In order to exercise either defeasance option, the Company must irrevocably
deposit in trust (the "defeasance trust") with the Trustee money or U.S.
Government Obligations for the payment of principal, premium (if any) and
interest on the Notes to redemption or maturity, as the case may be, and must
comply with certain other conditions, including delivery to the Trustee of an
Opinion of Counsel to the effect that holders of the Notes will not recognize
income, gain or loss for Federal income tax purposes as a result of such deposit
and defeasance and will be subject to Federal income tax on the same amounts and
in the same manner and at the same times as would have been the case if such
deposit and defeasance had not occurred (and, in the case of legal defeasance
only, such Opinion of Counsel must be based on a ruling of the Internal Revenue
Service or other change in applicable Federal income tax law).
CONCERNING THE TRUSTEE
The Bank of Montreal Trust Company is to be the Trustee under the Indenture
and has been appointed by the Company as Registrar and Paying Agent with regard
to the Notes.
GOVERNING LAW
The Indenture provides that it and the Notes will be governed by, and
construed in accordance with, the laws of the State of New York without giving
effect to applicable principles of conflicts of law to the extent that the
application of the law of another jurisdiction would be required thereby.
BOOK ENTRY, DELIVERY AND FORM
Except as described in the next paragraph, the Exchange Notes (and the
related guarantees) initially will be represented by a single permanent global
certificate in definitive, fully registered form (the "Global Note"). The Global
Note will be deposited promptly after the Expiration Date with, or on behalf of,
The Depository Trust Company, New York, New York (the "Depositary") and
registered in the name of a nominee of the Depositary. Notes (i) originally
purchased by or transferred to "foreign purchasers" or (ii) held by qualified
institutional buyers or Accredited Investors (as defined in Regulation D under
the Securities Act) who are not "qualified institutional buyers" (as defined in
Rule 144A under the Securities Act) ("QIBs") who elect to take physical delivery
of their certificates instead of holding their interests through the Global Note
(and which are thus ineligible to trade through the Depositary) (collectively
referred to herein as the "Non-Global Purchasers") will be issued in registered
form (the "Certificated Security"). Upon the transfer to a QIB of any
Certificated Security initially issued to a Non-Global Purchaser, such
Certificated Security will, unless the transferee requests otherwise or the
Global Note has previously been
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exchanged in whole for Certificated Securities, be exchanged for an interest in
the Global Note. For a description of the restrictions on the transfer of
Certificated Securities and any interest in the Global Note.
The Global Note. The Company expects that pursuant to procedures
established by the Depositary (i) upon the issuance of the Global Note, the
Depositary or its custodian will credit, on its internal system, the principal
amount of Notes of the individual beneficial interests represented by such
Global Note to the respective accounts of persons who have accounts with such
depositary and (ii) ownership of beneficial interests in the Global Note will be
shown on, and the transfer of such ownership will be effected only through,
records maintained by the Depositary or its nominee (with respect to interests
of participants) and the records of participants (with respect to interests of
persons other than participants). Such accounts initially will be designated by
or on behalf of the Initial Purchaser and ownership of beneficial interests in
the Global Note will be limited to persons who have accounts with the Depositary
("participants") or persons who hold interests through participants. QIBs may
hold their interests in the Global Note directly through the Depositary if they
are participants in such system, or indirectly through organizations which are
participants in such system. So long as the Depositary, or its nominee, is the
registered owner or holder of the Notes, the Depositary or such nominee, as the
case may be, will be considered the sole owner or holder of the Notes
represented by such Global Note for all purposes under the Indenture. No
beneficial owner of an interest in the Global Note will be able to transfer that
interest except in accordance with the procedures of the Depositary, in addition
to those provided under the Indenture with respect to the Notes.
The Depositary has advised the Company that it is (i) a limited purpose
trust company organized under the laws of the State of New York, (ii) a "banking
organization" within the meaning of the New York Banking Law, (iii) a member of
the Federal Reserve System, (iv) a "clearing corporation" within the meaning of
the Uniform Commercial Code, as amended, and (v) a "clearing agency" registered
pursuant to Section 17A of the Exchange Act. The Depositary was created to hold
securities for its participants (collectively, the "Participants") and
facilitates the clearance and settlement of securities transactions between
Participants through electronic book-entry changes to the accounts of its
Participants, thereby eliminating the need for physical transfer and delivery of
certificates. Participants in the Depositary include securities brokers and
dealers (including the Initial Purchaser), banks and trust companies, clearing
corporations and certain other organizations. Indirect access to the system of
the Depositary is also available to other entities such as banks, brokers,
dealers and trust companies (collectively, the "Indirect Participants") that
clear through or maintain a custodial relationship with a Participant, either
directly or indirectly. Investors who are not Participants may beneficially own
securities held by or on behalf of the Depositary only through Participants or
Indirect Participants.
The laws of some jurisdictions may require that certain purchasers of
securities take physical delivery of such securities in definitive form.
Accordingly, the ability to transfer interests in the Securities represented by
a global security to such persons may be limited. In addition, because the
Depositary can act only on behalf of its Participants, who in turn act on behalf
of persons who hold interests through Participants, the ability of a person
having an interest in Securities represented by a global security to pledge or
transfer such interest to persons or entities that do not participate in the
system of the Depositary, or to otherwise take actions in respect of such
interest, may be affected by the lack of a physical definitive security in
respect of such interest.
Payments with respect to the principal of, premium, if any, Liquidated
Damages, if any, and interest on, any Notes represented by the Global Note on
the applicable record date will be payable by the Trustee to or at the direction
of the Depositary or its nominee in its capacity as the registered holder of the
Global Note. Under the terms of the Indenture, the Company and the Trustee may
treat the persons in whose names the Notes, including the Global Note, are
registered as the owners thereof for the purpose of receiving payment thereon
and for any and all other purposes whatsoever. Accordingly, neither the Company
nor the Trustee has or will have any responsibility or liability for the payment
of such amounts to owners of beneficial interests in the Global Note (including
principal, premium, if any, Liquidated Damages, if any, and interest). Payments
by the Participants and the Indirect Participants to the owners of beneficial
interests in the Global Note will be governed by standing instructions and
customary industry practice and will be the responsibility of the Participants
or the Indirect Participants and the Depositary. Transfers between Participants
in the Depositary will be effected in accordance with the procedures of the
Depositary, and will be settled in same-day funds.
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CERTIFICATED NOTES
If (i) the Company notifies the Trustee in writing that the Depositary is
no longer willing or able to act as a depositary or the Depositary ceases to be
registered as a clearing agency under the Exchange Act and a successor
depositary is not appointed within 90 days of such notice or cessation, (ii) the
Company, at its option, notifies the Trustee in writing that it elects to cause
the issuance of Notes in definitive form or (iii) upon the occurrence of certain
other events, then, upon surrender by the Depositary of the Global Note,
Certificated Notes will be issued to each person that the Depositary identifies
as the beneficial owner of the Notes represented by the Global Note. Upon any
such issuance, the Trustee is required to register such Certificated Notes in
the name of such person or persons (or the nominee of any thereof) and cause the
same to be delivered thereto.
Neither the Company nor the Trustee shall be liable for any delay by the
Depositary or any Participant or Indirect Participant in identifying the
beneficial owners of the related Notes and each such person may conclusively
rely on, and shall be protected in relying on, instructions from the Depositary
for all purposes.
CERTAIN DEFINITIONS
"Affiliate" of any specified Person means any other Person, directly or
indirectly, controlling or controlled by or under direct or indirect common
control with such specified Person. For the purposes of this definition,
"control" when used with respect to any Person means the power to direct the
management and policies of such Person, directly or indirectly, whether through
the ownership of voting securities, by contract or otherwise; and the terms
"controlling" and "controlled" have meanings correlative to the foregoing. For
purposes of the provisions described under "-- Certain Covenants -- Limitation
on Transactions with Affiliates" only, "Affiliate" shall also mean any
beneficial owner of shares representing 5% or more of the total voting power of
the Voting Stock (on a fully diluted basis) of the Company or of rights or
warrants to purchase such Voting Stock (whether or not currently exercisable)
and any Person who would be an Affiliate of any such beneficial owner pursuant
to the first sentence hereof.
"Asset Disposition" means any sale, lease, transfer or other disposition
(or series of related sales, leases, transfers or dispositions) by the Company
or any Restricted Subsidiary, including any disposition by means of a merger,
consolidation, or similar transaction (each referred to for the purposes of this
definition as a "disposition"), of (i) any shares of Capital Stock of a
Restricted Subsidiary (other than directors' qualifying shares or shares
required by applicable law to be held by a Person other than the Company or a
Restricted Subsidiary), (ii) all or substantially all the assets of any division
or line of business of the Company or any Restricted Subsidiary or (iii) any
other assets of the Company or any Restricted Subsidiary other than inventory or
obsolete assets sold in the ordinary course of business of the Company or such
Restricted Subsidiary (other than, in the case of (i), (ii) and (iii) above, (x)
a disposition by a Restricted Subsidiary to the Company or by the Company or a
Restricted Subsidiary to a Wholly Owned Subsidiary, (y) for purposes of the
provisions described under "-- Certain Covenants -- Limitation on Sales of
Assets and Subsidiary Stock" only, a disposition subject to the covenant
described under "-- Certain Covenants -- Limitation on Restricted Payments" and
(z) a disposition of assets with a fair market value of less than $250,000).
"Attributable Debt" in respect of a Sale/Leaseback Transaction means, as at
the time of determination, the present value (discounted at the interest rate
borne by the Notes, compounded annually) of the total obligations of the lessee
for rental payments during the remaining term of the lease included in a Sale/
Leaseback Transaction (including any period for which such lease has been
extended).
"Average Life" means, as of the date of determination, with respect to any
Indebtedness or Preferred Stock, the quotient obtained by dividing (i) the sum
of the products of the numbers of years from the date of determination to the
dates of each successive scheduled principal payment of such Indebtedness or
redemption or similar payment with respect to such Preferred Stock multiplied by
the amount of such payment by (ii) the sum of all such payments.
"Bank Indebtedness" means any Indebtedness outstanding under any credit or
similar agreement with a financial institution which provides for revolving
credit loans, term loans or letters of credit or other credit
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facilities, as amended, waived, restated, supplemented, extended, replaced,
refinanced or otherwise modified from time to time.
"Board of Directors" means the Board of Directors of the Company or any
committee thereof duly authorized to act on behalf of such Board.
"Business Day" means each day which is not a Legal Holiday.
"Capital Stock" of any Person means any and all shares, interests, rights
to purchase, warrants, options, participations or other equivalents of or
interests in (however designated) equity of such Person, including any Preferred
Stock, but excluding any debt securities convertible into such equity.
"Capitalized Lease Obligations" means an obligation that is required to be
classified and accounted for as a capitalized lease for financial reporting
purposes in accordance with GAAP, and the amount of Indebtedness represented by
such obligation shall be the capitalized amount of such obligation determined in
accordance with GAAP; and the Stated Maturity thereof shall be the date of the
last payment of rent or any other amount due under such lease prior to the first
date upon which such lease may be prepaid by the lessee without payment of a
penalty.
"Cash Contribution Amount" means the aggregate amount of cash contributions
made to the capital of the Company described in the definition of "Contribution
Indebtedness".
"Closing Date" means the date of the Indenture.
"Code" means the Internal Revenue Code of 1986, as amended.
"Commission" means the Securities and Exchange Commission.
"Consolidated Interest Expense" means, for any period, the total interest
expense of the Company and its Consolidated Restricted Subsidiaries, plus, to
the extent Incurred by the Company and its Subsidiaries in such period but not
included in such interest expense, (i) interest expense attributable to
Capitalized Lease Obligations and the interest expense relating to Attributable
Debt, (ii) amortization of debt discount and debt issuance costs, (iii)
capitalized interest, (iv) non-cash interest expense, (v) commissions, discounts
and other fees and charges attributable to letters of credit and bankers'
acceptance financing, (vi) interest accruing on any Indebtedness of any other
Person to the extent such Indebtedness is Guaranteed by the Company or any
Restricted Subsidiary, (vii) net costs associated with Hedging Obligations
(including amortization of fees), (viii) dividends in respect of all
Disqualified Stock of the Company and all Preferred Stock of the Subsidiaries of
the Company to the extent held by Persons other than the Company or a Wholly
Owned Subsidiary, (ix) interest Incurred in connection with investments in
discontinued operations and (x) the cash contributions to any employee stock
ownership plan or similar trust to the extent such contributions are used by
such plan or trust to pay interest or fees to any Person (other than the
Company) in connection with Indebtedness Incurred by such plan or trust.
"Consolidated Net Income" means, for any period, the net income of the
Company and its Consolidated Subsidiaries for such period; provided, however,
that there shall not be included in such Consolidated Net Income: (i) any net
income or loss of any Person (other than the Company) if such Person is not a
Restricted Subsidiary, except that (A) subject to the limitations contained in
clause (iv) below, the Company's equity in the net income of any such Person for
such period shall be included in such Consolidated Net Income up to the
aggregate amount of cash actually distributed by such Person during such period
to the Company or a Restricted Subsidiary as a dividend or other distribution
(subject, in the case of a dividend or other distribution made to a Restricted
Subsidiary, to the limitations contained in clause (iii) below) and (B) the
Company's equity in a net loss of any such Person (including any Unrestricted
Subsidiary) for such period shall be included in determining such Consolidated
Net Income; (ii) any net income (or loss) of any Person acquired by the Company
or a Subsidiary in a pooling of interests transaction for any period prior to
the date of such acquisition; (iii) any net income (or loss) of any Restricted
Subsidiary if such Restricted Subsidiary is subject to restrictions, directly or
indirectly, on the payment of dividends or the making of distributions by such
Restricted Subsidiary, directly or indirectly, to the Company, except that (A)
subject to the limitations contained in clause (iv) below, the Company's equity
in the net income of any such Restricted Subsidiary for
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such period shall be included in such Consolidated Net Income up to the
aggregate amount of cash actually distributed by such Restricted Subsidiary
during such period to the Company or another Restricted Subsidiary as a dividend
or other distribution (subject, in the case of a dividend or other distribution
made to another Restricted Subsidiary, to the limitation contained in this
clause) and (B) the Company's equity in a net loss of any such Restricted
Subsidiary for such period shall be included in determining such Consolidated
Net Income; (iv) any gain (but not loss) realized upon the sale or other
disposition of any asset of the Company or its Consolidated Subsidiaries
(including pursuant to any Sale/Leaseback Transaction) that is not sold or
otherwise disposed of in the ordinary course of business and any gain (but not
loss) realized upon the sale or other disposition of any Capital Stock of any
Person; (v) any extraordinary gain or loss; and (vi) the cumulative effect of a
change in accounting principles. Notwithstanding the foregoing, for the purpose
of the covenant described under "-- Certain Covenants -- Limitation on
Restricted Payments" only, there shall be excluded from Consolidated Net Income
any dividends, repayments of loans or advances or other transfers of assets from
Unrestricted Subsidiaries to the Company or a Restricted Subsidiary to the
extent such dividends, repayments or transfers increase the amount of Restricted
Payments permitted under such covenant pursuant to clause (a)(3)(D) thereof.
"Consolidated Operating Cash Flow" for any period means the Consolidated
Net Income for such period, plus the following to the extent deducted in
calculating such Consolidated Net Income: (i) income tax expense of the Company
and its Consolidated Restricted Subsidiaries, (ii) Consolidated Interest
Expense, (iii) depreciation expense of the Company and its Consolidated
Restricted Subsidiaries, (iv) amortization expense of the Company and its
Consolidated Restricted Subsidiaries (excluding amortization expense
attributable to a prepaid cash item that was paid in a prior period) and (v) all
other non-cash charges of the Company and its Consolidated Restricted
Subsidiaries (excluding any such non-cash charge to the extent it represents an
accrual of or reserve for cash expenditures in any future period) in each case
for such period. Notwithstanding the foregoing, the provision for taxes based on
the income or profits of, and the depreciation and amortization and non-cash
charges of, a Restricted Subsidiary of the Company shall be added to
Consolidated Net Income to compute Consolidated Operating Cash Flow only to the
extent (and in the same proportion) that the net income of such Restricted
Subsidiary was included in calculating Consolidated Net Income and only if a
corresponding amount would be permitted at the date of determination to be
dividended to the Company by such Restricted Subsidiary without prior approval
(that has not been obtained), pursuant to the terms of its charter and all
agreements, instruments, judgments, decrees, orders, statutes, rules and
governmental regulations applicable to such Restricted Subsidiary or its
stockholders.
"Consolidation" means the consolidation of the amounts of each Restricted
Subsidiary with those of the Company in accordance with GAAP consistently
applied; provided, however, that "Consolidation" will not include consolidation
of the accounts of any Unrestricted Subsidiary, but the interest of the Company
or any Restricted Subsidiary in an Unrestricted Subsidiary will be accounted for
as an investment. The term "Consolidated" has a correlative meaning.
"Contribution Indebtedness" means Indebtedness of the Company in an
aggregate principal amount not greater than twice the aggregate amount of the
Net Cash Proceeds received by the Company from contributions made to the capital
of the Company after the date hereof, provided that such Contribution
Indebtedness (i) has a Stated Maturity later than the Stated Maturity of the
Notes, (ii) is Incurred substantially concurrently with such cash contribution,
and (iii) is so designated as Contribution Indebtedness, pursuant to an
Officers' Certificate, on the Incurrence date thereof.
"Currency Agreement" means with respect to any Person, any foreign exchange
contract, currency swap agreement or any similar agreement or arrangement to
which such Person is a party or of which it is a beneficiary.
"Debt to Annualized Operating Cash Flow Ratio" means the ratio of (a) the
Total Consolidated Indebtedness as of the date of calculation (the
"Determination Date") to (b) four times the Consolidated Operating Cash Flow for
the latest fiscal quarter for which financial information is available
immediately preceding such Determination Date (the "Measurement Period"). For
purposes of calculating Consolidated Operating Cash Flow for the Measurement
Period immediately prior to the relevant Determination Date,
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(i) any Person that is a Restricted Subsidiary on the Determination Date (or
would become a Restricted Subsidiary on such Determination Date in connection
with the transaction that requires the determination of such Consolidated
Operating Cash Flow) will be deemed to have been a Restricted Subsidiary at all
times during such Measurement Period, (ii) any Person that is not a Restricted
Subsidiary on such Determination Date (or would cease to be a Restricted
Subsidiary on such Determination Date in connection with the transaction that
requires the determination of such Consolidated Operating Cash Flow) will be
deemed not to have been a Restricted Subsidiary at any time during such
Measurement Period, and (iii) if the Company or any Restricted Subsidiary shall
have in any manner (x) acquired (through an acquisition or the commencement of
activities constituting such operating business) or (y) disposed of (by an Asset
Disposition or the termination or discontinuance of activities constituting such
operating business) any operating business during such Measurement Period or
after the end of such period and on or prior to such Determination Date, such
calculation will be made on a pro forma basis in accordance with GAAP as if all
such transactions had been consummated prior to the first day of such
Measurement Period (it being understood that in calculating Consolidated
Operating Cash Flow, the exclusions set forth in clauses (i) through (vi) of the
definition of Consolidated Net Income shall apply to a Person which has been
acquired as if it were a Restricted Subsidiary).
"Default" means any event which is, or after notice or passage of time or
both would be, an Event of Default.
"Disqualified Stock" means, with respect to any Person, any Capital Stock
which by its terms (or by the terms of any security into which it is convertible
or for which it is exchangeable or exercisable) or upon the happening of any
event (i) matures or is mandatorily redeemable pursuant to a sinking fund
obligation or otherwise, (ii) is convertible or exchangeable for Indebtedness or
Disqualified Stock or (iii) is redeemable at the option of the holder thereof,
in whole or in part, in each case on or prior to the first anniversary of the
Stated Maturity of the Notes; provided, however, that any Capital Stock that
would not constitute Disqualified Stock but for provisions thereof giving
holders thereof the right to require such Person to repurchase or redeem such
Capital Stock upon the occurrence of an "asset sale" or "change of control"
occurring prior to the first anniversary of the Stated Maturity of the
Securities shall not constitute Disqualified Stock if the "asset sale" or
"change of control" provisions applicable to such Capital Stock are not more
favorable to the holders of such Capital Stock than the provisions of the
covenants described under "-- Change of Control" and "-- Certain
Covenants -- Limitation on Sale of Assets and Subsidiary Stock".
"Equity Offering" means any public or private sale of common stock or
Preferred Stock of the Company (other than Disqualified Stock) other than any
sale to a Permitted Holder.
"Escrow Account" means an escrow account for the deposit of approximately
$56.6 million of the net proceeds from the sale of the Notes under the Escrow
and Disbursement Agreement.
"Escrow Agent" means The Chase Manhattan Bank as Escrow Agent under the
Escrow and Disbursement Agreement, or any successor thereto appointed pursuant
to such agreement.
"Escrow and Disbursement Agreement" means the Escrow and Disbursement
Agreement, dated as of the Closing Date, by and among the Escrow Agent, the
Trustee and the Company, governing the disbursement of funds from the Escrow
Account.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Fair Market Value" means, with respect to any asset or property, the price
that could be negotiated in an arm's-length free market transaction, for cash,
between a willing seller and a willing buyer, neither of whom is under pressure
or compulsion to complete the transaction. Unless otherwise specified in the
Indenture, Fair Market Value shall be determined by the Board of Directors of
the Company acting in good faith and shall be evidenced by a resolution of the
Board of Directors of the Company delivered to the Trustee.
"GAAP" means generally accepted accounting principles in the United States
of America as in effect as of the Closing Date, including those set forth in (i)
the opinions and pronouncements of the Accounting Principles Board of the
American Institute of Certified Public Accountants, (ii) statements and
pronounce-
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ments of the Financial Accounting Standards Board, (iii) such other statements
by such other entities as approved by a significant segment of the accounting
profession and (iv) the rules and regulations of the Commission governing the
inclusion of financial statements (including pro forma financial statements) in
periodic reports required to be filed pursuant to Section 13 of the Exchange
Act, including opinions and pronouncements in staff accounting bulletins and
similar written statements from the accounting staff of the Commission. All
ratios and computations based on GAAP contained in the Indenture shall be
computed in conformity with GAAP.
"Guarantee" means any obligation, contingent or otherwise, of any Person
directly or indirectly guaranteeing any Indebtedness or other obligation of any
other Person and any obligation, direct or indirect, contingent or otherwise, of
such Person (i) to purchase or pay (or advance or supply funds for the purchase
or payment of) such Indebtedness or other obligation of such other Person
(whether arising by virtue of partnership arrangements, or by agreement to
keep-well, to purchase assets, goods, securities or services, to take-or-pay, or
to maintain financial statement conditions or otherwise) or (ii) entered into
for purposes of assuring in any other manner the obligee of such Indebtedness or
other obligation of the payment thereof or to protect such obligee against loss
in respect thereof (in whole or in part); provided, however, that the term
"Guarantee" shall not include endorsements for collection or deposit in the
ordinary course of business. The term "Guarantee' used as a verb has a
corresponding meaning. The term "Guarantor" shall mean any Person Guaranteeing
any obligation.
"Hedging Obligations" of any Person means the obligations of such Person
pursuant to any Interest Rate Agreement or any Currency Agreement.
"Holder" or "Noteholder" means the Person in whose name a Note is
registered on the registrar's books.
"Incur" means issue, assume, Guarantee, incur or otherwise become liable
for; provided, however, that any Indebtedness or Capital Stock of a Person
existing at the time such Person becomes a Subsidiary (whether by merger,
consolidation, acquisition or otherwise) shall be deemed to be Incurred by such
Person at the time it becomes a Subsidiary. The term "Incurrence" when used as a
noun shall have a correlative meaning. The accretion of principal of a
non-interest bearing or other discount security shall be deemed the Incurrence
of Indebtedness.
"Indebtedness" means, with respect to any Person on any date of
determination (without duplication), (i) the principal of and premium (if any)
in respect of indebtedness of such Person for borrowed money; (ii) the principal
of and premium (if any) in respect of obligations of such Person evidenced by
bonds, debentures, notes or other similar instruments; (iii) all obligations of
such Person in respect of letters of credit or other similar instruments
(including reimbursement obligations with respect thereto); (iv) all obligations
of such Person to pay the deferred and unpaid purchase price of property or
services (except Trade Payables), which purchase price is due more than six
months after the date of placing such property in service or taking delivery and
title thereto or the completion of such services; (v) Capitalized Lease
Obligations and all Attributable Debt of such Person; (vi) the amount of all
obligations of such Person with respect to the redemption, repayment or other
repurchase of any Disqualified Stock or, with respect to any Subsidiary of such
Person, any Preferred Stock (but excluding, in each case, any accrued
dividends); (vii) all Indebtedness of other Persons secured by a Lien on any
asset of such Person, whether or not such Indebtedness is assumed by such
Person; provided, however, that the amount of Indebtedness of such Person shall
be the lesser of (A) the fair market value of such asset at such date of
determination and (B) the amount of such Indebtedness of such other Persons;
(viii) to the extent not otherwise included in this definition, Hedging
Obligations of such Person; and (ix) all obligations of the type referred to in
clauses (i) through (viii) of other Persons and all dividends of other Persons
for the payment of which, in either case, such Person is responsible or liable,
directly or indirectly, as obligor, guarantor or otherwise, including by means
of any Guarantee. The amount of Indebtedness of any Person at any date shall be
the outstanding balance at such date of all unconditional obligations as
described above and the maximum liability, upon the occurrence of the
contingency giving rise to the obligation, of any contingent obligations at such
date.
"Interest Rate Agreement" means with respect to any Person any interest
rate protection agreement, interest rate future agreement, interest rate option
agreement, interest rate swap agreement, interest rate cap
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agreement, interest rate collar agreement, interest rate hedge agreement or
other similar agreement or arrangement as to which such Person is party or a
beneficiary.
"Investment" in any Person means any direct or indirect advance, loan
(other than advances to customers in the ordinary course of business that are
recorded as accounts receivable on the balance sheet of the lender) or other
extension of credit (including by way of Guarantee or similar arrangement) or
capital contribution to (by means of any transfer of cash or other property to
others or any payment for property or services for the account or use of
others), or any purchase or acquisition of Capital Stock, Indebtedness or other
similar instruments issued by such Person. For purposes of the definition of
"Unrestricted Subsidiary" and the covenant described under "-- Certain
Covenants -- Limitation on Restricted Payments", (i) "Investment" shall include
the portion (proportionate to the Company's equity interest in such Subsidiary)
of the fair market value of the net assets of any Subsidiary of the Company at
the time that such Subsidiary is designated an Unrestricted Subsidiary;
provided, however, that upon a redesignation of such Subsidiary as a Restricted
Subsidiary, the Company shall be deemed to continue to have a permanent
"Investment" in an Unrestricted Subsidiary in an amount (if positive) equal to
(x) the Company's "Investment" in such Subsidiary at the time of such
redesignation less (y) the portion (proportionate to the Company's equity
interest in such Subsidiary) of the fair market value of the net assets of such
Subsidiary at the time of such redesignation; and (ii) any property transferred
to or from an Unrestricted Subsidiary shall be valued at its fair market value
at the time of such transfer, in each case as determined in good faith by the
Board of Directors.
"Legal Holiday" means a Saturday, Sunday or other day on which banking
institutions in New York State are authorized or required by law to close.
"Lien" means any mortgage, pledge, security interest, encumbrance, lien or
charge of any kind (including any conditional sale or other title retention
agreement or lease in the nature thereof).
"Net Available Cash" from an Asset Disposition means cash payments received
(including any cash payments received by way of deferred payment of principal
pursuant to a note or installment receivable or otherwise and proceeds from the
sale or other disposition of any securities received as consideration, but only
as and when received, but excluding any other consideration received in the form
of assumption by the acquiring Person of Indebtedness or other obligations
relating to the properties or assets that are the subject of such Asset
Disposition or received in any other non-cash form) therefrom, in each case net
of (i) all legal, title and recording tax expenses, commissions and other fees
and expenses incurred, and all Federal, state, provincial, foreign and local
taxes required to be paid or accrued as a liability under GAAP, as a consequence
of such Asset Disposition, (ii) all payments made on any Indebtedness which is
secured by any assets subject to such Asset Disposition, in accordance with the
terms of any Lien upon or other security agreement of any kind with respect to
such assets, or which must by its terms, or in order to obtain a necessary
consent to such Asset Disposition, or by applicable law be repaid out of the
proceeds from such Asset Disposition, (iii) all distributions and other payments
required to be made to minority interest holders in Subsidiaries or joint
ventures as a result of such Asset Disposition and (iv) appropriate amounts to
be provided by the seller as a reserve, in accordance with GAAP, against any
liabilities associated with the property or other assets disposed of in such
Asset Disposition and retained by the Company or any Restricted Subsidiary after
such Asset Disposition.
"Net Cash Proceeds", with respect to any issuance or sale of Capital Stock
or any equity contribution, means the cash proceeds of such issuance, sale or
contribution net of attorneys' fees, accountants' fees, underwriters' or
placement agents' fees, discounts or commissions and brokerage, consultant and
other fees actually incurred in connection with such issuance, sale or
contribution and net of taxes paid or payable as a result thereof.
"Noteholder" or "Holder" means the Person in whose name a Note is
registered on the registrar's books.
"Officer" means the Chairman of the Board, the Chief Executive Officer, the
Chief Financial Officer, the President, any Vice President, the Treasurer or the
Secretary of the Company.
"Officers' Certificate" means a certificate signed by two Officers.
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"Opinion of Counsel" means a written opinion from legal counsel who is
acceptable to the Trustee. The counsel may be an employee of or counsel to the
Company or the Trustee.
"Permitted Holders" means Kwok L. Li, William R. Wilson and Linsang
Partners, LLC and any Person acting in the capacity of an underwriter in
connection with a public or private offering of the Company's Capital Stock.
"Permitted Investment" means an Investment by the Company or any Restricted
Subsidiary in (i) the Company, a Restricted Subsidiary or a Person that will,
upon the making of such Investment, become a Restricted Subsidiary; provided,
however, that the primary business of such Restricted Subsidiary is a
Telecommunications Business; (ii) another Person if as a result of such
Investment such other Person is merged or consolidated with or into, or
transfers or conveys all or substantially all its assets to, the Company or a
Restricted Subsidiary; provided, however, that such Person's primary business is
a Telecommunications Business; (iii) Temporary Cash Investments; (iv)
receivables owing to the Company or any Restricted Subsidiary if created or
acquired in the ordinary course of business and payable or dischargeable in
accordance with customary trade terms; provided, however, that such trade terms
may include such concessionary trade terms as the Company or any such Restricted
Subsidiary deems reasonable under the circumstances; (v) Investments in prepaid
expenses; (vi) loans or advances to employees made in the ordinary course of
business of the Company or such Restricted Subsidiary and not exceeding $2.0
million in the aggregate outstanding at any one time; (vii) stock, obligations
or securities received in settlement of debts created in the ordinary course of
business and owing to the Company or any Restricted Subsidiary or in
satisfaction of judgments; (viii) any Person to the extent such Investment
represents the non-cash portion of the consideration received for an Asset
Disposition that was made pursuant to and in compliance with the covenant
described under "-- Certain Covenants -- Limitation on Sale of Assets and
Subsidiary Stock"; (ix) Investments made prior to the Closing Date; (x)
Investments in Telecommunications Assets not to exceed $30.0 million at any one
time outstanding; and (xi) other Investments, not to exceed the greater of (a)
10% of Total Assets of the Company at the time of such Investment (with the fair
market value of each Investment being measured at the time made and without
giving effect to subsequent changes in value) and (b) $30.0 million.
"Permitted Liens" means, with respect to any Person, (a) pledges or
deposits by such Person under worker's compensation laws, unemployment insurance
laws or similar legislation, or good faith deposits in connection with bids,
tenders, contracts (other than for the payment of Indebtedness) or leases to
which such Person is a party, or deposits to secure public or statutory
obligations of such Person or deposits of cash or United States government bonds
to secure surety or appeal bonds to which such Person is a party, or deposits as
security for contested taxes or import duties or for the payment of rent, in
each case Incurred in the ordinary course of business; (b) Liens imposed by law,
such as carriers', warehousemen's and mechanics' Liens, in each case for sums
not yet due or being contested in good faith by appropriate proceedings or other
Liens arising out of judgments or awards against such Person with respect to
which such Person shall then be proceeding with an appeal or other proceedings
for review; (c) Liens for property taxes not yet due or payable or subject to
penalties for non-payment or which are being contested in good faith by
appropriate proceedings; (d) Liens in favor of issuers of surety bonds issued
pursuant to the request of and for the account of such Person in the ordinary
course of its business; (e) minor survey exceptions, minor encumbrances,
easements or reservations of, or rights of others for, licenses, rights-of-way,
sewers, electric lines, telegraph and telephone lines and other similar
purposes, or zoning or other restrictions as to the use of real property or
Liens incidental to the conduct of the business of such Person or to the
ownership of its properties which were not Incurred in connection with
Indebtedness and which do not in the aggregate materially adversely affect the
value of said properties or materially impair their use in the operation of the
business of such Person; (f) Liens to secure Indebtedness permitted pursuant to
clauses (b)(i) and (b)(vi) of the covenant described under "-- Certain
Covenants -- Limitation on Indebtedness"; (g) Liens existing on the Closing
Date; (h) Liens on property or shares of stock of another Person at the time
such other Person becomes a Subsidiary of such Person; provided, however, that
such Liens are not created, Incurred or assumed in connection with, or in
contemplation of, such other Person becoming such a Subsidiary; provided
further, however, that such Liens do not extend to any other property owned by
such Person or any of its Subsidiaries; (i) Liens on property at
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the time such Person or any of its Subsidiaries acquires the property, including
any acquisition by means of a merger or consolidation with or into such Person
or any Subsidiary of such Person; provided, however, that such Liens are not
created, Incurred or assumed in connection with, or in contemplation of, such
acquisition; provided further, however, that the Liens do not extend to any
other property owned by such Person or any of its Subsidiaries; (j) Liens
securing Indebtedness or other obligations of a Subsidiary of such Person owing
to such Person or a wholly owned Subsidiary of such Person; (k) Liens securing
obligations under Interest Rate Agreements so long as such obligations under
Interest Rate Agreements relate to Indebtedness that is, and is permitted under
the Indenture to be, secured by a Lien on the same property securing such
obligations under Interest Rate Agreements; (l) Liens to secure any Refinancing
(or successive Refinancings) as a whole, or in part, of any Indebtedness secured
by any Lien referred to in the foregoing clauses (f), (g), (h) and (i);
provided, however, that (x) such new Lien shall be limited to all or part of the
same property that secured the original Lien (plus improvements to or on such
property) and (y) the Indebtedness secured by such Lien at such time is not
increased to any amount greater than the sum of (A) the outstanding principal
amount or, if greater, committed amount of the Indebtedness secured by Liens
described under clauses (f), (g), (h) or (i) at the time the original Lien
became a Permitted Lien under the Indenture and (B) an amount necessary to pay
any fees and expenses, including premiums, related to such Refinancings; and (m)
Liens in favor of the Trustee arising under the provisions of the Escrow and
Disbursement Agreement and the provisions of the Indenture relating thereto.
Notwithstanding the foregoing, "Permitted Liens" will not include any Lien
described in clauses (f), (h) or (i) above to the extent such Lien applies to
any Telecommunications Assets acquired directly or indirectly from Net Available
Cash pursuant to the covenant described under "-- Certain
Covenants -- Limitation on Sales of Assets and Subsidiary Stock".
"Person" means any individual, corporation, partnership, limited liability
company, joint venture, association, joint-stock company, trust, unincorporated
organization, government or any agency or political subdivision thereof or any
other entity.
"Preferred Stock", as applied to the Capital Stock of any Person, means
Capital Stock of any class or classes (however designated) that is preferred as
to the payment of dividends, or as to the distribution of assets upon any
voluntary or involuntary liquidation or dissolution of such Person, over shares
of Capital Stock of any other class of such Person.
"principal" of a Note means the principal of the Note plus the premium, if
any, payable on the Note which is due or overdue or is to become due at the
relevant time.
"Prodigy Agreement" means the Splitrock Full Service Agreement dated as of
June 24, 1997 between the Company and Prodigy, Inc. as in effect on the date
hereof.
"Purchase Money Indebtedness" means Secured Indebtedness (including
Capitalized Lease Obligations, mortgage financings and purchase money
obligations) incurred for the purpose of financing all or any part of the cost
of construction, installation, acquisition, lease, development or improvement by
the Company or any Restricted Subsidiary of any Telecommunications Assets of the
Company or any Restricted Subsidiary and including any related notes,
Guarantees, collateral documents, instruments and agreements executed in
connection therewith, as the same may be amended, supplemented, modified or
restated from time to time provided, however, that (i) the security agreement or
conditional sales or other title retention contract pursuant to which a Lien on
such assets is created shall be entered into within 180 days after the purchase
or acquisition of such assets and shall at all times be confined solely to the
assets so purchased or acquired, any additions, replacements, modifications and
accessions thereto and any proceeds and products therefrom, (ii) at no time
shall the aggregate principal amount of the outstanding Indebtedness secured
thereby be increased, except in connection with the purchase of additions and
accessions thereto and except in respect of fees and other obligations in
respect of such Indebtedness and (iii) the Indebtedness secured thereby shall be
with recourse solely to the assets so purchased or acquired, any additions,
replacements, modifications and accessions thereto and any proceeds and products
therefrom.
"Refinance" means, in respect of any Indebtedness, to refinance, extend,
renew, refund, repay, prepay, redeem, defease or retire, or to issue other
Indebtedness exchange or replacement for, such Indebtedness. "Refinanced" and
"Refinancing" shall have correlative meanings.
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"Refinancing Indebtedness" means Indebtedness that is Incurred to refund,
refinance, replace, renew, repay or extend (including pursuant to any defeasance
or discharge mechanism) any Indebtedness of the Company or any Restricted
Subsidiary existing on the date of the Indenture or Incurred in compliance with
the Indenture (including Indebtedness of the Company that Refinances Refinancing
Indebtedness); provided, however, that (i) the Refinancing Indebtedness has a
Stated Maturity no earlier than the Stated Maturity of the Indebtedness being
Refinanced, (ii) the Refinancing Indebtedness has an Average Life at the time
such Refinancing Indebtedness is Incurred that is equal to or greater than the
Average Life of the Indebtedness being refinanced, (iii) such Refinancing
Indebtedness is Incurred in an aggregate principal amount (or if issued with
original issue discount, an aggregate issue price) that is equal to or less than
the aggregate principal amount (or if issued with original issue discount, the
aggregate accreted value) then outstanding of the Indebtedness being Refinanced
and (iv) if the Indebtedness being Refinanced is subordinated in right of
payment to the Notes, such Refinancing Indebtedness is subordinated in right of
payment to the Notes at least to the same extent as the Indebtedness being
Refinanced; provided further, however, that Refinancing Indebtedness shall not
include (x) Indebtedness of a Restricted Subsidiary that Refinances Indebtedness
of the Company or (y) Indebtedness of the Company or a Restricted Subsidiary
that Refinances Indebtedness of an Unrestricted Subsidiary.
"Restricted Subsidiary" means any Subsidiary of the Company other than an
Unrestricted Subsidiary.
"Sale/Leaseback Transaction" means an arrangement relating to property now
owned or hereafter acquired by the Company or a Restricted Subsidiary whereby
the Company or a Restricted Subsidiary transfers such property to a Person and
the Company or such Restricted Subsidiary leases it from such Person, other than
leases between the Company and a Wholly Owned Subsidiary or between Wholly Owned
Subsidiaries.
"Secured Indebtedness" means any Indebtedness of the Company secured by a
Lien.
"Senior Indebtedness" of the Company means the principal of, premium (if
any) and accrued and unpaid interest on (including interest accruing on or after
the filing of any petition in bankruptcy or for reorganization of the Company,
regardless of whether or not a claim for post-filing interest is allowed in such
proceedings), and fees and other amounts owing in respect of, Bank Indebtedness
and all other Indebtedness of the Company, whether outstanding on the Closing
Date or thereafter Incurred, unless in the instrument creating or evidencing the
same or pursuant to which the same is outstanding it is provided that such
obligations are subordinated in right of payment to the Notes; provided,
however, that Senior Indebtedness shall not include (i) any obligation of the
Company to any Subsidiary, (ii) any liability for Federal, state, local or other
taxes owed or owing by the Company, (iii) any accounts payable or other
liability to trade creditors arising in the ordinary course of business
(including Guarantees thereof or instruments evidencing such liabilities), (iv)
any Indebtedness or obligation of the Company (and any accrued and unpaid
interest in respect thereof) that by its terms is subordinate or junior in any
respect to any other Indebtedness or obligation of the Company, including any
Subordinated Obligations, (v) any obligations with respect to any Capital Stock,
or (vi) any Indebtedness Incurred in violation of the Indenture.
"Significant Subsidiary" means any Restricted Subsidiary that would be a
"Significant Subsidiary" of the Company within the meaning of Rule 1-02 under
Regulation S-X promulgated by the Commission.
"Stated Maturity" means, with respect to any security, the date specified
in such security as the fixed date on which the final payment of principal of
such security is due and payable, including pursuant to any mandatory redemption
provision (but excluding any provision providing for the repurchase of such
security at the option of the holder thereof upon the happening of any
contingency beyond the control of the issuer unless such contingency has
occurred).
"Subordinated Obligation" means, with respect to any Person, any
Indebtedness of such Person (whether outstanding on the Closing Date or
thereafter Incurred) that is subordinate or junior in right of payment to the
Notes or any other indebtedness of such Person pursuant to a written agreement.
"Subsidiary" of any Person means any corporation, association, partnership
or other business entity of which more than 50% of the total voting power of
shares of Capital Stock or other interests (including
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partnership interests) entitled (without regard to the occurrence of any
contingency) to vote in the election of directors, managers or trustees thereof
is at the time owned or controlled, directly or indirectly, by (i) such Person,
(ii) such Person and one or more Subsidiaries of such Person or (iii) one or
more Subsidiaries of such Person.
"Subsidiary Guarantee" means each Guarantee of the obligations with respect
to the Notes issued by a Person pursuant to the terms of the Indenture.
"Subsidiary Guarantor" means any Person that has issued a Subsidiary
Guarantee.
"Telecommunications Assets" means all assets (including Capital Stock),
rights (contractual or otherwise) and properties, real or personal, whether
tangible or intangible, used or intended for use in connection with a
Telecommunications Business.
"Telecommunications Business" means the business of (i) transmitting, or
providing services relating to the transmission of, data, video or voice through
owned or leased transmission facilities, (ii) constructing, creating, developing
or marketing networks, related network transmission equipment, software and
other devices for use in a communication business or (iii) evaluating,
participating or pursuing any other activity or opportunity that is primarily
related to those identified in (i) or (ii) above; provided that the
determination of what constitutes a Telecommunications Business shall be made in
good faith by the Board of Directors of the Company.
"Temporary Cash Investments" means any of the following: (i) any investment
in direct obligations of the United States of America or any agency thereof or
obligations Guaranteed by the United States of America or any agency thereof,
(ii) investments in time deposit accounts, certificates of deposit and money
market deposits maturing within 180 days of the date of acquisition thereof
issued by a bank or trust company that is organized under the laws of the United
States of America, any state thereof or any foreign country recognized by the
United States of America having capital, surplus and undivided profits
aggregating in excess of $500.0 million (or the foreign currency equivalent
thereof) and whose long-term debt is rated "A" (or such similar equivalent
rating) or higher by at least one nationally recognized statistical rating
organization (as defined in Rule 436 under the Securities Act), (iii) repurchase
obligations with a term of not more than 30 days for underlying securities of
the types described in clause (i) above entered into with a bank meeting the
qualifications described in clause (ii) above, (iv) investments in commercial
paper, maturing not more than 90 days after the date of acquisition, issued by a
corporation (other than an Affiliate of the Company) organized and in existence
under the laws of the United States of America or any foreign country recognized
by the United States of America with a rating at the time as of which any
investment therein is made of "P-1" (or higher) according to Moody's Investors
Service, Inc. or "A-1" (or higher) according to Standard and Poor's Ratings
Service, a division of The McGraw-Hill Companies, Inc. ("S&P"), and (v)
investments in securities with maturities of six months or less from the date of
acquisition issued or fully guaranteed by any state, commonwealth or territory
of the United States of America, or by any political subdivision or taxing
authority thereof, and rated at least "A" by S&P or "A" by Moody's Investors
Service, Inc.
"TIA" means the Trust Indenture Act of 1939 (15 U.S.C.
sec.sec. 77aaa-77bbbb) as in effect on the date of the Indenture.
"Total Assets" means, with respect to any Person, the total Consolidated
assets of such Person and its Restricted Subsidiaries, as shown on the most
recent balance sheet of such Person.
"Total Consolidated Indebtedness" means, as of any date of determination,
an amount equal to the aggregate amount of all Indebtedness of the Company and
its Restricted Subsidiaries, determined on a Consolidated basis in accordance
with GAAP, outstanding as of such date of determination, after giving effect to
any Incurrence of Indebtedness and the application of the proceeds therefrom
giving rise to such determination.
"Trade Payables" means, with respect to any Person, any accounts payable or
any indebtedness or monetary obligation to trade creditors created, assumed or
Guaranteed by such Person arising in the ordinary course of business in
connection with the acquisition of goods or services.
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"Trustee" means the party named as such in the Indenture until a successor
replaces it and, thereafter, means the successor.
"Trust Officer" means the Chairman of the Board, the President or any other
officer or assistant officer of the Trustee assigned by the Trustee to
administer its corporate trust matters.
"Unrestricted Subsidiary" means (i) any Subsidiary of the Company that at
the time of determination shall be designated an Unrestricted Subsidiary by the
Board of Directors in the manner provided below and (ii) any Subsidiary of an
Unrestricted Subsidiary. The Board of Directors may designate any Subsidiary of
the Company (including any newly acquired or newly formed Subsidiary of the
Company) to be an Unrestricted Subsidiary unless (a) such Subsidiary or any of
its Subsidiaries owns any Capital Stock or Indebtedness of, or owns or holds any
Lien on any property of, the Company or any other Subsidiary of the Company that
is not a Subsidiary of the Subsidiary to be so designated; (b) a Default or
Event of Default shall have occurred and be continuing; or (c) immediately after
giving effect to such designation, the Company would not be able to Incur $1.00
of Indebtedness under paragraph (a) of the covenant entitled "-- Limitation on
Indebtedness"; provided, however, that either (A) the Subsidiary to be so
designated has total Consolidated assets of $1,000 or less or (B) if such
Subsidiary has Consolidated assets greater than $1,000, then such designation
would be permitted under the covenant titled "-- Limitation on Restricted
Payments". The Board of Directors may designate any Unrestricted Subsidiary to
be a Restricted Subsidiary; provided, however, that immediately after giving
effect to such designation (x) the Company could Incur $1.00 of additional
Indebtedness under paragraph (a) of the covenant described under "-- Certain
Covenants -- Limitation on Indebtedness" and (y) no Default shall have occurred
and be continuing. Any such designation of a Subsidiary as a Restricted
Subsidiary or Unrestricted Subsidiary by the Board of Directors shall be
evidenced to the Trustee by promptly filing with the Trustee a copy of the
resolution of the Board of Directors giving effect to such designation and an
Officers' Certificate certifying that such designation complied with the
foregoing provisions.
"U.S. Government Obligations" means direct obligations (or certificates
representing an ownership interest in such obligations) of the United States of
America (including any agency or instrumentality thereof) for the payment of
which the full faith and credit of the United States of America is pledged and
which are not callable or redeemable at the issuer's option.
"Voting Stock" of a Person means all classes of Capital Stock or other
interests (including partnership interests) of such Person then outstanding and
normally entitled (without regard to the occurrence of any contingency) to vote
in the election of directors, managers or trustees thereof.
"Wholly Owned Subsidiary" means a Restricted Subsidiary of the Company all
the Capital Stock of which (other than directors' qualifying shares) is owned by
the Company or another Wholly Owned Subsidiary.
DESCRIPTION OF THE WARRANTS
The Warrants were issued pursuant to a Warrant Agreement dated July 24,
1998 (the "Warrant Agreement"), between the Company and Bank of Montreal Trust
Company, as warrant agent (the "Warrant Agent"). The following summary of
certain provisions of the Warrant Agreement does not purport to be complete and
is qualified in its entirety by reference to all of the provisions of the
Warrant Agreement, including the definitions therein of certain terms.
Capitalized terms in this "Description of the Warrants" not defined in this
Offering Memorandum have the meanings assigned to them in the Warrant Agreement.
GENERAL
Each Warrant, when exercised, will entitle the holder thereof to purchase
10.125 shares of Common Stock from the Company at a price (the "Exercise Price")
of $0.01 per share. The Exercise Price and the number of shares of Common Stock
issuable upon exercise of a Warrant are both subject to adjustment in certain
cases. See "-- Adjustments" below. The Warrants initially entitle the holders
thereof to acquire, in the aggregate, 2,642,613 shares of Common Stock.
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The Warrants may be exercised at any time after the first anniversary of
the Issue Date; provided, however, that holders of Warrants will be able to
exercise their Warrants only if the Common Shelf Registration Statement (as
defined) relating to the Common Stock underlying the Warrants is effective or
the exercise of such Warrants is exempt from the registration requirements of
the Securities Act, and such securities are qualified for sale or exempt from
qualification under the applicable securities laws of the states or other
jurisdictions in which such holders reside. Unless earlier exercised, the
Warrants will expire on July 15, 2008. The Company will give notice of
expiration not less than 90 nor more than 120 days before the Expiration Date to
the registered holders of the then outstanding Warrants. If the Company fails to
give such notice, the Warrants will nevertheless expire and become void on the
Expiration Date. The Warrants will not trade separately from the Notes until the
Separation Date.
At the Company's option, fractional shares of Common Stock may not be
issued upon exercise of the Warrants. If any fraction of a share of Common Stock
would, except for the foregoing provision, be issuable upon the exercise of any
such Warrant (or specified portion thereof), the Company will pay an amount in
cash equal to the Current Market Value per share of Common Stock, as determined
on the day immediately preceding the date the Warrant is presented for exercise,
multiplied by such fraction, computed to the nearest whole cent.
Certificates for Warrants will be issued in fully registered form only. No
service charge will be made for registration of transfer or exchange upon
surrender of any Warrant Certificate at the office of the Warrant Agent
maintained for that purpose. The Company may require payment of a sum sufficient
to cover any tax or other governmental charge that may be imposed in connection
with any registration of transfer or exchange of Warrant Certificates.
In the event a bankruptcy, reorganization or similar proceeding is
commenced by or against the Company, a bankruptcy court may hold that
unexercised Warrants are executory contracts which may be subject to rejection
by the Company with approval of the bankruptcy court. As a result, holders of
the Warrants may, even if sufficient funds are available, not be entitled to
receive any consideration or may receive an amount less than they would be
entitled to if they had exercised their Warrants prior to the commencement of
any such bankruptcy, reorganization or similar proceeding.
CERTAIN TERMS
Exercise
In order to exercise all or any of the Warrants, the holder thereof is
required to surrender to the Warrant Agent the related Warrant Certificate and
pay in full the Exercise Price for each share of Common Stock or other
securities issuable upon exercise of such Warrants. The Exercise Price may be
paid (i) in cash or by certified or official bank check or by wire transfer to
an account designated by the Company for such purpose or (ii) without the
payment of cash, by reducing the number of shares of Common Stock that would be
obtainable upon the exercise of a Warrant and payment of the Exercise Price in
cash so as to yield a number of shares of Common Stock upon the exercise of such
Warrant equal to the product of (a) the number of shares of Common Stock for
which such Warrant is exercisable as of the date of exercise (if the Exercise
Price were being paid in cash) and (b) the Cashless Exercise Ratio (the
"Cashless Exercise"). The "Cashless Exercise Ratio" shall equal a fraction, the
numerator of which is the excess of the Current Market Value per share of Common
Stock on the Exercise Date over the Exercise Price per share as of the Exercise
Date and the denominator of which is the Current Market Value per share of the
Common Stock on the Exercise Date. Upon surrender of a Warrant Certificate
representing more than one Warrant in connection with the holder's option to
elect a Cashless Exercise, the number of shares of Common Stock deliverable upon
a Cashless Exercise shall be equal to the number of shares of Common Stock
issuable upon the exercise of Warrants that the holder specifies are to be
exercised pursuant to a Cashless Exercise multiplied by the Cashless Exercise
Ratio. All provisions of the Warrant Agreement shall be applicable with respect
to a surrender of a Warrant Certificate pursuant to a Cashless Exercise for less
than the full number of Warrants represented thereby.
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No Rights as Stockholders
The holders of unexercised Warrants are not entitled, by virtue of being
such holders, to receive dividends, to vote, to consent, to exercise any
preemptive rights or to receive notice as stockholders of the Company in respect
of any stockholders' meeting for the election of directors of the Company or any
other purpose, or to exercise any other rights whatsoever as stockholders of the
Company.
Mergers, Consolidations, etc.
If the Company consolidates with, merges with or into, or sells all or
substantially all of its assets to, another Person, each Warrant thereafter will
entitle the holder thereof to receive upon exercise thereof, per share of Common
Stock for which such Warrant is exercisable, the number of shares of common
stock or other securities or property which the holder of a share of Common
Stock is entitled to receive upon completion of such consolidation, merger or
sale of assets. However, if (i) the Company consolidates with, merges with or
into, or sells all or substantially all of its assets to, another Person and, in
connection therewith, the consideration payable to the holders of Common Stock
in exchange for their shares is payable solely in cash or (ii) there is a
dissolution, liquidation or winding-up of the Company, then the holders of the
Warrants will be entitled to receive distributions on an equal basis with the
holders of Common Stock or other securities issuable upon exercise of the
Warrants, as if the Warrants had been exercised immediately prior to such event,
less the Exercise Price. Upon receipt of such payment, if any, the Warrants will
expire and the rights of the holders thereof will cease. In the case of any such
merger, consolidation or sale of assets, the surviving or acquiring person and,
in the event of any dissolution, liquidation or winding-up of the Company, the
Company, must deposit promptly with the Warrant Agent the funds, if any,
required to pay the holders of the Warrants. After such funds and the
surrendered Warrant Certificates are received, the Warrant Agent is required to
deliver a check in such amount as is appropriate (or, in the case of
consideration other than cash, such other consideration as is appropriate) to
such Persons as it may be directed in writing by the holders surrendering such
Warrants.
ADJUSTMENTS
The number of shares of Common Stock issuable upon the exercise of the
Warrants and the Exercise Price will be subject to adjustment in certain events
including: (i) the payment by the Company of certain dividends (or other
distributions) on the Common Stock of the Company including dividends or
distributions payable in shares of Common Stock or other shares of the Company's
capital stock, (ii) subdivisions, combinations and certain reclassifications to
the Common Stock, (iii) the issuance to all holders of Common Stock of rights,
options or warrants entitling them to subscribe for shares of Common Stock, or
of securities convertible into or exchangeable or exercisable for shares of
Common Stock, for a consideration per share which is less than the Current
Market Value per share of the Common Stock, (iv) the issuance of shares of
Common Stock for a consideration per share which is less than the Current Market
Value per share of the Common Stock, and (v) the distribution to all holders of
the Common Stock of any of the Company's assets, debt securities or any rights
or warrants to purchase securities (excluding those rights and warrants referred
to in the foregoing clause (iii) and cash dividends and other cash distributions
from current or retained earnings other than any Extraordinary Cash Dividend).
No adjustment to the number of shares of Common Stock issuable upon the exercise
of the Warrants and the Exercise Price will be required in certain events
including: (i) the issuance of shares of Common Stock in bona fide public
offerings that are underwritten or in which a placement agent is retained by the
Company, (ii) the issuance of shares of Common Stock (including upon exercise of
options) pursuant to the terms of and in order to give effect to the 1997
Incentive Share Plan and (iii) the issuance of shares of Common Stock in
connection with acquisitions other than to affiliates of the Company.
In the event of a distribution to holders of Common Stock which results in
an adjustment to the number of shares of Common Stock or other consideration for
which a Warrant may be exercised, the holders of the Warrants may, in certain
circumstances, be deemed to have received a distribution subject to United
States Federal income tax as a dividend. See "Certain Federal Income Tax
Considerations".
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No adjustment in the Exercise Price will be required unless such adjustment
would require an increase or decrease of at least one percent in the Exercise
Price; provided, however, that any adjustment which is not made as a result of
this paragraph will be carried forward and taken into account in any subsequent
adjustment.
AMENDMENT
From time to time, the Company and the Warrant Agent, without the consent
of the holders of the Warrants, may amend or supplement the Warrant Agreement
for certain purposes, including curing defects or inconsistencies or making any
change that does not adversely affect the rights of any holder. Any amendment or
supplement to the Warrant Agreement that has an adverse effect on the interests
of the holders of the Warrants shall require the written consent of the holders
of a majority of the then outstanding Warrants. The consent of each holder of
the Warrants affected shall be required for any amendment pursuant to which the
Exercise Price would be increased or the number of shares of Common Stock
issuable upon exercise of Warrants would be decreased (other than pursuant to
adjustments provided in the Warrant Agreement).
REGISTRATION RIGHTS
Registration of Warrants. The Company is required under the Warrant
Agreement to file a shelf registration statement under the Securities Act
covering the resale of the Warrants by the holders thereof (the "Warrant Shelf
Registration Statement") within 45 days after the Issue Date and to use its best
efforts to cause the Warrant Shelf Registration Statement to be declared
effective under the Securities Act within 105 days after the date of original
issuance of the Warrants and to remain effective until the earliest of (i) such
time as all of the Warrants have been sold thereunder, (ii) two years after its
effective date and (iii) such time as the Warrants can be sold without
restriction under the Securities Act.
Each holder of Warrants that sells such Warrants pursuant to the Warrant
Shelf Registration Statement generally will be required to be named as a selling
securityholder in the related prospectus and to deliver a prospectus to the
purchaser, will be subject to certain of the civil liability provisions under
the Securities Act in connection with such sales and will be bound by certain
provisions of the Warrant Agreement which are applicable to such holder
(including certain indemnification obligations). In addition, each holder of
Warrants will be required to deliver information to be used in connection with
the Warrant Shelf Registration Statement in order to have its Warrants included
in the Warrant Shelf Registration Statement.
Registration of Underlying Common Stock. The Company is required under the
Warrant Agreement to file a shelf registration statement under the Securities
Act covering the issuance of shares of Common Stock to the holders of the
Warrants upon exercise of the Warrants by the holders thereof (the "Common Shelf
Registration Statement") and to use its best efforts to cause the Common Shelf
Registration Statement to be declared effective on or before 365 days after the
Issue Date and to remain effective until the earlier of (i) such time as all
Warrants have been exercised and (ii) the Expiration Date.
During any consecutive 365-day period, the Company shall be entitled to
suspend the availability of each of the Warrant Shelf Registration Statement and
the Common Shelf Registration Statement for up to two 45 consecutive-day periods
(except for the 45 consecutive-day period immediately prior to the Expiration
Date) if the Board of Directors of the Company determines in the exercise of its
reasonable judgment that there is a valid business purpose for such suspension
and provides notice that such determination was made to the holders of the
Warrants; provided, however, that in no event shall the Company be required to
disclose the business purpose for such suspension if the Company determines in
good faith that such business purpose must remain confidential. There can be no
assurance that the Company will be able to file, cause to be declared effective,
or keep a registration statement continuously effective until all of the
Warrants have been exercised or have expired.
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CERTAIN DEFINITIONS
The Warrant Agreement contains, among others, the following definitions:
"Current Market Value" per share of Common Stock or any other security
at any date means (i) if the security is not registered under the Exchange
Act, (a) the value of the security, determined in good faith by the Board
of Directors of the Company and certified in a board resolution, based on
the most recently completed arm's-length transaction between the Company
and a Person other than an Affiliate of the Company, the closing of which
shall have occurred on such date or within the six-month period preceding
such date, or (b) if no such transaction shall have occurred on such date
or within such six-month period, the value of the security as determined by
a nationally recognized investment banking firm or (ii) if the security is
registered under the Exchange Act, the average of the daily closing bid
prices (or the equivalent in an over-the-counter market) for each Business
Day during the period commencing 15 Business Days before such date and
ending on the date one day prior to such date, or if the security has been
registered under the Exchange Act for less than 15 consecutive Business
Days before such date, then the average of the daily closing bid prices (or
such equivalent) for all of the Business Days before such date for which
daily closing bid prices are available; provided, however, that if the
closing bid price is not determinable for at least ten Business Days in
such period, the "Current Market Value" of the security shall be determined
as if the security were not registered under the Exchange Act.
"Issue Date" means the date on which the Warrants are initially
issued.
"Person" means any individual, corporation, partnership, joint
venture, limited liability company, association, joint-stock company,
trust, unincorporated organization, government or any agency or political
subdivision thereof or any other entity.
"Warrant Certificates" mean the registered certificates (including the
Global Warrants (as defined)) issued by the Company under the Warrant
Agreement representing the Warrants.
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
GENERAL
The following is a summary of material United States Federal income tax
consequences relevant in the opinion of Winstead Sechrest & Minick P.C., counsel
to the Company, to the Exchange Offer and the acquisition, ownership and
disposition of the Exchange Notes, but does not purport to be a complete
analysis of all potential tax effects. This summary is based upon the Internal
Revenue Code of 1986, as amended (the "Code"), existing and proposed regulations
thereunder (the "Regulations"), published rulings and court decisions, all as in
effect and existing on the date hereof and all of which are subject to change at
any time, which change may be retroactive. Such counsel has relied upon
representations by the Company and its officers with respect to factual matters
for purposes of this summary. This summary is not binding on the Internal
Revenue Service or on the courts, and no ruling will be requested from the
Internal Revenue Service on any issues described below. There can be no
assurance that the Internal Revenue Service will not take a different position
concerning the matters discussed below and that such positions of the Internal
Revenue Service would not be sustained.
This summary applies only to U.S. Holders (as defined below) that are the
initial holders of the Original Notes and the Exchange Notes, who acquired the
Notes for cash and who hold the Notes as capital assets. It does not address the
tax consequences to taxpayers who are subject to special rules (such as
financial institutions, tax-exempt organizations, insurance companies, dealers
in securities or currencies and persons who hold Notes as a hedge or as a
position in a "straddle" for tax purposes). A "U.S. Holder" means a beneficial
owner of a Note who purchased the Notes pursuant to the offering of the Original
Notes that is for U.S. federal income tax purposes (i) a citizen or resident of
the United States; (ii) a corporation, partnership or other entity created or
organized in or under the laws of the United States or any political subdivision
thereof; (iii) an estate the income of which is subject to U.S. federal income
taxation regardless of its source; or (iv) a trust if (A) a court within the
United States is able to exercise primary supervision over the
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<PAGE> 122
administration of the trust and (B) one or more U.S. fiduciaries have the
authority to control all substantial decisions of the trust.
THE FOLLOWING DISCUSSION IS FOR GENERAL INFORMATION ONLY. EACH HOLDER OF A
NOTE IS STRONGLY URGED TO CONSULT WITH ITS OWN TAX ADVISORS TO DETERMINE THE
IMPACT OF SUCH HOLDER'S TAX SITUATION ON THE ANTICIPATED TAX CONSEQUENCES,
INCLUDING THE TAX CONSEQUENCES UNDER STATE, LOCAL, FOREIGN OR OTHER TAX LAWS, OF
THE ACQUISITION, OWNERSHIP AND DISPOSITION OF THE NOTES.
THE EXCHANGE
The exchange of the Original Notes for the Exchange Notes pursuant to the
Exchange Offer should not be a taxable event to the holder and thus the holder
should not recognize any taxable gain or loss as a result of the exchange. A
holder's adjusted tax basis in the Exchange Notes will be the same as its
adjusted tax basis in the Original Notes exchanged therefor, and its holding
period for the Original Notes will be included in its holding period for the
Exchange Notes. To the extent that a holder acquired the Original Notes at a
market discount or with amortizable bond premium, such discount or premium would
generally carry over to the Exchange Notes received in exchange for the Original
Notes. Such holders should consult their tax advisers regarding the United
States federal income tax treatment of market discount or amortizable bond
premium.
TAXATION OF THE NOTES
The stated interest payable on the Notes generally will be taxable to a
holder of Notes as ordinary income at the time that it is paid or accrued in
accordance with the holder's method of accounting for Federal income tax
purposes.
The Notes were issued with de minimis original issue discount ("OID") for
Federal income tax purposes. A debt instrument generally is issued with de
minimis OID if the amount by which its stated redemption price at maturity
exceeds its issue price is less than the product of .0025 multiplied by the
product of the stated redemption price at maturity and the number of complete
years to maturity from the issue date. De minimis OID is recognized as capital
gain upon the redemption, sale or other taxable disposition of the debt
instrument.
The issue price of the Notes is determined by allocating the "issue price"
of the Units between the Notes and the Warrants based on their relative fair
market values. The issue price of the Units was the first price at which a
substantial amount of the Units were sold for money. For purposes of determining
the issue price of the Notes, sales to bond houses, brokers or similar persons
or organizations acting in the capacity of underwriters, placement agents or
wholesalers are ignored. For purposes of determining whether OID is de minimis,
the issue price of the Notes is equal to the amount so allocated to the Notes.
The Company's allocation will be binding on a holder (but not on the Internal
Revenue Service) unless the holder discloses a different allocation on an
attachment to the holder's timely filed Federal income tax return for the
taxable year that includes the acquisition date of the Unit. The Company intends
to allocate 98.9% and 1.1% of the initial issue price of the Units to the Notes
and the Warrants, respectively.
Sale, Retirement or Other Taxable Disposition. Gain or loss upon a sale or
other disposition of a Note will be measured by the difference between the
amount of cash and the fair market value of property received with respect to
such sale and the holder's adjusted tax basis in such Note. A holder's adjusted
tax basis in a Note generally will be equal to the portion of the cost of the
Unit allocated to the Note (i.e., in the case of an initial purchaser in the
Offering, the Note's issue price. Such gain or loss generally will be capital
gain or loss, and will be long-term capital gain or loss if the holder held the
Note for more than one year.
Effect of Change of Control. Upon a Change of Control, each holder will
have the right to require the Company to repurchase all or any part of such
holder's Notes for a price equal to 101% of the principal amount thereof plus
accrued and unpaid interest and liquidated damages, if any, to the date of
payment. Under the Regulations, a provision such as the Change of Control
redemption requirement will not affect the
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<PAGE> 123
yield or maturity date of the Notes unless, based on all facts and circumstances
as of the date of issuance, it is more likely than not that a Change of Control
giving rise to the redemption will occur. The Company will not treat the Change
of Control redemption provision of the Notes as affecting the calculation of the
yield to maturity of any Note.
INFORMATION REPORTING AND BACKUP WITHHOLDING
The backup withholding and information reporting requirements may apply to
certain payments of principal and interest on a Note and to certain payments or
proceeds of the sale or retirement of a Note. The Company, its agent, a broker,
the Trustee or any paying agent, as the case may be, is required to withhold tax
from any payment that is subject to backup withholding at a rate of 31% of such
payment if the holder fails to furnish its taxpayer identification number
(social security number or employer identification number), to certify that such
holder is not subject to backup withholding rules. Certain holders (including,
among others, all corporations) are not subject to the backup withholding and
reporting requirements.
Under current Treasury regulations, backup withholding and information
reporting do not apply to payments made by the Company or any agent thereof (in
its capacity as such) to a holder of a Note who has provided the required
certification under penalties of perjury that it is not a U.S. Holder or has
otherwise established an exemption (provided that neither the Company nor such
agent has actual knowledge that the holder is a U.S. Holder or that the
conditions of any other exemption are not in fact satisfied).
Any amounts withheld under the backup withholding rules from a payment to a
holder may be claimed as a credit against such holder's United States federal
income tax liability.
PLAN OF DISTRIBUTION
Each broker-dealer that receives Exchange Notes for its own account
pursuant to the Exchange Offer must acknowledge that it will deliver a
prospectus in connection with any resale of such Exchange Notes. This
Prospectus, as it may be amended or supplemented from time to time, may be used
by a broker-dealer in connection with resales of Exchange Notes received in
exchange for Original Notes where such Original Notes were acquired as a result
of market-making activities or other trading activities. The Company has agreed
that for a period of 180 days after the Expiration Date, it will make this
Prospectus, as amended or supplemented, available to any broker-dealer for use
in connection with any such resale.
The Company will not receive any proceeds from any sales of the Exchange
Notes by broker-dealers. Exchange Notes received by broker-dealers for their own
account pursuant to the Exchange Offer may be sold from time to time in one or
more transactions in the over-the-counter market, in negotiated transactions,
through the writing of options on the Exchange Notes or a combination of such
methods of resale, at market prices prevailing at the time of resale, at prices
related to such prevailing market prices or negotiated prices. Any such resale
may be made directly to the purchaser or to or through brokers or dealers who
may receive compensation in the form of commissions or concessions from any such
broker-dealer and/or the purchasers of any such Exchange Notes. Any
broker-dealer that resells the Exchange Notes that were received by it for its
own account pursuant to the Exchange Offer and any broker or dealer that
participates in a distribution of such Exchange Notes may be deemed to be an
"underwriter" within the meaning of the Securities Act and any profit on any
such resale of Exchange Notes and any commissions or concessions received by any
such persons may be deemed to be underwriting compensation under the Securities
Act. The Letter of Transmittal states that by acknowledging that it will deliver
and by delivering a prospectus, a broker-dealer will not be deemed to admit that
it is an "underwriter" within the meaning of the Securities Act.
For a period of 180 days after the Expiration Date, the Company will
promptly send additional copies of this Prospectus and any amendment or
supplement to this Prospectus to any broker-dealer that requires such documents
in the Letter of Transmittal. The Company has agreed to pay all expenses
incident to the Exchange Offer, other than commissions or concessions of any
brokers or dealers, and will indemnify the holders of the Original Notes
(including any broker-dealers) against certain liabilities, including
liabilities under the Securities Act.
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<PAGE> 124
LEGAL MATTERS
Certain legal matters with respect to the Exchange Notes being offered
hereby will be passed upon for the Company by Winstead Sechrest & Minick P.C.,
Houston, Texas.
EXPERTS
The financial statements of Splitrock Services, Inc., as of December 31,
1997 and for the period from inception (March 5, 1997) to December 31, 1997
included in this Prospectus have been so included in reliance on the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
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<PAGE> 125
GLOSSARY
ATM........................ Asynchronous Transfer Mode. A communications
standard that provides for information transfer in
the form of fixed-length cells of 53 bytes each.
The ATM format can be used to deliver data, video
and voice traffic at varying rates.
Backbone................... A centralized high-speed network that interconnects
smaller, independent networks.
Bandwidth.................. Bandwidth. The number of bits of information which
can move over a communications medium in a given
amount of time; the capacity of a
telecommunications circuit/network to carry data,
video and voice information. Typically measured in
Kbps and Mbps. Bandwidth from public networks is
typically available to business and residential
end-users in increments from 56 Kbps to T-3.
CLEC....................... Competitive local exchange carrier.
Dedicated lines............ Telecommunications lines dedicated or reserved for
use by particular customers along predetermined
routes.
Ethernet................... A LAN protocol which supports data transfer rates
of up to 10 Mbps.
Extranet................... An Intranet expanded to include selected business
partners through secured links on the Internet.
56k........................ Equivalent to a single high-speed telephone service
line; capable of transmitting one voice call or 56
Kbps of data. Currently in widespread use by medium
and large businesses primarily for entry level
high-speed data and very low-speed video
applications.
Frame relay................ A communications standard that is optimized for
efficient switching of variable-length data
packets.
Host....................... A computer with direct access to the Internet.
ILEC....................... Incumbent local exchange carrier.
Internet................... An open global network of interconnected
commercial, educational and governmental computer
networks which utilize TCP/IP, a common
communications protocol.
Internet dial access....... Communications circuit that is established by a
switched-circuit connection using the telephone
network.
Intranet................... A TCP/IP based network and Web site which is
securely isolated from the Internet and serves the
internal needs of a company or institution.
IP......................... Internet protocol. Network protocols that allow
computers with different architectures and
operating system software to communicate with other
computers on the Internet.
ISDN....................... Integrated Services Digital Network. A network that
provides digital, voice and data services through a
single medium.
ISP........................ Internet service provider. Companies formed to
provide access to the Internet to consumers and
business customers via local networks.
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IXC........................ Interexchange Carrier. A telecommunications company
that provides telecommunications services between
local exchanges on an interstate or intrastate
basis.
K or Kbps.................. Kilobits per second. A measure of digital
information transmission rates. One kilobit equals
1,000 bits of digital information. Normally, 10
bits are used for each alpha-numeric character.
LAN........................ Local Area Network. A data communications network
designed to interconnect personal computers,
workstations, minicomputers, file servers and other
communications and computing devices within a
localized environment.
LEC........................ Local Exchange Carrier. A telecommunications
company that provides telecommunications services
in a geographic area in which calls generally are
transmitted without toll charges.
Mbps....................... Megabits per second. A measure of digital
information transmission rates. One megabit equals
1,000 kilobits.
Modem...................... A device for transmitting information over an
analog communications channel such as a POTS
telephone circuit.
NAP........................ Network access point.
Network.................... A collection of distributed computers which share
data and information through inter-connected lines
of communication.
NOC........................ Network operations center.
OC-3....................... An optical data communications line capable of
transmitting data at 155 Mbps.
Peering.................... The commercial practice under which nationwide ISPs
exchange each other's traffic, in most cases
without the payment of settlement charges.
POPs....................... Points-of-Presence. An interlinked group of modems,
routers and other computer equipment, located in a
particular city or metropolitan area, that allows a
nearby subscriber to access the Internet through a
local telephone call or using a short-distance
permanent data circuit.
PRI........................ Primary Rate Interface. ISDN interface to primary
rate access.
Protocol................... A formal description of message formats and the
rules two or more machines must follow in order to
communicate.
PSTN....................... Public Switched Telephone Network. That portion of
a local exchange company's network available to all
users generally on a shared basis (i.e., not
dedicated to a particular user).
RBOC....................... Regional Bell Operating Company.
Router..................... A device that receives and transmits data packets
between segments in a network or different
networks.
Server..................... Software that allows a computer to offer a service
to another computer. Other computers contact the
server program by means of matching client
software. The term also refers to the computer on
which server software runs.
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<PAGE> 127
SS7........................ Signaling System No. 7. The current (seventh)
version of the protocol used by switches to
establish a connection or call feature between
central offices.
Standards compliant........ A network or system that is compatible with
established industry standards or protocols.
TCP/IP..................... Transmission Control Protocol/Internet Protocol. A
compilation of network and transport-level
protocols that allow computers with different
architectures and operating system software to
communicate with other computers on the Internet.
T-1........................ A data communications line capable of transmitting
data at 1.5 Mbps.
T-3 or DS-3................ A data communications line capable of transmitting
data at 45 Mbps.
UNIX....................... A computer operating system for workstations and
personal computers and noted for its portability
and communications functionality.
VPN........................ Virtual Private Network. A network providing secure
transmission of IP traffic through the Internet.
WAN........................ Wide Area Network. A network spanning a wide
geographic area.
Web or World Wide Web...... A network of computer servers that uses a special
communications protocol to link different servers
throughout the Internet and permits communication
of graphics, video and sound.
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SPLITROCK SERVICES, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
FINANCIAL STATEMENTS:
Report of Independent Accountants......................... F-2
Balance Sheet as of December 31, 1997..................... F-3
Statement of Operations for the Period from Inception
(March 5, 1997) Through December 31, 1997.............. F-4
Statement of Stockholders' Equity for the Period from
Inception (March 5, 1997) Through December 31, 1997.... F-5
Statement of Cash Flows for the Period from Inception
(March 5, 1997) Through December 31, 1997.............. F-6
Notes to Financial Statements............................. F-7
INTERIM FINANCIAL STATEMENTS (UNAUDITED):
Condensed Balance Sheet as of June 30, 1998............... F-14
Condensed Statement of Operations for the Period from
Inception (March 5, 1997) Through June 30, 1997 and for
the Six Months Ended June 30, 1998..................... F-15
Condensed Statement of Stockholders' Equity for the Period
from Inception (March 5, 1997) through June 30, 1997
and for the Six Months Ended June 30, 1998............. F-16
Condensed Statement of Cash Flows for the Period from
Inception (March 5, 1997) Through June 30, 1997 and for
the Six Months Ended June 30, 1998..................... F-17
Notes to Condensed Financial Information.................. F-18
</TABLE>
F-1
<PAGE> 129
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Splitrock Services, Inc.
In our opinion, the accompanying balance sheet and the related statements
of operations, of stockholders' equity and of cash flows present fairly, in all
material respects, the financial position of Splitrock Services, Inc. at
December 31, 1997, and the results of its operations and its cash flows for the
period from inception (March 5, 1997) to December 31, 1997 in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audit. We conducted our audit
of these statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Houston, Texas
April 2, 1998
F-2
<PAGE> 130
SPLITROCK SERVICES, INC.
BALANCE SHEET
DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
ASSETS
<TABLE>
<S> <C>
Current assets:
Cash and cash equivalents................................. $ 7,710
Restricted cash equivalent................................ 3,472
Accounts receivable....................................... 4,252
Prepaids and other current assets......................... 221
--------
Total current assets.............................. 15,655
Property and equipment, net................................. 38,504
Other assets................................................ 229
--------
$ 54,388
========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of capital lease obligations........... $ 11,010
Accounts payable.......................................... 3,086
Accrued liabilities....................................... 5,775
--------
Total current liabilities......................... 19,871
Capital lease obligations................................... 13,110
Note payable to stockholder................................. 1,000
--------
Total liabilities................................. 33,981
Stockholders' equity:
Common Stock, $.001 par value, 150,000,000 shares
authorized, 76,800,000 shares issued and outstanding... 77
Additional paid-in capital................................ 30,451
Accumulated deficit....................................... (10,121)
--------
Total stockholders' equity........................ 20,407
--------
Commitments and contingencies (Note 6)...................... --
--------
$ 54,388
========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE> 131
SPLITROCK SERVICES, INC.
STATEMENT OF OPERATIONS
PERIOD FROM INCEPTION (MARCH 5, 1997) THROUGH DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<S> <C>
Revenue..................................................... $ 22,708
Operating expenses:
Network personnel costs................................... 437
Network operating costs................................... 1,925
Legacy Network costs...................................... 25,341
Severance costs........................................... 463
Selling, general and administrative....................... 1,276
Depreciation and amortization............................. 3,500
--------
32,942
--------
Loss from operations........................................ (10,234)
Other income (expense):
Interest income........................................... 348
Interest expense.......................................... (235)
--------
Loss before income taxes.................................... (10,121)
Provision for income taxes.................................. --
--------
Net loss.................................................... $(10,121)
========
Loss per share -- basic and diluted......................... $ (0.24)
========
Weighted average shares -- basic and diluted................ 42,824
========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE> 132
SPLITROCK SERVICES, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
PERIOD FROM INCEPTION (MARCH 5, 1997) THROUGH DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
COMMON STOCK
-------------- ADDITIONAL COMMON
PAR PAID-IN STOCK ACCUMULATED
SHARES VALUE CAPITAL WARRANTS DEFICIT TOTAL
------ ----- ---------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Initial capitalization.............. 28,000 $28 -- -- -- $ 28
Issuances of common stock for cash
of $0.625 per share and
warrants.......................... 32,800 33 $20,467 -- -- 20,500
Conversion of note payable to common
stock at $0.625 per share......... 16,000 16 9,984 -- -- 10,000
Net loss............................ $(10,121) (10,121)
------ --- ------- -------- -------- --------
Balance at December 31, 1997........ 76,800 $77 $30,451 -- $(10,121) $ 20,407
====== === ======= ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE> 133
SPLITROCK SERVICES, INC.
STATEMENT OF CASH FLOWS
PERIOD FROM INCEPTION (MARCH 5, 1997) THROUGH DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<S> <C>
Cash flows from operating activities:
Net loss.................................................. $(10,121)
Adjustments to reconcile net loss to net cash used by
operating activities:
Depreciation and amortization.......................... 3,500
Increase in accounts receivable........................ (4,252)
Increase in prepaids and other current assets.......... (221)
Increase in accounts payable and accrued liabilities... 8,861
--------
Net cash used by operating activities.................. (2,233)
--------
Cash flows from investing activities:
Purchase of equipment..................................... (16,969)
Increase in other assets.................................. (229)
--------
Net cash used by investing activities.................. (17,198)
--------
Cash flows from financing activities:
Sale of common stock and warrants......................... 20,528
Proceeds from notes payable to stockholder................ 11,750
Proceeds from sale-leaseback of equipment................. 1,152
Payments on notes payable to stockholder.................. (750)
Payments on capital lease obligations..................... (2,067)
Restriction of cash under credit agreement................ (3,472)
--------
Net cash provided by financing activities.............. 27,141
--------
Increase in cash and cash equivalents....................... 7,710
Cash and cash equivalents:
Beginning of period....................................... --
--------
End of period............................................. $ 7,710
========
Supplemental cash flow information:
Cash paid for interest.................................... $ 235
========
Noncash investing and financing activities:
Assumption of capital lease obligations and other
liabilities (Note 2)................................... $ 5,900
========
Capital lease obligations incurred........................ $ 20,916
========
Conversion of note payable to stockholder into common
stock.................................................. $ 10,000
========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE> 134
SPLITROCK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS
PERIOD FROM INCEPTION (MARCH 5, 1997) THROUGH DECEMBER 31, 1997
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Splitrock Services, Inc. (the "Company") was formed as a Texas corporation
on March 5, 1997. The Company was formed to build a nationwide, facilities-based
telecommunications network with the goal of providing telecommunications
services. The Company has designed and is in the process of deploying a network
based on Asynchronous Transfer Mode (ATM) switching technology which it believes
will provide high quality communications services on a flexible multi-service
platform. This platform flexibility will allow the Company to expand its service
offerings to provide fully integrated data, video and voice services and to
incorporate future technological innovations into its Network architecture with
a lower incremental investment than that required by other, less flexible,
networks. On June 24, 1997, the Company entered into a four-year service
agreement to provide Internet dial access services to Prodigy (Note 2).
During 1997, the Company launched the network construction program based on
ATM technology. This program was organized in two phases. As of December 31,
1997, the Company was in Phase I of the Network build which encompassed the
replacement of the network facilities previously owned by Prodigy (Note 2). The
Company anticipates the completion of Phase I in the first half of 1998.
In addition to the development of a new telecommunications network, the
Company has been engaged in recruiting management and operational personnel and
structuring financing for the Company's operations. The development of the
network will require substantial capital expenditures. Management of the Company
believes that funding from affiliates of its stockholders or other sources will
be sufficient to fund the Company's operations for the next twelve months.
The following is a summary of the Company's significant accounting
policies:
Revenue Recognition. The Company recognizes revenue when services are
provided and collectibility is deemed probable under its agreement with its
customer. Prodigy was the Company's only customer through December 31,
1997. Prodigy may terminate its agreement with the Company without payment
of future minimum service fees or the termination charge (Note 2) in the
event of certain defaults by the Company, including documented failures
(without cure) to meet certain network performance standards.
Legacy Network Costs. The Legacy Network refers to certain assets
which the Company acquired from Prodigy on July 1, 1997 related to
Prodigy's existing network infrastructure in order to provide services to
Prodigy while the Splitrock Network is being fully deployed (Note 2).
Legacy Network costs include amounts incurred under a network
infrastructure support agreement with Prodigy. These costs include all
expenses incurred in connection with the operation of the Legacy Network,
including facility fees, line charges, personnel costs, occupancy costs and
equipment maintenance costs.
Property and Equipment. Property and equipment are stated at cost.
Depreciation and amortization of new property and equipment, including
assets under capital leases, is provided upon installation using the
straight-line method over the estimated useful lives of three to five
years. Previously used equipment is depreciated over its estimated useful
life of nine months to three years.
Long-Lived Assets. The Company reviews for the impairment of
long-lived assets whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. The carrying amount
of a long-lived asset is considered impaired when anticipated undiscounted
cash flows expected to result from the use of the asset and its eventual
disposition are less than its carrying amount. The Company believes that no
material impairment exists at December 31, 1997.
Income Taxes. Deferred tax assets and liabilities are determined based
on the temporary differences between the financial statement carrying
amounts and the tax bases of assets and liabilities using
F-7
<PAGE> 135
SPLITROCK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
the enacted tax rates in effect in the years in which the differences are
expected to reverse. In estimating future tax consequences, all expected
future events are considered other than enactments of changes in the tax
law or rates.
Cash and Cash Equivalents. The Company considers highly liquid
investments with an original maturity of three months or less from the date
of purchase to be classified as cash and cash equivalents. The restricted
cash equivalent is a three-month time deposit held as collateral on a
letter of credit.
Concentration of Credit Risk. Financial instruments which potentially
subject the Company to concentration of credit risk are primarily cash and
cash equivalents and receivables. The Company's cash investment policies
limit investments to short-term, investment grade instruments with quality
financial institutions. The Company's revenues and its trade receivable
balance for the period ended December 31, 1997 were derived solely from
services provided to Prodigy, the Company's sole customer during this
period. Any interruption of this relationship could adversely affect the
Company. Management believes that the risk of incurring material losses
related to these credit risks are remote.
Net Loss Per Share. In February 1997, Statement of Financial
Accounting Standards No. 128 ("FAS 128") Earnings Per Share was issued. FAS
128 is effective for both interim and annual periods ending after December
15, 1997. The Company adopted the pronouncement for the period ended
December 31, 1997. FAS 128 requires the Company to report both basic
earnings per share, which is based on the weighted average number of common
shares outstanding, and diluted earnings per share, which is based on the
weighted average number of common shares outstanding and all dilutive
potential common shares outstanding. At December 31, 1997, options to
acquire 1,880,000 shares of common stock at the exercise price of $0.625
and a warrant to purchase 5,000,000 shares of common stock at $0.625 were
not included in the computation of diluted earnings per share because their
effect is anti-dilutive.
Stock-Based Compensation. The Company has adopted Statement of
Financial Accounting Standards No. 123 ("FAS 123"), Accounting for
Stock-Based Compensation, for disclosure purposes. Under FAS 123, the
Company measures compensation expense for its stock-based employee
compensation plan using the intrinsic value method prescribed in APB No.
25, Accounting for Stock Issued to Employees, and provides disclosure of
the effect of net income as if the fair value-based method prescribed in
FAS 123 has been applied in measuring compensation expense.
Fair Values of Financial Instruments. Due to the short-term nature of
the Company's financial instruments, as well as their interest rates and
terms, management believes the carrying values of the Company's assets and
liabilities approximate their fair values.
Use of Estimates. The preparation of the Company's financial
statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the
reported amounts of assets, liabilities, revenues and expenses, as well as
disclosures of contingent assets and liabilities. Because of inherent
uncertainties in this process, actual future results could differ from
those expected at the reporting date. Management believes the estimates are
reasonable.
New Accounting Pronouncements. In June 1997, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 130,
Reporting Comprehensive Income, and No. 131, Disclosures about Segments of
an Enterprise and Related Information. In February 1998, the Board issued
Statement of Financial Accounting Standards No. 132, Employers' Disclosures
about Pensions and Other Postretirement Benefits. The Company will adopt
these statements in 1998. As these statements only require additional
disclosures in the Company's financial statements, their adoption will not
have any effect on the Company's financial position or results of
operations.
F-8
<PAGE> 136
SPLITROCK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. PRODIGY TRANSACTIONS
On June 24, 1997, the Company entered a four-year Full Service Agreement
with Prodigy, in which the Company agreed to provide certain network services to
Prodigy from July 1, 1997 through June 30, 2001 for a price per hour of usage as
stipulated, subject to minimum and maximum amounts. Monthly minimum service
commitments set each year under this four-year contract range from $3,000 to
$4,500. Monthly maximum service commitments are based on average usage per
subscriber and the number of subscribers. Prodigy may terminate the Full Service
Agreement without payment of future minimum service fees or the termination
charge in an event of default by the Company; such defaults include documented
failures (without cure) to meet certain network performance standards. The
Company is subject to several financial covenants through June 30, 1999 under
this agreement, including the maintenance of at least $5,000 in net tangible
worth. The agreement also allows Prodigy to terminate its arrangement with the
Company at any time upon the payment of a termination charge.
Also on June 24, 1997, the Company entered into a Definitive Agreement with
Prodigy pursuant to which the Company acquired selected data transmission
equipment from Prodigy. In consideration for the equipment, the Company assumed
approximately $5,900 in equipment lease obligations and other liabilities.
The Company also entered into an agreement with Prodigy in which Prodigy
agreed to provide certain network infrastructure support for the Company for the
period July 1, 1997 through December 31, 1997. The Company incurred expenses of
$25,804 (which includes $463 of severance costs) under this agreement during
1997, of which $5,194 remained payable to Prodigy at December 31, 1997. These
services included the services of selected Prodigy employees and services
provided under vendor arrangements related to the Prodigy network
infrastructure. The costs of these services and other reasonable and customary
charges incurred by Prodigy in connection with the continued operations of the
network during this transition period are reimbursable by the Company. The
Company assumed no contractual liabilities of any services related to Prodigy's
existing network infrastructure as part of the transition agreement.
3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
1997
------------
<S> <C>
Network equipment........................................... $ 3,464
Office and other equipment.................................. 94
Network equipment under construction........................ 12,248
--------
15,806
Less -- accumulated depreciation............................ (103)
--------
Purchased property and equipment, net..................... 15,703
--------
Leased network equipment.................................... 13,648
Leased office and other equipment........................... 388
Leased network equipment under construction................. 12,162
--------
26,198
Less -- accumulated amortization............................ (3,397)
--------
Leased property and equipment, net........................ 22,801
--------
Property and equipment, net................................. $ 38,504
========
</TABLE>
F-9
<PAGE> 137
SPLITROCK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
4. INDEBTEDNESS
The components of indebtedness are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1997
------------
<S> <C>
Capital lease obligations................................... $ 24,120
Note payable to stockholder................................. 1,000
--------
25,120
Less -- current maturities.................................. (11,010)
--------
$ 14,110
========
</TABLE>
Capital leases require payments on a monthly basis over periods ranging
from 24 to 48 months, with implicit interest rates of 9% to 12%.
In December 1997, the Company borrowed $1,000 from a stockholder. The
unsecured note has a stated rate of interest of 9.75% and provides for monthly
interest payments beginning February 1, 1998, with the principal due on demand
after December 31, 1998, and maturing December 31, 2002.
5. INCOME TAXES
A provision for income taxes for the period ended December 31, 1997 has not
been recognized as the Company had operating losses for both tax and financial
reporting purposes. Due to the uncertainty surrounding the timing of realizing
the benefits of its favorable tax attributes in future tax returns, the Company
has recorded a full valuation allowance against its otherwise recognizable net
deferred tax asset.
Deferred tax assets at December 31, 1997 consist of the following:
<TABLE>
<S> <C>
Net operating loss carryforward............................. $ 3,248
Depreciation................................................ 167
Other....................................................... 21
-------
Gross deferred tax assets................................. 3,436
Valuation allowance......................................... (3,436)
-------
Net deferred tax assets................................... $ --
=======
</TABLE>
The Company's net operating loss carryforward of approximately $9,500
expires in 2012. Certain changes in ownership of the Company could result in
limitations on the Company's ability to utilize the losses.
6. COMMITMENTS AND CONTINGENCIES
The Company leases office space, equipment facilities and equipment under
noncancelable operating and capital leases expiring through the year 2002. Rent
expense for noncancelable operating leases amounted to $218 in 1997.
The Company leases telephone lines ("line costs") from competitive local
exchange suppliers, interchange carriers and long distance telephone companies
primarily for access and transport purposes. These line costs are leased under
both cancelable and noncancelable operating leases over periods up to three
years and are included in Legacy Network costs on the statement of operations.
Certain cancellation charges could become applicable upon termination of a
number of these agreements. Line costs incurred during the period from inception
(March 5, 1997) to December 31, 1997 comprise a substantial portion of the
Legacy Network costs.
F-10
<PAGE> 138
SPLITROCK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Future minimum payments by year and in the aggregate related to
noncancelable operating and capital leases at December 31, 1997 are:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES TOTAL
------- --------- -------
<S> <C> <C> <C>
1998.................................................. $12,049 $ 457 $12,506
1999.................................................. 7,893 553 8,446
2000.................................................. 5,548 553 6,101
2001.................................................. 427 565 992
2002.................................................. -- 578 578
------- ------ -------
Total minimum lease payments................ 25,917 $2,706 $28,623
------- ====== =======
Less amount representing interest........... (1,797)
-------
Present value of minimum capital lease payments....... $24,120
=======
</TABLE>
The Company has an agreement to purchase certain network equipment from the
Vendor (Note 9) over an eighteen-month period ending December 31, 1998. Total
commitments remaining under the agreement approximated $9,045 at December 31,
1997.
The Company has an outstanding letter of credit in the amount of $3,472 as
of December 31, 1997. This letter of credit is maintained as security for
performance under a certain capital lease obligation. This letter of credit is
secured by the restricted cash equivalent shown on the balance sheet.
As of December 31, 1997, the Company has an agreement with a
telecommunications company to pay a minimum of $1,266 for network installation
services over a period ending June 30, 1998. Total commitments remaining under
this agreement approximated $1,160 at December 31, 1997.
7. COMMON STOCK EXCHANGE
The Company effected a 1-for-100 stock exchange on June 3, 1997 and a
1-for-10 stock exchange on August 8, 1997. All share amounts included in these
financial statements have been adjusted to reflect the effect of the stock
exchanges.
8. STOCK OPTIONS
The Company's 1997 Incentive Share Plan (the Plan) provides that options to
purchase up to 20,000,000 shares of common stock may be granted to certain
directors, employees or consultants of the Company. Options under the Plan have
a term of ten years and are granted with an exercise price equivalent to market
value at the date of grant. Individual option grants vest over time, based upon
a schedule approved by the Board of Directors, which is generally four years.
All of the Company's common stock options vest automatically upon a change in
control of the Company, as defined.
The following summarizes the activity for the Plan:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE EXERCISE
SHARES PRICE
--------- ----------------
<S> <C> <C>
Balance, March 5, 1997...................................... -- --
Granted................................................... 1,880,000 $0.625
Exercised................................................. -- --
Canceled.................................................. -- --
--------- ------
Balance, December 31, 1997.................................. 1,880,000 $0.625
</TABLE>
F-11
<PAGE> 139
SPLITROCK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes information about the Company's stock
options outstanding at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------- -----------------------
NUMBER WEIGHTED- NUMBER
OUTSTANDING AVERAGE WEIGHTED EXERCISABLE WEIGHTED
RANGE OF AT REMAINING AVERAGE AT AVERAGE
EXERCISE DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
PRICES 1997 LIFE PRICE 1997 PRICE
--------------- ------------ ----------- -------- ------------ --------
<S> <C> <C> <C> <C> <C>
$0.625 1,880,000 9.58 years $0.625 257,000 $0.625
</TABLE>
The Company has adopted the disclosure-only provisions of FAS No. 123.
Accordingly, no compensation cost has been recognized for fixed options granted
to Company employees. Had compensation cost for the Company's stock option plan
been determined based on the fair value at the grant date for awards in 1997
consistent with the provisions of SFAS No. 123, the Company's pro forma net loss
would have been as follows (in thousands):
<TABLE>
<CAPTION>
PRO FORMA
YEAR ENDED
DECEMBER 31,
1997
------------
<S> <C>
Net loss....................................... $(10,141)
Net loss per share -- basic and diluted........ (0.24)
</TABLE>
Options granted in 1997 had weighted-average fair values of $0.077. The Company
used the minimum value method to estimate the fair values of options for the
above pro forma information. For purposes of the minimum value method, the
Company used average U.S. government security interest rates for its risk-free
interest rates, assumed no volatility or future dividends and assumed expected
life of the options of five years in 1997.
9. RELATED PARTY TRANSACTIONS
The Company's chairman of the Board of Directors (the Chairman), who is
also a shareholder of the Company, is the Chief Technical Officer and assistant
vice chairman and stockholder of a vendor (the Vendor) from which the Company
purchased approximately $16,500 in equipment through December 31, 1997.
Remaining commitments pursuant to a purchase agreement with the vendor
approximate $9,045 at December 31, 1997.
The Company also retained the Vendor to perform assembly services related
to the deployment of network equipment to the field. The Company incurred
approximately $1,500 for these services of which approximately $990 were
expensed in 1997. As of December 31, 1997, the Company owed $1,461 to the
Vendor.
Linsang, a stockholder (an affiliate of the Chairman) has agreed to lend up
to $10,000 to the Company for the purchase of certain network equipment. This
affiliate had loaned $1,000 to the Company, which remained outstanding as of
December 31, 1997. During the three months ended March 31, 1998 the affiliate
made further advances under this agreement (Note 10).
In September 1997, a wholly-owned subsidiary of a major stockholder of
Prodigy, the Company's sole customer, purchased 20,000,000 shares of the Company
for $0.625 per share and paid $0.1 for a warrant to purchase an additional
5,000,000 shares of the Company through September 18, 1998 for $0.625 per share.
F-12
<PAGE> 140
SPLITROCK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
10. SUBSEQUENT EVENTS
In March, 1998, the Company exercised its early purchase option under a
capital lease arrangement with AT&T Capital Corporation. The Company paid $3,455
to liquidate the obligation. Accordingly, the obligation is classified as
current indebtedness as of December 31, 1997.
In January 1998, the Company borrowed $3,000 from Linsang, a stockholder.
The note has a stated rate of interest of 9.75% and provides for monthly
interest payments beginning March 1, 1998, with the principal due on demand
after December 31, 1998. The note matures on December 31, 2002. The Company
borrowed $2,000 from the same stockholder in March 1998 on terms substantially
the same as the previous note.
F-13
<PAGE> 141
SPLITROCK SERVICES, INC.
CONDENSED BALANCE SHEET
JUNE 30, 1998
(UNAUDITED)
(IN THOUSANDS)
ASSETS
<TABLE>
<S> <C>
Current assets:
Cash and cash equivalents................................. $ 5,177
Restricted cash equivalent................................ --
Accounts receivable....................................... 6,238
Prepaids and other current assets......................... 420
-------
Total current assets.............................. 11,835
Property and equipment, net................................. 43,148
Other assets................................................ 2,647
-------
$57,630
=======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of capital leases...................... $ 8,600
Note payable.............................................. 1,477
Accounts payable.......................................... 11,042
Accrued liabilities....................................... 5,013
-------
Total current liabilities......................... 26,132
Capital lease obligations................................... 12,619
Notes payable to stockholder................................ 11,000
-------
Total liabilities................................. 49,751
-------
Stockholders' equity:
Common stock.............................................. 78
Additional paid-in capital................................ 31,550
Accumulated deficit....................................... (23,749)
-------
Total stockholders' equity........................ 7,879
-------
Commitments and contingencies............................... --
-------
$57,630
=======
</TABLE>
The accompanying notes are an integral part of these unaudited condensed
financial statements.
F-14
<PAGE> 142
SPLITROCK SERVICES, INC.
CONDENSED STATEMENT OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
PERIOD FROM INCEPTION
(MARCH 5, 1997) THROUGH SIX MONTHS ENDED
JUNE 30, 1997 JUNE 30, 1998
----------------------- ----------------
<S> <C> <C>
Revenue................................................. $ -- $ 32,214
Operating Expenses:
Network personnel costs............................... -- 2,156
Network operating costs............................... -- 9,402
Legacy Network costs.................................. -- 27,090
Selling, general and administrative................... 125 1,628
Depreciation and amortization......................... -- 4,907
------- --------
Total operating expenses...................... 125 45,183
------- --------
Loss from operations.................................... (125) (12,969)
Other income (expense):
Interest income....................................... 30 183
Interest expense...................................... -- (842)
------- --------
Loss before income taxes................................ (95) (13,628)
Provision for income taxes.............................. -- --
------- --------
Net loss................................................ $ (95) $(13,628)
======= ========
Loss per share -- basic and diluted..................... $ (0.01) $ (0.18)
======= ========
Weighted average shares -- basic and diluted............ 11,525 76,888
======= ========
</TABLE>
The accompanying notes are an integral part of these unaudited condensed
financial statements.
F-15
<PAGE> 143
SPLITROCK SERVICES, INC.
CONDENSED STATEMENT OF STOCKHOLDERS' EQUITY
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONAL COMMON
PAR PAID-IN STOCK ACCUMULATED
SHARES VALUE CAPITAL WARRANTS DEFICIT TOTAL
------- ----- ---------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Initial capitalization............. 28,000 $28 $ -- -- $ -- $ 28
Net loss........................... -- -- -- -- (95) (95)
------ --- ------- -------- -------- --------
Balance at June 30, 1997........... 28,000 28 -- -- (95) (95)
Issuances of common stock for cash
of $0.625 per share and
warrants......................... 32,800 33 20,467 -- -- 20,500
Conversion of note payable to
common stock at $0.625 per
share............................ 16,000 16 9,984 -- -- 10,000
Net loss........................... -- -- -- -- (10,026) (10,026)
------ --- ------- -------- -------- --------
Balance at December 31, 1997....... 76,800 77 30,451 -- (10,121) 20,407
Net loss........................... -- -- -- -- (13,628) (13,628)
Stock options exercises............ 1,000 1 1,099 -- -- 1,100
------ --- ------- -------- -------- --------
Balance at June 30, 1998........... 77,800 $78 $31,550 -- $(23,749) $ 7,879
====== === ======= ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these unaudited condensed
financial statements.
F-16
<PAGE> 144
SPLITROCK SERVICES, INC.
CONDENSED STATEMENT OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
PERIOD FROM INCEPTION
(MARCH 5, 1997) THROUGH SIX MONTHS ENDED
JUNE 30, 1997 JUNE 30, 1998
----------------------- ----------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss.............................................. $ (95) $(13,628)
Adjustments to reconcile net loss to net cash used by
operating activities:
Depreciation and amortization...................... -- 4,907
Changes in operating assets and liabilities
Accounts receivable................................ -- (1,986)
Prepaids and other current assets.................. -- (199)
Accounts payable................................... 92 7,956
Accrued liabilities................................ -- (762)
-------- --------
Net cash used by operating activities......... (3) (3,712)
-------- --------
INVESTING ACTIVITIES:
Purchase of property and equipment.................... (2,078) (5,548)
Increase in other assets.............................. -- (2,166)
-------- --------
Net cash used by investing activities......... (2,078) (7,714)
-------- --------
FINANCING ACTIVITIES:
Net proceeds from issuance of common stock............ 28 1,100
Borrowings under notes payable........................ -- 1,477
Proceeds from sale-leaseback of equipment............. -- 440
Release of restriction on cash under credit
agreement.......................................... -- 3,472
Principal payments on capital leases.................. -- (7,172)
Borrowings under notes payable to stockholder......... 10,750 10,000
Financing costs incurred.............................. -- (424)
-------- --------
Net cash provided by financing activities..... 10,778 8,893
-------- --------
Net increase (decrease) in cash......................... 8,697 (2,533)
Cash and equivalents at beginning of period............. -- 7,710
-------- --------
Cash and equivalents at end of period................... $ 8,697 $ 5,177
======== ========
NONCASH INVESTING AND FINANCING ACTIVITIES:
Capital lease obligations incurred.................... $ -- $ 4,055
======== ========
</TABLE>
The accompanying notes are an integral part of these unaudited condensed
financial statements.
F-17
<PAGE> 145
SPLITROCK SERVICES, INC.
NOTES TO CONDENSED FINANCIAL INFORMATION
SIX MONTHS ENDED JUNE 30, 1998
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
1. BASIS OF PRESENTATION
The interim financial statements of Splitrock Services, Inc. (the Company)
as of June 30, 1998, for the period from inception (March 5, 1997) through June
30, 1997 and for the six months ended June 30, 1998 are unaudited. They do not
include all information and notes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, such
financial statements include all adjustments, consisting only of normal
recurring adjustments necessary for a fair presentation of financial position,
results of operations, and cash flows for the periods presented.
The financial statements presented herein should be read in connection with
the Company's financial statements as of December 31, 1997 and for the period
from Inception (March 5, 1997) to December 31, 1997.
2. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
The Company was incorporated in Texas on March 5, 1997 and reincorporated
in Delaware on May 8, 1998.
The Company was formed to build a nationwide, facilities-based
telecommunications network with the goal of providing telecommunications
services on an advanced nationwide network. The Company has designed and is in
the process of deploying a network based on Asychronous Transfer Mode (ATM)
technology which it believes will provide high quality communications services
on a flexible multi-service platform.
During 1997, the Company launched a major network rebuilding program based
on ATM technology. This program was organized in two phases. As of June 30,
1998, the Company had completed Phase I of the network build which encompassed
the buildout of the nationwide ATM backbone and operational points of presence
in 70 metropolitan areas. During the second quarter of 1998, the Company had
begun the Phase II Expansion but no sites in this Phase were operational.
In addition to the development of a new telecommunications network, the
Company has been engaged in recruiting management and operational personnel and
structuring financing for the Company's operations.
Upon completion of the network build, the Company will offer basic
transport services to other internet service providers and will be positioned to
provide other value-added data, voice and video products to business customers.
Revenue Recognition. The Company recognizes revenue when services are
provided and collectibility is deemed probable under its agreement with its
primary customer. Prodigy was the Company's major customer (99% of revenue for
the six months ended June 30, 1998) through June 30, 1998, providing
substantially all of the Company's revenues. Prodigy may terminate its agreement
with the Company without payment of future minimum service fees or the
termination charge in the event of certain defaults by the Company, including
documented failures (without cure) to meet certain network performance
standards.
Property and Equipment. Property and equipment are stated at cost.
Depreciation and amortization of new property and equipment, including assets
under capital leases, is provided upon installation using the straight-line
method over their estimated useful lives of three to five years. Previously used
equipment is depreciated over its estimated useful life of nine months to three
years.
Net Loss Per Share. In February 1997, Financial Accounting Standards No.
128 ("FAS 128") Earnings Per Share was issued. FAS 128 is effective for both
interim and annual periods ending after December 15,
F-18
<PAGE> 146
SPLITROCK SERVICES, INC.
NOTES TO CONDENSED FINANCIAL INFORMATION -- (CONTINUED)
1997. The Company adopted the pronouncement for all periods presented. FAS 128
requires the Company to report both basic earnings per share, which is based on
the weighted average number of common shares outstanding, and diluted earnings
per share, which is based on the weighted average number of common shares
outstanding and all dilutive potential common shares outstanding. At June 30,
1998, 3,400,500 options to acquire shares of common stock at the
weighted-average exercise price of $0.77 and a warrant to purchase 5,000,000
shares of common stock at $0.625 were not included in the computation of diluted
earnings per share because their effect is anti-dilutive.
Comprehensive Income. Effective January 1, 1998, the Company adopted
Statement of Financial Accounting Standards No. 130, Reporting Comprehensive
Income ("FAS 130"). This Statement establishes standards for reporting and
display of comprehensive income and its components. For the six-month period
ended June 30, 1998 comprehensive net loss, as determined under FAS 130, was the
same as net loss reported in the Statement of Operations.
New Accounting Pronouncement. On June 15, 1998, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards No.
133, Accounting for Derivative Instruments and Hedging Activities ("FAS 133").
FAS 133 is effective for all fiscal quarters of all fiscal years beginning after
June 15, 1999 (January 1, 2000 for the Company). FAS 133 requires that all
derivative instruments be recorded on the balance sheet at their fair value.
Changes in the fair value of derivatives are recorded each period in current
earnings or other comprehensive income, depending on whether a derivative is
designed as part of a hedge transaction and, if it is, the type of hedge
transaction. Management of the Company anticipates that, due to its expected
limited or no use of derivative instruments, the adoption of FAS 133 will not
have a significant effect on the Company's results of operations or its
financial position.
3. INDEBTEDNESS
Components of indebtedness are summarized as follows:
<TABLE>
<CAPTION>
JUNE 30,
1998
--------
<S> <C>
Capital lease obligations................................... $ 21,219
Notes payable to stockholder................................ 11,000
Notes payable............................................... 1,477
--------
33,696
Less -- current maturities.................................. (10,077)
--------
$ 23,619
========
</TABLE>
In January 1998, the Company borrowed $3,000 from a stockholder. The note
has a stated rate of interest of 9.75% and provides for monthly interest
payments beginning March 1, 1998, with the principal due on demand after
December 31, 1998. The note matures on December 31, 2002. The Company borrowed
$2,000 and $5,000 from the same stockholder in March 1998 and June 1998,
respectively, on terms substantially the same as the previous note. The Notes
were refinanced in July, 1998 in connection with the Unit Offering.
In March 1998, the Company exercised its early purchase option under a
capital lease arrangement with AT&T Capital Corporation. The Company paid $3,455
to liquidate the obligation.
In April 1998, the Company entered into an agreement with a
telecommunications equipment supplier to obtain equipment and services for the
deployment of 99 points of presence. The Company obtained a $5,000 credit
facility from the same company (the Lender) to be used solely for the purchase
of such equipment and services. Borrowings on the credit facility bear an annual
rate of interest at 11%, with interest payable monthly, commencing on June 1,
1998. All principal and accrued interest is due the earlier of (i) the date the
Company
F-19
<PAGE> 147
SPLITROCK SERVICES, INC.
NOTES TO CONDENSED FINANCIAL INFORMATION -- (CONTINUED)
sells any of its equity securities or debt instruments (other than issuances to
officers, directors, employees or consultants in the ordinary course of
business) and the net proceeds to the Company are in an aggregate amount equal
to or greater than the then outstanding principal amount of the credit facility
or (ii) October 30, 1998. The Lender may extend the maturity to April 1, 2001
subject to the issuance of a transferable, noncallable stock purchase warrant
giving the Lender the right to purchase 1,111,000 shares of the Company's common
stock at an exercise price based upon the lower of $1.00 per share or the lowest
price at which shares of common stock are issued during the period from the date
the warrants are issued to the date the warrants expire (eight years following
issuance). Upon extension, the credit facility will have a stated rate of
interest of LIBOR plus 5.75% and a default rate of interest on all amounts not
paid when due of an additional 2%. The extended facility provides for monthly
interest payments through January 2, 1999, with the principal due in ten equal
consecutive quarterly installments commencing on January 2, 1999. At June 30,
1998, the Company had borrowed $1,477 under this credit facility presented as a
note payable on the face of the balance sheet.
4. INCOME TAXES
A provision for income taxes for the period from inception (March 5, 1997)
to June 30, 1997 or for the six months ended June 30, 1998 has not been
recognized as the Company had operating losses for both tax and financial
reporting purposes. Certain changes in the ownership of the Company could result
in limitations on the Company's ability to utilize the losses.
5. EQUITY
A director of the Company exercised an option to purchase one million
shares of Company common stock for $1,100 in June 1998.
6. SUBSEQUENT EVENTS
On July 24, 1998, the Company sold 261,000 Units consisting of $261,000
principal amount of 11 3/4% Senior Notes due 2008 and Warrants to purchase
2,642,613 shares of common stock (the Offering). In connection with the
Offering, the Company repaid the amount outstanding, $1,477, under the $5,000
credit facility discussed above and refinanced $11,000 of indebtedness owed to
Linsang, a stockholder of the Company. In connection with the refinancing, the
stockholder received 11,000 Units in the Offering. The net proceeds to the
Company, after Offering expenses, approximated $240,400.
On September 14, 1998, Orient Star, a wholly owned subsidiary of a major
stockholder of Prodigy exercised its warrant to purchase an additional 5,000,000
shares of the Company for $0.625 per share.
F-20
<PAGE> 148
- ------------------------------------------------------
- ------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS OFFERING MEMORANDUM, AND, IF
GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED. THIS OFFERING MEMORANDUM DOES NOT CONSTITUTE AN OFFER TO
SELL OR THE SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE
SECURITIES TO WHICH IT RELATES OR ANY OFFER TO SELL OR THE SOLICITATION OF AN
OFFER TO BUY SUCH SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR
SOLICITATION IS UNLAWFUL. NEITHER THE DELIVERY OF THIS OFFERING MEMORANDUM NOR
ANY OFFER OR SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY
IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE
THE DATE HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY
TIME SUBSEQUENT TO ITS DATE.
---------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Summary............................... 6
Risk Factors.......................... 20
Use of Proceeds....................... 35
Capitalization........................ 36
The Exchange Offer.................... 37
Selected Historical and Unaudited Pro
Forma Financial Data................ 46
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 50
Industry Overview..................... 62
Business.............................. 65
Management............................ 81
Principal Stockholders................ 88
Description of Certain Indebtedness... 89
Description of Capital Stock.......... 89
Description of the Notes.............. 90
Description of the Warrants........... 116
Certain Federal Income Tax
Considerations...................... 120
Plan of Distribution.................. 122
Legal Matters......................... 123
Experts............................... 123
Glossary.............................. 124
Index to Financial Statements......... F-1
</TABLE>
---------------------
UNTIL , 1998 (90 DAYS AFTER COMMENCEMENT OF THIS OFFERING), ALL
DEALERS EFFECTING TRANSACTIONS IN THE EXCHANGE NOTES, WHETHER OR NOT
PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
(SPLITROCK LOGO)
$250,000,000
SPLITROCK SERVICES, INC.
OFFER TO EXCHANGE
11 3/4% SERIES B SENIOR NOTES DUE 2008
FOR OUTSTANDING 11 3/4% SENIOR NOTES
DUE 2008
-----------------
PROSPECTUS
-----------------
, 1998
- ------------------------------------------------------
- ------------------------------------------------------
<PAGE> 149
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Splitrock is incorporated under the laws of the State of Delaware. Section
145 of the General Corporation Law of the State of Delaware ("Section 145")
provides that a Delaware corporation may indemnify any person who was or is a
party or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding, whether civil, criminal, administrative or
investigative, by reason of the fact that such person is or was an officer,
director, employee or agent of such corporation, or is or was serving at the
request of such corporation as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust or enterprise, including an
employee benefit plan. The indemnity may include expenses (including attorneys'
fees), judgments, fines and amounts paid in settlement actually and reasonably
incurred by such person in connection with such action, suit or proceeding,
provided that such person acted in good faith and in a manner he reasonably
believed to be in or not opposed to the corporation's best interests and, with
respect to any criminal action or proceeding, had no reasonable cause to believe
that his conduct was unlawful, except that no indemnification shall be made in
connection with any action or suit by or in the right of the corporation to
procure a judgment in its favor in respect of any claim, issue, or matter as to
which such person shall have been adjudged to be liable to the corporation
unless and only to the extent that the Court of Chancery or the court in which
such action or suit was brought shall determine upon application that, despite
the adjudication of liability but in view of all the circumstances of the case,
such person is fairly and reasonably entitled to indemnity for such expenses
that such court deems proper. The termination of any action, suit, or proceeding
by judgment, order, settlement, conviction or upon a plea of nolo contendere or
its equivalent, shall not, of itself, create a presumption that the person did
not act in good faith and in a manner which he reasonably believed to be in or
not opposed to the best interests of the corporation, and, with respect to any
criminal action or proceeding, had reasonable cause to believe that his conduct
was unlawful.
Section 145 also provides that to the extent that a director, officer,
employee or agent of the corporation has been successful on the merits or
otherwise in defense of any action, suit or proceeding referred to above, or in
defense of any claim, issue or matter therein, the corporation must indemnify
him against expenses (including attorneys' fees) actually and reasonably
incurred by him in connection therewith.
Section 145 further provides that any indemnification (unless ordered by a
court) must be made only as authorized in the specific case upon a determination
that indemnification of the director, officer, employee or agent is proper in
the circumstances because he has met the applicable standard of conduct set
forth above. Section 145 also provides that expenses (including attorneys' fees)
incurred by an officer or director in defending or settling any civil, criminal,
administrative or investigative action, suit or proceeding may be paid by the
corporation 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 is ultimately determined that he is not
entitled to be indemnified by the corporation. Additionally, Section 145
provides that the indemnification and advancement of expenses provided by, or
granted pursuant to, Section 145 shall not exclude any other rights to which a
person seeking indemnification or advancement of expenses may be entitled under
any bylaw, agreement, vote of stockholders or disinterested directors or
otherwise, both as to action in his official capacity and as to action in
another capacity while holding such office.
Article IX of Splitrock's Certificate of Incorporation requires Splitrock
to indemnify Splitrock's directors and officers to the extent permitted under
Section 145.
Article VII of Splitrock's Bylaws also provides that Splitrock shall
indemnify any person who was or is a party or is threatened to be made a party
to any threatened, pending, or completed action, suit, or proceeding whether
civil, criminal, administrative, or investigative, by reason of the fact that he
is or was a director or officer of Splitrock, or is or was serving at the
request of Splitrock as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust, or other enterprise, in
accordance with provisions corresponding to Section 145. Further, Splitrock's
Bylaws provide that any person, other than an officer or director, who was or is
a party or is threatened to be made a party to any threatened, pending, or
completed
II-1
<PAGE> 150
action, suit or proceeding, whether civil, criminal, administrative, or
investigative, by reason of the fact that he is or was an employee or agent of
Splitrock, or was serving at the request of Splitrock as a director, officer,
employee or agent of another corporation, partnership, joint venture, trust, or
other enterprise, and who desires indemnification shall make written application
for such indemnification to the Board of Directors for its determination that
indemnification is appropriate, and if so, to what extent.
Section 145 further provides that a corporation may purchase and maintain
insurance on behalf of any person who is or was a director, officer, employee or
agent of the corporation, or is or was serving at the request of the corporation
as a director, officer, employee or agent of another corporation, partnership,
joint venture, trust or other enterprise against any liability asserted against
him and incurred by him in any such capacity, or arising out of his status as
such, whether or not the corporation would have the authority to indemnify him
against such liability and expenses under the provisions described in the
preceding paragraphs. Splitrock maintains liability insurance covering its
directors and officers.
Section 102(b)(7) of the General Corporation Law of the State of Delaware
permits a Delaware corporation to include a provision in its Certificate of
Incorporation eliminating or limiting the personal liability of a director to
the corporation or its stockholders for monetary damages for breach of fiduciary
duty as a director, except (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) pursuant to Section 174 of the General Corporation Law of the State of
Delaware (providing for liability of directors for unlawful payment of dividends
or unlawful stock purchases or redemptions), or (iv) for any transaction from
which the director derived an improper personal benefit. Article VIII of
Splitrock's Certificate of Incorporation eliminates liability of directors of
Splitrock to Splitrock or its shareholders for monetary damages for breach of
fiduciary duty to the extent permitted by Section 102(b)(7) of the General
Corporation Law of the State of Delaware.
The foregoing discussion is qualified in its entirety by reference to the
General Corporation Law of the State of Delaware and Splitrock's Certificate of
Incorporation and Bylaws.
Splitrock's Bylaws also provide that Splitrock may indemnify, to the extent
of the provisions set forth therein, any person other than an officer or
director who was or is a party or is threatened to be made a party to any
threatened, pending or completed action, suit or proceeding, whether civil,
criminal, administrative or investigative, by reason of the fact that he is or
was an employee or agent of Splitrock, or was serving at the request of
Splitrock as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, if such person makes
written application for such indemnification to the Splitrock Board and the
Splitrock Board determines that indemnification is appropriate and the extent
thereof.
Splitrock's Bylaws further provide that the indemnification described
therein is not exclusive, and shall not exclude any other rights to which the
person seeking to be indemnified may be entitled under statute, any bylaw,
agreement, vote of shareholders or disinterested directors, or otherwise, both
as to action in his official capacity and to his action in another capacity
while holding such office.
The above discussion of Section 145 and of Splitrock's Certificate of
Incorporation and Bylaws is not intended to be exhaustive and is respectively
qualified in its entirety by such statute, the Certificate of Incorporation and
the By-laws.
II-2
<PAGE> 151
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following exhibits have been previously filed or, if noted with an
asterisk, are filed herewith:
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF EXHIBIT
----------- ----------------------
<C> <S>
1.1 -- Purchase Agreement dated July 21, 1998 between the
Company and Chase Securities Inc.
2.1 -- Plan of Merger effective May 8, 1998 between the Company
and Splitrock Services, Inc., a Texas corporation.
3.1 -- Certificate of Incorporation of the Company filed with
the Secretary of State of the State of Delaware on April
15, 1998.
3.2 -- Bylaws of the Company, adopted April 27, 1998.
4.1 -- Specimen 11 3/4% Senior Note due 2008.
*4.2 -- Specimen 11 3/4% Series B Senior Note due 2008.
4.3 -- Escrow and Disbursement Agreement dated as of July 24,
1998, among The Chase Manhattan Bank (as escrow agent),
Bank of Montreal Trust Company, and the Company.
4.4 -- Indenture dated as of July 24, 1998, between Bank of
Montreal Trust Company (as trustee) and the Company,
including table of contents and cross-reference sheet.
4.5 -- Exchange and Registration Rights Agreement dated as of
July 24, 1998 between Chase Securities Inc. and the
Company.
*5 -- Opinion of Winstead Sechrest & Minick P.C.
10.1 -- Splitrock Full Service Agreement dated as of June 24,
1997 between the Company and Prodigy Services
Corporation.
10.2 -- Definitive Agreement dated as of June 24, 1997 by and
between Prodigy Services Corporation and the Company.
10.3 -- Transition Services Agreement dated as of June 24, 1997
between Prodigy Services Corporation and the Company.
10.4 -- Network Implementation Agreement effective as of April
23, 1998 by and between the Company and Ericsson, Inc.
10.5 -- Security Agreement dated as of April 30, 1998 by and
between the Company and Ericsson.
10.6 -- Yurie Equipment Purchase Agreement effective July 1, 1997
between the Company and Yurie.
10.7 -- Customer Service Agreement effective April 1, 1998
between the Company and IBM Global Services Network.
10.8 -- IBM Customer Agreement effective April 1, 1998 between
the Company and International Business Machines
Corporation
10.9 -- Product Support Services Agreement dated February 27,
1998, together with Addendum effective March 1, 1998
10.10 -- Option Agreement dated May 28, 1998 between the Company
and Clark McLeod.
10.11 -- Form of Notes between the Company and Linsang.
10.12 -- Warrant Agreement dated as of July 24, 1998 between the
Company and Bank of Montreal Trust Company, as Warrant
Agent.
10.13 -- 1997 Incentive Share Plan.
10.14 -- Employment Agreement effective September 1, 1997 between
William R. Wilson and the Company (filed as Exhibit 10.14
to Registration Statement No. 333-63001 and incorporated
herein by this reference).
</TABLE>
II-3
<PAGE> 152
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF EXHIBIT
----------- ----------------------
<C> <S>
10.15 -- Employment Agreement effective September 1, 1997 between
Patrick J. McGettigan, Jr. and the Company.
10.16 -- Option to subscribe to purchase 5,000,000 shares of
common stock of the Company for $3.1 million, registered
in the name of Orient Star.
12 -- Statement re computation of ratios (filed as Exhibit 12
to Registration Statement No. 333-63001 and incorporated
herein by this reference).
*23.1 -- Consent of Winstead Sechrest & Minick P.C. (set forth in
Exhibit 5).
*23.2 -- Consent of PricewaterhouseCoopers LLP.
24 -- Powers of Attorney(3).
25 -- Statement of Eligibility of Bank of Montreal Trust
Company.
27 -- Financial Data Schedule (filed as Exhibit 27 to
Registration Statement No. 333-63001 and incorporated
herein by this reference).
99.1 -- Form of Letter of Transmittal.
99.2 -- Form of Notice of Guaranteed Delivery.
99.3 -- Form of Letter to Brokers.
99.4 -- Form of Letter to Clients.
99.5 -- Instructions to Registered Holder and/or Book Entry
Transfer Participant from Beneficial Owner.
99.6 -- Guidelines for Certificate of Taxpayer Identification
Number on Substitute Form W-9.
</TABLE>
(b) Financial Statement Schedules (filed as Schedule II to Registration
Statement No. 333-63001 and incorporated herein by this reference).
ITEM 22. UNDERTAKINGS
(i) The undersigned registrant hereby undertakes that prior to any public
reoffering of the securities registered hereunder through use of a prospectus
which is a part of this registration statement, by any person or party who is
deemed to be an underwriter within the meaning of Rule 145(c), such reoffering
prospectus will contain the information called for by the applicable
registration form with respect to reofferings by persons who may be deemed
underwriters, in addition to the information called for by the other Items of
the applicable form. Every prospectus (i) that is filed in accordance with the
undertaking above or (ii) that purports to meet the requirements of section
10(a)(3) of the Securities Act and is used in connection with an offering of
securities subject to Rule 415, will be filed as a part of an amendment to the
registration statement and will not be used until such amendment is effective,
and that, for purposes of determining liability under the Securities Act, each
such post-effective amendment shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering thereof.
(ii) The undersigned registrant hereby undertakes to respond to requests
for information that is incorporated by reference into the prospectus pursuant
to Item 4, 10(b), 11 or 13 of this Form, within one business day of receipt of
such request, and to send the incorporated documents by first class mail or
other equally prompt means. This includes information contained in documents
filed subsequent to the effective date of the registration statement through the
date of responding to the request.
(iii) The undersigned registrant hereby undertakes to supply by means of a
post-effective amendment all information concerning a transaction, and the
company being acquired involved therein, that was not the subject of and
included in the registration statement when it became effective.
(iv) 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 20
II-4
<PAGE> 153
above, or otherwise, the registrant has been advised that in the opinion of the
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 policy as expressed in the Securities Act and
will be governed by the final adjudication of such issue.
II-5
<PAGE> 154
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant has duly caused this Amendment No. 1 to the Registration Statement to
be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of The Woodlands, the State of Texas, on September 22, 1998.
SPLITROCK SERVICES, INC.
By: /s/ WILLIAM R. WILSON
----------------------------------
William R. Wilson
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 1 to the Registration Statement has been signed by the following persons on
behalf of the registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ WILLIAM R. WILSON President, Chief Executive September 22, 1998
- ----------------------------------------------------- Officer and Director
(William R. Wilson) (Principal Executive
Officer)
/s/ JAMES D. LONG Senior Vice President, Chief September 22, 1998
- ----------------------------------------------------- Financial Officer and
(James D. Long) Director (Principal
Accounting Officer)
/s/ KWOK L. LI Chairman of the Board, September 22, 1998
- ----------------------------------------------------- Director
(Kwok L. Li)
*/s/ CLARK MCLEOD Director September 22, 1998
- -----------------------------------------------------
(Clark McLeod)
*/s/ SAMER SALAMEH Director September 22, 1998
- -----------------------------------------------------
(Samer Salameh)
*/s/ ROY A. WILKENS Director September 22, 1998
- -----------------------------------------------------
(Roy A. Wilkens)
*By: /s/ PATRICK J. MCGETTIGAN, JR.
------------------------------------------------
Patrick J. McGettigan, Jr.
Attorney-in-fact
</TABLE>
II-6
<PAGE> 155
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF EXHIBIT
----------- ----------------------
<C> <S>
1.1 -- Purchase Agreement dated July 21, 1998 between the
Company and Chase Securities Inc.
2.1 -- Plan of Merger effective May 8, 1998 between the Company
and Splitrock Services, Inc., a Texas corporation.
3.1 -- Certificate of Incorporation of the Company filed with
the Secretary of State of the State of Delaware on April
15, 1998.
3.2 -- Bylaws of the Company, adopted April 27, 1998.
4.1 -- Specimen 11 3/4% Senior Note due 2008.
*4.2 -- Specimen 11 3/4% Series B Senior Note due 2008.
4.3 -- Escrow and Disbursement Agreement dated as of July 24,
1998, among The Chase Manhattan Bank (as escrow agent),
Bank of Montreal Trust Company, and the Company.
4.4 -- Indenture dated as of July 24, 1998, between Bank of
Montreal Trust Company (as trustee) and the Company,
including table of contents and cross-reference sheet.
4.5 -- Exchange and Registration Rights Agreement dated as of
July 24, 1998 between Chase Securities Inc. and the
Company.
*5 -- Opinion of Winstead Sechrest & Minick P.C.
10.1 -- Splitrock Full Service Agreement dated as of June 24,
1997 between the Company and Prodigy Services
Corporation.
10.2 -- Definitive Agreement dated as of June 24, 1997 by and
between Prodigy Services Corporation and the Company.
10.3 -- Transition Services Agreement dated as of June 24, 1997
between Prodigy Services Corporation and the Company.
10.4 -- Network Implementation Agreement effective as of April
23, 1998 by and between the Company and Ericsson, Inc.
10.5 -- Security Agreement dated as of April 30, 1998 by and
between the Company and Ericsson.
10.6 -- Yurie Equipment Purchase Agreement effective July 1, 1997
between the Company and Yurie.
10.7 -- Customer Service Agreement effective April 1, 1998
between the Company and IBM Global Services Network.
10.8 -- IBM Customer Agreement effective April 1, 1998 between
the Company and International Business Machines
Corporation
10.9 -- Product Support Services Agreement dated February 27,
1998, together with Addendum effective March 1, 1998
10.10 -- Option Agreement between dated May 28, 1998 the Company
and Clark McLeod.
10.11 -- Form of Notes between the Company and Linsang.
10.12 -- Warrant Agreement dated as of July 24, 1998 between the
Company and Bank of Montreal Trust Company, as Warrant
Agent.
10.13 -- 1997 Incentive Share Plan.
10.14 -- Employment Agreement effective September 1, 1997 between
William R. Wilson and the Company (filed as Exhibit 10.14
to Registration Statement No. 333-63001 and incorporated
herein by this reference).
</TABLE>
<PAGE> 156
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF EXHIBIT
----------- ----------------------
<C> <S>
10.15 -- Employment Agreement effective September 1, 1997 between
Patrick J. McGettigan, Jr. and the Company.
10.16 -- Option to subscribe to purchase 5,000,000 shares of
common stock of the Company for $3.1 million, registered
in the name of Orient Star.
12 -- Statement re computation of ratios (filed as Exhibit 12
to Registration Statement No. 333-63001 and incorporated
herein by this reference).
*23.1 -- Consent of Winstead Sechrest & Minick P.C. (set forth in
Exhibit 5).
*23.2 -- Consent of PricewaterhouseCoopers LLP.
24 -- Powers of Attorney (3).
25 -- Statement of Eligibility of Bank of Montreal Trust
Company.
27 -- Financial Data Schedule (filed as Exhibit 27 to
Registration Statement No. 333-63001 and incorporated
herein by this reference).
99.1 -- Form of Letter of Transmittal.
99.2 -- Form of Notice of Guaranteed Delivery.
99.3 -- Form of Letter to Brokers.
99.4 -- Form of Letter to Clients.
99.5 -- Instructions to Registered Holder and/or Book Entry
Transfer Participant from Beneficial Owner.
99.6 -- Guidelines for Certificate of Taxpayer Identification
Number on Substitute Form W-9.
</TABLE>
- ---------------
* Filed herewith.
<PAGE> 1
EXHIBIT 4.2
[FORM OF FACE OF EXCHANGE SECURITY]
No. $___________
11 3/4% Series B Senior Note due 2008
CUSIP No. _____
SPLITROCK SERVICES, INC., a Delaware corporation, promises to pay to
Cede & Co., or registered assigns, the principal sum [of ______________
Dollars] [listed on the Schedule of Increases or Decreases in Global Security
attached hereto](1) on July 15, 2008.
Interest Payment Dates: January 15 and July 15.
Record Dates: January 1 and July.
______________________
(1) Use the Schedule of Increases and Decreases language if Note is in
Global Form.
<PAGE> 2
Additional provisions of this Security are set forth on the other side
of this Security.
IN WITNESS WHEREOF, the parties have caused this instrument to be duly
executed.
SPLITROCK SERVICES, INC.,
By:
------------------------------------
Name:
----------------------------------
Title:
---------------------------------
Dated:
TRUSTEE'S CERTIFICATE OF
AUTHENTICATION
BANK OF MONTREAL TRUST COMPANY,
as Trustee, certifies
that this is one of
the Securities referred
to in the Indenture.
By:
-------------------------------
Authorized Signatory
__________________
(*) If the Security is to be issued in global form, add the Global Securities
Legend and the attachment from Exhibit A captioned "TO BE ATTACHED TO GLOBAL
SECURITIES SCHEDULE OF INCREASES OR DECREASES IN GLOBAL SECURITY."
<PAGE> 3
[FORM OF REVERSE SIDE OF EXCHANGE SECURITY]
11 3/4% Series B Senior Note due 2008
1. Interest
SPLITROCK SERVICES, INC., a Delaware corporation (such corporation,
and its successors and assigns under the Indenture hereinafter referred to,
being herein called the "Company"), promises to pay interest on the principal
amount of this Security at the rate per annum shown above. The Company shall
pay interest semiannually on January 15 and July 15 of each year. Interest on
the Securities shall accrue from the most recent date to which interest has
been paid or, if no interest has been paid, from July 24, 1998. Interest will
be computed on the basis of a 360-day year of twelve 30-day months.
2. Method of Payment
The Company shall pay interest on the Securities (except defaulted
interest) to the Persons who are registered holders of Securities at the close
of business on the January 1 or July 1 next preceding the interest payment date
even if Securities are canceled after the record date and on or before the
interest payment date. Holders must surrender Securities to a Paying Agent to
collect principal payments. The Company shall pay principal, premium and
interest in money of the United States of America that at the time of payment
is legal tender for payment of public and private debts. Payments in respect
of the Securities represented by a Global Security (including principal,
premium and interest) shall be made by wire transfer of immediately available
funds to the accounts specified by The Depository Trust Company. The Company
shall make all payments in respect of a certificated Security (including
principal, premium and interest), by mailing a check to the registered address
of each Holder thereof, provided, however, that payments on the Securities may
also be made, in the case of a Holder of at least $1,000,000 aggregate
principal amount of Securities, by wire transfer to a U.S. dollar account
maintained by the payee with a bank in the United States if such Holder elects
payment by wire transfer by giving written notice to the Trustee or the Paying
Agent to such effect designating such account no later than 30 days immediately
preceding the relevant due date for payment (or such other date as the Trustee
may accept in its discretion).
3. Paying Agent and Registrar
Initially, BANK OF MONTREAL TRUST COMPANY, a New York banking
corporation (the "Trustee"), shall act as Paying Agent and Registrar. The
Company may appoint and change any Paying Agent, Registrar or co-registrar
without notice. The Company or a domestically incorporated Wholly Owned
Subsidiary of the Company, if any, may act as Paying Agent, Registrar or
co-registrar.
4. Indenture
The Company issued the Securities under an Indenture dated as of July
24, 1998 (the "Indenture"), between the Company and the Trustee. The terms of
the Securities include those stated
3
<PAGE> 4
in the Indenture and those made part of the Indenture by reference to the Trust
Indenture Act of 1939 (15 U.S.C. Sections 77aaa-77bbbb) as in effect on the
date of the Indenture (the "TIA"). Terms defined in the Indenture and not
defined herein have the meanings ascribed thereto in the Indenture. The
Securities are subject to all terms and provisions of the Indenture, and
Securityholders are referred to the Indenture and the TIA for a statement of
such terms and provisions.
The Securities are senior unsecured obligations of the Company limited
to $311,000,000 aggregate principal amount at any one time outstanding, of
which $261,000,000 in aggregate principal amount will be initially issued on
the Closing Date. Subject to the conditions set forth in the Indenture, the
Company may issue up to an additional $50,000,000 aggregate principal amount of
Additional Securities. This Security is one of the Exchange Securities
referred to in the Indenture. The Securities include the Original Securities,
the Additional Securities and any Exchange Securities and Private Exchange
Securities issued in exchange for the Initial Securities pursuant to the
Indenture. The Original Securities, the Additional Securities, the Exchange
Securities and the Private Exchange Securities are treated as a single class of
securities under the Indenture. The Indenture imposes certain limitations on
the ability of the Company and its Restricted Subsidiaries to, among other
things, make certain Investments and other Restricted Payments, pay dividends
and other distributions, incur Indebtedness, enter into consensual restrictions
upon the payment of certain dividends and distributions by such Restricted
Subsidiaries, issue or sell shares of capital stock of such Restricted
Subsidiaries, enter into or permit certain transactions with Affiliates, create
or incur Liens, make asset sales and enter into Sale/Leaseback Transactions.
The Indenture also imposes limitations on the ability of the Company to
consolidate or merge with or into any other Person or convey, transfer or lease
all or substantially all of the property of the Company. In addition, the
Indenture provides that each Restricted Subsidiary of the Company that Incurs
Indebtedness shall jointly and severally Guarantee all of the Company's
obligations under the Securities and the Indenture.
5. Optional Redemption
Except as set forth in the following paragraph, the Securities shall
not be redeemable at the option of the Company prior to July 15, 2003. On or
after such date, the Securities shall be redeemable at the option of the
Company, in whole or in part, on not less than 30 nor more than 60 days prior
notice, at the following redemption prices (expressed as percentages of
principal amount), plus accrued and unpaid interest and liquidated damages (if
any) to the redemption date (subject to the right of holders of record on the
relevant record date to receive interest due on the relevant interest payment
date), if redeemed during the 12-month period commencing on July 15 of the
years set forth below:
REDEMPTION
YEAR PRICE
---- -----
2003 105.875%
2004 103.917%
2005 101.958%
2006 and thereafter 100.000%
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<PAGE> 5
In addition, at any time and from time to time prior to July 15, 2001,
the Company may redeem up to a maximum of 35% of the original aggregate
principal amount of the Securities (calculated giving effect to any issuance of
Additional Securities) with the Net Cash Proceeds of one or more Equity
Offerings by the Company, at a redemption price equal to 111.75 % of the
principal amount thereof, plus accrued and unpaid interest and liquidated
damages, if any, to date of redemption (subject to the right of holders of
record on the relevant record date to receive interest due on the relevant
interest payment date); provided, however, that at least 65% of the original
aggregate principal amount of the Securities remains outstanding immediately
after each such redemption (calculated giving effect to any issuance of
Additional Securities). Any such redemption shall be made within 60 days of
such Equity Offering upon not less than 30 nor more than 60 days notice mailed
to each holder of Securities being redeemed and otherwise in accordance with
the procedures set forth in the Indenture.
6. Sinking Fund
The Securities are not subject to any sinking fund.
7. Notice of Redemption
Notice of redemption will be mailed by first-class mail at least 30
days but not more than 60 days before the redemption date to each Holder of
Securities to be redeemed at his or her registered address. Securities in
denominations larger than $1,000 may be redeemed in part but only in whole
multiples of $1,000. If money sufficient to pay the redemption price of and
accrued and unpaid interest on all Securities (or portions thereof) to be
redeemed on the redemption date is deposited with the Paying Agent on or before
the redemption date and certain other conditions are satisfied, on and after
such date interest ceases to accrue on such Securities (or such portions
thereof) called for redemption.
8. Repurchase of Securities at the Option of Holders upon Change of
Control
Upon a Change of Control, any Holder of Securities shall have the
right, subject to certain conditions specified in the Indenture, to cause the
Company to repurchase all or any part of the Securities of such Holder at a
purchase price equal to 101 % of the principal amount of the Securities to be
repurchased plus accrued and unpaid interest, if any, to the date of repurchase
(subject to the right of Holders of record on the relevant record date to
receive interest due on the relevant interest payment date that is on or prior
to the date of purchase) as provided in, and subject to the terms of, the
Indenture.
9. Denominations; Transfer; Exchange
The Securities are in registered from without coupons in denominations
of $1,000 and whole multiples of $1,000. A Holder may transfer or exchange
Securities in accordance with the Indenture. Upon any transfer or exchange,
the Registrar and the Trustee may require a Holder, among other things, to
furnish appropriate endorsements or transfer documents and to pay any taxes
required by law or permitted by the Indenture. The Registrar need not register
the transfer of or exchange any
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<PAGE> 6
Securities selected for redemption (except, in the case of a Security to be
redeemed in part, the portion of the Security not to be redeemed) or to
transfer or exchange any Securities for a period of 15 days prior to a
selection of Securities to be redeemed or 15 days before an interest payment
date.
10. Persons Deemed Owners
The registered Holder of this Security may be treated as the owner of
it for all purposes.
11. Unclaimed Money
If money for the payment of principal or interest remains unclaimed
for two years, the Trustee or Paying Agent shall pay the money back to the
Company at its written request unless an abandoned property law designates
another Person. After any such payment, Holders entitled to the money must
look only to the Company and not to the Trustee for payment.
12. Discharge and Defeasance
Subject to certain conditions, the Company at any time may terminate
some of or all its obligations under the Securities and the Indenture if the
Company deposits with the Trustee money or U.S. Government Obligations for the
payment of principal and interest on the Securities to redemption or maturity,
as the case may be.
13. Amendment, Waiver
Subject to certain exceptions set forth in the Indenture, (i) the
Indenture or the Securities may be amended without prior notice to any
Securityholder but with the written consent of the Holders of at least a
majority in aggregate principal amount of the outstanding Securities and (ii)
any default or noncompliance with any provision may be waived with the written
consent of the Holders of at least a majority in principal amount of the
outstanding Securities. Subject to certain exceptions set forth in the
Indenture, without the consent of any Holder of Securities, the Company and the
Trustee may amend the Indenture or the Securities (i) to cure any ambiguity,
omission, defect or inconsistency; (ii) to comply with Article 5 of the
Indenture; (iii) to provide for uncertificated Securities in addition to or in
place of certificated Securities or to create and maintain a valid first
priority security interest in the Escrow Collateral in favor of the Trustee for
the benefit of Holders; (iv) to add Guarantees with respect to the Securities;
(v) to secure the Securities or to create and maintain a valid first priority
security interest in the Escrow Collateral in favor of the Trustee for the
benefit of Holders; (vi) to add additional covenants or to surrender rights and
powers conferred on the Company; (vii) to comply with the requirements of the
SEC in order to effect or maintain the qualification of the Indenture under the
TIA; (viii) to make any change that does not adversely affect the rights of any
Securityholder; or (ix) to provide for the issuance of the Exchange Securities,
Private Exchange Securities or Additional Securities.
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<PAGE> 7
14. Defaults and Remedies
If an Event of Default occurs (other than an Event of Default relating
to certain events of bankruptcy, insolvency or reorganization of the Company)
and is continuing, the Trustee or the Holders of at least 25% in principal
amount of the outstanding Securities may declare the principal of and accrued
but unpaid interest on all the Securities to be due and payable. If an Event
of Default relating to certain events of bankruptcy, insolvency or
reorganization of the Company occurs, the principal of and interest on all the
Securities shall become immediately due and payable without any declaration or
other act on the part of the Trustee or any Holders. Under certain
circumstances, the Holders of a majority in principal amount of the outstanding
Securities may rescind any such acceleration with respect to the Securities and
its consequences.
If an Event of Default occurs and is continuing, the Trustee shall be
under no obligation to exercise any of the rights or powers under the Indenture
at the request or direction of any of the Holders unless such Holders have
offered to the Trustee reasonable indemnity or security against any loss,
liability or expense. Except to enforce the right to receive payment of
principal, premium (if any) or interest when due, no Holder may pursue any
remedy with respect to the Indenture or the Securities unless (i) such Holder
has previously given the Trustee notice that an Event of Default is continuing,
(ii) Holders of at least 25% in principal amount of the outstanding Securities
have requested the Trustee in writing to pursue the remedy, (iii) such Holders
have offered the Trustee reasonable security or indemnity against any loss,
liability or expense, (iv) the Trustee has not complied with such request
within 60 days after the receipt of the request and the offer of security or
indemnity and (v) the Holders of a majority in principal amount of the
outstanding Securities have not given the Trustee a direction inconsistent with
such request within such 60-day period. Subject to certain restrictions, the
Holders of a majority in principal amount of the outstanding Securities are
given the right to direct the time, method and place of conducting any
proceeding for any remedy available to the Trustee or of exercising any trust
or power conferred on the Trustee. The Trustee, however, may refuse to follow
any direction that conflicts with law, the Indenture or the Escrow and
Disbursement Agreement or that the Trustee determines is unduly prejudicial to
the rights of any other Holder or that would involve the Trustee in personal
liability. Prior to taking any action under the Indenture, the Trustee shall
be entitled to indemnification satisfactory to it in its sole discretion
against all losses and expenses caused by taking or not taking such action.
15. Trustee Dealings with the Company
Subject to certain limitations imposed by the TIA, the Trustee under
the Indenture, in its individual or any other capacity, may become the owner or
pledgee of Securities and may otherwise deal with and collect obligations owed
to it by the Company or its Affiliates and may otherwise deal with the Company
or its Affiliates with the same rights it would have if it were not Trustee.
16. No Recourse Against Others
A director, officer, employee or stockholder, as such, of the Company
or any Subsidiary Guarantor shall not have any liability for any obligations of
the Company under the Securities or the Indenture or for any claim based on, in
respect of or by reason of such obligations or their creation.
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<PAGE> 8
By accepting a Security, each Securityholder waives and releases all such
liability. The waiver and release are part of the consideration for the issue
of the Securities.
17. Authentication
This Security shall not be valid until an authorized signatory of the
Trustee (or an authenticating agent) manually signs the certificate of
authentication on the other side of this Security.
18. Abbreviations
Customary abbreviations may be used in the name of a Securityholder or
an assignee, such as TEN COM (=tenants in common), TEN ENT (=tenants by the
entireties), JT TEN (=joint tenants with rights of survivorship and not as
tenants in common), CUST (=custodian), and U/G/M/A (=Uniform Gift to Minors
Act).
19. Governing Law
THIS SECURITY SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH,
THE LAWS OF THE STATE OF NEW YORK BUT WITHOUT GIVING EFFECT TO APPLICABLE
PRINCIPLES OF CONFLICTS OF LAW TO THE EXTENT THAT THE APPLICATION OF THE LAWS
OF ANOTHER JURISDICTION WOULD BE REQUIRED THEREBY.
20. CUSIP Numbers
Pursuant to a recommendation promulgated by the Committee on Uniform
Security Identification Procedures, the Company has caused CUSIP numbers to be
printed on the Securities and has directed the Trustee to use CUSIP numbers in
notices of redemption as a convenience to Securityholders. No representation
is made as to the accuracy of such numbers either as printed on the Securities
or as contained in any notice of redemption and reliance may be placed only on
the other identification numbers placed thereon.
THE COMPANY SHALL FURNISH TO ANY HOLDER OF SECURITIES UPON WRITTEN
REQUEST AND WITHOUT CHARGE TO THE HOLDER A COPY OF THE INDENTURE WHICH HAS IN
IT THE TEXT OF THIS SECURITY.
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<PAGE> 1
Exhibit 5
September 22, 1998
Board of Directors
Splitrock Services, Inc.
8665 New Trails Drive, Suite 200
The Woodlands, Texas 76381
Gentlemen:
We have acted as counsel to Splitrock Services, Inc. (the "Company") in
connection with the Registration Statement on Form S-4 (the "Registration
Statement") to be filed with the Securities and Exchange Commission in
connection with the registration under the Securities Act of 1933, as amended,
of $250 million aggregate principal amount of 11-3/4% Series B Senior Notes due
2008 of the Company (the "Exchange Notes") to be offered and issued by the
Company under an Indenture dated as of July 24, 1998 by and among the Company
and Bank of Montreal Trust Company, as Trustee.
We have examined the Indenture, the global note issued under the
Indenture and such statutes, corporate records and documents, certificates of
corporate and public officials and such other instruments and documents as we
have deemed necessary or appropriate for the purposes of the opinions expressed
herein.
Based upon the foregoing and subject to the qualifications, assumptions
and other statements set forth herein, we are of the opinion that, upon issuance
thereof in the manner described in the Registration Statement, the Exchange
Notes will be valid and binding obligations of the Company, except as the
enforceability thereof may be limited by bankruptcy, insolvency, reorganization
or other similar laws affecting the enforcement of creditors' rights generally
and by general equitable principles (regardless of whether the issue of
enforceability is considered in a proceeding in equity or at law).
The opinion expressed above assumes that the Exchange Notes issued
under the Indenture have been duly executed, authenticated, issued and delivered
in accordance with the provisions of the Indenture upon exchange for the 11-3/4%
Senior Notes due 2008 as provided for therein.
Except as otherwise stated below, the opinions expressed herein are
based upon, and limited to, the laws of the State of Texas and the United States
and the Delaware General Corporation Law, and to case decisions reported as of
this date under such laws, and to facts known to us on this date,
<PAGE> 2
Board of Directors
Splitrock Services, Inc.
September 22, 1998
Page 2
and we do not undertake to provide any opinion as to any matter or to advise any
person with respect to any events or changes occurring subsequent to the date of
this letter.
The opinions expressed in this letter are provided as legal opinions
only and not as any guaranties or warranties of the matters discussed herein,
and such opinions are strictly limited to the matters stated herein, and no
other opinions may be implied. This opinion letter is intended solely for your
benefit.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the reference to this Firm under the heading
"Legal Matters" in the Prospectus which is part of the Registration Statement.
Very truly yours,
WINSTEAD SECHREST & MINICK P.C.
By: /s/ WINSTEAD SECHREST & MINICK P.C.
----------------------------------------
For the Firm
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in the Prospectus constituting part of this
Registration Statement on Form S-4 of our report dated April 2, 1998 relating to
the financial statements of Splitrock Services, Inc., which appears in such
Prospectus. We also consent to the reference to us under the heading "Experts"
in such Prospectus.
PricewaterhouseCoopers LLP
Houston, TX
September 21, 1998
