<PAGE>
PROSPECTUS
Pursuant to Rule 424(b)(3)
SPLITROCK SERVICES, INC.
261,000 warrants 1,487,791 shares of $11,000,000
to purchase shares common stock 11 3/4% Series B
of common stock issuable upon senior notes due 2008
exercise of warrants
---------------
This prospectus relates to:
. an offering by us to our warrantholders of 1,487,791 shares of common
stock of Splitrock Services, Inc., to be issued by us upon the exercise
of our outstanding warrants;
. an offering by various selling securityholders identified in this
prospectus of 261,000 of our warrants to purchase shares of our common
stock; and
. an offering by Linsang Partners, LLC of an aggregate principal amount of
$11,000,000 of our Series B senior notes due 2008.
The shares of common stock included in this prospectus are not currently
outstanding and will be issued to the warrantholders upon the proper exercise
of any warrant. Persons who properly exercise the warrants will receive common
stock without any restriction on the resale of those shares. We may issue
additional shares under anti-dilution provisions of the warrants. The selling
securityholders will offer the warrants and the senior notes from time to time
at prevailing market prices. We will not receive any of the proceeds from the
sale of the warrants or senior notes by the selling securityholders.
There is currently no public market for our shares. We are offering 9,000,000
shares of our common stock at an initial public offering price of $10.00 per
share under a separate prospectus. See "Prospectus Summary--Recent
Developments." Our common stock has been approved for listing on the Nasdaq
National Market under the symbol "SPLT." There is currently no public market
for our warrants and senior notes and we do not intend to list them on any
securities exchange or to seek approval for quotation through any exchange or
automated quotation system.
See "Risk Factors" beginning on page 11 to read about certain risks that you
should consider before buying our securities.
Neither the Securities and Exchange Commission nor any other regulatory body
has approved or disapproved these securities or passed upon the adequacy or
accuracy of this prospectus. Any representation to the contrary is a criminal
offense.
---------------
The date of this prospectus is August 2, 1999
<PAGE>
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. The information contained in this prospectus is
accurate only as of the date of this prospectus, regardless of the time of
delivery of this prospectus or of any sale of our securities. Neither the
delivery of this prospectus nor any offer or sale 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.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 11
Use of Proceeds.......................................................... 26
Capitalization........................................................... 27
Selected Financial Data.................................................. 28
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 30
Business................................................................. 40
Management............................................................... 59
Certain Transactions..................................................... 66
Principal Stockholders................................................... 68
Selling Holders.......................................................... 70
Plan of Distribution..................................................... 71
Description of the Warrants.............................................. 73
Description of Capital Stock............................................. 77
Description of the Notes................................................. 81
Shares Eligible for Future Sale.......................................... 115
Material United States Federal Income Tax Considerations................. 116
Legal Matters............................................................ 120
Experts.................................................................. 120
Where You Can Find More Information...................................... 120
Index to Financial Statements............................................ F-1
Glossary of Terms........................................................ G-1
</TABLE>
FORWARD-LOOKING STATEMENTS
This prospectus includes forward-looking statements. Words such as
"anticipates," "plans," "estimates," "expects," "believes," and similar
expressions as used in this prospectus in connection with Splitrock or our
management, are intended to identify forward-looking statements. We have based
these forward-looking statements on our current expectations and projections
about future events. However, our actual results, performance, or achievements
may materially differ from those expressed in the forward-looking statements.
Please see "Risk Factors" for a more detailed description of those conditions
and events that could cause our results to differ.
We undertake no obligation publicly to update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
In light of these risks, uncertainties and assumptions, the forward-looking
events discussed in this offering memorandum might not occur.
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<PAGE>
PROSPECTUS SUMMARY
This summary highlights some of the information in this prospectus. The
summary may not contain all of the information that is important to you. This
prospectus includes forward-looking statements which involve risks and
uncertainties. You should carefully read the entire prospectus, including the
risk factors and the financial statements, before deciding whether to invest in
our securities.
Splitrock Services, Inc.
Our Company
We are a facilities-based provider of advanced data communications services.
We market our services to Internet service providers, telecommunications
carriers and other businesses throughout the United States. We own and operate
a state-of-the-art, broadband access network that:
. consistently achieves among the highest performance ratings in the
industry for network reliability, speed and throughput;
. currently handles more than 1.3 billion minutes of use per month;
. reaches businesses and households in every U.S. market with a population
of at least 100,000 as well as many smaller markets; and
. employs asynchronous transfer mode (ATM) switches at every point-of-
presence (POP).
The combination of our existing broadband access network with our pending
acquisition of significant fiber optic facilities positions us to deliver a
broad array of end-to-end data communications services on our own network,
including:
. dial and dedicated Internet access;
. Internet access for higher bandwidth services, such as digital
subscriber line (DSL) and cable modem;
. value-added services such as virtual private networks and web hosting;
and
. bandwidth leasing and colocation services.
We currently provide Internet dial access and related services to Prodigy
Communications Corporation, our primary customer and one of the largest
Internet service providers in the United States. Prodigy recently announced a
definitive agreement to acquire the Internet access customer base of Cable &
Wireless USA, which we believe will result in a significant increase in Prodigy
subscribers. We believe that our relationship with Prodigy and our high
performance ratings have demonstrated our strength as a network operator and
positioned us to expand our customer base and service offerings. Leveraging our
demonstrated network capabilities, we have recently entered into significant
new customer relationships with Juno Online Services and InfiNet. Juno, a
leading provider of Internet and e-mail services, currently has more than
200,000 subscribers for its billable Internet services launched in July 1998
and has created more than 6.8 million free e-mail accounts since April 1996.
InfiNet, a consortium sponsored by Knight-Ridder, Gannett and Landmark
Communications, provides Internet access and web publishing solutions to nearly
100,000 subscribers nationwide.
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<PAGE>
Our Strategy
Our mission is to strengthen our position as a leading facilities-based
provider of advanced data communications services. To achieve this objective,
our business strategy focuses on the following key principles:
. expanding our direct marketing activities, increasing the size of our
sales force and developing alternative distribution channels to
capitalize on the expected growth in demand for network services;
. broadening our portfolio of service offerings;
. exploiting the capabilities of our advanced nationwide communications
network;
. building strong customer loyalty through superior customer service;
. leveraging our experienced management team;
. increasing and optimizing total network utilization by offering
comprehensive services and targeting both daytime business users and
evening consumer users to balance our network's usage; and
. evaluating strategic alliances and acquisitions that increase traffic
over our network.
Our Market Opportunity
According to industry reports, data communications is one of the fastest
growing segments of the global telecommunications market. Forrester Research
estimates that business Internet access, web hosting and other value-added
services will grow from $3.7 billion in 1998 to approximately $56.6 billion in
2003. Forrester also projects that consumer Internet access spending will grow
from approximately $7 billion in 1998 to approximately $19.9 billion in 2003.
Our Network
As of June 30, 1999, our broadband access network included 324 installed
POPs 270 of which were operational. When our network is completed later this
year, we expect to have approximately 370 active POPs with a physical presence
in all 50 states, targeting over 90% of all U.S. businesses and households with
a local call. We have deployed ATM switches at every core, hub and remote POP
of our network. This network architecture, which we call "ATM-to-the-Edge(TM),"
enables us to serve as a broad-based provider of data communications services
through the creation of a platform that efficiently delivers multiple services,
such as Internet access, virtual private networks and web hosting, across
multiple protocols, including Internet Protocol (IP), frame relay and ATM. The
flexibility inherent in our network design allows us to expand our service
offerings to provide fully integrated data, video and voice services. This
flexibility also allows us to incorporate future technological innovations into
our network architecture with a lower incremental investment than that required
by other communications service providers with legacy systems that have
separate networks for voice and data.
As part of our ongoing efforts to further expand and enhance our network and
service offerings, we have agreed to acquire the indefeasible rights to use
four dark fiber strands in a state-of-the-art fiber optic network currently
under construction by Level 3 Communications, with an option to use up to 12
additional fibers. This nationwide fiber network will cover approximately
15,000 route miles and will be delivered in segments that are expected to
become available from the end of 1999 through the first quarter of 2001. The
combination of this fiber optic backbone with our broadband access network
positions us to:
. deliver, on our own facilities, a broad array of end-to-end data
communications services at the high level of quality and reliability
increasingly demanded by customers;
. reduce significantly our network costs as a percentage of revenues as we
substitute the acquired bandwidth for existing leased circuit
arrangements with various telecommunications carriers;
4
<PAGE>
. expand our service offerings by providing bandwidth leasing services on
a stand-alone basis or bundled with our other services;
. increase the reliability and redundancy of our network; and
. increase the variety of service options and speeds available to
customers.
Recent Developments
We are offering 9,000,000 shares of our common stock at an initial public
offering price of $10.00 per share under a separate prospectus. These shares
will be issued subject to the terms and conditions of an underwriting agreement
among us, certain of our stockholders, and the underwriters. Our initial public
offering is expected to be completed on August 6, 1999. We estimate that we will
receive net proceeds from our initial public offering of approximately $82.8
million, or approximately $93.9 million if the underwriters' over-allotment
option is exercised in full. We intend to use the net proceeds of our initial
public offering principally to fund capital expenditures, including:
. the acquisition of rights to use dark fiber and of the related
electronic equipment necessary to transmit data over the fiber;
. the completion of our broadband access network;
. the enhancement of our network to provide additional value-added
services; and
. the improvement of our network management, billing and other back office
systems.
Our common stock has been approved for listing on the Nasdaq National Market
System under the trading symbol "SPLT."
Prospective investors 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
Warrants, Warrant Shares and Notes.
----------------
We were incorporated in Texas on March 5, 1997 and reincorporated in
Delaware on May 8, 1998. Our headquarters are located at 8665 New Trails Drive,
The Woodlands, Texas 77381. Our telephone number at that location is (281) 465-
1200. Our website address is www.splitrock.net. The information contained on
our website is not part of this prospectus.
----------------
The terms "the Company," "Splitrock," "we," "our," and "us," as used in this
prospectus refer to Splitrock Services, Inc. Investors should carefully
consider the information set forth under "Risk Factors." Technical terms that
are important to an understanding of our business are defined in the Glossary
of Terms beginning on page G-1 of this prospectus. Except as otherwise noted,
the information in this prospectus (1) assumes that the underwriters' over-
allotment option in our proposed initial public offering will not be exercised,
and (2) reflects a 100-for-1 split of our common stock that was effected on
June 3, 1997, a 10-for-1 split of our common stock that was effected on August
8, 1997, and a 0.563-for-1 reverse stock split of our common stock that was
effected July 12, 1999.
5
<PAGE>
The Offering
The following is a brief summary of the terms of this offering. For a more
complete description of the securities offered by this prospectus, see
"Description of the Warrants," "Description of Capital Stock" and "Description
of the Notes."
The Warrants
Issuer...................... Splitrock Services, Inc.
Warrants Offered............ 261,000 warrants which, when exercised, will
entitle the holders to acquire an aggregate of
1,487,791 shares of our common stock.
Exercise Price.............. $.02 per share of common stock.
Manner of Exercise.......... The holders may exercise the warrants by
providing the exercise price to us in cash or by
cashless exercise whereby the aggregate value of
shares issued to the holder is reduced by the
exercise price owed.
Expiration.................. The warrants are currently exercisable and will
expire on July 15, 2008.
Anti-Dilution Provisions.... The warrants have customary anti-dilution
provisions.
Voting Rights............... The warrant holders have no voting rights.
Warrant Shares.............. The warrants entitle the holders to acquire
shares of our common stock. We refer to the
shares of our common stock and any other
securities issuable or deliverable upon exercise
of the warrants as the "warrant shares." For
additional information regarding the warrants and
the warrant shares, see "Description of the
Warrants" and "Description of Capital Stock."
The Warrant Shares
Issuer...................... Splitrock Services, Inc.
Common stock offered by us
to the warrantholders upon
exercise of the warrants.... 1,487,791 shares, assuming that all of the
warrants are exercised.
Common stock to be
outstanding after this
offering.................... 57,169,215 shares, assuming that all of the
warrants are exercised.
Use of proceeds............. We will receive proceeds of $0.02 per share
issued upon the cash exercise of any warrant. We
will not receive any proceeds upon the cashless
exercise of the warrants. Assuming that all of
the warrants are exercised for cash, we will
realize proceeds of approximately $29,756. We
intend to use the net proceeds from this offering
for working capital and other corporate purposes.
We will not receive any proceeds from the
subsequent resale of the shares of common stock
by our shareholders.
6
<PAGE>
The number of shares of common stock to be outstanding after this offering
is based on the 46,681,424 shares outstanding as of June 30, 1999 and includes
the 9,000,000 shares of common stock to be sold in our initial public offering.
The shares of common stock to be outstanding after this offering excludes:
. any shares of common stock that may be issued pursuant to the over-
allotment option in our initial public offering;
. 2,896,128 shares of common stock issuable upon the exercise of
outstanding options with a weighted average exercise price of $5.10 per
share; and
. 7,735,845 shares of common stock reserved for issuance upon the exercise
of options available to be granted under our stock option plans,
including options to purchase 1,233,715 shares exercisable at the
initial public offering price of $10.00 per share which are to be
granted in connection with the initial public offering.
The Notes
Issuer...................... Splitrock Services, Inc.
Notes Offered............... $11,000,000 in aggregate principal amount of 11
3/4% Series B Senior Notes due 2008.
Maturity.................... July 15, 2008.
Interest Payment Dates...... January 15 and July 15 of each year.
Escrow Proceeds............. We have deposited approximately $56.8 million in
temporary cash investments with an escrow agent,
that, together with the interest received on
those investments, will be sufficient to pay the
first four semi-annual interest payments on the
Notes when due. Any remaining balance will be
retained by us. The notes are collateralized by a
first priority and exclusive security interest in
this escrow account. See "Description of the
Notes-- Disbursement of Funds; Escrow Account."
Sinking Fund................ None.
Guarantees.................. Each of our restricted subsidiaries that incurs
indebtedness will fully and unconditionally
guarantee the notes on a senior, unsecured basis.
See "Description of the Notes--Certain
Covenants--Future Subsidiary Guarantors." We do
not currently have any subsidiaries.
Optional Redemption......... We may redeem some or all of the notes on or
after July 15, 2003, at the redemption prices
described in this prospectus. In addition, before
July 15, 2001, we may redeem up to 35% of the
notes with the net proceeds of a public equity
offering, at a redemption price equal to 111.75%
of the principal amount of the notes, plus
accrued and unpaid interest, if at least 65% of
the notes originally issued remain outstanding
after such redemption. See "Description of the
Notes--Optional Redemption."
7
<PAGE>
Change of Control........... Upon certain change of control events, each
holder of notes may require us to repurchase some
or all of its notes at a purchase price equal to
101% of their principal amount, plus accrued and
unpaid interest. See "Description of the Notes--
Change of Control."
Ranking..................... The notes are senior indebtedness and will rank
pari passu with all of our existing and future
senior indebtedness and will rank senior to all
of our future subordinated obligations, which
must be specifically designated as subordinate to
the notes. The notes are unsecured except for the
Trustee's security interest in the escrow account
for the benefit of the holders of the notes and
are therefore effectively subordinated to all of
our secured indebtedness. At June 30, 1999, we
had $12.5 million of indebtedness other than the
notes all of which is senior indebtedness and all
of which was secured. See "Description of the
Notes--Ranking."
Restrictive Covenants....... The indenture governing the notes contains
covenants that, among other things, limit our
ability and the ability of our restricted
subsidiaries to:
. incur additional indebtedness or liens or
enter into sale/leaseback transactions;
. pay dividends or make other distributions;
. make investments;
. repurchase equity interests or subordinated
obligations;
. consummate asset sales;
. enter into transactions with affiliates;
. engage in any business other than a
telecommunications business; and
. merge or consolidate with any other person or
sell, assign, transfer, lease, convey or
otherwise dispose of all or substantially all
of our assets.
These covenants are subject to important
exceptions and qualifications, which are
described under the heading "Description of the
Notes" in this prospectus.
8
<PAGE>
SUMMARY FINANCIAL DATA
Our statement of operations data for the period from inception (March 5,
1997) to December 31, 1997 and for the year ended December 31, 1998, and our
balance sheet data as of December 31, 1997 and 1998, shown in the table below
are derived from our audited financial statements. Our statement of operations
data for the six months ended June 30, 1998 and 1999 and our balance sheet data
as of June 30, 1999 have been derived from our unaudited financial statements
which, in the opinion of management, include all adjustments, consisting only
of normal recurring adjustments, necessary for a fair statement of the results
for the unaudited interim periods presented. You should read this information
together with our financial statements and the notes relating to those
statements and with the section entitled "Management's Discussion and Analysis
of Financial Condition and Results of Operations" appearing elsewhere in this
prospectus. Results of operations for the periods presented are not necessarily
indicative of results of operations for future periods.
The "As Adjusted" balance sheet data reflects the sale of the shares of
common stock offered by us in our initial public offering at the initial public
offering price of $10.00 per share, after deducting the underwriting discount
and the estimated offering expenses payable by us.
<TABLE>
<CAPTION>
Period from
Inception
(March 5, Year Ended Six Months Ended June
1997) through December 30,
December 31, 31, ------------------------
1997 1998 1998 1999
------------- ----------- ----------- -----------
(in thousands, except share and per share data)
<S> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues................ $ 22,708 $ 63,611 $ 32,214 $ 34,241
Operating expenses:
Splitrock network
costs................ 2,362 32,912 10,724 34,150
Legacy network costs.. 25,804 58,292 27,111 21,871
Selling, general and
administrative....... 1,276 6,390 2,441 6,338
Depreciation and
amortization......... 3,500 13,850 4,907 11,237
----------- ----------- ----------- -----------
Total operating
expenses........... 32,942 111,444 45,183 73,596
----------- ----------- ----------- -----------
Loss from operations.... (10,234) (47,833) (12,969) (39,355)
Other income (expense):
Interest income....... 348 5,393 183 4,335
Interest expense...... (235) (15,390) (842) (16,346)
----------- ----------- ----------- -----------
Loss before income tax.. (10,121) (57,830) (13,628) (51,366)
Provision for income
tax.................... -- -- -- --
----------- ----------- ----------- -----------
Net loss................ $ (10,121) $ (57,830) $ (13,628) $ (51,366)
=========== =========== =========== ===========
Net loss per share--
basic and diluted...... $ (0.42) $ (1.30) $ (0.31) $ (1.10)
=========== =========== =========== ===========
Weighted average
shares--basic and
diluted................ 24,109,823 44,388,948 43,288,168 46,668,728
</TABLE>
<TABLE>
<CAPTION>
As of June 30,
1999
-----------------
As
Actual Adjusted
------- --------
(in thousands)
<S> <C> <C>
Balance Sheet Data:
Cash and cash equivalents.................................. $ 8,327 $91,152
Unrestricted investments................................... 56,166 56,166
Restricted investments (1)................................. 44,840 44,840
Property and equipment, net................................ 88,721 88,721
Total assets............................................... 232,729 315,554
Long-term debt and capital lease obligations (including
current portion).......................................... 270,769 270,769
Stockholders' equity (deficit)............................. (81,925) 900
</TABLE>
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<TABLE>
<CAPTION>
Period from
Inception
(March 5, Six Months Ended June
1997) through Year Ended 30,
December 31, December 31, ---------------------
1997 1998 1998 1999
------------- ------------ ---------- ----------
(in thousands)
<S> <C> <C> <C> <C>
Other Financial Data:
Capital expenditures....................... $16,969 $ 45,261 $ 5,548 $ 25,311
EBITDA (2)................................. (6,734) (33,983) (8,062) (28,118)
Cash provided by (used in):
Operating activities.................. (2,233) (735) (3,712) (47,723)
Investing activities.................. (17,198) (169,512) (7,714) 33,064
Financing activities.................. 27,141 190,867 8,893 (5,344)
Ratio of earnings to fixed charges (3)..... -- -- -- --
</TABLE>
- --------
(1) Restricted investments as of June 30, 1999, represent escrowed funds that,
together with interest received on those funds, will be sufficient to pay,
when due, the next three semi-annual interest payments on our outstanding
11 3/4% senior notes.
(2) EBITDA is defined as net loss plus net interest expense, provision for
income taxes, depreciation and amortization. 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 flow or other income or cash flow data or
as a measure of a company's profitability or liquidity and is not a measure
calculated in accordance with generally accepted accounting principles.
EBITDA is not necessarily comparable with similarly titled measures
reported by other companies.
(3) Our historical earnings were insufficient to cover our fixed charges for
the period from inception (March 5, 1997) to December 31, 1997, the year
ended December 31, 1998, and the six month periods ended June 30, 1998 and
1999 by approximately $10.1 million, $57.8 million, $13.6 million and $51.4
million, respectively. Fixed charges consist of interest expense and that
portion of rent expense we believe to be representative of interest (i.e.,
one-third of rent expense).
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RISK FACTORS
You should carefully consider the risks described below before making an
investment decision. The risks and uncertainties described below are not the
only ones facing our company. Additional risks and uncertainties not presently
known to us or that we currently consider immaterial may also impair our
operations. If any of the following risks actually occur, our business,
financial condition or results of operations could be materially adversely
affected. In this case, the trading price, if any, of our securities could
decline, and you may lose all or part of your investment.
We make many forward-looking statements in this prospectus that are not
based on historical facts, but discuss our future expectations. You can
identify these statements by our use of forward-looking terms, such as
"anticipates," "believes," "plans," "expects," "future," "intends" and similar
expressions. Because these forward-looking statements involve risks and
uncertainties, there are important factors that may cause our actual results to
differ materially from those expressed or implied in our forward-looking
statements, including those discussed under this section and elsewhere in this
prospectus.
Our business is difficult to evaluate because we have a limited operating
history and implementation of our current business plan is not reflected in our
historical financial statements.
We were incorporated and commenced operations in March 1997. Accordingly, we
have a limited operating history from which you can evaluate our business and
prospects. In addition, we currently derive substantially all of our revenues
from Internet dial access services. We are now significantly expanding our
sales and marketing effort and our service offerings with the expectation of
broadening our customer base. We are also making a substantial capital
investment to acquire exclusive rights to use a fiber optic backbone, and
neither the revenues nor the expenses that may be associated with this
investment are reflected in our historical financial statements. As a result,
not only is our operating history limited, but our historical financial
statements do not reflect important elements of our business plan on a going
forward basis. The combination of these factors may make evaluation of our
business and prospects difficult.
As a participant in a new and rapidly evolving business, we face risks and
uncertainties relating to our ability to successfully implement our business
plan.
We have developed a business plan in the context of the rapidly evolving
data communications industry that leverages our current service offerings and
technical expertise and expands our operations into new service areas. The
risks and uncertainties associated with implementing our business plan relate
to:
. completing the construction and installation of our broadband access
network;
. expanding our sales and marketing activities;
. expanding and scaling operations support systems for planned services;
. providing services to our customers that are reliable and cost-
effective;
. responding to technological development or service offerings by
competitors;
. acquiring and integrating our fiber backbone into our network;
. increasing awareness of our brand;
. identifying and integrating strategic acquisitions and alliances; and
. attracting and retaining qualified personnel.
If we are unsuccessful in addressing these risks and uncertainties, our
business, results of operations and financial condition will be materially
adversely affected.
11
<PAGE>
We have a history of losses and we expect to continue to incur losses in the
foreseeable future.
We have incurred net losses and negative cash flows from operations since
our inception and we expect to continue to do so for the foreseeable future.
Starting up our company and building our network has required substantial
capital and other expenditures. As a result, we reported net losses of
approximately $57.8 million and $51.4 million, respectively during the year
ended December 31, 1998 and the six months ended June 30, 1999, and incurred
negative cash flows from operations of approximately $0.7 million and
$47.7 million for the same periods. As of June 30, 1999, we had an accumulated
deficit of $119.3 million. We cannot assure you that we will be able to achieve
or sustain revenue growth, profitability or positive cash flow on either a
quarterly or annual basis.
We currently depend on Prodigy for substantially all of our revenues, and our
revenues could decrease significantly if the number or usage of Prodigy
subscribers decreases or if Prodigy ceases to be a customer.
We currently derive substantially all of our revenues from Prodigy. Prodigy
accounted for 100%, 99% and 93% of our revenues for the period from inception
through December 31, 1997, the year ended December 31, 1998, and the six months
ended June 30, 1999, respectively. While we expect revenues from Prodigy to
decrease as a percentage of our total revenues in future periods, we believe
that Prodigy will continue to account for a significant portion of our
revenues. The initial four-year term of our agreement with Prodigy expires on
June 30, 2001. Prodigy may also terminate our agreement prior to June 30, 2001
if (1) we fail to meet specified service level objectives or otherwise fail to
comply with the agreement or (2) Prodigy gives us 12 months' notice of
termination and pays us a termination fee of $3.0 million. The loss of Prodigy
as a customer would have a material adverse effect on our business, financial
condition and results of operation.
Prodigy operates in a highly competitive environment and competes with a
wide range of national, regional and local Internet service providers. A
decrease in the number of Prodigy subscribers or their usage would likely
result in a corresponding decrease in our revenues under our agreement with
Prodigy. Prodigy reports that a majority of its subscriber enrollments result
from bundling arrangements with personal computer manufacturers and Microsoft.
Prodigy's loss of these arrangements and relationships or a decrease in the
number of enrollments it receives as a result of these marketing channels could
adversely affect our results of operations.
Prodigy's results may be affected by seasonal factors. Historically, the
growth in Prodigy subscribers and their total usage has been higher in the
first and fourth quarters of the calendar year, in part due to increased
marketing efforts and consumer demand during the year-end holiday season. The
seasonal nature of Prodigy's business could affect our quarterly revenues.
We may not be able to hire and retain qualified employees.
Our future success depends on our ability to attract, train, motivate and
retain highly skilled employees, especially qualified, competent and motivated
sales and marketing staff with contacts and expertise in the communications
sector. Competition for employees in the data communications industry,
especially sales and marketing personnel, is intense and our business plan
depends on hiring a significant number of these individuals. We may be unable
to retain our key employees or attract, assimilate or retain other highly
qualified employees in the future. We have from time to time in the past
experienced, and we expect to continue to experience in the future, difficulty
in hiring and retaining highly skilled employees with appropriate
qualifications.
We depend on our key management personnel for our future success.
Our future success depends to a significant extent on the continued service
and coordination of our management team, particularly Kwok L. Li, our Chairman
of the Board and Chief Technical Officer, and
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William R. Wilson, our Chief Executive Officer. The departure of any of our
officers or key employees could have a material adverse effect on our business,
financial condition and results of operations. Mr. Li currently acts as a
consultant for Lucent Technologies, Inc. and is the majority owner of Linsang
Partners L.L.C. Mr. Li devotes a portion of his work time to Lucent and
Linsang. Mr. Li's inability to devote his time exclusively to our affairs could
have a material adverse effect on our business.
Our quarterly financial results may not be a good indicator of future results
and may fluctuate significantly and could result in lower prices for our stock.
We expect our quarterly revenues, expenses and operating results to
fluctuate significantly in the future as a result of a variety of factors, some
of which are outside of our control. As a result, we believe that quarter to
quarter comparisons of our operating results are not a good indication of our
future performance and it is possible that our operating results may be below
the expectations of securities analysts or investors in some future period. If
the latter occurs, the trading price of our common stock would likely decline,
perhaps significantly. The factors which affect whether our results fluctuate
include:
. the number and level of usage of Prodigy subscribers;
. demand for network and Internet access services;
. capital expenditures and other costs relating to the construction and
installation of our network;
. marketing and other expenses aimed at increasing our customer base;
. pricing changes and the introduction of new products or services by us
or our competitors;
. our ability to obtain sufficient supplies of sole- or limited-source
equipment and telecom facilities on a timely basis;
. our ability to balance the use of our network over a 24-hour period;
. potential adverse regulatory developments;
. delays in the construction of our fiber optic backbone network;
. technical difficulties, system downtime, undetected software errors and
other problems affecting the Internet generally or the operation of our
network;
. economic conditions specific to the Internet and online media and
general economic conditions; and
. longer sales cycles for newer service offerings.
We base our expenses to a significant extent on our expectations of future
revenues. Most of our expenses are fixed in the short term, and we may not be
able to quickly reduce spending if our revenues are lower than we expect.
Moreover, in an attempt to enhance our long-term competitive position, we may
from time to time make decisions regarding pricing, marketing, services and
technology that could have a near-term material adverse effect on our business,
financial condition and operating results. For more information, see "Selected
Financial Data" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
We face intense competition in the data communications services industry.
The market for data communications, Internet and related services is
intensely competitive, quickly evolving and subject to rapid technological
change. We anticipate that competition will continue to intensify as the use of
data communications and the Internet grows. The tremendous growth and potential
size of the market have attracted many new start-ups as well as established
businesses from different industries. Our current and prospective competitors
fall into three major categories:
. companies that provide access services to Internet service providers
with both residential and small business customers, including Verio,
UUNET Technologies, Concentric Network, PSINet, and Netcom On-Line
Communications Services;
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. companies that provide access, virtual private network and other value-
added services to medium and large businesses, including UUNET
Technologies, Concentric Network, GTE Internetworking, and DIGEX, as
well as most major long distance telephone companies; and
. companies with high-speed networks that provide bandwidth capacity and
other network services, including IXC Communications, Qwest and Level 3
Communications.
Some of these competitors have significantly greater market presence, brand
recognition and financial, technical and personnel resources than we do. Many
of our competitors may also have the ability to bundle Internet access and data
transmission with basic local and long distance telecommunications services.
This bundling of services may have an adverse effect on our ability to compete
effectively with them and may result in pricing pressure on us.
We also believe that new competitors will enter the network services market
with new technologies and methods of distribution, including large computer
hardware, software and media and other technology and telecommunications
companies, resulting in greater competition and pricing pressure as more
capacity becomes available. For instance, cable companies, AT&T and Microsoft
have announced that they are exploring broadband services for high speed
Internet connectivity that will rely on cable modems and economical network
upgrades. Other companies have announced plans to provide Internet access via
wireless terrestrial and satellite-based technologies. This capacity will be
added to that of the U.S. long distance fiber optic networks owned by each of
AT&T, MCI WorldCom and Sprint, as well as numerous local networks. Others,
including Qwest, IXC Communications and Williams Companies, are deploying
additional networks that use advanced technology similar to that of our fiber
backbone being constructed by Level 3.
The increase in the number of competitors in this industry has been
accompanied by vertical and horizontal integration and consolidation among
competitors. The number of businesses providing Internet-related and network
services is growing rapidly. We are aware of other companies, in addition to
those named above, that have entered into or are forming joint ventures or
consortia to provide services similar to those provided by us. Others may
acquire the capabilities necessary to compete with us through acquisitions.
As a result of the increase in the number of competitors and the vertical
and horizontal integration in the industry, we currently encounter and expect
to continue to encounter significant pricing pressure and other competition in
the future. Increased price or other competition could result in erosion of our
market share and could have a material adverse effect on our business,
financial condition and results of operations. We cannot assure you that we
will have the financial resources, technical expertise, portfolio of services
or marketing and support capabilities to continue to compete successfully. For
more information, see "Business--Competition."
Increased industry capacity and other factors could lead to lower prices for
our services.
The long distance transmission industry has been characterized by
overcapacity and falling prices since shortly after the break-up of AT&T in
1984. We expect that prices for communications services generally will continue
to fall over the next several years, primarily due to:
. recent technological advances that permit large increases in the
transmission capacity of both new and existing fiber;
. strategic alliances or similar transactions, such as purchasing
alliances for long distance capacity among local exchange carriers that
increase the parties' purchasing power; and
. construction of new networks and competing satellite systems.
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We face risks associated with entering new lines of business that could cause
our results to suffer.
A key component of our strategy is to acquire fiber optic backbone that
increases our capacity to deliver services that require higher bandwidth and to
lease some of our fiber optic capacity to other companies. The following risks
are inherent in entering this new line of business:
. a potential decrease in the price for our bandwidth capacity resulting
from a significant increase in capacity in the marketplace as networks
currently under construction come on line;
. a lack of financial resources to make the necessary capital expenditures
to take full advantage of the bandwidth available to us;
. unexpected changes in regulatory requirements as a result of combining
our old lines of business with the new lines of business;
. loss of management and marketing staff focus and attention;
. problems reaching our new target market for bandwidth leasing services;
. failure to integrate the sales and marketing of our new lines of
business with our existing services; and
. inability to compete in the new line of business against established
brand names.
We have incurred substantial indebtedness and may not be able to service our
debt.
We have and will continue to have a significant amount of outstanding
indebtedness and debt service requirements. At June 30, 1999, our total debt
(including current portion of capital lease obligations) was $270.8 million and
stockholders' deficit was $81.9 million. Interest on this indebtedness totals
approximately $33 million per year. The historical earnings of Splitrock were
insufficient to cover its fixed charges for the year ended December 31, 1998
and the six months ended June 30, 1999 by approximately $57.8 million and $51.4
million, respectively. For more information, see "Selected Financial Data." Our
debt has important consequences for our company and for you, including the
following:
. our ability to obtain additional financing in the future, whether for
working capital, capital expenditures, acquisitions or other purposes,
may be impaired;
. a substantial portion of our cash flow from operations is dedicated to
the payment of interest on our debt, which reduces the funds available
to us for other purposes;
. our flexibility in planning for or reacting to changes in market
conditions may be limited; and
. we may be more vulnerable in the event of a downturn in our business.
Our ability to meet our debt service obligations will depend on our future
operating performance and financial results. This ability will be subject in
part to factors beyond our control. Although we believe that our cash flow will
be adequate to meet our interest payments, we cannot assure you that we will
continue to generate sufficient cash flow in the future to meet our debt
service requirements, including payment of interest expense and principal on
the notes. If we are unable to generate cash flow in the future sufficient to
cover our fixed charges and are unable to borrow sufficient funds from other
sources, then we may be required to:
. refinance all or a portion of our existing debt;
. attempt to issue additional equity securities, which may result in
dilution of ownership percentages for our existing shareholders; or
. sell all or a portion of our assets.
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We cannot assure you that a refinancing or offering of equity securities
would be possible. We cannot assure you that any asset sales would be timely or
that the proceeds which we could realize from asset sales would be sufficient
to meet our debt service requirements. In addition, the terms of our debt
securities and fiber agreements restrict our ability to sell or sublease our
assets and our use of the proceeds from any asset sale, See "Description of the
Notes--Certain Covenants" for more information.
We will need additional capital in the future and additional financing may not
be available.
We currently anticipate that our available cash resources, combined with the
net proceeds of our proposed initial public offering, will be sufficient to
meet our anticipated working capital and capital expenditure requirements
through the second quarter of 2000. We cannot assure you that these resources
will be sufficient for unanticipated working capital and capital expenditure
requirements during this period. Moreover, we expect that full implementation
of our current business plan will require that we raise substantial additional
capital for the needs that we anticipate funding during the remainder of 2000,
2001 and 2002. We may also need to raise additional funds in order to:
. take advantage of unanticipated opportunities, including more rapid
international expansion or acquisitions of complementary businesses or
technologies;
. develop new services; or
. respond to unanticipated competitive pressures.
We may also raise additional funds through public or private debt or equity
financings if these sources of financing become available on favorable terms.
We cannot assure you that the additional financing we will need will be
available on terms favorable to us, or at all. If adequate funds are not
available or are not available on acceptable terms, we may not be able to take
advantage of unanticipated opportunities, develop new services or otherwise
respond to unanticipated competitive pressures. In that case, our business,
results of operations and financial condition could be materially adversely
affected. Our forecast of the period of time through which our financial
resources will be sufficient to support our operations is a forward looking
statement that involves risks and uncertainties, and actual results could vary
materially as a result of a number of factors, including those set forth above.
Restrictions imposed on us as a result of our current indebtedness could
adversely affect our ability to raise further capital.
The terms of our current indebtedness, including the indentures governing
the notes, contain financial and operating covenants that limit the discretion
of our management. These covenants place significant restrictions on our
ability to:
. incur additional indebtedness;
. create liens or other encumbrances;
. make dividend payments and investments;
. sell or otherwise dispose of assets; or
. merge or consolidate with other companies.
These restrictions could adversely affect our ability to raise further capital.
Furthermore, the failure to comply with our current covenants may result in an
event of default, which, if not cured or waived, could have a material adverse
effect on Splitrock.
Some of our assets were previously pledged or may be pledged for other
obligations and the proceeds from their sale will not be available for payment
of our obligations on the notes until the other debts are satisfied.
The notes are senior obligations of Splitrock ranking pari passu in right
of payment with all existing and future senior indebtedness of Splitrock. The
notes are unsecured except for the security interest held by the
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Trustee in an escrow account established for the benefit of holders of the
notes. The Indenture will permit Splitrock to incur secured indebtedness.
Holders of secured indebtedness of Splitrock will have claims with respect to
the assets constituting collateral for that indebtedness that are prior to the
claims of holders of notes. In the event of a default on the notes, or a
bankruptcy, liquidation or reorganization of Splitrock, assets securing
indebtedness other than the notes will be available to satisfy those
obligations before any payment from the assets could be made on the notes and
the notes will be effectively subordinated to claims of secured creditors of
Splitrock to the extent of any pledged collateral. At June 30, 1999, Splitrock
had $12.5 million of secured indebtedness outstanding other than the notes. See
"Description of the Notes," "Selected Financial Data," "Description of Certain
Indebtedness" and Splitrock's historical financial statements and notes thereto
included elsewhere in this Prospectus for more information.
If we operate through subsidiaries in the future, then our cash flow, and
therefore our ability to meet payments on the notes may be dependent on the
financial results of our subsidiaries.
Splitrock 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. Our cash flow from operations and consequent ability to service
our debt, including the notes, may therefore in the future become in part
dependent upon the earnings of our subsidiaries, if any, and the distribution
of those earnings to Splitrock, or upon loans, advances or other payments of
funds by any subsidiaries to Splitrock. It is not anticipated that our
subsidiaries will have any obligation, contingent or otherwise, to make funds
available to Splitrock for payment of the principal of or interest on the
notes. The ability of any subsidiaries to make 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
subsidiary and holders of preferred stock, if any, of any subsidiary will have
priority as to the assets of that subsidiary over the claims of Splitrock and
the holders of Splitrock's indebtedness.Therefore, the notes will be
effectively subordinated in right of payment to all existing and future
indebtedness and other liabilities of Splitrock's subsidiaries, including trade
payables.
We may not have the financial resources to repurchase the notes as
required when events that constitute a "Change of Control" occur.
The Indenture governing the notes provides that upon the occurrence of an
event that constitutes a "Change of Control" each holder of notes can require
Splitrock to repurchase all or any part of the holder's notes at a price in
cash equal to 101% of the aggregate principal amount of their notes plus
accrued and unpaid interest and liquidated damages, if any, to the date of
repurchase. The Indenture allows Splitrock to incur senior indebtedness. The
terms of any senior indebtedness may prohibit the repurchase of the notes by
Splitrock in the event of a "Change of Control," unless and until such time as
the senior obligation is repaid in full. In that case, Splitrock would need to
obtain the consent of the requisite lenders of the senior indebtedness or repay
the senior indebtedness in full before repurchasing the notes. Our 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 Splitrock will have the financial resources necessary to repurchase the
notes or any other indebtedness upon a "Change of Control" event. See
"Description of the Notes -- Change of Control."
The ability of the Trustee to foreclose on the collateral in the escrow
account set aside by Splitrock for the benefit of the holders of the notes
could be impaired by applicable bankruptcy law.
The Trustee for the notes has the right under the Indenture governing the
notes and a related Escrow and Disbursement Agreement to foreclose upon and
sell collateral set aside in an escrow account when an event constituting
default on the notes occurs. Applicable bankruptcy law is likely to
significantly impair the Trustee's right to do this if a bankruptcy or
reorganization case were commenced by or against Splitrock because 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 once a proceeding has commenced. See "Description of the Notes --
Disbursement of Funds; Escrow Account."
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We may be unable to pay principal or interest on the notes in the event of
bankruptcy because federal and state statutes allow courts to further
subordinate or void those payments.
Fraudulent conveyance laws have been enacted for the protection of
creditors. A court could further subordinate payments under the notes to our
existing or future indebtedness or even void the payments or take other
detrimental actions if, in a bankruptcy or reorganization case or a lawsuit by
or on behalf of unpaid creditors of Splitrock, a court were to find that, at
the time Splitrock incurred indebtedness under the notes, that
. Splitrock incurred such indebtedness with the intent of hindering,
delaying or defrauding current or future creditors or
. Splitrock received less than reasonably equivalent value or fair
consideration for incurring such indebtedness and
. was insolvent or was rendered insolvent by reason of such incurrence,
. was engaged, or about to engage, in a business or transaction for
which its assets constituted unreasonably small capital,
. 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
. 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).
The measures of insolvency for purposes of these fraudulent transfer laws
vary depending upon the law of the jurisdiction which is being applied.
Generally, however, a party 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
. 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; or
. it could not pay its debts as they become due.
There can be no assurance as to what standard a court would apply in order
to determine whether Splitrock was insolvent as of the date the notes were
issued, whether a court would determine that Splitrock was insolvent on that
date, or whether the issuance constituted a fraudulent transfer. Additionally,
under federal bankruptcy law or applicable state insolvency law, if bankruptcy
or insolvency proceedings were initiated by or against Splitrock within 90 days
after any payment by Splitrock with respect to the notes or if Splitrock
anticipated becoming insolvent at the time of a payment, all or a portion of
the payment could be avoided as a preferential transfer and the Note holder, as
recipient of the payment, could be required to return the payment.
Any failure or delays by Level 3 in completing our new fiber optic backbone
network could materially and adversely affect our business.
In April 1999, we entered into an agreement with Level 3 Communications
which gives us the exclusive right to use portions of Level 3's nationwide
fiber network for a 20-year period. Our ability to fully implement our present
business plan could be adversely affected if Level 3 fails to perform its
obligations under this agreement. Level 3 may be delayed or prevented from
completing its fiber network and performing its obligations under our agreement
due to:
. insufficient capital resources;
. failure of its suppliers to provide the necessary equipment and
services;
. regulatory changes affecting its rights of way;
. a change in management strategy; or
. presently unforeseeable legal, technical or other factors.
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Our business plan assumes that we will use dark fiber strands from Level 3
to deliver our services on the fiber optic portion of our network. If Level 3
does not successfully complete the installation of these dark fiber segments,
we may not be able to provide our services or provide them at the level of
quality, efficiency and economy assumed in our business plan. While we believe
that we could transfer our business to another supplier if Level 3's segments
are not available, we may not find an alternate network which would provide
comparable technology at a competitive cost. Level 3 has not completed
construction of its network segments. Any failure by Level 3 to complete
construction of, or deploy and maintain, its dark fiber segments could hurt our
business.
Under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, we may be
required to notify the Federal Trade Commission of the transactions
contemplated by our agreement with Level 3. If this notification is required,
we will not be able to consummate the transactions contemplated by the Level 3
agreement until the requirements of the Hart-Scott-Rodino Act have been
satisfied and any applicable waiting period has expired or terminated.
Our business plan assumes that we will be able to expand and scale our network
infrastructure to accommodate increased volumes of traffic and customers;
however, our ability to scale our network by large proportions is unproven.
Our network currently handles approximately 1.3 billion minutes of use per
month. However, our ability to scale the network up to meet our expected
customer usage levels while maintaining superior performance and integrating
and managing the fiber optic backbone is unproven. As the number of our
customers grows or as network usage increases, we may need to make additional
investments to expand and adapt our network infrastructure and maintain
adequate data transmission speeds. Any future expansion and adaptation of our
communications and facility infrastructure could require substantial financial,
operational, technical and management resources. If we are required to expand
our network significantly and rapidly due to increased usage, additional stress
will be placed upon our network hardware, traffic management systems and
facilities.
Our business depends on the continued growth of the Internet and the demand for
data communications services and could suffer if demand declines.
Our business would be adversely affected if use of the Internet and the data
communications industry does not continue to grow or grows more slowly than
expected. Factors that may inhibit the continued growth of the Internet and the
data communications industry include the following:
. the ability of the Internet and data networking infrastructure to
support the growing demands placed on it;
. access costs;
. the performance and reliability of products and services as the number
of users and amount of traffic increases;
. the ability of businesses to adequately address security and privacy
concerns;
. the development of legislation or regulation related to the Internet;
and
. the nature and pace of technological changes relating to the Internet
and data communications.
In addition, websites have experienced interruptions in their service as a
result of outages and other delays occurring throughout the Internet network
infrastructure. If these outages or delays occur frequently, use of the
Internet as a commercial or business medium could, in the future, grow more
slowly than expected or decline. This would have an adverse affect on our
business.
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Our network system could fail resulting in losses and loss of user confidence.
Our success depends upon our ability to deliver reliable, high-speed access
to the Internet and upon the ability and willingness of our telecommunications
providers to deliver reliable, high-speed telecommunications service through
their networks. Our network, and other networks providing services to us, are
vulnerable to damage or cessation of operations from fire, earthquakes, severe
storms, power loss, telecommunications failures, excessive, sustained, or peak
user demand, and similar events, particularly if these events occur within a
high traffic location of the network. We cannot assure you that we will not
experience failures or shutdowns relating to individual POPs or even
catastrophic failure of the entire network. We carry business personal property
insurance to protect us against losses due to property damage and business
interruption. This coverage, however, may not be adequate or available to
compensate us for all losses that may occur. In any event, significant or
prolonged system failures or shutdowns could damage our reputation and result
in the loss of customers.
Our network is potentially vulnerable to viruses, break-ins or disruptions.
Despite our security measures, our network's infrastructure is potentially
vulnerable to computer viruses, break-ins and similar disruptive problems
caused by our customers or others. Computer viruses, break-ins or other
problems could lead to interruptions, delays or cessation in service to our
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 our customers. This could, in turn, deter
potential customers and adversely affect our existing customer relationships.
Security problems represent an ongoing threat to public and private data
networks. The security services that we offer in connection with our customers'
networks cannot assure complete protection from computer viruses, break-ins and
other disruptive problems. Although we attempt to limit contractually our
liability in these instances, the occurrence of problems may result in claims
against us or liability on our part. These claims, regardless of their ultimate
outcome, could result in costly litigation and could have a material adverse
effect on our business or reputation or on our ability to attract and retain
customers for our products. Moreover, until more consumer reliance is placed on
security technologies available, the security and privacy concerns of existing
and potential customers may inhibit the growth of the Internet service industry
and our customer base and revenues.
We must keep pace with technological change and evolving industry standards to
remain competitive and increase our revenues.
The market for data communications and Internet access and related services
is characterized by rapidly changing technology, evolving industry standards,
changes in customer needs and frequent new product and service introductions.
Our future success will depend, in part, on our ability to:
. effectively use and develop leading technologies;
. continue to develop our technical expertise;
. enhance our current services;
. develop new services that meet changing customer needs; and
. respond to emerging industry standards and technological changes in a
cost-effective manner.
If our services do not continue to be compatible and interoperable with
products and architectures offered by various other members of the industry,
our ability to compete could be impaired. We cannot assure you that we will be
successful in responding to changing technology or market trends. In addition,
services or technologies developed by others may render our services or
technologies uncompetitive or obsolete. Furthermore, changes to our services in
response to market demand may require the adoption of new technologies that
could likewise render many of our assets technologically uncompetitive or
obsolete. Even if we do successfully respond to technological advances and
emerging industry standards, the integration of new technology may require
substantial time and expense, and we cannot assure you that we will succeed in
adapting our network infrastructure in a timely and cost-effective manner.
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Changes in government regulations could adversely affect our business by
increasing costs or imposing limitations on the services we provide.
To date, we have not been subject to common carrier regulation by the FCC or
state public utility commissions, but the growth of Internet telephony and
changing technology has led regulators to consider regulating some Internet
services. We do not believe that we are subject to this type of regulation.
However, if such regulation is applied to us, we could incur substantial
regulatory costs, including obligations to contribute directly to federal and
state universal service funds. Government entities have also attempted to apply
various forms of content regulation to Internet service providers, though in
some cases Congress or the courts have made decisions that shielded Internet
service providers from liability for the content that they convey. Other
legislative and regulatory decisions designed to encourage the development of
competition in the provision of telecommunications services could benefit
certain of our competitors that are affiliated with facilities-based carriers,
and may provide at least a temporary competitive advantage to those companies.
For more information, see "Business--Regulation."
The imposition of taxes on our services could adversely affect our business.
We are uncertain what additional laws and regulations regarding taxation of
our services may be adopted due to the increasing popularity, development and
use of data communications facilities and services and the Internet in
particular. A number of state and local government officials have asserted the
right or indicated a willingness to impose taxes on Internet-related services
and commerce, including sales, use and access taxes. We cannot predict how the
activities in our industry will be taxed, and therefore how the costs of
supplying our services may be affected, in the future because there is no
precedent for many of these activities. The imposition of new taxes, directly
or indirectly, on our services could adversely affect our business, financial
condition and results of operations depending on their magnitude and our
ability to pass on the costs to end-users.
The services we provide to Prodigy may be subject to sales or use taxes in a
number of states. We believe that, under our agreement with Prodigy, we are
entitled to be reimbursed by Prodigy for these taxes if they are due. We have
billed Prodigy approximately $240,000 per month since May 1999 for taxes on
services provided and have informed Prodigy that we will be billing it for
prior periods. Prodigy has asserted that we may not be entitled to recover
these charges under the terms of our agreement. If our services to Prodigy are
ultimately determined to be subject to sales, use or other taxes and we are
unable to pass along these charges to Prodigy, our results of operations could
be materially adversely affected.
Potential problems related to the Year 2000 may decrease use of Internet
services, cause us reputational harm and adversely affect our business.
Some computer programs and systems use two digits, rather than four digits,
to define the applicable year and could fail or misfunction because they cannot
distinguish between 20th century and 21st century dates. This, in turn, could
result in a major system failure or miscalculations, including an inability to
process transactions, send invoices or engage in similar normal business
activities. The Internet and related service industries are susceptible to
year-2000 problems due to their reliance on computer hardware and software. If
these systems and programs should cause widespread problems across the
Internet, we expect users to curtail their use of the Internet dramatically
with consequent material adverse consequences to our revenues. However, we
cannot reasonably assess the magnitude of the consequences and risks of the
year-2000 problems on the basis of information currently available to us.
A failure of our systems or the systems of our suppliers, customers and
third parties with whom we do business could result in financial losses, legal
liability and reputational harm to our customers. If Internet usage and our
customers' subscriber count is reduced, it could result in a significant
reduction in our revenues and have a material adverse effect on our business.
Furthermore, Prodigy's and our other customers' purchasing patterns may be
affected by year-2000 issues as they expend significant resources to correct
their current systems for year 2000 compliance. We have not incurred material
costs in ensuring year-2000 compliance to date and do not expect to incur
material costs to make our software year-2000 compliant.
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We depend on sole- and limited-source suppliers for critical products and
services.
We rely on other companies to supply key components of our network,
operations support, and administration infrastructure. These components include
critical telecommunications services and networking equipment, which, in the
quantities and quality demanded by us, are available only from sole- or
limited-sources. We depend on sole- or limited-source suppliers for the
following products or services:
. ATM switching products--Lucent Technologies supplies us with all of our
ATM switching products, including the AC-120 switch, which is a key
component of our network.
. Internet dial access platform--Bay Networks provides us with its
Internet dial access platform.
. Routers--Cisco Systems manufactures the routers used in our network.
We do not carry significant inventories of these components and have no
guaranteed supply arrangements for these components. Our suppliers also sell
products to our competitors and may in the future themselves become our
competitors. We cannot assure you that our suppliers will not enter into
exclusive arrangements with our competitors or stop selling their products or
components to us at commercially reasonable prices, or at all. Our inability to
obtain sufficient quantities of sole- or limited-source components or to
develop alternative sources, if required, could result in delays and increased
costs in expanding, and overburdening of, our network infrastructure. Any
delay, increased costs or overburdening of our network would have a material
adverse effect on our business, financial condition and results of operations.
We also depend on local and long distance telephone companies to provide
telecommunications services to us and our customers. We experience delays from
time to time in receiving supplies and telecommunications services from our
suppliers. We cannot assure you that we will be able to obtain these supplies
or services on the scale, of the quality, and within the time frames required
by us at an affordable cost, or at all. Any failure to obtain these services on
a sufficient scale, on a timely basis or at an affordable cost would have a
material adverse effect on our business, financial condition and results of
operations.
We may be subject to legal liability for distributing or publishing content
over the Internet which could be costly for us to defend.
Congress and several states have enacted or are considering measures that
would, under some circumstances, impose civil and criminal liability upon
Internet service providers, or providers of transmission capacity to Internet
service providers, for the transmission or dissemination of information and
materials. It is possible that costly claims will be made against us in
connection with the nature and content of the materials disseminated through
our networks. Currently, several private lawsuits of this sort are pending
against other online services companies and Internet access providers. Given
the heightened attention this topic has recently received, and will continue to
receive if any of the current lawsuits are successful, we might be required to
respond by investing substantial resources or discontinuing some of our service
offerings. These factors may also cause growth of Internet use to decline.
Finally, although we carry general liability insurance, it may not be adequate
to compensate us or it may not cover us in the event we become liable for
information carried on or disseminated through our networks. Any costs not
covered by insurance incurred as a result of liability or asserted liability
for information carried on or disseminated through our networks could hurt our
business.
We depend on other companies for peering and interconnection arrangements.
We maintain peering and interconnection arrangements with other network
service providers so that we can exchange traffic with them. Recently,
companies that previously offered peering have eliminated peering relationships
or established new, more restrictive criteria for peering. We are uncertain
whether other network service providers will continue peering and
interconnection arrangements on acceptable terms or impose settlement charges
as a result of an increasingly competitive Internet services industry dominated
by a smaller group of national network providers. For more information, see
"Business--Our Network--Peering and Interconnection."
22
<PAGE>
The network design and technical expertise that we depend on may be developed
or similarly deployed by others.
Our success and ability to compete is dependent in part upon our technical
expertise. We do not have proprietary rights that would prevent our competitors
from deploying technologies or independently developing a network design and
technical expertise that are substantially equivalent or superior to our own.
For example, Sprint is in the process of designing a network which will contain
ATM switches at every core, hub and remote site. The construction by our
competitors of networks similar to our own may adversely affect our ability to
compete effectively.
Third parties may claim we infringe their proprietary rights and these claims
could result in increased costs.
Although we do not believe we infringe the proprietary rights of any third
parties, we cannot assure you that third parties will not assert claims against
us in the future or that those claims will not be successful. We could incur
substantial costs and diversion of management resources to defend any claims
relating to proprietary rights, which could have a material adverse effect on
our business, financial condition and results of operations. Furthermore,
parties making those claims could secure a judgment awarding substantial
damages, as well as injunctive or other equitable relief that could effectively
block our ability to license our products in the United States or abroad. Such
a judgment would have a material adverse effect on our business, financial
condition and results of operations. In addition, we are obligated under
various agreements to indemnify the other party for claims that we infringe on
the proprietary rights of third parties. If we are required to indemnify
parties under these agreements, our business, financial condition and results
of operations could be materially adversely affected. If someone asserts a
claim relating to proprietary technology or information against us, we may seek
licenses to that intellectual property. We cannot assure you, however, that we
could obtain licenses on commercially reasonable terms, if at all. The failure
to obtain the necessary licenses or other rights could have a material adverse
effect on our business, financial condition and results of operations.
We may not be able to successfully manage our expansion.
Our anticipated future growth will continue to place a significant strain on
our management systems and resources. We expect that we will need to continue
to improve our financial and managerial controls and reporting systems and
procedures. We will also need to continue to expand and maintain close
coordination among our technical, accounting, finance and sales and marketing
organizations. Key members of our management team, including our Chief
Financial Officer, Chief Marketing Officer and Senior Vice President for
Network Operations, have joined us within the last few months. These
individuals have not previously worked together and are becoming integrated
into our management team. They may not be able to work together effectively or
successfully manage our growth. Our inability to manage growth effectively
could have a material adverse effect on our business, financial condition and
results of operations.
We may be unable to successfully acquire other companies, form strategic
alliances or successfully integrate any acquisition or alliance.
We will evaluate strategic alliances and acquisitions both domestically and
internationally as they present themselves. Any future strategic alliance or
acquisition involves risks commonly encountered in business relationships. We
may encounter obstacles while integrating the operations and personnel of the
companies and the integration efforts may disrupt our ongoing business. Our
management may be unable to successfully incorporate licensed or acquired
technology and rights into our service offerings or maintain uniform standards,
controls, procedures and policies within the two organizations. Changes in
management resulting from an alliance or acquisition could impair relationships
with employees and customers. Any international alliance or acquisition would
involve 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. We may not
successfully overcome these risks or any other problems encountered in
connection with strategic alliances or acquisitions. In addition, we could
incur substantial expenses, including the expenses of integrating the parties'
businesses in a strategic alliance or after an acquisition, which could, in
turn, adversely affect our business, financial condition and results of
operations.
23
<PAGE>
Our directors have relationships that could present conflicts of interest.
Our directors have relationships with other companies that could result in
potential conflicts of interest.
. Since 1991, Mr. Nakfoor has served as the Vice President of Securities
Trading for Inversora Bursatil, S.A. de C.V., a wholly-owned subsidiary
of Grupo Financiero Inbursa, S.A. de C.V., and an affiliate of our
second largest shareholder, Carso Global. Carso Global currently
controls our largest customer, Prodigy, on whose board Mr. Nakfoor has
served since September 1997. Prodigy's President and Chief Executive
Officer, Samer Salameh, was a member of our board of directors until
April 1999.
. Mr. Li was Director, Vice Chairman, Chief Technology Officer and owner
of 12.4% of the common stock of Yurie, which was one of our principal
suppliers until it was sold to Lucent. 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
AC-120 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 is Chief
Technical Officer, Carrier Network Division of Lucent and has agreed not
to participate in designing, developing, producing, manufacturing or
marketing multi-service access equipment other than for Lucent. Mr. Li
and members of his family also control Linsang, which is our largest
shareholder.
. Mr. Turner is also a member of the board of directors of our largest
shareholder, Linsang Partners, LLC, a limited liability company
controlled by Mr. Li and members of his family.
As a result of these relationships, there is a potential for conflicts of
interest to arise when our directors are faced with a decision that could have
different implications for our company and the other companies with which our
directors have a relationship. Due to the nature of the potential conflicts of
interest presented by these relationships on an ongoing basis, we cannot
assure you that the directors involved will act in the best interests of our
company and our stockholders.
Affiliates of ours have engaged in numerous transactions with us in the
past. These transactions were not necessarily a result of arms'-length
negotiations. We may engage in additional related party transactions in the
future and we cannot assure you that these transactions will be on arms'-
length terms. For more information, see "Certain Transactions."
Our existing stockholders will maintain control of us.
Our executive officers and directors and entities affiliated with them
will, in the aggregate, beneficially own approximately 94.5% of our common
stock following this offering alone, and 79.8% after this offering and our
initial public offering. These stockholders will continue to be able to
exercise control over all matters requiring approval by our stockholders,
including the election of directors and the approval of significant corporate
transactions. This concentration of ownership may also have the effect of
delaying or preventing a change in control of our company, which could
negatively affect our stock price. For more information, see "Principal
Stockholders."
Future sales of our common stock may negatively affect our stock price.
We will have a large number of shares of common stock outstanding and
available for resale beginning at various points in time in the future. The
market price of our common stock could decline as a result of sales of a large
number of shares of our common stock in the market or the perception that
sales could occur. These sales also might make it more difficult for us to
sell equity securities in the future at a time and at a price that we deem
appropriate. For more information, see "Shares Eligible for Future Sale."
Provisions of our certificate of incorporation, bylaws and Delaware law could
deter takeover attempts.
Our certificate of incorporation and bylaws and the Delaware corporations
law contain provisions that could have the effect of making it more difficult
for a third party to acquire, or discourage a third party from attempting to
acquire, control of us. These provisions could limit the price that investors
might be willing to pay in the future for shares of our common stock. For more
information, see "Description of Capital Stock."
24
<PAGE>
There has been no prior public market for our securities, and our stock price
may experience extreme price and volume fluctuation after our initial public
offering.
There was no public market for our common stock prior to our initial public
offering, and Splitrock does not intend to list the warrants or the notes on
any national securities exchange or to seek approval for quotation through any
automated quotation system. The warrants and the notes are also no longer
eligible for trading in the Private Offerings, Resales and Trading through
Automated Linkages or PORTAL Market. We are offering 9,000,000 shares of our
common stock at an initial public offering price of $10.00 per share under a
separate prospectus. See "Prospectus Summary--Recent Developments." Our common
stock has been approved for listing on the Nasdaq National Market System. Chase
Securities currently makes a market in the warrants and the notes, but it is
not obligated to do so and may discontinue that market making at any time. In
addition, market making activities are subject to the limits imposed by the
Securities Act and the Exchange Act. Accordingly, no assurance can be given
that an active public or other market will develop for the notes, the warrants,
our common stock or as to the liquidity of the trading market for such
securities. If a trading market does not develop or is not maintained, holders
of the warrants, the warrant shares and the notes may experience difficulty
reselling their securities or may be unable to sell them at all and thus be
required to bear the financial risks of the investment for an indefinite period
of time. If a market for the securities develops, it may be discontinued at any
time.
If an active public trading market develops for the warrants, our common
stock or the notes, future trading prices of such securities will depend on
many factors, including, among other things, prevailing interest rates,
Splitrock's results of operations and the market for similar securities, and
such securities may trade at a discount from their initial offering price.
Historically, the market for similar securities, 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
our securities, if developed, will not be subject to similar disruptions.
The stock market has experienced extreme price and volume fluctuations. The
market prices of the securities of technology companies and Internet-related
companies in particular have been especially volatile. This volatility has
included rapid and significant increases in the trading prices of Internet
companies following initial public offerings to levels that do not bear any
reasonable relationship to the operating performance of those companies and
large inter-day swings in the trading prices of their securities. These
fluctuations may materially affect the trading price of our common stock
especially upon our intial public offering. We cannot guarantee that you will
be able to sell your warrant shares at or above the initial public offering
price of $10.00 per share.
In the past, stockholders have often instituted securities class action
litigation following periods of volatility in the market price for a company's
securities. Such litigation could result in substantial costs and the diversion
of management's attention and resources, which could have a material adverse
effect on our business, financial condition and results of operations.
The reliability of market data included in this prospectus is uncertain.
Since we are a new company and operate in a new and rapidly changing market,
we have included market data from industry publications, including reports
produced by Forrester Research, Inc. and International Data Corporation. The
reliability of these data cannot be assured. These industry publications
generally indicate that they have obtained information from sources believed to
be reliable, but do not guarantee the accuracy and completeness of their
information. While we believe these industry publications to be reliable, we
have not independently verified their data. We also have not sought the consent
of any of these organizations to refer to their reports in this prospectus.
25
<PAGE>
USE OF PROCEEDS
We will receive proceeds of $0.02 per share issued upon the cash exercise of
any warrant. Assuming that all of the warrants are exercised for cash, we will
realize net proceeds of approximately $29,756. We intend to use the net
proceeds from this offering for working capital and other corporate purposes.
We will not receive any proceeds from:
.the cashless exercise of any warrant; or
.the sale of any warrants or notes by selling securityholders.
.the subsequent resale of the shares of common stock by our shareholders.
DIVIDEND POLICY
We have never paid any cash dividends on our common stock and do not
anticipate declaring or paying any cash dividends in the foreseeable future. We
currently intend to retain future earnings, if any, to fund the development and
growth of our business. Declaration or payment of future dividends, if any,
will be at the discretion of our board of directors after taking into account
various factors, including our financial condition, operating results and
current and anticipated cash needs and plans for expansion. In addition, our
ability to pay dividends on the common stock is restricted by certain covenants
in the indenture governing our outstanding 11 3/4% senior notes.
26
<PAGE>
CAPITALIZATION
The following table shows our cash and cash equivalents, investments and
total capitalization:
. on an actual basis as of June 30, 1999; and
. as adjusted to reflected the sale of 9,000,000 shares of common stock to
be sold by us in our initial public offering at an initial public
offering price of $10.00 per share, after deducting the underwriting
discount and the estimated offering expenses payable to us.
You should read this information together with our financial statements and
the notes relating to those statements and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Use of
Proceeds" appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
As of June 30, 1999
-----------------------------------
Actual As Adjusted
---------------- -----------------
(in thousands, except share data)
<S> <C> <C>
Cash and cash equivalents.................. $ 8,327 $ 91,152
================ ================
Investments:
Unrestricted investments--short term..... $ 56,166 $ 56,166
Restricted investments--short term....... 21,597 21,597
Restricted investments--long term........ 23,243 23,243
---------------- ----------------
Total investments.......................... $ 101,006 $ 101,006
================ ================
Long Term Debt:
11 3/4% senior notes due 2008............ $ 258,298 $ 258,298
Capital lease obligations................ 12,471 12,471
---------------- ----------------
Total long term debt (including current
portion).................................. 270,769 270,769
Stockholders' Equity (Deficit):
Preferred stock, $.001 par value,
25,000,000
shares authorized, no shares issued..... -- --
Common stock, $.001 par value,
150,000,000 shares authorized,
46,681,424 shares issued and outstanding
actual; 55,681,424 shares issued and
outstanding, as adjusted................ 47 56
Additional paid-in capital............... 34,831 117,647
Common stock warrants.................... 2,849 2,849
Accumulated other comprehensive (loss)... (335) (335)
Accumulated deficit...................... (119,317) (119,317)
---------------- ----------------
Total stockholders' equity (deficit)... (81,925) 900
---------------- ----------------
Total capitalization....................... $ 188,844 $ 271,669
================ ================
</TABLE>
The number of shares as adjusted for this table excludes:
. any shares of common stock that may be issued pursuant to the
underwriters' over-allotment option in our initial public offering;
. 1,487,791 shares of common stock issuable upon the exercise of
outstanding warrants with an exercise price of $0.02 per share;
. 2,896,128 shares of common stock issuable upon the exercise of
outstanding options at June 30, 1999 with a weighted average exercise
price of $5.10 per share; and
. 7,735,845 shares of common stock reserved for issuance upon the exercise
of options available at June 30, 1999 to be granted under our stock
option plans including options to purchase 1,233,715 shares exercisable
at the initial public offering price of $10.00 per share which are to be
granted in connection with the initial public offering.
27
<PAGE>
SELECTED FINANCIAL DATA
Our statement of operations data for the period from inception (March 5,
1997) to December 31, 1997 and for the year ended December 31, 1998, and our
balance sheet data as of December 31, 1997 and 1998, shown in the table below
are derived from our audited financial statements. Our statement of operations
data for the six months ended June 30, 1998 and 1999 and our balance sheet data
as of June 30, 1999 have been derived from our unaudited financial statements
which, in the opinion of management, include all adjustments, consisting only
of normal recurring adjustments, necessary for a fair statement of the results
for the unaudited interim periods presented. You should read this information
together with our financial statements and the notes relating to those
statements and with the section entitled "Management's Discussion and Analysis
of Financial Condition and Results of Operations" appearing elsewhere in this
prospectus.
The "As Adjusted" balance sheet data reflects the sale of the shares of
common stock offered by us in our initial public offering at the initial public
offering price of $10.00 per share, after deducting the underwriting discount
and the estimated offering expenses payable by us.
<TABLE>
<CAPTION>
Period from
Inception
(March 5,
1997) through Year Ended Six Months Ended June 30,
December 31, December 31, --------------------------------------
1997 1998 1998 1999
------------- ----------------------- ------------------------ ------------
(in thousands, except share and per share data)
<S> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues.............. $ 22,708 $ 63,611 $ 32,214 $ 34,241
Operating expenses:
Splitrock network
costs.............. 2,362 32,912 10,724 34,150
Legacy network
costs.............. 25,804 58,292 27,111 21,871
Selling, general and
administrative..... 1,276 6,390 2,441 6,338
Depreciation and
amortization....... 3,500 13,850 4,907 11,237
---------- ---------------------- ------------------------ ------------
Total operating
expenses......... 32,942 111,444 45,183 73,596
---------- ---------------------- ------------------------ ------------
Loss from operations.. (10,234) (47,833) (12,969) (39,355)
Other income
(expense):
Interest income..... 348 5,393 183 4,335
Interest expense.... (235) (15,390) (842) (16,346)
---------- ---------------------- ------------------------ ------------
Loss before income
tax.................. (10,121) (57,830) (13,628) (51,366)
Provision for income
tax.................. -- -- -- --
---------- ---------------------- ------------------------ ------------
Net Loss.............. $ (10,121) $ (57,830) $ (13,628) $ (51,366)
========== ====================== ======================== ============
Net Loss per share--
basic and diluted.... $ (0.42) $ (1.30) $ (0.31) $ (1.10)
========== ====================== ======================== ============
Weighted average
shares--basic and
diluted.............. 24,109,823 44,388,948 43,288,168 46,668,728
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
As of December As of June
31, 30, 1999
-------------- -----------------
As
1997 1998 Actual Adjusted
------ ------- ------- --------
(in thousands)
<S> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents.................. $7,710 $28,330 $ 8,327 $91,152
Unrestricted investments................... -- 120,475 56,166 56,166
Restricted investments (1)................. 3,472 58,477 44,840 44,840
Property and equipment, net................ 38,504 73,899 88,721 88,721
Total assets............................. 54,388 296,141 232,729 315,554
Long-term debt and capital lease
obligations (including current portion)... 25,120 275,581 270,769 270,769
Stockholders' equity (deficit)............. 20,407 (30,291) (81,925) 900
<CAPTION>
Period from
Inception
(March 5,
1997) through Year Ended Six Months Ended June 30,
December 31, December 31, ---------------------------
1997 1998 1998 1999
------------- ------------ ------------ -------------
(in thousands)
<S> <C> <C> <C> <C>
Other Financial Data:
Capital expenditures.. $16,969 $ 45,261 $ 5,548 $ 25,311
EBITDA (2)............ (6,734) (33,983) (8,062) (28,118)
Cash provided by (used
in):
Operating
activities......... (2,233) (735) (3,712) (47,723)
Investing
activities......... (17,198) (169,512) (7,714) 33,064
Financing
activities......... 27,141 190,867 8,893 (5,344)
Ratio of earnings to
fixed charges (3).... -- -- -- --
</TABLE>
- --------
(1) Restricted investments as of June 30, 1999, represent escrowed funds that,
together with interest received those funds, will be sufficient to pay,
when due, the next three semi-annual interest payments on our outstanding
11 3/4% senior notes.
(2) EBITDA is defined as net loss plus interest expense, provision for income
taxes, depreciation and amortization. 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 liquidity and is not a measure calculated in accordance with
generally accepted accounting principles. EBITDA is not necessarily
comparable with similarly titled measures reported by other companies.
(3) Our historical earnings were insufficient to cover our fixed charges for
the period from inception (March 5, 1997) to December 31, 1997, the year
ended December 31, 1998, and the six month periods ended June 30, 1998 and
1999 by approximately $10.1 million, $57.8 million, $13.6 million and $51.4
million, respectively. Fixed charges consist of interest expense and that
portion of rent expense we believe to be representative of interest (i.e.,
one-third of rent expense).
29
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion together with our financial
statements and the notes to those statements included elsewhere in this
prospectus. The results shown in this prospectus are not necessarily indicative
of the results we will achieve in any future periods. This discussion contains
forward-looking statements based upon our current expectations which involve
risks and uncertainties. Our actual results could differ materially from those
described in the forward-looking statements due to a number of factors,
including those set forth in the section entitled "Risk Factors" and elsewhere
in this prospectus.
Overview
We are a facilities-based provider of advanced data communications services.
We market our services to Internet service providers, telecommunications
carriers and other businesses throughout the United States. Our services
include an array of Internet access and data communications services delivered
over our high capacity, facilities-based network.
We were founded in March 1997. In July 1997, we acquired the existing legacy
network infrastructure of Prodigy Communications Corporation, and agreed to
build and operate a nationwide communications network and to provide network
services for Prodigy's customers. We initially provided service to Prodigy's
subscribers using Prodigy's legacy network. For locations outside the coverage
area of the legacy network, we have been using the IBM Global Services network.
From September 1997 through April 1998, we deployed our broadband access
network in metropolitan areas across the country. Over time, as more coverage
has become available on our access network, we have been decommissioning the
Prodigy legacy network POPs and reducing our usage of the IBM network. In July
1998, we raised $261 million through the issuance of our 11 3/4% senior notes
and warrants to purchase common stock, principally to finance capital
expenditures related to the construction and installation of our broadband
access network. As of June 30, 1999, our network included 324 installed POPs,
270 of which were operational. Later this year, we expect to have approximately
370 active POPs, giving us a physical presence in all 50 states, and targeting
90% of U.S. businesses and households with a local call. Our expanding network
is supported by two network operations centers equipped with state-of-the-art
network management systems.
As part of our ongoing efforts to further expand and enhance our network and
service offerings, we have agreed to acquire indefeasible rights to use four
dark fiber strands in a state-of-the-art fiber optic network currently under
construction by Level 3 Communications, LLC, with an option to acquire
indefeasible rights to use an additional 12 fibers. This nationwide fiber
network will cover approximately 15,000 route miles and will be delivered in
segments that are expected to become available from the end of 1999 through the
first quarter of 2001. The combination of this fiber optic backbone with our
broadband access network positions us to:
. deliver, on our own facilities, a broad array of end-to-end data
communications services at the high level of quality and reliability
increasingly demanded by customers;
. reduce significantly our network costs as a percentage of revenues as we
substitute the acquired bandwidth for existing leased circuit
arrangements with various telecommunications carriers;
. expand our service offerings by providing bandwidth leasing services on
a stand alone basis or bundled with our other services;
. increase the reliability and redundancy of our network; and
. increase the variety of service options and speeds available to
customers.
30
<PAGE>
Revenues
Historically, Prodigy has been our primary customer and has accounted for
substantially all of our revenues since our inception. For the year ended
December 31, 1998 Prodigy accounted for 99% of our revenues. For the six months
ended June 30, 1999 Prodigy accounted for 93% of our revenues. While we expect
revenues from Prodigy to decrease as a percentage of our total revenues in
future periods, we believe that Prodigy will continue to account for a
significant portion of our revenues.
We provide network services, including Internet dial services and other
network connections, to Prodigy in exchange for a monthly service charge. The
service charge is calculated based on the lower of two alternative rates,
subject to a minimum. One rate is calculated based upon the total hours of
usage and the other rate is calculated based upon the total number of
subscribers. The minimum monthly service charge is $4.0 million and will
increase to $4.5 million on July 1, 2000. Through March 31, 1998, our Prodigy
revenues were a function of the amount of usage rather than the number of
subscribers. However, since April 1998, these revenues have been, and over the
long term are expected to continue to be, a function of the number of
subscribers rather than the amount of usage. In addition, if the average
monthly hours per subscriber exceeds a target amount, we will be entitled to
receive additional fees.
Our original four-year agreement with Prodigy expires on June 30, 2001.
After the initial term, either party may terminate the agreement upon 12
months' prior written notice. If no notice is received, the term of the
agreement is automatically extended for successive 12-month terms. Under the
agreement, we are required, among other things, to provide Prodigy with
financial and other information and to meet network performance standards. We
are required to provide credits to Prodigy if we fail to meet these standards.
Prodigy may terminate the agreement following a cure period if we fail to meet
specified service level objectives or otherwise fail to comply with our
agreement. Prodigy may also terminate the agreement during the initial term
without cause by providing 12 months' prior written notice and paying a
termination charge of $3.0 million.
Prodigy has announced plans to discontinue Prodigy Classic, its original on-
line service, on or before October 31, 1999 because of a shift in business
focus to Internet-based products and services and a determination not to make
Prodigy Classic Year 2000 compliant. Prodigy has reported that, although it
will continue to encourage Prodigy Classic subscribers to migrate to Prodigy
Internet, it has had difficulty in generating this migration and a substantial
portion of the remaining Prodigy Classic subscribers lack the minimum hardware
requirements for the Prodigy Internet service. While we expect continued growth
in Prodigy Internet subscribers, we do not expect that any significant portion
of this growth will be attributable to the migration of Prodigy Classic
subscribers.
On May 27, 1999, Prodigy announced that it had entered into a definitive
agreement to acquire the Internet access customer base of Cable & Wireless USA,
which we believe will result in a significant increase in Prodigy subscribers.
In addition to providing Internet dial access and related services to
Prodigy, we began offering Internet dedicated access services on a limited
basis to select customers during the second half of 1998. Given the nature of
our network costs and the fact that current network utilization peaks in the
evening hours to support Prodigy's residential Internet subscribers, we are
targeting providers of daytime intensive traffic as well as providers of
evening intensive traffic to maximize network utilization throughout a 24-hour
period. We plan to focus on providing virtual private network services,
Internet dedicated access, web hosting and Internet dial access services.
Historically, in the data communications industry, providing virtual private
network services increases the length of the sales cycle when compared to
providing Internet dedicated access services. Because we are in the early
stages of building our sales force, we expect growth in revenues to fluctuate
from quarter to quarter depending on the volume of monthly revenue of our
customers and the actual date the service becomes billable to our customers. We
cannot assure you that we will achieve the balance of utilization of the
network facilities necessary to attain or maximize profitability or positive
cash flow from operations.
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Leveraging our demonstrated network capabilities, we have recently entered
into significant new customer relationships with Juno Online Services and
InfiNet. Juno, a leading provider of Internet and e-mail services, currently
has more than 200,000 subscribers for its Internet services launched in July
1998 and has created more than 6.8 million free e-mail accounts since April
1996. InfiNet, a consortium sponsored by Knight-Ridder, Gannett and Landmark
Communications, provides Internet access and web publishing solutions to nearly
100,000 subscribers nationwide. We began providing Internet dial access to
InfiNet's subscribers in the second quarter of 1999.
As segments of our fiber backbone are constructed, we plan to use the
additional network capacity to offer bandwidth leasing services. However,
overcapacity could result from the construction of competing networks,
technological advances, strategic alliances, or a decline in the growth rate of
demand for bandwidth capacity. If this occurs, we could encounter significant
pricing pressure, which could limit the amount we could competitively charge
for these services.
Splitrock Network Costs
Our Splitrock network costs include all expenses incurred in connection with
operating our network. These costs primarily include leased telecommunication
line charges for connecting our POPs to local central offices and for backbone
transmission, personnel expenses, and operating expenses related to network
operations, maintenance field operations and facility management.
Increases in Splitrock network operating costs relate to the increase in
Splitrock network facilities and line charges incurred in connection with the
growth in total subscriber usage. As of June 30, 1999, we had 324 installed
POPs, 270 of which were operational, and we expect to have approximately 370
operational POPs when our network construction is completed later this year. We
anticipate continued increases in our network operating costs as additional
lines and facilities are deployed.
We are deliberately increasing our network operating expenditures to expand
our broadband access network and backbone capacity in anticipation of expected
increases in dial access and other services. We may incur expenditures to
increase our capacity to serve customers in advance of entering into new
customer relationships.
During March 1999, in order to maintain the quality and reliability of our
network performance, we entered into an agreement with Lucent Technologies to
provide us with maintenance on our broadband access network. Prior to entering
into this maintenance arrangement with Lucent, we had performed our own
maintenance of equipment and have relied on warranties from our vendors. We
expect our maintenance costs to increase as POP sites are added to the
maintenance contract through year end.
We expect our network operating costs to decrease significantly as a
percentage of revenues as we substitute our acquired fiber optic backbone
network for existing leased circuit arrangements with various
telecommunications carriers. Although we expect to incur new costs for
maintenance, colocation and software in connection with the fiber optic
network, we expect these new costs to be offset in future years by a larger
reduction in charges for backbone transmission.
Legacy Network Costs
Legacy network costs include all expenses incurred in connection with
operating and decommissioning the Prodigy legacy network and costs of operating
the InfiNet legacy network until we transition InfiNet traffic from its network
to our network. These costs include facility leases, line charges, occupancy
costs, equipment maintenance costs and access fees for the IBM network, as well
as significant transition costs which will be incurred until the traffic from
these legacy networks is migrated to our network.
Legacy network costs are expected to continue to decline, as more coverage
becomes available on our own broadband access network. As the construction and
installation of our own network progresses, the Prodigy
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legacy network is being decommissioned and usage of the IBM network is
declining. As of June 30, 1999, we had fully deactivated substantially all of
the original Prodigy legacy network POPs. Our network can service a substantial
portion of the InfiNet traffic acquired in May of 1999. We began migrating the
InfiNet traffic to our network in July 1999 and expect to be substantially
completed by the end of the year. Despite the increase in legacy network costs
resulting from the InfiNet network, our legacy network costs in total decreased
32.1% from the first quarter of 1999 to the second quarter of 1999. We do not
expect to incur any significant legacy network costs beyond the end of 1999.
The largest component of our legacy network costs are paid to IBM for usage
incurred on the IBM network. We have incurred quarterly costs from IBM of $6.3
million, $7.3 million, $11.0 million, $12.0 million, $12.6 million, $11.5 and
$6.5 million, respectively, for the seven quarters from October 1, 1997 through
June 30, 1999. The increase in costs through the fourth quarter of 1998 related
to a continued quarterly increase in total subscriber usage, coupled with an
increase in the hourly usage rate that went into effect at the beginning of the
second quarter of 1998. The IBM network costs have declined since the fourth
quarter of 1998 and we expect those costs to be substantially eliminated by the
end of 1999.
During construction of new POP sites, access and transmission lines are
installed and charges are incurred as a POP site becomes operational.
Transition costs result from a duplication of expenses on both the new POP and
the associated legacy network POP until the new POP is operational and the
associated legacy network POP is decommissioned.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist of personnel and
operating costs relating to executive management, accounting and finance,
information systems, human resources, sales and marketing, customer support,
network planning, development, and administrative employees. We expect our
selling, general and administrative expenses to continue to increase in dollar
amount and as a percentage of revenue in 1999, 2000 and 2001 principally due to
the following factors:
. expansion of our sales and marketing force; and
. expansion of our back-office, customer care, billing, and administrative
functions.
We expect to make a substantial investment in our sales and marketing
programs to achieve and properly support the intended expansion in our customer
base. Through the combination of a direct sales force and alternative
distribution channels, we believe that we will be able to access markets and
increase revenue-producing traffic on our network. To implement our
distribution strategy, we are developing an in-house direct sales force. We
intend to utilize our direct sales force to market our services directly to
Internet service providers, carriers, value added service providers, and medium
and large businesses. We intend to utilize alternate distribution channels,
such as agents, resellers and wholesalers, to market our services to medium and
small businesses. We cannot assure you that we will be successful in our
marketing plan. In addition to the expanded sales force, we anticipate
continued back-office expansion, including the continued implementation of a
new customer care and billing system. We have also signed a lease for 69,000
square feet of additional office space, which we expect to be available for
occupancy by August 1999. This office lease will increase selling, general and
administrative costs and will also require additional capital expenditures for
furniture and fixtures and leasehold improvements.
Depreciation and Amortization
Depreciation and amortization expense consists primarily of depreciation of
network equipment. We anticipate that our depreciation and amortization
expenses will increase significantly as we record amortization on amounts
expected to be paid to acquire dark fiber rights and depreciation expenses for
the related electronic equipment.
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Net Losses
We have incurred net losses since our inception in March 1997. We anticipate
that we will continue to incur net losses while we complete the construction
and installation of our nationwide network and expand our sales and marketing
force. The extent to which we continue to incur net losses is largely dependent
upon the timely deployment of the network, the rate at which we can expand our
customer and revenue base and our ability to maximize use of our nationwide
network.
Results of Operations
Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998
Revenues. Revenues for the six months ended June 30, 1999 totaled $34.2
million, an increase of $2.0 million from revenues of $32.2 million for the six
months ended June 30, 1998. This increase was due primarily to providing dial
access service to InfiNet subscribers commencing in May of 1999.
Splitrock Network Costs. Splitrock network costs for the six months ended
June 30, 1999 were $34.2 million compared to $10.7 million for the six months
ended June 30, 1998. This increase was due to the growth in the size of our
network from 70 operational POPs as of June 30, 1998 to 270 operational POPs as
of June 30, 1999. As a percentage of revenues, Splitrock network costs
increased to 100.0% of revenue for the six months ended June 30, 1999 from
33.3% of revenues for the six months ended June 30, 1998.
Legacy Network Costs. Legacy network costs for the six months ended June
30, 1999 were $21.9 million compared to $27.1 million for the six months ended
June 30, 1998. This decrease was primarily attributable to a decrease in the
IBM Network access charges as a result of the expanded coverage becoming
available on our network and the migration of additional traffic from the
Prodigy legacy network to our network. This decrease was offset by
approximately $1.9 million of additional costs from servicing InfiNet customers
on its legacy network beginning in May 1999. Despite the increase in legacy
network costs resulting from the InfiNet network, our legacy network costs in
total decreased 32.1% from the first quarter of 1999 to the second quarter of
1999. As a percentage of revenues, legacy network costs decreased to 63.8% of
revenue for the six months ended June 30, 1999 from 84.2% of revenues for the
six months ended June 30, 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the six months ended June 30, 1999 were $6.3
million compared to $2.4 million for the six months ended June 30, 1998. The
majority of this increase was due to personnel costs incurred in building our
internal sales force beginning in the second quarter of 1999 and the increase
in personnel throughout 1998 and 1999 to support the growth in the size of our
network. As a percentage of revenues, selling, general and administrative
expenses increased to 18.5% of revenues for the six months ended June 30, 1999
from 7.6% of revenues for the six months ended June 30, 1998.
Depreciation and Amortization. Depreciation and amortization was $11.2
million for the six months ended June 30, 1999 compared to $4.9 million for the
six months ended June 30, 1998. This increase was due to the increase in
equipment and facilities placed in service throughout 1998 and 1999.
Interest Expense. Interest expense was $16.3 million for the six months
ended June 30, 1999, compared to $0.8 million for the six months ended June 30,
1998. Historical interest expense was related to capital leases on equipment
and loans from a stockholder prior to completion of the senior notes offering
in July 1998. Beginning in the third quarter of 1998, interest expense
increased significantly due to the issuance of our senior notes.
Interest Income. Interest income relates to the interest earned on
investments of cash on hand in investment grade commercial paper and money
market accounts. Interest income was $4.3 million for the six months ended June
30, 1999, compared to $0.2 million for the six months ended June 30, 1998. This
increase was due to the interest earned on the proceeds from our senior notes
offering.
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Income Taxes. No provision for income taxes has been recognized because we
had operating losses for both tax and financial reporting purposes in all
periods.
On June 30, 1999, we had approximately $45.0 million of gross deferred tax
assets comprised primarily of net operating loss carryforwards. Given our
history of operating losses, it is uncertain that we would realize these
assets, and so we have provided a reserve to reduce the carrying value of the
assets to zero. We will continue to assess the ability to realize the deferred
tax assets based on actual and forecasted results.
Year Ended December 31, 1998 Compared to Period from Inception on March 5,
1997 through December 31, 1997
From inception on March 5, 1997 through June 30, 1997, we had not yet begun
deploying our network nor had we entered into our agreement with Prodigy. As a
result, we generated no revenue and incurred limited operating expenses prior
to the third quarter of 1997. Thus, any comparison of our results of operations
for the year ended December 31, 1998 with those results for the period from our
inception to December 31, 1997 is not meaningful.
Since inception, we have focused on the construction and installation of our
network while maintaining and decommissioning, when appropriate, the Prodigy
legacy network. Through December 31, 1998, we had not focused on increasing
sales, as our network had not yet been completed. Prodigy represented our
primary source of revenue during both 1997 and 1998. In the second quarter of
1998, we began our efforts to raise capital to complete the construction and
installation of our nationwide network. On July 24, 1998, we issued and sold
$261.0 million in senior notes and warrants to acquire 1,487,791 shares of
common stock and began a campaign to recruit and employ the personnel necessary
to complete, operate and maintain our network.
To support our expansion, we have been adding employees. At the end of 1997
and 1998, respectively, we had 67 and 188 full time employees and contractors.
Many of the employees we added represent field and office personnel for
construction management, assembly and installation, provisioning, and related
project management services for POP shelters. Additionally, during 1998, we
added our second state-of-the-art network operations center in The Woodlands,
Texas.
Liquidity and Capital Resources
Our operations have required substantial capital investment for the purchase
of communications equipment and the design and development of our network.
Capital expenditures were $45.3 million and $25.3 million for the year ended
December 31, 1998 and the six months ended June 30, 1999, respectively. We
expect that our capital expenditures will be substantially higher in future
periods in connection with the purchase of dark fiber and the related
facilities and telecommunications equipment.
Since our inception, we have satisfied our cash requirements primarily
through the issuance of equity or debt securities. As of June 30, 1999, we had
raised approximately $298.2 million, including
. $34.9 million through private sales of our equity securities, including
$18.0 million invested by our senior management and directors and $15.6
million invested by another major stockholder; and
. $263.3 million through the issuance of debt.
In addition we have arranged $30.6 million in equipment financing, primarily
from equipment vendors and leasing companies.
As of June 30, 1999, we had an accumulated deficit of $119.3 million, cash
and cash equivalents of $8.3 million, and restricted and unrestricted
investments of $101.0 million.
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Net cash used in operating activities was $47.7 million during the six
months ended June 30, 1999. The net cash used in operating activities in this
period was primarily attributable to the Company's net losses. Net cash used in
operating activities was $0.7 million for the year ended December 31, 1998.
During the year-ended December 31, 1998, the cash flow effect of net losses
were largely offset by increases of $42.0 million in current liabilities due to
the timing of payments for purchases to equipment vendors and accrued interest
to bond holders.
Net cash provided by investing activities during the six months ended June
30, 1999 was $33.1 million. This consisted primarily of net proceeds of $64.3
million from the liquidation of unrestricted investments $13.3 million net
liquidation of restricted investments which were used to pay the interest on
the senior notes, offset by $25.3 million used for purchases of property and
equipment, the payment of a deposit of $11.2 million related to dark fiber and
approximately $8.0 million primarily for costs incurred in connection with the
construction of our broadband access platform. Net cash used by investing
activities for the year ended December 31, 1998 was $169.5 million and
consisted primarily of the purchase of unrestricted investments of $119.5
million and $45.3 million in equipment purchases.
Net cash used in financing activities for the six months ended June 30, 1999
was $5.3 million and consisted primarily of principal payments on capital
leases. Net cash provided by financing activities for the year ended December
31, 1998 was $190.9 million, which was derived primarily from the issuance of
our senior notes, net of issuance costs and proceeds restricted to finance
future interest payments.
As of June 30, 1999, we had aggregate operating and capital lease payments
of $5.4 million remaining in 1999, and $9.9 million, $3.4 million, $2.6 million
and $2.1 million due in each of the next four years.
We also have agreed to acquire indefeasible rights to use four dark fibers,
with an option to use up to 12 additional fibers, in the fiber optic network
under construction by Level 3. We are required to pay for the dark fiber in
segments as they become available, which is expected to occur from the end of
1999 through the first quarter of 2001.
We expect our future liquidity and capital requirements to relate primarily
to:
. capital expenditures;
. operating losses;
. debt service payments; and
. working capital and other corporate purposes.
We currently estimate that our capital expenditures for 1999, 2000 and 2001
will be approximately $73 million, $139 million and $76 million, respectively,
including capital expenditures for:
. the acquisition of rights to use four dark fiber strands and the related
electronics necessary to transmit data over the fiber;
. the completion of our broadband access network;
. the enhancement of our network to provide additional value added
services; and
. the improvement of our network management, billing and other back office
systems.
Actual capital expenditures will depend on numerous factors beyond our control
or ability to predict, including the availability of financing, the timing of
our acquisition of dark fiber, customer demand, competition, regulatory
developments, and general economic conditions. Moreover, our capital
requirements would increase significantly if we were to exercise our option to
acquire rights to use up to 12 additional dark fiber strands over and above the
four strands for which we have committed.
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We currently anticipate that our available cash resources, together with the
proceeds from our initial public offering, will be sufficient to meet our
anticipated cash needs through the second quarter of 2000. However, we cannot
assure you that our financial resources will be adequate to fund all of our
anticipated or unanticipated working capital requirements and capital
expenditures during this period. Moreover, we expect that full implementation
of our current business plan will require that we raise substantial additional
capital for the needs that we anticipate funding during the remainder of 2000,
2001 and 2002. We may be required to raise additional funds through public or
private financing, strategic relationships or other arrangements, including
bank or vendor financing. The terms of our debt securities restrict our ability
to incur indebtedness, create liens, and make dividend payments and
investments, and may make it more difficult for us to raise the capital we will
need to fully implement our business plan. We cannot assure you that the
additional financing we will need, will be available on terms acceptable to us,
or at all. Furthermore, any additional equity financing may be dilutive to
stockholders, and debt financing, if available, may involve restrictive
covenants and significant interest expense.
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 our
financial condition and results of operations, the nature and extent of which
cannot reasonably be determined by us on the basis of information currently
available to us.
Our Year 2000 Program
We have established a program to ensure that, to the extent reasonably
possible, all systems are or will be year-2000 compliant prior to the end of
1999. Our Y2K program, designed with the assistance of an outside consultant,
consists of five phases:
. inventory of our potential exposures, including significant third-party
supplier and customer relationships;
. analysis of the assets to determine compliance or non-compliance;
. remediation and contingency plan development;
. remediation; and
. testing of affected systems.
A team consisting of our managers from Information Technology, Finance and
Operations has been established as the Y2K Readiness Team. With the assistance
of our outside consultant, the Y2K Readiness Team has designed an aggressive
schedule to identify information technology (IT) and non-IT assets requiring
compliance upgrades and a timetable for performance and testing of the affected
systems. In addition, the Y2K Program calls for validation of compliance by
significant suppliers and customers.
Current Status
Our Year 2000 assessment is completed. An inventory of computing,
communications and facility systems has been prepared and validated.
Significant suppliers, including competitive local exchange carriers, have also
been identified and validated.
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We have performed a technical review of significant third party suppliers
and customers and, if available, have surveyed the public year-2000 statements
issued by them. In addition, we have sent inquiry letters to certain third
party suppliers and customers requesting information regarding their
vulnerability to year-2000 issues. We have responded to these inquiries and
have evaluated the responses we received to determine if alternate business
actions are necessary. We continue to monitor new software and vendors to
insure their compliance.
To date, we have not incurred and do not anticipate incurring a significant
amount of costs to implement remedial actions required for year-2000
compliance.
Contingency Plans
Where any significant systems, customers or suppliers are determined to have
questionable remediation potential, the Y2K Readiness Team has established and
will continue to establish contingency plans to address the at-risk area. As we
continue to monitor all systems and suppliers, and identify specific risk
areas, we will take appropriate steps to implement remedial actions and
contingency plans as required under the circumstances.
Risks
The failure to correct a year-2000 issue could result in the interruption or
failure of certain normal business activities or operations. We believe that
the most reasonably likely worst-case scenario would result from interruption
or failure of third party services. Because we are dependent on a number of
third party vendors to provide network services, a significant year-2000-
related disruption of these network services could cause customers to consider
seeking alternate service providers, decrease Internet traffic generally or
cause a significant burden on customer service and technical support.
We are not presently aware of any vendor-related year-2000 issue that is
likely to result in any disruption of this type. Although there is inherent
uncertainty in the year-2000 issue, we expect that as we progress in our Y2K
Program, the level of uncertainty about the impact of the year-2000 issue will
be reduced significantly.
Disclosures about Market Risk
The following discusses our exposure to market risk related to changes in
interest rates, equity prices and foreign currency exchange rates. Market risk
generally represents the risk of loss that may result from the potential change
in the value of a financial instrument as a result of fluctuations in interest
rates and market prices. We have not traded or otherwise bought and sold
derivatives nor do we expect to in the future. We also do not invest in market
risk sensitive instruments for trading purposes.
This discussion contains forward-looking statements that are subject to
risks and uncertainties. Actual results could vary materially as a result of a
number of factors including those set forth under the captions "Risk Factors--
We have incurred substantial indebtedness and may not be able to service our
debt" and "Risk Factors--We may need additional capital in the future and
additional financing may not be available."
Interest Rate Risk
We may be exposed to market risk related to changes in interest rates. At
this time, we have not entered into any interest rate risk arrangements, and
while we may enter into interest rate risk hedging arrangements in the future,
we cannot assure you that we will be able to find commercially satisfactory
terms at that time. Our investment policy is to manage our investment portfolio
to preserve principal and liquidity while maximizing the return on the
investment portfolio through the full investment of available funds. We
diversify our marketable securities portfolio by investing in multiple types of
investment-grade securities. Our investment portfolio is primarily invested in
short-term securities with at least an investment grade rating to minimize
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interest rate and credit risk as well as to provide for an immediate source of
funds. Although changes in interest rates may affect the fair value of the
investment portfolio and cause unrealized gains or losses, such gains or losses
would not be realized unless the investments are sold.
Our Short-Term Investments. As of June 30, 1999, we had unrestricted short-
term investments of $56.2 million and restricted short-term investments of
$21.6 million. These short-term investments are highly liquid investments with
original maturities at the date of purchase of between three and twelve months
and consist primarily of money market funds and high-grade securities such as
corporate notes, municipal securities and U.S. Treasury notes. We value these
investments at fair market value. These investments are subject to interest
rate risk and will fall in value if market interest rates increase. A
hypothetical increase in market interest rates by 10% from levels at June 30,
1999 would cause the fair value of these short-term investments to decline by
an immaterial amount. We have the ability to hold these investments until
maturity, and therefore would not expect the value of these investments to be
affected to any significant degree by the effect of a sudden change in market
interest rates. Declines in interest rates over time will, however, reduce our
interest income, especially from money market funds whose rates change on a
daily basis. For more information, see Note 1 to the Financial Statements.
Our Long-Term Investments. As of June 30, 1999, we maintained restricted
long-term investments totaling $23.2 million in connection with our 11 3/4%
senior notes due 2008. These long-term investments consist of high-grade
securities such as corporate notes, municipal securities and U.S. Treasury
notes, all of which are considered liquid and available for sale. Certain of
these securities will not be held to maturity. A hypothetical increase in
market interest rates by 10% from levels at June 30, 1999 would cause the fair
value of these securities to decline by an immaterial amount.
Outstanding Debt. As of June 30, 1999, the carrying value of our
outstanding senior notes was approximately $258.3 million at a fixed interest
rate of 11 3/4%. In certain circumstances, we may redeem this long-term debt.
Because the interest rates on these instruments are fixed, a hypothetical 10%
decrease in interest rates would not have a material impact on our financial
condition, revenues or operations. Increases in interest rates could, however,
increase the interest expense associated with future borrowings, if any. We do
not hedge against interest rate increases.
Equity Price Risk
We do not own an equity stake or investment in another company or business
entity and therefore we do not believe that we have any direct equity price
risk. We do not hedge against equity price changes.
Foreign Currency Exchange Rate Risk
All of our revenues are realized in dollars and all of our revenues are from
customers in the United States. Therefore, we do not believe that we have any
significant direct foreign currency exchange rate risk. We do not hedge against
foreign currency exchange rate changes.
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BUSINESS
Our Company
We are a facilities-based provider of advanced data communications services.
We market our services to Internet service providers, telecommunications
carriers and other businesses throughout the United States. We own and operate
a state-of-the-art, broadband access network that:
. consistently achieves among the highest performance ratings in the
industry for network reliability, speed and throughput;
. currently handles more than 1.3 billion minutes of use per month;
. reaches businesses and households in every U.S. market with a population
of at least 100,000 as well as several smaller markets; and
. employs ATM switches at every POP.
We recently agreed to acquire indefeasible rights to use four dark fiber
optic strands, with an option to use up to 12 additional fibers, in a
nationwide network that will cover approximately 15,000 route miles. The
combination of our existing broadband access network with our pending
acquisition of significant fiber optic facilities positions us to deliver a
broad array of end-to-end data communications services on our own network,
including:
. dial and dedicated Internet access;
. Internet access for higher bandwidth services, such as DSL and cable
modem;
. value-added services such as virtual private networks and web hosting; and
. bandwidth leasing and colocation services.
As compared to router-based, data-oriented networks we believe our network
platform is more flexible for handling and deploying multiple and new services.
Our broadband access network can accept input from a wide range of devices
under all widely deployed protocols over all commercially deployed transmission
speeds. This enables quicker and more economical deployment of new service
offerings when combined with intelligent ATM processing residing solely at the
core sites.
We currently provide nationwide Internet dial access and related services to
Prodigy, our primary customer and one of the largest Internet service providers
in the United States. We are also offering to businesses nationwide dial and
dedicated access for virtual private network services, and plan to begin
offering web hosting and other value-added services by year end 1999. We
believe that our relationship with Prodigy and our high network performance
have demonstrated our strength as a network operator and positioned us to
expand our customer base and service offerings. Leveraging our demonstrated
network capabilities, we have recently entered into significant new customer
relationships with Juno Online Services, Inc. and InfiNet. Juno, a leading
provider of Internet and e-mail services, currently has more than 200,000
subscribers for its Internet services launched in July 1998, and has created
more than 6.8 million free e-mail accounts since April 1996. InfiNet, a
consortium sponsored by Knight-Ridder, Gannett and Landmark Communications,
provides Internet access and web publishing solutions to nearly 100,000
subscribers nationwide.
Industry Overview
Data communications services, including Internet and other network services,
is one of the fastest growing segments of the global telecommunications market
place. Businesses of all sizes are demanding advanced, highly reliable
solutions for their data transmission needs that enhance productivity, improve
efficiency and reduce operating expenses. As a result, businesses are seeking
communications providers that can securely and efficiently connect
geographically-dispersed locations uniformly and offer a full range of value-
added services
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that meet their data networking needs. Businesses have begun to utilize value-
added data communications services such as web hosting, e-mail, file transfer
and, more recently, intranet and extranet services, e-mail outsourcing, e-mail
broadcast and security. High speed data communications access services link
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 the high-speed dedicated access services used
primarily by mid-sized and larger organizations.
Businesses have also rapidly established corporate websites as a means to
expand customer reach and improve communications efficiency. Many businesses
are currently using the Internet as a lower cost alternative to building
expensive private data communications networks. For example, many corporations
are connecting their remote locations using intranets to enable efficient
communications with employees, customers and suppliers, reducing
telecommunications costs by using IP-based faxing and migrating legacy database
applications to run over IP-based networks.
Market Size and Growth
According to industry reports, data communications services is one of the
fastest growing segments of the global telecommunications market. For example,
according to Forrester Research:
. business Internet access services are projected to grow at a compound
annual growth rate of 71% from $2.8 billion in 1998 to $41.9 billion in
2003;
. consumer Internet access spending is projected to increase from
approximately $7 billion in 1998 to approximately $19.9 billion in
2003; and
. web hosting and other value-added services are projected to grow at a
compound annual growth rate of 76% from $0.9 billion in 1998 to $14.7
billion in 2003.
In addition, according to International Data Corporation,
. frame relay services are projected to grow at a compound annual growth
rate of 19% from $4.4 billion in 1998 to $10.7 billion in 2003; and
. ATM services are projected to grow at a compound annual growth rate of
37% from $0.3 billion in 1998 to $1.6 billion in 2003.
Our Strategy
Our mission is to strengthen our position as a leading facilities-based
provider of advanced data communications services. To achieve this objective,
our business strategy focuses on the following key principles:
Expand Our Marketing Activities to Capitalize on Expected Demand
We intend to capitalize on the expected growth in demand for network
services from businesses by aggressively marketing our services through a
variety of distribution channels. We believe that utilizing a range of
distribution channels will enable us to cost-effectively reach a broad base of
potential customers. We are significantly expanding our direct sales force to
attract Internet service providers, telecommunications carriers, value-added
service providers and medium and large businesses. We are hiring highly
motivated personnel who have a background in or experience with the data
communications industry. In addition, we intend to use alternative distribution
channels, including agents, resellers and wholesalers, to gain access to a
substantially larger base of potential customers than we could otherwise
initially address through our direct sales force. Through the combination of a
direct sales force and alternative distribution channels, we will seek to
rapidly increase network traffic, market penetration and customer base.
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Broaden Our Portfolio of Service Offerings
We are broadening our portfolio of value-added services to address business
customers who are increasingly outsourcing their critical applications and
integrating web-based services as part of their core data networking strategy.
We are positioned to offer a number of value-added services, including virtual
private networks with a wide range of access options and speeds, web hosting
and colocation on our nationwide broadband access network. These services can
be bundled with Internet access services to provide complete, turnkey
solutions. We have begun construction on our first web hosting data center in
Houston, Texas and plan to build three additional data centers later this year.
In addition, the enhanced capacity resulting from our recent acquisition of
dark fiber capacity will enable us to offer a wider variety of data services on
our own network, including bandwidth leasing. We believe that providing value-
added services not only improves customer loyalty by making our services more
attractive as a package but also improves profitability, as value-added
services often provide higher margins.
Exploit the Capabilities of Our Advanced Nationwide Communications Network
We are completing deployment of our advanced, high-capacity, facilities-
based nationwide communications network. We believe that our ATM-to-the-
Edge(TM) network results in:
. an easily scalable network architecture;
. the ability to efficiently add new services and integrate further
technological innovations at a lower incremental investment than that
required by other communications service providers with legacy systems
that have separate networks for voice and data;
. interoperability with other network platforms; and
. improved network manageability.
To enhance our broadband access network, we have agreed to acquire
indefeasible rights to use four dark fiber strands, with options to acquire
indefeasible rights to use an additional 12 fibers, in a state-of-the-art
nationwide fiber optic network currently under construction by Level 3. We
believe that the combination of this fiber optic backbone with our broadband
access network positions us to:
. deliver, on our own facilities, a broad array of end-to-end data
communications services at the high level of quality and reliability
increasingly demanded by customers;
. reduce significantly our network costs as a percentage of revenues as we
substitute the acquired bandwidth for existing leased circuit
arrangements with various telecommunications carriers;
. expand our service offerings by providing bandwidth leasing services on
a stand-alone basis or bundled with our other services;
. increase the reliability and redundancy of our network; and
. increase the variety of service options and speeds available to customers.
Build Strong Customer Loyalty Through Superior Customer Service
We believe that superior customer service is a critical element in
attracting and retaining customers. Our broadband network is designed to
provide uniform quality and consistent service offerings at every point
nationwide. We have also made significant investments in personnel and our
scalable operating support systems. We believe that these systems give us a
competitive advantage relative to traditional network service providers because
we can better meet new customer demands and accommodate new service offerings.
We oversee our network operations from two existing network operating centers
24 hours a day, seven days a week. With our integrated web-based network
management tools we can monitor every POP in our network for quick and
efficient problem resolution from our network operations centers.
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Leverage Our Experienced Management Team
Our senior management team has extensive experience in the data
communications industry. Our ten most senior executives have an average of over
15 years of industry experience. We believe that our ability to combine and
draw upon the collective talent and expertise of our senior managers gives us a
competitive advantage in the effective and efficient execution of network
deployment, sales, provisioning, service installation, billing and collection,
customer service and delivering communications solutions to businesses. Our co-
founders, Mr. Li and Mr. Wilson, were both executives at WilTel and helped
establish that organization's ATM and frame relay marketing strategies. Mr. Li
was part of the leadership team that established Yurie Systems as a start-up
company, took the company public and built it into a successful organization
that was sold to Lucent Technology, Inc. for approximately $1 billion in 1998.
Our senior management team also includes experienced marketing, finance and
operating personnel. David Boatner, our Executive Vice President and Chief
Marketing Officer, has built effective nationwide sales teams that target
business customers in the telecommunications industry for McLeodUSA, LDDS-
WorldCom, WilTel, Southwestern Bell and AT&T. Robert Fugate, our Chief
Financial Officer, was part of the team that successfully built SkyTel into a
leading provider of domestic and international wireless messaging services.
Larry Walberg, our Senior Vice President of Operations, has had significant
management experience at both WilTel and MCI WorldCom, where he served as Vice
President, Global Data Network Operations. Todd Wilkens, our Senior Vice
President of Engineering, managed the deployment of a nationwide frame
relay/ATM network at GridNet, now a subsidiary of MCI WorldCom. Other key
executives have significant experience in the critical functions of network
operations, sales and marketing, customer and operations support systems,
finance and regulatory affairs.
Increase and Optimize Network Utilization
Given the nature of our network costs and the fact that our current network
utilization peaks in the evening hours to support Prodigy's residential
Internet subscribers, we seek to increase and optimize total network
utilization primarily by targeting providers of business services with daytime
intensive traffic as well as providers of consumer services with evening
intensive traffic. By pursuing this strategy, we believe that we will be able
to optimize network utilization throughout a 24-hour period by offering both
business-oriented services, such as dial virtual private networks and dedicated
and dial Internet access services, during the day, and consumer-oriented
services, such as Internet dial access services in the evening.
Evaluate Strategic Alliances and Acquisitions That Increase Our Network
Traffic
We also intend to evaluate strategic alliances and acquisitions that could
provide additional traffic over our network. We are primarily focused on the
domestic services market and we believe that many opportunities for strategic
alliances and acquisitions will be available to us in the future. For example,
we may enter into joint marketing relationships with other companies that offer
complementary services to business customers. We may also acquire companies
that would drive increased traffic on our network without corresponding cost
increases.
We also believe that the demand for Internet services outside the United
States will grow over the next few years. We intend to enter into international
alliances to originate and terminate international traffic on our network. We
will be targeting international Internet service providers and other carriers
for two types of opportunities--traffic termination in the United States and
data transport via the United States for termination in other countries. For
example, in cooperation with Telefonos de Mexico, Mexico's primary telephone
company and an affiliate of Prodigy, we intend to test connectivity between our
respective data networks. In addition, we have engaged European Marketing
Services, a marketing firm that successfully introduced Dell and other
technology firms to the European markets, to facilitate our own entry into the
European market.
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Our Services
We currently provide Internet dial access services and Internet dedicated
access services, as well as value-added services such as dial and dedicated
virtual private networks. We also have the ability to provide frame relay and
ATM virtual private network services and web hosting and will begin to market
these services by the end of this year. The addition of the fiber optic
backbone to our network and acquisition of dark fiber will also allow us to
offer bandwidth capacity and related colocation services as well.
Internet Access Services
Dial Access. Our Internet dial access services offer a cost effective
Internet solution with V.90 modem access to our advanced network via ordinary
telephone lines. Regional Internet service providers using our Internet dial
service can rapidly scale their service from regional or local coverage to
national coverage. National Internet service providers can expand their market
share by using our extensive local dial and 800 services to reach more
customers. We are primarily targeting Internet service providers with business
as well as residential customers to maximize traffic throughout our network.
We currently provide Internet dial access services to Prodigy for its
subscribers. Leveraging on our demonstrated network capabilities, we have
recently entered into significant new customer relationships with Juno Online
Services and InfiNet.
Dedicated Access. We offer high speed dedicated connectivity to the Internet
for both business users and Internet service providers. Our Internet dedicated
access services provide connectivity at access speeds ranging from 1.54 Mbps to
155 Mbps. We are targeting corporate users and carriers, including Internet
service providers, local exchange companies, regional long distance providers
and wireless providers as potential customers for this service.
In the future, we believe that our fiber backbone will position us to
support Internet access for higher bandwidth services, such as DSL and cable
modem. These high-speed access methods will enable new Internet services such
as video and high quality audio services.
Value-Added Services
We believe that business customers will continue to increase their use of
the Internet and other data services. Customers increasingly rely on a range of
value-added services, including virtual private networks and web hosting. We
will continue to develop new services to meet these business needs that
capitalize on our technologically advanced, high-speed broadband access network
and our fiber optic backbone.
Virtual Private Network Services. Many companies today have private data
communication networks built on expensive leased lines designed to transfer
data between office locations. Private data networks are expensive to set up,
operate and maintain, requiring the use of leased lines and the purchase of
networking hardware and software. Our virtual private network services can
provide businesses with a lower-cost alternative to private data networks.
Virtual private network services are valuable to business customers because
they:
. eliminate the need to invest significant amounts in proprietary equipment
and software;
. securely and efficiently connect multiple, geographically dispersed
locations;
. provide remote access capabilities; and
. allow businesses to add, delete or move company locations to meet changing
needs.
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We have begun offering both dial and dedicated access for frame relay and
ATM virtual private network services to businesses, Internet service providers,
competitive local exchange carriers and others. We expect that the provision of
virtual private network services will be an important focus of our future
business.
Web Hosting. We now offer, on a limited basis, web hosting services bundled
with our Internet access services that permit companies to market themselves
and their products on the Internet without having to invest in technology,
infrastructure and operations staff. We are developing for roll-out later this
year a web hosting service that will be marketed on a stand-alone basis or
bundled with our Internet access and virtual private network services. Web
hosting is an ideal solution for customers who want to "publish" web pages on
the Internet without purchasing, configuring, maintaining and administering the
necessary sophisticated hardware and software. Due to economies of scale, we
can generally offer more sophisticated web hosting solutions than our customers
can provide for themselves. Our data centers will be located at selected core
POP sites and will make use of multiple high bandwidth connections to the
Internet. File structure directories, domain name registration and security
privileges can be set up for customers on our hosting servers, thus enabling
customers to remotely "publish" their content for distribution over the
Internet. In addition, we can provide network and systems administration and
maintenance, tape back-ups and security. In the future, we may also offer
applications hosting and other e-commerce services.
Bandwidth Leasing
With control over our fiber optic backbone network, we expect to offer
bandwidth leasing services that allow Internet service providers and other
business customers to transfer their traffic through our network. Bandwidth
leasing services will enable customers to reduce their data communications
expense by leasing network utilization from us in lieu of leasing point-to-
point circuits from other communications providers. We expect to be able to
offer high volume transmission capacity at a variety of speeds over our fiber
optic network. We may also target large capacity users who want to augment
their own networks or provide diverse routing alternatives in strategic areas
of their systems. Our potential customers for these services include
interexchange carriers, cable, data and transmission companies, the regional
Bell operating companies, Internet service providers, and local exchange
carriers. We expect to offer a variety of pricing and system options to meet
the specific needs of each customer. For instance, a customer may lease the
bandwidth capacity on a short or long term basis for extensive or minimal
coverage.
Colocation
We plan to house business-critical servers and other electrical, networking
and communications equipment in our secure network facilities on behalf of our
customers.The demand for these colocation services has increased as companies
expand into geographic areas in which they do not have appropriate space or
technical personnel to support their equipment and operations. Colocation
customers are typically larger enterprises employing more sophisticated
Internet hardware, software, and web servers, and have the expertise to
maintain their own web sites and related equipment. We plan to offer customers,
including Internet service providers, the opportunity to colocate their web-
server computers at our sites.
Our Network
We own and operate a state-of-the-art, broadband access network that employs
ATM technology at every core, hub and remote POP site. When our broadband
access network is completed later this year, it will include approximately 370
active POPs, giving us a physical presence in all 50 states, and targeting over
90% of U.S. businesses and households with a local call.
We recently agreed to acquire indefeasible rights to use four dark fiber
strands, with an option to acquire indefeasible rights to use an additional 12
fibers, in an approximately 15,000 route mile nationwide fiber optic network.
The combination of our existing broadband access network with our pending
acquisition of significant fiber optic facilities will allow us to deliver a
broad array of end-to-end data communications services on our
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own facilities at the high level of quality, cost-effectiveness and reliability
increasingly demanded by customers. The increased bandwidth capacity will allow
the network to support advanced services such as DSL and video.
Through its ATM-to-the-Edge(TM) architecture, our broadband access network
allows us to concurrently provide multiple services such as data, video and
voice to customers and to incorporate future technology changes at relatively
low incremental investments. As a result, we believe that we have created a
more efficient network than our competitors, thereby reducing future operating
costs and improving reliability to the end user. 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
switching only along the core sites in the backbone, our broadband access
network deploys ATM switching at every POP site--core, hub and remote. Each POP
is supported by the Lucent AC-120 switch which we believe provides significant
quality of service advantages over typical ATM switches. Our management
believes that our network contains more ATM-based switches than any other
commercial network.
Our network was designed to meet the following strategic goals:
. provide uniform service nationwide that is reliable, fast, efficient and
easy to access;
. build high capacity to move data more quickly, more efficiently and at
greater traffic volumes;
. provide better quality service than our competitors at a lower cost;
. provide broad coverage to points not served by other networks;
. use the industry's best suppliers for network components; and
. build redundancy into the network for better reliability.
Network Performance
We believe that our network delivers the high level of quality increasingly
demanded by customers. We have consistently achieved among the highest
performance ratings in the industry for network reliability, speed and
throughput. Inverse Technology measures and reports on nine network performance
parameters of Internet service providers. Our ratings exceeded or equaled the
industry average in each of the categories shown below for five of the last six
months.
<TABLE>
<CAPTION>
Inverse 1999 Rating
-----------------------------
Selected Performance Attributes Jan Feb Mar Apr May June
- ------------------------------- --- --- --- --- --- ----
<S> <C> <C> <C> <C> <C> <C>
24-Hour Call Success................................... A A+ A A A+ A
Evening-Hour Call Success.............................. B A+ A+ A+ A+ A
Business-Hour Call Success............................. A A+ A A A+ B
Modem Connect Speed.................................... A+ A+ A+ A+ A+ A+
Average Web Throughput................................. A+ A+ A+ A+ A+ A+
</TABLE>
Inverse Technology rates the network performance of all major nationwide
Internet service providers by making more than 250,000 test calls per month.
The national providers compared in the Inverse rating are: AOL, AT&T, Cable &
Wireless, CompuServe, Earthlink, GTE, IBM, Microsoft Network, Mindspring,
NETCOM, Prodigy (Splitrock) and UUNET. In addition to the performance
attributes in the table above, Inverse Technology also rates average time to
login, average domain name system lookup time, average download time, and
average total web failures/timeouts. In our view, however, these attributes
reflect the performance of the Internet service provider and do not reflect the
performance of the underlying network. You should not place undue reliance on
Inverse Technology's reports as a measure of network performance because these
reports do not measure all factors that may affect the quality of our services
and are based on a random sampling of our network's POPs.
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Network Infrastructure
We believe that we have provided for future growth by ensuring that our
network is:
. scalable;
. flexible;
. fault tolerant;
. based on open standards and interoperable; and
. manageable from remote locations.
Scalable. Our flexible, multi-layer network architecture utilizes a high-
speed switching fabric that enables us to increase the number of POPs and the
number of users served in an incremental manner that matches investment with
demand. Our network's scalability extends beyond the currently installed base
of POPs to allow for growth without fundamental design changes or loss of
service quality.
Flexible. We believe that our network will enable us to adapt to new
services and manage network resources according to each service's needs,
permitting us to efficiently offer data, video and voice services concurrently.
Fault Tolerant. Redundancy and adaptive technology in our 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 switches, routers and workstations are configured to
search for alternate paths if an individual component or transmission line
fails. We also have an uninterruptible power supply at each POP, limiting the
impact of local power outages on our network.
Open Standards and Interoperable. Our entire network supports various
protocols, including IP, ATM, frame relay, ISDN, video and SS7. This
architecture allows us to interconnect freely with other carrier networks or
customer networks. As a result, we can extend services of another carrier
outside of that carrier's own region. In addition, potential virtual private
network clients that use standards-based protocols can easily access our
network without having to purchase special equipment that would otherwise be
necessary with a proprietary network.
Manageable. From our network operations centers, we are able to monitor our
network remotely, perform network diagnostics and equipment surveillance, and
inform customers when a network problem occurs. Our network operations centers
are open 24-hours a day, seven days a week. As a result of our network
architecture, these tasks may be performed remotely regardless of POP location
or network status. This capability allows us to control costs associated with
on-site network configuration and repair.
Broadband Access Network
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. Practical considerations and
equipment constraints have led 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 and 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, benefit from highly
intelligent terminals at the end-user that 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
communication networks 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 communication service networks often have unpredictable
performance.
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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,
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 has been a practical way for older networks to
provide multiple services. 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.
Our network was designed to address constraints facing older networks by not
requiring the separation of bandwidth for different types of services. In the
process of designing our network we sought to create a network infrastructure
which could:
. efficiently offer data, video, and voice services concurrently;
. reduce operating costs by more efficient utilization of network resources;
and
. provide high quality service for all services offered on the network.
We believe that three features distinguish our network from other data
communications networks. First, we use the Lucent AC-120 switch which supports
multiple services at every POP of the network. We believe that this
"intelligent" ATM switch differs from typical ATM backbone switch engines
because it supports many access protocols to the network whereby an array of
data, video and voice services can be sent and/or received, including IP, frame
relay, ATM, Ethernet, T-1, T-3, OC-3 and many other digital as well as analog
interfaces. Also, the Lucent AC-120 is scalable with up to 14 interface module
slots designed to house interface cards supporting these various services. The
Lucent AC-120 translates these native service protocols into standard ATM
format and transports any service as an ATM connection. In addition, the Lucent
AC-120 implements a patented queuing algorithm that eliminates the need for
bandwidth allocation to different kinds of services and simultaneously supports
data, video and voice services on a unified platform without loss of quality of
service even during periods of high network utilization.
Second, to manage the large number of ATM switches in our network, we
organized the network architecture into classes and regions. This architecture
allows us to introduce new services more quickly 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. Our 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 traditional IP-based network. Therefore,
to introduce a new service, we only need 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 permits better management and typically faster throughput than other
networks.
Third, most modern networks achieve transmission efficiencies by deploying
ATM switching engines in three to 20 access sites only in the core backbone of
their network. In contrast, ATM switches are located in all POPs throughout the
network. At the completion of our network construction and installation, we
expect to have approximately 370 ATM switches deployed in our network. The ATM-
to-the-Edge(TM) network forms the basic platform for us to offer multiple
services to all users on the network.
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Network Organization
Our 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 site. The core sites
form the backbone of the network, with the hub and remote access sites
extending the reach of the backbone.
Our 21 core sites are logically and fully meshed to allow 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. We can
purchase bandwidth on an actual need basis between each site and upgrade these
links as the bandwidth demand increases because the Lucent AC-120 conforms to
standard transmission specifications.
In addition, each core site is equipped with special protocol processors to
enable our network to accommodate demand for a wide variety of services. IP
protocol, for instance is supported by routers at each core site as compared to
other networks that must install routers at each POP. As a result of our
design, each of our routers is directly connected to every other router in the
network and can forward packets from region to region efficiently via simple
routing tables.
Hub sites service the major cities within a region and 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 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.
Our network has a large number of remote sites to reach the smaller cities
within a region. These sites 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 can also be protected from transmission
failures by being connected redundantly to other access sites in the region.
Fiber Optic Backbone
As part of our ongoing efforts to further expand and enhance our network, we
recently entered into an agreement to acquire long-term indefeasible rights to
use four dark fiber strands, with an option to use up to 12 additional fibers,
in the nationwide fiber optic network currently under construction by Level 3
Communications.
Fiber optic technology uses light to transport information from one point to
another. Fiber optic strands are thin filaments of glass through which light
beams are transmitted over long distances carrying large amounts of data.
Modulating light on thin strands of glass produces major benefits including
high bandwidth, relatively low cost, low power consumption, small space needs
and total insensitivity to electromagnetic interference.
The optical fiber strands that will comprise our fiber backbone network are
designed to accommodate dense wave division multiplexing transmission
technology. As a result, we can deploy equipment which transmits signals on 32
or more individual wavelengths of light per strand. This capability will
significantly increase the potential capacity of our fiber backbone relative to
older networks which generally use fiber optic strands that transmit fewer
wavelengths per strand. In addition, we believe that the installation of newer
optical fibers will allow a combination of greater wavelengths of light per
strand, higher digital transmission speeds, and greater spacing of network
electronics.
Network Management and Customer Service
We believe that superior customer service is a critical element in
attracting and retaining new customers and expanding value-added services to
existing customers. In particular, we believe that it is critical to maintain
two geographically dispersed network operations centers, each of which enables
us to monitor our entire
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network and provide rapid problem resolution. We have established two 24-hours
per day, seven days per week network operations center facilities located in
The Woodlands, Texas and Yorktown Heights, New York. Each of these network
operations centers permits us to manage traffic, monitor system status and
remotely implement solutions to system interruptions.
In the first half of 1998, we implemented a number of new systems and
procedures to provide superior customer service. We have installed a leading
customer support trouble ticketing and workflow management system to track,
route and report on customer service issues. We also implemented new industry-
standard billing systems in late 1998. We expect to offer wholesale customers a
system that generates invoices tailored to the client's service mix and use a
second billing system for retail customers that authenticates and bills through
credit cards. To support anticipated growth in customers on our network, we
have established a customer call center to provide customer support 24 hours
per day, seven days a week.
Through the development of scalable operating support systems, we believe
that we have the opportunity to establish a competitive advantage relative to
traditional network service providers. Traditional network service providers
typically operate extensive legacy operating support systems with
compartmentalized architectures that limit their ability to scale rapidly and
introduce enhanced services and features. In connection with the expansion of
our network, we are creating operating support systems with an architecture
designed to maximize both reliability and scalability. Furthermore, in
establishing our operating support systems, we have 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. Operating support systems are, or will be, distributed
throughout our network, which improves network performance, recovery and
reliability, while also providing real-time capture of statistical and
accounting data. We utilize, when available, industry-standard software systems
developed and maintained by third party vendors but customized for our specific
needs.
We believe that an up-to-date management platform is critical for us to be
competitive and provide customers with quality services. We have put in place a
modern management platform to manage our extensive network. The new management
platform performs operations, administration and management tasks. We have
customized most of these platforms to ensure maximum network flexibility and
efficiency.
Peering and Interconnection
Peering and interconnection agreements with other carriers enable us to
exchange traffic destined for other networks and allow external traffic access
to our network. With Prodigy as a customer, we carry a significant amount of
Internet traffic. Currently, we have direct connection with all major carriers,
including Cable & Wireless, MCI WorldCom, PSINet, Sprint, UUNET and others, and
we are currently in discussions with other Internet service providers in order
to broaden our interconnection capabilities. We interconnect with other
networks from a core site through an industry standard Cisco router, which
promotes proper protocol exchange between us and other Internet service
providers.
Transmission Services
We lease long distance connections of various bandwidths to connect sites in
our network. The choice of long distance carriers is based on their network
reliability, bandwidth availability, responsiveness and pricing. We currently
lease a majority of our long distance connections from MCI WorldCom and
periodically review the capability and costs of these services by other
suppliers, such as Sprint and Qwest. Prior to the completion of our fiber
network, we expect to receive interim backbone transmission services from Level
3 beginning in the third quarter of 1999. As these services become available,
they will replace backbone transmission services we currently receive from
third parties. As segments of our fiber optic backbone network are constructed,
we will use this bandwidth in lieu of existing leased circuit arrangements.
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We lease 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, we have existing relationships with many
competitive local exchange carriers and all major incumbent local exchange
carriers in the country.
Sales and Marketing
We are deploying multiple distribution sales channels to rapidly increase
our market penetration and customer base. The primary sales distribution
channel will be a direct sales force. Additional channels will include agents,
wholesalers and resellers.
Our focus on multiple, leading-edge offerings makes it essential to create a
sophisticated sales organization. We began developing our direct sales force in
the first quarter of 1999 and are actively recruiting highly experienced data
communications sales professionals. This sales force will have a nationwide
presence, and will market our services directly to Internet service providers,
telecommunications carriers, value-added service providers, and medium and
large businesses. To support our direct sales force, we are developing web-
based tools, such as sales automation and sales tracking systems, that will
integrate pricing, order management, provisioning and billing systems.
Additionally, the salesforce will be equipped with customer-tailored marketing
material.
We also intend to utilize alternate distribution channels, which include
agents, resellers and wholesalers, to market our products and services to
medium and small businesses. As independent entities, agents sell our services
under the Splitrock brand name to end-users in exchange for revenue based
commissions. We intend to identify agents that generally focus on specific
market segments, such as medium and small businesses, and have existing
customer bases. Resellers are independent companies that would purchase our
services and then "repackage" under their own brand name these services for
sale to their customers. Finally, wholesalers are independent companies that
will purchase network service capabilities in large quantities from us in order
to market their own services under a brand name other than Splitrock. These
alternative channels are expected to optimize revenue growth and market
penetration.
We are creating a marketing infrastructure with three primary areas of
responsibility: marketing communications, marketing management and product
development.
Marketing communications builds Splitrock's image and provides
communications interface to customers on services. Marketing communications
will also promote Splitrock's services at industry conferences, trade shows
and other events.
Marketing management develops service literature, price positioning,
sales support materials, service revenue forecasts, competitive industry
and service analysis for our suite of service offerings.
Product development will work with internal organizations such as
information technology, engineering, operations and billing to develop and
enhance our services.
Relationship with Level 3 Communications
On April 26, 1999, we entered into a Cost Sharing National IRU Agreement
with Level 3 Communications, LLC, a subsidiary of Level 3 Communications, Inc.
Under this agreement, Level 3 has granted to us indefeasible rights to use four
dark fibers, with an option to use up to 12 additional fibers, in the
nationwide multiconduit fiber optic communications system currently under
construction by Level 3. The fiber will be delivered in segments that are
expected to become available from the end of 1999 through the first quarter of
2001. When completed, the fiber network will cover approximately 15,000 route
miles. If Level 3 expands its nationwide fiber optic network by adding
additional routes or otherwise enhances its network, Level 3 has agreed to give
us the opportunity to participate in that expansion or enhancement, subject to
Level 3's own business needs and subject to our agreeing on the allocation of
costs in the expansion or enhancement. Our
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agreement with Level 3 relates to dark fiber only and does not include the
electronic equipment necessary to allow the fiber to transmit communications.
Under our agreement, we have made a down payment of $11.2 million to Level 3
and we are required to make additional payments as we accept delivery of
segments of the dark fiber. The total amount we will be required to pay Level 3
is dependent on the number of fibers we acquire and the number of actual route
miles. In addition to IRU payments, we are required to make payments to Level 3
for facilities, maintenance and utilities charges.
We anticipate that the acquisition of the right to use the four dark fiber
strands and the related electronics equipment, will require capital
expenditures of approximately $34 million, $89 million, and $27 million in
1999, 2000 and 2001, respectively.
We have agreed that prior to the fourth anniversary of the agreement, we
will not grant any dark fiber IRU or assign or transfer any IRU or other
similar right or interest in any IRU to anyone other than an affiliate of ours.
However, the agreement allows us to sell or lease capacity over the fibers.
Our agreement with Level 3 has an initial term of 20 years and may be
extended. If we default in any payments due to Level 3 under the agreement,
Level 3 may terminate the agreement, provided that Level 3 may not terminate
the agreement or our rights to use fiber in segments for which we have paid in
full. We have the right to terminate the agreement prior to October 31, 1999,
under certain circumstances, but we would forfeit up to 80% of our down payment
if we exercise that right.
Level 3 has agreed to provide interim backbone transmission services at
capacities ranging from DS-3 to OC-48 for a monthly charge per DS-0 mile,
subject to an aggregate monthly minimum of $0.5 million. We expect to receive
these services beginning in the third quarter of 1999. As these services become
available, they will replace backbone transmission services we currently
receive from other third parties.
Under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, we may be
required to notify the Federal Trade Commission of the transactions
contemplated by our agreement with Level 3. If this notification is required,
we will not be able to consummate the transactions contemplated by the Level 3
agreement until the requirements of the Hart-Scott-Rodino Act have been
satisfied and any applicable waiting period has expired to terminated.
Suppliers
We depend on third parties for key components of our network infrastructure,
including leased lines, transmission services and networking equipment, such as
routers, switches and modems. The quantities and quality of such networking
equipment that we require are available only from limited sources. We currently
utilize Lucent for ATM switching products, Bay Networks for our Internet dial
access platform, Cisco for routers and Sun Microsystems and Compaq for servers.
We also depend upon a variety of local exchange carriers and interexchange
carriers to provide telecommunication services, including leased line and
colocation facilities. For long distance connections and backbone long distance
transmission facilities, we currently use MCI WorldCom. In addition, we obtain
bandwidth capacity under leased line connection agreements with local exchange
carriers, including regional Bell operating companies. We also obtain
telecommunications services and lease physical space under local
access/colocation agreements with various competitive local exchange carriers.
We continue to monitor our needs for greater bandwidth and may enter into
agreements to enlarge our bandwidth capability.
We have entered into an agreement with IBM to use the IBM network to cover
market areas that are not served by our network or the Prodigy network. Under
this agreement, either party may terminate its obligations under the contract
for the remaining POP sites, upon 60 days prior notice. During March 1999, we
entered into an agreement with Lucent to provide us with maintenance on our
broadband access network in order to maintain the quality and reliability of
our network performance. Prior to entering into this maintenance
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arrangement with Lucent, we had performed our own maintenance of equipment and
have relied on warranties from our vendors.
We rely upon third parties to provide equipment and services to assist in
the construction and installation of our broadband access network. As of June
30, 1999, we had 324 installed POPs, 270 of which were operational and we
expect to have approximately 370 operational POPs when our construction is
completed later this year.
As previously disclosed in our annual report on Form 10-K for 1998, we
entered into an agreement with a contractor to construct 99 POP sites on a
turnkey basis. By November 1998, the contractor had failed to meet construction
milestones under our agreement. As a result, we had to hire other service
providers and suppliers in addition to supervisory field and office personnel
to complete the network on schedule. We also incurred additional expenses to
maintain POP sites on our legacy network. We have received invoices totaling
$9.1 million from the contractor and we are disputing the amount due. The
contractor has indicated that it will seek to secure payment of these invoices.
We believe that the amounts the contractor has claimed are not owed because of
the contractor's failure to perform under the terms of our agreement and the
offsetting expenses we incurred to complete the work. We also believe that
resolution of this matter will not have a material adverse effect on our
business.
Competition
The data communications service industry is highly competitive. We expect
that competition will continue to intensify as customers seek additional
capacity to satisfy the continued growth of the Internet. In addition, numerous
competitors, including major telecommunications carriers such as AT&T, MCI
WorldCom, Sprint and Cable & Wireless, are rapidly expanding their data network
capabilities. We believe that the primary competitive factors for the provision
of data network services are quality of service, network coverage, reliability,
price, and service innovation.
Our current and prospective competitors generally may be divided into three
groups:
. companies that provide access services to Internet service providers
with both residential and small business customers, including UUNET
Technologies, Verio, Concentric Network, PSINet, and Netcom On-Line
Communications Services;
. companies that provide access, virtual private network and other value-
added services to medium and large businesses, including Concentric,
UUNET, GTE Internetworking, and DIGEX, as well as most major long
distance telephone companies; and
. companies with high-speed networks that provide bandwidth capacity and
other network services, including IXC Communications, Qwest and Level 3.
Internet Service Providers
According to International Data Corporation, there are over 4,000 Internet
service providers in the United States, consisting of national, regional and
local providers. We intend to market Internet dial access services to these
Internet service providers. Our competitors in this market will be other
companies that provide Internet access service to Internet service providers as
well as Internet service providers which possess backbone networks enabling
them to provide capacity to other Internet service providers. While we believe
that our status as an independent service provider distinguishes us from many
of these competitors, some of these competitors have significantly greater
market presence, brand recognition and financial, technical and personnel
resources than we do.
Corporate Internet Access and Virtual Private Networks
In the corporate Internet access and virtual private network markets, the
competitors include Internet service providers as well as traditional
telecommunications carriers. Many of these competitors, in addition to
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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 dial
access and virtual private network services with other services such as web
hosting or long distance services. This bundling of services may have a
material adverse effect on our ability to compete effectively and thus could
have an adverse effect on our business, financial condition and results of
operations.
Other Network Services
We believe that significant new competitors will enter the data network
services market. Other companies are in the process of building or expanding
networks that will have the ability to provide services comparable to ours. In
addition, many of our competitors have the financial and operational resources
to construct networks similar to our own. For example, Sprint is in the process
of designing a network which will contain ATM switches at every core, hub and
remote site. We cannot assure you that we will be able to compete effectively
with these companies. The market for the colocation of web-servers is extremely
competitive. In this market, we would compete with Internet service providers
and network providers as well as others, including inter exchange carriers,
companies that provide only web hosting and IP colocation services and a number
of companies in the computer industry.
There are currently three principal facilities-based long distance fiber
optic networks, as well as numerous incumbent local exchange carrier and
competitive local exchange carrier networks. Others, including Qwest, IXC and
Williams, are building additional networks that employ advanced technology
similar to that of the Level 3 network and offer significantly more capacity to
the marketplace. The additional capacity that is expected to become available
in the next several years may cause significant decreases in the prices for
services. Our ability to compete effectively in this market will depend upon
our ability to maintain high quality services at prices equal to or below those
charged by our competitors. Interexchange carriers and competitive local
exchange carriers with excess fiber optic strands may be competitors in the
dark fiber business.
Recent reforms in the federal regulation of the telecommunications industry
have also created greater opportunities for local exchange carriers, including
the regional Bell operating companies, to enter the Internet network services
market and therefore compete with us. This increased competition could have a
material adverse effect on our business. We believe that there is a trend
toward horizontal integration through acquisitions of, joint ventures with, and
the wholesale purchase of connectivity from, Internet service providers. The
WorldCom/MFS/UUNET/MCI consolidation, the Netcom/ICG Communications merger, the
Intermedia/DIGEX merger and GTE's acquisition of BBN are indicative of this
trend. These consolidations may increase competition.
Regulation
Overview
Although we are not currently subject to direct regulation by the FCC, the
telecommunications industry is highly regulated. As a result, changes in the
regulatory environment relating to the Internet and telecommunications
services, including regulatory changes which directly or indirectly affect
telecommunications costs or increase the likelihood or scope of competition
from regional Bell operating companies or other telecommunication companies,
could have a material adverse effect on our financial position or results of
operations.
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. We
cannot predict the outcome of these proceedings, or the impact they may have on
the telecommunications or Internet services industries generally, or on us
particularly. In addition, over the past several years both the federal and
state governments have adopted new legislation and rules profoundly affecting
the telecommunications and Internet services industries. We cannot assure you
that the changes in
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current legislation or new legislation, and the regulations adopted by the FCC
or state regulators pursuant to that legislation, would not have a material
adverse impact on our business.
Regulation of Internet Communications
In 1980, the FCC created a distinction between "basic" services, which it
regulated as common carrier services, and "enhanced services," which it
deregulated. The FCC exempted enhanced service providers from federal
regulations governing common carriers, including the obligation to pay access
charges and contribute to universal services.
The Federal Telecommunications Act of 1996 established a similar distinction
between "telecommunications services" and "information services," but a
combination of changing technology and other provisions of the Federal
Telecommunications Act have made it increasingly difficult to discern the
boundary between unregulated and regulated services. The act directs the FCC to
adopt regulations requiring all telecommunications service providers to
contribute to the federal Universal Service Fund. When fully implemented, that
fund will be greatly enlarged. This distinction greatly magnifies the
significance of the boundary between regulated and unregulated services.
Since the Federal Telecommunications Act was adopted, several companies have
begun providing voice telephony services over Internet-style packet-switched
networks, and traditional long distance telephone companies have announced
plans to migrate their services to packet-switched networks. As a consequence,
the regulatory status of communications services over Internet-style packet-
switched networks is presently uncertain. In an April 10, 1998 Report to
Congress regarding Universal Service, the FCC concluded that the provision of
underlying transmission capacity to Internet service providers constitutes
"telecommunications" under the Federal Telecommunications Act. The FCC has also
indicated in the report that it would consider, in an upcoming proceeding,
issues related to whether Internet service providers 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 universal service. 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 Internet service providers and
carriers providing service to Internet service providers must make universal
service contributions could increase our cost of doing business and have a
material adverse effect on our business.
On April 5, 1999, US WEST, Inc. filed a petition asking the FCC to rule that
providers of certain forms of IP telephony services must pay the same charges
that traditional interexchange carriers pay for access to local telephone
exchanges. If US WEST's request is granted, we could be subjected to regulation
that would have the practical effect of forcing us to differentiate data
transmission provided in support of black phone to black phone IP telephony
from data transmission provided in support of other services. This type of
regulation could impose substantial operational inefficiencies and attendant
costs upon us depending upon the method of implementation required. We cannot
predict how or when the FCC will respond to the US WEST petition.
We operate as an Information Services Provider
We operate as an unregulated provider of information services, as that term
is defined in the Federal Telecommunications Act, and as an enhanced service
provider, as that term is defined in FCC rules. Because the regulatory
boundaries in this area are unclear and subject to dispute, however, the FCC
could seek to characterize some or all of our services as "telecommunications
services." If that happens, we will be required to contribute directly to
universal service.
Our status as a reseller of underlying telecommunications services provided
by others has reinforced our status as an unregulated information service
provider. A longstanding FCC policy holds that, when a reseller enhances some
of the transmission capacity that it obtains from an unaffiliated facilities-
based common carrier by modifying or adding content to transmitted messages,
the entire package of resold services will be classified
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as an unregulated enhanced service, even if much of the resold transmission
capacity is not being modified by the reseller. By contrast, the FCC has
required some enhanced service providers that use their own facilities to
segregate those facilities and subscribe to them as regulated common carrier
offerings. To the extent that we begin to provide our own transmission
facilities, parts of our company could thus become exposed to common carrier
regulation.
Recently, we obtained rights to use several strands of unlit fiber, referred
to as "dark fiber," on another company's nationwide fiber network. The FCC and
at least one federal district court have taken the position that provision of
dark fiber is a form of "wire communications," not a sale of facilities. On
that basis, we believe that our acquisition of previously installed dark fiber
capacity does not transform us into a facilities-based provider of
telecommunications, and that we remain a reseller and provider of unregulated,
enhanced services. The treatment of dark fiber under these circumstances is an
unsettled area of the law, however, and we cannot predict with certainty
whether the FCC, or state regulatory commissions, will regulate this kind of
service.
Under current FCC policy, enhanced service providers are exempted from
having to pay access charges to local telephone companies. Without this
exemption, the local telephone companies could charge enhanced service
providers for connecting the customer to the enhanced service provider.
Recently, the FCC has determined that both dedicated access and dial-up calls
from a customer to an Internet service provider are interstate, not local,
calls, and, therefore, are subject to the FCC's jurisdiction. The FCC
determined that, for the time being, it will allow states to continue tariffing
dial-up Internet access as a local business line service. However, it did not
require states to do so. If the access charge exemption for enhanced service
providers is eliminated, our costs of providing service may increase
substantially, which could have a detrimental effect on our business.
Universal Service Proceeding
If we maintain our current unregulated status, we may contribute indirectly
to universal service to the extent that we are billed by telecommunications
providers for the underlying service. Beginning on January 1, 2000, the federal
universal service program is scheduled to provide subsidy support for service
to high-cost areas served by so-called "non-rural" incumbent local exchange
carriers. We cannot predict the potential impact of these universal service
funding reforms on the rates that we are charged for the underlying
telecommunications services we receive from our telecommunications providers.
Regulatory Safeguards Affecting Underlying Service Providers
We are heavily dependent upon telecommunications carriers for the
transmission capacity that underlies our enhanced network. Some of these
carriers are considered dominant in their geographic markets and may compete
with us in providing enhanced services. This creates an incentive and potential
means for those carriers to discriminate against us. At present, the regional
Bell operating companies are allowed to provide information services within
local access and transport areas (LATAs) but they are restricted from providing
information services on an inter-LATA basis.
Under Section 271 of the Federal Telecommunications Act, the regional Bell
operating companies will be allowed to provide inter-LATA service, including
inter-LATA information services, when the FCC determines that they satisfy a
regulatory checklist of local competition requirements. No regional Bell
operating company has yet obtained a determination by the FCC that it has
satisfied the checklist of local competition requirements, but it is likely
that such determinations will eventually be issued. We cannot assure you that
we will be able to compete effectively with the regional Bell operating
companies once they are permitted to provide inter-LATA services.
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Potential Liability of Internet Service Providers
Because we do not hold ourselves out as editing or otherwise controlling the
content of communications that traverse our network, we are generally
unaffected by government content regulation. However, the law in the United
States relating to the liability of Internet service providers and providers of
transmission capacity for information carried on, disseminated through or
hosted on their systems is currently unsettled. Congress and several states
have enacted or are considering measures that would, under some circumstances,
impose civil and criminal liability upon Internet service providers, or
providers of transmission capacity to Internet service providers, for the
transmission or dissemination of information and materials. The imposition of
this type of liability, if upheld by the courts, may require us to implement
measures to reduce our exposure to this liability, which may require us to
expend substantial resources and could affect the demand for our services.
Trademarks and Trade Names
We filed federal trademark applications for the marks "Splitrock" and "A
Carrier of Wisdom" on September 18, 1997, and "splitrock.net" on March 6, 1998.
We also filed separate federal trademark applications for logos on the above
dates, for the Splitrock with triangle design on June 16, 1998, for the mark
"splitrock.com" on July 27, 1998, and for the mark "ATM-to-the-Edge" in March,
1999. We have also filed trademark applications for the marks "Splitrock", "A
Carrier of Wisdom" and the Splitrock with triangle design in numerous foreign
countries. These applications are pending and we cannot assure you that they
will be granted. "Splitrock Services, Inc." is a trade name of our company.
Insurance
We have insurance coverage that we believe to be adequate for the risks of
our business. We carry property, general liability and directors and officers
liability insurance. In addition, we have an umbrella policy applicable to
general liability, auto liability, and employer's liability. Our insurance
coverage may not be adequate or available to compensate us for all losses that
may occur. The occurrence of a significant loss not fully covered by insurance
could have a material adverse effect on our company.
Employees
As of June 30, 1999, we had 307 full-time employees and 20 independent
contract workers. None of our employees is represented by a union, and we have
experienced no strikes or work stoppages. Our management believes that we have
good relations with our employees.
Properties
We are headquartered in The Woodlands, Texas in a leased facility consisting
of approximately 25,000 square feet. This facility houses our principal
executive and administrative offices as well as one of our network operations
centers. The lease on this facility expires in 2003. In March 1999, we entered
into a long-term lease agreement for approximately 69,000 square feet in The
Woodlands, Texas and expect the new facility will be ready for occupancy not
later than August 1999. The new facility will become our headquarters, and the
existing space will continue to be utilized as a network operations center and
customer care center.
We also sublease from Prodigy a facility of approximately 12,500 square feet
in Yorktown Heights, New York for our Yorktown Heights office and network
operations center. This lease expires on February 28, 2001 but is subject to
early termination on December 31, 1999 upon three months written notice. We
intend to exercise the early termination provision, and currently plan to move
our Yorktown Heights, New York facility to another location in the New York
metropolitan area.
In connection with our network operations, we lease commercial space or have
colocation agreements for our installed communications equipment throughout the
United States.
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We believe that our facilities are adequate for our present purposes and
that suitable additional facilities will be available as needed.
Legal Proceedings
We are not currently a party to any material legal proceedings.
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MANAGEMENT
Directors and Executive Officers
Our directors and executive officers are as follows:
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Kwok L. Li ............. 41 Chairman of the Board of Directors and Chief Technical Officer
William R. Wilson ...... 51 President, Chief Executive Officer and Director
J. Robert Fugate ....... 38 Executive Vice President and Chief Financial Officer
David M. Boatner ....... 51 Executive Vice President and Chief Marketing Officer
Larry A. Walberg ....... 50 Senior Vice President of Network Operations
Todd W. Wilkens ........ 32 Senior Vice President of Engineering
Patrick J. McGettigan,
Jr. ................... 46 Senior Vice President, Secretary and General Counsel
Roy A. Wilkens ......... 56 Director
Marshall C. Turner ..... 57 Director
James M. Nakfoor ....... 35 Director
</TABLE>
Kwok L. Li has served as Chairman of the Board since July 1997 and has
served as Chief Technical Officer of Splitrock since April 1998. Mr. Li is a
co-founder of Splitrock. 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 Systems from
1995 until the consummation of the sale of Yurie to Lucent in 1998. Mr. Li also
served as Vice Chairman of Yurie from June 1997 until the sale, 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 1994, Mr. Li was Director of Strategic
Planning at WilTel. Mr. Li is the primary technical architect of the Lucent AC-
120 switch technology. Mr. Li received a B.E.S. in electrical engineering from
The Johns Hopkins University in 1979.
William R. Wilson has served as President of Splitrock since its inception
and as Chief Executive Officer since April 1997. Mr. Wilson is a co-founder of
Splitrock. Prior to joining Splitrock, 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 Global and Telmex on strategic matters. From
1989 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 M.B.A. from The University of
Texas at Austin.
J. Robert Fugate joined Splitrock as Executive Vice President and Chief
Financial Officer in March 1999. From 1997 to 1999, Mr. Fugate served as
Executive Vice President and Chief Financial Officer of Fuego Technology
Corporation, a privately held software development company based in Dallas,
Texas. From 1996 to 1997, Mr. Fugate was Vice President, Corporate Development
for General Wireless Inc., a private Dallas-based company with licenses to
develop personal communications services. In addition, Mr. Fugate served as
Senior Vice President, Finance and Chief Financial Officer of Mobile
Telecommunication Technologies Corp. (since renamed SkyTel Communications,
Inc.) from 1988 to 1996, a publicly traded nationwide and international
provider of personal messaging services. Mr. Fugate received an M.B.A. from
Harvard University and a B.B.A. from The University of Mississippi.
David M. Boatner joined Splitrock in March 1999 as Executive Vice President
and Chief Marketing Officer. Prior to joining Splitrock, Mr. Boatner was the
President of Business Services for McLeodUSA, an integrated telecommunications
provider in the Midwest, where he was responsible for sales, marketing and
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customer support for business subscribers. From January 1995 to February 1996,
Mr. Boatner served as Regional Vice President of Sales for LDDS-WorldCom, where
he was responsible for business telecommunications sales in the central,
southwest and western United States. Mr. Boatner was employed as Vice President
of Sales for WilTel from 1985 until WilTel was acquired by LDDS-WorldCom in
1995. In this capacity he managed the nationwide data and long distance sales
for WilTel. Prior to joining WilTel, Mr. Boatner held numerous sales and
marketing positions at Southwestern Bell and AT&T.
Larry A. Walberg joined Splitrock as Senior Vice President of Network
Operations in April 1999. Prior to joining us, Mr. Walberg was Vice President,
Global Data Network Operations, at MCI WorldCom, where he managed the
operational expansion of a data network from North America into five
continents, directed the merger of operations of local and long-distance data
network platforms and integrated and migrated the data network platforms of
WorldCom, MCI, MFS and BrooksFiber into a single network architecture.
Previously, Mr. Walberg served as Director/Manager of Advanced Product Support
for WilTel and successor entities from May 1992 to May 1997 where he
established the operational model for the first public frame relay offering.
Todd W. Wilkens has served as Vice President of Engineering of Splitrock
since July 1997 and as Senior Vice President since April 1999. 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 1994 to 1996, Mr. Wilkens
was Manager, Advanced Products Support, at WorldCom where he helped build the
Internet Support Organization which specialized in building and operating
Internet service provider backbones. Prior to that, Mr. Wilkens supported
offshore communications in the Gulf of Mexico for Conoco/Dupont. Mr. Wilkens
holds a B.S.E.E. from Oklahoma State University. Mr. Wilkens is the son of
Roy A. Wilkens, a director of Splitrock.
Patrick J. McGettigan, Jr., has served as General Counsel of Splitrock since
September 1997, as Secretary since March 1998, and as Senior Vice President
since April 1998. Prior to joining Splitrock, 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 Splitrock when it was formed
in March 1997. Mr. McGettigan received a B.A. degree from The University of
Texas and his J.D. degree from South Texas College of Law, and is a member of
the State Bar of Texas.
Roy A. Wilkens has served as a director of Splitrock since April 1998. Mr.
Wilkens was President of The Williams Pipeline Company when he founded WilTel
in 1985. He was Founder/Chief Executive Officer of WilTel Network Services from
1985 to 1995. 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., McLeodUSA, Invensys Corporation Inc. and
Williams Communications. Mr. Wilkens is the father of Todd Wilkens, Splitrock's
Vice President of Engineering.
Marshall C. Turner joined our board of directors in April 1999. Since 1990
Mr. Turner has been an independent consultant and technology venture investor
at Turner Venture Associates. From 1981 through 1998, Mr. Turner was General
Partner of Taylor & Turner Associates, Ltd., which itself was a general partner
of several venture capital partnerships. Mr. Turner has been a venture capital
principal or operating executive in technology industries for 25 years. He is a
director of the Alliance Technology Fund, Inc., DuPont Photomasks, Inc., and
four privately-held companies, including Linsang Partners, LLC, one of our
largest shareholders. In June 1999, Mr. Turner was appointed as acting Chief
Executive Officer and Chairman of the Board of DuPont Photomasks, Inc.
Mr. Turner is also a Vice Chairman of the board of the Public Broadcasting
Service, of the Smithsonian Museum of Natural History, and director of the
George Lucas Educational Foundation. Mr. Turner received B.S. and M.S. degrees
in Mechanical Engineering and Product Design from Stanford University and an
M.B.A. from Harvard University.
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James M. Nakfoor joined our board of directors in April 1999. Since 1991,
Mr. Nakfoor has served as Vice President of Securities Trading for Inversora
Bursatil, S.A. de C.V., a wholly-owned subsidiary of Grupo Financiero Inbursa,
S.A. de C.V., which is engaged in the securities brokerage, investment banking
and money management business in Mexico. Grupo Financiero, which is affiliated
with Carso Global Telecom, is a Mexican financial group whose businesses
include banking, brokerage, insurance, leasing, factoring and other financial
services. Since September 1997, Mr. Nakfoor has been a member of the Board of
Directors of Prodigy Communication Corporation. Mr. Nakfoor holds a B.A. degree
in Economics and an M.B.A. degree from The University of Texas at Austin.
Other Significant Employees
Tracy Hammond joined Splitrock as Controller in September 1997. In October
of 1998, Ms. Hammond was named Vice-President and Controller. 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 B.S. in
Accountancy from The University of Missouri.
Frank W. Williams joined Splitrock in December of 1998 as Vice President of
Operations. Prior to joining Splitrock, Mr. Williams held several management
and senior executive positions with WilTel. His most recent position was as
Senior Operations Executive where he directed and developed the National
Technical Resource Center. This center supported 2,500 field technicians
servicing digital communications products manufactured by Nortel, NEC, Octel,
Cisco, Bay Networks and 3Com. Mr. Williams received a B.A. in Business from
Trinity University and an Associate of Arts from the Marion Institute in
Marion, Alabama.
Ralph Freeman joined Splitrock as Vice President of Information Services in
February 1999. From 1996 to June 1998, Dr. Freeman was Chief Information
Officer at American Telco. In June 1998, he became Vice President of
Information Systems at Logix Communications Enterprises, one of the largest
competitive local exchange carriers in the country, which acquired American
Telco. During this tenure, he helped build a new multi-state network
architecture. From 1991 to 1994, Dr. Freeman was the manager in the electronics
and software departments of Walt Disney Imagineering. Dr. Freeman holds a B.S.
in Engineering Management from the Air Force Academy; a M.S. in Business
Administration, Computer Methods from The University of California at Los
Angeles; and a Ph.D. in Information Technology from George Mason University.
Board of Directors
Our board of directors is divided into three classes. Each class consists of
up to two directors elected for staggered, three-year terms.
<TABLE>
<CAPTION>
Directors whose Directors Directors whose
terms expire in 2000 whose terms expire in 2001 terms expire in 2002
-------------------- -------------------------- --------------------
<S> <C> <C>
Marshall C. Turner William R. Wilson Kwok L. Li
Roy A. Wilkens James M. Nakfoor
</TABLE>
Committees of the Board of Directors
Our board has standing audit and compensation committees. The compensation
committee currently consists of Kwok L. Li, William R. Wilson and Roy A.
Wilkens although it may be changed to consist solely of non-employee directors.
The audit committee members are Roy A. Wilkens, Marshall C. Turner and James M.
Nakfoor.
61
<PAGE>
Director Compensation
Directors who are employed by our company are not entitled to receive any
additional compensation for serving on our board of directors. We pay each of
our non-employee directors 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. We also reimburse directors for reasonable expenses incurred in
conjunction with attending meetings. We did not make any cash compensation
payments to our directors in 1998, except for the reimbursement of expenses.
Each of our non-employee directors, waived all cash compensation for 1998.
Directors are also eligible for grants of awards under our stock option plan.
On May 28, 1998, we granted our outside directors --Messrs. Salameh and
Wilkens-- options to purchase 45,040 shares of common stock at $1.95 per share,
with options to purchase 11,260 shares vesting on each of the first four
anniversaries of the date of grant. On April 22, 1999, our board accelerated
the vesting of 11,260 of Mr. Salameh's options otherwise due to vest on May 28,
1999 as a result of his service on the board. On April 22, 1999, we granted
each of our new outside directors --Messrs. Turner and Nakfoor-- options to
purchase 45,040 shares of common stock at $9.77 per share, with options to
purchase 11,260 shares vesting on each of the first four anniversaries of the
date of grant.
Executive Compensation
The following table sets forth certain information regarding the
compensation earned by or awarded to our Chief Executive Officer and each
executive officer whose compensation exceeded $100,000 for the year ended
December 31, 1998.
Summary Compensation Table
<TABLE>
<CAPTION>
Long-term
Compensation
Annual Compensation Awards
------------------------------- ------------
Securities
Other Annual Underlying
Year Salary ($) Compensation ($) Options(#)
---- --------- --------------- ------------
<S> <C> <C> <C> <C>
Kwok L. Li, Chairman of the Board
and Chief Technical Officer..... 1998 -- -- --
1997 -- $10,600 --
William R. Wilson, President and
Chief Executive Officer......... 1998 $151,440 -- --
1997 62,980 $16,400
Patrick J. McGettigan, Jr.,
Senior
Vice President, Secretary and
General Counsel................. 1998 $150,833 -- --
1997 46,933 $65,000 140,750
</TABLE>
The other annual compensation for services rendered by Mr. Li and Mr. Wilson
was paid in the form of shares of common stock in May 1997. Mr. McGettigan
became an employee of Splitrock in September 1997. Prior to being employed by
Splitrock, Mr. McGettigan performed legal services on behalf of Splitrock and
his former law firm received approximately $18,000 from Splitrock in 1997. The
other annual compensation for Mr. McGettigan was granted to him as a bonus upon
becoming an employee of Splitrock. In 1997 Mr. McGettigan also received options
to acquire 140,750 shares of our common stock with an exercise price of $1.11,
of which 45,040 vested immediately and the balance vests over four years in
equal installments.
Option Grants in Fiscal Year 1998
We did not grant any stock options to the executive officers named in the
Summary Compensation Table during 1998.
62
<PAGE>
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, 1998. No stock options were exercised by any executive officers
during the year ended December 31, 1998.
<TABLE>
<CAPTION>
Number of Securities
Underlying Value of Unexercised
Unexercised Options In-the-Money Options
at December 31, 1998 at December 31, 1998
------------------------- -------------------------
Exercisable Unexercisable Exercisable Unexercisable
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Kwok L. Li................ -- -- -- --
William R. Wilson......... -- -- -- --
Patrick J. McGettigan,
Jr....................... 68,967 71,783 $333,813 $347,438
</TABLE>
Options are "in-the-money" if the value of our common stock exceeds the
exercise price of the options. There was no public market for our common stock
as of December 31, 1998. Accordingly, we have calculated these values on the
basis of a valuation of our common stock made by an independent firm and which
was determined to be $5.95 per share.
Employment Agreements
We have entered into employment agreements with Messrs. Wilson, McGettigan,
Boatner and Fugate.
Under Mr. Wilson's employment agreement, which terminates on March 15, 2002,
he is entitled to receive an annual base salary of $150,000, subject to
adjustment by the board of directors or the Compensation Committee. The board
adjusted Mr. Wilson's annual salary to $200,000 as of January 1, 1999. If Mr.
Wilson's employment is terminated upon his death or disability or by us without
cause, then he is entitled to continue to receive his base salary through the
remaining term of the agreement. The agreement further provides that Mr. Wilson
may engage in other business endeavors without violating any of provisions of
the agreement.
Under Mr. McGettigan's employment agreement, which terminates on August 31,
1999, he is entitled to receive an annual base salary of $140,000, subject to
adjustment by the board of directors or the Compensation Committee. We adjusted
Mr. McGettigan's annual salary to $180,000 as of January 1, 1999. If we
terminate Mr. McGettigan's employment without cause, then he is entitled to
continue to receive his base salary through the remaining term of the
agreement. Under his employment agreement, Mr. McGettigan received a signing
bonus of $65,000 and was granted options to purchase 140,750 shares of our
common stock at an exercise price of $1.11 per share. 45,040 shares of these
options vested immediately and the remaining 95,710 shares will vest in four
equal annual installments.
Under Mr. Boatner's employment agreement, which terminates on February 28,
2001, he is entitled to receive an annual base salary of $175,000. Mr. Boatner
also received a signing bonus of $75,000 and was granted options to acquire
225,200 shares of our common stock at an exercise price of $9.77 per share.
These options vest in four equal annual installments beginning on March 1,
2000. If we terminate Mr. Boatner's employment without cause, then he is
entitled to continue to receive his base salary through the remaining term of
his agreement.
Under Mr. Fugate's employment agreement, which terminates on March 21, 2001,
he is entitled to an annual base salary of $185,000. Mr. Fugate also received a
signing bonus of $50,000 and was granted options to purchase 197,050 shares of
our common stock at an exercise price of $9.77 per share. These options vest in
four equal annual installments beginning on March 21, 2000. If we terminate Mr.
Fugate's employment without cause, then he is entitled to continue to receive
his base salary for 12 months following termination, if his employment is
terminated before March 21, 2000, or for six months following termination, if
his employment is terminated after March 21, 2000.
63
<PAGE>
Stock Incentive Plans
1997 Incentive Share Plan
Our 1997 incentive share plan became effective on June 16, 1997. On April 1,
1998, our board of directors approved and adopted an amendment and restatement
of the plan which was subsequently approved and adopted by our stockholders on
April 27, 1998. The purpose of the plan is to provide employees, and non-
employee directors, and consultants with additional incentives by increasing
their ownership interests in our company.
Individual awards under the plan may take the form of one or more of :
. either incentive or non-qualified stock options;
. stock appreciation rights;
. restricted stock; and
. other awards, the value of which is based in whole or in part upon the
value of our common stock.
Options under the 1997 plan have a term of ten years and are generally
granted with an exercise price equivalent to fair market value at the date of
grant. Individual option grants vest over time, based upon a schedule approved
by our board of directors, which is generally four years. All of our common
stock options vest automatically upon a change in control, as defined in the
1997 plan.
Our compensation committee administers the 1997 plan, determines the persons
who will receive awards and establishes the terms and conditions of those
awards. Our President is also authorized to grant awards to other employees who
are not executive officers. The maximum number of shares of common stock that
may be subject to outstanding awards is 11,260,000. As of June 30, 1999,
options for 3,702,908 shares had been granted, of which:
. options to purchase 628,027 shares had been exercised, including an
option to purchase 563,000 shares granted to a former director of our
company;
. options to purchase 2,896,128 shares were outstanding; and
. options to purchase 178,753 shares, which were previously granted, had
been canceled or forfeited.
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.
1999 Stock Incentive Plan
Our 1999 stock incentive plan became effective on July 1, 1999. The purpose
of the 1999 stock incentive plan is to strengthen our company by providing an
incentive to our employees, officers, consultants, directors and advisors
through the granting or awarding of incentive and nonqualified stock options,
stock appreciation and dividend equivalent rights, restricted stock,
performance units, performance shares, share awards and phantom stock awards,
thereby encouraging these individuals to devote their abilities and energies to
our success.
The 1999 stock incentive plan will be administered by our board of directors
or a committee of the board consisting of non-employee directors although our
President may be authorized to grant options or awards to eligible persons who
are not executive officers. Under the 1999 stock incentive plan, the board of
the committee administering the plan will have the authority to, among other
things:
. select the employees to whom stock options and other incentive awards
will be granted;
64
<PAGE>
. determine the type, size and the terms and conditions of stock options
and other incentive awards; and
. establish the terms for treatment of stock options and other incentive
awards upon a termination of employment.
The 1999 stock incentive plan will replace the 1997 plan on a going-forward
basis, but the adoption of the 1999 plan will not increase the total number of
shares available for the grant of options or awards. Upon the effective date of
the 1999 plan:
. no further options will be granted under the 1997 plan;
. each option outstanding under the 1997 plan will remain outstanding and
continue to be subject to the terms of the 1997 plan and the agreement
under which it was granted;
. the shares initially available for options or awards under the 1999 plan
will be equal to the approximately 7.7 million shares available for
option grants under the 1997 plan as of July 1, 1999, including options
to purchase 1,233,715 shares exercisable at the initial public offering
price which are to be granted in connection with the initial public
offering, and
. any shares that are the subject of an option granted under the 1997
plan, but not exercised prior to the time the option expires or is
otherwise terminated, will become available for the granting of
additional options or awards under the 1999 plan.
We will authorize shares of common stock for issuance under the 1999 stock
incentive plan for the grant of stock options and other incentive awards to
eligible individuals. The 1999 stock incentive plan will terminate on June 30,
2009. The board of directors will be able to at any time and from time to time
amend or terminate the 1999 stock incentive plan; provided, however, that, to
the extent necessary under applicable law, no such change will be effective
without the requisite approval of our stockholders. In addition, no such change
will alter or adversely impair any rights or obligations under any stock
options and other incentive awards previously granted, except with the written
consent of the grantee.
Compensation Committee Interlocks and Insider Participation
In 1997, the compensation of our executive officers was determined by our
board of directors. In April 1998, the board of directors appointed a
compensation committee that now consists of Kwok L. Li, William R. Wilson, and
Roy A. Wilkens, who will determine the compensation of our executive officers
consistent with guidelines established by the board of directors. Mr. Li and
Mr. Wilson are executive officers of Splitrock.
Kwok L. Li, our Chairman and Chief Technical Officer, was also the Vice
Chairman and a director of Yurie, one of our principal suppliers, until its
acquisition by Lucent. Mr. Li acts as a consultant to Lucent. As of June 30,
1999, we had purchased approximately $12.7 million of products and $1.5 million
of services from Yurie and Lucent.
Samer Salameh, a member of our board of directors until April 1999, is
chairman of the board of directors and Chief Executive Officer of Prodigy, our
principal customer, and James M. Nakfoor, a current member of our board of
directors, has been a member of Prodigy's board of directors and its
compensation committee since September 1997. We have entered into an agreement
to provide network services to Prodigy for its subscribers in exchange for a
monthly service charge. During the fiscal year ended December 31, 1998, we
received approximately $63.6 million in revenues from Prodigy.
65
<PAGE>
CERTAIN TRANSACTIONS
Financings
In March 1997, we issued to our founders, Kwok L. Li and William R. Wilson,
225,200 and 337,800 shares, respectively, of our common stock for $0.00297 per
share. In May 1997, we issued 6.0 million and 9.2 million shares of our common
stock, respectively, to Mr. Li and Mr. Wilson in consideration of services
performed since March 1997.
In June 1997, Mr. Li advanced $10.0 million to us, evidenced by a $10.0
million convertible note. Mr. Li subsequently assigned the convertible note to
Linsang, which converted it into 9.0 million shares of common stock on August
9, 1997.
In August 1997, Linsang acquired 6.8 million shares in a private transaction
for $7.5 million. In December 1997, we borrowed $1.0 million from Linsang. This
loan was repayable 30 days after written demand or, if no demand was made, on
December 1, 2002 and bore interest at the rate of 9.75% per annum beginning in
February 1998. In January, March and June 1998, we borrowed an additional $3.0
million, $2.0 million and $5.0 million, respectively, from Linsang on similar
terms. In July 1998, outstanding indebtedness was refinanced in connection with
our senior notes offering. In connection with this refinancing, Linsang
purchased 11,000 units in the senior notes offering.
In August 1997, Roy Wilkens and Sandra Wilkens purchased 450,400 shares of
our common stock for $0.5 million. Mr. Wilkens became a member of our board of
directors in April 1998.
In September 1997, Orient Star, a wholly owned subsidiary of Carso Global,
purchased 11.3 million shares of our common stock for $12.5 million. Orient
Star subsequently acquired, pursuant to an option, an additional 2.8 million
shares for $3.1 million and merged into Carso Global. Carso Global currently
holds approximately 30.2% of our outstanding common stock at April 30, 1999.
Samer Salameh, the Chairman of Prodigy, an affiliate of Carso Global, was a
member of our board of directors from April 1998 to April 1999, when he was
succeeded on the board of directors by James Nakfoor, another director of
Prodigy. Mr. Nakfoor is Vice President of another Carso Global affiliate,
Inversora Bursatil, S.A. de C.V., a wholly-owned subsidiary of Grupo Financiero
Inbursa, S.A. de C.V. Carso Global is a controlling stockholder of Prodigy and
an affiliate of Telefonos de Mexico. We are currently testing connectivity
between our network and Telmex's network in anticipation of possible future
business relationships. As a result of Mr. Nakfoor's relationships with Carso
Global and Prodigy, conflicts of interest may arise, including conflicts
relating to potential corporate opportunities. If any conflict arises, we
anticipate that the non-interested members of the board of directors will pass
on the appropriateness of any particular matter.
In June 1998, Clark McLeod, Chief Executive Officer of McLeodUSA, then one
of our directors, exercised in full a stock option previously granted to him
and purchased 563,000 million shares of our common stock for $1.1 million. Mr.
McLeod was a member of our board of directors from May 1998 to May 1999.
On July 24, 1998, we offered and sold 261,000 units pursuant to the senior
notes 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 stated above. Each unit consisted of a senior note and a warrant to
purchase approximately 5.7 shares of our common stock at an exercise price of
$0.02 per share. We received gross proceeds of $261.0 million from the senior
notes offering.
Other
Kwok L. Li, our Chairman and Chief Technical Officer, was also the Vice
Chairman and a Director of Yurie, one of our principal suppliers until its
acquisition by Lucent. Mr. Li acts as a consultant to Lucent. As of June 30,
1999, we had purchased approximately $12.7 million of products and $1.5 million
of services from Yurie and Lucent. As a result of Mr. Li's relationship with
Lucent and with Linsang, each of which has
66
<PAGE>
business relationships with us, there may be conflicts of interest that arise
including conflicts relating to potential corporate opportunities. If any
conflict arises we anticipate that the non-interested members of our board of
directors will pass on the appropriateness of any particular matter.
In March and April 1999, we granted executive officers options to purchase a
total of 506,700 shares of our common stock as follows: David Boatner, 225,200
shares; Robert Fugate, 197,050 shares; and Larry Walberg, 84,450 shares. These
options were granted under our 1997 incentive plan, are exercisable at a price
of $9.77 per share, and vest in four equal annual installments beginning on the
first anniversary of the grant date. In connection with our initial public
offering, additional options to purchase a total of 464,550 shares of common
stock are to be granted to our executive officers as follows: David Boatner,
99,800 shares; Robert Fugate, 52,950 shares; Larry Walberg, 165,550 shares;
Todd Wilkens, 37,000 shares; and Patrick McGettigan, 109,250 shares. These
options will be exercisable at a price per share equal to the initial public
offering price of $10.00 per share and will vest in four equal annual
installments beginning on the first anniversary of the grant date.
67
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table provides information regarding the beneficial ownership
of our common stock as of June 30, 1999 by:
. each stockholder known by us to own beneficially 5% or more of our
outstanding common stock;
. each of our current directors;
. our Chief Executive Officer and each executive officer whose
compensation exceeded $100,000 during 1998; and
. all of our directors and executive officers as a group.
As of June 30, 1999, there were 46,681,424 shares of our common stock
outstanding. Following this offering and completion of our initial public
offering, there will be 57,169,215 shares of our common stock issued and
outstanding assuming that all of the warrants are exercised. Beneficial
ownership is determined in accordance with the rules of the Securities and
Exchange Commission. In computing the number of shares beneficially owned by a
person and the percentage ownership of that person, shares of common stock
subject to options and warrants held by that person that are currently
exercisable or exercisable within 60 days of June 30, 1999, are treated as
outstanding. However, these shares are not deemed to be outstanding for the
purpose of computing the percentage ownership of any other person.
<TABLE>
<CAPTION>
Beneficially Owned Securities
Number of Shares Beneficially Percentage of Shares
Owned Includes Beneficially Owned
-------------------------------- ------------------------
Total Number
of shares Securities Securities
Beneficially Underlying Underlying Before After
Owned Warrants Options Offering Offering
------------ -------------- --------------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Kwok L. Li.............. 21,599,143 62,704 -- 46.2% 37.7%
Linsang Partners,
L.L.C.................. 15,425,848 62,704 -- 32.9% 27.0%
8301 Professional Drive
Landover, MD 20785
William R. Wilson....... 9,571,000 -- -- 20.5% 16.7%
Roy A. Wilkens.......... 309,650 -- 11,260 * *
Marshall C. Turner...... 28,150 -- -- * *
Patrick J. McGettigan,
Jr..................... 92,895 92,895 * *
James M. Nakfoor........ -- -- -- -- --
Carso Global Telecom,
S.A. de C.V............ 14,075,000 -- -- 30.2% 24.6%
Insurgentes Sur #3500
Col. Pena Pobre
Mexico DF CP 14060
Directors and executive
officers as a group
(10 people) ........... 31,882,338 62,704 385,655 67.4% 55.3%
</TABLE>
- --------
* Less than 1%.
The shares beneficially owned by Mr. Li include 1,182,300 shares owned by
his spouse, 30,402 shares owned by his minor children, and 15,425,848 shares
owned beneficially and of record by Linsang, a limited liability company
controlled by Mr. Li, and members of his family.
The shares beneficially owned by Linsang include 62,704 shares issuable upon
exercise of warrants included as part of the units purchased by Linsang in the
senior notes offering.
The shares beneficially owned by Mr. Nakfoor exclude stock owned by Carso
Global Telecom, S.A. de C.V. Carso Global is an affiliate of Grupo Financiero
Inbursa, S.A. de C.V. and Mr. Nakfoor is a Vice President of Inbursa. Mr.
Carlos Slim Helu, a Mexican citizen, and members of his immediate family,
directly and through their ownership of a majority of the voting and economic
interests in two trusts, own a majority of the outstanding voting equity
securities of Carso Global.
The shares beneficially owned by Mr. Wilkens are held by Mr. Wilkens and
Sandra L. Wilkens jointly. These shares exclude 281,500 shares attributable to
vested options beneficially owned by Mr. Wilkens' son and 152,010 shares owned
by other family members of Mr. Wilkens.
68
<PAGE>
The shares beneficially owned by Mr. Turner do not include shares
beneficially owned by Linsang, of which Mr. Turner is a director.
Messrs. William R. Wilson, Patrick J. McGettigan, Jr., and six other selling
stockholders have granted the underwriters an option to purchase up to 100,000,
25,000 and 32,372 shares of common stock, respectively, at the initial public
offering price of $10.00 per share less the underwriting discount, as part of
the underwriters' over-allotment option in our initial public offering. The six
stockholders other than Messrs. Wilson and McGettigan are partners or advisors
of Linsang Partners, L.L.C. but otherwise have no relationship to us. If the
underwriters' over-allotment is exercised in full, after this offering and our
initial public offering Mr. Wilson will beneficially own 9,471,000 shares, or
16.1% of our outstanding common stock, and Mr. McGettigan will own 67,895
shares, or less than 1% of our outstanding common stock. The other six selling
stockholders will own 136,528 shares in the aggregate, which is also less than
1% of our outstanding common stock.
69
<PAGE>
SELLING HOLDERS
The following tables set forth information about the selling holders as of
July 23, 1999 that we obtained from the selling holders. The figures in the
last column assume that all of the warrants have been properly exercised for
cash. Other than Linsang, a company controlled by Kwok L. Li, which together
with Mr. Li, a founder and Chairman of the Board of Splitrock, owns
approximately 46.2% of the Company's outstanding shares, none of the selling
holders has or since our inception has had any position, office or other
material relationship with Splitrock or any of its affiliates.
<TABLE>
<CAPTION>
Number of Shares
Number of Warrants of Common Stock
Beneficially Owned Beneficially Owned
Selling Holder and Offered Hereby and Offered Hereby
-------------- ------------------ ------------------
<S> <C> <C>
Stationary Engineers Local 39........... 150 855
Bank of New York/Societe Generale Bank.. 1,000 5,700
Horizon Strategic Income................ 150 855
Pacific Life Insurance Company.......... 500 2,850
Chase Securities, Inc................... 5,220 29,756
Pacific Life Insurance Company.......... 2,500 14,251
Prospect Street High Income Portfolio
Inc.................................... 5,000 28,502
Series Trust High Yield Portfolio....... 1,500 8,551
Sun America High Income Fund............ 1,500 8,551
LB Series Fund, Inc. High Yield
Portfolio (RF03)....................... 4,800 27,362
Lutheran Brotherhood High Yield Fund
(RF06)................................. 3,200 18,241
T. Rowe Price High Yield Fund, Inc...... 2,000 11,401
North Dakota State Investment Board High
Yield.................................. 500 2,850
Legg Mason Income Trust Inc.--High Yield
Portfolio.............................. 2,000 11,400
Goldman Sachs High Yield Bond Fund...... 1,000 5,700
Goldman Sachs Global High Yield Bond
Fund................................... 500 2,850
One Group High Yield Bond Fund.......... 1,125 6,413
Phoenix-Goodwin High Yield Fund......... 6,000 34,202
Prudential High Yield Fund, Inc......... 8,000 45,603
Prudential High Yield Total Return Fund,
Inc.................................... 750 4,275
The Prudential Series Fund, Inc., High
Yield Bond Portfolio................... 1,750 9,976
Van Kampen High Yield Fund.............. 3,500 19,951
Van Kampen High Yield Corporate Bond
Fund................................... 7,000 39,902
Van Kampen Strategic Income Fund........ 250 1,425
Van Kampen Income Trust................. 1,000 5,700
UBS Brinson Investment Co............... 2,400 13,681
Prudential High Yield Fund, Inc......... 8,000 45,603
Prudential High Yield Total Return Fund,
Inc.................................... 750 4,275
Prudential Series Fund, Inc., High Yield
Bond Portfolio......................... 1,750 9,976
Goldman Sachs High Yield Bond Fund...... 1,000 5,700
Goldman Sachs Global High Yield Bond
Fund................................... 500 2,850
Corporate High Yield Fund III, Inc...... 5,250 29,927
Merrill Lynch Corporate Bond Fund, Inc.
High Income Portfolio.................. 1,250 7,125
Merrill Lynch Corporate Bond Fund, Inc.
High Income Portfolio.................. 7,000 39,903
UBS Brinson Investment Co............... 2,400 13,681
Fidelity Adviser Series II: Fidelity
Adviser High Yield Fund................ 11,500 65,554
Fidelity Management Trust Company....... 5,700 32,492
Debt Strategies Fund II, Inc............ 3,000 17,101
Debt Strategies Fund III, Inc........... 3,000 17,101
Linsang Partners L.L.C.................. 11,000 62,704
Continental Casualty Company............ 19,400 110,587
Other Selling Holders(1)................ 116,205 662,409
------- ---------
Total................................. 261,000 1,487,791
======= =========
</TABLE>
- --------
(1) Information regarding these persons or entities will be added by supplement
to this prospectus.
70
<PAGE>
<TABLE>
<CAPTION>
Principal Amount of Notes
Selling Holder Beneficially Owned and Offered Hereby
-------------- -------------------------------------
<S> <C>
Linsang Partners L.L.C. .............. $11,000,000
</TABLE>
The warrants offered hereby were originally issued by us and sold by Chase
Securities in a transaction, with respect to 250,000 warrants, exempt from the
registration requirements of the Securities Act to persons reasonably believed
by Chase Securities to be qualified institutional buyers (as defined in Rule
144A under the Securities Act) and, with respect to 11,000 warrants, in a
private offering to Linsang, an affiliate of Splitrock. The selling holders may
from time to time offer and sell pursuant to this prospectus any or all of the
warrants and the warrant shares issued upon exercise of such warrants.
The notes offered hereby were received by Linsang in a private exchange
between us and Linsang for notes substantially identical in form and terms to
the notes originally issued by us and sold by Chase Securities in a private
offering to Linsang. Linsang, as a selling holder, may from time to time offer
and sell pursuant to this prospectus any or all of the notes.
Information concerning the selling holders may change from time to time and
any such changed information will be set forth in supplements to this
prospectus if and when necessary. The per share exercise price and the number
of shares issuable upon exercise of the warrants is subject to adjustment
upwards or downwards in certain circumstances. See "Description of the Warrants
- -- Adjustments." Moreover, because the selling holders may offer all or some of
the notes, the warrants or the warrant shares issuable upon exercise of the
warrants, no estimate can be given as to the amount of the notes, warrants or
warrant shares that will be held by the selling holders upon the termination of
any such sales. In addition, the selling holders identified above may have sold
or otherwise transferred, in transactions exempt from the registration
requirements of the Securities Act, all or a portion of the warrants, the
warrant shares or the notes since the date with respect to which the
information in the preceding table is presented. See "Plan of Distribution."
The Company is paying the expenses of the registration of the securities
being offered by this prospectus.
PLAN OF DISTRIBUTION
The warrants, the warrant shares and the notes offered hereby may be sold
from time to time in one or more transactions at fixed prices, at prevailing
market prices at the time of sale, at varying prices determined at the time of
sale or at negotiated prices. These securities may be sold by one or more of
the following methods:
. a block trade (which may involve crosses) in which the broker or dealer
so engaged will attempt to sell such securities as agent but may
position and resell a portion of the block as principal to facilitate
the transaction;
. purchases by a broker or dealer as principal and resale by the broker or
dealer for its account pursuant to this prospectus;
. an exchange distribution in accordance with the rules of such exchange;
. ordinary brokerage transactions and transactions in which the broker
solicits purchasers;
. direct transactions between a selling holder and a purchaser without a
broker or dealer; or
. through the writing of options.
Upon being notified by a selling holder that any material arrangement has been
entered into with a broker-dealer for the sale of warrants, warrant shares or
notes through a block trade, special offering, exchange
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distribution or secondary distribution or a purchase by a broker or dealer, we
will file a supplement to this prospectus, if required, pursuant to Rule 424(b)
under the Securities Act, disclosing:
. the names of each selling holder and of the participating broker-
dealer(s);
. the number of securities involved;
. the price at which such securities were sold;
. the commissions paid or discounts or concessions allowed to the broker-
dealer(s), where applicable;
. that the broker-dealer(s) did not conduct any investigation to verify
the information set out or incorporated by reference in this prospectus,
and
. other facts material to the transaction.
In addition, upon being notified by a selling holder that a donee or pledgee
intends to sell more than 50 warrants or 500 warrant shares, we shall file a
supplement to this prospectus. Such prospectus supplement and,
if required, post-effective amendment to the Registration Statement of which
this prospectus is a part, will be filed with the Commission to reflect the
disclosure of additional information with respect to the distribution of the
warrants, warrant shares and notes. In addition, any securities covered by this
prospectus may be sold in private transactions or, if qualified for sale
pursuant to Rule 144 under the Securities Act, may be sold under Rule 144
rather than pursuant to this prospectus.
To the knowledge of Splitrock, there are currently no plans, arrangements or
understandings between any selling holders and any broker, dealer, agent or
underwriter regarding the sale of the warrants, the warrant shares or the notes
by the selling holders. There is no assurance that any selling holder will sell
any or all of such securities held by such holder or that any selling holder
will not otherwise transfer, devise or gift such securities by other means not
described herein.
The selling holders and any broker-dealers that act in connection with the
sale of the warrants, the warrant shares and the notes might be deemed to be
"underwriters" within the meaning of Section 2(11) of the Securities Act, and
any commissions received by such broker-dealers and any profit on the resale of
the warrants, the warrant shares and the notes sold by them while acting as
principals might be deemed to be underwriting discounts or commissions under
the Securities Act. The Company has agreed to indemnify each selling holder
against certain liabilities, including liabilities arising under the Securities
Act. The selling holders may agree to indemnify any agent, dealer or broker-
dealer that participates in transactions involving sales of the warrants, the
warrant shares and the notes against certain liabilities, including liabilities
arising under the Securities Act. Because selling holders may be deemed to be
"underwriters" within the meaning of Section 2(11) of the Securities Act, the
selling holders will be subject to the prospectus delivery requirements of the
Securities Act.
The selling holders and any other person participating in the distribution
contemplated in this prospectus will be subject to applicable provisions of the
Exchange Act and the rules and regulations thereunder, including without
limitation Regulation M, which may limit the timing of purchase and sales of
any of the warrants, the warrant shares or the notes by the selling holders and
any other such person. Furthermore, Regulation M of the Exchange Act may
restrict the ability of any person engaged in the distribution of the warrants,
warrant shares or notes to engage in market-making activities with respect to
the warrants, warrant shares and notes being distributed for a period of up to
five business days before commencement of such distribution. All of the
foregoing may effect the marketability of the warrants, the warrant shares and
the notes.
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DESCRIPTION OF THE WARRANTS
The warrants were issued pursuant to a Warrant Agreement, dated July 24,
1998, between Splitrock and Bank of Montreal Trust Company, as 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 prospectus have the meanings assigned to them in the Warrant
Agreement. For more information about the form of the warrants, see
"Description of the Notes Book Entry, Delivery and Form" and "-- Certificated
Securities."
General
Each warrant, when exercised, will entitle the holder to purchase
approximately 5.7 shares of our common stock from Splitrock at an exercise
price of $0.02 per share. The exercise price and the number of shares of common
stock issuable upon exercise of a warrant are both subject to adjustment. For
more information, see "-- Adjustments" below. The warrants initially entitle
the holders to acquire, in the aggregate, 1,487,791 shares of our common stock.
The warrants became exercisable on July 26, 1999; however, the holders of
warrants will be able to exercise their warrants only if the Registration
Statement of which this prospectus is a part 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 the Expiration
Date of 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 our 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), we 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. We 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 Splitrock, a bankruptcy court may hold that unexercised warrants
are executory contracts which may be subject to rejection by Splitrock 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
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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 Splitrock 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.
This second method is a "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.
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 Splitrock in respect
of any stockholders' meeting for the election of directors of Splitrock or any
other purpose, or to exercise any other rights whatsoever as stockholders of
Splitrock.
Mergers, Consolidations, etc.
If Splitrock 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) Splitrock 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 Splitrock, 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 Splitrock, Splitrock, 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 us of certain dividends (or other distributions)
on our common stock including dividends or distributions payable in shares of
common stock or other shares of our 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
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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 our 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 us, (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 Splitrock.
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. For more information, see
"Certain Federal Income Tax Considerations".
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 oft
his paragraph will be carried forward and taken into account in any subsequent
adjustment.
Amendment
From time to time, Splitrock 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. This prospectus constitutes a part of the
Warrant Shelf Registration Statement that we filed.
Each holder of warrants that sells such warrants pursuant to the Warrant
Shelf Registration Statement is required to be named as a selling security
holder in the prospectus and to deliver the prospectus to the purchaser, is
subject to certain of the civil liability provisions under the Securities Act
in connection with such sales and is bound by certain provisions of the Warrant
Agreement which are applicable to such holder (including certain
indemnification obligations). In addition, each holder of warrants is 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.
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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. The Common
Shelf Registration Statement and the Warrant Shelf Registration Statement have
been filed by the Company as a single registration statement (the "Shelf
Registration Statement"), of which this prospectus constitutes a part.
During any consecutive 365-day period, the Company shall be entitled to
suspend the availability of the 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 our board of directors 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 and the notes; provided, however, that in no event
shall we be required to disclose the business purpose for such suspension if we
determine in good faith that such business purpose must remain confidential.
There can be no assurance that we will be able to keep a registration statement
continuously effective until all of the warrants have been exercised or have
expired.
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 our board of
directors and certified in a board resolution, based on the most recently
completed arm's-length transaction between Splitrock and a Person other than an
Affiliate of Splitrock, 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.
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DESCRIPTION OF CAPITAL STOCK
Authorized stock; issued and outstanding shares
Our authorized capital stock consists of 150,000,000 shares of common stock,
par value $0.001 per share, and 25,000,000 shares of preferred stock, par value
$0.001 per share.
Common Stock
Following this offering, and completion of our initial public offering,
there will be 57,169,215 shares of our common stock issued and outstanding
assuming that all of the warrants are exercised. All of the issued and
outstanding shares of common stock are and, upon the completion of this
offering, the shares of common stock offered in this offering will be, fully
paid, validly issued and non-assessable.
The following summarizes the rights of holders of our common stock:
. each holder of shares of common stock is entitled to one vote per share
on all matters to be voted on by stockholders generally, including the
election of directors;
. there are no cumulative voting rights;
. the holders of our common stock are entitled to dividends and other
distributions as may be declared from time to time by the board of
directors out of funds legally available for that purpose, if any;
. upon our liquidation, dissolution or winding up, the holders of shares
of common stock will be entitled to share ratably in the distribution of
all of our assets remaining available for distribution after
satisfaction of all our liabilities and the payment of the liquidation
preference of any outstanding preferred stock; and
. the holders of common stock have no preemptive or other subscription
rights to purchase shares of our stock, nor will holders be entitled to
the benefits of any redemption or sinking fund provisions.
As of June 30, 1999, there were 46,681,424 shares of our common stock
outstanding, held of record by 52 persons.
Preferred Stock
Our certificate of incorporation authorizes our board of directors to create
and issue one or more series of preferred stock and determine the rights and
preferences of each series within the limits set forth in our certificate of
incorporation and applicable law. Among other rights, the board of directors
may determine, without further vote or action by our stockholders:
. the number of shares constituting the series and the distinctive
designation of the series;
. the dividend rate on the shares of the series, whether dividends will be
cumulative, and if so, from which date or dates, and the relative rights
of priority, if any, of payment of dividends on shares of the series;
. whether the series will have voting rights in addition to the voting
rights provided by law and, if so, the terms of the voting rights;
. whether the series will have conversion privileges and, if so, the terms
and conditions of conversion;
. whether or not the shares of the series will be redeemable or
exchangeable, and, if so, the dates, terms and conditions of redemption
or exchange, as the case may be;
. whether the series will have a sinking fund for the redemption or
purchase of shares of that series, and, if so, the terms and amount of
the sinking fund; and
. the rights of the shares of the series in the event of our voluntary or
involuntary liquidation, dissolution or winding up and the relative
rights or priority, if any, of payment of shares of the series.
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Unless otherwise provided by our board of directors, the shares of all
series of preferred stock will rank on a parity with respect to the payment of
dividends and to the distribution of assets upon liquidation. Although we have
no present plans to issue any shares of preferred stock, any future issuance of
shares of preferred stock, or the issuance of rights to purchase preferred
shares, may have the effect of delaying, deferring or preventing a change of
control in our company or an unsolicited acquisition proposal. The issuance of
preferred stock also could decrease the amount of earnings and assets available
for distribution to the holders of common stock or could adversely affect the
rights and powers, including voting rights, of the holders of the common stock.
Anti-Takeover Effects of Delaware Law and Our Certificate of Incorporation and
Bylaws
Section 203 of the Delaware General Corporation Law
We are subject to the provisions of Section 203 of the Delaware General
Corporation Law. Under Section 203, business combinations between a Delaware
corporation whose stock generally is publicly traded or held of record by more
than 2,000 stockholders and an interested stockholder are generally prohibited
for a three-year period following the date that such a stockholder became an
interested stockholder, unless:
. the corporation has elected in its original certificate of incorporation
not to be governed by Section 203. We did not make this election;
. the business combination was approved by the board of directors of the
corporation before the other party to the business combination became an
interested stockholder;
. upon consummation of the transaction that made it an interested
stockholder, the interested stockholder owned at least 85% of the voting
stock of the corporation outstanding at the commencement of the
transaction, excluding voting stock owned by directors who are also
officers or held in employee benefit plans in which the employees do not
have a confidential right to tender or vote stock held by the plan; or
. the business combination was approved by the board of directors of the
corporation and ratified by two-thirds of the voting stock not owned by
the interested stockholder.
The three-year prohibition also does not apply to some business combinations
proposed by an interested stockholder following the announcement or
notification of an extraordinary transaction involving the corporation and a
person who had not been an interested stockholder during the previous three
years or who became an interested stockholder with the approval of the majority
of the corporation's directors. The term "business combination" is defined
generally under Section 203 to include mergers or consolidations between a
Delaware corporation and an interested stockholder, transactions with an
interested stockholder involving the assets or stock of the corporation or its
majority-owned subsidiaries and transactions which increase an interested
stockholder's percentage ownership of stock. The term "interested stockholder"
is defined generally under Section 203 as a stockholder who, together with
affiliates and associates, owns or within three years prior did own 15% or more
of a Delaware corporation's voting stock. Section 203 could prohibit or delay a
merger, takeover or other change in control of Splitrock and therefore could
discourage attempts to acquire us.
Board of Directors Vacancies. Our certificate of incorporation authorizes
the board of directors to fill vacant directorships or increase the size of the
board of directors. This may deter a stockholder from removing incumbent
directors and simultaneously gaining control of the board of directors by
filling the vacancies created by this removal with its own nominees.
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Special Meeting of Stockholders. Our bylaws provide that special meetings of
our stockholders may be called only by the board of directors.
Advance Notice Requirements for Stockholder Proposals and Director
Nominations. Our bylaws provide that stockholders seeking to bring business
before an annual meeting of stockholders, or to nominate candidates for
election as directors at an annual meeting of stockholders, must provide timely
notice in writing. To be timely, a stockholder's notice must be delivered to or
mailed and received at our principal executive offices not less than 90 days
prior to the anniversary of the previous year's annual meeting of stockholders.
If no annual meeting of stockholders was held in the previous year or the date
of the annual meeting of stockholders has been changed to be more than 30
calendar days earlier than or 60 calendar days after this anniversary, notice
by the stockholder, to be timely, must be received not later than the later of:
. 90 days prior to the annual meeting of stockholders or
. the close of business on the 10th day following the date on which notice
of the date of the meeting is mailed to stockholders or made public,
whichever occurs first.
According to our bylaws, stockholders seeking to nominate candidates for
election as directors at special meetings of stockholders must also provide
timely notice in writing in accordance with restrictions similar to those for
annual meetings.
Our bylaws also specify certain requirements as to the form and content of a
stockholder's notice. These provisions may preclude stockholders from bringing
matters before an annual meeting of stockholders or from making nominations for
directors at an annual meeting of stockholders.
Authorized But Unissued Shares. The authorized but unissued shares of common
stock and preferred stock are available for future issuance without stockholder
approval, subject to various limitations imposed by the Nasdaq National Market.
These additional shares may be utilized for a variety of corporate purposes,
including future public offerings to raise additional capital, corporate
acquisitions and employee benefit plans. The existence of authorized but
unissued and unreserved common stock and preferred stock could make more
difficult or discourage an attempt to obtain control of us by means of a proxy
contest, tender offer, merger or otherwise.
Delaware law provides generally that the affirmative vote of a majority of
the shares entitled to vote on any matter is required to amend a corporation's
certificate of incorporation or bylaws, unless a corporation's certificate of
incorporation or bylaws, as the case may be, requires a greater percentage.
Limitation of Liability and Indemnification Matters
Our certificate of incorporation provides that the liability of our
directors shall be eliminated or limited to the fullest extent permitted by
Delaware law. Under Delaware law, the directors have a fiduciary duty to us
that is not eliminated by this provision of our certificate of incorporation
and, in appropriate circumstances, equitable remedies such as injunctive or
other forms of non-monetary relief will remain available. In addition, each
director will continue to be subject to liability under Delaware law for:
. breach of the director's duty of loyalty to us or our stockholders;
. acts or omissions which are found by a court of competent jurisdiction
to be not in good faith or which involve intentional misconduct, or
knowing violations of law;
. actions leading to improper personal benefit to the director; and
. payment of dividends or approval of stock repurchases or redemptions
that are prohibited by the Delaware law.
This provision also does not affect the directors' responsibilities under any
other laws, such as the federal securities laws.
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Our certificate of incorporation also generally provides that we are
required to fully 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 that person is or was a director or officer of
Splitrock, or is or was serving at our request as a director or officer of
another corporation, partnership, joint venture, trust, employee benefit plan
or other enterprise. This indemnification covers expenses including attorney's
fees, judgments, fines and amounts paid in settlement actually and reasonably
incurred by the indemnitee in connection with such action, suit or proceeding.
Transfer agent and registrar
The transfer agent and registrar for our common stock is Continental Stock
Transfer & Trust Company.
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DESCRIPTION OF THE NOTES
General
The notes were issued under an indenture dated as of July 24, 1998, between
Splitrock and Bank of Montreal Trust Company, as trustee, a copy of which has
been filed as an exhibit to the Registration Statement. We refer to the
indenture, as supplemented from time to time, as the "Indenture." The notes and
all other 11 3/4% Series B Senior notes due 2008 issued by Splitrock are deemed
the same class of notes under the Indenture and are 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 and Disbursement 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 and the notes issued in the Exchange Offer, 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 the notes issued
in the Exchange Offer and will vote on all matters with the notes offered
hereby and the notes issued in the Exchange Offer.
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 notes are 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
We have 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 held by the Escrow Agent for the benefit
of the Trustee under the Indenture in accordance with the Escrow and
Disbursement Agreement. The Company entered into the Escrow and Disbursement
Agreement, which provides, among other things, that funds maybe disbursed from
the Escrow Account only to pay interest on the notes (or, if a portion of the
notes has been retired by us, funds representing the interest payment on the
retired notes may be paid to Splitrock). Pending such
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disbursement, we 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, Splitrock will grant to the
Trustee, for the benefit of the holders, a first priority and exclusive
security interest in the Escrow Account. We refer to that interest as 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 Splitrock 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 Splitrock.
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 Splitrock.
Optional Redemption
Except as set forth in the following paragraph, the notes will not be
redeemable at our option prior to July 15, 2003. On or after such date, the
notes will be redeemable at our option, 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:
<TABLE>
<CAPTION>
Year Redemption 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,
Splitrock may redeem up to a maximum of 35% of the original aggregate principal
amount of the notes (calculated giving effect to the notes issued in the
Exchange Offering and any issuance of additional notes) with the Net Cash
Proceeds of one or more Equity Offerings by Splitrock, 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 the notes
issued in the Exchange Offering and 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.
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Ranking
The indebtedness evidenced by the notes will be unsecured Senior
Indebtedness of Splitrock, will rank pari passu in right of payment with all
our existing and future Senior Indebtedness and will be senior in right of
payment to all our existing and future Subordinated Obligations, which must be
specifically designated as subordinate to the notes. The notes will also be
effectively subordinated to any Secured Indebtedness of Splitrock and its
subsidiaries to the extent of the value of the assets securing such
Indebtedness.
At June 30, 1999, Splitrock had $12.5 million of Indebtedness other than the
notes all of which is senior indebtedness and all of which is secured. We
currently do not have any Subsidiaries.
Although the Indenture contains limitations on the amount of additional
Indebtedness that we may incur, under certain circumstances the amount of such
Indebtedness could be substantial and, in any case, such Indebtedness may be
Senior Indebtedness. For more information see "-- Certain Covenants --
Limitation on Indebtedness."
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 us 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, we shall not be obligated to repurchase the notes
pursuant thereto if it has exercised its right to redeem all the notes under
the terms of the section titled "Optional Redemption":
(1) prior to our first public offering of common stock, 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 Splitrock, whether as a result of issuance of securities of
Splitrock, any merger, consolidation, liquidation or dissolution of
Splitrock, any direct or indirect transfer of securities by any
Permitted Holder or otherwise (for purposes of this clause (1) and
clause (2) 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);
(2) on the date of or after our first public offering of common stock
referred in clause (1):
(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 (1) above,
except that for purposes of this clause (2) 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 Splitrock, and
(b) the Permitted Holders "beneficially own" (as defined in clause (1)
above), directly or indirectly, in the aggregate a lesser
percentage of the total voting power of the Voting Stock of
Splitrock 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 our board of directors (for
the purposes of this clause (2), 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 (2)), 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
(1)
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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);
(3) during any period of two consecutive years, individuals who at the
beginning of such period constituted our board of directors (together
with any new directors whose election by such board of directors or
whose nomination for election by the stockholders of Splitrock was
approved by a vote of 66 2/3% of the directors of Splitrock 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 our board of directors
then in office;
(4) the adoption of a plan relating to the liquidation or dissolution of
Splitrock; or
(5) the merger or consolidation of Splitrock with or into another Person or
the merger of another Person with or into Splitrock, or the sale of all
or substantially all the assets of Splitrock 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 Splitrock
that are outstanding immediately prior to such transaction and which
represent 100% of the aggregate voting power of the Voting Stock of
Splitrock 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,
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, we shall mail a notice to
each holder with a copy to the Trustee (the "Change of Control Offer") stating:
. that a Change of Control has occurred and that such holder has the right
to require us 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);
. the circumstances and relevant facts and financial information regarding
such Change of Control;
. the repurchase date (which shall be no earlier than 30 days nor later
than 60 days from the date such notice is mailed); and
. the instructions determined by us, consistent with this covenant, that a
holder must follow in order to have its notes purchased.
We 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 us and purchases all
notes validly tendered and not withdrawn under such Change of Control Offer.
We 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, we 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
Splitrock and Chase Securities, the Initial Purchaser. Management has no
present intention to engage in a transaction involving a Change of Control,
although it is possible that we would decide to do so in the future. Subject to
the limitations discussed below, we could, in the future, enter into certain
transactions, including acquisitions, refinancings or other
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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 our capital structure or credit ratings.
Restrictions on the ability of Splitrock 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.
Our future Senior Indebtedness 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 us 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 Splitrock. Finally,
our ability to pay cash to the holders upon a repurchase may be limited by our
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 our 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 following restrictions apply to the notes:
Limitation on Indebtedness. a) We will not, and will not permit any
Restricted Subsidiary to, Incur, directly or indirectly, any Indebtedness;
provided, however, that we may Incur Indebtedness if on the date of such
Incurrence and after giving effect thereto the Debt to Annualized 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, Splitrock and its Restricted
Subsidiaries may Incur the following Indebtedness:
(1) 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;
(2) Indebtedness of Splitrock owed to and held by any Wholly Owned
Subsidiary or Indebtedness of a Restricted Subsidiary owed to and held
by Splitrock or any Wholly Owned Subsidiary; provided, however, that
. 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 Splitrock or a Wholly Owned Subsidiary)
shall be deemed, in each case, to constitute the Incurrence of such
Indebtedness by the issuer thereof and
. if Splitrock 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;
(3) Indebtedness:
. represented by the notes (not including any additional notes),
. outstanding on the Closing Date (other than the Indebtedness
described in clauses (1) and (2) above),
. consisting of Refinancing Indebtedness Incurred in respect of any
Indebtedness described in this clause (3) (including Indebtedness
Refinancing) or the foregoing paragraph (a),
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. consisting of Guarantees of any Indebtedness permitted under clauses
(1) and (2) of this paragraph (b) and
. consisting of any Guarantees of the notes;
(4) Indebtedness of a Restricted Subsidiary Incurred and outstanding on or
prior to the date on which such Restricted Subsidiary was acquired by
us (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 us); provided, however, that on the date that
such Restricted Subsidiary is acquired by us, we 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 (4);and refinancing Indebtedness
Incurred by a Restricted Subsidiary in respect of Indebtedness
Incurred by such Restricted Subsidiary pursuant to this clause (4);
(5) Indebtedness
. 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
. 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;
(6) 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;
(7) Contribution Indebtedness; or
(8) 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 (8) and then outstanding, shall not exceed
$40.0 million.
(c) Notwithstanding the foregoing, we may not Incur any Indebtedness
pursuant to paragraph (b) above if the proceeds thereof are used, directly or
indirectly, to repay, prepay, redeem, defease, 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 we 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, Splitrock, 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.
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Limitation on Restricted Payments. a) Splitrock will not, and will not
permit any Restricted Subsidiary, directly or indirectly, to:
(1) 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 Splitrock) 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
Splitrock or another Restricted Subsidiary (and, if such Restricted
Subsidiary has stockholders other than Splitrock or other Restricted
Subsidiaries, to its other stockholders on a pro rata basis);
(2) purchase, redeem, retire or otherwise acquire for value any Capital
Stock of Splitrock or any Restricted Subsidiary held by Persons other
than Splitrock or another Restricted Subsidiary;
(3) 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
(4) 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 Splitrock or such Restricted Subsidiary
makes such Restricted Payment:
(1) a Default will have occurred and be continuing (or would result
therefrom);
(2) Splitrock 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 our board of directors, whose
determination will be conclusive and evidenced by a resolution of our
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 us from the issue or
sale of our Capital Stock (other than Disqualified Stock)
subsequent to the Closing Date (other than an issuance or sale to
(x) a Subsidiary of Splitrock or (y) an employee stock ownership
plan or other trust established by Splitrock or any of its
Subsidiaries); plus,
(C) the amount by which Indebtedness of Splitrock or its Restricted
Subsidiaries is reduced on Splitrock's balance sheet upon the
conversion or exchange (other than by a Subsidiary of Splitrock)
subsequent to the Closing Date of any Indebtedness of Splitrock or
its Restricted Subsidiaries issued after the Closing Date which is
convertible or exchangeable for Capital Stock (other than
Disqualified Stock)of Splitrock (less the amount of any cash or
the fair market value
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of other property distributed by Splitrock 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 principal of loans or advances or other transfers
of assets to Splitrock 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 Splitrock 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:
(1) any purchase, repurchase, retirement or other acquisition or
retirement for value of Capital Stock of Splitrock made by exchange
for, or out of the proceeds of the substantially concurrent sale of,
Capital Stock of Splitrock (oher than Disqualified Stock and other
than Capital Stock issued or sold to a Subsidiary of Splitrock or an
employee stock ownership plan or other trust established by Splitrock
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;
(2) any purchase, repurchase, redemption, defeasance or other acquisition
or retirement for value of Subordinated Obligations of Splitrock made
by exchange for, or out of the proceeds of the substantially
concurrent sale of, Indebtedness of Splitrock that is permitted to be
Incurred pursuant to paragraph (b) of the covenant described under "--
Limitation on Indebtedness" or Capital Stock of Splitrock (other than
Disqualified Stock and other than Capital Stock issued or sold to a
Subsidiary of Splitrock or an employee stock ownership plan or other
trust established by Splitrock 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;
(3) 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 in the calculation of
the amount of Restricted Payments;
(4) 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
(5) the repurchase or other acquisition of shares of, or options to
purchase shares of, common stock of Splitrock or any of its
Subsidiaries from employees, former employees, directors or former
directors of Splitrock 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 our 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.
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Limitation on Restrictions on Distributions from Restricted
Subsidiaries. Splitrock 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 (a) pay dividends or make any other distributions on its Capital
Stock or pay any Indebtedness or other obligations owed to Splitrock, (b) make
any loans or advances to Splitrock or (c) transfer any of its property or
assets to Splitrock, 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)(1) or (b)(6) of the covenant described under "-- Limitation
on Indebtedness", provided that the chief financial officer of
Splitrock 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 Splitrock (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 Splitrock) and outstanding on such date;
(3) any encumbrance or restriction 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) Splitrock will not,
and will not permit any Restricted Subsidiary to, make any Asset Disposition
unless:
(1) Splitrock 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;
(2) at least 75% of the consideration thereof received by Splitrock or
such Restricted Subsidiary is in the form of cash or cash equivalents
and
(3) an amount equal to 100% of the Net Available Cash from such Asset
Disposition is applied by Splitrock (or such Restricted Subsidiary, as
the case may be):
(A) first, to the extent Splitrock 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
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Splitrock or another Restricted Subsidiary) or (y) prepay, repay,
redeem or purchase Bank Indebtedness of Splitrock Incurred pursuant
to clause (b)(1) 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 Splitrock
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 Splitrock; 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, Splitrock 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 Splitrock (other than Disqualified Stock of
Splitrock) or any Restricted Subsidiary and the release of Splitrock or such
Restricted Subsidiary from all liability on such Indebtedness in connection
with such Asset Disposition and (y) securities received by Splitrock or any
Restricted Subsidiary from the transferee that are converted by Splitrock 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)(3)(B) of this
covenant, Splitrock will be required to purchase notes (and other Senior
Indebtedness) tendered pursuant to an offer by Splitrock 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 over subscription), 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), Splitrock may apply the
remaining Net Available Cash in accordance with clause (a)(3)(C) of this
covenant. Splitrock will not be required to make an Offer for notes (and other
Senior Indebtedness) pursuant to this covenant if the Net Available Cash
available therefor (after application of the proceeds as provided in
clause(a)(3)(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) Splitrock 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, Splitrock 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) We 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 Splitrock (an
"Affiliate Transaction") unless such transaction is on terms:
(1) that are no less favorable to Splitrock 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;
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(2) that, in the event such Affiliate Transaction involves an aggregate
amount in excess of $1.0 million,
. are set forth in writing and
. have been approved by a majority of the members of our board of
directors having no personal stake in such Affiliate Transaction and
(3) 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 Splitrock and its Restricted Subsidiaries.
(b) The provisions of the foregoing paragraph (a) will not prohibit:
(1) any Restricted Payment permitted to be paid pursuant to the covenant
described under "-- Limitation on Restricted Payments",
(2) 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 our board of directors;
(3) the grant of stock options or similar rights to employees and directors
of Splitrock pursuant to plans approved by our board of directors,
(4) loans or advances to employees in the ordinary course of business in
accordance with past practices of Splitrock, but in any event not to
exceed $2.0 million in the aggregate outstanding at anyone time,
(5) the payment of reasonable fees to directors of Splitrock and its
Subsidiaries who are not employees of Splitrock or its Subsidiaries;
(6) any transaction between Splitrock and a Wholly Owned Subsidiary or
between Wholly Owned Subsidiaries; or
(7) 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. We will not permit:
(a) any Restricted Subsidiary of Splitrock to issue any Capital Stock
except for
(1) Capital Stock issued or sold to, held by or transferred to Splitrock or
a Wholly Owned Subsidiary,
(2) Capital Stock issued by a Person prior to the time
(A) such Person becomes a Restricted Subsidiary of Splitrock,
(B) such Person merges with or into a Restricted Subsidiary of
Splitrock or
(C) a Restricted Subsidiary of Splitrock 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
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(b) any Person (other than Splitrock or a Wholly Owned Subsidiary) to
acquire Capital Stock of any Restricted Subsidiary of Splitrock from us or any
of our Restricted Subsidiaries, 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.
Limitation on Liens. We 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 Splitrock may not be subject to the
reporting requirements of Section 13 or 15(d) of the Exchange Act Splitrock
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 Splitrock, we
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 Splitrock to its public stockholders generally. We also
will comply with the other provisions of Section 314(a) of the TIA.
Future Subsidiary Guarantors. We 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. We will not, and will not permit any
Restricted Subsidiary to, engage in any business other than a
Telecommunications Business.
Limitation on Sale/Leaseback Transactions. We will not, and will not permit
any Restricted Subsidiary to, enter into any Sale/Leaseback Transaction with
respect to any property unless:
(a) Splitrock or such Restricted Subsidiary would be entitled to:
. 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
. 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";
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(b) the net proceeds received by Splitrock 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 our board of
directors) of such property; and
(c) the transfer of such property is permitted by, and Splitrock applies
the proceeds of such transaction in compliance with, the covenant
described under"-- Limitation on Sale of Assets and Subsidiary Stock".
Merger and Consolidation
We will not consolidate with or merge with or into, or convey, transfer or
lease all or substantially all its assets to, any Person, unless:
(1) the resulting, surviving or transferee Person (We refer to that Person
as 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
Splitrock) 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 Splitrock under the
notes, the Indenture and the Escrow and Disbursement Agreement;
(2) 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;
(3) immediately after giving effect to such transaction, the Successor
Company would be able to Incur an additional $1.00 of Indebtedness
under paragraph (a) of the covenant described under "--Certain
Covenants -- Limitation on Indebtedness";
(4) Splitrock 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;
(5) Splitrock 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
(6) Splitrock 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, Splitrock 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.
We 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:
(1) 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;
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(2) 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
(3) Splitrock 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:
(1) a default in any payment of interest on any Note when due and payable,
continued for 30 days;
(2) 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;
(3) our failure to comply with its obligations under the covenant described
under "-- Merger and Consolidation";
(4) our failure 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;
(5) our failure to comply for 60 days after notice with its other
agreements contained in the notes or the Indenture;
(6) the failure by Splitrock 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;
(7) certain events of bankruptcy, insolvency or reorganization of the
Company or a Significant Subsidiary (the "bankruptcy provisions");
(8) 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
. an enforcement proceeding thereon is commenced by any creditor, or
. 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");
(9) 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 Subsidiary Guarantor denies or
disaffirms such Subsidiary Guarantor's obligations under the Indenture
or any Subsidiary
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Guarantee and such Default continues for 10 days after receipt of the
notice specified in the Indenture; or
(10) Splitrock 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 us, the Escrow Collateral becoming
subject to any lien other than liens under the Escrow Agreement or the
Escrow and Disbursement Agreement becomes, or Splitrock 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 (4), (5), (6) or (9) 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 Splitrock of the default and we do not
cure such default within the time specified in clauses (4), (5), (6) or (9)
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 Splitrock) occurs and is
continuing, the Trustee or the Holders of at least 25% in principal amount of
the outstanding notes by notice to Splitrock 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 Splitrock 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:
(1) such holder has previously given the Trustee notice that an Event of
Default is continuing;
(2) holders of at least 25% in principal amount of the outstanding notes
have requested the Trustee in writing to pursue the remedy;
(3) such holders have offered the Trustee reasonable security or indemnity
against any loss, liability or expense;
(4) 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
(5) 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
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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 the previous year. We are also 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 Splitrock 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:
(1) reduce the amount of notes whose holders must consent to an amendment;
(2) reduce the rate of or extend the time for payment of interest or any
liquidated damages on any note;
(3) reduce the principal of or extend the Stated Maturity of any note;
(4) 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";
(5) make any note payable in money other than that stated in the note;
(6) 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;
(7) make any change in the amendment provisions which require each holder's
consent or in the waiver provisions;
(8) modify the Subsidiary Guarantees in any manner adverse to the holders;
or
(9) 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, Splitrock and the 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 Splitrock under the Indenture,
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. 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 Splitrock's covenants for the benefit of the holders 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 holders 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, Splitrock is
required to mail to the holders a notice briefly describing such amendment.
However, the failure to give such notice to all holders, or any defect therein,
will not impair or affect the validity of the amendment.
Transfer
A holder may transfer notes in accordance with the Indenture. Upon any
transfer, the registrar and the Trustee may require a holder, among other
things, to furnish appropriate endorsements and transfer documents and
Splitrock may require a holder to pay any taxes required by law or permitted by
the Indenture. We are not required to transfer any note selected for redemption
or to transfer 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.
Defeasance
Splitrock 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. Splitrock
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 (3) under the
first paragraph of "-- Merger and Consolidation" ("covenant defeasance").
Splitrock may exercise its legal defeasance option notwithstanding its prior
exercise of its covenant defeasance option. If Splitrock exercises its legal
defeasance option, payment of the notes may not be accelerated because of an
Event of Default with respect thereto. If Splitrock exercises its covenant
defeasance option, payment of the notes may not be accelerated because of an
Event of Default specified in clause (4), (6), (7) (with respect only to
Significant Subsidiaries) or (8) under "-- Defaults" or because of the failure
of the Company to comply with clause (3) under the first paragraph of "--
Merger and Consolidation."
In order to exercise either defeasance option, we 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
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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).
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
The warrants and the notes (and the related guarantees) initially will each
be represented by a single permanent global certificate in definitive, fully
registered form, (We refer to them as the "Global Warrant" and the "Global
Note," respectively), deposited with the Depository Trust Company and
registered in the name of DTC's nominee. Except under the circumstances
described below, we will not issue the warrants and the notes in definitive
form.
Warrants and 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) (We refer to them as the "QIBs".) who elect to take physical delivery of
their certificates instead of holding their interests through the Global
Warrant or Global Note (and which are thus ineligible to trade through the
Depositary) (We collectively referred to them as the "Non-Global Purchasers")
will be issued in registered form (We refer to it as 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 Warrant or Global Note has
previously been exchanged in whole for Certificated Securities, be exchanged
for an interest in the Global Warrant or Global Note.
Pursuant to procedures established by the Depositary (i) upon the issuance
of the Global Warrant and Global Note, the Depositary or its custodian
credited, on its internal system, the number of warrants of the individual
beneficial interests represented by the Global Warrant and 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 Warrant and 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 were initially
designated by or on behalf of the Initial Purchaser and ownership of beneficial
interests in the Global Warrant and 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
Warrant and 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 s the Depositary, or its nominee, is the
registered owner or holder of the warrants or notes, the Depositary or such
nominee, as the case may be, will be considered the sole owner or holder of the
warrants or notes represented by such Global Warrant or Global Note for all
purposes under the Indenture. No beneficial owner of an interest in the
warrants or Global Note will be able to transfer that interest except in
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accordance with the procedures of the Depositary, in addition to those provided
under the Indenture with respect to the notes.
The Depositary has advised us that it is
. a limited purpose trust company organized under the laws of the State of
New York,
. a "banking organization" within the meaning of the New York Banking Law,
. a member of the Federal Reserve System,
. a "clearing corporation" within the meaning of the Uniform Commercial
Code, as amended, and
. a "clearing agency" registered pursuant to Section 17A of the Exchange
Act.
The Depositary was created to hold securities for its 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 referred to as 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, Splitrock 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.
Certificated Securities
If (1) Splitrock 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 success or
depositary is not appointed within 90 days of such notice or cessation, (2)
Splitrock, at its option, notifies the Trustee in writing that it elects to
cause the issuance of warrants and notes in definitive form or (3) upon the
occurrence of certain other events, then, upon surrender by the Depositary of
the Global Warrant and Global Note, certificated notes and warrants will be
issued to each person that the Depositary identifies as the beneficial owner of
the warrants and notes represented by the Global Warrant and Global Note. Upon
any such
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issuance, the Trustee is required to register such certificated notes and
warrants in the name of such person or persons (or the nominee of any thereof)
and cause the same to be delivered thereto.
Neither Splitrock 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 warrants and 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 Splitrock 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 Splitrock 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:
(1) 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 Splitrock or a Restricted Subsidiary);
(2) all or substantially all the assets of any division or line of business
of Splitrock or any Restricted Subsidiary; or
(3) any other assets of Splitrock or any Restricted Subsidiary other than
inventory or obsolete assets sold in the ordinary course of business of
Splitrock or such Restricted Subsidiary.
For the purposes of this definition, the term "Asset Sale" shall not
include:
(a) a disposition by a Restricted Subsidiary to Splitrock or by Splitrock
or a Restricted Subsidiary to a Wholly Owned Subsidiary;
(b) 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
(c) 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 (1) 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
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or similar payment with respect to such Preferred Stock multiplied by the
amount of such payment by (2) 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 facilities, as
amended, waived, restated, supplemented, extended, replaced, refinanced or
otherwise modified from time to time.
"Board of Directors" means our board of directors 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 contribution
made to the capital of Splitrock 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 Splitrock and its Consolidated Restricted Subsidiaries, plus, to the
extent Incurred by Splitrock and its Subsidiaries in such period but not
included in such interest expense,
(1) interest expense attributable to Capitalized Lease Obligations and the
interest expense relating to Attributable Debt,
(2) amortization of debt discount and debt issuance costs,
(3) capitalized interest,
(4) non-cash interest expense,
(5) commissions, discounts and other fees and charges attributable to
letters of credit and bankers' acceptance financing,
(6) interest accruing on any Indebtedness of any other Person to the
extent such Indebtedness is Guaranteed by Splitrock or any Restricted
Subsidiary,
(7) net costs associated with Hedging Obligations (including amortization
of fees),
(8) dividends in respect of all Disqualified Stock of Splitrock and all
Preferred Stock of the Subsidiaries of Splitrock to the extent held by
Persons other than Splitrock or a Wholly Owned Subsidiary,
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(9) interest Incurred in connection with investments in discontinued
operations and
(10) 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 Splitrock) in
connection with Indebtedness Incurred by such plan or trust.
"Consolidated Net Income" means, for any period, the net income of Splitrock
and its Consolidated Subsidiaries for such period; provided, however, that
there shall not be included in such Consolidated Net Income:
(1) any net income or loss of any Person (other than Splitrock) if such
Person is not a Restricted Subsidiary, except that:
(A) subject to the limitations contained in clause (4) below,
Splitrock'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 Splitrock 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 (3) below) and
(B) Splitrock'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;
(2) any net income (or loss) of any Person acquired by Splitrock or a
Subsidiary in a pooling of interests transaction for any period prior
to the date of such acquisition;
(3) 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 Splitrock,
except that:
(A) subject to the limitations contained in clause (4) below,
Splitrock's equity in the net income of any such Restricted
Subsidiary for 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 Splitrock 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) Splitrock's equity in a net loss of any such Restricted Subsidiary
for such period shall be included in determining such Consolidated
Net Income;
(4) any gain (but not loss) realized upon the sale or other disposition of
any asset of Splitrock 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;
(5) any extraordinary gain or loss; and
(6) 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 Splitrock 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.
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"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:
(1) income tax expense of Splitrock and its Consolidated Restricted
Subsidiaries,
(2) Consolidated Interest Expense,
(3) depreciation expense of Splitrock and its Consolidated Restricted
Subsidiaries,
(4) amortization expense of Splitrock and its Consolidated Restricted
Subsidiaries (excluding amortization expense attributable to a prepaid
cash item that was paid in a prior period) and
(5) all other non-cash charges of Splitrock 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 Splitrock 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 Splitrock 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 Splitrock 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 Splitrock
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 Splitrock in an aggregate
principal amount not greater than twice the aggregate amount of the Net Cash
Proceeds received by Splitrock from contributions made to the capital of
Splitrock after the date hereof, provided that such Contribution Indebtedness
. has a Stated Maturity later than the Stated Maturity of the notes,
. is Incurred substantially concurrently with such cash contribution, and
. 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
(1) 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;
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(2) 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
(3) if Splitrock or any Restricted Subsidiary shall have in any manner:
. acquired (through an acquisition or the commencement of activities
constituting such operating business) or
. 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 (1) through (6) 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
. matures or is mandatorily redeemable pursuant to a sinking fund
obligation or otherwise,
. is convertible or exchangeable for Indebtedness or Disqualified Stock or
. 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 Splitrock (other than Disqualified Stock) other than any
sale to a Permitted Holder.
"Escrow Account" means an escrow account for the deposit of approximately
$56.8 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 Splitrock, governing the disbursement of funds from the Escrow
Account.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
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"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 our board of
directors acting in good faith and shall be evidenced by a resolution of our
board of directors 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:
. the opinions and pronouncements of the Accounting Principles Board of
the American Institute of Certified Public Accountants,
. statements and pronouncements of the Financial Accounting Standards
Board,
. such other statements by such other entities as approved by a
significant segment of the accounting profession and
. 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:
(1) 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
(2) 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.
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"Indebtedness" means, with respect to any Person on any date of
determination (without duplication):
(1) the principal of and premium (if any)in respect of indebtedness of such
Person for borrowed money;
(2) the principal of and premium (if any) in respect of obligations of
such Person evidenced by bonds, debentures, notes or other similar
instruments;
(3) all obligations of such Person in respect of letters of credit or
other similar instruments (including reimbursement obligations with
respect thereto);
(4) 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;
(5) Capitalized Lease Obligations and all Attributable Debt of such
Person;
(6) 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);
(7) 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:
. the fair market value of such asset at such date of determination and
. the amount of such Indebtedness of such other Persons;
(8) to the extent not otherwise included in this definition, Hedging
Obligations of such Person; and
(9) all obligations of the type referred to in clauses (1) through (8) 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 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":
(1) "Investment" shall include the portion (proportionate to Splitrock's
equity interest in such Subsidiary) of the fair market value of the net
assets of any Subsidiary of Splitrock at the time that such Subsidiary
is designated an Unrestricted Subsidiary; provided, however, that upon
a redesignation of such Subsidiary as a Restricted Subsidiary,
Splitrock shall be deemed to continue to have a permanent "Investment"
in an Unrestricted Subsidiary in an amount (if positive) equal to:
. Splitrock's "Investment" in such Subsidiary at the time of such
redesignation, less
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. the portion (proportionate to Splitrock'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
(2) 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 our 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
(1) 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;
(2) 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;
(3) 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
(4) 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 Splitrock 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 Splitrock.
"Officers' Certificate" means a certificate signed by two Officers.
"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
Splitrock 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 Splitrock's Capital Stock.
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"Permitted Investment" means an Investment by Splitrock or any Restricted
Subsidiary in:
(1) Splitrock, 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;
(2) 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, Splitrock or a Restricted Subsidiary;
provided, however, that such Person's primary business is a
Telecommunications Business;
(3) Temporary Cash Investments;
(4) receivables owing to Splitrock 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 Splitrock or any such Restricted Subsidiary deems reasonable
under the circumstances;
(5) Investments in prepaid expenses;
(6) loans or advances to employees made in the ordinary course of business
of Splitrock or such Restricted Subsidiary and not exceeding $2.0
million in the aggregate outstanding at any one time;
(7) stock, obligations or securities received in settlement of debts
created in the ordinary course of business and owing to Splitrock or
any Restricted Subsidiary or in satisfaction of judgments;
(8) 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";
(9) Investments made prior to the Closing Date;
(10) Investments in Telecommunications Assets not to exceed $30.0 million
at any onetime outstanding; and
(11) other Investments, not to exceed the greater of:
. 10% of Total Assets of Splitrock 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
. $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;
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(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 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:
. 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
. 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.
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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 Splitrock 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 Splitrock or any Restricted Subsidiary of any Telecommunications Assets of
Splitrock 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
(1) 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,
(2) 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
(3) 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
there from.
"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.
"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 Splitrock or any
Restricted Subsidiary existing on the date of the Indenture or Incurred in
compliance with the Indenture (including Indebtedness of Splitrock that
Refinances Refinancing Indebtedness); provided, however, that:
(1) the Refinancing Indebtedness has a Stated Maturity no earlier than the
Stated Maturity of the Indebtedness being Refinanced,
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(2) 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,
(3) 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
(4) 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:
. Indebtedness of a Restricted Subsidiary that Refinances Indebtedness of
Splitrock or
. Indebtedness of Splitrock or a Restricted Subsidiary that Refinances
Indebtedness of an Unrestricted Subsidiary.
"Restricted Subsidiary" means any Subsidiary of Splitrock other than an
Unrestricted Subsidiary.
"Sale/Leaseback Transaction" means an arrangement relating to property now
owned or hereafter acquired by Splitrock or a Restricted Subsidiary whereby
Splitrock or a Restricted Subsidiary transfers such property to a Person and
Splitrock or such Restricted Subsidiary leases it from such Person, other than
leases between Splitrock and a Wholly Owned Subsidiary or between Wholly Owned
Subsidiaries.
"Secured Indebtedness" means any Indebtedness of Splitrock secured by a
Lien.
"Senior Indebtedness" of Splitrock 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 Splitrock,
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 Splitrock, 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:
(1) any obligation of Splitrock to any Subsidiary,
(2) any liability for Federal, state, local or other taxes owed or owing
by Splitrock,
(3) any accounts payable or other liability to trade creditors arising in
the ordinary course of business (including Guarantees thereof or
instruments evidencing such liabilities),
(4) any Indebtedness or obligation of Splitrock(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
Splitrock, including any Subordinated Obligations,
(5) any obligations with respect to any Capital Stock, or
(6) any Indebtedness Incurred in violation of the Indenture.
"Significant Subsidiary" means any Restricted Subsidiary that would be a
"Significant Subsidiary" of Splitrock 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
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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 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:
. such Person,
. such Person and one or more Subsidiaries of such Person or
. 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:
(1) transmitting, or providing services relating to the transmission of,
data, video or voice through owned or leased transmission facilities,
(2) constructing, creating, developing or marketing networks, related
network transmission equipment, software and other devices for use in
a communication business or
(3) evaluating, participating or pursuing any other activity or
opportunity that is primarily related to those identified in (1) or
(2) above;
provided that the determination of what constitutes a Telecommunications
Business shall be made in good faith by our board of directors.
"Temporary Cash Investments" means any of the following:
(1) 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,
(2) 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),
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(3) repurchase obligations with a term of not more than 30 days for
underlying securities of the types described in clause (1) above
entered into with a bank meeting the qualifications described in
clause (2) above,
(4) investments in commercial paper, maturing not more than 90 days after
the date of acquisition, issued by a corporation (other than an
Affiliate of Splitrock) 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
(5) 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. secs. 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 Splitrock 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.
"Trustee" means the party named as such in the Indenture until a success or
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 (1) any Subsidiary of Splitrock that at the
time of determination shall be designated an Unrestricted Subsidiary by our
board of directors in the manner provided below and (2) any Subsidiary of an
Unrestricted Subsidiary. The Board of Directors may designate any Subsidiary of
Splitrock (including any newly acquired or newly formed Subsidiary of
Splitrock) 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,
Splitrock or any other Subsidiary of Splitrock 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, Splitrock 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
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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:
(1) Splitrock could Incur $1.00 of additional Indebtedness under paragraph
(a) of the covenant described under "-- Certain Covenants -- Limitation
on Indebtedness" and
(2) no Default shall have occurred and be continuing.
Any such designation of a Subsidiary as a Restricted Subsidiary or Unrestricted
Subsidiary by our board of directors shall be evidenced to the Trustee by
promptly filing with the Trustee a copy of the resolution of our 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
on the election of directors, managers or trustees thereof.
"Wholly Owned Subsidiary" means a Restricted Subsidiary of Splitrock all the
Capital Stock of which, other than directors' qualifying shares, is owned by
Splitrock or another Wholly Owned Subsidiary.
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SHARES ELIGIBLE FOR FUTURE SALE
Immediately following this offering and completion of our initial public
offering, there will be 57,169,215 shares of our common stock issued and
outstanding assuming that all of the warrants are exercised. Of these shares,
the 1,487,791 shares of common stock to be sold in this offering and the
9,000,000 shares of common stock to be sold in our initial public offering will
be immediately eligible for sale in the public market, except for warrant
shares owned at any time by our affiliates within the meaning of Rule 144 under
the Securities Act. The remaining 46,681,424 issued and outstanding shares are
restricted securities within the meaning of Rule 144 and may not be publicly
resold, except in compliance with the registration requirements of the
Securities Act or pursuant to an exemption from registration, including that
provided by Rule 144.
Rule 144
In general, under Rule 144, a person, or persons whose shares are
aggregated, who has beneficially owned restricted securities for at least one
year, including a person who may be deemed affiliate, is entitled to sell
within any three month period a number of our shares of common stock that does
not exceed the greater of:
. 1% of the then-outstanding shares of our common stock; or
. the average weekly trading volume of our common stock on the Nasdaq
National Market during the four calendar weeks preceding the date on
which notice of the sale is filed with the Securities and Exchange
Commission.
Sales under Rule 144 are subject to restrictions relating to manner of sale,
notice and the availability of current public information about us. A person
who is not our affiliate at any time during the 90 days preceding a sale and
who has beneficially owned shares for at least two years would be entitled to
sell shares following this offering under Rule 144(k) without regard to the
volume limitations, manner of sale provisions or notice requirements of Rule
144.
Rule 701
Our employees, directors, officers or consultants who purchased our shares
in connection with a written compensatory plan or contract may be entitled to
rely on the resale provisions of Rule 701. Rule 701 permits non-affiliates to
sell their Rule 701 shares without having to comply with the public
information, holding period, volume limitation or notice provisions of Rule
144. Affiliates may sell their Rule 701 shares without having to comply with
Rule 144's holding period restrictions.
Registration Statement on Form S-8
We have filed a registration statement on Form S-8 under the Securities Act
registering the shares of common stock reserved for issuance under our employee
benefit plans. The stock registered under that registration statement will be
available for sale in the public market, subject to the resale limitations of
Rule 144 applicable to our affiliates.
Prior to the date of this prospectus, no public market has existed for our
common stock. We expect that trading of our common stock on the Nasdaq National
Market will commence on the date of the prospectus. We do not make any
prediction regarding the effect, if any, that future sales of shares, or the
availability of our shares for future sale, will have on the market price of
our common stock. The market price of our common stock can be adversely
affected by sales of substantial amounts of common stock or by the perception
that these sales could occur.
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MATERIAL UNITED STATES FEDERAL TAX CONSIDERATIONS
General
The following is a summary of material United States federal income tax
consequences relevant to the acquisition, ownership and disposition of the
notes, the warrants and the warrant shares. This summary does not purport to be
a complete analysis of all potential tax effects that may be relevant to
holders of the notes, warrants or the warrant shares. In particular, it does
not address United States federal income tax consequences relevant to holders
who are not U.S. holders (as defined below) and does not deal with tax
consequences arising under the laws of any foreign, state or local
jurisdiction. This summary is based upon the provisions of the Internal Revenue
Code of 1986, as amended (the "Code"), existing and proposed Treasury
regulations promulgated thereunder, 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.
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 notes, warrants or warrant shares, who acquired
the same for cash and who hold the same as capital assets within the meaning of
Section 1221 of the Code. It does not address the United States federal income
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, warrants, or warrant
shares as a hedge or as a position in a "straddle" for tax purposes). A "U.S.
holder" means a beneficial owner of a note, warrant, or warrant shares that is,
for U.S. federal income tax purposes:
. a citizen or individual resident of the United States;
. a corporation, partnership or other entity created or organized in
or under the laws of the United States or any political subdivision
thereof;
. an estate the income of which is subject to U.S. federal income
taxation regardless of its source; or
. a trust, if, in general, the trust is subject to the supervision of
a court within the Unites States and 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 prospective
investor 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 warrants, or
the warrant shares.
Taxation of the Notes
Payment of Interest and Original Issue Discount. The stated interest
payable on the notes generally will be taxable to a U.S. holder of notes as
ordinary income at the time that it is paid or accrued in accordance with the
U.S. holder's regular 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
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of the stated redemption price at maturity and the number of complete years to
maturity from the issue date. The issue price of the notes was determined by
allocating the "issue price" of the Units between the notes and the warrants
based on their relative fair market values. De minimis OID is recognized as
capital gain upon the redemption, sale or other taxable disposition of the debt
instrument.
Market Discount. A U.S. holder that purchases a note at a purchase price
less than the stated redemption price at maturity will be considered to have
purchased the note at a "market discount" equal to such difference. Market
discount, however, will be considered to be zero if it is less than 0.25% of
the stated redemption price at maturity of the note multiplied by the number of
complete years to maturity remaining after the date of its purchase.
A U.S. holder generally will be required to treat any principal payment
on, or any gain realized on the sale, exchange, retirement or other disposition
of, a note as ordinary income (generally treated as interest income) to the
extent of the market discount which accrued but was not previously included in
income. Unless a U.S. holder irrevocably elects to accrue under a constant-
interest method, market discount accrues ratably and accrued market discount is
the total market discount multiplied by a fraction, the numerator of which is
the number of days the U.S. holder has held the obligation and the denominator
of which is the number of days from the date the U.S. holder acquired the
obligation until its maturity.
In addition, a U.S. holder may be required to defer all or a portion of
its interest deductions for the taxable year attributable to any indebtedness
incurred or continued to purchase or carry a note purchased with market
discount. Any such deferred interest expense would not exceed the market
discount that accrued during such taxable year and, in general, is allowed as a
deduction not later than the year in which such market discount is includible
in income.
A U.S. holder may elect to include market discount in income currently as
it accrues (under either a ratable or constant interest method), in which case
the rules described above regarding the treatment as ordinary income of gain
upon the disposition of a note and upon the receipt of payments of principal
and the deferral of interest deductions will not apply. The election to include
market discount in income currently, once made, applies to all market discount
obligations acquired on or after the first day of the first taxable year to
which the election applies, and may not be revoked without the consent of the
Internal Revenue Service. Under a proposal contained in the President's Fiscal
Year 2000 Budget, a U.S. holder that is an accrual method taxpayer would be
required to include market discount in income as it accrues. The proposal would
be effective for debt instruments acquired on or after the date of enactment.
Subject to various limitations, a U.S. holder may elect to treat all
"interest" that accrues on any note as original issue discount and calculate
the amount includible in gross income under the constant yield method. For this
purpose, "interest" includes stated and unstated interest, OID, de minimis OID,
acquisition discount, market discount and de minimis market discount as
adjusted by any amortizable bond premium or acquisition premium. Such election,
if made with respect to a market discount obligation, will constitute an
election to include market discount in income currently, once made, applies to
all market discount obligations acquired by such U.S. holder on or after the
first day of the first taxable year to which the election applies. The election
is to be made for the taxable year in which the U.S. holder acquired the note
and may not be revoked without the consent of the Internal Revenue Service.
Bond Premium. If a U.S. holder purchases a note for an amount in excess of
the amount payable at maturity of the note, such holder will be considered to
have purchased the note with "bond premium" equal to the excess of the U.S.
holder's purchase price over the amount payable at maturity (or on an earlier
call date if it results in a smaller amortizable bond premium). A U.S. holder
may elect to amortize such premium using a constant yield method over the
remaining term of the note (or until an earlier call date if it results in a
smaller amortizable bond premium). The amortized amount of such premium for a
taxable year generally will be treated first as a reduction of interest on such
note included in such taxable year to the extent thereof, then as a deduction
allowed in that taxable year to the extent of the U.S. holder's prior interest
inclusions on such note,
117
<PAGE>
and finally as a carryforward allowable against the U.S. holder's future
interest inclusions on such note. Such election, once made, is irrevocable
without the consent of the Internal Revenue Service and applies to all taxable
bonds held during the taxable year for which the elections is made or
subsequently acquired.
Sale, Retirement or Other Taxable Disposition. Upon the sale, retirement,
exchange or other disposition of a note, a U.S. holder generally will recognize
taxable gain or loss in an amount equal to the difference, if any, between the
amount of cash and the fair market value of property received with respect to
such sale, retirement, exchange or other disposition and such holder's adjusted
tax basis in the note. A U.S. holder's adjusted tax basis in a note generally
will be equal to the purchase price of such note, increased by the amount of
market discount previously included in the U.S. holder's gross income, and
reduced by the amount of any amortizable bond premium applied to reduce, or
allowed as a deduction against, interest with respect to such note. Gain or
loss recognized by a U.S. holder on the sale, retirement, exchange or other
disposition of a note generally will be capital gain or loss except with
respect to amounts received upon a disposition attributable to accrued but
unpaid interest or accrued market discount not previously included in income,
which in either case will be taxable as ordinary income. Such capital gain or
loss will be long-term capital gain or loss if the note has been held for more
than one year at the time of the disposition.
Information Reporting and Backup Withholding. The backup withholding and
information reporting requirements may apply to payments of principal and
interest on a note and to 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 U.S. 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 U.S. 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 Splitrock 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 Splitrock 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 U.S. holder may be claimed as a credit against such holder's United States
federal income tax liability.
Effect of Change of Control. Upon a Change of Control, each U.S. holder
will have the right to require Splitrock 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 Treasury regulations, a provision such as the Change of Control
redemption requirement will not affect the 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.
Taxation of the Warrants
Characterization of Warrants. Although the matter is not free from doubt,
and the form of the warrants may be respected for federal income tax purposes,
it is possible that the warrants would be treated for federal income tax
purposes as common stock due to, among other things, the nominal Exercise Price
and lack of any meaningful contingency. Although the matter is thus not free
from doubt, the following discussion assumes that the warrants would be
properly characterized as warrants and describes, as appropriate, any differing
federal income tax treatment that would result if the warrants are treated as
stock.
118
<PAGE>
Exercise. A U.S. holder of a warrant generally will not recognize gain or
loss upon exercise of the warrant. The U.S. holder's federal income tax basis
in the common stock received will be equal to the holder's federal income tax
basis in the warrant immediately prior to exercise (the cost of the warrant),
plus the amount of cash paid upon exercise. The holding period of the common
stock acquired upon exercise of the warrant will begin on the day after the
date of exercise of the warrant and will not include the period during which
the warrant was held. If the warrants are treated as stock from the date of
issuance, the holder would not recognize any gain or loss on the exercise of
the warrants, and the holding period of the stock received would include the
entire period during which the warrant was held.
Adjustments. An adjustment to the exercise price of the warrants made
pursuant to the antidilution provisions of the warrants may, in some
circumstances, result in constructive distributions to U.S. holders of the
warrants which could be taxable as dividends to such holders under Section 305
of the Code. A U.S. holder's federal income tax basis in the warrants generally
would be increased by the amount of any such dividend. The consequences of such
adjustment generally should not differ if the warrants are recharacterized as
stock on the date of issuance.
Disposition. Upon a sale, exchange or other taxable disposition of a
warrant or a share of common stock received upon exercise of a warrant, a
holder generally will recognize gain or loss for federal income tax purposes in
an amount equal to the difference between (i) the sum of the amount of cash and
fair market value of any property received upon such sale exchange or
disposition and (ii) the holder's adjusted tax basis in the warrant or common
stock. Such gain or loss would be long-term capital gain or loss if the warrant
or stock was held by the holder for more than one year at the time of sale or
exchange. The consequences of a sale or disposition to the holder should not
differ (except potentially as to holding periods, see "--Exercise") if the
warrants are recharacterized as stock on the day they are issued.
Lapse. Upon the lapse of a warrant, a holder will recognize a capital loss
equal to such holder's adjusted tax basis in the warrant. If the warrants are
treated as stock on the date of issuance and are never exercised, the treatment
of such warrants generally should not differ.
119
<PAGE>
LEGAL MATTERS
The validity of the shares of common stock, notes and warrants offered by
this prospectus has been passed upon for us by Winstead, Secrest & Minick,
P.C., Houston, Texas.
EXPERTS
The financial statements as of December 31, 1998 and 1997 and for the year
ended December 31, 1998 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.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 under the Securities Act of 1933 with respect to the
securities offered by this prospectus. This prospectus does not contain all of
the information set forth in the registration statement and its exhibits and
schedules. Particular items are omitted in accordance with the rules and
regulations of the Securities and Exchange Commission. For further information
about our company and the securities offered by this prospectus, we refer you
to the registration statement, including its exhibits and schedules. You may
read and copy the registration statement at the Securities and Exchange
Commission's following locations:
<TABLE>
<S> <C> <C>
Public Reference Room New York Regional Office Chicago Regional Office
Room 1024 Seven World Trade Center Citicorp Center
450 Fifth Street, N.W. Suite 1300 500 West Madison Street
Washington, DC 20549 New York, NY 10048 Suite 1400
Chicago, IL 60661-2511
</TABLE>
You may also obtain copies of the registration statement by mail from the
Public Reference Section of the Securities and Exchange Commission at 450 Fifth
Street, N.W., Judiciary Plaza, Washington, D.C. 20549 or by telephone at 1-800-
SEC-0330. The registration statement is also available to the public from
commercial document retrieval services and at the Securities and Exchange
Commission's World Wide Web site located at http://www.sec.gov. Upon approval
of our common stock for quotation on The Nasdaq Stock Market's National Market,
you will be able to read our filings with the Securities and Exchange
Commission at the office of Nasdaq Operations, 1734 K Street, N.W. Washington,
DC 20006.
Statements in this prospectus as to the contents of any contract or other
document are not necessarily complete, and in each instance we refer you to the
full text of such contract or document filed as an exhibit to the registration
statement, each such statement being qualified in all respects by such
reference.
We intend to furnish our stockholders with annual reports containing
financial statements audited by an independent public accounting firm and make
available to our stockholders quarterly reports for the first three quarters of
each fiscal year containing interim unaudited financial information.
120
<PAGE>
SPLITROCK SERVICES, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Financial Statements:
Report of Independent Accountants....................................... F-2
Balance Sheets as of December 31, 1997 and 1998 and June 30, 1999
(unaudited)............................................................ F-3
Statements of Operations and Comprehensive Loss for the Period from
Inception (March 5, 1997) Through December 31, 1997, the year ended
December 31, 1998 and the six months ended June 30, 1998 and 1999
(unaudited)............................................................ F-4
Statements of Stockholders' Equity (Deficit) for the Period from
Inception (March 5, 1997) Through December 31, 1998 and the six months
ended June 30, 1999 (unaudited)........................................ F-5
Statements of Cash Flows for the Period from Inception (March 5, 1997)
Through December 31, 1997, the year ended December 31, 1998 and the six
months ended June 30, 1998 and 1999 (unaudited)........................ F-6
Notes to Financial Statements........................................... F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Splitrock Services, Inc.
In our opinion, the accompanying balance sheets and the related statements of
operations and comprehensive loss, of cash flows and of changes in
stockholders' equity, present fairly, in all material respects, the financial
position of Splitrock Services, Inc. at December 31, 1997 and 1998, and the
results of its operations and its cash flows for the period from inception
(March 5, 1997) to December 31, 1997 and the year ended December 31, 1998, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for the
opinion expressed above.
PricewaterhouseCoopers LLP
Houston, Texas
March 24, 1999, except as to Note 12 which is as of July 12, 1999.
F-2
<PAGE>
SPLITROCK SERVICES, INC.
BALANCE SHEETS
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
December 31,
------------------ June 30,
1997 1998 1999
-------- -------- -----------
(unaudited)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.................... $ 7,710 $ 28,330 $ 8,327
Unrestricted investments--short term......... -- 120,475 56,166
Restricted investments--short term........... 3,472 39,476 21,597
Accounts receivable, net of $0, $537 and
$459, respectively.......................... 4,252 3,205 3,919
Prepaid expenses and other current assets.... 221 480 948
-------- -------- ---------
Total current assets....................... 15,655 191,966 90,957
Property and equipment, net.................... 38,504 73,899 88,721
Restricted investments--long term.............. -- 19,001 23,243
Other assets, net.............................. 229 11,275 29,808
-------- -------- ---------
$ 54,388 $296,141 $ 232,729
======== ======== =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current maturities of capital lease
obligations................................. $ 11,010 $ 9,121 $ 9,088
Accounts payable............................. 3,086 21,582 11,533
Accrued interest payable..................... -- 13,375 14,141
Accrued liabilities and other current
liabilities................................. 5,775 15,894 18,211
-------- -------- ---------
Total current liabilities.................. 19,871 59,972 52,973
Senior notes payable ($261,000 face value net
of $2,783 and $2,702 unamortized discount,
respectively (Note 5))........................ -- 258,217 258,298
Capital lease obligations...................... 13,110 8,243 3,383
Note payable to stockholder.................... 1,000 -- --
-------- -------- ---------
Total liabilities.......................... 33,981 326,432 314,654
Commitments and contingencies (Note 7)
Stockholders' equity (deficit):
Preferred stock, $.001 par value, 25,000,000
shares authorized, no shares issued......... -- -- --
Common stock, $.001 par value, 150,000,000
shares authorized, 43,238,400, 46,624,845,
and 46,681,424 shares issued and outstanding
as of December 31, 1997, 1998, and June 30,
1999, respectively.......................... 43 47 47
Additional paid-in capital................... 30,485 34,717 34,831
Common stock warrants........................ -- 2,849 2,849
Accumulated other comprehensive income
(loss)...................................... -- 47 (335)
Accumulated deficit.......................... (10,121) (67,951) (119,317)
-------- -------- ---------
Total stockholders' equity (deficit)....... 20,407 (30,291) (81,925)
-------- -------- ---------
$ 54,388 $296,141 $ 232,729
======== ======== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
SPLITROCK SERVICES, INC.
STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
Period from
Inception Six Months Six Months
(March 5, 1997) to Year Ended Ended Ended
December 31, 1997) December 31, 1998 June 30, 1998 June 30, 1999
------------------ ----------------- ------------- -------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenue................. $ 22,708 $ 63,611 $ 32,214 $ 34,241
Operating expenses:
Splitrock network
costs................ 2,362 32,912 10,724 34,150
Legacy network costs.. 25,804 58,292 27,111 21,871
Selling, general and
administrative....... 1,276 6,390 2,441 6,338
Depreciation and
amortization......... 3,500 13,850 4,907 11,237
---------- ---------- ---------- ----------
32,942 111,444 45,183 73,596
---------- ---------- ---------- ----------
Loss from operations.... (10,234) (47,833) (12,969) (39,355)
Other income (expense):
Interest income....... 348 5,393 183 4,335
Interest expense...... (235) (15,390) (842) (16,346)
---------- ---------- ---------- ----------
Loss before income
taxes.................. (10,121) (57,830) (13,628) (51,366)
Provision for income
taxes.................. -- -- -- --
---------- ---------- ---------- ----------
Net loss................ (10,121) (57,830) (13,628) (51,366)
Other comprehensive
income (loss):
Unrealized gain (loss)
on securities........ -- 47 -- (382)
---------- ---------- ---------- ----------
Comprehensive loss...... $ (10,121) $ (57,783) $ (13,628) $ (51,748)
========== ========== ========== ==========
Net loss per share--
basic and diluted...... $ (0.42) $ (1.30) $ (0.31) $ (1.10)
========== ========== ========== ==========
Weighted average
shares--basic and
diluted................ 24,109,823 44,388,948 43,288,168 46,668,728
========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
SPLITROCK SERVICES, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Period From Inception (March 5, 1997) Through June 30, 1999
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
Common Stock Accumulated
---------------- Additional Common Other
Par Paid-in Stock Comprehensive Accumulated
Shares Value Capital Warrants Income Deficit Total
---------- ----- ---------- -------- ------------- ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Initial capitalization.. 15,764,000 $16 $12 -- -- -- $ 28
Issuances of Common
Stock for cash of
$1.11 per share and
warrant............... 18,466,400 18 $20,482 -- -- -- 20,500
Conversion of note
payable to Common
Stock at $1.11 per
share................. 9,008,000 9 9,991 -- -- -- 10,000
Net loss............... -- -- -- -- -- $ (10,121) (10,121)
---------- --- ------- ------ ----- --------- --------
Balance at December 31,
1997................... 43,238,400 43 30,485 -- -- (10,121) 20,407
Unrealized gain on
securities............ -- -- -- -- $ 47 -- 47
Issuance of warrants to
purchase 1,487,791
shares of Common Stock
in connection with
Senior Notes (Note
5).................... -- -- -- $2,849 -- -- 2,849
Exercise of stock
options and Warrant... 3,386,445 4 4,232 -- -- -- 4,236
Net loss............... -- -- -- -- -- (57,830) (57,830)
---------- --- ------- ------ ----- --------- --------
Balance at December 31,
1998................... 46,624,845 $47 $34,717 $2,849 $ 47 $ (67,951) $(30,291)
Net loss (unaudited)... -- -- -- -- -- (51,366) (51,366)
Unrealized loss on
securities
(unaudited)........... -- -- -- -- (382) -- (382)
Exercise of stock
options (unaudited)... 56,579 -- 114 -- -- -- 114
---------- --- ------- ------ ----- --------- --------
Balance at June 30, 1999
(unaudited)............ 46,681,424 $47 $34,831 $2,849 $(335) $(119,317) $(81,925)
========== === ======= ====== ===== ========= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
SPLITROCK SERVICES, INC.
STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Period from
Inception (March Six Months Six Months
5, 1997) through Year Ended Ended Ended
December 31, 1997 December 31, 1998 June 30, 1998 June 30, 1999
----------------- ----------------- ------------- -------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Cash flows from
operating activities:
Net loss............... $(10,121) $(57,830) $(13,628) $(51,366)
Adjustments to
reconcile net loss to
net cash used by
operating activities:
Depreciation and
amortization.......... 3,500 13,850 4,907 11,237
Amortization of debt
discount and deferred
financing costs....... -- 467 -- 554
Changes in assets and
liabilities:
(Increase) decrease in
accounts receivable,
net................... (4,252) 1,047 (1,986) (714)
(Increase) decrease in
prepaid and other
current assets........ (221) (259) (199) (468)
Increase (decrease) in
accounts payable and
accrued liabilities... 8,861 28,615 7,194 (7,732)
Increase (decrease) in
accrued interest
payable............... -- 13,375 -- 766
-------- -------- -------- --------
Net cash used in
operating activities.. (2,233) (735) (3,712) (47,723)
-------- -------- -------- --------
Cash flows from
investing activities:
Purchase of equipment.. (16,969) (45,261) (5,548) (25,311)
Increase in
unrestricted
investments........... -- (119,462) -- --
Use of unrestricted
investments........... -- -- -- 64,255
Use of restricted
investments........... -- -- -- 13,309
Reinvestment of
interest earned on
unrestricted
investments........... -- (966) -- --
Reinvestment of
interest earned on
restricted
investments........... -- (1,725) -- --
Increase in other
assets................ (229) (2,098) (2,166) (19,189)
-------- -------- -------- --------
Net cash used by
investing activities.. (17,198) (169,512) (7,714) 33,064
-------- -------- -------- --------
Cash flows from
financing activities:
Proceeds from senior
notes payable and
warrants issued....... -- 261,000 -- --
Proceeds from notes
payable to
stockholder........... 11,750 10,000 10,000 --
Repayments of notes
payable to
stockholder........... (750) (11,000) -- --
Proceeds from notes
payable............... -- 1,477 1,477 --
Repayments of notes
payable............... -- (1,477) -- --
Financing costs
incurred.............. -- (9,501) (424) (565)
Restriction of cash
under senior note
agreement............. -- (56,752) -- --
Sale of common stock
and exercise of stock
options and warrant... 20,528 4,236 1,100 114
Proceeds from sale-
leaseback of
equipment............. 1,152 960 440 --
Principal payments on
capital lease
obligations........... (2,067) (11,548) (7,172) (4,893)
Restriction of cash
under credit
agreement............. (3,472) 3,472 3,472 --
-------- -------- -------- --------
Net cash provided by
financing activities.. 27,141 190,867 8,893 (5,344)
-------- -------- -------- --------
Increase (decrease) in
cash and cash
equivalents............ 7,710 20,620 (2,533) (20,003)
Cash and cash
equivalents:
Beginning of period.... -- 7,710 7,710 28,330
-------- -------- -------- --------
End of period.......... $ 7,710 $ 28,330 $ 5,177 $ 8,327
======== ======== ======== ========
Supplemental cash flow
information:
Cash paid for
interest.............. $ 235 $ 1,536 $ 631 $ 15,025
======== ======== ======== ========
Approximately $18,400
of the increase in
accounts payable and
accrued liabilities at
December 31, 1998, was
related to equipment
purchases.............
Noncash investing and
financing activities:
Assumption of capital
lease obligations and
other liabilities
(Note 2).............. $ 5,900 $ -- $ -- $ --
======== ======== ======== ========
Capital lease
obligations incurred.. $ 20,916 $ 4,792 $ 4,055 $ --
======== ======== ======== ========
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>
SPLITROCK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS
(amounts in thousands, except share and per share amounts)
1. Organization and Summary of Significant Accounting Policies
Splitrock Services, Inc. (the "Company") was formed on March 5, 1997 as a
Texas corporation and was 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. 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. 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 began building its "ATM-to-the-Edge"(TM) network.
The Company expects to have approximately 370 points of presence operational in
the United States upon completion of its network build by the end of 1999. This
network is currently supported by two network operating centers equipped with
state-of-the-art network management systems. In July 1998 the Company issued
Senior Notes (Note 5) in order to finance the expansion of the network. Upon
completion of the network build, the Company expects to offer value-added data,
video and voice products to business customers.
Interim Financial Information. The accompanying unaudited interim condensed
financial statements, as of June 30, 1999, and for the six months ended June
30, 1999 and 1998, reflect all adjustments (consisting of normal recurring
adjustments) which, in the opinion of management, are necessary for a fair
presentation of the results for the interim periods presented. Accordingly,
they do not include all information and notes required by generally accepted
accounting principles for complete financial statements. The results for the
interim period ended June 30, 1999, are not necessarily indicative of results
to be expected for the entire year ending December 31, 1999, or future
operating results. Certain amounts previously reported have been reclassified
in order to ensure comparability among the periods reported.
The following is a summary of the Company's significant accounting policies:
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.
Cash and Cash Equivalents and Investments. 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. Cash and cash
equivalents are stated at cost, which approximates fair value.
Short-term investments have original maturities of more than three months
and a remaining maturity of less than one year at the date of purchase. At
December 31, 1998, cash equivalents and short-term investments consisted
primarily of money market funds and securities of the highest grade. All short-
term investments have been classified as available for sale under the
provisions of Statement of Financial Accounting Standards No. ("SFAS") 115,
Accounting for Certain Investments in Debt and Equity Securities, and have
various maturity dates which do not exceed one year. Available for sale
securities are carried at fair value, with the unrealized gains and losses, net
of tax, reported as a separate component of stockholders' equity. The cost of
investments sold is determined on the specific identification or the first-in,
first-out method.
F-7
<PAGE>
SPLITROCK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The following is a summary of the investments classified as restricted and
unrestricted as of December 31, 1998:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
Available for sale securities:
Money market funds.............. $ 23,557 $-- $ -- $ 23,557
Corporate notes................. 108,496 3 (80) 108,419
Municipal securities............ 12,061 -- (6) 12,055
U.S. Treasury notes............. 34,791 181 (51) 34,921
-------- ---- ----- --------
$178,905 $184 $(137) $178,952
======== ==== ===== ========
</TABLE>
The following is a summary of the investments classified as restricted and
unrestricted as of June 30, 1999 (unaudited):
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
Available for sale securities:
Money market funds.............. $ 491 $-- $ -- $ 491
Corporate notes................. 56,325 -- (159) 56,166
U.S. Treasury notes............. 44,525 -- (176) 44,349
-------- ---- ----- --------
$101,341 $-- $(335) $101,006
======== ==== ===== ========
</TABLE>
The restricted investment at December 31, 1997 was a three-month time
deposit held as collateral on a letter of credit. In the first quarter of 1998,
the letter of credit was retired with the Company's exercise of its early
purchase option with regard to the related capital lease. The restricted
investments at December 31, 1998 and June 30, 1999 relate to funds held in
escrow to pay future semi-annual interest payments due under the terms of the
Senior Note obligation (Note 5).
Concentration of Credit Risk. Financial instruments which potentially
subject the Company to concentration of credit risk are primarily cash and cash
equivalents, investments 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
balances for the periods ended December 31, 1997 and 1998, were derived
primarily from services provided to Prodigy, the Company's major customer
during the periods. Any interruption of this relationship could adversely
affect the Company. Management believes that the risk of incurring material
losses related to credit risk is remote.
Fair Values of Financial Instruments. Due to the short-term nature of the
Company's financial instruments, management believes the carrying values of the
Company's assets, short-term liabilities and lease obligations approximate
their fair values. The fair value of the Company's Senior Notes (Note 5) at
December 31, 1998 and June 30, 1999, approximated $227,000 and $244,035,
respectively, based upon quoted market prices.
Property and Equipment. Property and equipment are stated at cost.
Depreciation and amortization of telecommunications network equipment,
including assets under capital leases, is provided when placed into service
using the straight-line method over the estimated useful lives of three years
from the date of installation. Shelters are depreciated using the straight-line
method over its estimated useful life of twenty
F-8
<PAGE>
SPLITROCK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
years. Software, furniture, fixtures and office equipment is depreciated using
the straight-line method over the useful lives of the assets, which range from
three to ten years. Equipment acquired from Prodigy is depreciated over its
estimated useful life of nine months to three years.
Other Assets. Other assets consist primarily of deposits, debt issuance
costs, and other intangible assets such as capitalized circuit charges and
trademarks. Debt issuance costs are amortized using the effective interest rate
method. All other assets, except for deposits, are amortized by use of the
straight-line method over their estimated lives, which are generally two to
five years. At December 31, 1998 and June 30, 1999, debt issuance costs, net of
accumulated amortizations were $9,027 and $9,188 (unaudited). At June 30, 1999
deposits were $12,044 (unaudited--see Note 11).
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, 1998.
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 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 with the
exception of enacted changes in the tax law or rates.
Stock-Based Compensation. The Company has adopted SFAS No. 123, Accounting
for Stock-Based Compensation, for disclosure purposes. Under SFAS No. 123, the
Company measures compensation expense for its stock-based employee compensation
plan using the intrinsic value method prescribed in Accounting Principles Board
("APB") No. 25, Accounting for Stock Issued to Employees. The Company provides
disclosure of the effect on net loss as if the fair value-based method
prescribed in SFAS No. 123 has been applied in measuring compensation expense.
Revenue Recognition. The Company recognizes revenue when services are
provided and collectibility is deemed probable under its agreement with the
customer. Prodigy was the Company's only customer through December 31, 1997 and
the Company's major customer thereafter (99% of revenue) through December 31,
1998 and 93% of the revenue for the six months ended June 30, 1999 (unaudited).
Legacy Network Costs. Legacy network costs contain all expenses incurred in
connection with operating and decommissioning legacy networks. These costs
primarily refer to the operations related 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 deployed (Note 2). This includes facility fees, line charges
for legacy network POPs, certain personnel costs, occupancy costs, equipment
maintenance costs and access fees for the IBM Global Services Network.
Comprehensive Income. Effective January 1, 1998, the Company adopted SFAS
No. 130, Reporting Comprehensive Income, as displayed in its Statements of
Operations for all periods presented. This SFAS establishes standards for
reporting and display of comprehensive income and its components. The Company's
comprehensive income is comprised of net loss and unrealized gains and losses
on available for sale securities.
Net Loss Per Share. Basic and diluted net loss per share have been computed
in accordance with SFAS No. 128, Earnings Per Share. SFAS No. 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
F-9
<PAGE>
SPLITROCK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
common shares outstanding. At December 31, 1997, options to acquire 1,058,440
shares of Common Stock at the weighted-average exercise price of $1.11 and a
warrant to purchase 2,815,000 shares of Common Stock at $1.11 and at December
31, 1998, options to acquire 1,801,882 shares of Common Stock at the weighted-
average exercise price of $2.31 and warrants to acquire 1,487,791 shares of
Common Stock at an exercise price of $0.02 were not included in the computation
of diluted earnings per share because their effect is anti-dilutive. At June
30, 1998, options to acquire 1,351,482 shares of Common Stock at the weighted-
average exercise price of $1.11 and a warrant to acquire 2,815,000 shares of
Common Stock at an exercise price of $1.11 were not included in the computation
of diluted earnings per share because their effect is anti-dilutive. At June
30, 1999, options to acquire 2,896,128 shares of Common Stock at the weighted
average exercise price of $5.10 and warrants to acquire 1,487,791 shares of
Common Stock at an exercise price of $0.02, were not included in the
computation of diluted earnings per share because their effect is anti-dilutive
(unaudited).
Segment Reporting. The Company conducts its business within one industry
segment. The Company presents its financial statements to reflect how the "key
operating decision maker" views the business and has made the appropriate
enterprise-wide disclosures in accordance with SFAS No. 131, Disclosures About
Segments of an Enterprise and Related Information.
New Accounting Pronouncements. In June 1998, the Financial Accounting
Standards Board ("FASB") issued SFAS No. 133 Accounting for Derivative
Instruments and Hedging Activities ("SFAS No. 133"), which is effective for
fiscal years beginning after June 15, 1999, and establishing accounting and
reporting standards for derivative instruments. In June 1999, the FASB issued
SFAS No. 137, which deferred the effective date of SFAS No. 133 to June 15,
2000. The Company has historically not engaged in derivative instrument
activity. The adoption of this standard is not expected to have a material
effect on the Company's financial position or results of operations.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 98-1, Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use. This standard
requires that certain costs related to the development or purchase of internal-
use software be capitalized and amortized over the estimated useful life of the
software. This SOP also requires that costs related to the preliminary project
stage, data conversion and the post-implementation/operation stage of an
internal-use computer software development project be expensed as incurred. SOP
98-1 is effective for financial statements issued for fiscal years beginning
after December 15, 1998. The adoption of this Statement did not have a material
effect on the Company's financial position or results of operations.
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 the lower of a price per
hour of usage or a price per subscriber as stipulated. Monthly minimum service
charges under this contract have increased from $3,500 to $4,000 and will
increase to $4,500 on July 1, 2000. Monthly maximum service charges are based
on average usage per subscriber and the number of subscribers. Prodigy may
terminate the Full Service Agreement without termination charges in an event of
default by the Company; such defaults include documented failures (without
cure) to meet certain network performance standards. The agreement also allows
Prodigy to terminate its arrangement with the Company at any time upon the
payment of a termination charge.
The Company also entered into a transition 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
infrastructure support 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 included in Legacy Network costs. The
Company assumed no
F-10
<PAGE>
SPLITROCK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
contractual liabilities of any services related to Prodigy's existing network
infrastructure as part of the transition agreement.
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.
3. Property and Equipment
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
December 31,
---------------- June 30,
1997 1998 1999
------- ------- -----------
(unaudited)
<S> <C> <C> <C>
Telecommunications network equipment and
shelters.................................... $ 3,464 $43,275 $68,776
Software..................................... 94 2,186 4,123
Furniture, fixtures and office equipment..... -- 1,749 2,193
Telecommunications network equipment under
construction................................ 12,248 13,289 10,599
------- ------- -------
15,806 60,499 85,691
Less--accumulated depreciation............... (103) (10,392) (16,658)
------- ------- -------
Purchased property and equipment, net...... 15,703 50,107 69,033
------- ------- -------
Leased telecommunications network equipment.. 13,648 29,102 29,102
Leased office equipment...................... 388 1,496 1,496
Leased telecommunications network equipment
under construction.......................... 12,162 -- --
------- ------- -------
26,198 30,598 30,598
Less--accumulated amortization............... (3,397) (6,806) (10,910)
------- ------- -------
Leased property and equipment, net......... 22,801 23,792 19,688
------- ------- -------
Property and equipment, net.................. $38,504 $73,899 $88,721
======= ======= =======
4. Accrued Liabilities
Accrued liabilities consisted of the following:
<CAPTION>
December 31,
---------------- June 30,
1997 1998 1999
------- ------- -----------
(unaudited)
<S> <C> <C> <C>
Telecommunications network equipment and
shelters.................................... $ -- $ 9,900 $ 7,901
Access and transmission telecommunications
line costs (Note 7)......................... 41 3,172 3,181
Other........................................ 5,734 2,822 7,129
------- ------- -------
Accrued liabilities........................ $ 5,775 $15,894 $18,211
======= ======= =======
</TABLE>
F-11
<PAGE>
SPLITROCK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
5. Indebtedness
The components of indebtedness are summarized as follows:
<TABLE>
<CAPTION>
December 31,
----------------- June 30,
1997 1998 1999
------- -------- -----------
(unaudited)
<S> <C> <C> <C>
Senior Notes.................................. $ -- $258,217 $258,298
Capital lease obligations..................... 24,120 17,364 12,471
Note payable to stockholder................... 1,000 -- --
------- -------- --------
25,120 275,581 270,769
Less--current maturities...................... (11,010) (9,121) (9,088)
------- -------- --------
$14,110 $266,460 $261,681
======= ======== ========
</TABLE>
On July 24, 1998, the Company sold 261,000 units consisting of $261,000
principal amount of 11 3/4% Senior Notes due 2008 ("Senior Notes") and warrants
to purchase 1,487,791 shares of common stock ("the Senior Notes Offering").
Upon issuance, the Senior Notes were recorded in the Company's financial
statements net of a $2,849 discount. The discount was attributable to the
Company's estimate of the value of the warrants based on an independent third
party valuation. The discount is amortized as a component of interest expense
over the life of the Senior Notes using the effective interest rate method.
This amortization will result in an increase in the financial statement balance
of the Senior Notes to a $261,000 face value by 2008.
Upon the occurrence of a change of control (as defined in the Indenture for
the Senior Notes) the Company will be required to make an offer to repurchase
all Senior Notes properly tendered at a price equal to 101% of the principal
amount plus accrued and unpaid interest to the date of repurchase. The
indenture also provides for redemption of the Senior Notes at any time, in
whole or in part, on or after July 15, 2003 at a premium through July 15, 2005.
In addition, on or prior to July 15, 2001, the Company may redeem up to 35% of
the original aggregate principal amount of the Senior Notes at a premium with
the proceeds of one or more equity offerings.
The Senior Note indenture also restricts the Company's ability to incur
additional indebtedness, to create liens or other encumbrances, to make certain
payments, investments, loans and guarantees and to sell or otherwise dispose of
a substantial portion of assets to, or merge or consolidate with, an
unaffiliated entity.
In connection with the Senior Notes Offering, the Company repaid $1,477
outstanding under a credit facility and refinanced $11,000 of indebtedness owed
to Linsang Partners L.L.C. ("Linsang"), a stockholder of the Company. In
connection with the refinancing, Linsang acquired 11,000 units in the Senior
Notes Offering. The net proceeds to the Company, after the Senior Notes
Offering expenses and retirement and refinancing of debt, approximated
$239,000.
In November 1998, the Senior Notes were exchanged in an offering registered
under the Securities Act of 1933 for $261,000 in principal amount of Series B
Senior Notes, which have substantially the same terms as the Senior Notes,
except that there is no restriction on transferability.
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 Linsang. The unsecured
note had a stated rate of interest of 9.75% and provided for monthly interest
payments beginning February 1, 1998, with the principal due on demand after
December 31, 1998, and maturing December 31, 2002. During 1998, the Company
F-12
<PAGE>
SPLITROCK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
borrowed $10,000 from Linsang on terms substantially the same as the previous
note. The Linsang notes were refinanced in July 1998, in connection with the
Senior Notes Offering, as stated above.
6. Income Taxes
A provision for income taxes for the periods ended December 31, 1997 and
1998 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 net deferred tax asset.
Deferred tax assets (liabilities) consist of the following:
<TABLE>
<CAPTION>
December 31,
-----------------
1997 1998
------- --------
<S> <C> <C>
Net operating loss carryforward........................... $ 3,248 $ 22,465
Depreciation.............................................. 167 3,325
Other..................................................... 21 429
------- --------
Deferred tax assets..................................... 3,436 26,219
------- --------
Leases.................................................... -- (474)
------- --------
Deferred tax liabilities................................ -- (474)
------- --------
Net deferred tax assets................................... 3,436 25,745
Valuation allowance....................................... (3,436) (25,745)
------- --------
Net deferred tax assets................................... $ -- $ --
======= ========
</TABLE>
The Company's net operating loss carryforward totaled approximately $59,000
at December 31, 1998 ($110,000 at June 30, 1999--unaudited), of which
approximately $9,500 expires in 2012 and the remainder expires in 2018. Certain
changes in ownership of the Company could result in limitations on the
Company's ability to utilize the losses.
7. Commitments and Contingencies
The Company leases office space, equipment facilities and equipment under
noncancelable operating and capital leases expiring through the year 2003. Rent
expense for noncancelable operating leases amounted to $218 in 1997 and $663 in
1998.
Future minimum payments by year and in the aggregate related to
noncancelable operating and capital leases at December 31, 1998 are:
<TABLE>
<CAPTION>
Capital Operating
Leases Leases Total
------- --------- -------
<S> <C> <C> <C>
1999............................................ $10,576 $1,049 $11,625
2000............................................ 7,101 903 8,004
2001............................................ 746 801 1,547
2002............................................ 37 422 459
2003............................................ -- 265 265
------- ------ -------
Total minimum lease payments.................. 18,460 $3,440 $21,900
====== =======
Less amount representing interest............. (1,096)
-------
Present value of minimum capital lease
payments....................................... $17,364
=======
</TABLE>
F-13
<PAGE>
SPLITROCK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
In March 1999, the Company signed a lease for sixty-nine thousand square
feet of additional office space, which the Company expects to be available for
occupancy in August 1999. In connection with this lease, the Company issued a
$850 letter of credit.
The Company leases telephone lines from competitive local exchange
suppliers, interexchange carriers and long distance telephone companies
primarily for access and transport purposes ("line costs"). These line costs
are leased under both cancelable and noncancelable operating leases over
periods ranging from month-to-month to five years and are included in Splitrock
network costs on the statement of operations. The Company has commitments to
certain of these telecommunication vendors to meet minimum usage volumes.
Additionally, the Company is subject to cancellation penalties which could
become applicable upon termination of a number of these agreements. The
cancellation penalties typically require a payment of a percentage of the
remaining amounts due under the contract, depending on the year in which
cancellation may occur.
Line costs included in the Splitrock network costs were $547 and $22,617
during the period from inception (March 5, 1997) to December 31, 1997 and the
year ended December 31, 1998, respectively. Line costs incurred during the
period from inception (March 5, 1997) to December 31, 1997 and the year ended
December 31, 1998, comprise a substantial portion of the Legacy network costs.
The Company is in the process of resolving certain issues related to the
collection and remittance of certain taxes. The Company believes resolution of
these issues will not have a material adverse effect on the Company's financial
condition or results of operations.
The Company had an outstanding letter of credit in the amount of $3,472 as
of December 31, 1997. This letter of credit was maintained as security for
performance under a certain capital lease obligation and was retired in the
first quarter of 1998 with the Company's exercise of its early purchase option
on the related capital lease.
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 approximately $1,300. As of
December 31, 1998, the Company has incurred approximately $700 of such amount
in connection with this agreement.
8. Equity Transactions
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 these financial
statements have been adjusted to reflect the effect of the stock splits.
Warrants issued in connection with the Company's Senior Note Offering are
exercisable at $.02 per share at any time on or after July 26, 1999 through
July 15, 2008 for 1,487,791 shares of Common Stock.
9. Stock Options
The Company's 1997 Incentive Share Plan (the "Plan") provides that options
to purchase up to 11,260,000 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
estimated fair market value at the date of grant which has been determined by
the Board of Directors for periodic intervals based upon actual issuances of
shares in exchange for cash, third party appraisals and significant events
effecting the value of the Company. 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 in the Plan.
F-14
<PAGE>
SPLITROCK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The following summarizes the activity for the Plan:
<TABLE>
<CAPTION>
1997 1998 June 30, 1999
------------------ ------------------ ------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- -------- --------- -------- --------- --------
(unaudited)
<S> <C> <C> <C> <C> <C> <C>
Options outstanding at
beginning of fiscal pe-
riod................... -- -- 1,058,440 $1.11 1,801,882 $2.31
Granted............... 1,058,440 $1.11 1,443,251 $2.97 1,201,214 $8.61
Exercised............. -- -- 571,445 $1.94 56,579 $1.88
Canceled.............. -- -- 128,364 $1.49 50,389 $3.38
--------- --------- ---------
Options outstanding at
end of period.......... 1,058,440 $1.11 1,801,882 $2.31 2,896,128 $5.10
</TABLE>
The following table summarizes information about the Company's stock options
outstanding at December 31, 1998:
<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 1998 Life (Years) Price 1998 Price
-------- ------------ ------------ -------- ------------ --------
<S> <C> <C> <C> <C> <C>
$1.11.............. 1,193,842 8.71 $1.11 446,670 $1.11
$1.95.............. 197,050 9.37 $1.95 704 $1.95
$5.95.............. 410,990 9.75 $5.95 -- $ --
--------- -------
$1.11--$5.95....... 1,801,882 9.02 $2.31 447,374 $1.11
</TABLE>
In October 1996, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation," which allows the Company to account for its employee stock-based
compensation plans under APB No. 25 and the related interpretations. According
to APB No. 25, deferred compensation is recorded for stock-based compensation
grants based on the excess of the market value of the common stock on the
measurement date over the exercise price. The deferred compensation is
amortized over the vesting period of each unit of stock-based compensation
grant. If the exercise of the stock-based compensation grants is equal to the
market price of the Company's stock on the date of grant, no compensation
expense is recorded.
During the year ended December 31, 1998, the Company recognized compensation
expense of $46 for options granted at a discount from the then estimated fair
market value of the Company's Common Stock.
F-15
<PAGE>
SPLITROCK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Had compensation cost for the Company's stock option plan been determined
based on the estimated fair market value at the grant date, consistent with the
provisions of SFAS No. 123, the Company's pro forma net loss would have been as
follows:
<TABLE>
<CAPTION>
Pro forma
Period from
Inception
(March 5,
1997) Pro forma
through Year ended
December 31, December 31,
1997 1998
------------ ------------
<S> <C> <C>
Net loss........................................... $(10,141) $(58,254)
Net loss per share--basic and diluted.............. (0.42) (1.31)
</TABLE>
Options granted in 1997 and 1998 had weighted-average fair values of $0.14
and $1.78, respectively. For purposes of estimating the fair value of options
granted, the Company used no future dividends, used average U.S. government
security interest rates for its risk-free interest rates of 5.80% and 4.39%,
assumed no volatility and 70.5% volatility, and assumed expected life of the
options of five and four years in 1997 and 1998, respectively.
10. Related Party Transactions
The Company's chairman of the Board of Directors (the "Chairman") was also
the Vice Chairman and a director of Yurie Systems, Inc. ("Yurie"), a principal
supplier of the Company until its acquisition by Lucent Technologies. The
Company purchased from Yurie approximately $11,000 in equipment through
December 31, 1997 and approximately $1,400 during the year ended December 31,
1998.
The Company also retained Yurie to perform assembly services related to the
deployment of network equipment to the field during 1997. The Company incurred
approximately $1,500 for these services of which approximately $990 were
expensed in 1997. As of December 31, 1997 and 1998, the Company owed $1,461 and
$0 to Yurie, respectively.
Linsang, an affiliate of the Chairman, loaned $1,000 to the Company for the
purchase of certain network equipment in December 31, 1997. During 1998, the
affiliate made further advances of $10,000 under this agreement. The unsecured
notes had a stated rate of interest of 9.75% and provided for monthly interest
payments beginning February 1, 1998, with the principal due on demand after
December 31, 1998, and maturing December 31, 2002. The Notes were refinanced in
July 1998, in connection with the Senior Notes Offering (Note 5).
A director of the Company exercised an option to purchase 563,000 shares of
the Company Common Stock for $1,100 in June 1998.
In September 1997, Orient Star Holdings, a wholly-owned subsidiary of Carso
Global Telecom, S.A. de C.V. (the controlling stockholder of Prodigy),
purchased 11,260,000 shares of the Company for $1.11 per share and paid $0.10,
for a warrant to purchase an additional 2,815,000 shares of the Company through
September 18, 1998 for $1.11 per share. The warrants were exercised in
September 1998 (Note 8).
11. Subsequent Event (Unaudited)
In April 1999, the Company entered into a cost sharing agreement with a
national telecommunications provider (the Provider). The agreement grants the
Company an exclusive indefeasible right of use (IRU) in 4
F-16
<PAGE>
SPLITROCK SERVICES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
dark fibers in the nationwide fiber optic communication system currently under
construction by the Provider with an option to acquire the indefeasible rights
to use an additional 12 dark fibers. The Company made an initial payment of
$11,200 to the Provider and is required to make additional payments as dark
fiber segments are accepted, which is expected to occur from the end of 1999
through the first quarter of 2001. The Company expects to incur approximately
$150,000 in capital expenditures over the next three years related to its
current network fiber optic deployment plans, including the electronic
equipment necessary to operate its fiber optic network. The Company may
terminate the agreement prior to October 31, 1999, under certain circumstances,
but the Company would forfeit up to 80% of its initial payment to the Provider
if it exercises that termination right.
12. Subsequent Event--Reverse Stock Split
All share and per share amounts included in these financial statements have
been retroactively adjusted to give effect to the 0.563-for-1 reverse stock
split of the Common Stock of the Company effected on July 12, 1999.
F-17
<PAGE>
GLOSSARY OF TERMS
Set forth below are definitions of some of the technical terms used in this
prospectus.
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.................... 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.
competitive local exchange
carrier...................... A category of telephone service provider that
offers services similar to the former monopoly
local telephone company and other types of
telecommunications.
dark fiber................... Fiber which does not have connected to it the
electronics required to transmit data on that
fiber.
DSL.......................... A Digital Subscriber line. A high-speed data
delivery technology that uses standard copper
wires and is the main broadband alternative to
cable modems.
DS-3 or T-3.................. A data communications line capable of
transmitting data at 45 Mbps
Ethernet..................... A local area network 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.
incumbent local exchange
carrier...................... The local carrier exchange that was the
monopoly carrier, prior to the opening of local
exchange services to competition.
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.
G-1
<PAGE>
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.
Internet service
providers................... Companies formed to provide access to the
Internet to consumers and business customers
via local networks.
interexchange carrier....... A telecommunications company that provides
telecommunications services between local
exchanges on an interstate or intrastate basis.
IRUs........................ Indefeasible rights of use in network bandwidth
capacity.
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.
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.
local exchange carrier...... A telecommunications company that provides
telecommunications services in a geographic
area in which calls generally are transmitted
without toll charges. Local exchange carriers
include both regional Bell operating companies
and competitive local exchange carriers.
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
telephone circuit.
network..................... A collection of distributed computers which
share data and information through inter-
connected lines of communication.
OC-3........................ A high capacity optical data communications
line capable of transmitting data at 155 Mbps.
OC-48....................... A high capacity optical data communications
line capable of transmitting data at 2488 Mbps.
peering..................... The commercial practice under which nationwide
Internet service providers 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.
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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.
regional Bell operating
company...................... One of the local exchange carriers created by
the divestiture of the local exchange business
by AT&T. These include BellSouth, Bell
Atlantic, Ameritech, US West, SBC, and PacTel.
route mile................... One mile of actual geographic length of the
high capacity telecommunications fiber route.
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.
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.
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.
virtual private network...... A network providing secure transmission of IP
traffic through the Internet.
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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