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Filed pursuant to Rule 424(b)(3) under
the Securities Act of 1933, as
amended, in relation to Registration
Statement No. 333-91469
PATHNET TELECOMMUNICATIONS, INC.
SENIOR GUARANTEES OF PATHNET, INC. 12 1/4% SENIOR NOTES DUE 2008
[PATHNET LOGO]
Pathnet Telecommunications, Inc. is offering to all holders of Pathnet, Inc.'s
12 1/4% Senior Notes due 2008 our absolute, irrevocable and unconditional senior
guarantees of those notes. Concurrent with our offer, Pathnet, Inc. is seeking
consents from the holders of those notes to the waiver and amendment of certain
provisions of the indenture governing those notes. Pathnet, Inc. is seeking
these consents in connection with a contribution and reorganization transaction
in which Pathnet, Inc. will become our wholly owned subsidiary. In addition to
our guarantees, each holder of the notes on the record date who consents to the
requested waivers and amendments in connection with our reorganization will
receive a consent fee payment of $25.00 per $1,000 in face amount of notes owned
of record by the consenting holder on the record date. Pathnet, Inc. is also
agreeing to purchase and pledge for the benefit of the holders of the notes,
additional United States Treasury securities sufficient to cover the October 16,
2000 interest payment on the notes. Pathnet, Inc. has conditioned its payment of
the consent fee and pledge of additional securities upon the receipt of the
requisite consents to approve the requested waivers and amendments.
PUBLIC OFFERING PRICE: None
PROCEEDS TO PATHNET TELECOM: None
THIS INVESTMENT INVOLVES SUBSTANTIAL RISK. SEE "RISK FACTORS" BEGINNING ON PAGE
7 TO READ ABOUT CERTAIN FACTORS YOU SHOULD CONSIDER BEFORE INVESTING IN THE
SECURITIES.
------------------------------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED THESE SECURITIES OR DETERMINED WHETHER
THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The date of this prospectus is March 14, 2000.
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TABLE OF CONTENTS
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PAGE
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PROSPECTUS SUMMARY.......................................... 1
RISK FACTORS................................................ 7
USE OF PROCEEDS............................................. 26
CAPITALIZATION.............................................. 27
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA.......... 29
BUSINESS.................................................... 31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................. 51
MANAGEMENT.................................................. 60
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............. 73
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................ 77
DESCRIPTION OF OUR REORGANIZATION........................... 80
THE PATHNET SENIOR NOTEHOLDER WAIVERS AND OTHER PROPOSED
INDENTURE AMENDMENTS...................................... 91
DESCRIPTION OF THE GUARANTEES............................... 105
DESCRIPTION OF THE CONSENT SOLICITATION PROCESS............. 106
DESCRIPTION OF THE NOTES AND THE INDENTURE.................. 109
DESCRIPTION OF OTHER INDEBTEDNESS AND OTHER FINANCING
ARRANGEMENTS.............................................. 143
DESCRIPTION OF CAPITAL STOCK................................ 145
FEDERAL INCOME TAX CONSEQUENCES............................. 151
PLAN OF DISTRIBUTION........................................ 156
LEGAL MATTERS............................................... 156
EXPERTS..................................................... 156
WHERE YOU CAN FIND MORE INFORMATION......................... 156
INDEX TO FINANCIAL STATEMENTS............................... F-1
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PROSPECTUS SUMMARY
This summary highlights information that we believe is especially important
concerning our business, the offering of our guarantees and Pathnet's noteholder
consent solicitation. As a summary, it does not contain all of the information
that you should consider before accepting our guarantees and granting your
consent to the requested waivers and amendments to the Indenture that we
describe in this prospectus. Please read the entire prospectus carefully. Except
as otherwise required by the context, references in this prospectus to "Pathnet
Telecom," "we," "us," or "our" refer to Pathnet Telecommunications, Inc., and
references to "Pathnet" refer to Pathnet, Inc. only.
OVERVIEW
We are Pathnet Telecommunications, Inc., a newly formed Delaware
corporation and the issuer of the guarantees in this offering. We are offering
to all holders of Pathnet's 12 1/4% senior notes due 2008 our absolute,
unconditional and continuing guarantee of Pathnet's performance and compliance
with its obligations under the indenture that governs the terms of those notes,
including Pathnet's obligations to make interest and principal payments on the
notes. Concurrent with our offer, Pathnet is seeking consents from the
noteholders to the waiver and amendment of certain provisions of the indenture.
OUR REORGANIZATION
Pathnet is seeking your consent to these waivers and amendments in
connection with a single plan of contribution and reorganization in which:
- the existing shareholders of Pathnet will exchange their shares of
Pathnet's common stock and series A, B and C convertible preferred stock
solely in return for substantially similar shares of our common stock and
our series A, B, and C convertible preferred stock;
- Pathnet will become our wholly owned subsidiary;
- three new investors in the Pathnet business -- The Burlington Northern
and Santa Fe Railway Company, CSX Transportation, Inc. and Colonial
Pipeline Company -- will contribute to us rights of way to permit us to
build our telecommunications network along their existing railroad and
pipeline corridors, with an estimated value of $187 million in return for
an aggregate of 8,511,607 shares of our series D convertible preferred
stock;
- Colonial will also contribute -- in two separate tranches -- an aggregate
of $68 million in cash in return for:
- an aggregate of 2,867,546 shares of our series E convertible preferred
stock at a price of $21.97 per share;
- an option, exercisable by Colonial and certain of Colonial's affiliates,
to purchase up to 1,593,082 shares of our series E convertible preferred
stock at a price of $21.97 per share;
- an option to purchase a number of shares of our common stock equal to up
to 10% of the number of shares that we actually issue in an underwritten
initial public offering, at a price equal to 90% of the per share price
that we charge for the sale of the shares in our initial public
offering; and
- a single fiber optic conduit along a portion of the Colonial right of
way corridors or other telecommunications assets of equivalent value;
- Pathnet will lend to us $50 million of the proceeds remaining from
Pathnet's initial equity investments and the issue of its notes; and
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- Pathnet will sell to us, for a $70 million promissory note, three fiber
optic development contracts, related assets, other agreements and the
rights to use Pathnet's name and other intellectual property as well as
fiber assets currently held by Pathnet's subsidiary, Pathnet Fiber
Optics, LLC.
Following the conclusion of our reorganization, our beneficial ownership
will be allocated among the participants in our reorganization as set forth in
the following table. For purposes of determining the beneficial ownership of our
voting capital stock following the completion of our reorganization, we assume
in the table:
- Colonial's purchase of the second tranche of shares of our series E
preferred stock and the conversion of those shares into shares of our
common stock;
- except for the Colonial option to purchase shares of our common stock in
connection with our initial public offering, the exercise of all options
to purchase shares of our common stock;
- the exercise of the Colonial option to purchase additional shares of our
series E convertible preferred stock and the conversion of all of our
series of preferred stock into our common stock; and
- the conversion of all outstanding warrants to purchase shares of Pathnet
common stock into warrants to purchase shares of our common stock and the
full exercise of those warrants.
Because we cannot at this time determine the precise number of our shares
that are covered by Colonial's option to purchase our common stock prior to our
initial public offering, we have not assumed the exercise of that option in our
determination of beneficial ownership interests in the table.
<TABLE>
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BENEFICIAL OWNERSHIP OF
CATEGORY OF EQUITY HOLDER OUR VOTING STOCK
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Holders of existing shares of Pathnet series A, B and C
preferred stock........................................... 44.4%
Holders of existing shares of Pathnet common stock (assuming
the conversion and exercise in full of all existing
warrants and options for Pathnet common stock into shares
of our common stock)...................................... 19.2%
The Burlington Northern and Santa Fe Railway Company........ 9.6%
Colonial Pipeline Company and affiliates.................... 17.2%
CSX Transportation, Inc. ................................... 9.6%
------
Total................................................... 100.0%
======
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CONSENT SOLICITATION FOR PATHNET NOTEHOLDER WAIVERS AND OTHER INDENTURE
AMENDMENTS
The structure of our proposed reorganization requires Pathnet to obtain
waivers and consents from the holders of a majority in principal amount of
Pathnet's notes. In consideration for the required consents:
- we are offering our guarantees for all of the notes;
- Pathnet will make a consent payment of $25 per $1,000 in face amount of
the notes to each of the consenting noteholders who held notes on the
record date of the consent solicitation; and
- Pathnet will purchase and pledge as additional security to the indenture
trustee, for the benefit of the noteholders, additional United States
Treasury securities sufficient to cover the October 16, 2000 interest
payment on the notes.
To consent to the transaction, the noteholders will need to:
- waive Pathnet's compliance, for purposes of the transaction, with the
"Change of Control" repurchase obligation and the "Excess Proceeds Offer"
requirements of the indenture, which otherwise would be triggered by the
closing of the transaction; and
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- agree to the adoption of amendments to the terms of the indenture that
are intended to subject us to indenture covenants parallel to those
currently applicable to Pathnet and extend the scope of indenture tests
and covenants to us and any of our future subsidiaries.
The amendments will permit transactions between Pathnet, us and our other
future subsidiaries to the same extent that the indenture now permits those
transactions between Pathnet and its subsidiaries. We describe specific
amendments of the terms of the indenture below in "THE PATHNET SENIOR NOTEHOLDER
WAIVERS AND OTHER PROPOSED INDENTURE AMENDMENTS".
TAX MATTERS
Pathnet has obtained an opinion from Covington & Burling regarding the
material federal income tax consequences to you and to Pathnet if the proposed
indenture amendments are approved, the waivers are obtained and Pathnet makes
the consent payment. You may be subject to federal income taxation as a
consequence of the proposed indenture amendments, the waivers and the consent
payment, and Pathnet may incur substantial federal income taxes as a consequence
of the proposed indenture amendments, the waivers and the consent payment.
Covington has advised Pathnet that, due to the lack of specific guidance and
inherently factual nature of the issues involved, Covington is unable to opine
definitively on the consequences of the proposed indenture amendments, the
waivers and the consent payment. For a description of the potential tax
consequences of the proposed indenture amendments, the waivers and the consent
payment, see "FEDERAL INCOME TAX CONSEQUENCES."
THE CONSENT SOLICITATION AND THIS OFFERING WILL END ON MARCH 27, 2000,
UNLESS EXTENDED. IF WE HAVE NOT RECEIVED BEFORE THE EXPIRATION DATE THE
REQUISITE CONSENTS FROM THE HOLDERS OF A MAJORITY IN OUTSTANDING PRINCIPAL
AMOUNT OF THE NOTES, OUR OFFER OF THE GUARANTEES WILL TERMINATE AND OUR
REORGANIZATION WILL NOT TAKE PLACE AS PLANNED.
OUR COMPANY
We were formed on November 1, 1999, in order to give effect to our
reorganization and become Pathnet's parent company. Pathnet was formed on August
25, 1995. Since inception, Pathnet has operated as a development stage
enterprise, and its operations have resulted in cumulative net losses of $101.5
million through December 31, 1999. Together, we are a wholesale
telecommunications provider building a nationwide network designed to provide
other wholesale and retail telecommunications service providers with access to
underserved and second and third tier markets throughout the United States.
We plan to serve those second and third tier markets with
telecommunications network backbone infrastructure products and services, long
distance network services and local access services. We also expect to capture a
portion of the long distance network services segment between first tier
markets. We estimate that our addressable market for these products and services
was $13 billion in 1999, growing to $27 billion in 2004.
As of December 31, 1999, our network consisted of over 6,300 wireless route
miles, providing wholesale transport services to 30 cities, and 500 route miles
of installed fiber. We are constructing an additional 600 route miles of fiber
optic network scheduled for completion in the first half of 2000. We have also
entered into two co-development agreements for the construction of an additional
750 route miles of fiber optic network. We expect to develop more backbone
network from a pool of over 12,000 route miles of right of way -- 8,000 of which
will have some form of exclusivity -- that we will receive from our new
investors in our reorganization.
Our network will enable our customers, including existing local telephone
companies, long distance companies, Internet service providers, competitive
telecommunications companies, cellular operators and other telecommunications
service providers to offer additional services to new and existing customers in
these markets without having to expend their own resources to build, expand or
upgrade their networks. We expect our nationwide network to grow to
approximately 20,000 route
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miles using both fiber optic and wireless microwave technologies. We intend to
continue to develop our backbone on a "smart build" basis by prioritizing route
development along corridors with high demand for inactive fiber optic strands
and conduit or by partnering with established companies in the joint development
of those routes.
This prospectus contains the trademark of Pathnet, which is the property of
Pathnet and is licensed to us.
Our principal executive office is located at 1015 31st Street, N.W.,
Washington, D.C. 20007, and our telephone number is (202) 625-7284.
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SUMMARY CONSOLIDATED FINANCIAL DATA
We present below summary historical consolidated financial data for Pathnet
and the pro forma balance sheet data for Pathnet Telecom. The summary historical
statements of operations data for the years ended December 31, 1997, 1998 and
1999 and the period from August 25, 1995 (the date of Pathnet's inception) to
December 31, 1999 and the summary historical balance sheet data as of December
31, 1999 have been derived from Pathnet's audited financial statements that are
included elsewhere in this prospectus. The unaudited pro forma balance sheet
data as of December 31, 1999 gives effect to our reorganization as if it
occurred on January 1, 1999. We have provided the unaudited pro forma balance
sheet data for informational purposes only.
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PATHNET
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PERIOD FROM
AUGUST 25, 1995
(DATE OF
YEAR ENDED DECEMBER 31, INCEPTION) TO
----------------------------------------- DECEMBER 31,
1997 1998 1999 1999
----------- ------------ ------------ ---------------
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STATEMENTS OF OPERATIONS DATA:
Revenue................................ $ 162,500 $ 1,583,539 $ 3,311,096 $ 5,058,135
Operating loss......................... (4,131,243) (16,312,761) (31,280,939) (53,495,700)
Net loss............................... $(3,977,400) $(36,296,596) $(59,036,312) $(101,480,769)
Basic and diluted loss per common
share................................ $ (1.37) $ (12.51) $ (20.14)
Weighted average number of common
shares outstanding................... 2,900,000 2,902,029 2,931,644
OTHER FINANCIAL DATA:
Ratio of earnings to fixed charges..... <1 <1 <1
Deficiency of earnings to fixed
charges.............................. $(3,977,400) $(36,658,917) $(62,626,459)
</TABLE>
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December 31,
----------------------------
1999
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HISTORICAL PRO FORMA (a)
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(unaudited)
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BALANCE SHEET DATA:
Cash, cash equivalents and marketable securities (excluding
marketable securities pledged as collateral) (b).......... $138,402,131 $170,448,726
Property and equipment, net................................. 131,928,365 131,928,365
Intangible assets -- rights of way.......................... -- 187,275,006
Total assets................................................ 320,535,987 547,188,488
Long-term obligations (c)................................... 349,714,404 353,989,404
Total liabilities........................................... 380,303,073 383,749,675
Redeemable preferred stock.................................. 35,969,639 37,871,959
Stockholders' equity (deficit) (d).......................... (95,736,725) 125,566,854
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(a) Our unaudited pro forma balance sheet data as of December 31, 1999 gives
effect to our reorganization as if it occurred on January 1, 1999. The
unaudited pro forma balance sheet was derived by adjusting Pathnet's
historical balance sheet as of December 31, 1999 to reflect the transaction
described below:
- Contribution of over 12,000 route miles of rights of way with an
estimated value of $187 million for 8,511,607 shares of our series D
preferred stock;
- Receipt of $38 million in cash at the initial closing for 1,729,631
shares of our series E preferred stock. Another $25 million in cash
(which is excluded from our above pro forma balance sheet data) will be
received in exchange for 1,137,915 shares of our series E preferred stock
(conditioned upon the completion of a fiber optic network segment build
that we expect to complete during the second calendar quarter of 2000);
- Exchange of 2,977,593 shares of outstanding Pathnet common stock for
2,977,593 shares of our common stock;
- Exchange of 5,470,595 shares of Pathnet mandatorily redeemable preferred
stock into 15,864,715 shares of our convertible preferred stock;
- Receipt of $1 million in cash for options to purchase 1,593,082 shares of
our series E preferred stock at $21.97 per share and shares of our common
stock at the time of an initial public offering;
- Receipt of $4 million in cash for our sale to Colonial of rights in a
specified number of conduit miles of our future network;
- Receipt of $275,000 in rights of way for our sale to CSX of rights a
specified number of conduit miles of our future network; and
- Payment by Pathnet of the proposed 2.5% consent fee to consenting holders
of the notes (assuming all noteholders provide their consent) of
approximately $8.8 million.
See "DESCRIPTION OF OUR REORGANIZATION" included elsewhere in this
prospectus.
(b) Cash, cash equivalents and marketable securities include investments in
marketable securities available for sale.
(c) Long term obligations include other noncurrent liabilities of $3,092,779.
(d) We have not included unaudited pro forma statement of operations information
to give effect to our reorganization as if it occurred on January 1, 1999.
An unaudited pro forma statement of operations would reflect only
amortization expense of approximately $939,000 of deferred financing cost
attributable to the consent fee that we plan to pay in connection with our
reorganization and approximately $2,878,000 of anticipated transaction
costs, of which $2,398,000 will be expensed as incurred and the remainder
offset against the carrying value of the series D and series E preferred
stock. The deferred financing cost will be amortized and charged to interest
expense over the remaining life of the notes. Generally, we do not begin
amortizing rights of way used in our network until the network is completed
and available for use. As of December 31, 1999, none of the rights of way
contemplated by our reorganization were used in our fiber optic network.
Because the amortization of the deferred financing cost and expensed
transaction costs would have represented the only pro forma adjustments to
the statement of operations data, we have not presented unaudited pro forma
statement of operations data. Instead, we have adjusted our pro forma
stockholders' equity (deficit) to account for these expenses.
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RISK FACTORS
Pathnet Telecom is a new business venture that plans to build on the
existing Pathnet business following the closing of our reorganization. As such,
we will face all of the risks currently faced by Pathnet, as well as a variety
of new risks associated with the expansion of the existing Pathnet business.
You should consider carefully the risk factors described below, in addition
to the other information in this prospectus, before you decide to accept our
guarantees and grant your consent to the requested waivers and amendments to the
indenture necessary to authorize our reorganization. If any of the risks
described below materializes and we are unsuccessful in managing or addressing
the risk, there could be a material adverse effect on our business, financial
condition or results of operations. We cannot assure you that we will
successfully manage or address these risks.
RISKS RELATING TO OUR COMPANY OPERATIONS
IF WE ARE UNABLE TO DEVELOP THE RIGHTS OF WAY THAT WE WILL RECEIVE IN OUR
REORGANIZATION, OR IF THE DEVELOPMENT COSTS MORE OR TAKES LONGER THAN WE
ANTICIPATE, WE MAY NOT BE ABLE TO DEVELOP ALL PORTIONS OF OUR NETWORK OR
GENERATE THE REVENUES NECESSARY TO BECOME PROFITABLE.
Several factors could interfere with our ability to develop or even prevent
us from developing the rights of way or portions of those rights of way that are
the subject of our reorganization:
- our inability to obtain property rights from third parties where BNSF,
CSX and Colonial do not own outright much of the property over which they
are granting us rights of way;
- restrictions imposed by BNSF, CSX, and Colonial to minimize or prevent
interference with their primary business operations;
- physical or engineering restrictions;
- terms of existing contractual arrangements between BNSF, CSX or Colonial
and third parties, including our competitors; and
- competitive factors, including potential oversupply of communications
capacity along the segments that we wish to develop.
We cannot assure you that we will obtain the necessary property rights and
access to the segments that we wish to develop. If we fail to obtain these
rights, we may not be able to develop these rights of way for our network, and
our business plans would be impaired. In addition, we cannot predict with
certainty the costs of developing segments of our network on these rights of
way. These costs could be significantly higher than we anticipate and may be
prohibitively expensive.
IF WE ARE UNABLE TO COMPLETE CONSTRUCTION OF THE NETWORK ROUTE SEGMENT ON WHICH
COLONIAL HAS CONDITIONED THE $25 MILLION SECOND TRANCHE OF ITS INVESTMENT IN OUR
SERIES E PREFERRED STOCK, WE MAY NOT RECEIVE THOSE FUNDS FROM COLONIAL AS
PLANNED.
Our contribution agreement with Colonial requires us to complete the
buildout of our network along a route from Chicago, Illinois to Aurora (a suburb
of Denver), Colorado as a condition to our receiving the second tranche of the
Colonial investment. If we are unsuccessful in building this portion of the
network, we will not receive $25 million of the funds that we expect to receive
from Colonial in our reorganization. The loss of these funds could hinder our
ability to implement our business plan.
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WE HAVE AGREED TO INDEMNIFY BNSF, CSX AND COLONIAL FROM CERTAIN LOSSES AND
LIABILITIES IN DEPLOYING AND OPERATING OUR NETWORK, AND THESE LOSSES AND
LIABILITIES COULD BE SIGNIFICANT.
In the agreements by which we obtain our rights of way, we have agreed to
release and indemnify BNSF, CSX and Colonial from claims, losses or liabilities
resulting from damage to property, personal injury to personnel, and many other
circumstances while we construct and operate our network. In some cases, our
release and indemnity apply even to circumstances outside of our control,
including where the claim, loss or liability arises from the negligence or gross
negligence of BNSF, CSX, Colonial or their employees or contractors within their
control. While we intend to obtain insurance to address these issues, we cannot
ensure that insurance coverage will be available or, if it is available,
adequate to cover all of these risks. If our insurance coverage is inadequate,
or if coverage is not available for some of these risks, we could be exposed to
significant losses and liabilities.
OUR TELECOMMUNICATIONS NETWORK WILL BE CONSTRUCTED ON RIGHTS OF WAY USED FOR
RAILROAD AND PIPELINE PURPOSES AND COULD BE DAMAGED OR DELAYED BY OTHER BUSINESS
OPERATIONS CONDUCTED ALONG THOSE RIGHTS OF WAY.
BNSF, CSX and Colonial use the rights of way on which we intend to install
our telecommunications network for railroad and pipeline purposes. Events could
occur, including the derailment of a train, the breach of a pipeline or damage
resulting from track or pipeline maintenance or construction, that could
interrupt telecommunications services on or otherwise damage our network. If any
of those events occur, our ability to provide telecommunications services to our
customers could be compromised, and our relationship with those customers could
be seriously damaged.
IF WE CANNOT SUCCESSFULLY COORDINATE OUR NETWORK CONSTRUCTION AND OPERATIONS
WITH OUR RIGHTS OF WAY PROVIDERS' EXISTING OPERATIONS, WE MAY NOT BE ABLE TO
DEVELOP OR OPERATE OUR NETWORK AS PLANNED AND OUR REVENUES COULD BE MATERIALLY
IMPAIRED.
The lease and access agreements we will enter into with BNSF, Colonial, CSX
and our other rights of way providers require that we coordinate our network
design, construction, deployment, operation and maintenance with the rail,
pipeline, utility and other operations of the applicable rights of way
providers. Those agreements generally provide that the rights of many providers'
operational needs take precedence over our own in terms of scheduling, access
time, personnel and other rights. Scheduling conflicts could increase our
development or operational costs on particular segments of rights of way, or
make deployment along the affected segment commercially impracticable. If we
cannot coordinate these activities successfully with the rights of way
providers, the development, design, construction, deployment, operation and
maintenance of the affected segments of our network could be delayed or become
prohibitively expensive.
WE ARE UNDERTAKING A MAJOR EXPANSION OF THE BUSINESS PREVIOUSLY CONDUCTED BY
PATHNET AND WE MAY NOT BE ABLE TO MANAGE THIS EXPANSION EFFECTIVELY GIVEN OUR
LIMITED PAST OPERATING EXPERIENCE.
Pathnet was incorporated in August 1995 and is a development stage company
with only a limited operational history. As of December 31, 1999, Pathnet had
constructed approximately 6,300 wireless route miles and 500 fiber route miles
of our digital network. Pathnet had also completed 40 separate
installations -- often referred to as physical collocations -- of our
telecommunications network equipment at existing local telephone company
switching stations, often referred to as central offices. To achieve our
business plan, we will need to expand our fiber network substantially and at a
much faster rate than in prior years.
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The success of this expansion will depend upon, among other things, our
ability effectively to:
- implement our sales and marketing strategy;
- evaluate markets for our products and services;
- acquire additional rights of way;
- identify profitable network routes;
- secure additional financing for our network deployment;
- reach agreement with a sufficient number of appropriate co-development
partners to develop the network necessary to complete our business plan;
- install facilities;
- obtain required government authorizations;
- interconnect to, and collocate with, facilities owned by existing local
telephone companies; and
- obtain appropriately priced individual network service features such as
call switching and local subscriber line access, which are often referred
to in the industry as "unbundled network elements" and wholesale services
from existing local telephone companies.
We must accomplish these activities in a timely manner, at reasonable cost
and on satisfactory terms and conditions. As we increase our product and service
offerings and expand our network into our targeted markets, there will be
additional demands on operating support systems, sales and marketing,
administrative resources and network infrastructure. We cannot assure you that
we will be able to manage our growth successfully, and if we are unsuccessful in
doing so, our business, results of operations and financial condition will be
negatively affected. Moreover, because we are expanding our business plan into
new markets and technologies not previously used by Pathnet, we may not be able
to identify and manage all of the material risks that may arise as we pursue
this new business plan.
DEVELOPING AND EXPANDING OUR BUSINESS MAY SUBJECT US TO ADDED MARKET AND
REGULATORY RISKS.
The rights of way acquired in connection with our reorganization may
significantly expand our business, making us more vulnerable to competition from
major telecommunications companies and more likely to become the subject of
regulatory scrutiny. Increased competition or regulatory burdens could interfere
with our ability to capitalize on the expansion of our business.
OUR BUSINESS PLANS REQUIRE US TO MAKE SIGNIFICANT INVESTMENTS IN A RAPIDLY
EVOLVING INDUSTRY AND OUR BUSINESS AND FINANCIAL PERFORMANCE MAY SUFFER IF
MARKET AND TECHNOLOGICAL DEVELOPMENTS RENDER OUR CHOSEN TECHNOLOGIES AND
STRATEGIES OBSOLETE OR UNRESPONSIVE TO MARKET DEMAND.
Our business strategy is to provide an integrated bundle of
telecommunications services and expand our operations and network. To implement
this strategy we will be investing heavily in a rapidly evolving industry. As a
result, our investments will be subject to a variety of risks in addition to
those described in the other "risk factors" set forth in this prospectus. These
additional risks include:
- market pricing pressures for the services and products we offer;
- changes in expenses associated with the construction and expansion of our
network and services;
- operating and technical problems;
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- availability of alternative technologies; and
- variations in market growth rates for our products and services.
These factors could adversely affect our business strategies by increasing
the cost and difficulty of implementing our business plans, or making it more
difficult for us to generate adequate revenues.
WE MAY BE UNABLE TO HIRE AND RETAIN SUFFICIENT QUALIFIED PERSONNEL, AND THE LOSS
OF ANY OF OUR KEY EMPLOYEES COULD MATERIALLY ADVERSELY AFFECT OUR ABILITY TO
CONSTRUCT OUR NETWORK, CONDUCT OUR NETWORK OPERATIONS AND IMPLEMENT OUR SALES
STRATEGY.
Our products and services are technical in nature, and the market for
employees in the telecommunications industry is competitive and dynamic. As a
result, our future success will depend in large part on our ability to attract
and retain a substantial number of highly skilled, knowledgeable, sophisticated
and qualified managerial, professional and technical personnel. Pathnet has
experienced, and we expect to experience, significant and increasing competition
from other companies in attracting and retaining personnel who possess the
skills that we are seeking. We therefore may be unable to attract and retain
senior management, other key employees, or other skilled personnel in the
future. We depend on these employees to implement our business plan and manage
our planned growth successfully, and losing key employees could have a material
adverse effect on our ability to implement the essential components of our
business plan.
THE LOSS OR INTERRUPTION OF RELATIONSHIPS WITH OR SERVICES FROM KEY SUPPLIERS OR
THIRD PARTY CONTRACTORS COULD DELAY AND INCREASE COSTS ASSOCIATED WITH THE
CONSTRUCTION OF OUR NETWORK.
We depend on third party suppliers for a number of components and parts
used in our network. We may be unable to obtain supplies or services from our
usual suppliers for reasons beyond our control. Although there may be
alternative suppliers of components for all of the components and transmission
equipment contained in our network or required to offer our products and
services, those alternatives may not be available to us on as favorable terms.
Any nationwide shortage, or extended delay or other interruption in the supply
of any of the key components, change in the pricing arrangements with our
suppliers and manufacturers or delay in transitioning a replacement supplier's
product into the network could disrupt our operations.
We also use third party contractors to build various segments of our
network. If any of these relationships is terminated or a supplier or contractor
fails to provide reliable services or equipment, and we are unable to reach
suitable alternative arrangements quickly or on favorable terms, we may
experience significant delays and additional costs. The failure of our
contractors to complete their activities in a timely manner, within anticipated
budgets and in accordance with our quality standards and performance criteria,
could also delay the completion of our network or make it more costly to
construct.
OUR FAILURE TO IDENTIFY, DEPLOY AND MAINTAIN SOPHISTICATED BILLING, CUSTOMER
SERVICE AND INFORMATION SYSTEMS COULD HAVE A NEGATIVE EFFECT ON OUR PRODUCT AND
SERVICE OFFERINGS, CUSTOMER RELATIONS AND REVENUES.
We will depend on sophisticated information and processing systems to grow,
monitor costs, bill customers, service customer orders and achieve operating
efficiencies. As we expand our services and increase our customer base, our need
for enhanced billing and information systems will increase. If we are unable to
adequately identify our information and processing needs or develop or upgrade
systems as necessary, we may not be able to offer services or products that our
customers require, our customer relations could be damaged, and our ability to
reach our financial and operational objectives could be compromised.
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OUR YEAR 2000 COMPLIANCE EFFORTS MAY NOT ULTIMATELY PROVE TO BE SUCCESSFUL,
WHICH COULD MATERIALLY INTERFERE WITH OUR NETWORK AND OTHER BUSINESS OPERATIONS.
The Year 2000 issue is the result of computer programs using two digits,
rather than four, to define the applicable year. Because of this programming
convention, software, hardware or firmware may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in system failures,
miscalculations or errors causing disruptions of operations or other business
problems, including, among others, an inability to process transactions, send
invoices, or engage in similar normal business activities. As of March 13, 2000,
neither Pathnet nor us had experienced any significant Year 2000 issues.
However, we will not be able to fully assess the impact of Year 2000 issues on
our business and operations until later this year. If we or our major vendors,
other key service providers or customers fail to address adequately their
respective Year 2000 issues in a timely manner, we could experience, among other
things, interruptions in our network and a decline in sales which would
adversely affect our business. The Year 2000 issues and our Year 2000 readiness
program are described in further detail below in "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Year 2000 Readiness
Disclosure."
IF WE DO NOT SUCCESSFULLY MANAGE ACQUISITIONS, STRATEGIC ALLIANCES AND JOINT
VENTURES THAT WE MAY NEED TO IMPLEMENT OUR BUSINESS PLAN, OUR FINANCIAL AND
OPERATIONAL PERFORMANCE MAY BE ADVERSELY AFFECTED.
To expand and deploy our network in a timely manner, we may need to acquire
other businesses, form strategic alliances or enter into joint ventures that
will complement our existing business markets or accelerate our entry into our
target markets. These transactions may:
- pose challenges in assimilating the acquired operations and personnel;
- disrupt our ongoing business;
- divert resources;
- create difficulties in maintaining uniform standards, controls,
procedures and policies;
- impede management of our growth and information systems;
- present challenges where entering markets in which we have little
experience; or
- impair relationships with employees or customers.
We currently have no definitive acquisition agreement in place, although we
have had discussions with other companies and will continue to assess
opportunities on an ongoing basis. Our failure to implement our expansion and
growth strategy successfully would have a material adverse effect on our
business, results of operations and financial condition.
RISKS RELATING TO OUR FINANCING
WE EXPECT NEGATIVE OPERATING CASH FLOWS AND SUBSTANTIAL OPERATING LOSSES FOR THE
FORESEEABLE FUTURE.
Pathnet has incurred operating losses and negative cash flow since
inception. From August 25, 1995 through December 31, 1999, Pathnet's operations
have resulted in cumulative net losses of $101.5 million. We expect to incur
continued operating losses and negative cash flow as we build our network, offer
additional products and services and increase our customer base. These losses
will reduce our ability to meet working capital needs and increase our need for
external financing to support our objectives. Until and unless we develop an
adequate customer base and revenue stream, our capital and other operating
expenditures will result in negative cash flow and operating losses. We
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expect these expenditures to increase as we develop our customer base in
existing markets, expand into new markets and diversify our service offerings.
We may never develop an adequate customer base, sustain profitability or
generate sufficient cash flow to meet our obligations on the guarantees, debt or
fund our other business needs. We therefore cannot assure you that we will
become profitable in the future.
WE ANTICIPATE THAT OUR FUTURE GROWTH WILL REQUIRE SIGNIFICANT CAPITAL THAT WE
MAY BE UNABLE TO OBTAIN ON ACCEPTABLE TERMS.
Our business plan requires us to expand our existing network and services,
acquire and develop additional networks and services in new markets, deploy our
own fiber capacity in the majority of our markets and fund our initial operating
losses. These activities will require significant capital and operational
expenditures for the foreseeable future. Although we estimate that our currently
available resources will, together with those received in our reorganization, be
sufficient to fund the implementation of our long term business plan through the
fourth quarter of 2000, after that time we expect we will require additional
financing, which may include commercial bank borrowings, vendor financing or the
sale or issuance of equity or debt securities. Our required financing needs may
change if our reorganization is not consummated or is consummated on different
terms or on a later schedule than anticipated. If we are unable to obtain
necessary additional financing on acceptable terms, our business could be
adversely affected.
WE WILL BE GUARANTEEING AND/OR INCURRING A SUBSTANTIAL AMOUNT OF DEBT THAT MAY
INCREASE OUR OPERATING COSTS AND COULD HINDER OR PREVENT US FROM RAISING
ADDITIONAL REQUIRED FUNDS, INVESTING IN OUR OPERATIONS, OR WITHSTANDING A
DECLINE IN OUR PROJECTED REVENUES.
Pathnet currently has, and after our reorganization has closed we will
have, a substantial amount of debt in relation to its stockholders' equity. As
of December 31, 1999, Pathnet had approximately $380.3 million of indebtedness
outstanding and total stockholders' equity (deficit) of ($95.7) million. We plan
to incur additional indebtedness in developing our business.
The amount of our debt could adversely affect our future prospects by:
- impairing our ability to borrow additional money;
- requiring us to use a substantial portion of our cash flows from
operations to pay interest or repay debt which will reduce the funds
available to us for our operations, acquisition opportunities and capital
expenditures;
- placing us at a competitive disadvantage with companies that are less
restricted by their debt arrangements; and
- making us more vulnerable in the event of a downturn in general economic
conditions or upon the occurrence of any risks described in this section.
WE MAY NOT HAVE SUFFICIENT FUNDS FROM OUR OWN CASH FLOW OR OTHER SOURCES TO
SERVICE OUR DEBT.
We cannot assure you that we or Pathnet will be able to meet our debt
obligations under the guarantees, the Pathnet notes or otherwise. If we are
unable to generate sufficient cash to meet our obligations or if we fail to
satisfy the requirements of our debt agreements, we will be in default. A
default under the notes, which may include a material default under other
indebtedness, would permit the holders of the Pathnet notes (and other debt for
which we will be directly or indirectly responsible) to require payment before
the scheduled due date of the debt, resulting in further financial strain on us
and causing additional defaults under our other indebtedness.
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OUR INABILITY TO OBTAIN ADDITIONAL FINANCING NEEDED IN THE FUTURE MAY DELAY OR
PREVENT THE COMPLETION OF OUR NETWORK AND THE ROLLOUT OF OUR PRODUCTS AND
SERVICES TO OUR CUSTOMERS.
We expect to need significant additional capital to complete the buildout
of our planned network and fulfill our long-term business strategies. We may be
unable to produce sufficient cash flows from ongoing operations to fund our
business plan and future growth. This could require us to alter our business
plan, including delaying, reducing or abandoning our expansion or spending
plans, which could have a material adverse effect on our future revenue
prospects or our business.
In addition, we may elect to pursue other business opportunities that could
require additional capital investments in our network. If any of these events
were to occur, we could be required to sell assets, borrow more money than we
currently anticipate, issue additional debt or equity securities, refinance or
restructure our debt or enter into joint ventures.
Our ability to arrange financing depends upon many factors, including:
- general economic and capital markets conditions, especially the
non-investment grade debt market;
- conditions in the telecommunications industry;
- regulatory, technological or competitive developments;
- investor confidence and credit availability from banks or other lenders;
- the success of our network and demand for our products and services;
- cost overruns and unforeseen delays; and
- provisions of tax and securities laws that affect capital raising
activities.
Our inability to raise additional funds would have an adverse effect on our
ability to complete our network. If we decide to raise additional funds by
incurring more debt, we may become subject to additional or more restrictive
financial covenants. These covenants or other terms of the additional financing
may place significant limits on our financial and operating flexibility, or may
not be acceptable to us. Our failure to raise sufficient funds when needed and
on reasonable terms may require us to modify or significantly curtail our
business expansion plans. These modifications could have a material adverse
impact on our growth and ability to compete and to service our existing debt.
ALTHOUGH YOUR NOTES ARE REFERRED TO AS "SENIOR NOTES" THEY ARE, AND WILL
CONTINUE TO BE, EFFECTIVELY SUBORDINATED TO OUR SECURED DEBT AND THE SECURED AND
UNSECURED DEBT OF OUR SUBSIDIARIES.
The notes are unsecured and therefore are and will continue to be
effectively subordinated to any secured debt we may incur to the extent of the
value of the assets securing that debt. In the event of a default, foreclosure,
bankruptcy or similar proceeding involving us, our assets that serve as
collateral will be available to satisfy the obligations under any secured debt
before any payments are made on the notes. If there is any shortfall after the
foreclosure on these assets, our secured creditors would have a claim for that
shortfall ranking equally with your claim against us under the guarantees. In
addition we may secure any additional debt with our assets or borrow through
subsidiaries. Those secured assets, or the assets of our borrowing subsidiaries,
will be available to other creditors before they are available to you.
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WE WILL DEPEND ON PAYMENTS FROM OUR SUBSIDIARIES TO REPAY OUR DEBTS, AND OTHER
CREDITORS OF OUR SUBSIDIARIES OTHER THAN PATHNET WILL HAVE CLAIMS AGAINST THE
ASSETS OF THOSE SUBSIDIARIES THAT ARE SENIOR TO YOUR NOTES.
After our reorganization has closed, we will be a holding company that
receives a substantial part of our revenues from our subsidiaries. Our ability
to obtain payments from our subsidiaries may be restricted by the profitability
and cash flows of our subsidiaries and laws relating to the payment of dividends
by a subsidiary to its parent company. If our subsidiaries are unable to pay
dividends, we may be unable to service our debt, including our obligations under
the supplemental indenture and the guarantees. If any of our subsidiaries
experiences a bankruptcy, liquidation or reorganization, its creditors will
generally be entitled to payment of their claims from the assets of that
subsidiary before any assets are made available for distributions to us, except
to the extent we may also have a claim as a creditor. In that situation,
creditors of our subsidiaries and future holders of preferred stock, if any, of
our subsidiaries, would have claims on the assets of the subsidiaries with
priority over our claims.
OTHER THAN PATHNET, OUR SUBSIDIARIES, INCLUDING SUBSIDIARIES THAT WE MAY FORM IN
THE FUTURE, WILL NOT GUARANTEE OR OTHERWISE BE RESPONSIBLE FOR MAKING FUNDS
AVAILABLE TO US OR TO PATHNET TO MAKE PAYMENTS ON YOUR NOTES OR GUARANTEES.
Like your notes, your rights under the guarantees will be structurally
subordinated to both secured and unsecured debts of our subsidiaries other than
Pathnet. Under the terms of the existing indenture, Pathnet has formed new
subsidiaries that are separate legal entities with no obligations under the
notes. The supplemental indenture will extend this structure to us. If we
incorporate additional subsidiaries, whether new subsidiaries of Pathnet or
"sister" companies to Pathnet, these new subsidiaries also will be separate
legal entities. They will have no obligation under the supplemental indenture or
the guarantees to make payments or to provide dividends or other funds to us or
Pathnet to permit us to make payments on the notes or guarantees.
We have concluded that revising the indenture to provide for these
guarantees would interfere with our ability to obtain equipment and other
financing necessary in connection with the future development of our network. As
a result, the notes are and will continue to be, and the guarantees will be,
effectively subordinated to the debts of our subsidiaries other than Pathnet.
VENDOR FINANCING ARRANGEMENTS WILL LIKELY REQUIRE US TO FORM SUBSIDIARIES WITH
SUBSTANTIAL ASSETS THAT WILL NOT BE OBLIGATED TO GUARANTEE THE NOTES.
We expect to take advantage of vendor financing in constructing our
network. Our proposed vendor financing agreement with Lucent specifically
requires us, if we wish to take advantage of the Lucent financing, to form a new
subsidiary and to contribute to this new subsidiary a substantial portion of our
assets. This contribution of assets would include the rights of way relating to
the segments of our network that we plan to construct with fiber for which
Lucent provides vendor financing, and could include additional cash
contributions. This new subsidiary will not guarantee the notes. See
"DESCRIPTION OF OTHER INDEBTEDNESS AND OTHER FINANCING ARRANGEMENTS -- Proposed
Credit Facility with Lucent."
OUR INDEBTEDNESS WILL CONTAIN RESTRICTIVE COVENANTS, WHICH COULD EXPOSE US TO
ADDITIONAL DEFAULTS AND RESTRICT OUR OPERATIONS.
By entering into the supplemental indenture, we will become subject to a
number of restrictive covenants parallel to those contained in the indenture and
applicable to Pathnet. These restrictions
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affect, and, in certain cases significantly limit (and in some cases prohibit),
among other things, our ability and the ability of our subsidiaries to:
- incur additional indebtedness;
- create liens;
- make investments;
- pay dividends;
- issue stock; and
- sell assets.
For example, the indenture restricts and the supplemental indenture will
restrict our ability to incur indebtedness other than indebtedness to finance
the acquisition of equipment, inventory or network assets and other specified
indebtedness. In addition, if and when we (or our subsidiaries) borrow funds
under our proposed credit facility with Lucent or under other credit facilities
with other vendors or third parties who may provide financing, we may be
required to maintain specified financial ratios. We cannot assure you that we
will be able to maintain those required ratios after each borrowing, and our
failure to do so or comply with other covenants could lead to a default on those
facilities and a foreclosure against any assets securing the facilities. These
restrictive covenants may also adversely affect our ability to finance our
future operations or capital needs, or to engage in other business activities
that may be in our interest.
PROVISIONS IN OUR CERTIFICATE OF INCORPORATION AND BYLAWS, THE STOCKHOLDERS
AGREEMENT TO WHICH WE WILL BECOME A PARTY AND THE TERMS OF THE INDENTURE AND
SUPPLEMENTAL INDENTURE COULD DELAY OR PREVENT OUR CHANGE OF CONTROL, EFFECTIVELY
HINDERING OUR ACCESS TO ADDITIONAL EQUITY FINANCING.
Our certificate of incorporation, bylaws and stockholders agreement contain
provisions that will make any acquisition of us or investment in us more
difficult, including restrictions on removal of directors and limitations on the
ability of stockholders to call special meetings. The terms of the indenture and
supplemental indenture may also restrict and discourage attempts to change
control of Pathnet Telecom. Our ability to attract future equity investment may
be hindered because of these provisions, thereby limiting our access to
additional capital.
RISKS RELATING TO TAX MATTERS
YOU MAY BE SUBJECT TO FEDERAL INCOME TAXATION AS A CONSEQUENCE OF THE WAIVERS,
CONSENT AND PROPOSED INDENTURE AMENDMENTS.
Due to the lack of specific guidance and the inherently factual nature of
the issues involved, Covington & Burling is unable to render an opinion
regarding the tax consequences to you as a result of the waivers, consent and
proposed indenture amendments. Covington has opined that, if the waivers,
consent and proposed indenture amendments result in a "deemed exchange" of the
notes for federal income tax purposes, you will recognize gain or loss on such
deemed exchange if the notes do not constitute securities for purposes of
Section 354 of the tax code. There is uncertainty as to whether the notes
constitute securities for these purposes and as to whether the waivers, consent,
and proposed indenture amendments will result in a "deemed exchange." In
addition, regardless of whether the notes constitute securities, if a deemed
exchange occurs and the notes are publicly traded within the meaning of the tax
code, the notes likely would be treated as having original issue discount. If
the notes have original issue discount, it is Covington's opinion that you
generally will be required to include such discount in income as it accrues in
advance of the receipt of cash attributable to such income. There is uncertainty
as to whether the consent fee should be treated as a
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fee paid to holders for their consents or, alternatively, as a premium that is
part of a deemed exchange. Accordingly, Covington is unable to render an opinion
as to the extent to which you will recognize income on receipt of the consent
fee. The tax consequences of the waivers, consent and proposed indenture
amendments are described more fully in "FEDERAL INCOME TAX CONSEQUENCES."
PATHNET MAY INCUR SUBSTANTIAL FEDERAL INCOME TAXES AS A CONSEQUENCE OF THE
WAIVERS, CONSENT AND PROPOSED INDENTURE AMENDMENTS.
Due to the lack of specific guidance and the inherently factual nature of
the issues involved, Covington & Burling is unable to render an opinion that the
waivers, consent and proposed indenture amendments will not cause Pathnet to
recognize any income for federal income tax purposes. If the waivers, consent
and proposed indenture amendments result in a "deemed exchange" of the notes for
federal income tax purposes and the notes are treated as publicly traded within
the meaning of the tax code, Pathnet could recognize a substantial amount of
cancellation of indebtedness income. Moreover, we cannot assure you that
Pathnet's net operating losses in prior years could be used to offset such
income and thereby reduce any taxes payable with respect to such income. The tax
consequences of the waivers, consent and proposed indenture amendments are
described more fully in "FEDERAL INCOME TAX CONSEQUENCES."
RISKS RELATING TO THE CONSENT SOLICITATION
IF WE HAVE NOT CLOSED OUR REORGANIZATION ON OR BEFORE MARCH 31, 2000, THE
PARTIES TO OUR REORGANIZATION MAY TERMINATE THEIR AGREEMENTS WITH US.
If we have not closed our reorganization on or before March 31, 2000,
provisions in the contribution agreements permit the parties to elect to
terminate those agreements. As a result, if we do not obtain the necessary
consents from the holders of the notes and complete the other steps necessary to
close the reorganization on or before the March 31 termination date, the
reorganization may not proceed as planned. If the reorganization does not take
place, the new investors will not contribute the cash and other assets that we
expect to receive in the reorganization, and Pathnet's business will not expand
as contemplated. We cannot assure you, in the absence of the reorganization,
that Pathnet will be able to find other investors to pursue its business plans.
IF WE HAVE NOT COMPLETED THE REORGANIZATION BEFORE MARCH 31, 2000, WE WILL NEED
TO DELAY AND MAY NEED TO RESTRUCTURE THE REORGANIZATION.
If we have not completed the contribution and reorganization transaction by
the termination date in the contribution agreements, and regardless of whether
the participants in the transaction have elected to exercise their termination
rights, applicable federal securities law may prevent us from completing the
reorganization. Currently, the reorganization and the consent solicitation are
separate offerings. However, if the parties to the reorganization could
voluntarily terminate the agreements, the two offerings might be subject to
integration under the Securities Act. Accordingly, to avoid any suggestion that
our issue of shares in the reorganization should be integrated with the offering
of the guarantees in the consent solicitation, we might need to delay or
restructure the reorganization. If we were required to delay or restructure the
reorganization, we cannot assure you that the parties to the reorganization
would still wish to participate in the transaction.
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RISKS RELATING TO OUR NETWORK BUSINESS
DIFFICULTIES THAT WE MAY EXPERIENCE IN EXPANDING OUR NETWORK COULD INCREASE OUR
ESTIMATED COSTS AND DELAY SCHEDULED COMPLETION OF OUR NETWORK.
We plan to expand our existing network, enter new markets and broaden our
product and service offerings -- all of which are significant undertakings.
These activities will require us to install and operate additional facilities
and equipment, and develop, introduce and market new products and services. To
deploy these additional services we will need to modify and add to our existing
network architecture. We will also need to obtain and install our equipment in
the existing local telephone companies' central office collocation space as
described in further detail below. We may encounter administrative, technical,
operational, regulatory and other problems as a result of our expansion. Many of
these factors and problems are beyond our control. If we experience difficulties
in addressing and solving these problems, we may not be able to complete our
network buildout or expand our products and services as planned or in accordance
with our current cost or time estimates.
WE MAY PURSUE RELATIONSHIPS WITH TELECOMMUNICATIONS PROVIDERS AND OTHER BUSINESS
OPPORTUNITIES THAT COULD EXPOSE US TO ADDITIONAL RISKS OR DELAY THE CONSTRUCTION
AND OPERATION OF OUR NETWORK.
We may enter into relationships with long distance telephone companies,
existing local telephone companies, Internet service providers, competitive
telecommunications companies or other entities to manage existing assets or to
deploy alternative telecommunications products and services. We may also seek to
serve markets in addition to underserved or second or third tier markets and
customers in addition to telecommunications service providers. Pursuing these
other opportunities could require additional financing, pose additional risks
(such as increased or different competition, additional regulatory burdens and
network economics and pricing different from our currently planned network and
products and services) and divert our resources and management time. We cannot
assure you that we will successfully integrate any new opportunity into our
operations or that the opportunity would perform as expected.
WE MAY NOT BE ABLE TO OBTAIN OR MAINTAIN APPROPRIATE RIGHTS OF WAY AND OTHER
ACCESS RIGHTS THAT WE NEED TO BUILD AND OPERATE OUR NETWORK, DEPRIVING US OF THE
REVENUES NECESSARY TO IMPLEMENT OUR BUSINESS PLAN.
In addition to the rights of way to which we will gain access as a result
of our reorganization, we expect that we will need to obtain and maintain
additional rights of way to construct and develop our network. We cannot assure
you, however, that we will continue to have access to existing rights of way,
leases and licenses after the expiration of our current agreements, or that we
will obtain additional rights necessary to extend our network on reasonable
terms. In addition, if a franchise, license or lease agreement is terminated and
we are forced to remove or abandon a significant portion of our network, our
business, results of operations, and financial condition will be materially
adversely affected.
THIRD PARTY CHALLENGES TO OUR USE OF RIGHTS OF WAY OBTAINED FROM OTHERS MAY
DELAY, HINDER OR OTHERWISE LIMIT THE DEVELOPMENT AND OPERATION OF OUR NETWORK
AND IMPLEMENTATION OF OUR BUSINESS PLAN.
To construct and maintain our fiber optic and wireless network, we have
obtained and will obtain easements, leases, rights of way, franchises and
licenses from various private parties, including railroads, pipelines,
utilities, actual and potential competitors and local governments. Some of our
agreements with right of way providers require us to acknowledge that others who
question the right of way providers' ownership claim to the easement or property
right may challenge our claim to the rights of way being granted. Third parties
have challenged, and we expect in the future that third
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parties may challenge, our use of rights of way obtained by or from others,
including the rights of way we will obtain upon the closing of our
reorganization. If we are unable to resolve any of these challenges, or if the
cost of addressing them is higher than we contemplate, these challenges may
hinder or delay our business plans.
IF WE ARE UNABLE TO OBTAIN THE ADDITIONAL PERMITS AND AGREEMENTS NECESSARY TO
OPERATE AND EXPAND OUR NETWORK, WE MAY BE UNABLE TO DEVELOP OUR NETWORK OR
GENERATE SUFFICIENT REVENUES.
We may require additional pole attachment or conduit use agreements with
existing local telephone companies, utilities or other local telephone
companies. We cannot guarantee that we, or our operating companies or partners,
will be able to obtain new or maintain existing permits, pole attachment and
conduit use agreements needed to develop and operate and expand our network and
provide our planned products and services. Our failure to obtain or maintain
necessary permits, pole attachments and conduit use agreements could have a
material adverse effect on our ability to operate and expand our network.
IF WE ARE UNABLE TO OBTAIN AND MAINTAIN ON GOOD TERMS THE LEASEHOLD ACCESS OR
OTHER SERVICES AND MAINTENANCE AGREEMENTS ON WHICH WE RELY TO OPERATE THE
WIRELESS PORTIONS OF OUR NETWORK, IT MAY BECOME MORE EXPENSIVE, OR WE MAY EVEN
BE UNABLE, TO OPERATE THOSE PORTIONS OF OUR NETWORK.
We do not own, and we do not expect to own in the future, the underlying
sites and facilities upon which Pathnet's current wireless digital network is
deployed. Instead, we (or our affiliated companies) have entered into long term
fixed point microwave services agreements with certain of our co-development
partners such as Kinder Morgan, formerly KN Energy. Under these agreements, each
co-development partner has agreed to grant us a leasehold interest in, or a
similar right to use, their facilities and infrastructure as required for us to
deploy our network. As a result, we depend and will continue to depend on the
facilities and infrastructure of our co-development partners for the operation
of our business. In many cases, we also rely on our co-development partners for
the maintenance and provisioning of circuits on our network. We have entered
into maintenance agreements with some of these co-development partners where
they perform maintenance and provisioning services for us in return for a
monthly fee. The cancellation or non-renewal of any of these arrangements or
agreements could have a material adverse effect on our business.
DISAGREEMENTS WITH OUR CO-DEVELOPMENT PARTNERS OR DIFFICULTIES WE MAY EXPERIENCE
IN OUR OTHER STRATEGIC RELATIONSHIPS COULD HINDER THE DEVELOPMENT OF OUR NETWORK
AND OUR EXPANSION INTO TARGET MARKETS.
As part of our "smart build" strategy and our reorganization, we have
formed and plan to continue in the future to pursue strategic alliances and
relationships which would allow us to enter certain markets for
telecommunications services sooner than if we had made the attempt
independently. As our network is further developed, we will be dependent on some
of these arrangements in order to expand our network into target markets.
Any disagreements with our co-development partners or companies with which
we have a strategic alliance could impair or adversely effect our ability to
conduct our business. In addition, the bankruptcy or insolvency of a
co-development partner could result in the termination of its agreement with us
and any related right of way agreements. The effect of those terminations or the
failure of a co-development partner to make required capital contributions would
have a material adverse effect on us.
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WE MAY BE UNABLE TO OBTAIN ACCESS TO AND INTERCONNECTION WITH THE FACILITIES OF
EXISTING LOCAL TELEPHONE COMPANIES ON FAVORABLE TERMS, WHICH COULD DELAY,
INCREASE THE COST OF OR PREVENT US FROM PROVIDING LOCAL ACCESS SERVICES IN OUR
TARGET MARKETS.
Our ability to provide local access services depends upon our securing
access to existing local telephone companies' networks, including locating our
network equipment in, or otherwise fully connecting our network equipment with,
the existing local telephone companies' central offices in our target markets.
Challenges we may face in obtaining central space from the existing local
telephone companies include:
- limitations on the availability of such space in high demand target
markets where other competitive telecommunications companies are seeking
or have obtained such space to offer services;
- delays when existing local telephone companies fail to promptly address
our requests for such space; and
- expenditure of time and money to pursue negotiations, regulatory
disputes, and legal actions for resolution of disputes regarding lack of
sufficient central office space.
We expect that these challenges may delay our attempts to obtain central
office space, which would slow down our deployment of our network and our
ability to increase the number of our customers.
IF EXISTING LOCAL TELEPHONE COMPANIES ON WHOM WE DEPEND FOR INTERCONNECTION AND
OTHER NETWORK ELEMENTS REFUSE TO COOPERATE OR FAIL TO PERFORM THEIR AGREEMENTS
WITH US, WE MAY BE DELAYED IN OR EVEN PREVENTED FROM COMPLETING OUR NETWORK AND
OFFERING COMPETITIVE SERVICES TO OUR CUSTOMERS.
We will interconnect with and use existing local telephone companies'
networks to provide local access services to our customers. This strategy
presents a number of challenges because we depend on existing local telephone
companies to:
- allow us to use their technology and capabilities of their networks to
service our customers;
- cooperate with us to provide and repair facilities; and
- provide the services and network components that we order, for which they
depend significantly on unionized labor. Labor issues have in the past
and may in the future hurt the existing local telephone companies'
performance.
Our dependence on existing local telephone companies may cause us to
encounter delays in establishing our network and rolling out our products and
services. We must also establish satisfactory billing and payment arrangements
with existing local telephone companies. We may not be able to do these things
in a manner that will allow us to retain and grow our customer base.
IF THE QUALITY, AVAILABILITY OR MAINTENANCE OF EXISTING LOCAL TELEPHONE
COMPANIES' NETWORKS IS UNSATISFACTORY, OUR NETWORK MAY NOT BE SUFFICIENTLY
AVAILABLE OR RELIABLE TO MEET OUR BUSINESS PLANS OR CUSTOMER EXPECTATIONS.
We may not be able to obtain the facilities and the services we need from
existing local telephone companies at satisfactory quality levels, rates, terms
and conditions. Our inability to do so could delay the expansion of our network
and degrade the quality of our services to our customers.
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<PAGE> 22
WIRELESS PATH FAILURES OR CABLE CUTS ON OUR NETWORK COULD INTERFERE WITH OUR
NETWORK OPERATIONS, DAMAGE OUR RELATIONSHIPS WITH OUR CUSTOMERS OR EXPOSE US TO
LIABILITY.
We do not have multiple or redundant network paths, often referred to as
"route diversity," on our digital network to maintain services if a wireless
path failure or fiber cable cut occurs. If we were to suffer a deterioration in
the perceived quality or reliability of our service as a result of a path
failure, cable cut, or other network outage, our customer relations would be
materially adversely affected and we could be exposed to liability claims.
RISKS RELATING TO OUR INDUSTRY
OUR BUSINESS AND INDUSTRY ARE VERY COMPETITIVE AND INCREASED COMPETITION COULD
REQUIRE US TO LOWER OUR PRICES OR PROVIDE MORE EXPENSIVE SERVICES THAT WOULD
ADVERSELY AFFECT OUR FINANCIAL PERFORMANCE.
The telecommunications industry is extremely competitive, particularly with
regard to price and service. Many of our existing and potential competitors have
significantly greater financial, personnel, marketing and other resources than
we do. For example, some of our competitors have already made substantial
long-term investments in the construction of wireless and fiber optic networks
and the acquisition of telecommunications capacity. Many of our competitors also
have the added competitive advantage of an established network and existing
customer base. For example, some communications carriers and local cable
companies have extensive networks in place that could be upgraded to fiber optic
cable. Those companies also have more employees and more substantial capital
resources to begin those upgrades. If communications carriers and local cable
companies decide to equip their existing networks with fiber optic cable, they
could become significant competitors of ours in a short period of time.
IF WE ENCOUNTER INCREASED COMPETITION FROM EXISTING AND FUTURE
TELECOMMUNICATIONS SYSTEMS ON ROUTES WHERE WE PLAN TO PROVIDE INFRASTRUCTURE
SERVICES AND WHOLESALE TRANSPORT SERVICES, WE MAY BE UNABLE TO COMPETE
EFFECTIVELY FOR THESE SERVICES OR WE MAY NEED TO REDUCE OUR PRICES IN A MANNER
THAT ADVERSELY AFFECTS OUR FINANCIAL PERFORMANCE.
Other companies may choose to compete with us in our current or planned
markets by selling or leasing network assets or wholesale transport services to
our targeted customers. This competition could have a material adverse effect on
our business. Our competitors for these products and services include:
- long distance companies, such as AT&T Corp., MCI WorldCom, Inc. and
Sprint Corporation;
- wholesale providers, such as Qwest Communications International Inc.,
Williams Communications Group, Inc., IXC Communications, Inc., DTI
Holdings, Inc., Global Crossing Ltd. and Level 3 Communications, Inc.;
- existing local telephone companies, such as US West, BellSouth, Bell
Atlantic, SBC and GTE Corporation, which currently dominate their local
telecommunications markets and have sought or may soon seek or obtain
authority to provide long distance services in their local markets;
- competitive telecommunications companies, such as GST Telecommunications,
Inc., ITC/ Deltacom, Inc. and Metromedia Fiber Network, Inc.; and
- potential competitors capable of offering services similar to those we
offer, such as communications service providers, cable television
companies, electric utilities, microwave carriers, satellite carriers,
wireless telephone operators and large end users with private networks.
20
<PAGE> 23
ADDITIONAL COMPETITION FROM LOCAL TELEPHONE COMPANIES OR OTHER
TELECOMMUNICATIONS SERVICES PROVIDERS AS THEY BEGIN TO PROVIDE OR EXPAND THEIR
LOCAL ACCESS SERVICES IN THE MARKETS THAT WE HAVE TARGETED MAY PREVENT US FROM
ACHIEVING OUR SALES GOALS.
Our principal competitor in the provision of local access services in each
of our markets is the existing local telephone company. Although recent federal
legislation and rule-making proceedings afford us increased opportunities to
compete in providing these services, some aspects of these proceedings also
benefit existing local telephone companies. Potential changes in the regulation
of telecommunications services could deprive us of some competitive advantages
that we now enjoy, which could harm our business.
In addition to the existing local telephone companies, other
telecommunications service providers, such as Covad Communications Group, Inc.,
NorthPoint Communications Group, Inc. and Rhythms Netconnections, Inc., have
recently begun providing some local services. Other competitors and potential
entrants in the market for the provision of these services include long distance
companies, cable television companies, electric utilities, microwave carriers,
wireless telephone system operators, data service companies and operators of
private networks. Significant new competitors also could enter the local market
through consolidation and strategic alliances in the industry, foreign carriers
being allowed to compete in the U.S. market, technological advances, and further
deregulation and other regulatory initiatives. The introduction of any of these
new competitors into our markets for local services could materially and
adversely affect our business. See "BUSINESS -- Competition."
WE DO NOT PLAN TO OFFER A BROAD RANGE OF PRODUCTS OR SERVICES IN THE IMMEDIATE
FUTURE, AND THIS LIMITATION COULD INCREASE OUR VULNERABILITY TO CHANGING TRENDS
IN OUR INDUSTRY OR INCREASED COMPETITION. AT THE SAME TIME, OUR FUTURE SUCCESS
WILL DEPEND ON GROWTH IN THE DEMAND FOR LOCAL ACCESS SERVICES WE PLAN TO
CONTINUE TO OFFER.
We have planned to undertake only a narrow scope of activities in the
immediate future, which could limit potential revenues and result in lower
revenues than competitors who now provide a wide range of services. Although
Pathnet has recently commenced marketing local access services to
telecommunications service providers, we cannot assure you that we will be
successful in entering this business. If the markets for these services fail to
develop, grow more slowly than anticipated or become saturated with competitors,
our business prospects, operating results and financial condition could be
materially adversely affected.
OUR PRODUCT AND SERVICE OFFERINGS ARE SUBJECT TO RISKS OF INDUSTRY OVER-CAPACITY
AND RESULTING DOWNWARD PRICING PRESSURES.
Since shortly after the AT&T divestiture in 1984, the long distance
transmission industry generally has experienced over-capacity and declining
prices. These trends have exerted downward pricing pressures on a number of
telecommunications services, including our wholesale transport services, and we
anticipate that prices for these services will continue to decline over the next
several years because:
- existing long distance carriers and potential new carriers are
constructing new fiber optic and other long distance transmission
networks;
- regulatory changes may permit the existing local telephone companies to
provide long-distance services out-of-region;
- expansion and new construction of transmission networks, particularly
fiber optic cable networks, are likely to create substantial excess
capacity relative to demand in the short or medium term; and
21
<PAGE> 24
- recent technological advances may greatly expand the capacity of existing
and new fiber optic cable.
Dramatic and substantial price reductions in the long distance industry
could require us to reduce our prices significantly or to revise the mix of
products and services we plan to offer. Either of these results could adversely
affect our business. Also, an increase in the capacity of any of our competitors
to provide transport services could adversely affect our business even if we are
also able to increase our capacity.
INCREASED SUPPLY OF FIBER OPTIC CABLE IN THE INDUSTRY MAY LEAD TO LOWER PRICES
FOR OUR PRODUCTS OR SERVICES.
The supply of fiber optic cable that is already buried in conduits but has
none of the associated transmission electronics installed has increased,
resulting in downward pricing pressure on sales of fiber optic strands. The FCC
recently issued an order requiring existing local telephone companies to make
inactive fiber optic strands and other transport facilities available to other
telecommunications carriers at cost-based nondiscriminatory prices. This
requirement could further increase the supply of and decrease demand for fiber
optic strands that we sell and services that we plan to offer, adversely
affecting our business, financial condition and results of operations.
IF WE FAIL TO RECOGNIZE OR MAKE THE INVESTMENTS NECESSARY TO KEEP PACE WITH
RAPID TECHNOLOGICAL CHANGES, OUR SERVICES MAY BECOME LESS DESIRABLE OR OBSOLETE
AND WE MAY FACE HIGHER COSTS OR BE UNABLE TO COMPETE EFFECTIVELY.
The telecommunications industry is characterized by rapid and significant
changes in technology. We cannot predict the effect of technological changes on
our business. The introduction of new products or technologies may reduce the
cost or increase the supply of services similar to those that we plan to
provide, or could render those services and our network assets less desirable or
even obsolete. As a result, new entrants in the communications services industry
may become our most significant competitors in the future. These new entrants
may not be burdened by an installed base of outdated equipment and the resulting
competition they may provide could have a material adverse effect on our ability
to meet our sales targets.
RISKS RELATING TO REGULATION
REGULATORY CHANGES COULD REQUIRE US TO POSTPONE OR MODIFY OUR BUSINESS PLANS OR
DEPRIVE US OF THE MEANS TO ESTABLISH OUR NETWORK IN OUR TARGET MARKETS.
Communications services are subject to significant regulation at the
federal, state and local levels. Our business plans require us to exploit new
opportunities afforded by recent regulatory changes. However, the regulatory
environment could adversely affect us in a number of ways, including:
- delays in receiving required regulatory approvals or the imposition of
onerous conditions for these approvals;
- difficulties in completing and obtaining regulatory approval of
interconnection agreements, which provide for the interconnection of our
networks with existing local telephone companies' networks; and
- enactment of new and adverse legislation or regulatory requirements or
changes in the interpretation of existing laws or regulations.
Many regulatory proceedings regarding issues that are important to our
business are currently underway or are being contemplated by federal and state
authorities. Changes in regulations or future regulations adopted by federal,
state or local regulators, or other legislative or judicial initiatives
22
<PAGE> 25
relating to the telecommunications industry could cause our pricing and business
models to fluctuate dramatically or otherwise have a material adverse effect on
us.
THE FCC MAY IMPLEMENT PROVISIONS OF THE TELECOMMUNICATIONS ACT OF 1996 IN A
MANNER THAT IS ADVERSE TO OUR BUSINESS PLANS AND STRATEGIES.
The Telecommunications Act of 1996 was intended, among other things, to
foster competition in the local telephone market. However, the FCC and the
states are still implementing many of its rules and policies and it remains
uncertain how successfully the Telecommunications Act will promote competition.
Moreover, the Telecommunications Act and other recent federal laws regarding the
U.S. telecommunications industry remain subject to judicial review and
additional FCC rule-making proceedings. Our business strategy involves taking
advantage of some of the competitive opportunities advanced by the
Telecommunications Act, and the FCC may promulgate regulations implementing the
Telecommunications Act that are adverse to our business.
OUR ABILITY TO OFFER LONG DISTANCE COMPANIES LOCAL ACCESS SERVICES AT
COMPETITIVE RATES MAY BE LIMITED BY NEW REGULATIONS AND LEGISLATIVE INITIATIVES.
Like most companies in the communications industry, we must comply with
many regulatory requirements. However, unlike some of our competitors,
particularly the existing local telephone companies, we are not currently
subject to some of the burdensome regulations federal law imposes on the
telecommunications industry. Our ability to compete in the provision of local
access services will depend upon a continued favorable, pro-competitive
regulatory environment. New regulations or legislation affording greater
flexibility and regulatory relief to our competitors could adversely affect us
by increasing competition in the provision of local access services.
The FCC is currently considering an industry proposal to restructure the
fees that existing local telephone companies charge long distance companies to
use their local networks. These fees are referred to as access charges. Changes
in the access charge structure could fundamentally affect the economic
environment in which we and our customers operate. If the FCC reduces the access
charges imposed by existing local telephone companies, it would significantly
reduce our price advantage in the market for local access services used by long
distance companies to access the existing local telephone companies' local
networks.
The FCC is also considering whether to impose limits on certain uses of
unbundled network elements we purchase from the existing local telephone
companies. If the FCC limits our ability to offer long distance companies a
package of unbundled network elements that can be used to reach end users, our
ability to offer our local access services at competitive rates may be harmed.
PENDING REGULATORY INITIATIVES MAY MAKE IT EASIER FOR EXISTING LOCAL TELEPHONE
COMPANIES AND THEIR AFFILIATES TO OFFER DIGITAL SUBSCRIBER LINE SERVICES TO
CUSTOMERS IN OUR TARGET MARKETS, INCREASING THE COMPETITION THAT WE FACE FOR
CUSTOMERS SEEKING THESE SERVICES.
In August 1998, the FCC proposed new rules that would allow existing local
telephone companies to provide digital subscriber line services, which utilize a
transmission technology enabling high-speed access in a local network over
copper wires, through separate affiliates not subject to existing local
telephone company regulation. The FCC recently decided some of the other issues
raised in that proceeding, but the question of whether existing local telephone
companies can provide unregulated digital subscriber line services through a
separate affiliate remains unresolved. Any decision that would permit an
existing local telephone company affiliate to offer digital subscriber line
services without being subject to regulation imposed on existing local telephone
companies could have a material adverse effect on us by, for example, increasing
the competition we face in the provision of digital subscriber line services.
23
<PAGE> 26
IF WE ARE UNABLE TO OBTAIN AND MAINTAIN THE NECESSARY FCC LICENSES, WE MAY BE
UNABLE TO OPERATE THE WIRELESS PORTIONS OF OUR NETWORK.
Portions of our network are wireless, meaning that we provide access
services via over-the-air microwave transmissions instead of through fiber optic
cables. Our arrangements with certain of our wireless co-development partners
contemplate that the wireless portion of our digital network will largely
provide "common carrier fixed point-to-point microwave" telecommunications
services under Part 101 of the FCC's rules. These services are subject to
regulation by federal, state and local governmental agencies. Changes in
existing laws and regulations governing our provision of these services could
have a material adverse effect on our business, financial condition, and results
of operations.
IF WE DO NOT ACCURATELY PREDICT THE COST OF COMPLYING WITH FEDERAL AND STATE TAX
AND OTHER SURCHARGES ON OUR SERVICES, WE MAY NOT ACCURATELY ANTICIPATE THE COST
OF PROVIDING OUR SERVICES TO CUSTOMERS, AND OUR EARNINGS AND CUSTOMER
RELATIONSHIPS COULD BE ADVERSELY AFFECTED.
As a telecommunications provider, we must pay a variety of surcharges and
fees on our gross revenues from interstate services and intrastate services.
Interstate surcharges include fees for federal universal service and common
carrier obligations, number administration, the provision of telecommunications
services to the disabled and other miscellaneous FCC requirements. State
regulators impose similar surcharges and fees on intrastate services. The
division of our services between interstate services and intrastate services is
a matter of interpretation, and FCC or relevant state commission authorities may
in the future contest how we allocate our charges. If this allocation is
changed, our payment obligations for the relevant surcharges could increase.
Periodic revisions by state and federal regulators of the applicable surcharges
may also increase the surcharges and fees we currently pay.
For more information on these and other risks posed by regulatory
initiatives, see "BUSINESS -- Government Regulation."
WE MAY BE REQUIRED TO REGISTER AS AN INVESTMENT COMPANY, WHICH WOULD SUBJECT US
TO SIGNIFICANT ADDITIONAL REGULATORY BURDENS AND INTERFERE WITH OUR ABILITY TO
HOLD INVESTMENTS OR RAISE FINANCING FOR OUR BUSINESS.
Pathnet has, and after the consummation of our reorganization we will have,
substantial cash balances and short-term investments on a consolidated basis. As
a result, we may be considered an "investment company" under the Investment
Company Act of 1940. The Investment Company Act requires companies that are
engaged primarily in the business of investing, reinvesting, owning, holding or
trading in securities, or that fail numerical tests regarding composition of
assets and sources of income and that are not primarily engaged in a business
other than investing, reinvesting, owning, holding or trading in securities, to
register as "investment companies." Various substantive restrictions are imposed
on investment companies by the Investment Company Act.
We are primarily engaged in a business other than investing, reinvesting,
owning, holding or trading securities. However, we could be deemed an investment
company within the meaning of the Investment Company Act. If we are required to
register as an investment company under the Investment Company Act, we would
become subject to substantial regulation of our capital structure, management,
operations, transactions with "affiliated persons," as defined in the Investment
Company Act, and other matters. To avoid having to register as an investment
company, we may have to hold a portion of our liquid assets as cash or
government securities instead of as investment securities. Having to register as
an investment company or holding a material portion of our liquid assets as cash
or government securities to avoid registration could have a material adverse
effect on us.
24
<PAGE> 27
THIS PROSPECTUS CONTAINS "FORWARD-LOOKING STATEMENTS" AND INFORMATION RELATING
TO OUR BUSINESS AND US THAT ARE NOT HISTORICAL FACTS.
We make statements in this prospectus that are not historical facts. You
can identify these forward-looking statements by our use of terminology such as
"believes," "expects," "plans," "may," "will," "should" or "anticipates" or
comparable words. These forward-looking statements include, among others,
statements concerning:
- Our business strategy and competitive advantages;
- Our anticipated potential revenues from designated markets;
- The growth of the telecommunications industry and our business;
- The markets for our services and products;
- Forecasts of when we will enter particular markets or begin offering
particular services;
- Our anticipated capital expenditures and future funding requirements,
including the role of vendor and other sources of financing for equipment
and related asset purchases; and
- Anticipated regulatory developments.
These statements are only predictions. You should be aware that these
forward-looking statements are subject to risks and uncertainties, including
financial and regulatory developments, industry trends, and projections that
could cause actual events or results to differ materially from those expressed
or implied by the statements. Should one or more of these risks or uncertainties
materialize, or should our underlying assumptions about them prove incorrect,
our actual results, our performance or our proposed activities may vary
materially from those expressed or implied by these forward-looking statements.
We disclose factors that could cause our actual results to differ materially
from our descriptions in this "RISK FACTORS" section and elsewhere in this
prospectus including the sections under the "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," "DESCRIPTION OF
OTHER INDEBTEDNESS AND OTHER FINANCING ARRANGEMENTS" and "BUSINESS" captions.
Please read the entire prospectus for a description of some of these risks,
including competitive, financial, developmental, operational, technical,
regulatory and other risks associated with our business, before accepting our
guarantees. You should not place undue reliance on the forward-looking
statements in this prospectus, which speak only as of the date of this
prospectus. Beyond April 23, 2000 (the 40th day following the effective date of
this prospectus), we undertake no obligation, and do not intend, to update or
revise any forward-looking statements, whether as a result of new information,
future events or otherwise. However, we will become subject to the requirements
of the Exchange Act following our issuance of the guarantees, and will be
required to disclose to investors all material information that the periodic
reporting requirements of the Exchange Act requires us to disclose.
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<PAGE> 28
USE OF PROCEEDS
We will not receive any proceeds from the issue of our guarantees on your
notes. At December 31, 1999, the proceeds remaining from private placements of
equity securities and the 1998 offering of notes, less pledged funds for
interest payments, consisted of $154.8 million of cash, cash equivalents and
marketable securities. Pathnet will lend $50 million of these proceeds to us in
our reorganization. In addition, in connection with the closing of our
reorganization (including both of the Colonial tranches), we will receive $68
million in cash proceeds from Colonial, comprised of $38 million at the initial
closing; $25 million upon the completion of a fiber optic network segment that
we expect to complete during the second calendar quarter of 2000; $1 million at
the initial closing for the issuance of an option to purchase more of our
shares; and $4 million at the initial closing to acquire a single fiber optic
conduit along a portion of the Colonial right of way corridors or other
telecommunications assets of equivalent value.
We anticipate that after payment of the expenses of this offering and our
reorganization, we will use our proceeds to fund:
- Capital expenditures to be incurred in the development of our digital
network and for other purposes relating to our business (including the
business currently conducted by Pathnet);
- Expenses associated with our (and Pathnet's) development and sales and
marketing activities;
- Operating losses;
- Possible strategic investments and strategic acquisitions; and
- Working capital and other general corporate purposes.
The amounts that we actually expend will vary depending on a number of
factors, including future revenue growth, capital expenditures and the amount of
cash generated by our operations. Additionally, if we determine it would be in
our best interest, we may increase or decrease the number, selection and timing
of entry of our targeted regions. Accordingly, our management will retain broad
discretion in the allocation of such proceeds. We may also use a portion of the
proceeds to pursue possible strategic investments in or acquisitions of
businesses, technologies or products complementary to ours in the future. At
present, we have no understandings, commitments or agreements with respect to
any acquisitions or material investments. Pending use of such net proceeds for
the above purposes, we intend to invest such funds in short-term,
interest-bearing, investment-grade securities.
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<PAGE> 29
CAPITALIZATION
The following table sets forth Pathnet's total cash, cash equivalents and
marketable securities and capitalization as of December 31, 1999 on an actual
basis and our unaudited cash, cash equivalents and marketable securities and
capitalization as of December 31, 1999 on a pro forma basis to give effect to
the consummation of our reorganization and the offering of the guarantees as if
they occurred on January 1, 1999. You should read the information in this table
in conjunction with Pathnet's consolidated financial statements and the notes
related thereto included elsewhere in this prospectus. See also "USE OF
PROCEEDS" and "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, LIQUIDITY AND CAPITAL RESOURCES."
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1999
-------------------------------
PATHNET PATHNET TELECOM
HISTORICAL PRO FORMA(a)
------------- ---------------
(UNAUDITED)
<S> <C> <C>
Cash, cash equivalents and marketable securities (excluding
marketable securities pledged as collateral)(b)........... $ 138,402,131 $ 170,448,726
============= =============
Pledged securities.......................................... $ 21,265,206 $ 21,265,206
============= =============
Long-term obligations:
Notes..................................................... $ 346,621,625 $ 346,621,625
------------- -------------
Mandatorily redeemable preferred stock:
Series A convertible preferred stock, par value $0.01 per
share, 1,000,000 and 0 shares authorized, issued and
outstanding actual and pro forma, respectively.......... 1,000,000 --
Series B convertible preferred stock, par value $0.01 per
share, 1,651,046 and 0 shares authorized, issued and
outstanding actual and pro forma, respectively.......... 5,008,367 --
Series C convertible preferred stock, par value $0.01 per
share, 2,819,549 and 0 shares authorized, issued and
outstanding actual and pro forma, respectively.......... 29,961,272 --
Series E convertible preferred stock, par value $0.01 per
share, 0 and 4,506,145 shares authorized actual and pro
forma, respectively, 0 and 1,729,631 shares issued and
outstanding actual and pro forma, respectively.......... -- 37,871,959
------------- -------------
Total mandatorily redeemable preferred stock....... 35,969,639 37,871,959
------------- -------------
Stockholders' (deficit) equity:
Series A convertible preferred stock, par value $0.01 per
share, 0 and 2,899,999 shares authorized, issued and
outstanding actual and pro forma, respectively.......... -- 29,000
Series B convertible preferred stock, par value $0.01 per
share, 0 and 4,788,030 shares authorized, issued and
outstanding actual and pro forma, respectively.......... -- 47,880
Series C convertible preferred stock, par value $0.01 per
share, 0 and 8,176,686 shares authorized, issued and
outstanding actual and pro forma, respectively.......... -- 81,767
Series D convertible preferred stock, par value $0.01 per
share, 0 and 9,250,000 shares authorized actual and pro
forma, respectively, 0 and 8,511,607 shares issued and
outstanding actual and pro forma, respectively.......... -- 85,116
Undesignated preferred stock, par value $0.01 per share, 0
and 10,000,000 shares authorized, 0 shares issued and
outstanding actual and pro forma........................ -- --
Common stock, par value $0.01 per share, 60,000,000 shares
authorized; 3,068,218 shares issued and outstanding
actual and pro forma.................................... 30,682 30,682
Deferred compensation..................................... (441,760) (441,760)
Additional paid in capital................................ 6,264,362 229,638,152
Accumulated other comprehensive loss...................... (90,240) (90,240)
Deficit accumulated during development stage(c)........... (101,499,769) (103,813,743)
------------- -------------
Total stockholders' (deficit) equity............... (95,736,725) 125,566,854
------------- -------------
Total capitalization............................... $ 286,854,539 $ 510,060,438
============= =============
</TABLE>
Footnotes on following page
27
<PAGE> 30
- ---------------
(a) Our unaudited pro forma balance sheet data as of December 31, 1999 gives
effect to the reorganization as if it occurred on January 1, 1999. The
unaudited pro forma balance sheet was derived by adjusting Pathnet's
historical balance sheet as of December 31, 1999 to reflect the transaction
described below:
- Contribution of over 12,000 route miles of rights of way with an
estimated value of $187 million for 8,511,607 shares of our series D
preferred stock;
- Receipt of $38 million in cash at the initial closing for 1,729,631
shares of our series E preferred stock. Another $25 million in cash
(which is excluded from our above pro forma balance sheet data) will be
received in exchange for 1,137,915 shares of our series E preferred stock
(conditioned upon the completion of a fiber optic network segment build
that we expect to complete during the second calendar quarter of 2000);
- Exchange of 2,977,593 shares of outstanding Pathnet common stock for
2,977,593 shares of our common stock;
- Exchange of 5,470,595 shares of Pathnet mandatorily redeemable preferred
stock into 15,864,715 shares of our convertible preferred stock;
- Receipt of $1 million in cash for options to purchase 1,593,082 shares of
our series E preferred stock at $21.97 per share and shares of our common
stock at an initial public offering;
- Receipt of $4 million in cash for our sale to Colonial of rights in a
specified number of conduit miles of our future network;
- Receipt of $275,000 in rights of way for our sale to CSX of rights in a
specified number of conduit miles of our future network; and
- Pathnet's payment of a 2.5% consent fee to holders of the notes (assuming
all holders of notes consent to our reorganization) of approximately $8.8
million.
See "DESCRIPTION OF OUR REORGANIZATION" included elsewhere in this
prospectus.
(b) Cash, cash equivalents and marketable securities include investments in
marketable securities available for sale.
(c) We have not included unaudited pro forma statement of operations information
to give effect to our reorganization as if it occurred on January 1, 1999.
An unaudited pro forma statement of operations would reflect only
amortization expense of approximately $939,000 of deferred financing cost
attributable to the consent fee that we plan to pay in connection with our
reorganization and approximately $2,878,000 of anticipated transaction
costs, of which $2,398,000 will be expensed as incurred and the remainder
offset against the carrying value of the series D and series E preferred
stock. The deferred financing cost will be amortized and charged to interest
expense over the remaining life of the notes. Generally, we do not begin
amortizing rights of way used in our network until the network is completed
and available for use. As of December 31, 1999, none of the rights of way
contemplated by our reorganization were used in our fiber optic network.
Because the amortization of the deferred financing cost and expensed
transaction costs would have represented the only pro forma adjustments to
the statement of operations data, we have not presented unaudited pro forma
statement of operations data. Instead, we have adjusted our pro forma
deficit accumulated during the development stage to account for these
expenses.
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<PAGE> 31
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
We present below selected historical consolidated financial information for
Pathnet and the pro forma balance sheet data for Pathnet Telecom. The summary
historical statements of operations data for the years ended December 31, 1997,
1998 and 1999 and for the period from August 25, 1995 (the date of Pathnet's
inception) to December 31, 1999 and the summary historical balance sheet data as
of December 31, 1998 and 1999 have been derived from Pathnet's audited financial
statements that are included elsewhere in this prospectus. The summary
historical statements of operation data for the period from August 25, 1995
(date of inception) to December 31, 1995 and for the year ended December 31,
1996 and the balance sheet data as of December 31, 1995, 1996 and 1997 have been
derived from Pathnet's audited financial statements that are not included
elsewhere in this prospectus. The unaudited pro forma balance sheet data as of
December 31, 1999 gives effect to our reorganization as if it occurred on
January 1, 1999. We have provided the unaudited pro forma balance sheet data for
informational purposes only.
<TABLE>
<CAPTION>
PATHNET
-------------------------------------------------------------------------------------------
PERIOD FROM PERIOD FROM
AUGUST 25, 1995 AUGUST 25, 1995
(DATE OF YEAR ENDED (DATE OF
INCEPTION) TO DECEMBER 31, INCEPTION) TO
DECEMBER 31, ------------------------------------------------------- DECEMBER 31,
1995 1996 1997 1998 1999 1999
--------------- ----------- ----------- ------------ ------------ ---------------
<S> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Revenue............................. $ -- $ 1,000 $ 162,500 $ 1,583,539 $ 3,311,096 $ 5,058,135
---------- ----------- ----------- ------------ ------------ -------------
Operating expenses:
Cost of revenue................... -- -- -- 7,547,620 12,694,909 20,242,529
Selling, general and
administrative.................. 429,087 1,333,294 4,247,101 9,615,867 14,669,747 30,295,096
Reorganization expenses........... -- -- -- -- 1,022,998 1,022,998
Depreciation and amortization
expense......................... 352 9,024 46,642 732,813 6,204,381 6,993,212
---------- ----------- ----------- ------------ ------------ -------------
Total operating expenses............ 429,439 1,342,318 4,293,743 17,896,300 34,592,035 58,553,835
---------- ----------- ----------- ------------ ------------ -------------
Operating loss...................... (429,439) (1,341,318) (4,131,243) (16,312,761) (31,280,939) (53,495,700)
Interest expense(a)................. -- (415,357) -- (32,572,454) (41,010,069) (73,997,880)
Interest income..................... 2,613 13,040 159,343 13,940,240 13,111,953 27,227,189
Write off of initial public offering
costs............................. -- -- -- (1,354,534) -- (1,354,534)
Other income (expense), net......... -- -- (5,500) 2,913 142,743 140,156
---------- ----------- ----------- ------------ ------------ -------------
Net loss............................ $ (426,826) $(1,743,635) $(3,977,400) $(36,296,596) $(59,036,312) $(101,480,769)
========== =========== =========== ============ ============ =============
Basic and diluted loss per common
share............................. $ (0.15) $ (0.60) $ (1.37) $ (12.51) $ (20.14)
Weighted average number of common
shares outstanding................ 2,900,000 2,900,000 2,900,000 2,902,029 2,931,644
OTHER FINANCIAL DATA (UNAUDITED):
Ratio of earnings to fixed
charges........................... <1 <1 <1 <1 <1
Deficiency of earnings to fixed
charges........................... $ (426,826) $(1,743,635) $(3,977,400) $(36,658,917) $(62,626,459)
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------------------------------
1995 1996 1997 1998 1999
---- ----------- ----------- ------------ ---------------------------
HISTORICAL PRO FORMA(b)
------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and marketable
securities (excluding marketable
securities pledged as collateral)(c).... $ 82,973 $ 2,318,037 $ 7,631,384 $227,117,417 $138,402,131 $170,448,726
Property and equipment, net............... 8,551 46,180 7,207,094 47,971,336 131,928,365 131,928,365
Intangible assets -- rights of way........ -- -- -- -- -- 187,275,006
Total assets.............................. 91,524 2,365,912 16,097,688 365,414,129 320,535,987 547,188,488
Long-term obligations(d).................. -- -- -- -- 349,714,404 353,989,404
Total liabilities......................... 17,350 145,016 5,892,918 366,492,370 380,303,073 383,749,675
Redeemable preferred stock................ 500,000 4,008,387 15,969,641 35,969,639 35,969,639 37,871,959
Stockholders' equity (deficit)(e)......... $(425,826) $(1,787,471) $(5,764,871) $(37,047,880) $(95,736,725) $125,566,854
</TABLE>
29
<PAGE> 32
- ---------------
(a) The 1996 expense relates to the beneficial conversion feature of a loan at
December 31, 1996.
(b) Our unaudited pro forma balance sheet data as of December 31, 1999 gives
effect to our reorganization as if it occurred on January 1, 1999. The
unaudited pro forma balance sheet was derived by adjusting Pathnet's
historical balance sheet as of December 31, 1999 to reflect the transaction
described below.
- Contribution of over 12,000 route miles of rights of way with an
estimated value of $187 million for 8,511,607 shares of our series D
preferred stock;
- Receipt of $38 million in cash at the initial closing for 1,729,631
shares of our series E preferred stock. Another $25 million in cash
(which is excluded from our above pro forma balance sheet data) will be
received in exchange for 1,137,915 shares of our series E preferred stock
(conditioned upon the completion of a fiber optic network segment build
that we expect to complete during the second calendar quarter of 2000);
- Exchange of 2,977,593 shares of outstanding Pathnet common stock for
2,977,593 shares of our common stock;
- Exchange of 5,470,595 shares of Pathnet mandatorily redeemable preferred
stock into 15,864,715 shares of our convertible preferred stock;
- Receipt of $1 million in cash for options to purchase 1,593,082 shares of
our series E preferred stock at $21.97 per share and shares of our common
stock at an initial public offering;
- Receipt of $4 million in cash for our sale to Colonial of rights in a
specified number of conduit miles of our future network;
- Receipt of $275,000 in rights of way for our sale to CSX of rights in a
specified number of conduit miles of our future network; and
- Pathnet's payment of a 2.5% consent fee to holders of the notes (assuming
all holders of notes consent to our reorganization) of approximately $8.8
million.
See "DESCRIPTION OF OUR REORGANIZATION" included elsewhere in this
prospectus.
(c) Cash, cash equivalents and marketable securities include investments in
marketable securities available for sale.
(d) Long-term obligations include other noncurrent liabilities of $3,092,779
(e) We have not included unaudited pro forma statement of operations information
to give effect to our reorganization as if it occurred on January 1, 1999.
An unaudited pro forma statement of operations would reflect only
amortization expense of approximately $939,000 of deferred financing cost
attributable to the consent fee that we plan to pay in connection with our
reorganization and approximately $2,878,000 of anticipated transaction
costs, of which $2,398,000 will be expensed as incurred and the remainder
offset against the carrying value of the series D and series E preferred
stock. The deferred financing cost will be amortized and charged to interest
expense over the remaining life of the notes. Generally, we do not begin
amortizing rights of way used in our network until the network is completed
and available for use. As of December 31, 1999, none of the rights of way
contemplated by the our reorganization were used in our fiber optic network.
Because the amortization of the deferred financing cost and expensed
transaction costs would have represented the only pro forma adjustments to
the statement of operations data, we have not presented unaudited pro forma
statement of operations data. Instead, we have adjusted our pro forma
stockholders' equity (deficit) to account for these expenses.
30
<PAGE> 33
BUSINESS
You should assume, for the purposes of this section, that all references to
our business, strategies, plans or conditions affecting us prior to the date of
this prospectus are references to Pathnet's business, strategies, plans or
conditions affecting Pathnet. Unless we indicate otherwise, references to our
current or future business, strategies or plans are references to our
consolidated business, strategies or plans, including Pathnet and our other
future subsidiaries. We are providing information regarding Pathnet's past and
future business, strategies, plans and conditions affecting Pathnet because
Pathnet will be our wholly owned subsidiary, and we will be assuming many of
Pathnet's assets and obligations, immediately following the closing of our
reorganization.
OVERVIEW
We are a wholesale telecommunications provider building a nationwide
network designed to provide other wholesale and retail telecommunications
service providers with access to underserved and second and third tier markets
throughout the United States. We have partnered with owners of
telecommunications assets, including utility, pipeline and railroad companies,
to upgrade and aggregate wireless infrastructure to a microwave network using
high capacity synchronous optical network technology, also known as "SONET".
Through 1998, we signed agreements with eight such incumbents and had over 6,000
miles of wireless network under development.
In early 1999, we expanded the scope of our business strategy to include
fiber optic technology to enable us to deliver to our customers -- including
long distance companies, existing local telephone companies, internet service
providers, competitive telecommunications companies, cellular operators and
other telecommunications service providers -- high capacity services as well as
dark fiber and fiber optic strands that have some but not all of the electronics
required to transmit voice or data signals. "Dark fiber" consists of fiber
strands contained within a fiber optic cable which has been laid out but does
not yet have its transmission electronics installed. Our network will enable our
customers, to offer additional services to new and existing customers in these
markets without having to expend their own resources to build, expand, or
upgrade their own networks. In addition to serving unique markets, our network
will be differentiated by both its:
- Ability to provide a complete access solution in our target markets,
including collocations in telephone company central offices and intercity
transport, and
- Advanced network architecture that will allow our customers to offer the
latest voice, video, and data services across a single network at very
high speeds.
We expect our nationwide network to grow to approximately 20,000 route
miles utilizing fiber and SONET microwave. We intend to continue to develop our
backbone on a "smart build" basis by prioritizing route development along
corridors with high demand for dark fiber and conduit or partnering with
established companies in the joint development of those routes. We expect our
network will terminate in central offices in our target markets where we intend
to collocate and use existing local telephone company unbundled network elements
or other third party local network assets in the provision of service to our
customers.
As of December 31, 1999, our network consisted of over 6,300 wireless route
miles, providing wholesale transport services to 30 cities, and 500 route miles
of installed fiber. We are constructing an additional 600 route miles of fiber
network, which is scheduled for completion in the first half of 2000. We have
also entered into two additional co-development agreements for the construction
of an additional 750 route miles of fiber optic network. We expect to develop
additional backbone network from a pool of over 12,000 route miles of right of
way received in our reorganization -- 8,000 of which will have some form of
exclusivity. These additional route miles will provide us with the
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<PAGE> 34
opportunity to develop unique and diverse paths connecting our target markets
back to major tier one metropolitan areas.
In addition to building our network backbone, since inception we have:
- Obtained state regulatory certification or otherwise been authorized to
provide our planned telecommunications services in 15 states, with
applications pending in an additional 6 states, which will allow us to
obtain unbundled network elements from the existing local telephone
companies (we have also obtained certification in Illinois, conditioned
on the closing of our reorganization);
- Executed interconnection agreements with three existing local telephone
companies: US West, Ameritech and Southwestern Bell;
- Executed agreements providing for collocations with US West and
BellSouth;
- Launched our "alliance program" under which we expanded our virtual
network to reach additional markets by reselling portions of two other
carriers' networks;
- Signed master service agreements with the three largest U.S. long
distance companies;
- Completed our fully operational network operations center, providing
twenty-four hours a day, seven days-a-week coverage; and
- Entered into a long-term lease of specific strands of fiber optic cable
or conduit on an "indefeasible right to use" basis (sometimes referred to
as an IRU), for a portion of our dark fiber capacity on our fiber route
currently being constructed from Chicago to Aurora (a suburb of Denver),
Colorado.
MARKET OPPORTUNITY
INDUSTRY OVERVIEW
We believe that the following five factors create a substantial market
opportunity for our products and services:
- Increasing demand for high capacity access and transport services to
accommodate unprecedented consumer demand for internet access and related
services;
- Growing disparity, sometimes referred to as the "digital divide," between
telecommunications services available in the largest markets and those
services available in second and third tier markets due to our
telecommunications service provider customers' nearly exclusive focus of
resources and product offerings on first tier domestic and global
markets;
- Rapid development of new technologies such as digital subscriber line
technology that allow carriers to exploit existing local network
infrastructure to deliver multiple media (including voice, data, video
and internet) at high speed over a single physical local access
connection to a network;
- Rapid migration from circuit-based network architectures to fast
packet-based network technologies that allow for the efficient
integration of multiple customers across a common backbone network
infrastructure; and
- Adoption of the Telecommunications Act and certain state regulatory
initiatives that provide increased opportunities in the
telecommunications marketplace by opening local markets to competition
and requiring existing local telephone companies to provide additional
direct interconnection and collocation to their competitors.
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<PAGE> 35
We intend to exploit these developments and employ emerging convergent
technologies in the deployment of our backbone network and local access
platform. We believe the emergence and acceptance of advanced
convergence-supporting technologies at the user premise will significantly
increase our abilities to provide low cost solutions to our carrier customers in
underserved and second and third tier markets that have been overlooked by other
emerging telecommunications service providers.
ADDRESSABLE MARKET
We worked with The Yankee Group on an addressable market study for the
products and services we expect to bring to the marketplace in the near term.
The study found that the communications market is currently a $270 billion
market in the U.S. and is expected to grow at over 10% annually for the next
five years. According to The Yankee Group, the sections of the market that we
expect to address -- backbone infrastructure services, inter-city and local
wholesale transport services and local access services -- are among the most
rapidly growing components of the current telecommunications landscape which The
Yankee Group forecasts to grow at approximately 18% annually for the next five
years. The Yankee Group estimates that the addressable market for these products
and services in the United States was $30 billion in 1999, expanding to $80
billion by 2005.
We plan to serve second and third tier markets with populations between
600,000 and 50,000, of which there are over 200, with backbone infrastructure
services, long distance network wholesale transport and local access services.
We also expect to capture a portion of the long distance network wholesale
transport services segment between first tier markets with populations over
600,000. We estimate that the addressable market for these products and services
was $13 billion in 1999, growing to $27 billion in 2004.
BUSINESS STRATEGY
Our business objective is to become the preferred facilities-based
wholesale telecommunications provider to customers in our target markets. To
achieve this goal, we plan to:
- Concentrate our focus on the needs of telecommunications service
providers and their customers;
- Focus on underserved and second and third tier markets;
- Enter and roll-out service rapidly in our target markets;
- Design, build and acquire a low-cost network;
- Provide superior customer service and service quality; and
- Pass to our customers savings from the deployment of our local network
access program.
Each of these strategies is discussed in more detail below:
- CONCENTRATE OUR FOCUS ON THE NEEDS OF TELECOMMUNICATIONS SERVICE
PROVIDERS AND THEIR CUSTOMERS. Our customers are companies in the
business of selling communications services to end user customers. We
believe that these companies are investing considerable sums to connect
as many customers as possible to keep pace with the rapidly evolving
telecommunications marketplace and that these carriers would like to find
the means to maximize the return on their investments and deployment of
resources. We further believe that these challenges are magnified when
they consider serving customers in second and third tier markets. Very
few of these telecommunications service providers operate at a scale that
justifies significant investment in building their own network in smaller
markets. The alternative -- re-selling networks of existing local
telephone companies -- has limited appeal because it can be
33
<PAGE> 36
expensive and, in many cases, the network components of existing local
telephone companies lack the broadband capabilities that these
telecommunications service providers need to compete effectively in the
marketplace. We believe that our customers will be able to effectively
"timeshare" our products and services. This will enable them to access
second and third tier markets to serve their customers without incurring
high capital expenditures, or many of the franchising and licensing fees
and long lead times that are usually associated with building their own
networks and establishing a meaningful local collocation presence in
these markets.
- FOCUS ON UNDERSERVED AND SECOND AND THIRD TIER MARKETS. We plan to serve
second and third tier markets with populations between 600,000 and
50,000, of which there are over 200, as well as a portion of the first
tier markets with populations over 600,000. We believe our customers will
value our backbone network because, for the most part, it will be built
along unique rights of way offering route separation and diversity in the
event of a network system failure. Also, unlike other backbone networks
that bypass second and third tier markets, we will construct and design
our backbone to interconnect into these markets. We seek to be among the
first to market advanced wholesale transport and local access services in
many of our markets. By pioneering in second and third tier markets, we
hope to capitalize on escalating demand for high capacity services that
is a product of the current unprecedented demand for Internet access and
related services.
- ENTER AND ROLL OUT SERVICE RAPIDLY IN OUR TARGET MARKETS. We seek to
become the first emerging carrier to enter and roll out our products and
services broadly in our targeted underserved and second and third tier
markets by:
- Securing central office space before our competitors do;
- Obtaining and retaining customers before significant competition for
our products and services in these markets arises; and
- Maintaining advantages over our competitors by offering superior
coverage and high customer satisfaction.
- DESIGN, BUILD AND ACQUIRE A LOW-COST NETWORK. Consistent with our
conservative capital expenditure program, one of our key strategies since
inception has been to establish strategic relationships with owners of
existing telecommunications infrastructure, to reduce our capital costs
and time to market. As of December 31, 1999, we had entered into
strategic relationships with eight companies who have provided the
foundation for our existing 6,300-route mile wireless network. We have
also entered into three co-development agreements relating to the
construction of 1,850 fiber route miles. After completing our
reorganization through our strategic relationships with BNSF, CSX and
Colonial, we will have access to over 12,000 miles of valuable rights of
way, 8,000 miles of which will have some form of exclusivity.
We are developing our network using a "smart build" approach. Under this
approach, we attempt to reduce the risk of building our network by
obtaining one or more co-development partners to share in the costs. We
also determine the level of customer demand before construction by
obtaining direct customer input regarding the attractiveness of a route.
In certain cases, we enter into pre-construction sales of (or, where
appropriate, grant indefeasible rights to use) dark fiber and conduit. As
a result, we expect that the cost of our retained nationwide backbone
network will be significantly less than a comparable network built or
acquired at market rates. We intend to continue this low cost approach in
providing our local access services. We plan to secure status as a
"competitive telecommunications company," which is a category of
telephone service provider that offers services similar to the former
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<PAGE> 37
monopoly local telephone company, in each state where we provide service
and we anticipate signing interconnection agreements with all of the
relevant existing local telephone companies. Under these interconnection
agreements we can construct our microwave tributary routes directly to
the existing local telephone company's switching station, which allows us
to use the existing switching station as a location that serves as a
focal point for our network where transmission or switching equipment is
usually installed, or "point of presence," in the market, and avoid the
cost of separate facilities. This will enable us to obtain and use
unbundled network elements from the existing local telephone companies at
favorable rates and terms, including space in the existing local
telephone company's switching stations that is necessary to establish our
collocations.
- PROVIDE SUPERIOR CUSTOMER SERVICE AND SERVICE QUALITY. As part of our
strategy to obtain and retain business and telecommunications service
provider customers, we intend to provide superior service and customer
care. We will aim to provide high quality services by offering what we
believe to be state-of-the-art networking solutions and superior customer
service. These networking solutions include end-to-end proactive network
monitoring and management through our network operations center, 24 hours
a day, seven days-a-week. We also offer multiple security features and we
have completed implementing our Year 2000 readiness program to ensure
that our networks and systems are Year 2000 compliant. See "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- Year 2000 Readiness Disclosure." We plan to provide
superior customer service to promote a high level of customer
satisfaction, achieve customer loyalty and accelerate the use of our
products and services. In addition, we have, and will continue to
install, a technologically advanced network that we believe provides the
high level of reliability, security and flexibility that our customers
demand. Our fiber and wireless network is designed to meet industry
standards for delivering network reliability of 99.999% per network
segment. We are installing management systems to measure network
reliability, but these systems have not yet been implemented. We cannot
be sure what our actual reliability figures are until the installation of
these management systems is complete.
- PASS TO OUR CUSTOMERS SAVINGS FROM THE DEPLOYMENT OF OUR LOCAL NETWORK
ACCESS PLATFORM. We plan to deploy a convergent local network access
platform. In other words, we intend to combine, or enable the combination
of, all multiple customer applications onto a single physical local
access connection, which will travel on our fast packet-based capable
backbone infrastructure. Using this convergent platform we believe that
our telecommunications service provider customers will be able to launch
their own services to better serve their end user customers.
PROJECTED DEVELOPMENT OF BUSINESS PLAN
With the funds and other assets received in our reorganization, and
additional equity financings, we plan to complete the first phase of our long
term business plan. Our long term business plan calls for us to develop an
approximately 20,000 mile network and provide services to over 200 second and
third tier markets. In the first phase of this plan we expect to complete
development of approximately 12,500 route miles of network and approximately 400
collocations by the end of 2002. We have not yet scheduled or developed the
phase-specific financial models for the remaining phases of our long term
business plan. The timing of these subsequent phases will ultimately depend upon
overall telecommunications market conditions, the availability of alternative
sources of network and customer demand in our target markets, construction
costs, and our capital resources. We plan to complete the schedule and financial
planning for the next phase of our long term business plan before the end of
35
<PAGE> 38
2002. We project the development of our network and associated physical
collocations through June 30, 2001 to be as follows:
<TABLE>
<CAPTION>
PROJECTED
PROJECTED PHYSICAL PROJECTED
NETWORK MILES COLLOCATIONS CITIES
------------- ------------ ---------
<S> <C> <C> <C>
As of December 31, 1999......................... 6,800 40 30
End of Second Quarter 2000...................... 7,600 85 50
End of Fourth Quarter 2000...................... 9,100 150 80
End of Second Quarter 2001...................... 10,500 230 120
</TABLE>
We will draw on the following sources of cash to fund the first phase of
our long term business plan:
- our current cash resources;
- the anticipated proceeds (after associated expenses) from both tranches
of Colonial's investment in our shares of series E convertible preferred
stock as part of our reorganization;
- borrowings under senior secured vendor financing that we propose to
execute in connection with the purchase of fiber optic cable and
associated network equipment;
- payments from our co-development partners and sales to infrastructure and
telecommunications services customers; and
- additional equity investment(s) of at least $100 million.
Based on our projected development costs, we believe that these resources
will be sufficient to satisfy the anticipated cash requirements (including both
network development and operating losses) of the first phase of our long term
business plan through its completion at the end of 2002. However, we will
require additional resources to fund the remaining phases of our current long
term business plan, and cannot assure you that these projections will prove to
be accurate or that our development costs will not exceed those that we
currently anticipate.
STRATEGIC RELATIONSHIPS
FIBER CO-DEVELOPMENT PARTNERS
WORLDWIDE FIBER. In March 1999, we entered into a co-development agreement
with Worldwide Fiber, Inc. for the design, engineering and construction by
Worldwide Fiber of a multiple conduit fiber-optic system. One of the conduits
will contain a fiber optic cable consisting of a specified number of fiber optic
strands. The conduits and any installed strands will be equally divided between
Pathnet and Worldwide Fiber, and the costs to construct the route will be shared
equally by the parties. In addition, Pathnet will pay Worldwide Fiber a
management fee equal to 10% of Pathnet's share of the development costs. The
system will be approximately 1,100 route miles long, between Aurora, Colorado (a
suburb of Denver) and Chicago, Illinois. The first segment, Chicago to Omaha,
Nebraska, was completed in the fourth quarter 1999, and the second segment,
Omaha to Aurora, is scheduled to be completed by the end of the second quarter
of 2000. In connection with the co-development agreement, we entered into a
joint marketing agreement with Worldwide Fiber under which both Worldwide Fiber
and we will attempt to sell certain inactive fiber optic strands on the route,
and will share the revenues from such sales. The joint marketing agreement also
permits each party to retain fiber optic strands for its own use, subject to
certain restrictions on resale, and to swap a certain number of fiber optic
strands to third parties.
TRI-STATE. In August 1999, we entered into a co-development agreement with
Tri-State Generation and Transmission Association, Inc. and four regional
electric cooperatives for our design, engineering and construction of an aerial
fiber system, approximately 420 route miles long, between Albuquerque, New
Mexico and Grand Junction, Colorado. This system, constructed on power
36
<PAGE> 39
transmission lines, will contain a specified number of fiber optic strands. The
costs to construct the system will be borne equally between Pathnet and the
other parties. In connection with the co-development agreement, we entered into
a joint marketing agreement under which each party will reserve a portion of the
fiber strands for its own operations, a subset of which will be available for
swaps with third parties. The remaining fiber strands will be jointly sold, with
Pathnet as the exclusive marketing agent. Any revenues derived from the sale of
those fiber strands will be shared equally between Pathnet and Tri-State, after
deduction of a Pathnet marketing fee. We expect this system to be completed in
the second half of 2000.
ALLIANCE PROGRAM. We have entered into capacity purchase agreements with
two other carriers, IXC and Frontier, enabling us to resell capacity on their
networks. This allows us to extend our network reach to points-of-presence, or
POPs, where transmission or switching equipment is usually installed, throughout
the markets reached by Frontier's and IXC's networks and pre-sell capacity along
routes we intend to develop.
WIRELESS CO-DEVELOPMENT PARTNERS
FIXED POINT MICROWAVE SERVICES AGREEMENTS. We have entered into several
fixed point microwave services agreements with co-development partners who own
existing wireless telecommunications assets. Typically, under these agreements
we lease an interest in the co-development partner's sites and facilities on
which our network is built and in return we provide the co-development partner
with capacity on such network for its own internal use. We also typically pay
the co-development partner a portion of the revenue derived from our selling the
excess communications capacity on that co-development partner's route.
Generally, the co-development partner receives up to 20% of the revenues earned
after the systems have been in place for 48 months. In addition, these
agreements generally require the co-development partner to make capital
investments toward the upgrade of its system infrastructure to make it suitable
for installation of the equipment used in our digital network which, in most
cases, includes significant modifications to structures, towers, battery plants
and equipment shelters. These agreements generally provide for a five or ten
year term that is subject to renewal by us upon the occurrence of certain
events, for up to a 25-year term. As of the date of this prospectus, we had
entered into fixed point microwave services agreements with these co-development
partners:
- Idaho Power Company;
- Northern Indiana Public Service Company;
- The Burlington Northern and Santa Fe Railway Company;
- Kinder Morgan, Inc. (formerly KN Energy, Inc.);
- Kinder Morgan, Inc. (formerly KN Telecommunications, Inc.);
- Texaco Pipeline, Inc.;
- Northern Border Pipeline Company; and
- Northeast Missouri Electric Power Cooperative.
TOWER LEASE AGREEMENTS. We entered into a leasing arrangement with
American Tower Corporation under which American Tower granted us a 25-year
license to use certain of its towers to deploy several wireless portions of our
network.
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<PAGE> 40
PRODUCTS AND SERVICES
We plan to offer the following products and services:
- DARK FIBER AND CONDUIT FOR SALE OR GRANT OF LONG TERM LEASES. We sell
rights for dark fiber and related services as well as rights to conduit.
A sale or grant of an indefeasible right to use our dark fiber typically
has a term which approximates the economic life of a fiber optic strand
(generally 20 to 30 years). Purchasers of dark fiber rights typically
install their own electrical and optical transmission equipment.
Substantially all of our current and planned builds include laying spare
conduits, and we may sell rights to use them. A purchaser of conduit
rights typically lays its own cable inside the conduit. Related services
for both sales of rights for dark fiber and conduits may include
installation of customer equipment at the locations where we have
installed transmission equipment and network equipment and maintenance of
the purchased fiber or conduit. Generally, we expect our customers to pay
for dark fiber rights and conduit at the time of delivery and acceptance
of the fiber or conduit, although other payment options may be available.
In addition, depending upon the nature of our contractual terms, we will
treat our sales of dark fiber and conduit as sales-type leases or
operating leases. The impact of recently adopted accounting
pronouncements are described more fully in "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL AND OPERATING DATA." We typically require our
customers to make ongoing payments for maintenance services.
- DARK FIBER FOR LEASE OR LEASE TO PURCHASE. We will also lease dark fiber
for a term less than the period for which the indefeasible usage rights
are typically granted. Leases will be typically structured with monthly
payments over the term of the lease. Generally, we expect to realize a
premium in lease pricing for bearing the risk that the lease will not be
renewed for the balance of the life of the asset. We plan to offer
customers the option to lease to purchase.
- WAVELENGTH LEASE. In our network, we intend to use "dense wavelength
division multiplexing," or DWDM, a technology that allows multiple
optical signals to be combined so that they can be aggregated as a group
and transported over a single fiber to increase capacity. This will allow
us to sell a customer exclusive long-term use of a portion of the
transmission capacity of a fiber optic strand rather than the entire
strand. We expect that the installation of the necessary transmission
equipment to provide these services along our first completed fiber route
from Chicago to Denver will be complete in the first half of 2000. We
expect to be able to derive up to 160 individual wavelength channels at
either OC-48 or OC-192 per fiber pair. "OC" is a measure of digital
transmission speed, and is equal to the corresponding number of DS-3s.
For example, OC-48 is equal to 48 DS-3s. In turn, "DS" is a standard
telecommunications industry digital signal speed that is distinguishable
by the relative number of binary digits transmitted per second.
- INTER-CITY WHOLESALE TRANSPORT SERVICES. Our inter-city transport
services are focused on second and third tier markets and are comprised
of point-to-point services offered as Time Division Multiplexing, or TDM,
which is an electronic process that combines multiple communication
channels into a single, higher-speed channel by interleaving portions of
each in a consistent manner over time-based private dedicated
telecommunications link between different customer locations, or private
lines, at high speed including DS-1, DS-3, OC-3, OC-12, OC-48 and OC-192.
We believe that our services will be particularly attractive to our
customers because of our low cost backbone transport and low cost "local
loops," which are the physical wires that run from the end user's
telephone to the existing local telephone company's central office
(attributable to our collocation in the existing local telephone
company's central office and our use of unbundled network element
transport). We believe that we offer more flexible commitment levels with
higher reliability than are currently available on traditional
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multiplexed services. As of December 31, 1999, we offered inter-city
wholesale transport services on our 6,300 route mile-wireless network as
well as via our Alliance Program.
- LOCAL WHOLESALE TRANSPORT SERVICES. Once we establish collocation in the
central offices of existing local telephone companies in second and third
tier markets, we believe that we will be able to deliver local transport
between central offices or to connect those central offices to our
backbone or a telecommunications service provider customer backbone. We
plan to offer local transport services, such as xDSL-based private lines
or TDM-based private lines at high rates of speed including DS-0, DS-1,
DS-3, OC-3, OC-12, OC-48. We expect our customers to use these services
to reduce charges for inter-office transport or to provide end office
trunking.
- LOCAL ACCESS SERVICES. We plan to deliver our local access services from
network presences we have established by collocating with the existing
local telephone companies in second tier and third tier markets and
through the local networks we have established using a combination of
unbundled network elements and other network components from other
communications carriers.
- VIRTUAL POINTS OF PRESENCE (VPOP). We plan to bundle our wholesale
transport services and local access services to offer our "virtual points
of presence" service, sometimes referred to as VPOP. Through this bundle
of services, we intend to offer our customers the ability to establish a
virtual point of presence for their networks using our facilities, thus
avoiding the need to place any equipment at a collocation site. We will
focus this VPOP service on second and third tier markets. We expect that
our VPOP service will allow our customers to virtually extend the reach
of their networks while expending less resources and incurring far less
risk than if that customer had expanded and built its own network.
SALES AND MARKETING STRATEGY
Our wholesale customers tend to be very knowledgeable about the nature of
the services and technology available in the marketplace. As a result, our
marketing efforts are largely limited to ensuring that our products and services
are visible and well represented in the market. As part of our marketing
strategy, we attempt to position ourselves as the provider of choice for
telecommunication service providers because of the quality of our service, the
control we provide customers over their service platforms, the reliability of
our services and our low cost position. We believe our cost advantages allow us
to sell our services on our network at prices that represent potentially
significant savings for our large-volume customers relative to their other
alternatives.
We sell our services to large regional and national telecommunications
service providers through our direct sales team on a national account basis.
Since we sell primarily to other telecommunications service providers, we expect
that our sales and marketing department will remain relatively small and
focused, resulting in strong customer relationships and lower operating costs.
Our sales team consists of senior level management personnel and experienced
sales representatives with extensive knowledge of the industry and our products.
This team also has key industry contacts at various levels within many
telecommunications service provider organizations.
CUSTOMERS
We have defined a range of products and services designed to meet the
unique needs of our customers and, as a result, we intend to offer several types
of services to these types of customers:
- Full service long distance companies: we intend to provide low cost
digital subscriber line-based transport, used to deliver broadband
access. We expect to provide lower cost access and short haul transport
to reduce the cost of delivering traditional voice, private line or data
services;
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- Competitive telecommunications companies and competitive long distance
companies: we can extend reach to new markets by providing a more
efficient means for competitive telecommunications companies to originate
or terminate voice traffic and a lower cost source of inter-city
wholesale transport or infrastructure services;
- Internet service providers: we intend to offer low cost digital
subscriber line technology to deliver broadband access. We expect to be
able to extend Internet service providers' reach to new markets. We plan
to provide low cost infrastructure services and wholesale transport
services. We expect to provide direct access to the locations at which
Internet service providers exchange each other's traffic.
- Existing local telephone companies: we expect to provide lower cost
network services within the existing local telephone company's own region
and wholesale transport services and local access services out of region
as existing telephone companies become permitted to provide these
services;
- Wireless and cable providers (including cellular companies): we plan to
provide backhaul services, head end distribution services and wholesale
transport services; and
- Other telecommunications service providers: we expect to provide low cost
termination for switched traffic.
THE PATHNET NETWORK
BACKBONE NETWORK
We plan to create an approximately 20,000 route mile nationwide network.
Tributaries using either fiber or wireless technology will connect our backbone
to our targeted markets. We believe that connecting the second and third tier
markets to a national backbone is the key to funneling traffic between these
markets and first tier markets.
NETWORK ROUTE SELECTION AND SMARTBUILD APPROACH. In order to utilize
capital effectively, we employ a "smart-build" approach. This means that we seek
to reduce our risks in undertaking the build by:
- Obtaining one or more co-development partners to share in the costs;
- Determining the levels of customer demand before construction (by
obtaining direct customer input on the route); and
- In certain cases, seeking to effect pre-construction leases or sales of
dark fiber and conduit.
Before deciding to construct or acquire a network to serve particular
markets, we review the demographic, economic, competitive and telecommunications
demand characteristics of the markets along proposed routes, including their
location, the concentration of potential business, government and institutional
end-user customers, the economic prospects for the area, available data
regarding transport demand and actual and potential competitive
telecommunications company competitors. We estimate market demand on the basis
of market research performed by us and others, utilizing a variety of data
including estimates of the number of interstate access and intrastate private
lines in the market based primarily on FCC reports and commercial databases.
We expect to enter into a co-development relationship with one or more
partners to share the costs of building the route as well as the dark fiber
revenue from each constructed route. We recently employed this approach in
developing our fiber routes from Chicago to Aurora (a suburb of Denver,
Colorado), and from Albuquerque, New Mexico to Grand Junction, Colorado with our
partners, Worldwide Fiber and Tri-State. Typically, independent contractors
selected through a competitive bidding process provide our construction and
installation services. In certain of our network builds, we
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provide project management services, including contract negotiation and
supervision of the construction, testing and certification of our facilities.
FIBER CURRENCY, SWAPS AND ACQUISITIONS. When determining the fiber optic
cable and conduit sizing for a particular route, we take into account these
considerations:
- Fiber strands required for our retained network;
- Fiber strands required by our co-development partner's network;
- Projected sales of fiber strands and conduits along the route;
- Quantity of fiber strands to be retained and allocated for swaps to
obtain fiber strands on routes owned by others; and
- Retained empty conduit in the event we desire to deploy different or
advanced technologies.
We believe fiber has a "currency" value depending upon the value of the
route to specific telecommunications service providers. Once we determine a
particular route has a high currency value, we expect to capitalize on this by
using excess fibers and conduit to enable advantageous fiber swaps and sales of
fiber and conduit. If we determine that a particular route is being sufficiently
served by existing fiber, we will not build our own network along that route.
Instead we will use our fiber "currency" to swap for existing fiber along those
routes or we will enter into long term leases for (or purchase indefeasible
rights to use) dark fiber that is already installed by another company. In this
way, swaps will allow us to leverage our network, gain more geographical
coverage and decrease our time to market.
In order to connect our network with our customers, we develop
interconnections from our backbone network into our targeted underserved and
second and third tier markets. We design and install our interconnections using
the most cost effective technology to meet the market's needs. This may include
building fiber optic cable, leasing or purchasing rights to use existing fiber,
installing wireless components, or employing combinations of these technologies.
LOCAL ACCESS CONVERGENT PLATFORM
We believe establishing a local presence in our target markets will
position us to deploy a convergent local network access platform that will
enable multiple customer applications to be combined at a single physical local
access connection and then travel onto our advanced, fast packet-based backbone
infrastructure. From this convergent platform, we expect to enable our
telecommunications service provider customers to launch their own services to
better serve their customers.
We intend to obtain state certification or authorization as a competitive
telecommunications company in each state in which we are required to do so, and
to sign interconnection agreements with the relevant existing local telephone
companies in our target markets. Once we have obtained the appropriate state
authorization and entered into interconnection agreements with the existing
local telephone companies, we will be able to construct our central office
collocation facilities at the premises of, and obtain and use network elements
from, the existing local telephone companies. As of the date of this prospectus,
we were authorized to provide our products and services in 13 states and have
interconnection agreements with US West, Ameritech and Southwestern Bell.
As of December 31, 1999, we had 40 collocations, which are environmentally
controlled, secure sites designed to house transmission, routing and other
equipment. We are designing our collocations with an average of 100 square feet
in order to provide our customers direct local access via our access platform to
those markets. We intend to expand our network to include multiple collocations
in existing local telephone company central offices within our target markets in
order to provide the platform for our end-to-end service offerings for our
customers.
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Once our collocations are established, we plan to link these collocations
together within the market using unbundled network element transport from the
existing local telephone companies in order to provide our products and services
throughout the market. In addition to these unbundled network elements, there
are other possible alternatives for us to employ in linking these central
offices. For instance, we may lease or purchase dark fibers from a third party
provider, use wireless connections or possibly even lay our own local fiber if
warranted based upon demand.
EQUIPMENT SUPPLIER RELATIONSHIPS
We have agreed upon an exclusive vendor agreement with Lucent Technologies
which provides for discounted pricing on the fiber that we purchase from Lucent
as well as marketing and engineering support in connection with the expansion of
our network. The effectiveness of this agreement is conditioned on the execution
of documents relating to the financing by Lucent of such purchases of fiber and
the execution of these financing documents is, in turn, conditioned on the
closing of the reorganization.
Under a master agreement between Pathnet and NEC, dated August 8, 1997, we
agreed to purchase from NEC certain equipment, services and licensed software
for us to use in our network under pricing and payment terms that we believe are
favorable. In addition, NEC has agreed, subject to certain conditions, to
warranty equipment that we purchase from NEC for three years, if defective, to
repair or replace certain equipment promptly and to maintain a stock of critical
spare parts for up to 15 years. This agreement with NEC provides for fixed
prices during the first three years of its term.
We have also entered into a purchase agreement with the Andrew Corporation
in which we agreed exclusively to recommend to our co-development partners
certain products manufactured by Andrew. In return, Andrew agreed to sell those
products to our co-development partners and to us for a three year period,
renewable for two additional one-year periods at our option. The agreement
generally provides for discounted pricing based on projected order volume.
NETWORK RELIABILITY
We have constructed our network operations center in Washington, D.C. This
network operations center currently provides real-time, end-to-end monitoring of
our network operations 24 hours a day, seven days-a-week, as well as pro-active
customer care for all of our customers' services. Our network operations center
ensures the efficient and reliable performance of the network through pro-active
early identification and prevention of potential network disruptions. In
addition, our network operations center enables us to schedule and conduct
maintenance of our network while minimizing interference with the use of the
network by our customers. Specific features provided by our network operations
center include network fault and event management, network and service level
performance management and analysis as well as remote configuration of all
network elements. Our network operations center has full fallback capability and
it appears to be Year 2000 compliant.
COMPETITION
Competition in the telecommunications industry is intense. In our target
markets, we expect to face increasing competition in the areas of price and
performance, transmission quality, breadth and reliability of our network,
customer service and support, brand recognition and critical relationships with
third parties such as Internet service providers. While we generally will not
compete with telecommunications service providers for end user customers, we may
compete as a "carriers' carrier" with certain of those providers including long
distance companies (such as AT&T Corp., MCI WorldCom, Inc. and Sprint
Corporation), wholesale providers (such as Qwest Communications International
Inc., Williams Communications Group, Inc., DTI Holdings, Inc., Global Crossing
Ltd
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and Level 3 Communications, Inc.), existing local telephone companies (such as
US West, BellSouth, Bell Atlantic, SBC and GTE Corporation) and competitive
telecommunications companies (such as GST Communications, Inc., ITC/Deltacom,
Inc. and Metromedia Fiber Network, Inc.) who would otherwise be our customers in
our target markets. Other entities which may become our competitors in this
regard include communications service providers, cable television companies,
electric utilities, wireless telephone operators, microwave carriers, satellite
carriers, and large end users with private networks.
Initially, in second and third tier markets our most significant
competitors will be existing local telephone companies and other competitive
telecommunications companies. Many of the largest existing local telephone
companies will begin offering in the near future some of the products and
services we plan to offer and some have already begun to do so. These companies
are able to draw upon established networks, well-known brand names, customer
loyalty, a pre-existing base of management and employees, and greater access to
capital than will likely be available to us. Moreover, many existing local
telephone companies own the telephone wires they use, and can bundle digital
data services, for example, without having to incur the costs of negotiating
interconnection agreements. As other industry participants also seek to enter
these markets, we will face increasing competition.
Industry consolidation and strategic alliances between participants in the
telecommunications industry will also increase the level of competition we will
face, particularly as the demand for bundling of services surges. New
technologies, further deregulation and other changes in our regulatory
environment will create further competitive pressures as we enter our target
markets.
GOVERNMENT REGULATION
OVERVIEW. Our telecommunications businesses are subject to varying degrees
of federal, state and local regulation. We are a telecommunications carrier
under the terms of the federal Communications Act. As a telecommunications
carrier, we are subject to FCC and state utility commission regulation of our
activities. Local authorities also may regulate the permitting and construction
of our telecommunications facilities.
The Telecommunications Act created a uniform national policy in favor of
competition in all telecommunications market segments. As described below, the
rules and policies implementing the Telecommunications Act remain subject to
agency action and litigation at both the federal and state level. We nonetheless
believe that the national policy in favor of competition that was created by the
Telecommunications Act will lead to increased market opportunities for us.
Because these opportunities require additional agency action before the
Telecommunications Act is fully implemented, and because these actions may be
subject to court review, we cannot predict the pace at which the law will be
fully implemented.
We are required to file federal and state tariffs describing the prices,
terms and conditions of our services, and these tariffs are subject to varying
degrees of regulatory oversight and approval. We must also comply with state and
local license or permit requirements relating to the installation and operation
of our network. Burdensome license, permit or other regulatory requirements or
developments could make it more difficult for us to comply with these laws and
regulations.
The FCC and state public service commissions generally have the right to
impose sanctions, forfeitures, or other penalties mandating refunds if a carrier
fails to comply with applicable rules. We cannot assure you that regulators or
such third parties will determine that we have complied with all applicable laws
and regulations. Any proceedings against us could have a material adverse effect
on our business, financial condition, or results of operations.
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FEDERAL REGULATION. The FCC regulates interstate and international
telecommunications services, and it also regulates the holders of radio
licenses. We are subject to FCC regulation as a common carrier, which means that
we are subject to longstanding general requirements that our rates be "just and
reasonable" and that we not engage in "unjust or unreasonable discrimination" in
serving the public. As a common carrier, we also must file certain periodic
reports and applications with the FCC, and the FCC has jurisdiction to act on
certain complaints for failure to comply with regulatory obligations. We also
are required to file basic tariffs at the FCC for our provision of
telecommunications services generally, although those tariffs are not subject to
pre-effective review and can be amended on one day's notice. We are subject to
the licensing processes of the FCC for the use of our microwave licenses. We
also generally must apply to the FCC for its consent before assigning a radio
license or transferring control (for example, through the sale of stock) of any
company holding radio licenses or common carrier authorizations.
We are not, however, subject to the particular laws and FCC regulations
imposed by the Telecommunications Act on the existing local telephone companies
including, among others, the former Bell operating companies and GTE. These
regulations have provided, and we believe they will continue to provide,
significant opportunities for us to compete with existing local telephone
companies for the provision of competitive telecommunications services. These
laws and regulations require existing local telephone companies to:
- Provide "physical collocation" to competitors, a requirement that permits
us and other similarly licensed common carriers to install and maintain
our own network termination equipment at the existing local telephone
company's central offices;
- "Unbundle" components of their local service networks in a
nondiscriminatory manner so that we and other new competitors can obtain
network facilities, equipment, features, functions and capabilities at
cost-based prices (which may include a reasonable profit);
- Permit us and other competitors to "interconnect" with the existing local
telephone company's facilities at any technically feasible point within
their networks, at prices based on cost (which may include a reasonable
profit);
- Engage in "reciprocal compensation" for the exchange of
telecommunications traffic, an obligation that requires existing local
telephone companies and new competitors to complete calls originated by
competing carriers under reciprocal arrangements at prices based on a
reasonable approximation of incremental cost, or through the mutual
exchange of traffic without explicit payment;
- Establish wholesale prices for their services to promote resale of
services and facilities by new competitors;
- Establish "number portability" so that customers can maintain their
existing phone numbers when they switch from one telecommunications
provider to another without impairing quality, reliability or
convenience;
- Establish "dialing parity" so that customers will not detect a difference
in quality or complexity in dialing telephone numbers or accessing
operators and emergency services; and
- Provide nondiscriminatory access to telephone poles, ducts, conduits and
rights of way.
Applicable FCC regulations require existing local telephone companies to
negotiate in good faith with carriers requesting any of the above arrangements.
If the negotiating carriers cannot reach agreement in a prescribed time, either
carrier may request binding arbitration of the disputed issues by a state
regulatory commission. This set of obligations provides significant market
opportunity for new competitors, but, as discussed below, we cannot assure you
that the various government agencies
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responsible for implementing these pro-competitive policies and requirements
will do so in a timely and effective manner.
The Telecommunications Act requires the FCC to establish rules and
regulations to implement its local competition provisions. In August 1996, the
FCC issued rules governing interconnection, resale, unbundled network elements,
the pricing of those facilities and services, and the negotiation and
arbitration procedures that would be utilized by states to implement those
requirements. These rules, which were generally favorable to new competitors,
were vacated in part by a July 1997 ruling of the United States Court of Appeals
for the Eighth Circuit. On January 25, 1999, the United States Supreme Court
issued an opinion upholding the authority of the FCC to establish rules,
including pricing rules, to implement statutory provisions governing both
interstate and intrastate services under the Telecommunications Act. The Court
also upheld rules allowing carriers to select provisions from among different
interconnection agreements approved by state commissions for the carriers' own
agreements (the "pick-and-choose" rule) and a rule allowing carriers to obtain
combinations of unbundled network elements.
The Supreme Court, however, vacated the FCC rule setting forth the specific
unbundled network elements that existing local telephone companies must make
available, finding that the FCC had failed to apply the appropriate statutory
standard. On November 5, 1999, the FCC responded to the Court's decision by
issuing a decision that maintains competitors' access to a wide variety of
unbundled network elements. Six of the seven unbundled elements the FCC had
originally required carriers to provide in its 1996 order implementing the
Telecommunications Act remain available to competitors. These elements are
loops, including loops used to provide high-capacity and advanced
telecommunications services; network interface devices; local circuit switching,
subject to restrictions in major urban markets; dedicated and shared transport;
signaling and call-related databases; and operations support systems. The FCC
removed access to operator and directory assistance service from the list of
available unbundled network elements. In addition, the FCC added to its list
certain unbundled network elements that were not at issue in 1996. These
elements include subloops, or portions of loops, and dark fiber loops and
transport. The FCC did not, however, require existing local telephone companies
to unbundle facilities used to provide digital subscriber line service (packet
switches and digital subscriber line access multiplexers, which are devices that
house individual circuit cards used to provide digital subscriber line
services). The FCC did not decide, but sought additional information on, the
question of whether carriers may combine certain unbundled network elements to
provide special access services to compete with those provided by the existing
local telephone companies. The ability to obtain unbundled network elements is
an important element of our business, and we believe that the FCC's actions in
this area have generally been positive. However, we cannot predict the extent to
which the existing rules will be sustained in the face of additional legal
action and the scope of the rules that are yet to be crafted by the FCC. For
example, the FCC may restrict the use of unbundled network elements for the
provision of services affording long distance companies access to local
telephone networks, which would reduce our competitive price advantage and limit
the market opportunities in that segment of the telecommunications market.
The rates charged for interconnection and unbundled network elements we
require vary greatly. These rates are subject to the approval of state
regulatory commissions, through approval processes that typically involve a
lengthy review of the rates proposed by the existing local telephone companies
in each state. The final rates approved typically depend on the existing local
telephone company's initial rate proposals and the policies of the state public
utility commission. These rate approval proceedings are time-consuming and
expensive. Recurring and non-recurring charges for telephone lines and other
unbundled network elements may increase based on the rates proposed by the
existing local telephone companies and approved by state regulatory commissions
from time to time, which would have a material adverse effect on the results of
our operations. Moreover, because the cost-
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based methodology for determining these rates is still subject to judicial
review, there is great uncertainty about how these rates will be determined in
the future.
Under the rules adopted by the FCC pursuant to the Telecommunications Act,
we have entered into comprehensive interconnection agreements with three major
existing local telephone companies (US West, Ameritech and Southwestern Bell)
covering 17 states. These agreements include the provision of unbundled network
elements to be used in connection with competitive telecommunications services.
We have also entered into a collocation agreement with another existing local
telephone company, BellSouth, covering 9 states. We expect this collocation
agreement to be part of a more comprehensive interconnection agreement currently
under negotiation. In addition, we are negotiating additional interconnection
and collocation agreements in other states. We expect the pace of these
negotiations to continue for the foreseeable future. Although we expect, based
on our experience thus far, that such negotiations will yield acceptable
agreements that will permit us to implement our business plan on schedule, we
cannot predict the extent to which existing local telephone companies
interpreting the FCC regulations may seek to frustrate our collocation or
interconnection plans or the extent to which we will need to seek arbitration or
commence litigation to achieve our goal. If we are unable to enter into, or
experience a delay in obtaining, interconnection agreements, this inability or
delay may materially and adversely affect our business and financial prospects.
The FCC has been reviewing the policies and practices of the existing local
telephone companies with the goal of facilitating the efforts of
telecommunications companies to obtain access to central office space and other
network facilities more easily and on more favorable terms. On March 31, 1999,
the FCC adopted rules to make it easier and less expensive for
telecommunications companies to obtain central office space and to require
existing local telephone companies to make new alternative arrangements for
providing such space. However, the FCC's new rules are currently subject to
judicial review, have not been uniformly implemented in a timely manner and may
not ultimately enhance our ability to obtain central office space. Difficulties
we experience in obtaining access to and interconnection with the existing local
telephone companies' facilities can negatively impact our future plans for
providing certain services.
Our expected provision of digital subscriber line services is largely
unregulated by the Telecommunications Act or the FCC because we, and the
telecommunications companies that are our target customers for these services,
are not existing local telephone companies. Moreover, our customers providing
digital subscriber line service to end users, such as internet service
providers, are unregulated "information services providers." The FCC affirmed in
a report adopted on April 10, 1998, that internet service providers will not be
subject to regulation as telecommunications carriers under the
Telecommunications Act. They thus will not be subject to universal service
obligations and other regulations. We cannot, however, assure you that neither
Congress nor the FCC will alter that regulatory scheme in the future. Further,
in August 1998, the FCC proposed new rules that would allow existing local
telephone companies to provide their own digital subscriber line services
through separate affiliates that are not subject to existing local telephone
company regulation. Although the FCC recently decided some of the other issues
raised in that proceeding, the question of whether existing local telephone
companies can provide unregulated digital subscriber line services through a
separate affiliate remains unresolved. Some members of Congress also have
expressed interest in giving existing local telephone companies additional
pricing flexibility for high speed data services and expanding the geographic
area in which existing local telephone companies may offer these services to
their customers. Any expansion of existing local telephone companies' ability to
offer high speed data and internet services may have an adverse impact on our
business. On November 18, 1999, the FCC decided to require existing local
telephone companies to share telephone lines with digital subscriber line
service providers, an action that may foster competition by allowing competitors
to offer digital subscriber line services without their customers having to
purchase a second telephone line. Whether
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this development will be implemented in an effective way remains to be seen.
Moreover, it is impossible to predict whether the FCC or Congress may change the
rules under which these services are offered and, if such changes are made, the
extent of the impact of such changes on our business.
The Telecommunications Act obligates the FCC to establish "universal
service" mechanisms to ensure that certain subscribers living in rural and
high-cost areas, as well as certain low-income subscribers, continue to have
access to telecommunications and information services at prices reasonably
comparable to those charged for similar services in urban areas. These
mechanisms also are meant to foster the provision of advanced telecommunications
services to schools, libraries and rural health-care facilities. Under the rules
adopted by the FCC to implement these requirements, we and all other
telecommunications providers will be required to contribute to a fund to support
universal service. The amount that we must contribute to the federal universal
service subsidy will be based on our share of specified defined
telecommunications end-user revenues. Therefore, it is difficult to predict in
advance the precise contributions that we will be required to make.
The FCC regulates the fees that local telephone companies charge long
distance companies for access to their local networks. These fees are commonly
called access charges. The FCC is currently considering a proposal, supported by
parts of both the local and long distance telephone industries, that would
restructure and most likely significantly reduce access charges. Changes in the
access charge structure could fundamentally change the economics of some aspects
of our business. Any material reduction in the access charges imposed by local
telephone companies could significantly reduce our price advantage in the market
for services affording long distance companies access to local telephone
networks.
As an enhancement to our local access services, during the second half of
2000, we expect to begin marketing and selling digital subscriber line services
to our second and third tier markets. To provide unbundled digital subscriber
line capable lines to connect each customer to our equipment, we will use
networks owned by existing local telephone companies. The terms upon which we
connect our network to existing local telephone companies' networks are
specified in interconnection agreements that we must negotiate with the existing
local telephone companies operating in our existing and target markets. Federal
law requires existing local telephone companies to provide access to their
networks through interconnection agreements and to offer network elements to
other telecommunications carriers at rates which generally must be cost-based
and nondiscriminatory. However, we may be unable to negotiate interconnection
agreements on favorable terms. The failure of existing local telephone companies
to comply with their obligations under these interconnection agreements could
result in customer dissatisfaction and the loss of potential customers.
We also are regulated by the FCC as the holder of a substantial number of
common carrier fixed point-to-point microwave licenses that we use on the
wireless portion of our network. Under the FCC's rules, we must coordinate our
proposed frequency use with other existing users of the spectrum to prevent
interference. After completing that process, we (and, in some cases, our co-
development partners) must apply to the FCC for the issuance of a license to
permit us to transmit information on the frequencies we desire to use. To obtain
a license we must demonstrate that the owner of the transmission site has
complied with the reporting, notification and technical requirements of the
Federal Aviation Administration for the construction, installation, location,
lighting and painting of transmitter towers and antennae like ours. Once the
license is obtained, we must make routine regulatory filings and obtain the
FCC's prior consent for any assignment of the license or any substantial change
in control of the entity holding the license and for certain modifications to a
licensed facility. We cannot assure you that we, or any of our co-development
partners who desire to be the licensee for their portion of our network, will
obtain all of the licenses or approvals necessary for the operation of our
business, the transfer of any license or the
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modification of any facility, or that the FCC will not impose burdensome
conditions or limitations on any such license, transfer or approval.
Our ownership also is regulated by the FCC to ensure that we do not exceed
the foreign ownership restrictions imposed by the Communications Act. Under the
Communications Act, we cannot increase our foreign ownership to a level greater
than 25% without obtaining prior FCC consent. The FCC has determined that it
will authorize a higher level of foreign ownership, up to 100%, on a streamlined
basis where the foreign ownership is by citizens of, or companies organized
under the laws of, World Trade Organization member states. (A more demanding
public interest showing is required by proposals to increase foreign ownership
by citizens or countries of non-WTO member states.) We currently comply with the
25% cap on foreign ownership, and we will monitor foreign investment to ensure
that we do not exceed that benchmark without obtaining appropriate FCC consent.
These requirements may, in some circumstances, be applied to our co-development
partners as well. If a co-development partner were to choose to hold the
relevant license itself, and not through a holding company, that co-development
partner would be subject to a provision that limits direct foreign ownership of
FCC licenses to 20%. The FCC does not have discretion to waive this limitation.
If a co-development partner exceeded the 20% limitation it would be required to
reduce its foreign ownership in order to obtain or retain its license.
STATE REGULATION. The Telecommunications Act preempts state statutes and
regulations that restrict the provision of competitive local telecommunications
services. State commissions can, however, impose reasonable terms and conditions
upon the provision of telecommunications service within their respective states.
States also can require that telecommunications providers apply for and obtain a
certificate of public convenience and necessity or other authorization prior to
commencing service in their respective states. We are in the process of becoming
certified, to the extent such certification is required, in the 48 contiguous
states and the District of Columbia as a competitive local exchange carrier or
other competitive telecommunications carrier under the regulations of each
state's regulatory commission. We currently are authorized or permitted to
provide at least a portion of our proposed services in 16 states: Colorado,
Florida, Idaho, Illinois (conditioned on the closing of our reorganization),
Indiana, Iowa, Kentucky, Michigan, Minnesota, Montana, Nebraska, Ohio, Oregon,
Texas, Wisconsin and Wyoming (long distance services only). We have pending
applications before an additional six state commissions. Although we do not
anticipate any issues that would prevent us from obtaining authorization as a
competitive telecommunications carrier in each of the states in which we will
apply, we cannot assure you that all required state authorizations will be
granted.
In most states, we are required to file tariffs setting forth the general
terms, conditions and prices for services classified as intrastate by the
particular state commission in question. Most states require us to list the
services provided and the specific rate for each service. Under various states'
rules, however, we have regulatory flexibility to set price ranges for specific
services and, in some cases, prices can be set on an individual customer basis.
We also may be required to file applications with some states for the assignment
of our state certifications to any other entity and for any transfer of
substantial control that we decide to undertake in the future. Some states also
may require a filing prior to the issuance of substantial debt or equity
securities or other transactions that would result in a lien upon the property
we use to provide intrastate telecommunications services. States generally
require us to file various reports and pay certain fees, including state
universal service subsidies. Like the FCC, most state commissions are empowered
to consider complaints filed against carriers subject to their jurisdiction. We
cannot assure you that our state certificates will not be revoked or amended by
state commissions.
LOCAL REGULATION. We may be required to obtain local permits for street
opening and construction permits to install and expand fiber optic networks.
Local zoning authorities often regulate
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our use of towers for microwave and other telecommunications sites. We also are
subject to general regulations concerning building codes and local licensing.
The Telecommunications Act requires that fees charged to telecommunications
carriers be applied in a competitively neutral manner, but there can be no
assurance that existing local telephone companies and others with whom we will
be competing will bear costs similar to those we will bear in this regard.
OTHER LAWS AND REGULATIONS. Although the foregoing discussion provides an
overview of the material regulatory issues that confront our business, this
discussion does not attempt to describe all current and proposed federal, state
and local rules and initiatives affecting the telecommunications industry. Other
federal and state laws and regulations are currently the subject of judicial
proceedings and proposed additional legislation. In addition, some of the FCC's
rules implementing the Telecommunications Act will be subject to further
judicial review and could be altered or vacated by courts in the future. We
cannot predict the ultimate outcome of any such further proceedings or
legislation.
INTELLECTUAL PROPERTY
We have entered into a license agreement with Pathnet under which we may
use all of Pathnet's tradenames, trademarks and other intellectual property. We
use the name "Pathnet" as our primary business name and service mark, and have
registered that name with the United States Patent and Trademark Office. In
addition, Pathnet has registered its service mark "A NETWORK OF OPPORTUNITIES"
and its logo with the United States Patent and Trademark Office.
We regard our products, services and technology as proprietary and we
attempt to protect them with patents, copyrights, trademarks, trade secret laws,
restrictions on disclosure and other methods. These methods may not be
sufficient to protect our technology. We also enter into confidentiality or
license agreements with our employees and consultants, and generally control
access to and distribution of our documentation and other proprietary
information. Despite these precautions, it may be possible for a third party to
copy or otherwise obtain and use our products, services or technology without
authorization, or to develop similar technology independently.
Pathnet currently has a patent application pending and we intend to prepare
additional applications and seek patent protection for our systems to the extent
possible. These patents may not be issued to us, and if issued, they may not
protect our intellectual property from competition that could seek to design
around or invalidate these patents.
PROPERTIES
Our network and our component assets are the principal properties that we
own. Our installed fiber optic cable is laid on rights of way held by us or our
co-development partners, and our digital wireless network is constructed on our
leasehold interests in telecommunications infrastructure. We also own, or are
contracted to purchase, three small parcels of one to five acres of undeveloped
real property along our network backbone, on which we plan to construct
telecommunications equipment shelters for the fiber optic portions of our
network.
Our corporate headquarters are located in Washington, D.C., and Pathnet
leases this space from 6715 Kenilworth Avenue General Partnership, under a Lease
Agreement dated August 9, 1997. Recently, Pathnet executed a lease with 11720
Sunrisecorp., L.L.C. for approximately 40,000 square feet of office space in
Reston, Virginia which will become our new headquarters in the first half of
2000. We also lease office space in Richardson, Texas under a lease that expires
in 2003.
We believe that all of our properties are well maintained.
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EMPLOYEES
As of January 31, 2000, we employed 126 people. As needed, we also hire
temporary employees and independent contractor computer programmers. In
connection with our growth strategy, we anticipate hiring a significant number
of additional personnel in sales and other areas of our operations in the near
future. Our employees are not unionized, and we believe our relations with our
employees are good. Our success will continue to depend in part on our ability
to attract and retain highly qualified employees.
LEGAL PROCEEDINGS
From time to time, we are a party to routine litigation and proceedings in
the ordinary course of business. We are not aware of any current or pending
litigation to which we are or may be a party that we believe could materially
adversely affect our financial position, results of operations or cash flows.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
You should read the following discussion and analysis in conjunction with
our combined financial statements and related notes included in this prospectus.
You can find additional information concerning our businesses and strategic
investments and alliances in the section of this prospectus entitled "BUSINESS."
OVERVIEW
Since Pathnet's inception on August 25, 1995, its principal activities have
included:
- Entering into strategic relationships with owners of telecommunications
assets and co-development partners;
- Developing and constructing our digital backbone network;
- Negotiating collocation and interconnection agreements and installing
collocations and interconnections off our backbone network;
- Designing and developing our network architecture and operations support
systems, including the buildout and launch of our 24-hour network
operations center;
- Raising capital and hiring management and other key personnel;
- Developing leading edge products and services; and
- Procuring governmental authorizations.
As of December 31, 1999, our network consisted of over 6,300 wireless route
miles providing wholesale transport services to 30 cities and 500 miles of
installed fiber available for sale. We are constructing an additional 600 route
miles of fiber optic network scheduled for completion in the first half of 2000.
We have also entered into two co-development agreements for the construction of
an additional 750 route miles of fiber optic network. We expect to develop more
backbone network from a pool of over 12,000 route miles of right of way -- 8,000
of which have some form of exclusivity -- that we will receive from our new
investors in our reorganization. During 2000, we intend to deploy additional
products and services including bundled wholesale transport and local access
services.
Pathnet has experienced operating losses since its inception, and we expect
these operating losses to continue as we expand our operations. Implementing our
business plan will require significant capital expenditures. Our financial
performance will vary from market to market, and the time when we will achieve
positive earnings before interest, taxes, depreciation and amortization, if at
all, will depend on the:
- Size of our target markets;
- Timely completion of backbone routes, collocations and interconnections;
- Cost of the necessary infrastructure;
- Timing of and barriers to market entry; and
- Commercial acceptance of our services.
SOURCES OF REVENUE
INFRASTRUCTURE SERVICES. We employ a "smart build" approach in the
development of our network that includes determining the level of customer
demand on a route before construction and, in certain cases, entering into
pre-construction sales of fiber optic strands and conduit. We can sell
indefeasible rights of use or leases of fiber or conduit along a segment of our
network at a fixed price.
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Under our dark fiber and conduit rights of use or lease agreements, we expect to
receive all of the proceeds relating to the disposition of the dark fiber and
conduits upon completion of the route and acceptance by the customer. We face
increasing competition in marketing our dark fiber and conduit for sale or lease
as other carriers build and expand their networks. To expedite infrastructure
development and decrease development risk, we have sought, and in the future
will continue to seek, co-developers to share the project construction costs. We
have pursued co-marketing arrangements to facilitate selling the assets along
network segments and we may continue to do so in the future.
MANAGEMENT SERVICES. To date, we have generated revenues primarily from
services related to the construction of our digital network. We expect to
continue construction of our digital network with co-development partners when
these projects will allow us to retain communications capacity, fiber or conduit
assets on routes that complement and reduce the costs of completing our network.
We anticipate that the percentage of revenues that we receive from management
services will decline as we near the completion of our network.
WHOLESALE TRANSPORT AND LOCAL ACCESS SERVICES. We provide inter-city and
local wholesale transport services and local access services to our customers on
a long-term or month-to-month basis. We plan to bundle local access services
with our wholesale transport services to provide low cost, end-to-end solutions
for our customers. Our service agreements with customers are generally leases of
capacity which provide for monthly payments due in advance on a fixed-rate
basis. We price our customer contracts according to the capacity, the length of
the circuit used, the term of the contract and the extent of value added
services provided. Nonrecurring revenues include installation and activation
charges for new customers. We seek to price our services competitively in
relation to those of the existing local telephone companies and other
competitive telecommunications companies in our targeted underserved and second
and third tier markets.
Although pricing will be an important part of our strategy, we believe that
customer relationships, customer care and consistent quality will be the key to
generating customer loyalty. During the past several years, market prices for
many telecommunications services have been declining -- a trend we believe will
likely continue. As prices decline for any given service, we expect that the
total number of customers and the proportion of our customers purchasing our
bundled services will increase.
OPERATING EXPENSES
COST OF REVENUE. The primary components of our cost of services to date
have been costs relating to network engineering, operations and maintenance.
With expected growth of our bundled wholesale transport and local access
services we expect components such as access costs (including fees for use of
the local loop, rent, power and other fees charged by existing local telephone
companies, competitive telecommunications companies and other providers) and
costs associated with the provision of services to comprise a greater portion of
our costs of service.
SELLING, OPERATIONS AND ADMINISTRATION. We are building a small and
focused sales and marketing department that should allow us to maintain a low
ratio of overhead expenses to revenues compared to other telecommunications
service providers. Our general and administrative costs include expenses typical
of other telecommunications service providers, including office leases, customer
care, billing, corporate administration and human resources. We expect that
these costs will grow significantly as we expand our operations and that our
administrative overhead will be a large portion of these expenses. However, we
expect these expenses to decline as a percentage of our revenue as we build our
customer base and increase the number of customers connected to our network.
DEPRECIATION AND AMORTIZATION. Because we are primarily a facilities-based
wholesale provider, expenses associated with depreciation of property, plant and
equipment will be a substantial ongoing expense for us. We expect depreciation
and amortization expense to increase significantly as more of
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our network becomes operational and as we increase capital expenditures to
expand our network. Depreciation and amortization expense will include:
- Depreciation of network infrastructure equipment;
- Depreciation of improvements to telephone company central offices, other
collocations and related equipment;
- Depreciation of network control center facilities, furniture, fixtures
and corporate facilities;
- Amortization of rights of way; and
- Amortization of software.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
During the year ended December 31, 1999, we continued to focus on:
- Developing relationships and strategic alliances with owners of valuable
telecommunications assets such as rights of way and with co-development
partners,
- Building out our network,
- Obtaining the regulatory status and entering into interconnection
agreements in each of our target markets to enable us to obtain unbundled
network elements and central office space from the existing local
telephone companies, and
- Developing our infrastructure including the hiring of key management
personnel.
REVENUE. For the twelve months ended December 31, 1999 and 1998, we
generated revenues of approximately $3.3 million and $1.6 million, respectively.
This increase is attributable to revenues from our sales of telecommunications
services, which were $2.4 million in 1999 compared with approximately $165,000
in 1998. We expect that a substantial portion of our future revenue will be
generated from our sale of wholesale transport services, local access services
and backbone infrastructure services.
OPERATING EXPENSES. For the twelve months ended December 31, 1999 and
1998, we incurred operating expenses of approximately $34.6 million and $17.9
million, respectively. The increase is primarily a result of additional staff
costs incurred in developing our infrastructure, depreciation expenses as more
of our network came on line and administrative costs related to obtaining
regulatory status. Cost of revenue reflects direct costs we incurred in
performing construction and management services and providing telecommunications
services.
INTEREST EXPENSE. Interest expense for the twelve months ended December
31, 1999 and 1998 was approximately $41.0 million and $32.6 million,
respectively. Interest expense primarily represents interest on the notes
together with the amortization expense related to bond issuance costs in respect
of the notes.
INTEREST INCOME. Interest income for the twelve months ended December 31,
1999 and 1998 was approximately $13.1 million and $13.9 million, respectively.
The decrease in interest income reflects a decrease in cash and cash equivalents
and marketable securities as those funds were used in building our network,
funding operations, and making interest payments on our notes in April and
September of 1999.
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YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
During the twelve months ended December 31, 1998, we focused on (1)
developing relationships and strategic alliances with owners of valuable
telecommunications assets such as rights of way and with co-development
partners, (2) building out our network, and (3) hiring key management and other
personnel.
REVENUE. Substantially all of our revenue for the year ended December 31,
1998 consisted of fees received for services we provided to our wireless
co-development partners, including analysis of existing facilities and system
performance, advisory services relating to personal communication system (or
PCS) provider spectrum relocation matters, and turnkey network construction and
management services. For the years ended December 31, 1998 and 1997, we
generated revenue of approximately $1.6 million and $162,500, respectively. This
increase was attributable to fees we received for performing construction and
management services primarily for one customer.
OPERATING EXPENSES. For the twelve months ended December 31, 1998 and
1997, we incurred operating expenses of approximately $17.9 million and $4.3
million, respectively. This increase results primarily from accelerating the
buildout of our network and additional staff costs incurred in developing our
infrastructure. Cost of revenue reflects direct costs we incurred in performing
construction and management services and providing telecommunications services.
INTEREST EXPENSE. Interest expense for the twelve months ended December
31, 1998 was approximately $32.6 million. We had no interest expense for the
twelve months ended December 31, 1997. Interest expense primarily represents
interest on the notes together with the amortization expense related to bond
issuance costs in respect of the notes.
INTEREST INCOME. Interest income for the twelve months ended December 31,
1998 and 1997 was approximately $13.9 million and $159,300, respectively. The
increase in interest income represents interest earned on the proceeds of the
notes issued in April, 1998.
CAPITAL EXPENDITURES
We have invested a significant amount of capital constructing and deploying
our digital network. We intend to continue to expand our network coverage. We
plan to add a bundled product comprised of local access and wholesale transport
to our existing products. These efforts will require us to fund our operating
losses and we will require significant capital to:
- Continue construction and development of our nationwide network
infrastructure;
- Purchase and install electronics, transmission and interconnection
equipment and other components along the network and as needed to
establish the platform for our local access and bundled services;
- Procure, design and construct telephone company central offices and other
collocation and interconnection sites; and
- Continue development of our corporate infrastructure.
Capital expenditures were approximately $80.2 million for the year ended
December 31, 1999. We expect that our capital expenditures will be substantially
higher in future periods in connection with the expansion of our network and
services in our target markets.
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As of December 31, 1999, we had capital commitments of approximately $89.9
million relating to the development of our network pursuant to existing
agreements. From December 31, 1999 until December 31, 2000 we intend to:
- Complete the construction and lighting of network segments to which we
are currently committed, including Chicago, Illinois to Aurora (a suburb
of Denver), Colorado, Grand Junction, Colorado to Alberquerque, New
Mexico and Alberquerque to El Paso, Texas;
- Begin perfection and pre-engineering of selected network segments from
the right of way acquired under our reorganization;
- Commence construction on up to three additional fiber routes; and
- Continue interconnecting and collocating in 60 to 80 of our targeted
underserved and second and third tier markets.
LIQUIDITY AND CAPITAL RESOURCES
From inception through December 31, 1999, we financed our operations
primarily through private placements of $36 million of equity securities and
$338.7 million of net proceeds raised from the issuance of the notes in April
1998. As of December 31, 1999, we had approximately $138.4 million of cash, cash
equivalents and marketable securities to fund future operations. In connection
with our reorganization, Colonial is contributing an aggregate (including both
tranches) of $68 million in cash to us in exchange for shares of our series E
convertible preferred stock, rights to a single conduit along the Colonial
rights of way and an option to purchase additional shares of our capital stock.
The reorganization will bring the total cash equity investment in Pathnet
Telecom and our subsidiaries to $100 million, including $25 million which will
be received upon the completion of a fiber optic network during the second
calendar quarter of 2000.
In addition, we expect to finance the cost of some of our equipment through
vendor financing arrangements. We have negotiated with Lucent a proposed credit
facility in which Lucent will, subject to certain conditions (including the
closing of our reorganization), provide us with financing for fiber optic cable
that we purchase from them. For a description of the terms and conditions of the
proposed financing transaction with Lucent see "DESCRIPTION OF OTHER
INDEBTEDNESS AND OTHER FINANCING ARRANGEMENTS -- Proposed Credit Facility with
Lucent."
We estimate that our current available resources, together with those
received in our reorganization, will be sufficient to fund the implementation of
our long term business plan, operating losses in new markets, and working
capital needs through the fourth quarter of 2000. In the event the strategic
investment from Colonial is not consummated or is consummated on different
terms, this projection of available resources may change. After such time, we
expect we will require additional financing, which may include commercial bank
borrowings, additional vendor financing or the sale or issuance of equity or
debt securities.
Our expectations of our future capital requirements and cash flows from
operations are based on current estimates. If our plans or assumptions change or
prove to be inaccurate, we may require additional sources of capital or
additional capital sooner than anticipated.
ANTICIPATED FUNDING SOURCES AND CASH USES
Assuming that we close our reorganization on or before March 31, 2000, we
anticipate that our total cash expenditures during the period from January 1,
2000, through June 30, 2001, will be
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approximately $619 million. Our projected sources and uses during the period
January 1, 2000, through June 30, 2001 are set forth in the table below:
PROJECTED SOURCES AND USES
(IN MILLIONS)
<TABLE>
<S> <C>
Sources:
Cash balances at December 31, 1999
Unrestricted cash........................................... $139
Construction/development project escrows.................... 16
Interest escrow for notes................................... 21
----
176
Payments received from co-development partners and
infrastructure and communications capacity services
customers................................................. 200
Drawings under senior secured vendor financings............. 75
Investment from Colonial Pipeline........................... 68
Additional equity investment................................ 100
----
Total sources.......................................... $619
====
Uses:
Operating expenses.......................................... $ 95
Fiber optic network construction............................ 270
Lighting of fiber optic routes.............................. 60
Interconnection and collocation development................. 70
Net interest expense/income................................. 55
Other....................................................... 5
Unrestricted cash balance at June 30, 2001.................. 64
----
Total uses............................................. $619
====
</TABLE>
FUNDING SOURCES
Our primary funding sources consist of the following:
- UNRESTRICTED AND RESTRICTED CASH BALANCES. As of December 31, 1999, our
unrestricted cash balances totaled $139 million. As of December 31, 1999,
we had restricted cash balances totaling $37 million, consisting of $16
million escrowed against our obligations under co-development agreements
with third parties and $21 million in pledged securities escrowed for the
April 2000 interest payment on the notes.
- PAYMENTS RECEIVED FROM CO-DEVELOPMENT PARTNERS AND INFRASTRUCTURE AND
COMMUNICATIONS CAPACITY SERVICES CUSTOMERS. We expect to receive
approximately $200 million from co-development partners and
infrastructure and communications capacity services (local access and
wholesale transport) customers from January 1, 2000, through June 30,
2001. We expect to generate payments from co-development agreements along
future route segments similar to our existing agreement with Tri-State
together with sales or long term leases of dark fiber and conduit to
infrastructure customers for the purpose of reducing our retained cost of
our retained fiber optic strands. We currently project that these
payments will substantially reduce our retained capital cost of our
retained fiber optic strands.
- DRAWINGS UNDER SENIOR SECURED VENDOR FINANCINGS. We intend to enter into
senior secured financing agreements with the vendors providing equipment
for our network. We expect that the economic terms of these agreements
will be similar to the Lucent credit facility that we have negotiated for
our fiber optic cable purchases. We expect these vendors to include those
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providing fiber optic cable, fiber optic lighting optronics equipment and
equipment supporting digital subscriber line and Time Division
Multiplexing, or TDM,-based services. We expect to draw approximately $75
million in senior secured financing from our equipment vendors from
January 1, 2000 through June 30, 2001.
- EQUITY INVESTMENT FROM COLONIAL. As described in the prospectus summary,
we expect to receive from Colonial as part of our reorganization an
aggregate of $68 million in cash in return for two tranches of shares of
our series E preferred stock, an option to acquire additional shares of
our capital stock, and rights to conduit along certain of our corridors.
- ADDITIONAL EQUITY INVESTMENT. We expect to raise approximately $100
million in new equity financing from January 1, 2000 through June 30,
2001. We have not yet identified the sources of this equity investment.
CASH USES
- OPERATING EXPENSES. We expect to incur approximately $95 million in cash
operating expenses from January 1, 2000, through June 30, 2001.
- FIBER OPTIC NETWORK CONSTRUCTION AND LIGHTING OF FIBER OPTIC ROUTES. The
first phase of our business plan involves approximately 12,500 miles of
network route mile construction. We expect to have completed development
of approximately 10,500 routes miles of network capacity by June 30, 2001
consisting of:
- approximately 6,500 miles of wireless network (of which 6,300 miles
were complete as of December 31, 1999);
- 2,600 miles of dark fiber (of which 500 miles were complete as of
December 31, 1999); and
- 1,400 miles of dark fiber acquired through barter exchanges of fiber
optic cable with third parties.
Within these cost projections, we have included our costs of lighting and
making fully operational two of our retained fiber optic strands in each
network route segment. Upon completing the construction of each network
segment, we plan to light these two strands to a minimum initial capacity
of OC-192.
- INTERCONNECTION AND COLLOCATION DEVELOPMENT. We currently expect, on or
before June 30, 2001, to interconnect our fiber optic backbone network to
approximately 120 cities. We contemplate that these interconnections will
require us to develop interconnection paths between our backbone network
and cities in which we establish interconnections. These interconnections
paths -- essentially tributaries from our network backbone -- vary in
distance from several hundred feet to 75 miles. In addition, we expect to
develop over 200 collocations as of June 30, 2001.
- NET INTEREST EXPENSE/INCOME. Projected interest expense from January 1,
2000, through June 30, 2001 consists principally of semi-annual interest
payments on the notes and cash interest paid on senior secured vendor
financing facilities, offset by interest income from short-term
investments of cash balances.
YEAR 2000 READINESS DISCLOSURE
The Year 2000 issue exists because many computer systems and software
applications use two, rather than four, digits to designate a particular year.
As a result, these systems and applications may
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not properly recognize the Year 2000, or process data that includes that date,
potentially causing data miscalculations or inaccuracies, operational
malfunctions or failures.
OVERVIEW OF OUR YEAR 2000 PROGRAM. In the fourth quarter of 1998, we began
a corporate-wide program to ready technology systems, non-technology systems and
software applications for the Year 2000. We identified all systems and
applications that we believe needed to be modified or reprogrammed to achieve
Year 2000 compliance and implemented the necessary changes.
In December 1999, we completed the inventory, assessment and remediation of
mission critical hardware systems and software applications, including network
computing and network systems engineering. We have developed and tested
contingency plans in the event that certain of our suppliers or service
providers may not have been Year 2000 compliant.
In preparation for the Year 2000 transition, we provided 24-hour coverage
from December 31, 1999 through January 3, 2000 in our network operating center
and our corporate data center. We encountered no Year 2000 related problems and
observed no interruption of service during that time.
As part of our Year 2000 plan, we requested confirmation from our
communications equipment vendors and other key suppliers, financial institutions
and customers that their systems would be Year 2000 compliant. Responses
received indicated a high level of Year 2000 compliance at these companies.
Although we have incurred no Year 2000 problems to date, we cannot assure you
that the systems of companies with which we do business are Year 2000 compliant.
If the vendors important to us fail to provide needed products and services, our
network buildout and operations could be affected and thereby have a material
adverse effect on our results of operations, liquidity and financial condition.
Moreover, to the extent that significant customers are not Year 2000 compliant
and that affects their network needs, our sales could be lower than otherwise
anticipated.
We have hired outside consultants to assist us with our Year 2000
compliance, but we have relied primarily on our own employees to develop and
implement our Year 2000 compliance strategy. Because our existing systems are
relatively new, we have not replaced any significant portion of them. As a
result our expenditures to implement our Year 2000 plan have not been material
to date and we do not believe our future expenditures on this matter will be
material (remediation costs incurred to date have been less than $100,000). Such
expenditures represented less than 1% of 1999 capital expenditures and were
funded out of cash flow from operations. To the extent we will have to replace a
significant portion of our technology systems, which currently appears unlikely,
our expenditures could have material adverse effects on us. As a result, our
expenditures to ensure Year 2000 compliance have not been material to date. We
expect to continue to use existing employees for the significant part of our
Year 2000 compliance efforts.
The discussion of our efforts and management's expectations relating to
Year 2000 compliance are, in part, forward-looking statements. Due to the
general uncertainty inherent in the Year 2000 problem, resulting in large part
from the uncertainty of the Year 2000 readiness of third parties, we cannot
ensure our ability to timely and cost effectively resolve problems associated
with the Year 2000 issue that may adversely affect our operations and business
or expose us to third party liability and we have been unable to fully determine
the risks associated with the reasonably likely worst case scenario.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to minimal market risks. We manage sensitivity of our
results of operations to these risks by maintaining a conservative investment
portfolio, (which primarily consists of debt securities, that typically mature
within one year), and entering into long-term debt obligations with appropriate
pricing and terms. We do not hold or issue derivative, derivative commodity or
other
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financial instruments for trading purposes. Financial instruments held for other
than trading purposes do not impose a material market risk on us.
We are exposed to interest rate risk. We periodically need additional debt
financing due to our large operating losses, and capital expenditures associated
with establishing and expanding our network coverage increase our financing
needs. The interest rate that we will be able to obtain on debt financing will
depend on market conditions at that time, and may differ from the rates we have
obtained on our current debt.
Although all of our long-term debt bears fixed interest rates, the fair
market value of our fixed rate long-term debt is sensitive to changes in
interest rates. We have no cash flow or earnings exposure due to market interest
rate changes for our fixed long-term debt obligations.
NEW ACCOUNTING PRONOUNCEMENT
In July 1999, the Financial Accounting Standards Board (FASB) issued FIN
43, "Real Estate Sales, an interpretation of FASB Statement No. 66". We are
still assessing the impact of FIN 43 on our future operations. Specifically, we
are assessing the impact of the requirement that title transfer in order to use
sale type lease accounting for the sales of dark fiber and conduit. Under FIN 43
the arrangement is accounted for as a operating lease if title does not
transfer. For the year ended December 31, 1999 there has been no revenue
generated from sales of dark fiber and conduit.
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MANAGEMENT
OUR DIRECTORS AND EXECUTIVE OFFICERS
The table below contains information about the ages and positions of our
executive officers, selected key employees, and directors as of the date of this
prospectus.
<TABLE>
<CAPTION>
NAME AGE POSITION(S) WITH PATHNET TELECOM
---- --- --------------------------------
<S> <C> <C>
Richard A. Jalkut....................... 55 President, Chief Executive Officer and
Director
Robert A. Rouse......................... 51 Executive Vice President, Chief
Operating Officer and President, Network
Services
James M. Craig.......................... 43 Executive Vice President, Chief
Financial Officer and Treasurer
William R. Smedberg, V.................. 38 Executive Vice President, Corporate
Development
Michael A. Lubin........................ 50 Vice President, General Counsel and
Secretary
Shawn F. O'Donnell...................... 34 Senior Vice President of Engineering and
Construction
Peter J. Barris......................... 47 Director
Kevin J. Maroni......................... 37 Director
Patrick J. Kerins....................... 44 Director
Stephen A. Reinstadtler................. 33 Director
</TABLE>
Richard A. Jalkut has served as President, CEO and director of Pathnet
since August 1997. He will serve in these capacities for Pathnet Telecom upon
the close of our reorganization. Mr. Jalkut has over 30 years of
telecommunications experience. From 1995 to August 1997, he served as President
and Group Executive of NYNEX Telecommunications Group, where he was responsible
for all activities of the NYNEX Telecommunications Group, an organization with
over 60,000 employees. From 1991 until 1995, Mr. Jalkut served as President and
CEO of New York Telephone Co. Inc., the predecessor company to NYNEX
Telecommunications Group. Mr. Jalkut currently serves as a member of the board
of directors of HSBC Bank USA, a commercial bank; Ikon Office Solutions, Inc., a
company engaged in wholesale and retail office equipment; Digex, Incorporated;
and Home Wireless Networks, a start-up company developing a wireless product for
home and business premises.
Robert A. Rouse has served as Pathnet's Executive Vice President, President
of Network Services since April 1999 and, since September 1999, as Pathnet's
Chief Operating Officer. He will hold these positions for Pathnet Telecom after
completion of our reorganization. Mr. Rouse joined Pathnet with over 30 years
experience in the telecommunications industry. Before Pathnet, from October 1996
to November 1998, Mr. Rouse was Executive Vice President, Engineering, Systems
and Operations of Intermedia, responsible for network services, engineering and
systems. Before that, from October 1986 to October 1996, he served in several
positions at MCI beginning as the Director of New York City Operations and
spending the last three years as Senior Vice President of Network Services for
MCI/Concert. As Senior Vice President of Network Services for MCI/Concert, he
was responsible for integrating the network and product functionality between
MCI and British Telecom as well as building global networks. From March 1986
until September 1986, Mr. Rouse served as the Regional Vice President for
Eastern Operations for US West. In addition, Mr. Rouse spent 17 years, from June
1969 until March 1986, with Frontier Communications, Inc. where he was
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involved in a series of unregulated start-up business ventures, and he played a
key role in developing Frontier's long distance company.
James M. Craig has served as Executive Vice President, Chief Financial
Officer and Treasurer of Pathnet since April 1999. He will serve in these
capacities for Pathnet Telecom upon the close of our reorganization. Mr. Craig
has 22 years of accounting and finance experience, including 15 years
specifically in the communications industry. From February 1997 to April 1999,
Mr. Craig served as the Senior Director Treasury Management for Omnipoint
Communications, Mr. Craig was responsible for corporate planning and
forecasting. In this position, he also served as a point of contact for
investment banks, sell-side analysts and rating agencies. Before that, Mr. Craig
assisted in the launch of two start-up telecommunications companies, from
February 1996 to February 1997 at UniSite and from September 1995 to February
1997 at National Telecom PCS, Inc. While with UniSite, he established regional
and national alliances between UniSite and telecommunications tower owners. Mr.
Craig also spent a total of 11 years, from 1983 to 1995, with MCI, holding
positions such as Director of Wireless Communications, Director of Corporate
Development, Director of Telecommunications Group Planning and Director of
Corporate Treasury Group. From 1982 through 1983 and from 1977 through 1980, Mr.
Craig served as a Senior Accountant at the Cowper Companies and from 1980 to
1982 he practiced as a certified public accountant with Touche Ross & Co.
William R. Smedberg, V joined Pathnet initially as a consultant in 1996,
served as Vice President, Finance and Corporate Development of Pathnet from
January 1997 to February 1999 and assumed the position of Executive Vice
President, Corporate Development of Pathnet in March 1999. Mr. Smedberg will
serve as Pathnet Telecom's Executive Vice President, Corporate Development after
completion of our reorganization. Before joining Pathnet, Mr. Smedberg served as
Director, Strategic Planning and Corporate Development for Jamont, a European
consumer products joint venture among Nokia Oy, Montedison S.p.A. and James
River Corporation of Virginia, Inc., from 1991 to 1996, where he was responsible
for Jamont's corporate finance, strategic planning and corporate development.
Michael A. Lubin has served as Vice President, General Counsel and
Secretary of Pathnet since its inception in August 1995. He will serve in this
capacity for Pathnet Telecom upon the close of our reorganization. Before
joining Pathnet, Mr. Lubin was an attorney-at-law at Michael A. Lubin, P.C., a
law firm he founded in 1985. Mr. Lubin has experience in telecommunications,
copyright and intellectual property matters, corporate and commercial law,
construction claims adjudication and trial work. From 1976 until 1981, he served
as a federal prosecutor with the Fraud Section, Criminal Division, United States
Department of Justice.
Shawn O'Donnell has served as Senior Vice President of Engineering and
Construction of Pathnet since August 1999. He will serve in this capacity for
Pathnet Telecom upon the close of our reorganization. Mr. O'Donnell has more
than 14 years of engineering experience in the telecommunications industry.
Before joining Pathnet, Mr. O'Donnell served as Director of Transmissions and
Facility Standards and Engineering with MCI WorldCom from November 1996 to
August 1999. In that position, he was in charge of a 340+ person team that was
responsible for overall transmission and facility engineering for local, long
distance and Internet networks. From April 1988 to November 1996, he also held a
variety of other positions at MCI WorldCom, including Senior Manger of
Transmission Engineering Implementation and Senior Manager of Switched Network
Planning. Before MCI WorldCom, from June 1986 to April 1988, Mr. O'Donnell was a
Control Engineer with Potomac Edison. While there, he was responsible for the
management of communications networks associated with high voltage control
systems.
Peter J. Barris has been a director of Pathnet since August 1995 and will
serve as a director of Pathnet Telecom upon consummation of our reorganization.
Since 1992, Mr. Barris has been a
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partner; in 1994, was appointed a General Partner; and, in 1999, was appointed
Managing General Partner of New Enterprise Associates, a firm that manages
venture capital investments. Mr. Barris is also a member of the board of
directors of Mobius Management Systems, Inc., PcOrder.com, Inc. and
Careerbuilder, Inc., each of which is quoted on the NASDAQ National Market.
Kevin J. Maroni has been a director of Pathnet since August 1995 and will
serve as a director of Pathnet Telecom after the closing of our reorganization.
Since 1994, Mr. Maroni has been a principal, and, in 1995, was appointed a
General Partner of Spectrum Equity Investors, which manages private equity funds
focused on growth capital for Telecommunications companies. Prior to Spectrum,
Mr. Maroni worked at Time Warner and Harvard Management Company. Mr. Maroni is
currently on the board of directors of several private companies and CTC
Communications Corp (which is quoted on the NASDAQ National Market).
Patrick J. Kerins has been a director of Pathnet since July 1997 and will
serve as a director of Pathnet Telecom after consummation of our reorganization.
Since March 1997, Mr. Kerins has served as Managing Director of Grotech Capital
Group, which is engaged in venture capital and other private equity investments.
From 1987 to March 1997, he worked in the investment banking division of Alex
Brown & Sons, Incorporated, including serving as Managing Director beginning in
January 1994. Mr. Kerins is a member of the board of directors of CD Now, Inc.,
an online retailer of compact discs and other music related projects which is
quoted on the NASDAQ National Market.
Stephen A. Reinstadtler has been a director of Pathnet since October 1997
and will, upon consummation of our reorganization, serve as a director of
Pathnet Telecom. Since August 1995, Mr. Reinstadtler has served as Vice
President and Director at Toronto Dominion Capital (U.S.A.) Inc., where he has
been involved in private equity and mezzanine debt investments. From April 1994
to July 1995, he was Manager at The Toronto-Dominion Bank, where he was involved
in commercial lending activities to the telecommunications industry. From August
1992 to April 1994, Mr. Reinstadtler also served as Associate at
Kansallis-Osake-Pankki, where he was involved in commercial lending activities
to the telecommunications industry.
ADDITIONAL DIRECTORS TO BE ELECTED
Our board of directors currently consists of Richard Jalkut, Kevin Maroni,
Patrick Kerins, Stephen Reinstadtler and Peter Barris, all of whom are also
directors of Pathnet. Upon the closing of our reorganization our stockholders
will designate additional directors as provided in the stockholders agreement
that will be executed at the closing.
Upon the closing of our reorganization, Mr. Barris and Mr. Maroni will
serve as the representative of the holders of our series A convertible preferred
stock, Mr. Kerins will serve as the representative of the holders of our series
B convertible preferred stock, Mr. Reinstadtler will serve as the representative
of our series C convertible preferred stock, and Mr. Jalkut, our President and
CEO, will serve by virtue of his position as CEO. The remaining directors will
be elected as set forth in "CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS -- Our Stockholders Agreement." After an initial "Qualified Public
Offering," which the stockholders agreement defines as an underwritten public
offering of more than $75 million in value of our securities at a per share
price that implies a valuation in excess of $600 million for all of the shares
of our capital stock, for so long as BNSF, CSX and Colonial hold at least 5% of
our outstanding voting securities, all of the stockholders who are party to the
stockholders agreement have agreed to vote their shares to elect each of BNSF's,
CSX's and Colonial's designees to the board of directors. The terms of the
stockholders agreement relating to election of directors (other than the
election of the BNSF, CSX and Colonial designees as described above) will
terminate upon the earlier of the date on which no shares of our preferred stock
remain outstanding or, if applicable, on which we complete an initial
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"qualified public offering." After the termination of these stockholders
agreement provisions and the conversion of our preferred stock into common
stock, each of our directors, other than the designees of BNSF, CSX and
Colonial, will be elected by a majority vote of our stockholders.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Although we may establish a compensation committee in the future, we do not
currently have one. Unless our board of directors determines otherwise, our
present intention is to keep Pathnet employees, other than our executive
officers, and accordingly our decisions regarding compensation, at the level of
our Pathnet subsidiary. Pathnet does have a compensation committee of its board
of directors, which currently consists of two of Pathnet's directors, Messrs.
Maroni and Barris. Prior to the resignation of Richard Prins from Pathnet's
board of directors in 1999, Pathnet had a three member compensation committee,
consisting of Messrs. Maroni, Barris and Prins. Pathnet's compensation committee
was established to, among other things, administer Pathnet's stock incentive
plans, review and make recommendations to the board of directors concerning the
compensation of executive officers, and consider existing and proposed
employment agreements between Pathnet and its executive officers.
During the fiscal year ended December 31, 1999, no executive officer of
Pathnet served as a member of Pathnet's compensation committee or as a director
of any entity of which any of our or Pathnet's directors served as an executive
officer. No member of Pathnet's compensation committee is currently a Pathnet
employee.
COMPENSATION OF OUR DIRECTORS
Currently, our directors do not receive directors' fees or other
compensation and they are not compensated or reimbursed for their out-of-pocket
expenses incurred in serving as directors or for attending meetings of the board
of directors or its committees. However, our new stockholders agreement
contemplates the election of at least one director who is not an affiliate of
any stockholder or member of management. As a result, after the close of our
reorganization, we may consider changing the compensation arrangements for our
directors.
LIMITATION OF LIABILITY AND INDEMNIFICATION
We are incorporated under the laws of the State of Delaware.
Section 102(b)(7) of the Delaware General Corporation Law permits a
provision in the certificate of incorporation of each corporation organized
thereunder, eliminating or limiting, with certain exceptions, the personal
liability of a director to the corporation or its stockholders for monetary
damages for certain breaches of fiduciary duty as a director.
Our certificate of incorporation limits, to the fullest extent permitted by
law, the liability of our directors to us and our stockholders for monetary
damages for breach of their fiduciary duty. This provision is intended to afford
our directors the benefit of the Delaware General Corporation Law. This
limitation on liability does not extend to:
- Any breach of a director's duty of loyalty to us or our stockholders;
- Acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
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- Violations of the Delaware General Corporation Law regarding the improper
payment of dividends; or
- Any transaction from which the director derived any improper personal
benefit.
Section 145 of the Delaware General Corporation Law, in summary, empowers a
Delaware corporation, within certain limitations, to indemnify its officers,
directors, employees and agents against expenses (including attorneys' fees),
judgments, fines and amounts paid in settlement, actually and reasonably
incurred by them in connection with any suit or proceeding other than by or on
behalf of the corporation, if they acted in good faith and in a manner
reasonably believed to be in or not opposed to the best interest of the
corporation, and, with respect to a criminal action or proceeding, had no
reasonable cause to believe their conduct was unlawful.
With respect to actions by or on behalf of the corporation, Section 145 of
the Delaware General Corporation Law permits a corporation to indemnify its
officers, directors, employees and agents against expenses (including attorneys'
fees) actually and reasonably incurred in connection with the defense or
settlement of such action or suit, provided such person meets the standard of
conduct described in the preceding paragraph, except that no indemnification is
permitted in respect of any claim where such person has been found liable to the
corporation, unless the Court of Chancery or the court in which such action or
suit was brought approves such indemnification and determines that such person
is fairly and reasonably entitled to be indemnified.
Our certificate of incorporation requires us to indemnify our directors and
officers to the extent not prohibited by law for actions or proceedings arising
because of their positions as directors or officers.
Our stockholders agreement provides for indemnification of us, our
directors and officers, and persons who control us within the meaning of Section
15 of the Securities Act or Section 20 of the Exchange Act for certain
liabilities, including liabilities under the Securities Act.
In addition, Pathnet maintains, and we will maintain, standard directors'
and officers' insurance policies.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers or persons controlling Pathnet Telecom
pursuant to the foregoing agreements and provisions, we have been informed that
in the opinion of the SEC such indemnification is against public policy as
expressed in the Securities Act and is therefore unenforceable.
COMPENSATION OF OUR EXECUTIVE OFFICERS
We are being formed as part of our reorganization and, as such, we have no
historical compensation information. However, we expect that each of the
executive officers who will serve as our officers immediately after closing the
transaction will be the individuals that held the same office at Pathnet
immediately before closing. Consequently, the following tables present the
compensation information for Pathnet's last three fiscal years as illustrative
of the total compensation that we (including Pathnet) will pay to our executive
officers.
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The table below presents information about compensation earned by Pathnet's
CEO and each of Pathnet's six other Named Executive Officers. The officers
listed in the table below are referred to as the Named Executive Officers:
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
------------
ANNUAL COMPENSATION OTHER SECURITIES
--------------------- ANNUAL UNDERLYING
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION* OPTIONS**
--------------------------- ---- -------- -------- ------------- ------------
<S> <C> <C> <C> <C> <C>
Richard A. Jalkut................ 1999 $400,000 $300,000 $40,733(1) --
President and Chief 1998 400,000 -- 40,289(2) --
Executive Officer 1997 166,154(3) -- 9,857(4) 858,754
Michael A. Lubin................. 1999 135,019 47,120 -- --
Vice President, General 1998 136,840 5,000 -- 15,000
Counsel and Secretary 1997 136,115 -- -- --
William R. Smedberg V............ 1999 182,886 139,000 -- 50,000
Executive Vice President, 1998 111,250 28,267 -- 78,656
Corporate Development 1997 100,384 -- -- --
James M. Craig................... 1999 122,206(5) 78,750 -- 125,000
Executive Vice President, Chief
Financial Officer and Treasurer
Shawn F. O'Donnell............... 1999 58,739(6) 57,500 -- 50,000
Senior Vice President of
Engineering and Construction
Robert A. Rouse.................. 1999 239,276(7) 133,751 36,943(8) 350,000
Executive Vice President, Chief
Operating Officer and President
of Network Services
Kevin J. Bennis.................. 1999 207,138(9) 27,500 -- --
Executive Vice President and 1998 246,353(10) -- 185,602(11) 382,500
President Communications
Services
</TABLE>
- ---------------
* Except as stated herein, none of the above Named Executive Officers
received perquisites or other personal benefits in excess of the lesser of
$50,000 or 10% of that individual's salary plus annual bonus.
** We have not issued any stock appreciation rights or long-term incentive
plans.
(1) Consists of $7,227 for club dues; $13,368 for lodging; $15,090 for airfare;
and $5,048 for other transportation.
(2) Consists of $16,277 for club dues; $7,756 for lodging; $11,685 for airfare;
and $4,571 for other transportation.
(3) Mr. Jalkut began his employment with Pathnet in August 1997, and his salary
was $400,000 per annum in 1997.
(4) Reimbursement for travel expenses.
(5) Mr. Craig began his employment with Pathnet on April 19, 1999, and his
salary was $175,000 per annum in 1999.
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(6) Mr. O'Donnell began his employment with Pathnet on August 9, 1999, and his
salary was $150,000 per annum in 1999.
(7) Mr. Rouse began his employment with Pathnet on April 26, 1999, and his
salary was $325,000 per annum in 1999.
(8) Reimbursement for moving expenses.
(9) Mr. Bennis' employment with Pathnet was terminated on September 17, 1999.
(10) Mr. Bennis began his employment with Pathnet on February 9, 1998, and his
salary was $275,000 per annum.
(11) Consisting of $48,093 in residence settlement charges in Georgia, $99,319
residence settlement charges in Virginia, $22,780 in other moving expenses
and $15,410 in rent.
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STOCK OPTION GRANTS IN OUR LAST FISCAL YEAR
The table below provides information regarding stock options granted to the
named executive officers of Pathnet during the year ended December 31, 1999.
None of the named executive officers received stock appreciation rights. As part
of our reorganization, each of the option grants for Pathnet common stock will
be assumed by us and will be exercisable for shares of our common stock on terms
and conditions substantially identical to the terms of the Pathnet options,
including terms relating to the option vesting schedule.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE VALUE AT
NUMBER OF PERCENT OF ASSUMED ANNUAL RATE OF STOCK
SECURITIES TOTAL OPTIONS PRICE APPRECIATION FOR THE
UNDERLYING GRANTED TO EXERCISE OPTION TERM(1)
OPTIONS EMPLOYEES IN PRICE EXPIRATION -----------------------------
GRANTED FISCAL YEAR $/SHARE DATE 0% 5% 10%
---------- -------------- -------- ---------- --- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Richard A. Jalkut.............. -- --% $ -- -- $-- $ -- $ --
Michael A. Lubin............... -- -- -- -- -- -- --
William R. Smedberg V.......... 50,000(2) 6.88 5.20 5/13/2009 0 163,513 414,373
James M. Craig................. 125,000(2) 17.21 5.20 5/13/2009 0 408,782 1,035,933
Shawn F. O'Donnell............. 50,000(2) 6.88 5.20 8/5/2009 0 163,513 414,373
Robert A. Rouse................ 350,000(2) 48.18 5.20 5/13/2009 0 1,144,588 2,900,611
Kevin J. Bennis................ -- -- -- -- -- -- --
</TABLE>
- ---------------
(1) The information disclosed assumes, solely for purposes of demonstrating
potential realizable value of the stock options, that the estimated fair
value per share of common stock of Pathnet was $5.20 per share as of the
date of grant and increases at the rate indicated during the option term.
(2) The options vest ratably over a four-year period. The option may be
transferred by will or by the laws of descent and distribution. Upon a
change in control of Pathnet and a termination of the optionee's employment
without cause, the options that would otherwise become vested within one
year will be deemed vested immediately before such optionee's termination.
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<PAGE> 70
OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES
The following table lists information about the number and value of stock
options held by each of the Named Executive Officers as of December 31, 1999.
None of the Named Executive Officers holds stock appreciation rights.
OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED
OPTIONS AT VALUE OF UNEXERCISED
SHARES DECEMBER 31, 1999 IN-THE-MONEY OPTIONS(1)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Richard A. Jalkut............. -- -- 572,502 286,252 5,650,595 2,825,307
Michael A. Lubin.............. -- -- 145,215 11,250 1,573,621 65,250
William R. Smedberg V......... -- -- 58,686 69,970 513,093 492,191
James M. Craig................ -- -- 0 125,000 0 725,000
Shawn F. O'Donnell............ -- -- 0 50,000 0 290,000
Robert A. Rouse............... -- -- 0 350,000 0 2,030,000
Kevin J. Bennis............... 90,625 $894,469 0 0 0 0
</TABLE>
- ---------------
(1) Based on an assumed market price of Pathnet's common stock of $11.00 per
share as of December 31, 1999.
1995 STOCK OPTION PLAN
We will assume Pathnet's 1995 stock option plan at the closing of our
reorganization. Additionally, upon the close of our reorganization, we will
assume, and we have agreed with the existing option holders to amend, all
existing awards under Pathnet's "1995 plan" so that the awards will be
exercisable for shares of our common stock rather than common stock of Pathnet.
The total number of shares of common stock that we may issue under the 1995 plan
may not exceed 495,126 shares of common stock. As of December 31, 1999, Pathnet
had awarded options on all shares reserved under Pathnet's 1995 plan, at an
exercise price of $0.03 per share. The 1995 plan will permit our board of
directors, or a committee of the board, to exercise broad discretion to grant
stock options to our employees. If additional shares are authorized under the
1995 plan, the 1995 plan will permit the board of directors to exercise its
discretion to determine:
- The exercise price of the options;
- Any vesting provisions, including whether accelerated vesting will occur
with a "change in control"; and
- The term of the options, which cannot exceed 10 years.
Within one year following the closing of our reorganization, our
stockholders must approve our assumption of the 1995 plan and the options
awarded under the plan.
1997 STOCK INCENTIVE PLAN
At the closing of our reorganization, we will assume Pathnet's 1997 stock
incentive plan, which will become our "1997 plan." Additionally, upon the close
of our reorganization, we will assume and amend all existing awards under
Pathnet's 1997 plan so that the awards will be exercisable for our shares of
common stock rather than Pathnet common stock. Our stockholders also must
approve our assumption of the 1997 plan and the options awarded under the 1997
plan. The 1997 plan will permit
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<PAGE> 71
our board of directors, or a committee of the board, to grant a variety of
awards to employees and consultants. Under our 1997 plan, the board of directors
will have the authority to grant:
- Incentive and non-qualified stock options;
- Stock appreciation rights, which are rights to receive an amount equal to
a specified portion of the increase in market value of common stock over
a specified exercise price between the date of grant and the date of
exercise;
- Restricted shares, which involve the immediate transfer of shares of
common stock for the performance of services. Restricted shares must be
subject to a "substantial risk of forfeiture" within the meaning of
Section 83 of the tax code;
- Deferred shares, which involve an agreement to deliver shares of common
stock in the future in consideration for the performance of service;
- Performance awards, each of which is a bookkeeping unit equivalent to one
share of common stock;
- Performance compensation awards; and
- Other stock based awards.
The total number of shares of common stock that may be issued or
transferred under our 1997 plan may not exceed 5,004,874. The maximum share
number is subject to adjustment in the event of a stock split, stock dividend or
other similar transactions.
The board of directors will have broad discretion in granting and
establishing the terms of awards under our 1997 plan. However, our 1997 plan
will contain limitations, including:
- No individual may be granted, in any calendar year, options and stock
appreciation rights for more than 1,160,000 total shares of common stock;
- No individual may be granted, in any one calendar year, performance
compensation awards for more than 1,160,000 shares of common stock or, in
the event the performance compensation is paid in cash, the equivalent
cash value thereof;
- The term of options may not be more than 10 years; and
- Performance compensation awards must specify a performance period not to
exceed one year and pre-established objective performance criteria which,
if achieved, will result in payment.
Similar to our 1995 plan, our 1997 plan will allow the board of directors
to exercise broad discretion in determining:
- The exercise price of any stock based award;
- Any vesting terms of an award, including whether vesting will accelerate
with a "change in control" (which is described below); and
- The term of the options, which cannot exceed 10 years.
Under our 1997 plan, the board of directors may establish performance
criteria for purposes of performance awards. The 1997 plan will also allow the
board of directors to specify performance criteria for stock options, stock
appreciation rights and restricted stock awards that are designated as
performance compensation awards. Performance criteria may be described in terms
of either company-wide objectives or objectives that are related to the
performance of the individual participant or a division, department, region or
function within Pathnet Telecom. Performance criteria applicable to any award to
a participant who is, or is determined by the board of directors likely to
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<PAGE> 72
become, a "covered employee" within the meaning of Section 162(m) of the tax
code must be limited to specified levels of, or growth in, one or more of these
criteria:
- Return on net assets;
- Return on stockholders' equity;
- Return on assets;
- Return on capital;
- Stockholder returns;
- Profit margin;
- Earnings per share;
- Net earnings;
- Operating earnings;
- Price per share; and
- Sales or market share.
Except where a modification would result in an award to a "covered
employee" no longer qualifying as performance-based compensation within the
meaning of Section 162(m) of the tax code, the board of directors may modify a
part or all of these performance criteria as it deems appropriate and equitable
in light of events and circumstances, such as changes in our business,
operations, corporate structure or capital structure.
The 1997 plan provides that, if we terminate the optionee's employment
either actually or constructively, following the occurrence of a change in
control, the portion of the option that otherwise would have vested in the
12-month period following the change in control will be deemed vested as of the
date immediately before the date of the change in control.
"Change in control" is defined under the 1997 plan to mean:
- A sale of all or substantially all of our assets or a merger or other
similar transaction involving us which results in less than a majority of
the voting power of the surviving corporation being held by our common
stockholders immediately before the transaction;
- During any two year period, a majority of the board of directors consists
of persons who are not members of or have not been approved by the
incumbent board of directors; or
- The ownership or acquisition of 50% or more of our voting power by any
person or group.
Under the 1997 plan, if Richard Jalkut's or Robert Rouse's employment,
whichever the case may be, is terminated after a change of control, then certain
of their options will be deemed to become vested immediately before the change
in control. Both Mr. Jalkut and Mr. Rouse have agreed with Pathnet that the
reorganization does not constitute a change in control under the 1997 plan.
In August 1997, Mr. Jalkut was granted an option to purchase 296,122 shares
of common stock under the 1997 plan, which vests in equal installments over
three years; the number of shares and the exercise price were subsequently
adjusted in a stock split.
As of December 31, 1999, there were options covering 2,251,204 shares of
Pathnet's common stock outstanding under the 1997 plan.
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SCHAEFFER BOARD RESIGNATION
In October 1997, Mr. Schaeffer was an employee of Pathnet and was granted
an option to purchase 148,418 shares of common stock under the 1997 plan; the
number of shares and the exercise price were subsequently adjusted in a stock
split. Mr. Schaeffer is no longer an officer or director of Pathnet and has not
been an officer or director of Pathnet Telecom. In a letter agreement dated
November 4, 1999, in which Mr. Schaeffer resigned from his position as a
director of Pathnet, Pathnet and Mr. Schaeffer agreed that Mr. Schaeffer holds
options for a total of 107,389 shares of Pathnet common stock, which are fully
vested at an exercise price of $3.67 per share. We will assume these option
grants and convert them to options for shares of our common stock at closing of
our reorganization.
JALKUT EMPLOYMENT AGREEMENT
Pathnet is currently a party to an employment agreement with Mr. Jalkut.
Under this employment agreement, Mr. Jalkut will receive a minimum annual base
salary of $400,000 (or any greater amount approved by a majority of the board of
directors), bonuses and other benefits determined by the board of directors.
Additionally, Mr. Jalkut is entitled to receive reimbursement of certain
expenses, all of which expenses may not exceed $50,000 per year. In accordance
with his employment agreement, on August 4, 1997, Mr. Jalkut received
nonqualified stock options for 296,122 shares of common stock at an exercise
price of $3.28 per share; the number of shares and the option price were
subsequently adjusted in a stock split. These options vest ratably over three
years. We have granted Mr. Jalkut registration rights for the shares he will
receive upon exercise of his options. If we terminate Mr. Jalkut's employment he
may elect, within 10 business days of his termination, to have us pay him,
subject to the terms of the indenture and the supplemental indenture, the
aggregate fair value of his options then vested or held by him. We will be
required to make any payments in accordance with his employment agreement.
During his employment and for two years after his termination, Mr. Jalkut's
employment agreement requires him to refrain from investing in businesses or
activities that compete with us, soliciting our employees or otherwise competing
with us, by, for example, working with or for one of our competitors. Mr.
Jalkut's employment agreement also prevents him from disclosing or using our
confidential or proprietary information at any time.
Other than the restrictions on Mr. Jalkut described above and our
obligation to pay severance for one year following the termination of Mr.
Jalkut's employment (depending on the basis for his termination), Mr. Jalkut's
employment agreement will terminate in the event of his death and may be
terminated:
- By us:
(a) Without cause (as defined in his employment agreement), by giving
60 days' prior written notice; or
(b) For cause, generally subject to a 30-day written notice of the
board's intention to terminate him for cause;
(c) Upon Mr. Jalkut's disability (as defined in his employment
agreement); and
- By Mr. Jalkut:
(a) Without cause, by giving 180 days' prior written notice; and
(b) Immediately, upon a constructive termination (as defined in his
employment agreement).
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<PAGE> 74
Unless we terminate Mr. Jalkut's employment for cause, or Mr. Jalkut
terminates his employment without cause, Mr. Jalkut is entitled to continue to
receive his salary for 12 months following the termination of his employment
with us.
OTHER AGREEMENTS
Messrs. Schaeffer, Lubin, O'Donnell, Rouse, Craig and Smedberg each have
entered into an agreement with Pathnet which requires each of them to (1) assign
to Pathnet all inventions developed by them during their employment, (2)
maintain the confidentiality of our proprietary information, and (3) refrain
from working with or for a competitor of ours for two years after his
termination.
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<PAGE> 75
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
We summarize in this section selected material terms of our stockholders
agreement. For a more complete description of these rights, we refer you to the
copy of our stockholders agreement filed as an exhibit to the registration
statement of which this prospectus is a part. If there is an inconsistency
between this summary and our stockholders agreement, the stockholders agreement
will control.
OUR STOCKHOLDERS AGREEMENT
Overview
Upon closing of the various contribution agreements comprising our
reorganization, we will enter into a stockholders agreement with CSX, Colonial,
BNSF, our other preferred stockholders and David Schaeffer. Our stockholders
agreement will put in place at the Pathnet Telecom level many of the provisions
that currently apply under Pathnet's existing investment and stockholders
agreement. Pathnet's existing investment and stockholders agreement will be
terminated after our reorganization.
In accordance with our stockholders agreement, each stockholder will agree
to vote in favor of the election of a board of directors consisting of 10
members:
- Two designees of the series A preferred stockholders (initially, a
designee of Spectrum Equity Investors L.P. and the other will initially
be a designee of New Enterprise Associates VI Limited Partnership);
- One designee of the series B preferred stockholders (initially, a
designee of Grotech Partners, IV, L.P.);
- One designee of the series C preferred stockholders (initially, a
designee of Toronto Dominion Capital (U.S.A.), Inc.) who may not be a
partner or associate of Spectrum, New Enterprise Associates or Grotech
for so long as they have designation rights under our stockholders
agreement;
- Three designees of the series D and E preferred stockholders (one
designated by BNSF, one by CSX and one by Colonial);
- Our CEO;
- One independent "outside" director, who is neither a member of management
nor an affiliate of any stockholder; and
- One director who will be elected by all voting stockholders voting
together as a single class, as provided by our certificate of
incorporation.
Under the stockholders agreement, we will be subject to covenants
substantially similar to those in effect under Pathnet's investment and
stockholders agreement. For so long as at least 25% of the shares of preferred
stock outstanding immediately after the closing of our reorganization remain
outstanding, these covenants will require that we obtain the approval of the
holders of two-thirds of the outstanding shares of preferred stock (all voting
as a single class) before we undertake certain fundamental actions, including
mergers, dispositions, acquisitions, amendments to our certificate of
incorporation and bylaws, affiliated transactions, and certain issuances of
securities. In addition, certain actions that would adversely affect the rights
of a single series of preferred stock relative to any other series of preferred
stock would require the majority vote of each adversely affected series.
Each party to our stockholders agreement will represent and warrant to the
other stockholders that they, he or it (1) has no present intention or plan,
formally or informally, on the closing date to transfer or dispose of any of the
shares received by such party under their, his or its contribution agreement,
and (2) intends for their, his or its contribution of Pathnet shares or other
property to us
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<PAGE> 76
in accordance with their, his or its contribution agreement to be treated as
part of a single integrated transaction in which gain or loss will not be
recognized for tax purposes. Each existing Pathnet stockholder who participates
will represent and warrant to the other parties that it intends its contribution
of Pathnet shares to us to qualify as a tax-free reorganization under Section
368(a)(1)(B) of the tax code, pursuant to which gain or loss will not be
recognized.
Registration Rights
In our stockholders agreement, we will grant registration rights to our
preferred stockholders and to Mr. Jalkut and Mr. Schaeffer. These registration
rights are substantially similar to the registration rights granted to these
same holders in the Pathnet investment and stockholders agreement, except that
Mr. Schaeffer will now have registration rights. The holders of securities
subject to registration rights will have both "demand" and "piggy back"
registration rights.
Demand Rights
We will grant "demand" registration rights for two separate groups of our
equity securities. The groups are broadly distinguished by the identity of the
holders who can demand that we register their shares under the Securities Act.
The first group consists of the holders of:
- Shares of common stock issued to our preferred stockholders, or issuable
to our preferred stockholders upon the conversion of their shares of
preferred stock; and
- Shares of common stock issued or issuable to Mr. Jalkut upon the exercise
of his options.
We refer to these groups of shares as "registrable securities." On three
separate occasions, by the vote of the holders of the applicable percentage of
the registrable securities outstanding in this first group, the holders of the
shares in this group may require us to use our best efforts to file a
registration statement with the SEC in respect of their registrable securities.
Before we make an initial "qualified public offering" (which the stockholders
agreement defines as an underwritten public offering of more than $75 million in
value of our securities at a per share price that implies a valuation in excess
of $600 million for all of the shares of our capital stock), the holders of at
least 67% of the total number of outstanding registrable securities must
affirmatively vote to exercise any of these demand rights. After we make an
initial qualified public offering, the holders of 20% of the total number of
outstanding registrable securities may make the demand. Although we do not
include Mr. Schaeffer's shares in calculating the percentages for purposes of
the demand by this group, he will be entitled to participate on a proportional
basis in any registration demanded by this group of our stockholders.
Separately, we have granted Mr. Schaeffer a single right to demand that we
register his shares of our common stock under the Securities Act. Mr. Schaeffer
may exercise his demand registration right if: (1) we complete an initial
qualified public offering, and (2) our registration statement filed in respect
of that initial offering either:
- Does not include Mr. Schaeffer's shares of our common stock that he
proposes to register; or
- Has ceased to be effective within the thirty-day period following the
expiration of a mandatory "lock-up" period applicable to all of the
holders of our securities with registration rights. (The lock-up
provisions of our stockholders agreement will prohibit sales of our
securities by the parties to our stockholders agreement for a period up
to 180 days following the completion of an initial public offering.)
Although they may not initiate a "demand" under this provision, the holders
of our registrable securities identified above may participate on a proportional
basis in any registration demanded by Mr. Schaeffer under this provision of the
stockholders agreement.
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<PAGE> 77
In exercising these demand registration rights, the stockholders must in
all cases have selected an underwriter reasonably acceptable to us who is
prepared to underwrite the offering of the shares on a firm commitment basis. We
have additional obligations to assist in the registration and underwriting of
any shares that these holders seek to sell pursuant to their registration
rights. We have a right to defer each of those demand registrations for up to 60
days, if our legal counsel has advised us that filing a registration statement
relating to such a demand registration would require us either (1) to disclose a
material impending transaction and we have determined in good faith that the
disclosure would have a material adverse effect on us, or (2) to conduct a
special audit.
Pathnet has separate "demand registration" obligations under a warrant
registration rights agreement executed in conjunction with Pathnet's note and
warrant offering in April 1998. Under that agreement, the holders of a majority
of the Pathnet warrants may require Pathnet on one occasion after an initial
public offering to register under the Securities Act their shares of common
stock received upon the exercise of their warrants, subject to Pathnet's right
to defer the registration of those shares for up to 60 days in similar
circumstances. As we discuss below in "DESCRIPTION OF OUR
REORGANIZATION -- Disposition of Existing Pathnet Stock Options and Warrants,"
we are proposing to the holders of these rights that we assume Pathnet's
obligations under this warrant registration rights agreement. If the requisite
holders of the Pathnet warrants consent to the proposed amendments, or if
individual holders elect to exercise their rights to require us to exchange our
warrants for their Pathnet warrants, we may be required by the terms of the
warrant registration rights agreement to register additional shares of our
common stock upon the exercise of these warrants.
Piggyback Rights
We will also grant to each of these groups of our stockholders (and, if we
assume Pathnet's obligations to the holders of its warrants, then also to those
warrant holders) so-called "piggyback" registration rights, under which they can
require us to register their shares of common stock whenever we register any of
our equity securities under the Securities Act. These piggyback registration
rights will be subject to underwriter "cutbacks," which means that our managing
underwriter may decide to limit the number of shares added to a registration
that we initiate because the underwriter has concluded that including the
additional "piggyback" shares would have an adverse impact on the marketing of
the securities to be sold in the underwritten offering. These piggyback
registration rights will not apply to any registration relating to a public
offering pursuant to demand registration rights granted to the Pathnet
warrantholders, to the registration of securities with our employee benefit
plans, on any SEC form that does not permit secondary offerings, or to
securities we issue in a merger, exchange offer or similar transaction.
We are required to bear up to $60,000 of registration expenses for each
demand registration under our stockholders agreement. In addition, we have
agreed to indemnify the registration rights holders against, and provide
contribution for, liabilities under the Securities Act, the Exchange Act or
other federal or state laws regarding the registration of our securities.
However, we will not indemnify the registration rights holders against, or
provide them contribution for, any untrue statements or omissions made by us in
reliance on and in conformity with information furnished to us in writing by the
registration rights holders.
Preemptive Rights
Under our stockholders agreement, each of our preferred stockholders and
Mr. Schaeffer have the right to participate in certain of our sales of
securities. Specifically, on each occasion between the closing of our
reorganization and an initial "qualified public offering" that we issue shares
of our capital stock (or other securities convertible or exchangeable for our
capital stock), our preferred
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<PAGE> 78
stockholders and Mr. Schaeffer will have the right to purchase their pro rata
share of the newly issued securities. In addition, in the event that any of our
preferred stockholders or Mr. Schaeffer elects not to purchase his or its pro
rata share of the newly issued securities, the remaining preferred stockholders
and Mr. Schaeffer have the right to purchase those shares as well.
Transfer Restrictions
Mr. Schaeffer's ability to transfer his shares of our capital stock is
subject to restrictions under our stockholders agreement. He is prohibited from
making any transfers other than specifically enumerated "permitted transfers."
Those permitted transfers include:
- Transfers made in accordance with specified provisions of our
stockholders agreement which, among other things, grant a right of first
refusal to our preferred stockholders with respect to the shares Mr.
Schaeffer proposes to transfer.
- Transfers by Mr. Schaeffer to his spouse or his children, to a trust he
establishes for his spouse or children, upon his death, to a trust
established under his will and other similar transfers, provided that the
transferee enters into an enforceable written agreement that is
satisfactory to us and to a majority of our preferred stockholders,
providing that the shares transferred by Mr. Schaeffer remain subject to
our stockholders agreement.
- Transfers that constitute a bona fide pledge or other granting of a
security interest in Mr. Schaeffer's shares of our stock to secure a loan
for borrowed money, subject to specified restrictions, including
limitations on the purpose of any such loan, the minimum net assets of
the lending institution, and a review of the applicable loan documents by
our outside counsel for compliance with the terms of our stockholders
agreement.
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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The table below provides some information regarding beneficial ownership of
our capital stock as of December 31, 1999 for:
- Each of the named executive officers.
- Each of our directors.
- All of our executive officers and directors as a group.
- Each other person, entity or group who we know beneficially owns 5% or
more of any class of our stock.
All share amounts in the table have been adjusted and are presented
assuming that our reorganization was closed as of December 31, 1999. Unless
otherwise noted, the address of each of our named executive officers and
directors is 1015 31st Street, N.W., Washington, D.C. 20007.
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<PAGE> 80
<TABLE>
<CAPTION>
ISSUED AND OUTSTANDING
COMMON STOCK SERIES A PREFERRED SERIES B PREFERRED
---------------------- ---------------------- ----------------------
PERCENTAGE PERCENTAGE PERCENTAGE
STOCKHOLDER (a) SHARES OF CLASS SHARES OF CLASS SHARES OF CLASS
--------------- --------- ---------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Spectrum Equity Investors, L.P.(d)................ 0 0.00% 1,372,668 47.33% 1,220,099 25.48%
Spectrum Equity Investors II, L.P.(d)............. 0 0.00% 0 0.00% 0 0.00%
New Enterprise Associates VI, Limited
Partnership(e)................................... 0 0.00% 522,000 18.00% 685,014 14.31%
Onset Enterprise Associates II, L.P.(f)........... 0 0.00% 522,000 18.00% 463,976 9.69%
Onset Enterprise Associates III, L.P.(f).......... 0 0.00% 0 0.00% 0 0.00%
Paul Capital Partner Funds(g)..................... 0 0.00% 245,989 8.48% 125,144 2.61%
Thomas Domencich(h)............................... 0 0.00% 145,000 5.00% 62,573 1.31%
Toronto Dominion Capital (USA) Inc.(i)............ 0 0.00% 0 0.00% 884,146 18.47%
Grotech Partners IV, L.P.(j)...................... 0 0.00% 0 0.00% 884,146 18.47%
Utech Climate Challenge Fund, L.P.(k)............. 0 0.00% 0 0.00% 442,076 9.23%
Utility Competitive Advantage Fund, LLC(l)........ 0 0.00% 0 0.00% 0 0.00%
FBR Technology Venture Partners, L.P.(m).......... 0 0.00% 0 0.00% 0 0.00%
BNSF(n)........................................... 0 0.00% 0 0.00% 0 0.00%
Colonial(o)....................................... 0 0.00% 0 0.00% 0 0.00%
CSX(p)............................................ 0 0.00% 0 0.00% 0 0.00%
David Schaeffer(q)................................ 2,900,000 94.52% 0 0.0% 0 0.0%
Richard A. Jalkut................................. 0 0.00% 0 0.00% 0 0.00%
Michael A. Lubin.................................. 0 0.00% 0 0.00% 0 0.00%
William R. Smedberg V............................. 0 0.00% 0 0.00% 0 0.00%
James M. Craig.................................... 0 0.00% 0 0.00% 0 0.00%
Shawn F. O'Donnell................................ 0 0.00% 0 0.00% 0 0.00%
Robert A. Rouse................................... 0 0.00% 0 0.00% 0 0.00%
Kevin J. Bennis(r)................................ 90,625 2.95% 0 0.00% 0 0.00%
Kevin J. Maroni(s)................................ 0 0.00% 1,372,668 47.33% 1,220,099 25.48%
Peter J. Barris(t)................................ 0 0.00% 522,000 18.00% 685,014 14.31%
Stephen A. Reinstadtler(u)........................ 0 0.00% 0 0.00% 884,146 18.47%
Patrick J. Kerins(v).............................. 0 0.00% 0 0.00% 884,146 18.47%
All Directors and Executive Officers as a Group... 0 0.00% 1,894,668 65.33% 3,673,405 76.72%
<CAPTION>
SERIES C PREFERRED SERIES D PREFERRED SERIES E PREFERRED
---------------------- ---------------------- ----------------------
PERCENTAGE PERCENTAGE PERCENTAGE
STOCKHOLDER (a) SHARES OF CLASS SHARES OF CLASS SHARES OF CLASS
--------------- --------- ---------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Spectrum Equity Investors, L.P.(d)................ 1,363,406 16.67% 0 0.00% 0 0.00%
Spectrum Equity Investors II, L.P.(d)............. 1,363,406 16.67% 0 0.00% 0 0.00%
New Enterprise Associates VI, Limited
Partnership(e)................................... 1,374,051 16.80% 0 0.00% 0 0.00%
Onset Enterprise Associates II, L.P.(f)........... 817,672 10.00% 0 0.00% 0 0.00%
Onset Enterprise Associates III, L.P.(f).......... 272,553 3.33% 0 0.00% 0 0.00%
Paul Capital Partner Funds(g)..................... 136,275 1.67% 0 0.00% 0 0.00%
Thomas Domencich(h)............................... 0 0.00% 0 0.00% 0 0.00%
Toronto Dominion Capital (USA) Inc.(i)............ 1,006,500 12.31% 0 0.00% 0 0.00%
Grotech Partners IV, L.P.(j)...................... 1,006,500 12.31% 0 0.00% 0 0.00%
Utech Climate Challenge Fund, L.P.(k)............. 136,276 1.67% 0 0.00% 0 0.00%
Utility Competitive Advantage Fund, LLC(l)........ 366,980 4.49% 0 0.00% 0 0.00%
FBR Technology Venture Partners, L.P.(m).......... 272,556 3.33% 0 0.00% 0 0.00%
BNSF(n)........................................... 0 0.00% 3,413,746 40.11% 0 0.00%
Colonial(o)....................................... 0 0.00% 1,684,115 19.79% 2,867,546 100.00%
CSX(p)............................................ 0 0.00% 3,413,746 40.11% 0 0.00%
David Schaeffer(q)................................ 0 0 0 0.00% 0 0.00%
Richard A. Jalkut................................. 0 0.00% 0 0.00% 0 0.00%
Michael A. Lubin.................................. 0 0.00% 0 0.00% 0 0.00%
William R. Smedberg V............................. 0 0.00% 0 0.00% 0 0.00%
James M. Craig.................................... 0 0.00% 0 0.00% 0 0.00%
Shawn F. O'Donnell................................ 0 0.00% 0 0.00% 0 0.00%
Robert A. Rouse................................... 0 0.00% 0 0.00% 0 0.00%
Kevin J. Bennis(r)................................ 0 0.00% 0 0.00% 0 0.00%
Kevin J. Maroni(s)................................ 2,726,812 33.35% 0 0.00% 0 0.00%
Peter J. Barris(t)................................ 1,374,051 16.80% 0 0.00% 0 0.00%
Stephen A. Reinstadtler(u)........................ 1,006,500 12.31% 0 0.00% 0 0.00%
Patrick J. Kerins(v).............................. 1,006,500 12.31% 0 0.00% 0 0.00%
All Directors and Executive Officers as a Group... 6,113,863 74.77% 0 0.00% 0 0.00%
<CAPTION>
BENEFICIAL OWNERSHIP OF
COMMON STOCK
----------------------------
STOCK PRO FORMA
STOCKHOLDER (a) OPTIONS(b) TOTAL SHARES PERCENTAGE(c)
--------------- ---------- ------------ -------------
<S> <C> <C> <C>
Spectrum Equity Investors, L.P.(d)................ 0 3,956,173 56.32%
Spectrum Equity Investors II, L.P.(d)............. 0 1,363,406 30.77%
New Enterprise Associates VI, Limited
Partnership(e)................................... 0 2,581,065 45.69%
Onset Enterprise Associates II, L.P.(f)........... 0 1,803,648 37.02%
Onset Enterprise Associates III, L.P.(f).......... 0 272,553 8.16%
Paul Capital Partner Funds(g)..................... 0 507,408 14.19%
Thomas Domencich(h)............................... 0 207,573 6.34%
Toronto Dominion Capital (USA) Inc.(i)............ 0 1,890,646 38.13%
Grotech Partners IV, L.P.(j)...................... 0 1,890,646 38.13%
Utech Climate Challenge Fund, L.P.(k)............. 0 578,352 15.86%
Utility Competitive Advantage Fund, LLC(l)........ 0 366,980 10.68%
FBR Technology Venture Partners, L.P.(m).......... 0 272,556 8.16%
BNSF(n)........................................... 0 3,413,746 52.67%
Colonial(o)....................................... 1,593,082 6,144,743 66.70%
CSX(p)............................................ 0 3,413,746 52.67%
David Schaeffer(q)................................ 107,389 3,007,389 94.70%
Richard A. Jalkut................................. 572,502 572,502 15.72%
Michael A. Lubin.................................. 145,215 145,215 4.52%
William R. Smedberg V............................. 128,656 128,656 4.02%
James M. Craig.................................... 0 0 0.00%
Shawn F. O'Donnell................................ 0 0 0.00%
Robert A. Rouse................................... 0 0 0.00%
Kevin J. Bennis(r)................................ 0 90,625 2.95%
Kevin J. Maroni(s)................................ 0 5,319,579 63.42%
Peter J. Barris(t)................................ 0 2,581,065 45.69%
Stephen A. Reinstadtler(u)........................ 0 1,890,646 38.13%
Patrick J. Kerins(v).............................. 0 1,890,646 38.13%
All Directors and Executive Officers as a Group... 903,172 12,585,108 80.40%
</TABLE>
- ---------------
(a) In accordance with the rules of the SEC, each beneficial owner's holding
has been calculated assuming full exercise of outstanding warrants and
options exercisable or convertible by the holder within 60 days after
December 31, 1999.
(b) Only options exercisable within 60 days after December 31, 1999 are listed.
(c) The pro forma percentages of beneficial ownership of common stock as to
each beneficial owner assumes the exercise or conversion into common stock
of all outstanding options, warrants and convertible securities held by
such owner that are exercisable or convertible within 60 days of December
31, 1999, but not the exercise or conversion of options, warrants and
convertible securities held by others shown in the table.
(d) Spectrum Equity Investors, L.P.'s and Spectrum Equity Investors II, L.P.'s
address is One International Place, Boston, Massachusetts, 02110.
(e) New Enterprise Associates VI, Limited Partnership's address is 1119 Saint
Paul Street, Baltimore, Maryland, 21202.
(f) Onset Enterprise Associates II, L.P.'s and Onset Enterprise Associates III,
L.P.'s address is 8911 Capital of Texas Highway, Austin, Texas, 78759.
(g) The Paul Capital Partner Funds are five funds that constitute a "group"
under Section 13(d) of the Exchange Act. Each fund's address is: c/o Paul
Capital Partners, 50 California Street, Suite 3000, San Francisco,
California, 94111. The five funds are Paul Capital Partners V L.P., Paul
Capital Partners V (Domestic Annex Fund) L.P., Paul Capital Partners V
International, L.P., Paul Capital Partners VI, L.P. and PCP Associates,
L.P.
(h) Thomas Domencich's address is 104 Benevolent Street, Providence, Rhode
Island, 02906.
(i) Toronto Dominion Capital (USA) Inc.'s address is 31 West 52nd Street, New
York, New York, 10019.
(j) Grotech Partners IV, L.P.'s address is 9690 Deereco Road, Timonium,
Maryland, 21093.
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(k) Utech Climate Challenge Fund, L.P.'s and Utility Competitive Advantage Fund,
L.L.C.'s address is c/o Arete Ventures, Two Wisconsin Circle, Chevy Chase,
Maryland 20815.
(l) Utility Competitive Advantage Fund L.L.C.'s address is c/o William T.
Heflin, Managing Director, Kinetic Ventures, L.L.C., 2 Wisconsin Circle,
Suite 620, Chevy Chase, Maryland 20815.
(m) FBR Technology Venture Partners, L.P.'s address is 11600 Sunrise Valley
Drive, Suite 460, Reston, VA 20191.
(n) BNSF's address is 2500 Lou Menk Drive, Fort Worth, Texas, 76131.
(o) Colonial Pipeline Company's address is 945 East Paces Ferry Road, NE,
Atlanta, Georgia, 30326.
(p) CSX's address is c/o CSX Real Property, Inc., 301 West Bay Street, J915,
Jacksonville, Florida, 32202.
(q) Mr. Schaeffer is no longer an officer or director of Pathnet and is not an
officer or director of Pathnet Telecom. Mr. Schaeffer's address is 11017
Riverwood Dr., Potomac, MD 20854.
(r) Mr. Bennis is no longer employed by Pathnet, but he is included in the
beneficial ownership computation of all directors and officers as a group
because Mr. Bennis would have been a Named Executive Officer except that he
was not an executive officer of Pathnet at the end of the fiscal year 1999.
(s) Mr. Maroni, who is a limited partner of the general partner of Spectrum and
a general partner of the general partner of Spectrum Equity Investors II,
L.P., disclaims beneficial ownership of the shares owned by Spectrum Equity
Investors, L.P. and Spectrum Equity Investors II, L.P.
(t) Mr. Barris, who is general partner of the general partner of New Enterprise
Associates VI, Limited Partnership, disclaims beneficial ownership of the
shares owned by New Enterprise Associates VI, Limited Partnership.
(u) Mr. Reinstadtler, Vice President and Director of Toronto Dominion Capital
(USA) Inc., disclaims beneficial ownership of the shares owned by Toronto
Dominion Capital (USA) Inc.
(v) Mr. Kerins, Managing Director of the general partner of Grotech Partners
IV, LP, disclaims beneficial ownership of the shares owned by Grotech
Partners IV, LP.
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DESCRIPTION OF OUR REORGANIZATION
TRANSACTION OVERVIEW
OVERVIEW. We have entered into agreements providing for our reorganization
with each of BNSF, CSX, Colonial and all of the existing stockholders of
Pathnet. This section describes the material terms of those agreements and the
reorganization in general. As discussed in the following section entitled "THE
PATHNET SENIOR NOTEHOLDER WAIVERS AND OTHER PROPOSED INDENTURE AMENDMENTS," we
intend by this offering and the consent solicitation to address the current
requirements of the indenture governing the notes that would otherwise inhibit
our ability to complete our reorganization and to operate our businesses
(including the business currently conducted by Pathnet) following the completion
of the reorganization.
Our reorganization consists of the following principal steps:
- Our issuance of 8,511,607 shares of our series D preferred stock, valued
at $187 million, to three new investors -- BNSF, CSX and Colonial -- in
exchange for leasehold interests or comparable license rights to their
railroad and pipeline rights of way in order to construct and operate our
fiber optic telecommunications network;
- Our issuance, at a cash purchase price of $21.97 per share for an
aggregate purchase price of $38 million, of 1,729,631 shares of our
series E preferred stock to Colonial;
- Our issuance of an additional 1,137,915 shares of our series E preferred
stock to Colonial at a cash purchase price of $25 million conditioned
upon the completion of our fiber optic build between Chicago, Illinois
and Aurora (a suburb of Denver), Colorado;
- Our grant, in exchange for a $1 million cash payment at the closing of
the reorganization, of an option to Colonial and certain affiliates of
Colonial to purchase up to an additional 1,593,082 shares of our series E
or, under certain circumstances, series D preferred stock and a separate
option to purchase our common stock;
- The exchange of all shares of the outstanding common and preferred
Pathnet stock solely for shares of our common and preferred stock on
substantially similar terms, after which we will own 100% of Pathnet;
- Our sale to Colonial of rights in a specified number of conduit miles of
our future network along Colonial's rights of way (or equivalent
telecommunications assets) for a $4 million cash payment at the closing
of our reorganization;
- Our purchase from Pathnet for $70 million (payable by means of our
promissory note to Pathnet) of the following Pathnet assets (see "THE
PATHNET SENIOR NOTEHOLDER WAIVERS AND OTHER PROPOSED INDENTURE
AMENDMENTS -- Waiver of Pathnet Obligations" for additional information
on this purchase):
- three fiber co-development contracts and the agreements related to
those co-development contracts;
- those fiber network assets that are currently constructed and
installed relating to Pathnet's network segment build between Chicago
and Aurora (a suburb of Denver), Colorado;
- all other fiber network assets, properties and contracts held by
Pathnet;
- a license to Pathnet's tradenames, trademarks and other intellectual
property;
- all goodwill and going concern rights associated with each of the
items listed above; and
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- fiber assets Pathnet will receive from its subsidiary, Pathnet Fiber
Optics, LLC under an assignment and acceptance agreement.
- Our borrowing from Pathnet (following the execution of the supplemental
indenture referred to under "THE PATHNET SENIOR NOTEHOLDER WAIVERS AND
OTHER PROPOSED INDENTURE AMENDMENTS") of $50 million of the remaining
proceeds from Pathnet's initial equity investments and the issue of its
notes to assist in the development of our fiber optic rights of way
received from BNSF, CSX and Colonial.
Following the conclusion of our reorganization, our beneficial ownership
will be allocated among the participants in our reorganization as set forth in
the following table. For purposes of determining the beneficial ownership of our
voting capital stock following the completion of our reorganization, we assume
in the table:
- Colonial's purchase of the second tranche of shares of our series E
preferred stock and the conversion of those shares into shares of our
common stock;
- except for the Colonial option to purchase shares of our common stock in
connection with our initial public offering, the exercise of all options
to purchase shares of our common stock;
- the exercise of the Colonial option to purchase additional shares of our
series E preferred stock and the conversion of all of our series of
preferred stock into our common stock; and
- the conversion of all outstanding warrants to purchase shares of Pathnet
common stock into warrants to purchase shares of our common stock and the
full exercise of those warrants;
Because we cannot at this time determine the precise number of our shares
that are covered by Colonial's option to purchase our common stock prior to our
initial public offering, we have not assumed the exercise of that option in our
determination of beneficial ownership interests in the table.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP OF
CATEGORY OF EQUITY HOLDER OUR VOTING STOCK
------------------------- -----------------------
<S> <C>
Holders of existing shares of Pathnet Series A, B and C
preferred stock........................................... 44.4%
Holders of existing shares of Pathnet common stock (assuming
the conversion and exercise in full of all existing
warrants and options for Pathnet common stock into shares
of our common stock)...................................... 19.2%
BNSF........................................................ 9.6%
Colonial and affiliates..................................... 17.2%
CSX......................................................... 9.6%
------
Total................................................... 100.0%
======
</TABLE>
THE PARTIES. Pathnet Telecom was formed on November 1, 1999, to effectuate
the reorganization and become the parent company of Pathnet. Pathnet, a company
formed in August 1995, is a wholesale telecommunications provider building a
nationwide network designed to provide our customers, who are telecommunications
providers, with access to underserved and second and third tier markets, of
which there are over 200. CSX, BNSF and Colonial are each holders of extensive
right of way assets that were originally acquired and maintained for use in
their primary railroad and pipeline businesses. The other parties to our
reorganization include all of the existing stockholders of Pathnet.
THE TRANSACTION. BNSF, CSX, and Colonial have agreed to contribute right
of way assets and, in the case of Colonial, both right of way assets and cash,
in exchange for newly-issued shares of our capital stock. At the same time, we
are reorganizing the Pathnet corporate structure, and through an exchange of
shares of our capital stock with existing Pathnet stockholders, Pathnet Telecom
will
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become the parent company of Pathnet. As discussed below, prior to the filing of
the registration statement of which this prospectus is a part, the parties
executed the definitive contribution agreements providing for these
contributions of assets and exchanges of shares. The closing of those
transactions is conditioned principally upon our obtaining the consents of the
holders of a majority in principal of the notes.
PURPOSE OF THE TRANSACTION. We plan to use the rights of way and cash
obtained in our reorganization in the construction of our fiber optic
telecommunications network. BNSF, CSX and Colonial have committed to enter into
right of way leases or licenses permitting us to install and operate a fiber
optic and wireless network across their rights of way for periods ranging from
30 to 35 years. We expect that the access rights that we obtain from CSX, BNSF
and Colonial will satisfy substantially all of our planned right of way
requirements for our backbone network. We will obtain additional rights of way
as necessary to link our backbone network to our target markets. Once the
contribution transactions with CSX, BNSF and Colonial have closed, we will have
right of way agreements in place to access over 12,000 railroad track and
pipeline miles. One of our purposes in entering into the reorganization is to
enhance our ability to conduct and finance the future operations of Pathnet and
Pathnet Telecom in an efficient and competitive manner, but we cannot assure you
that we will realize this goal.
CONSENT OF NOTEHOLDERS REQUIRED. The indenture executed in 1998 between
Pathnet and The Bank of New York as trustee contains the covenants,
restrictions, events of default, and other terms relating to the notes. Under
the terms of the indenture, completing our reorganization technically would
constitute a "change of control" of Pathnet, triggering its obligation (under
Section 1010 of the indenture) to offer to repurchase the notes at a premium to
both their face amount and their current market value. Pathnet likely would not
have access to the funds necessary to meet this repurchase obligation if it were
to arise. Moreover, repurchasing the notes would deprive Pathnet of resources
needed to help fund the development of the Pathnet and Pathnet Telecom network
and other telecommunications businesses. As a result, our reorganization is
subject to conditions, as more fully described below in "-- Conditions to
Closing the Reorganization," under which it will not close if Pathnet is unable
to obtain the waiver of this repurchase obligation from the holders of a
majority in outstanding principal amount of the notes.
In seeking the waiver of this "change of control," Pathnet will also seek
related waivers and amendments to the terms of the Indenture as more fully
described below in "THE PATHNET SENIOR NOTEHOLDER WAIVERS AND OTHER PROPOSED
INDENTURE AMENDMENTS," including a waiver of obligations to consummate the
Excess Proceeds Offer because our reorganization constitutes an "Asset Sale"
under the terms of the indenture. Pathnet's purpose in seeking these related
waivers and amendments is to impose upon us substantially the same covenant
restrictions that are currently imposed upon Pathnet, and to permit
inter-company transactions between us and Pathnet (and our other subsidiaries)
to the same extent that the indenture currently permits those transactions
between Pathnet and its subsidiaries.
One bondholder has informed us that it believes the indenture requires the
unanimous consent of the bondholders in order for us to obtain the requested
waivers of provisions of the indenture in connection with our reorganization. We
and our counsel have carefully considered this claim, and have concluded that it
is plainly inconsistent with the terms of the indenture and is therefore without
merit. We have so informed this bondholder of our view. In granting your
requested consent, you are required to acknowledge that the consent of the
holders of a majority in principal amount of the notes is sufficient for
purposes of the requested waivers and amendments. Pathnet will not accept
partial consents or consents that do not contain the requested acknowledgement.
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DESCRIPTION OF THE REORGANIZATION AGREEMENTS
We have executed contribution agreements with our new investors and former
Pathnet stockholders to accomplish our reorganization. We summarize the material
terms of these agreements in this section. We have filed complete copies of
these agreements as exhibits to our registration statement filed in connection
with this offering, and we encourage you to review the agreements for further
details concerning their terms.
CONTRIBUTION AGREEMENTS WITH CSX, BNSF AND COLONIAL. On November 4, 1999,
we entered into definitive contribution agreements with each of CSX, BNSF and
Colonial to issue our shares of series D and series E preferred stock and obtain
right of way access rights along their railroad and pipeline properties and
easements. Each of these companies has significant property and easement
holdings in areas where we expect to build and expand our fiber optic
telecommunications network. Under those contribution agreements:
- CSX agreed to enter into a Fiber Optic Access and License Agreement by
which CSX will provide us with access to portions of CSX's extensive
railroad corridors covering the eastern United States;
- BNSF agreed to enter into a Fiber Optic Access Agreement by which BNSF
will provide us with access to portions of BNSF's extensive railroad
corridors covering the western United States; and
- Colonial agreed to contribute access to portions of its pipeline
corridors covering the eastern United States.
The contribution agreements are subject to certain conditions to closing,
which are described in more detail below in "-- Conditions to Closing the
Reorganization." In exchange for granting us these rights of way, we will issue
to CSX, BNSF and Colonial shares of our series D preferred stock. In addition,
our contribution agreement with Colonial provides for Colonial to contribute $38
million in cash in exchange for shares of our series E preferred stock. Colonial
has agreed to pay this amount at the initial closing of the reorganization, and
another $25 million in exchange for additional shares of series E preferred
stock promptly following Pathnet's substantial completion of the fiber optic
build between Chicago, Illinois and Aurora, a suburb of Denver, Colorado (which
Pathnet is currently constructing with World Wide Fiber, Inc.). We currently
expect Pathnet to complete this fiber build during the second calendar quarter
of 2000, but we cannot assure you that construction will be completed within
this time frame.
Colonial will pay an additional $4 million at the initial closing of our
reorganization in return for the future right to receive a specified number of
"conduit miles" of installed fiber optic conduit or the equivalent value in
other telecommunications assets.
Under the contribution agreements with BNSF, CSX and Colonial, we have made
a variety of representations and warranties to each of the new investors with
respect to the reorganization, our securities to be issued to each of them, and
the current business and financial condition of Pathnet. We have also agreed to
indemnify the new investors against any breach of those representations and
warranties.
COLONIAL OPTION AGREEMENT. In addition to the contribution and conduit
purchase investments outlined above, our contribution agreement with Colonial
provides for a separate option agreement which will permit Colonial to purchase
additional shares of our stock. Upon the execution of the Colonial option
agreement at the closing of our reorganization, Colonial will pay us a
non-refundable fee of $1 million for the purchase of these options. Under the
Colonial option agreement, we have agreed to grant two options to Colonial in
exchange for their cash contribution.
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The first option, which may be exercised by a number of Colonial's
affiliated companies, permits those affiliates to purchase up to $35 million of
additional shares of our series E preferred stock at the same purchase price as
that paid by Colonial under the Colonial contribution agreement. Colonial also
has the right to exercise up to $10 million of the $35 million on its own
behalf. This option will expire on the later of the date which is 120 days after
the date Colonial's contribution agreement was signed or 15 days after the
closing of the reorganization.
The option agreement also allows us during the same period to enter into
agreements with one or more of Colonial's designated affiliated entities, where
those entities would contribute rights of way in exchange for shares of our
series D preferred stock at $21.97 per share.
The second option permits Colonial to purchase a number of shares of our
common stock equal to 10% of the total number of shares of common stock that we
actually sell in any initial public offering of our common stock. This second
option must be exercised by Colonial at least ten days prior to the filing of
our registration statement for an initial public offering of our common stock,
but the shares will be issued only if and when we close on a firm commitment
underwritten initial public offering. The price at which Colonial may purchase
our shares under this option will be 90% of the price per share of the common
stock offered by us to the public, as reflected in the final prospectus filed
with respect to our initial public offering.
CONTRIBUTION AGREEMENTS WITH PATHNET'S EXISTING STOCKHOLDERS. Concurrent
with our contribution agreements with BNSF, CSX and Colonial, we entered into
contribution agreements with existing Pathnet preferred and common stockholders.
All of the Pathnet common stockholders (except for David Schaeffer) are parties
to one contribution agreement under which those stockholders agreed to exchange
their entire stock and interest in Pathnet for shares of our common stock.
Mr. Schaeffer signed a separate contribution agreement with us under which
he also agreed to exchange his entire stock and interest in Pathnet for shares
of our common stock. Mr. Schaeffer is the only common stockholder that is a
party to the Pathnet Investment and Stockholders Agreement, and he has agreed in
his contribution agreement to enter into our new stockholders agreement.
The holders of Pathnet's series A, B and C preferred stock have also
elected to participate in our reorganization. They executed a contribution
agreement, under which they agreed to exchange their shares of Pathnet series A,
B and C preferred stock solely for shares of our series A, B and C preferred
stock, respectively, with substantially similar terms for each corresponding
series. The contribution agreement with the existing Pathnet preferred
stockholders also requires that those stockholders enter into our new
stockholders agreement. For a discussion of the provisions of that new
stockholders agreement, please refer to the section below entitled "CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS -- Our Stockholders Agreement."
As with the contribution transactions involving BNSF, CSX and Colonial, the
closing of the contribution transactions involving all of the existing
stockholders of Pathnet remains subject to the effectiveness of this
registration statement, our receiving appropriate waivers and consents from the
holders of the notes, the FCC, the Antitrust Division of the Department of
Justice and the FTC to all required filings under applicable law.
Under the contribution agreements with the Pathnet existing stockholders,
we have made a limited number of representations and warranties with respect to
our reorganization and our securities to be issued. However, these contribution
agreements do not contain representations and warranties with respect to the
business and financial condition of Pathnet, nor do they contain the
indemnification provisions contained in the contribution agreements with CSX,
BNSF and Colonial.
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STRUCTURE OF THE PATHNET BUSINESS FOLLOWING THE CONCLUSION OF OUR REORGANIZATION
The structure of the issued and outstanding stock and debt security of
Pathnet business immediately following the closing of the reorganization will be
as follows:
[PATHNET GRAPHIC]
To facilitate vendor financing and other business relationships that will
be required to permit us to continue to develop and maintain our network, we may
in the future need to incorporate other subsidiaries ("sister" companies to
Pathnet or other subsidiaries of Pathnet). We plan to enter into vendor
financing arrangements, including a pending fiber optic purchase agreement and
related vendor financing facility with Lucent Technologies, Inc., that would
require us to incorporate those separate subsidiaries and to contribute some of
our assets to those subsidiaries. See "DESCRIPTION OF OTHER INDEBTEDNESS AND
OTHER FINANCING ARRANGEMENTS -- Proposed Credit Facility with Lucent."
To support additional vendor and other financing, we (or our relevant
subsidiaries) may in the future need to pledge or secure our assets, together
with any other assets provided by the vendors, in order to obtain vendor
financing. Because the notes and our guarantees are unsecured, any security that
we provide to a vendor will be senior to your interests as holders of the notes.
Moreover, after our reorganization, we may establish subsidiaries for purposes
of such vendor financing or for other reasons associated with the operation of
our business, which we are permitted to do under the indenture and the
supplemental indenture, and the supplemental indenture, like the indenture, will
not require these new subsidiaries to guarantee the notes. Accordingly, if we
establish additional subsidiaries in the future, your notes will be effectively
subordinated to the claims of the creditors of those subsidiaries, except in
cases in which we or Pathnet are creditors to the new subsidiaries. In
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those cases (and assuming that our status or Pathnet's status as a creditor is
respected in any proceeding relating to a claim as a creditor), our claims still
would be effectively subordinated to any security interests in the assets of the
subsidiary held by vendor finance providers or other creditors.
DESCRIPTION OF FIBER OPTIC ACCESS AGREEMENTS AND RELATED FIBER OPTIC LEASES AND
LICENSES FROM BNSF, CSX AND COLONIAL
Upon the successful completion of the consent solicitation process and the
closing of the reorganization, we will enter into two further agreements
relating to the rights of way with each of BNSF, CSX and Colonial. In each case,
the first agreement, which we refer to as an "access agreement," will describe
the basic structure of our right to develop the rights of way. These agreements
will address the number of miles available for development, the nature and
duration of any exclusive rights we will have in the rights of way, and any
obligation we have to provide additional benefits to BNSF, CSX or Colonial. The
second agreement, which we refer to as a "lease agreement," identifies the
particular segments in which we will have a right of way interest. These
agreements will also ensure that our construction and operational activities
will not interfere with any of the grantors' rail or pipeline businesses,
including any other contractual obligations to which that grantor is a party. We
describe each agreement with BNSF, CSX and Colonial in more detail below.
BNSF AGREEMENTS. The access agreement with BNSF authorizes us to develop
up to a specified number of miles of BNSF's rail corridor. Prior to December 31,
2004, we will have the exclusive right to develop approximately 4,000 miles of
this right of way. In addition, for five years after commencing construction of
each segment along these exclusive corridors, and for three years after
commencing construction on all other BNSF rights of way, any party that requests
the right to develop BNSF rights of way for fiber optic uses must first
negotiate with us to provide for their communications needs. If we do not reach
agreement within a specified time period, the party may proceed to negotiate its
development directly with BNSF.
We could lose these exclusivity rights in certain specified circumstances,
including our failure to develop at least 800 miles of the BNSF rights of way
over which we have exclusive rights before April 30, 2001, and an additional 800
miles per year thereafter. We must also develop or acquire fiber optic rights in
at least 3,000 miles of telecommunications network nationally (including, but
not limited to, the BNSF right of way) by June 30, 2001, increasing to 12,500
miles by June 30, 2005.
The lease agreement with BNSF, which addresses conditions of construction
and operations, is for a term of 35 years and permits us to install an unlimited
number of fibers and conduits. It requires us to use BNSF personnel for
supervising all construction and to pay all costs associated with using these
personnel. It also contains other provisions associated with construction and
operation of our facilities, including indemnification, insurance provisions and
mechanisms for complying with BNSF safety and operations regulations.
CSX AGREEMENTS. The CSX access agreement authorizes us to develop up to a
specified number of miles of CSX's right of way on the former Conrail system and
an additional specified number of miles on the remainder of CSX's system. For
the first three years after the date of the access agreement we will have the
exclusive right to develop up to 2,000 of the former Conrail system rights of
way, subject to restrictions concerning the length and location of specific
developments. For an additional four years after the end of the exclusivity
period on the CSX rights of way, any party that requests the right to develop a
segment of the former Conrail system rights of way where we have commenced
construction must first negotiate with us to provide for their communications
and development needs. If we do not reach an agreement within a specified time
period, the party can proceed to negotiate its development with CSX. If we fail
to develop at least 500 miles of CSX rights of way in each year after the date
of the access agreement, or if at least
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75% of our development is not in contiguous segments of 200 miles each, we will
lose our exclusivity for all segments of right of way on which development is
not complete.
The CSX access agreement also provides that we will construct four conduits
for CSX between Boston and Framingham, Massachusetts and one conduit for CSX
wherever else we develop CSX rights of way. CSX may sell or use the Boston to
Framingham conduits for commercial purposes as soon as we complete construction
but may use each completed segment of the other CSX conduit only for CSX
internal communications until the earlier of five years after completion of
construction of that segment of the conduit, or ten years after the closing of
the reorganization.
The CSX lease agreement is for a term of 30 years and addresses the terms
of constructing and operating our telecommunications network on the CSX rights
of way. We must use CSX personnel to supervise our construction activities and
are responsible for all costs associated with using these personnel. We may
install an unlimited amount of fibers but we may not install more than eight
conduits (plus the conduits that we provide to CSX) without CSX's permission.
COLONIAL AGREEMENTS. The Colonial access agreement authorizes us to
develop our network along the entire route of Colonial's right of way up to a
specified number of miles. We have the exclusive right to develop these rights
of way for ten years following the date of the Colonial lease agreement. Any
segment of the Colonial right of way that we have not designated for development
within five years of the date of the lease agreement, or on which development is
not completed within seven years of the date of the lease agreement, reverts to
Colonial and we have no further right to develop those segments.
Concurrent with the closing of the reorganization, Colonial will pay us $4
million for our obligation to construct a single conduit for Colonial along
2,200 miles of Colonial's right of way. If the full amount of conduit is not
available within five years after the date of the lease agreement, we may
provide alternate telecommunications services or assets of equivalent value on
other portions of our network. Until the fifth anniversary of the date of the
lease, Colonial may use the Colonial conduit only for its internal
communications. After that date, Colonial may sell its conduit on any terms it
desires. However, subject to certain limitations, if Colonial desires to sell
any portion of its conduit, it must first give us an opportunity to purchase
that portion on the same terms. If we decide not to purchase that portion,
Colonial may proceed with the sale.
The Colonial lease agreement is for a term of 30 years, which we may renew
for one term of 10 years by paying a fair market value rental rate. Like the
other lease agreements, the Colonial lease agreement addresses construction and
operational issues affecting the Colonial right of way, and provides that we may
not install more than ten conduits (including the conduit we provide to
Colonial).
TERMS COMMON TO THE BNSF, CSX AND COLONIAL AGREEMENTS. In addition to the
terms described above, several additional provisions are common to our
agreements with each of BNSF, CSX and Colonial. Each may purchase
telecommunications capacity on our national telecommunications network at prices
at least as favorable as we are then offering to our other customers. In certain
defined circumstances which constitute a material breach of our obligations
under a lease agreement or an access agreement, the other party may terminate
that agreement.
Our rights under the access agreements and the lease agreements are subject
to the rights of others with existing contractual arrangements with BNSF, CSX
and Colonial. Other provisions in the lease agreements and the access agreements
describe our obligations to maintain certain levels of insurance and our
obligations to indemnify BNSF, CSX and Colonial for certain specified
liabilities. Our indemnification obligations are broad, and we could incur
significant liabilities if deploying our fiber optic network interferes in any
way with the rail or pipeline operations of BNSF, CSX or Colonial. We are
required to coordinate our construction and maintenance activities with our
partners,
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and we are in some cases responsible for the actions of their employees or
contractors, even where we do not control them.
While our partners own many of their rights of way in fee, in many other
cases they have only an easement or other limited property interest in their
right of way. In many cases, this easement or other limited property interest
may permit railroad or pipeline uses, but may not permit use of the right of way
for fiber optic development. Where that situation exists, we are responsible for
all costs required to obtain any additional property or legal rights necessary
to permit us to develop each right of way. These costs will vary significantly
and could be substantial. In addition, the process of obtaining these additional
rights is time consuming and could significantly delay completion of affected
segments of our network.
DISPOSITION OF EXISTING PATHNET STOCK OPTIONS AND WARRANTS
STOCK OPTIONS. On December 31, 1999, options to purchase an aggregate of
2,675,597 shares of common stock of Pathnet were outstanding with employees and
several consultants of Pathnet under Pathnet's 1995 Stock Option Plan and its
1997 Stock Incentive Plan. As discussed above in "MANAGEMENT -- 1995 Stock
Option Plan" and "MANAGEMENT -- 1997 Stock Incentive Plan," we will upon the
closing of our reorganization assume Pathnet's obligations under its 1995 Plan
and its 1997 Plan. We have entered into agreements with the two employees of
Pathnet who currently hold options issued under Pathnet's 1995 Plan to amend
both the 1995 Plan and their existing option awards under the 1995 Plan. The
amended plan and amended awards will provide that upon the exercise of their
options, we will issue to these two optionees shares of our common stock in lieu
of the shares of Pathnet common stock for which the awards were originally
issued.
Under the terms of Pathnet's 1997 Plan as we will assume it, our board of
directors and the committee appointed to administer the 1997 Plan will exercise
their authority to amend that Plan and the awards already issued under that Plan
at the closing of our reorganization. The amended plan and amended awards will
provide that upon the exercise of awards granted under Pathnet's 1997 Plan, we
will issue shares of our common stock in lieu of the shares of Pathnet common
stock for which the awards were originally issued. For a more detailed
description of our stock option plans, see "MANAGEMENT -- 1995 Stock Option
Plan" and "MANAGEMENT -- 1997 Stock Incentive Plan."
WARRANTS. In April 1998, Pathnet issued warrants for the purchase of
shares of its common stock under a warrant agreement (and a related warrant
registration rights agreement) together with the original private placement of
the Pathnet notes. The Pathnet warrants are not currently exercisable, but
would, unless amended, become exercisable upon the closing of our
reorganization. Concurrent with this offering and the consent solicitation, in a
separate private transaction, Pathnet plans to approach the qualified
institutional buyers permitted to hold the warrants to request that they agree
to amend the terms of the Pathnet warrants, the effect of which would be to
waive their right to exercise their warrants for shares of Pathnet common stock
upon the closing of the reorganization. In return, we propose to amend the
warrant agreement (and the related warrant registration rights agreement) to
require us, upon the closing of our reorganization, to convert their existing
warrants into warrants to purchase shares of our common stock on substantially
similar terms. The terms of the warrant agreement provide that Pathnet may amend
or waive any term of the warrants with the consent of the holders of at least a
majority of the outstanding warrants.
Neither the consent solicitation for the notes nor our reorganization are
conditioned upon the success of the warrant transaction. If the warrant consent
solicitation is not successful, the Pathnet warrants will remain outstanding,
and will be exercisable upon the closing of the reorganization. For additional
information concerning the Pathnet warrants, see "DESCRIPTION OF CAPITAL
STOCK -- Warrants."
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CONDITIONS TO CLOSING THE REORGANIZATION
The conditions listed below must be met before we, or the other parties to
the contribution agreements, are obligated to complete our reorganization:
- There must be no court order or injunction restraining the
reorganization;
- As required by the Hart-Scott-Rodino Antitrust Improvement Act of 1976,
as amended, and the FTC rules promulgated thereunder, BNSF, CSX, Colonial
and certain existing Pathnet stockholders must file premerger
Notification and Report Forms with the FTC and Department of Justice and
all waiting periods applicable to such filings must have either expired
or been terminated early so that all HSR requirements arising from our
transaction will have been satisfied;
- If required by applicable law, we must obtain consents from the FCC or
applicable state public utility commissions either to transfer or license
the FCC or state authorizations and licenses currently held by Pathnet
and its subsidiaries to us, or to continue to operate under the current
Pathnet FCC and state authorizations and licenses;
- All of the representations and warranties made by BNSF, CSX, Colonial and
the existing Pathnet stockholders in the contribution agreements must be
correct in all material respects on the date those agreements are signed
and on the date that the transactions described in the agreements are
completed before we are obligated to close;
- All of the representations and warranties made by Pathnet or by us in the
contribution agreements must be correct in all material respects on the
date those agreements were signed and on the date the transactions
described in the agreements are completed before the other parties are
obligated to close;
- We must have performed our obligations under the contribution agreements
in all material respects;
- On the date the transactions described in the contribution agreements
close, we must also close, as a single overall plan of contribution,
contribution agreements with (1) each of BNSF, CSX and Colonial; (2) the
holders of at least 90% of Pathnet's preferred stock; and (3) certain
common stockholders of Pathnet; so that immediately after closing, we
will own enough Pathnet stock to constitute control under a provision of
the tax code that will require us to hold 80% or more of Pathnet's
outstanding voting stock and 80% or more of any class of Pathnet
non-voting stock;
- All parties to the contribution agreements must deliver closing documents
listed in the contribution agreements, such as certified board
resolutions from us and from Pathnet authorizing the reorganization, and
certificates from us certifying that the representations and warranties
we make in the contribution agreements are correct; and
- Pathnet and we must have obtained the required consents from the holders
of the notes to waivers and amendments to the indenture governing the
notes, as more completely described in this prospectus.
In addition to the conditions outlined above, it is a general condition to
closing all of the contribution agreements that they not have been terminated.
If we have not closed our reorganization on or before the contribution agreement
termination date of March 31, 2000, provisions in the contribution agreements
will permit the parties to elect to terminate those agreements and refuse to
complete the reorganization. As a result, if we do not obtain the necessary
consents from the holders of the notes and complete the other steps necessary to
close our reorganization on or before the March 31 termination date, one or more
parties to the reorganization -- potentially including BNSF, CSX or
Colonial -- may elect to terminate their contribution agreements with us.
Moreover, if we have not completed our reorganization by the termination date,
and regardless of whether the participants in the transaction have elected not
to exercise their termination rights, applicable federal securities law may
prevent us from completing the reorganization as currently structured. After
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March 31, 2000, to avoid any suggestion that our issue of shares in the
reorganization should be integrated with the offering of our guarantees, we
might need to delay or restructure the reorganization. In either of those
circumstances, the current parties to our reorganization might not choose to
participate in our reorganization, and we might be unable to complete the
transaction as planned.
Although not a condition to the closing of our reorganization, we must
complete the buildout of our network from Chicago, Illinois to Aurora (a suburb
of Denver), Colorado in order to receive the second tranche of Colonial's
investment in our shares of series convertible preferred stock. This second
tranche consists of $25 million of the aggregate $68 million cash investment by
Colonial.
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THE PATHNET SENIOR NOTEHOLDER WAIVERS AND OTHER PROPOSED
INDENTURE AMENDMENTS
In April 1998, Pathnet issued $350 million in principal amount of 12 1/4%
senior notes due 2008. A separate agreement, called the indenture, contains a
series of covenants, restrictions, events of default, and other terms relating
to the notes. When we refer in this document to the "senior notes" or just the
"notes" and the indenture, we are referring to those notes and that agreement
unless we expressly state otherwise. The indenture was originally filed by
Pathnet in connection with the registration of the notes in 1998 and was an
exhibit to that registration statement, and we have included that original
indenture as an exhibit to the registration statement of which this prospectus
is a part.
Before our reorganization can occur, Pathnet needs to obtain a waiver of
certain provisions of the indenture, namely the "Change of Control" repurchase
obligation and the "Excess Proceeds Offer" obligation, each of which is more
fully described under the heading "Waiver of Pathnet Obligations" below. Under
section 1019 of the indenture, the holders of at least a majority in outstanding
principal amount of the notes can waive Pathnet's compliance with the Change of
Control Offer obligation and with the Excess Proceeds Offer obligation in
connection with the closing of our reorganization.
To facilitate the consents to the necessary waivers for our reorganization,
we are proposing to issue to the holders of the notes our senior irrevocable and
unconditional guarantees of the notes. The holders of the notes will have
recourse against us, as the ultimate parent entity of the underlying business,
in the form of our guarantees of Pathnet's payment on the notes (as described
more fully under the heading "DESCRIPTION OF THE GUARANTEES" below). You do not
need to provide your consent as a holder of notes to our issue of the
guarantees. However, we will not issue the guarantees unless we obtain the
requisite number of consents, as described below, and close on our
reorganization.
In addition to our agreement to issue the guarantees, upon the receipt of
the requisite consents, we propose to become a party to and be bound by a
supplemental indenture. The supplemental indenture will contain covenants that
correspond to the indenture covenants currently applicable to Pathnet. In return
for our agreement to become bound by the supplemental indenture covenants and to
guarantee Pathnet's obligations under the notes, Pathnet wishes to amend the
scope and application of several terms of the indenture. By proposing the
amendments, Pathnet intends solely to expand the corporate group covered by the
indenture to include Pathnet Telecom and its other Restricted Subsidiaries (as
defined in supplemental indenture), and thereby permit transactions between
Pathnet and Pathnet Telecom (and our other future subsidiaries) to the same
extent that the indenture currently permits such transactions between Pathnet
and its Restricted Subsidiaries (as defined in the indenture). Accordingly,
Pathnet proposes to amend the scope of the restrictions in the indenture that
previously applied to Pathnet and its Restricted Subsidiaries to apply more
broadly to include us and any other Restricted Subsidiaries (as defined in
supplemental indenture) that we may create in the future that would, if Pathnet
created them, fall within the indenture definition of Restricted Subsidiaries.
In order to effect the proposed amendments, it will also be necessary to make
amendments to a number of other defined terms of the indenture.
Pathnet may amend most terms of the indenture by obtaining the approval of
the holders of at least a majority in outstanding principal amount of the notes.
However, section 902(2) of the indenture provides that certain provisions of the
indenture (including the Change of Control Offer obligation and the Excess
Proceeds Offer obligation) cannot be amended without the consent of the holders
of all outstanding notes. Pathnet intends to preserve without modification those
covenant obligations that cannot be amended without the consent of the holders
of all outstanding notes. We describe the proposed amendments to the indenture
more fully in "Proposed Indenture Amendments" below.
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Pathnet has undertaken the consent solicitation process in order to obtain
the waivers and consent to the proposed amendments from the holders of at least
a majority in outstanding principal amount of the notes. The consent
solicitation process and the documentation produced in connection with it is
described in more detail in "The Consent Solicitation Process" below. The
consent solicitation documentation is included as an exhibit to the registration
statement of which this prospectus is a part.
WAIVER OF PATHNET OBLIGATIONS
Waiver of "Change of Control" Offer Obligation. Section 1010 of the
indenture requires Pathnet to repurchase the notes at a premium if a "Change of
Control" (as that term is defined in the indenture) occurs before the notes
mature in 2008. Our reorganization involves a proposed exchange of our shares
with all of Pathnet's current stockholders. Interposing Pathnet Telecom as a
holding company for Pathnet technically constitutes a "Change of Control" of
Pathnet under the applicable definition in the indenture. As a result, if this
change of control repurchase provision were to apply to our reorganization,
closing the reorganization would trigger Pathnet's obligation under the
indenture to offer to repurchase the notes at 101% of their face value, plus
accrued and unpaid interest.
Pathnet does not have the funds to finance the repurchase of the notes at
the price required by the section 1010 change of control provision of the
indenture. Moreover, the repurchase obligation would deprive us and Pathnet of
the funds necessary to contribute to the development of our telecommunications
business, and BNSF, CSX and Colonial would be unwilling to invest in us on the
terms provided in the contribution agreements if Pathnet remained subject to the
repurchase obligation. As a result, if Pathnet does not obtain from the
requisite holders of a majority in outstanding principal amount of the notes the
necessary waiver under section 1019 of the indenture of the Change of Control
Offer Obligation, our reorganization will not take place, and BNSF, CSX and
Colonial will not invest in us as contemplated in the contribution agreements.
Waiver of "Excess Proceeds Offer" Obligation. Section 1017 of the
indenture requires Pathnet to make an Excess Proceeds Offer (as that term is
defined in the indenture) in connection with certain sales and other conveyances
of assets and similar transactions. The Excess Proceeds Offer provision in
effect requires Pathnet to apply excess cash generated from the sale of Pathnet
assets outside the ordinary course of business -- to the extent not applied to
repayment of the notes or investment in other telecommunications assets -- to a
proportional repurchase of the notes.
Pathnet seeks a one-time waiver, pursuant to section 1019 of the indenture,
of the obligation to make an "Excess Proceeds Offer" to permit it to sell to us
in return for a promissory note in the principal amount of $70 million the
following assets:
- The fiber optic network assets already installed and constructed along
the Chicago to Aurora, Colorado, a suburb of Denver route including all
inventories of work-in-progress, raw materials, finished products,
supplies, spare parts and other materials relating to the route;
- The agreement between Pathnet and Worldwide Fiber dated March 31, 1999,
relating to the development of the fiber optic route between Chicago and
Aurora and the joint marketing agreement and other documents and
agreements relating to that agreement and the assets acquired in
accordance with that agreement;
- The Dark Fiber Network Agreement between Pathnet, Tri-State and others
dated August 5, 1999 relating to the development of the fiber optic
network between Albuquerque, New Mexico and Grand Junction, Colorado and
the related escrow arrangements and other documents and agreements with
Tri-State, including the associated right of way under the Fiber Optic
Cable Construction and Use Agreement with Public Service Company of New
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Mexico, dated June 9, 1999 and the Fiber Optic Cable License Agreement
with Public Service Company of New Mexico, dated December 23, 1999;
- The fiber optic development agreement, joint marketing agreement and
other related documents and agreements with CapRock Telecommunications
Corporation relating to the development of an approximately 340 route
mile fiber route between El Paso, Texas and Albuquerque, New Mexico;
- All other fiber network assets, properties and contracts held by Pathnet
including:
-- all rights in and to insurance and indemnity claims;
-- all prepaid expenses, advances and deposits; and
-- all rights, choices in actions and claims (known or unknown, matured
or unmatured, accrued or contingent) against third parties;
- A license to Pathnet's tradenames, trademarks and other intellectual
property;
- All goodwill and going concern rights associated with each of the items
listed above; and
- Fiber assets Pathnet will receive from its subsidiary, Pathnet Fiber
Optics, LLC under an assignment and acceptance agreement
For more detailed information on the transfer of assets described above,
you may refer to the Form of Assignment and Acceptance Agreement between Pathnet
and us and the Form of Assignment and Acceptance Agreement between Pathnet Fiber
Optics, LLC and Pathnet, both of which are filed as exhibits to the registration
statement of which this prospectus is a part.
These sales and other transfers by Pathnet to us would constitute an Asset
Sale and would trigger Pathnet's obligation to make and consummate an Excess
Proceeds Offer. The imposition of this obligation would deprive us and Pathnet
of funds necessary to contribute to the development of our telecommunications
business. Accordingly, Pathnet, BNSF, CSX and Colonial have conditioned their
obligation to consummate the reorganization upon Pathnet having obtained a
waiver of the Excess Proceeds Offer obligation from the requisite holders of the
notes. As a result, if Pathnet does not obtain from the holders of a majority in
outstanding principal amount of the notes the necessary waiver under section
1019 of the indenture of the Excess Proceeds Offer obligation, our
reorganization will not take place, and BNSF, CSX and Colonial will not invest
in us as contemplated in the contribution agreements.
Following the completion of our reorganization, we expect that Pathnet
will:
- Continue to own and operate its existing 6,300 route miles of wireless
network segments and the associated wireless partner contracts, together
all of Pathnet's existing central office collocations, the network
operations center, intellectual property previously developed by Pathnet
and the current Pathnet employees; and
- Provide management and general and administrative services, and related
network operations center functions and support, to Pathnet Telecom and
other companies within the Pathnet Telecom affiliated group, pursuant to
the terms of a management services agreement that we plan to execute with
Pathnet at the closing of our reorganization.
We expect that Pathnet Telecom, either directly or through other
subsidiaries of either Pathnet or Pathnet Telecom, will conduct the fiber and
other businesses made possible by the contribution of the railroad and pipeline
company rights of way.
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PROPOSED INDENTURE AMENDMENTS
The proposed indenture amendments are designed to impose upon us and our
Restricted Subsidiaries restrictions parallel to those that the indenture
currently imposes upon Pathnet and its Restricted Subsidiaries, and to permit
transactions between Pathnet and us (and our other Restricted Subsidiaries) to
the same extent that the indenture currently permits such transactions between
Pathnet and its Restricted Subsidiaries. The necessary amendments to the
indenture will be contained in the supplemental indenture, which will bind both
Pathnet and us. The major changes as proposed in the supplemental indenture are
described in the table below.
This table is a summary of complex provisions contained in the indenture
and the supplemental indenture, and it may omit detailed information important
to your understanding of the operation of relevant covenants of the indenture
and the supplemental indenture in specific circumstances important to you.
<TABLE>
<CAPTION>
CHANGES AS PROPOSED IN THE
PROVISION CURRENT INDENTURE SUPPLEMENTAL INDENTURE
--------- ----------------- --------------------------
<S> <C> <C>
EVENTS OF DEFAULT Payment defaults on the notes. No change for the notes; adds
failure of guarantees to be in
effect.
Covenant defaults on the indenture. Covenant defaults on the indenture,
including obligations imposed
directly on Pathnet Telecom.
Cross defaults to other indebtedness or Cross defaults to other
adverse judgments over $7.5 million indebtedness or adverse judgments
against Pathnet or any Significant over $7.5 million against any of
Subsidiary of Pathnet. Pathnet, Pathnet Telecom, or any
Significant Subsidiary of either
Pathnet or Pathnet Telecom.
Bankruptcy proceedings by or in respect Bankruptcy proceedings by or in
of Pathnet or any Significant respect of Pathnet, Pathnet
Subsidiary of Pathnet. Telecom, or any Significant
Subsidiary of Pathnet or Pathnet
Telecom.
Pledge Agreement ceases to be in full No change.
force and effect.
CONSOLIDATION, Restricts the ability of Pathnet and Expands the covenant so that it
MERGER, CONVEYANCE, its Restricted Subsidiaries to enter applies to Pathnet Telecom and its
TRANSFER OR LEASE into transactions involving a merger or consolidated group, rather than
disposition of all or substantially all solely to Pathnet and its
of Pathnet's and its Restricted consolidated group. Provisions
Subsidiaries' assets on a consolidated relating to the required
basis. substitution of successors and the
requirement to secure the notes in
certain circumstances apply to
Pathnet obligations under the notes
and as appropriate to Pathnet
Telecom obligations under the
guarantees.
</TABLE>
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<TABLE>
<CAPTION>
CHANGES AS PROPOSED IN THE
PROVISION CURRENT INDENTURE SUPPLEMENTAL INDENTURE
--------- ----------------- --------------------------
<S> <C> <C>
AMENDMENTS Certain types of amendments (and Provides that Pathnet Telecom and
TO THE supplemental indentures) may be adopted Pathnet can amend the indenture in
INDENTURE without consent of noteholders. the same circumstances, and with
the same levels of approvals, as
Pathnet is permitted to make such
amendments under the indenture.
Most types of amendments (and Applies to the supplemental
supplemental indentures) may be adopted indenture the same majority consent
with the consent of a majority of the threshold for those amendments that
noteholders. currently require such a majority
in the indenture.
AMENDMENTS TO THE Certain types of amendments (and Subjects Pathnet Telecom to the
INDENTURE (CONTINUED) Supplemental indentures) may not be unanimous consent threshold for the
adopted without the consent of all amendments requiring unanimous
noteholders. consent in the original indenture,
and adds to that list any amendment
that modifies the provisions of the
indenture relating to the
guarantees in a manner adverse to
the holders of the notes.
MAINTENANCE OF OFFICE Pathnet must maintain an office or Both Pathnet and Pathnet Telecom
agency in New York City for service of must maintain an office or agency
notices and demands. in New York City for the service of
notices and demands under the notes
and the guarantees, on the same
terms as that obligation currently
applies to Pathnet.
MONEY FOR NOTE PAYMENTS Regulates Pathnet's dealings with Regulates Pathnet Telecom's
paying agents and its ability to act as dealings with paying agents and
its own paying agent. Pathnet Telecom's ability to make
payments directly to the holders of
the guarantees in the same manner
as Pathnet's dealings are regulated
under the indenture.
CORPORATE EXISTENCE Pathnet and its subsidiaries must Expands the covenant so that it
maintain corporate existence. also applies to Pathnet Telecom and
its other subsidiaries.
PAYMENT OF TAXES AND Pathnet and its subsidiaries must pay Expands the covenant so that it
OTHER CLAIMS taxes and other claims. also applies to Pathnet Telecom and
its other subsidiaries.
</TABLE>
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<TABLE>
<CAPTION>
CHANGES AS PROPOSED IN THE
PROVISION CURRENT INDENTURE SUPPLEMENTAL INDENTURE
--------- ----------------- --------------------------
<S> <C> <C>
MAINTENANCE OF Pathnet and Restricted Subsidiaries Expands the covenant so that it
PROPERTIES must maintain material properties in also applies to Pathnet Telecom and
good condition and repair. its Restricted Subsidiaries.
INSURANCE Pathnet and Restricted Subsidiaries Expands the covenant so that it
must maintain customary insurance. also applies to Pathnet Telecom and
its Restricted Subsidiaries.
OFFICERS COMPLIANCE Required from Pathnet. Required from Pathnet and from
CERTIFICATE Pathnet Telecom.
FINANCIAL STATEMENTS Pathnet must file Exchange Act reports Pathnet Telecom must file Exchange
with the SEC (whether or not required Act reports (including consolidated
by law to do so) and must provide reports) with the SEC (whether or
trustee with copies. not required by law to do so) and
must provide trustee with copies.
To the extent permitted in the
future by applicable law, releases
Pathnet from separate SEC and
trustee periodic report filing
obligations.
CHANGE OF CONTROL Pathnet required to offer to repurchase No change to Pathnet's obligation.
REPURCHASE OBLIGATION the notes at a premium upon occurrence Expands the provision so that
of a Change of Control. Pathnet's repurchase obligation is
also triggered by a Change of
Control of Pathnet Telecom;
guarantees apply to this
obligation.
</TABLE>
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<TABLE>
<CAPTION>
CHANGES AS PROPOSED IN THE
PROVISION CURRENT INDENTURE SUPPLEMENTAL INDENTURE
--------- ----------------- --------------------------
<S> <C> <C>
LIMITATION ON Subject to a ratio test for Expands the existing covenant so
INDEBTEDNESS Consolidated Indebtedness to that both Pathnet and Pathnet
Consolidated Operating Cash Flow Test Telecom are subject to the same
for Pathnet and its Restricted limitations (including the
Subsidiaries, neither Pathnet nor its limitations on their respective
Restricted Subsidiaries can incur Restricted Subsidiaries), except
Indebtedness other than Permitted that:
Indebtedness. Permitted Indebtedness
includes Telecommunications (1) the definition of Permitted
Indebtedness of either Pathnet or any Indebtedness will continue to
Restricted Subsidiary; subordinated include Telecommunications
indebtedness of Pathnet to its Indebtedness, but will apply to
Restricted Subsidiaries; and any Pathnet Telecom's Restricted
indebtedness of a Restricted Subsidiary Subsidiaries as well as
to Pathnet or to any other Restricted Pathnet's, and will allow
Subsidiary. intercompany Indebtedness among
Pathnet Telecom, Pathnet, and
their respective Restricted
Subsidiaries subject to the
corresponding restrictions; and
(2) the Consolidated Indebtedness
to Consolidated Operating Cash
Flow Ratio used to determine
whether any of the covered
entities can incur additional
debt is calculated by reference
to Pathnet Telecom, Pathnet and
all Restricted Subsidiaries on
a consolidated basis.
RESTRICTED PAYMENTS Restricts Pathnet and its Restricted Changes the cash dividend
LIMITATION Subsidiaries from declaring cash declaration and capital stock
dividends on Pathnet capital stock, redemption restrictions to apply to
redeeming capital stock or subordinated Pathnet Telecom rather than to
debt of Pathnet, or making investments Pathnet.
(other than Permitted Investments), Imposes parallel restrictions on
unless Pathnet could, after such Pathnet Telecom's ability to make
payment, incur additional Indebtedness other Restricted Payments.
under the Permitted Indebtedness
covenant and the aggregate amount of
permitted Restricted Payments does not
exceed an amount determined as
described in the Restricted Payments
covenant.
</TABLE>
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<TABLE>
<CAPTION>
CHANGES AS PROPOSED IN THE
PROVISION CURRENT INDENTURE SUPPLEMENTAL INDENTURE
--------- ----------------- --------------------------
<S> <C> <C>
SALE OF CAPITAL STOCK OF Restricts the sale or issuance of Expands the covenant to apply to
RESTRICTED SUBSIDIARIES Capital Stock of Restricted capital stock of Pathnet and
Subsidiaries of Pathnet to third Restricted Subsidiaries of both
parties. Pathnet Telecom and Pathnet.
TRANSACTIONS WITH Restricts transactions by Pathnet and Imposes the same restriction on
AFFILIATES its Restricted Subsidiaries with Pathnet Telecom and its Restricted
Affiliates unless conducted on an Subsidiaries and expands the
arms'-length basis. definition of Affiliates to include
all Affiliates of Pathnet Telecom.
As provided in the current
indenture for transactions among
Pathnet and its own Restricted
Subsidiaries, the supplemental
indenture provides that
transactions among any of Pathnet
Telecom, Pathnet and any Restricted
Subsidiary are not restricted.
LIEN RESTRICTIONS Neither Pathnet nor any Restricted Expands the restriction to include
Subsidiary can permit any Lien to exist Pathnet Telecom and its Restricted
other than Permitted Liens, unless the Subsidiaries, and expands the
notes are equally and ratably secured. definition of Permitted Liens to
Permitted Liens include liens for include liens among Pathnet
Telecommunications Indebtedness and Telecom, Pathnet and their
liens among Pathnet and any Restricted respective Restricted Subsidiaries.
Subsidiary.
LIMITATIONS ON Prohibits Restricted Subsidiaries of Expands the restrictions to apply
GUARANTEES AND OTHER Pathnet from issuing or guaranteeing to Pathnet Telecom's Restricted
DEBT Debt Securities unless they Subsidiaries; exception for vendor
concurrently guarantee the notes; financings and other borrowings
specific exception excludes from the continues to apply.
definition of Debt Securities any
vendor equipment financing facilities
or similar financings and other
borrowings incurred in a manner not
customarily viewed as a securities
offering.
</TABLE>
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<TABLE>
<CAPTION>
CHANGES AS PROPOSED IN THE
PROVISION CURRENT INDENTURE SUPPLEMENTAL INDENTURE
--------- ----------------- --------------------------
<S> <C> <C>
LIMITATION ON ASSET Pathnet and its Restricted Subsidiaries Retains unmodified Pathnet's
SALES may not engage in an Asset Sale unless obligations in respect of Asset
the transaction is for fair market Sales. Imposes corresponding
value and meets other requirements as obligations on Pathnet Telecom and
to the nature of the consideration; if its Restricted Subsidiaries.
the amount of proceeds exceeds a
specified threshold, Pathnet is
required to commence an offer to
purchase notes up to such amount within
15 business days of the closing of the
Asset Sale.
PROHIBITION AGAINST Subject to exceptions, including, among Expands the existing covenant to
DIVIDEND RESTRICTIONS others, those for Secured Indebtedness apply to Pathnet and to Restricted
and Telecommunications Indebtedness, Subsidiaries of both Pathnet and
Pathnet cannot permit any Restricted Pathnet Telecom.
Subsidiary to accept a restriction on
its ability to pay dividends or make
other payments to Pathnet or any
Restricted Subsidiary of Pathnet to the
extent necessary to permit Pathnet to
make payment on the notes.
SECURITY Pathnet acquired Government Securities Pathnet will acquire additional
and pledged them to the Trustee as Government Securities and pledge
security for the benefit of the holders them to the trustee as security for
of the notes with respect to the the benefit of the holders of the
payment of the first four scheduled notes with respect to the October
interest payments on the notes (through 16, 2000 interest payment on the
the April 15, 2000 interest payment notes.
date).
</TABLE>
The following description provides a narrative summary of the material
amendments to the indenture that Pathnet proposes to make in the supplemental
indenture. Like the table above, this description does not restate the
supplemental indenture in its entirety and you should refer to the supplemental
indenture, which is filed as an exhibit to the registration statement of which
this prospectus is a part, for further information regarding the provisions
summarized here. Capitalized terms used in this description have the meaning
given to them in the indenture as amended by the supplemental indenture unless
we refer to the "original indenture," in which case terms are used as defined in
that version.
- CERTAIN DEFINITIONS IN THE INDENTURE. The definitions used in the
original indenture will be amended to the extent necessary to effect the
proposed amendments to the original indenture
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<PAGE> 102
described below. Revised definitions that are used generally throughout
the supplemental indenture will be contained in section 102 of the
supplemental indenture.
As discussed above, the indenture (section 902(2)) provides that two of
Pathnet's obligations cannot be amended, changed or modified without the
consent of the holders of each outstanding note. These are Pathnet's
obligations to make and consummate (1) an Excess Proceeds Offer with
respect to any Asset Sale by Pathnet or any of its Restricted
Subsidiaries in accordance with section 1017 of the indenture; and (2) a
Change of Control Offer in the event of a Change of Control of Pathnet in
accordance with section 1010 of the indenture. The indenture also
provides that Pathnet cannot, without the consent of the holder of each
affected note, amend the definitions relating to these obligations in any
way that would amend, change or modify any of these obligations.
Accordingly, none of the amendments in the supplemental indenture in any
way amends, changes or modifies Pathnet's independent obligation to make
and consummate an Excess Proceeds Offer or a Change of Control Offer
under the indenture.
However, in order to effect the amendments necessary to impose
corresponding obligations on us, Pathnet must amend certain defined terms
that are otherwise used in section 1017 of the original indenture. For
ease of application, we have reproduced in the supplemental indenture as
a new section 1017(a) of the indenture the independent obligation on
Pathnet and its Restricted Subsidiaries pursuant to section 1017 of the
original indenture to make an Excess Proceeds Offer in respect of any
Asset Sale by those entities. We have also reproduced (in section 103 of
the supplemental indenture and without the inclusion of any references to
us) the applicable definitions from section 102 of the supplemental
indenture used in section 1017(a) of the supplemental indenture. These
"section 1017(a)-only" definitions represent definitions previously set
forth in section 101 of the indenture that have been modified solely to
conform to changes to other defined terms or provisions of the indenture
necessitated by the new corporate structure. Examples of these amendments
are the frequent replacement of the term "Restricted Subsidiary" (which
meant all restricted subsidiaries of Pathnet under section 101 of the
original indenture but now means all restricted subsidiaries of Pathnet
and us under section 102 of the supplemental indenture) with the new term
"Restricted Company Subsidiary," which means all restricted subsidiaries
of Pathnet. These changes preserve the meaning of the original provisions
of section 1017 of the indenture.
- MODIFICATION AND AMENDMENT. Section 901 of the indenture specifies the
amendments that Pathnet and the Trustee can make without the consent of
the holders of notes. Section 902 states that Pathnet and the Trustee
must have the unanimous consent of holders of the notes to make any of
the amendments specifically listed in that section, but that any other
amendment can be made with the consent of a majority of holders of the
notes. These sections are modified in the supplemental indenture so that
we can make amendments on the same terms as Pathnet, except that any
amendment to the guarantees adverse to the holders of the notes requires
unanimous consent of the holders.
The defined terms used in section 1010 of the original indenture are
either unamended in the supplemental indenture, or were already defined
within that section. Accordingly, Pathnet does not propose to reproduce
these terms in a separate section of the supplemental indenture.
Defined terms listed in section 101 of the indenture that do not need to
be amended for the purposes of the supplemental indenture, and are not
included in the revised definitions in section 102 or 103 of the
supplemental indenture, retain the meaning given to them in the
indenture.
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<PAGE> 103
- EVENTS OF DEFAULT. Section 501 of the indenture currently contains the
definition of "Event of Default." The supplemental indenture deletes this
section in its entirety and inserts the same definitions of "Event of
Default" in the definition sections, except that:
- the same Events of Default that previously applied to Pathnet (and in
several cases to any of Pathnet's "Significant Subsidiaries") will also
be triggered by us (and in several cases by any of our Significant
Subsidiaries); and
- the supplemental indenture will include an additional Event of Default
for the guarantees ceasing to be in full force and effect before payment
in full of the notes.
- CONSOLIDATION, MERGER, CONVEYANCE, TRANSFER OR LEASE. Article 8 of the
indenture currently restricts the ability of Pathnet and its Restricted
Subsidiaries to consolidate or merge with or into any other person or
entity or to sell, assign, convey, transfer, lease or otherwise dispose
of all or substantially all of the properties or assets of Pathnet or its
Restricted Subsidiaries. The supplemental indenture amends this article
so that the corresponding restrictions apply to us and our Restricted
Subsidiaries as well as Pathnet and its Restricted Subsidiaries, except
that:
- the exceptions for transactions with Restricted Subsidiaries will
include Pathnet and our Restricted Subsidiaries (as redefined in the
supplemental indenture to include any of our other direct or indirect
subsidiaries, which would if Pathnet incorporated them, fall within the
original indenture definition of Restricted Subsidiaries); and
- with respect to us, the provisions relating to substitution of
successors and the requirement to secure the notes in certain events
apply to our obligations under the guarantees.
In determining whether the merger, conveyance, transfer or lease satisfies
paragraph (3) of indenture section 801 (with respect to our ability to
incur additional Indebtedness), the test refers to our "Consolidated
Indebtedness to Consolidated Operating Cash Flow Ratio" calculated by
reference to Pathnet, Pathnet Telecom and all of the Restricted
Subsidiaries on a consolidated basis.
- MAINTENANCE OF OFFICE OR AGENCY. Section 1002 of the indenture currently
requires Pathnet to maintain an office or agency in the City of New York
where notes can be presented or surrendered for payment, or surrendered
for registration of transfer or exchange and where notices and demands to
or upon Pathnet in respect of the notes and the indenture can be served.
The supplemental indenture provides that we are also required to maintain
an office for the service of notice or demands on us with respect to the
guarantees on the terms set out in that section.
- MONEY FOR NOTE PAYMENTS TO BE HELD IN TRUST. Section 1003 of the
indenture currently places certain obligations on Pathnet with respect to
its dealings with Paying Agents and regulates the terms on which Pathnet
is able to make any payments on the notes directly to any holder of the
Notes. The supplemental indenture provides that our dealings with Paying
Agents, and our ability to make payments directly to the holders of notes
pursuant to the guarantees, are regulated in the same manner.
- AFFIRMATIVE COVENANTS. These provisions of the indenture currently
contain affirmative covenants of Pathnet (and in certain cases its
subsidiaries or Restricted Subsidiaries):
- Section 1004 (corporate existence);
- Section 1005 (payment of taxes and other claims);
- Section 1006 (maintenance of properties);
- Section 1007 (insurance);
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- Section 1008 (statement by officers as to default); and
- Section 1009 (provision of financial statements).
The supplemental indenture amends these covenants so that each affirmative
covenant also applies to us (and, where the corresponding covenant from
the indenture is so applicable, to any other subsidiaries or Restricted
Subsidiaries that we may in the future incorporate), except that:
- the separate SEC filing requirements and the obligation to prepare and
deliver financial statements under section 1009(a) of the original
indenture will not apply to Pathnet if Pathnet is able to rely on any
law, rule, regulation or SEC approval, whether in force now or
subsequently introduced, to limit the scope of or cease compliance with
these obligations and we are otherwise in compliance with our SEC filing
obligations; and
- the requirements to file documents with the trustee under section
1009(b) will apply only to us and not to Pathnet.
- CHANGE OF CONTROL. Section 1010 of the indenture currently gives holders
of the notes a right to require Pathnet to repurchase notes upon the
occurrence of a Change of Control. The supplemental indenture expands the
definition of Change of Control so that the repurchase right is also
triggered by a change of control of Pathnet Telecom. The proposed
amendment does not change, amend or modify the existing obligation of
Pathnet to make and consummate a Change of Control Offer in the event of
a Change of Control of Pathnet in accordance with section 1010.
- LIMITATION ON INDEBTEDNESS. Section 1011 of the indenture currently
limits the ability of Pathnet and its Restricted Subsidiaries to incur
additional Indebtedness, other than Permitted Indebtedness or
Indebtedness that would not result in Pathnet's Consolidated Indebtedness
to Consolidated Operating Cash Flow Ratio being outside the parameters
described in that section. The supplemental indenture amends this section
so that:
- the Consolidated Indebtedness to Consolidated Operating Cash Flow Ratio
that we must use to determine whether any indebtedness that either we or
Pathnet (or any of our respective Restricted Subsidiaries) wish to incur
is allowed -- is calculated by reference to Pathnet Telecom, Pathnet and
the Restricted Subsidiaries on a consolidated basis; and
- we are subject to the same limitations on our ability (and the ability
of any of our other Restricted Subsidiaries) to incur additional
indebtedness as Pathnet and its Restricted Subsidiaries.
- LIMITATION ON RESTRICTED PAYMENTS. Section 1012 of the indenture
currently restricts the ability of Pathnet and its Restricted
Subsidiaries to (1) declare or pay cash dividends or other distributions;
(2) purchase, redeem or otherwise acquire or retire for value any shares
of Capital Stock of Pathnet or certain of its Affiliates; (3) make any
principal payment on, repurchase, redeem, defease or otherwise acquire or
retire for value indebtedness of Pathnet that is subordinated in right of
payment to the notes; or (4) make any investment (other than a Permitted
Investment) in any Person. The supplemental indenture expands the scope
of this section so that;
- the restriction on cash dividends applies to us, rather than to Pathnet;
- the purchase and redemption restrictions apply to our Capital Stock and
the Capital Stock of our Affiliates (other than our Affiliates that are,
directly or indirectly, wholly-owned by us);
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- the restrictions on principal payments or retirement of Indebtedness
refers to any of our Indebtedness or Indebtedness of Pathnet that is so
expressly subordinated in right of payment to the guarantees or the
notes;
- the restrictions on investment apply to Investments by us, by Pathnet
and by any of our Restricted Subsidiaries, except that the definition of
Permitted Investments will be correspondingly expanded to include
Investments in all Restricted Subsidiaries (and not just those of our
Restricted Subsidiaries that are also Pathnet Restricted Subsidiaries);
and
- in determining whether a Restricted Payment satisfies the test with
respect to our ability to incur additional Indebtedness, reference is
made to the Consolidated Indebtedness to Consolidated Operating Cash
Flow Ratio calculated by reference to Pathnet, Pathnet Telecom and all
Restricted Subsidiaries on a consolidated basis.
- LIMITATION ON ISSUANCE AND SALE OF CAPITAL STOCK OF RESTRICTED
SUBSIDIARIES. Section 1013 of the indenture currently restricts the
ability of Pathnet and its Restricted Subsidiaries to issue or sell any
capital stock of a Restricted Subsidiary (other than to Pathnet or to a
Restricted Subsidiary). The supplemental indenture expands the scope of
this section so that the same restriction also applies to us and the
issuance or sale of the capital stock of Pathnet and our Restricted
Subsidiaries.
- LIMITATION ON TRANSACTIONS WITH AFFILIATES. Section 1014 of the
indenture currently imposes restrictions on the ability of Pathnet and
its Restricted Subsidiaries to engage in any transaction or series of
related transactions with or for the benefit of Affiliates, unless
conducted on an arms'-length basis with appropriate certifications to the
holders of the notes of the arms'-length nature of such transactions.
This provision also permits transactions between Pathnet and its
Restricted Subsidiaries. This section is amended by the supplemental
indenture so that our ability and the ability of our Restricted
Subsidiaries to engage in transactions with Affiliates is restricted in
the same manner, but so that transactions between us and Pathnet or any
of our Restricted Subsidiaries are not subject to the restrictions under
this section. We have also included (as the indenture provides in respect
of the existing Pathnet Stockholders Agreement) that Pathnet Telecom will
be permitted to perform its obligations under the Pathnet Telecom
stockholders agreement.
- LIMITATION ON LIENS. Section 1015 of the indenture currently limits the
ability of Pathnet or any Restricted Subsidiary to create, incur, assume
or suffer to exist any Lien (other than Permitted Liens) on the property
or assets of Pathnet or any Restricted Subsidiary. The supplemental
indenture amends this section so that our ability and the ability of our
Restricted Subsidiaries to create, incur, assume or suffer to exist any
Lien (other than Permitted Liens) on our respective property or assets is
also restricted in the same manner. The definition of the term "Permitted
Liens" is correspondingly expanded to cover liens and indebtedness within
the Pathnet Telecom "Restricted Entity" group, which will include
Pathnet, Pathnet Telecom, and all their respective Restricted
Subsidiaries, to the extent previously permitted as between Pathnet and
its Restricted Subsidiaries.
- LIMITATION ON ISSUANCE OF CERTAIN GUARANTEES AND DEBT SECURITIES. Section
1016 of the indenture currently limits the ability of Restricted
Subsidiaries of Pathnet to guarantee, assume or in any other manner
become liable for any Debt Securities or to issue any Debt Securities
unless, in either such case, the Restricted Subsidiary simultaneously
executes and delivers a guarantee of payment for the notes. The scope of
this section is expanded so that our Restricted Subsidiaries are subject
to the same limitations. The amendment does not provide for us to be
subject to such limitations as we are already secondarily liable for the
notes under the guarantees.
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- LIMITATIONS ON ASSET SALES. Section 1017 of the indenture currently
restricts the ability of Pathnet and its Restricted Subsidiaries to
engage in Asset Sales. The supplemental indenture expands this section by
adding a new paragraph that imposes equivalent restrictions on Asset
Sales by us and our Restricted Subsidiaries, except that in the new
paragraph, for the purpose of determining whether any transfer of
property or assets by Pathnet or any Restricted Subsidiary of Pathnet
falls within the exemptions in clause (A) or clause (G) of the definition
of "Asset Sale," the Consolidated Indebtedness to Consolidated Operating
Cash Flow Ratio is calculated by reference to Pathnet, Pathnet Telecom,
and all Restricted Subsidiaries on a consolidated basis. Asset Sales
between Pathnet and Pathnet Telecom will continue to be subject to the
limitations under this section, and the proposed amendment will not
change, amend or modify Pathnet's existing obligation to make and
consummate an Excess Proceeds Offer in connection with any Asset Sale in
accordance with section 1017(a) of the indenture. In particular, for the
purpose of determining whether any transfer of property or assets by
Pathnet or any Restricted Subsidiary of Pathnet falls within the
exemptions in clause (A) or clause (G) of the definition of "Asset Sale,"
with respect to section 1017(a), the Consolidated Indebtedness to
Consolidated Operating Cash Flow Ratio is calculated by reference to
Pathnet and its Restricted Subsidiaries alone.
- LIMITATIONS ON DIVIDEND RESTRICTIONS. Section 1018 of the indenture
currently limits the ability of Pathnet and its Restricted Subsidiaries
to create or otherwise cause or suffer to exist or become effective any
encumbrance or restriction on the ability of the Restricted Subsidiaries
to: (1) pay dividends or other distributions; (2) pay Indebtedness owed
to Pathnet or any other Restricted Subsidiary; (3) make Investments in
Pathnet or any other Restricted Subsidiary, (4) transfer any of their
assets or property to Pathnet or any other Restricted Subsidiary; or (5)
guarantee any Indebtedness of Pathnet or any other Restricted Subsidiary.
This Section is expanded in the supplemental indenture so that these
restrictions apply more broadly to Pathnet and all Restricted
Subsidiaries.
- SECURITY. Article 12 of the indenture currently requires Pathnet to
acquire Government Securities and pledge them to the trustee as security
for the benefit of the holders of the notes with respect to the payment
of the first four scheduled interest payments on the notes (through the
April 15, 2000 interest payment date). This provision is expanded in the
supplemental indenture to provide for a similar escrow obligation with
respect to the October 16, 2000 interest payment on the notes.
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DESCRIPTION OF THE GUARANTEES
The following description is a summary of the material provisions of the
guarantees. It does not restate the terms of the guarantees in their entirety
and is subject to, and qualified in its entirety by reference to, the provisions
of the guarantees. We urge you to read the Form of Guarantee, which is filed as
an exhibit to the registration statement of which this prospectus is a part.
Capitalized terms used in this section have the meanings given to them in the
indenture and the notes.
- GUARANTEE OF THE NOTES. We will unconditionally guarantee to the holder
of any outstanding note(s) all obligations, covenants, liabilities,
undertakings and agreements of any kind of Pathnet contained in the
indenture, including:
(1) the prompt payment in full, in United States currency, when due, of
the principal and of the interest on the notes and all other amounts
that may be owing from Pathnet to the holders of the notes under the
indenture and the notes; and
(2) the prompt performance and observance by Pathnet of all covenants,
agreements and conditions to be performed and observed by Pathnet
under the indenture.
The guarantees will be absolute, unconditional and continuing guarantees of
the obligations of Pathnet under the indenture, including its obligations to
make interest and principal payments. If Pathnet does not comply with its
obligations under the indenture, the holders may proceed directly against us
without being required to seek payment or performance from Pathnet.
- DURATION OF THE GUARANTEES. The guarantees will continue in effect with
respect to any note until the holder of that note has received payment in
full of the Redemption Price with respect to that note, when the
guarantees terminate. Until that time, the holder of any note can enforce
the guarantees as many times as necessary. If we make a payment to any
holder of notes under the guarantees, as a result of Pathnet's
non-compliance with any provision of the indenture, and that payment is
or can be avoided, invalidated, recaptured or set-aside for any reason,
then the guarantees will be reinstated with respect to Pathnet's
compliance with that provision.
- NATURE OF OUR OBLIGATIONS UNDER THE GUARANTEES. Our obligation and
liability under the guarantees is absolute and unconditional. If any
holder of notes makes a claim under the guarantees we will not be
entitled to make any counterclaim, set-off, deduction or raise any
defense based on any claim that we may have against Pathnet or any other
person. We will remain liable even if there is an intervening event,
circumstance or condition that might ordinarily give us a defense,
discharge our liability under the guarantees or limit the extent of any
claim made against us.
- AMENDMENT. We will not be able to amend, modify, waive, discharge or
terminate the guarantees in any way that is adverse to the holders of the
notes without the consent of the holders of all of the notes outstanding
at the time.
- TRANSFERABILITY. The guarantees are intended solely for the benefit of
the holders of the notes. The guarantees will not be transferable
separately from the notes.
- GOVERNING LAW. The guarantees will be governed by the laws of the State
of New York.
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DESCRIPTION OF THE CONSENT SOLICITATION PROCESS
PRINCIPAL TERMS OF THE SOLICITATION
On the terms and subject to the conditions set forth in this prospectus and
in the Consent Letter, Pathnet is soliciting consents in connection with our
reorganization. Pathnet seeks consents from those persons who are holders of
outstanding notes on March 14, 2000 (referred to in this section as the "record
date") to each of the following:
- The waiver of Pathnet's compliance with the Change of Control Offer
obligation (as described above);
- The waiver of Pathnet's compliance with the Excess Proceeds Offer
obligation (as described above); and
- The proposed amendments to the indenture (as described above under the
heading "THE PATHNET SENIOR NOTEHOLDER WAIVERS AND OTHER PROPOSED
INDENTURE AMENDMENTS").
Pathnet will make consent payments to the holders of notes on the record
date (referred to in this section as the "record holders") in the amount of
$25.00 in cash for each $1,000 in principal amount of notes for which a validly
delivered and unrevoked consent has been received by the Depositary on or prior
to 5:00 p.m., New York City time, on March 27, 2000, unless (1) Pathnet extends
the solicitation (referred to in this section as the "expiration date"), or (2)
the solicitation is unsuccessful. If Pathnet extends the solicitation, the term
"expiration date" will mean the latest date and time to which the exchange offer
is extended. In addition, Pathnet agrees to purchase and pledge, for the benefit
of the holders of the notes, additional United States Treasury securities
sufficient to cover the October 16, 2000 interest payment on the notes
conditioned upon Pathnet's receipt of the requisite consents.
CERTAIN CONDITIONS TO THE SOLICITATION
Pathnet will not be required to accept the delivery of consents or make any
consent payments, and we will not be required to deliver the guarantees, if:
- Pathnet and the trustee have not received validly delivered and unrevoked
consents from the holders as at the record date of a majority in
aggregate principal amount of the notes outstanding on that date;
- Any of the conditions to closing our reorganization (as listed under the
heading "DESCRIPTION OF OUR REORGANIZATION -- Conditions to Closing the
Reorganization" above) has not been satisfied;
- The supplemental indenture providing for the proposed amendments has not
been executed by the trustee;
- The trustee objects in any respect to or takes any action that could, in
our judgment, adversely affect the consummation of the solicitation or
Pathnet's or our ability to effect any of the proposed amendments, or
takes any action that challenges the validity or effectiveness of the
procedures used by Pathnet and us in soliciting the consents to the
waivers described above and to the proposed amendments or in the making
of the solicitations or payment for any of the consents; and
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- Any order, statute, rule, regulation, executive order, stay, decree,
judgment or injunction has been proposed, enacted, entered, issued,
promulgated, enforced or deemed applicable by any court or governmental
regulatory or administrative agency or instrumentality that:
- in our judgment might prohibit, prevent, restrict or delay
consummation of the solicitation or any part of our reorganization;
or
- is, or is reasonably likely to be, materially adverse to our
business, operations, properties, condition (financial or
otherwise), assets, liabilities or prospects.
PROCEDURE FOR DELIVERING CONSENTS
DELIVERY OF CONSENTS. To accept your consent in the solicitation, the
depositary must receive it before the expiration date at the address given in
the Consent Letter. Except as otherwise provided below, the delivery will be
deemed made only when actually received or confirmed by the depositary. You
should send your consent only to the depositary, not to Pathnet, Pathnet
Telecom, the trustee, the information agent or the solicitation agent.
Pathnet intends to cause the execution of a supplemental indenture
providing for the proposed amendments immediately prior to our reorganization
if, as of the expiration date, it has obtained the consents of at least a
majority in aggregate principal amount of the holders of outstanding notes to
the proposed amendments. When executed, the supplemental indenture will be
binding upon you as a holder of notes as at the record date, whether or not you
have given a consent with respect to the proposed amendments.
REVOCATION OF CONSENT. All properly completed and executed consents (1)
waiving Pathnet's compliance with the Change of Control Offer obligation, (2)
waiving Pathnet's compliance with the Excess Proceeds Offer obligation, and (3)
consenting to the proposed amendments that are received by the depositary will
be counted as consents with respect to the waiver of the Change of Control Offer
obligation, the waiver of the Excess Proceeds Offer obligation and the proposed
amendments, unless the depositary receives, prior to the consent date, a written
notice of revocation. You may revoke your consent by delivering a written notice
of revocation in accordance with the procedures described in the consent form.
To be effective, a notice of revocation of consent must (1) contain the name of
the person who delivered the consent and the description of the notes to which
it relates, the certificate number or numbers of such notes and the aggregate
principal amount represented by such notes, (2) be signed by the record holder
thereof in the same manner as the original signature on the consent or be
accompanied by evidence, satisfactory to Pathnet, Pathnet Telecom, the trustee
and the depositary that the holder of the notes revoking the consent has
succeeded to the beneficial ownership of the notes, and (3) be received prior to
the expiration date by the depositary at the address given on the front page of
the Consent Letter. A purported notice of revocation that lacks any of the
required information or is dispatched to any other address will not be effective
to revoke a consent previously given.
RECORD HOLDERS ENTITLED TO CONSENT. Only a record holder (or his or her
duly authorized proxy) or a beneficial owner who has complied with the
procedures set out in this section may deliver a consent. If you beneficially
own notes that are registered in the name of a broker, dealer, commercial bank,
trust company or other nominee and you wish to deliver a consent, you should
contact the record holder promptly and instruct the record holder to execute and
deliver the consent on your behalf.
The Consent Letter (available from the solicitation agent and the
information agent identified below) contains additional details concerning
signatures, payment, delivery instructions and tax information necessary to
complete the consent.
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IRREGULARITIES. All questions as to the form of all documents and the
validity (including time of receipt) of deliveries and revocations of consents
will be determined by Pathnet, in its sole discretion, which determination will
be final and binding. Alternative, conditional or contingent consents will not
be considered valid. Pathnet reserves the absolute right to reject any or all
consents that are not in proper form or the acceptance of which would, in
Pathnet's opinion, be unlawful. Pathnet also reserves the right to waive any
defects, irregularities or conditions of delivery as to particular consents.
Pathnet's interpretation of the terms and conditions of the solicitation
(including the instructions in the consent) will be final and binding. Any
defect or irregularity in connection with deliveries of consents must be cured
within such time as Pathnet determines, unless waived by Pathnet. Deliveries of
consents will not be deemed to have been made until all defects and
irregularities have been waived by Pathnet or cured. None of Pathnet, the
trustee, the depositary, the information agent, the solicitation agent or any
other person will be under any duty to give notice of any defects or
irregularities in deliveries of consents, or will incur any liability to record
holders for failure to give any such notice.
WAIVER OF CONDITIONS. Pathnet has expressly reserved the absolute right,
in its sole discretion, to amend or waive any of the conditions to the
solicitation in the case of any consents delivered, in whole or in part, at any
time and from time to time.
SOLICITATION AGENTS
Pathnet has retained Lazard Freres & Co. LLC to act as solicitation agent
in connection with the solicitation. In its capacity as solicitation agent,
Lazard Freres & Co. LLC may contact the holders of outstanding notes regarding
the solicitation and may request brokers, dealers and other nominees to forward
this prospectus and related materials to beneficial owners of notes.
Pathnet has agreed to pay Lazard Freres & Co. LLC a fee for their services
as solicitation agent in connection with the solicitation equal to 0.25 percent
of the principal amount of each note for which consent is given.
DEPOSITARY AND INFORMATION AGENT
The Bank of New York has been appointed depositary for the solicitation.
All deliveries and correspondence sent to the depositary should be directed to
the address set forth on the back cover of the Consent Letter. Requests for
additional copies of the Consent Letter should be directed to MacKenzie
Partners, Inc., as information agent, at the address set forth on the Consent
Letter. Pathnet has agreed to pay the depositary and the information agent
reasonable and customary fees for their services and to reimburse the depositary
and the information agent for their reasonable and out-of-pocket expenses in
connection therewith. These fees, together with the expenses of counsel to the
bondholders, counsel to the solicitation agent and fees of counsel, and
accountants to Pathnet and Pathnet Telecom, are in addition to the consent fee
payable to the holders of the notes consenting to the transaction.
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DESCRIPTION OF THE NOTES AND THE INDENTURE
Terms that are used in this section but not previously defined are defined
under the caption "-- certain definitions" below.
Pathnet issued $350 million in aggregate principal amount of 12 1/4% senior
notes due 2008 under an indenture dated April 8, 1998 between Pathnet and The
Bank of New York, as trustee. The indenture is subject to and governed by the
Trust Indenture Act.
The description below is a summary of the material terms of the current
indenture and the notes. The description does not restate the indenture or the
notes in their entirety and you should refer to the indenture and the notes
(including the definitions of certain terms contained in the indenture and those
terms made a part of the indenture by reference to the Trust Indenture Act as in
effect on the date of the indenture), for additional information about terms of
the indenture and the notes. Please note that this summary excludes certain
terms of the notes and the indenture which have been summarized in Pathnet's
Registration Statement No. 333-53467 filed with the SEC on May 22, 1998. We urge
you to read the indenture and a sample note, which have been filed as an exhibit
to the Registration Statement No. 333-52247, filed with the SEC on May 8, 1998.
For your convenience should you wish to read more detail about any particular
provision of the indenture or the notes, parenthetical section references are
provided in this section that refer to the section or sections of the indenture
summarized.
Upon issuance of the guarantees, the indenture as described below will be
modified by the supplemental indenture. See "THE PATHNET SENIOR NOTEHOLDER
WAIVERS AND OTHER PROPOSED INDENTURE AMENDMENTS -- Proposed Indenture
Amendments" for a description of the modifications.
GENERAL
The notes will mature on April 15, 2008, and are limited to an aggregate
principal amount of $350 million. The notes are issued in fully registered form,
without coupons, in denominations of $1,000 and integral multiples of $1,000.
Payments in respect of the notes are made, and the notes are exchangeable and
transferable, at Pathnet's office or agency in the City of New York maintained
for such purposes. That office or agency is currently the office of The Bank of
New York located at 101 Barclay Street, Floor 7 East, New York, New York 10286.
No service charge is made for any registration of transfer, exchange or
redemption of notes, except in certain circumstances for any tax or other
governmental charge that may be imposed. (Sections 202, 203, 301 and 305)
INTEREST
The notes bear interest at the rate of 12 1/4% per annum, payable in
arrears on April 15 and October 15 of each year to holders of record of the
notes at the close of business on the April 1 or October 1 immediately preceding
such interest payment date. Interest is calculated on the basis of a 360-day
year comprised of twelve 30-day months. If Pathnet defaults on any payment of
principal, whether at Stated Maturity, upon redemption or otherwise, interest
will continue to accrue and, to the extent permitted by law, interest will
accrue on overdue installments of interest at the rate of interest borne by the
notes. (Sections 202, 301, 307 and 310)
RANKING
The notes are general unsecured obligations of Pathnet, except for the
pledge by Pathnet of the Pledged Securities under the pledge agreement. The
indebtedness evidenced by the notes ranks equally in right of payment with all
other existing and future unsubordinated senior obligations of Pathnet and
senior in right of payment to all existing and future obligations of Pathnet
expressly
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subordinated in right of payment to the notes. The notes, however, are
effectively subordinated to secured senior obligations of Pathnet with respect
to the assets of Pathnet securing such obligations, including Telecommunications
Indebtedness, which is or may be secured by substantially all of the assets of
Pathnet.
As of December 31, 1999 Pathnet had approximately $0.3 million in
outstanding Indebtedness other than the notes and approximately $33.3 million of
other liabilities. Subject to certain limitations, Pathnet and its Restricted
Subsidiaries may incur additional Indebtedness in the future, including secured
Indebtedness.
SINKING FUND
The notes are not entitled to the benefit of any sinking fund.
REDEMPTION
Pathnet may not redeem the notes before April 15, 2003, except in the
limited circumstances described in the next paragraph. Beginning April 15, 2003,
the notes are redeemable at the option of Pathnet, in whole or in part, on not
less than 30 nor more than 60 days prior notice. The redemption prices for the
notes are listed below and are expressed as percentages of principal amount, if
redeemed during the 12-month period beginning on April 15 of the years listed
below:
<TABLE>
<CAPTION>
YEAR REDEMPTION PRICE
---- ----------------
<S> <C>
2003........................................................ 106.125%
2004........................................................ 104.083
2005........................................................ 102.042
2006 and thereafter......................................... 100.000
</TABLE>
Accrued and unpaid interest, if any, to the redemption date must also be
paid. (Sections 203, 1101 and 1102)
In addition, at any time on or before April 15, 2001, Pathnet may redeem up
to 35% of the aggregate principal amount of the notes originally issued with the
net cash proceeds of one or more Public Equity Offerings at a redemption price
equal to 112.25% of the principal amount of the notes, plus any accrued and
unpaid interest to the redemption date. Redemption must occur within 60 days of
the closing date of the Public Equity Offering and, immediately after the
redemption, at least 65% of the principal amount of the notes originally issued
must remain outstanding. (Sections 203 and 1102)
If less than all the notes are redeemed at any time, the trustee will
select, not more than 60 days prior to the redemption date, by such method as it
deems fair and appropriate, the particular notes to be redeemed. No partial
redemption will reduce the principal amount of a note not redeemed to less than
$1,000. Notice of redemption will be mailed, first-class postage prepaid, at
least 30 but not more than 60 days before the redemption date to each holder of
notes whose notes are to be redeemed at its registered address. On and after the
date of redemption, interest will cease to accrue on notes or the portions of
the notes that are called for redemption and accepted for payment. (Sections
1104, 1105 and 1107)
SECURITY
At the time of issuance of the notes, Pathnet purchased and pledged to the
trustee, in accordance with the terms of the indenture and the Pledge Agreement,
dated April 8, 1998, certain United States Treasury securities as security for
the benefit of the holders of the notes with respect to the payment of the first
four scheduled interest payments on the notes. In addition, in connection
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with our reorganization, Pathnet has offered to purchase and pledge to the
trustee, in accordance with the terms of the supplemental indenture and of an
amended and restated pledge agreement to be executed and delivered upon
consummation of that transaction, approximately $20.9 million of additional
United States Treasury securities as security for the benefit of the holders of
the notes with respect to the payment of the October 16, 2000 interest payment
on the notes. These securities are held by the trustee in an escrow account.
Immediately before any date on which an interest payment to which any such
securities relate is to be made, Pathnet may either (1) deposit with the
trustee, from funds otherwise available to Pathnet, cash sufficient to pay the
interest scheduled to be paid on such date, or (2) direct the trustee to release
from the escrow account proceeds sufficient to pay such scheduled interest
amount. If Pathnet exercises the former option, it may direct the trustee to
release to Pathnet from the escrow account a sum of money or United States
Treasury securities equal to the amount of the deposit that it makes. Pathnet
has exercised that option in respect of each of the payments that have been made
to date and the value of the securities in the escrow account has been reduced
accordingly. Any failure by Pathnet to pay interest on the notes in a timely
manner on the fourth scheduled interest payment date, namely April 15, 2000, or
the fifth scheduled interest payment date, namely October 16, 2000, will
constitute an immediate event of default under the indenture, with no grace or
cure period.
Interest earned on the pledged securities is added to the escrow account.
In the event that, in the opinion of a nationally recognized firm of independent
public accountants selected by Pathnet, the funds or pledged securities held in
the escrow account exceed the sum necessary to provide for payment in full of
the remaining interest payment the trustee is permitted to release to Pathnet,
at Pathnet's request, any such excess amount.
The notes are secured by a first priority security interest in the pledged
securities and in the escrow account and, accordingly, the pledged securities
and the escrow account also secure repayment of the principal amount of the
notes.
Under the pledge agreement, as amended and restated, after Pathnet has made
the fourth scheduled interest payment and the October 16, 2000 interest payment
following consummation of our reorganization in a timely manner, all of the
remaining pledged securities, if any, will be released from the escrow account
and thereafter the notes will be unsecured.
CERTAIN COVENANTS
The indenture contains, among others, the following covenants:
LIMITATION ON INDEBTEDNESS. In general, Pathnet will not, and will not
permit any of its Restricted Subsidiaries to, incur any Indebtedness including
any Acquired Indebtedness. However, Pathnet and its Restricted Subsidiaries can
incur Permitted Indebtedness, as defined below. In addition, Pathnet can incur
additional Indebtedness if, after giving effect to such Indebtedness, the
Consolidated Indebtedness to Consolidated Operating Cash Flow Ratio would have
been less than or equal to (i) 6.0 to 1.0 but greater than zero, for
Indebtedness incurred on or prior to December 31, 2001, or (ii) 5.0 to 1.0 but
greater than zero, for Indebtedness incurred after that date.
For the purposes of determining compliance with this covenant, if an item
of Indebtedness or any portion of such item meets the criteria of more than one
of the types of Indebtedness that Pathnet and the Restricted Subsidiaries are
permitted to incur, Pathnet will have the right, in its sole discretion, to
classify such item of Indebtedness or any portion of such item at the time of
its incurrence and will only be required to include the amount and type of such
Indebtedness or portion of such Indebtedness under the clause permitting the
Indebtedness classified in that manner. (Section 1011)
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LIMITATION ON RESTRICTED PAYMENTS. (a) In general, Pathnet will not, and
will not permit any of its Restricted Subsidiaries to take, directly or
indirectly, any of the following actions:
(i) declare or pay any dividend on, or make any distribution to
holders of, any shares of the Capital Stock of Pathnet (other than
dividends or distributions payable solely in shares of its Qualified
Capital Stock or in options, warrants or other rights to acquire such
shares of Qualified Capital Stock);
(ii) purchase, redeem or otherwise acquire or retire for value,
directly or indirectly, any shares of Capital Stock of Pathnet or any
Capital Stock of any of its Affiliates (other than Capital Stock of any
Wholly Owned Restricted Subsidiary) or any options, warrants or other
rights to acquire such shares of Capital Stock;
(iii) make any principal payment on, or repurchase, redeem, defease or
otherwise acquire or retire for value, prior to the Stated Maturity of any
principal payment or any sinking fund payment, any Indebtedness of Pathnet
that is expressly subordinated in right of payment to the notes; or
(iv) make any Investment (other than any Permitted Investment) in any
Person.
The payments or other actions described in (but not excluded from) the list
above are collectively referred to as "Restricted Payments." However, Pathnet
and its Restricted Subsidiaries will be able to make Restricted Payments if,
immediately after giving effect to the proposed Restricted Payment:
(1) no Default or Event of Default will have occurred and be
continuing;
(2) Pathnet could incur at least $1.00 of additional Indebtedness
(other than Permitted Indebtedness) pursuant to the "Limitation on
Indebtedness" covenant; and
(3) the aggregate amount of all Restricted Payments declared or made
after the date of the indenture shall not exceed the sum of:
(A) (i) 100% of Consolidated Operating Cash Flow less 1.5 times
Consolidated Interest Expense or (ii) if Consolidated Operating Cash
Flow is a negative, minus 100% of such negative amount, in each case on
a cumulative basis for the period beginning on the first day of
Pathnet's first fiscal quarter after the date of the indenture and
ending on the last day of Pathnet's last fiscal quarter ending prior to
the date of such proposed Restricted Payment; PLUS
(B) the aggregate Net Cash Proceeds and the Fair Market Value of
Telecommunications Assets or Voting Stock of a Person that becomes a
Restricted Subsidiary, the assets of which consist primarily of
Telecommunications Assets, received by Pathnet after the Issue Date as
capital contributions or from the issuance or sale (other than to any
Subsidiary) of shares of Qualified Capital Stock of Pathnet (including
upon the exercise of options, warrants or rights) or warrants, options
or rights to purchase shares of Qualified Capital Stock of Pathnet; PLUS
(C) the aggregate Net Cash Proceeds and the Fair Market Value of
Telecommunications Assets or Voting Stock of a Person that becomes a
Restricted Subsidiary, the assets of which consist primarily of
Telecommunications Assets, received by Pathnet after the Issue Date from
the issuance or sale (other than to any Subsidiary) of debt securities
or Redeemable Capital Stock that have been converted into or exchanged
for Qualified Capital Stock of Pathnet, together with the aggregate Net
Cash Proceeds and the Fair Market Value of Telecommunications Assets or
Voting Stock of a Person that becomes a Restricted
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Subsidiary, the assets of which consist primarily of Telecommunications
Assets, received by Pathnet at the time of such conversion or exchange;
PLUS
(D) to the extent not otherwise included in Consolidated Operating
Cash Flow, an amount equal to the sum of (i) the net reduction in
Investments (other than Permitted Investments) in any Person (other than
a Restricted Subsidiary) resulting from the payment in cash of
dividends, repayments of loans or advances or other transfers of assets,
in each case to Pathnet or any Restricted Subsidiary after the Issue
Date from such Person and (ii) the amount of any net reduction in
Investments resulting from the redesignation of an Unrestricted
Subsidiary as a Restricted Subsidiary (valued as provided in the
definition of "Investment") at the time of such redesignation; provided
that, in the case of (i) or (ii) above, the foregoing sum will not
exceed the total amount of Investments (other than Permitted
Investments) previously made in such Person or Unrestricted Subsidiary
by Pathnet and its Restricted Subsidiaries.
The amount of any such Restricted Payment, if other than cash, shall be
determined by the Board of Directors of Pathnet, whose determination will be
conclusive and evidenced by a Board Resolution.
(b) Notwithstanding paragraph (a) above, Pathnet and any Restricted
Subsidiary may take the following actions so long as with respect to clauses
(ii) through (vi) below no Default or Event of Default shall have occurred and
be continuing:
(i) the payment of any dividend within 60 days after the date of
declaration of such dividend, if at such date of declaration the payment of
such dividend would have complied with the provisions of paragraph (a)
above and such payment will be deemed to have been paid on such date of
declaration for purposes of the calculation required by paragraph (a)
above;
(ii) the purchase, redemption or other acquisition or retirement for
value of any shares of Capital Stock of Pathnet (x) in exchange for, or out
of the Net Cash Proceeds of a substantially concurrent issuance and sale
(other than to a Subsidiary) of, shares of Qualified Capital Stock of
Pathnet; (y) that are held by former officers, employees or directors (or
their estates or beneficiaries under their estates) of Pathnet or any of
its Subsidiaries; provided that the aggregate amount of such purchase,
redemption or other acquisition or retirement for value under this clause
(y) will not exceed $250,000 in any given fiscal year; or (z) pursuant to
the employment agreement dated August 4, 1997, between Pathnet and Richard
Jalkut, as amended and as in effect on the Issue Date (and any extensions
or renewals thereof); provided that the amount of such purchase, redemption
or other acquisition or retirement for value under this clause (z) will not
exceed $1.0 million in any given fiscal year;
(iii) the purchase, redemption, defeasance or other acquisition or
retirement for value of any Indebtedness of Pathnet that is expressly
subordinated in right of payment to the notes in exchange for, or out of
the Net Cash Proceeds of a substantially concurrent issuance and sale
(other than to a Subsidiary) of, shares of Qualified Capital Stock of
Pathnet;
(iv) the purchase of any Indebtedness of Pathnet that is expressly
subordinated in right of payment to the notes at a purchase price not
greater than 101% of the principal amount thereof in the event of a Change
of Control in accordance with provisions similar to the "Purchase of Notes
upon a Change of Control" covenant; provided that prior to such purchase
Pathnet has made the Change of Control Offer as provided in such covenant
with respect to the notes and has purchased all notes validly tendered for
payment in connection with such Change of Control Offer;
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(v) the purchase, redemption, defeasance or other acquisition or
retirement for value of Indebtedness (other than Redeemable Capital Stock)
of Pathnet that is expressly subordinated in right of payment to the notes
in exchange for, or out of the Net Cash Proceeds of a substantially
concurrent incurrence (other than to a Subsidiary) of, new Indebtedness of
Pathnet that is expressly subordinated in right of payment to the notes, so
long as (A) the principal amount of such new Indebtedness does not exceed
the principal amount (or, if such Indebtedness being refinanced provides
for an amount less than the principal amount thereof to be due and payable
upon a declaration of acceleration thereof, such lesser amount as of the
date of determination) of the Indebtedness being so purchased, redeemed,
defeased, acquired or retired, plus the lesser of (x) the amount of any
premium required to be paid in connection with such refinancing pursuant to
the terms of the Indebtedness being refinanced or (y) the amount of any
premium reasonably determined by Pathnet as necessary to accomplish such
refinancing, PLUS, in either case, the amount of expenses of Pathnet
incurred in connection with such refinancing; (B) such new Indebtedness is
subordinated to the notes to the same extent as such Indebtedness so
purchased, redeemed, defeased, acquired or retired; and (C) such new
Indebtedness has an Average Life longer than the Average Life of the
Indebtedness being refinanced and a final Stated Maturity of principal
later than the final Stated Maturity of the Indebtedness being refinanced;
and
(vi) the payment of cash in lieu of fractional shares of common stock
pursuant to the warrant agreement.
The actions described in items (i) through (iv) and (vi) above will be
Restricted Payments that will be permitted in accordance with this paragraph (b)
but will reduce the amount that would otherwise be available for Restricted
Payments under clause (3) of paragraph (a) above. The actions described in item
(v) above will be Restricted Payments that will be permitted in accordance with
this paragraph (b) and will not reduce the amount that would otherwise be
available for Restricted Payments under clause (3) of paragraph (a). (Section
1012)
LIMITATION ON ISSUANCE AND SALES OF CAPITAL STOCK OF RESTRICTED
SUBSIDIARIES. In general, Pathnet will not, and will not permit any Restricted
Subsidiary to, issue or sell any Capital Stock of a Restricted Subsidiary (other
than to Pathnet or to a Restricted Subsidiary). However, this covenant will not
prohibit:
(i) issuances or sales of Capital Stock of a Restricted Subsidiary if,
immediately after giving effect to such issuance or sale, such Restricted
Subsidiary would no longer be 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 under the "Limitation on Restricted
Payments" covenant if made on the date of such issuance and sale;
(ii) the ownership by directors of director's qualifying shares or the
ownership by foreign nationals of Capital Stock of any Restricted
Subsidiary, to the extent mandated by applicable law;
(iii) the issuance and sale of Capital Stock of any Restricted
Subsidiary owned by Pathnet and the Restricted Subsidiaries in compliance
with the "Limitation on Sale of Assets" covenant; provided that such
Restricted Subsidiary would remain a Restricted Subsidiary after such
transaction; or
(iv) the issuance and sale of Capital Stock of any Restricted
Subsidiary to any Person that transfers, leases, licenses or grants a right
to use Telecommunications Assets to Pathnet pursuant to an Incumbent
Agreement; provided that, after such issuance and sale, such subsidiary
remains a Restricted Subsidiary and, in the good faith determination of the
board of directors of Pathnet, the Fair Market Value of any such transfer,
lease, license or grant is not less than the Fair
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Market Value of the Capital Stock of such Restricted Subsidiary issued and
sold in respect thereof. (Section 1013)
LIMITATION ON TRANSACTIONS WITH AFFILIATES. Pathnet will not, and will not
permit any Restricted Subsidiary to, enter into or suffer to exist, directly or
indirectly, any transaction or series of related transactions (including,
without limitation, the sale, purchase, exchange or lease of assets, property or
services) with, or for the benefit of, any Affiliate of Pathnet or any
Restricted Subsidiary (other than Pathnet or a Restricted Subsidiary so long as
no Affiliate of Pathnet (other than a Restricted Subsidiary) shall beneficially
own Capital Stock in such Restricted Subsidiary) unless:
(i) such transaction or series of related transactions are on terms,
taken as a whole, that are no less favorable to Pathnet or such Restricted
Subsidiary, as the case may be, than those that could have been obtained in
an arms' length transaction with unrelated third parties that are not
Affiliates;
(ii) with respect to any transaction or series of related transactions
involving aggregate consideration equal to or greater than $5 million,
Pathnet will deliver an officers' certificate to the Trustee certifying
that such transaction or series of related transactions complies with
clause (i) above; and
(iii) with respect to any transaction or series of related
transactions involving aggregate consideration in excess of $10 million,
Pathnet will deliver the officers' certificate described in clause (ii)
above which will also certify that such transaction or series of related
transactions has been approved by a majority of the Disinterested Directors
of the board of directors of Pathnet or that Pathnet has obtained a written
opinion from a nationally recognized investment banking or public
accounting firm or, if Pathnet believes that an investment banking or
public accounting firm is generally not qualified to give such an opinion,
by a nationally recognized appraisal firm (an "independent financial
expert") certifying that the financial terms of such transaction or series
of related transactions, taken as a whole, are fair to Pathnet or such
Restricted Subsidiary, as the case may be, from a financial point of view;
provided, however, that this covenant will not restrict (1) any transaction
or series of related transactions among Pathnet and one or more of its
Restricted Subsidiaries or among its Restricted Subsidiaries, (2) Pathnet
from paying reasonable and customary regular compensation and fees to
directors of Pathnet or any Restricted Subsidiary who are not employees of
Pathnet or any Restricted Subsidiary, (3) the performance of Pathnet's
obligations under the Investment and Stockholders' Agreement, dated as of
October 31, 1997, among Pathnet, David Schaeffer and the Investors named
therein, as amended; the Investment and Stockholders' Agreement, dated as
of August 28, 1995, by and among Pathnet and the Investors named therein;
the Investment and Stockholders' Agreement, dated as of December 23, 1996,
by and among Pathnet and the Investors named therein; the Non-Qualified
Stock Option Agreement, dated August 4, 1997, between Pathnet and Richard
Jalkut; and the Employment Agreement, dated August 4, 1997, between Pathnet
and Richard Jalkut, in each case as amended through the Issue Date;
provided that any amendments or modifications to the terms of transactions
described in this clause (3) will be (x) no less favorable to Pathnet than
those that could have been obtained in an arm's length transaction with
unrelated third parties who are not Affiliates and (y) approved by the
board of directors of Pathnet (including a majority of the Disinterested
Directors), (4) the making of any Restricted Payment not prohibited by the
"Limitations on Restricted Payments" covenant and (5) loans or advances
made to directors, officers or employees of Pathnet or any Restricted
Subsidiary, or guarantees in respect thereof or otherwise made on their
behalf, in respect of expenses incurred in the ordinary course of business,
in an aggregate principal amount not to exceed $500,000 in any calendar
year. (Section 1014)
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Under Delaware law, the Disinterested Directors' fiduciary obligations
require that they act in good faith and in a manner which they reasonably
believe to be in the best interests of Pathnet and its stockholders, which may
not necessarily be the same as the interests of holders of the notes.
LIMITATION ON LIENS. Pathnet will not, and will not permit any Restricted
Subsidiary to, directly or indirectly, create, incur, assume or suffer to exist
any Lien (other than Permitted Liens) on or with respect to any of its property
or assets (including, without limitation, any shares of Capital Stock or
Indebtedness of any Restricted Subsidiary) whether owned at the Issue Date or
thereafter acquired, or any income, profits or proceeds therefrom, or assign or
otherwise convey any right to receive income thereon, unless (x) in the case of
any Lien securing Indebtedness of Pathnet that is expressly subordinated in
right of payment to the notes, the notes are secured by a Lien on such property,
assets or proceeds that is senior in priority to such Lien and (y) in the case
of any other Lien, the notes are secured by a Lien on such property, assets or
proceeds that is senior in priority to, or equally and ratably secured with, the
obligation or liability secured by such Lien. (Section 1015)
LIMITATION ON ISSUANCE OF CERTAIN GUARANTEES BY, AND DEBT SECURITIES OF,
RESTRICTED SUBSIDIARIES. Pathnet will not permit any Restricted Subsidiary to:
(i) directly or indirectly guarantee, assume or in any other manner
become liable with respect to any Debt Securities ("Guaranteed
Indebtedness"); or
(ii) issue any Debt Securities, unless, in either such case, such
Restricted Subsidiary simultaneously executes and delivers a supplemental
indenture providing for the guarantee (a "Subsidiary Guarantee") of payment
of the notes. If the Guaranteed Indebtedness (A) ranks equally in right of
payment with the notes, then the guarantee of such Guaranteed Indebtedness
will rank equally in right of payment with, or be subordinated in right of
payment to, the Subsidiary Guarantee or (B) is subordinated in right of
payment to the notes, then the guarantee of such Guaranteed Indebtedness
will be subordinated in right of payment to the Subsidiary Guarantee at
least to the extent that the Guaranteed Indebtedness is subordinated in
right of payment to the notes. The obligations of each Restricted
Subsidiary under a Subsidiary Guarantee will be limited to the maximum
amount, and will, after giving effect to all other contingent and fixed
liabilities of such Restricted Subsidiary, result in the obligations of
such Restricted Subsidiary under the Subsidiary Guarantee not constituting
a fraudulent conveyance or fraudulent transfer under applicable law.
Notwithstanding the foregoing, any Subsidiary Guarantee by a Restricted
Subsidiary of the notes will provide by its terms that it shall be automatically
and unconditionally released and discharged upon:
(i) the sale or other disposition, by way of merger or otherwise, to
any Person not an Affiliate of Pathnet, of all of Pathnet's and its
Restricted Subsidiaries' Capital Stock in such Restricted Subsidiary;
(ii) the merger or consolidation of the applicable Restricted
Subsidiary with and into Pathnet or another Restricted Subsidiary that has
guaranteed the notes and that is the surviving Person in such merger or
consolidation; and
(iii) the release by all of the holders of Debt Securities of Pathnet
of such Restricted Subsidiary's obligations under all of its Guarantees in
respect thereof and the release by all of the holders of Debt Securities of
such Restricted Subsidiary of its obligations thereunder. (Section 1016)
PURCHASE OF NOTES UPON A CHANGE OF CONTROL. If a Change of Control occurs
at any time, then each holder of notes will have the right to require that
Pathnet purchase all of such holder's notes, in whole or in part in integral
multiples of $1,000, at a purchase price (the "Change of Control
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Purchase Price") in cash in an amount equal to 101% of the principal amount
thereof, plus accrued and unpaid interest and liquidated damages, if any,
thereon to the date of purchase (the "Change of Control Purchase Date") pursuant
to the procedures described below (the "Change of Control Offer") and the other
procedures set forth in the indenture.
Within 15 days following any Change of Control, Pathnet will notify the
trustee thereof and give written notice of such Change of Control to each holder
of notes by first-class mail, postage prepaid, at the address of such holder
appearing in the security register, stating, among other things:
(i) the purchase price and the purchase date, which shall be a
business day no earlier than 30 days nor later than 60 days from the date
such notice is mailed, or such later date as is necessary to comply with
requirements under the Exchange Act or any applicable securities laws or
regulations;
(ii) that any note not tendered will continue to accrue interest;
(iii) that, unless Pathnet defaults in the payment of the purchase
price, any notes accepted for payment pursuant to the Change of Control
Offer will cease to accrue interest and Liquidated Damages, if any, after
the Change of Control Purchase Date; and
(iv) certain other procedures that a holder of notes must follow to
accept a Change of Control Offer or to withdraw such acceptance. (Section
1010)
If a Change of Control Offer were made, we cannot assure you that Pathnet
would have available funds sufficient to pay the Change of Control Purchase
Price for all of the notes that might be delivered by holders thereof seeking to
accept the Change of Control Offer. The failure of Pathnet to make or consummate
the Change of Control Offer would result in an Event of Default and would give
the trustee and the holders of the notes the rights described under "Events of
Default."
One of the events that constitutes a Change of Control under the indenture
is the disposition of "all or substantially all" of Pathnet's assets. This term
has not been interpreted under New York law (which is the governing law of the
indenture) to represent a specific quantitative test. As a consequence, if
holders of the notes elect to require Pathnet to purchase the notes and Pathnet
elects to contest such election, there can be no assurance as to how a court
interpreting New York law would interpret the phrase.
The existence of a holder's right to require Pathnet to purchase such
holder's notes upon a Change of Control may deter a third party from acquiring
Pathnet in a transaction that constitutes a Change of Control.
The definition of "Change of Control" in the indenture is limited in scope.
The provisions of the indenture may not afford holders of notes the right to
require Pathnet to purchase such notes in the event of a highly leveraged
transaction or certain transactions with Pathnet's management or its Affiliates,
including a reorganization, restructuring, merger or similar transaction
involving Pathnet (including, in certain circumstances, an acquisition of
Pathnet by management or its Affiliates) that may adversely affect holders of
the notes, if such transaction is not a transaction defined as a Change of
Control. See "Certain Definitions" for the definition of "Change of Control." A
transaction involving Pathnet's management or its Affiliates, or a transaction
involving a recapitalization of Pathnet, would result in a Change of Control if
it is the type of transaction specified by such definition.
Pathnet will comply with the applicable tender offer rules, including Rule
l4e-l under the Exchange Act, and any other applicable securities laws and
regulations in connection with a Change of Control Offer.
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LIMITATION ON SALE OF ASSETS. (a) Pathnet will not, and will not permit
any Restricted Subsidiary to, directly or indirectly, engage in any Asset Sale
unless (i) the consideration received by Pathnet or such Restricted Subsidiary
for such Asset Sale is not less than the Fair Market Value of the shares or
other assets sold (as determined by the board of directors of Pathnet, whose
determination shall be conclusive and evidenced by a resolution thereof) and
(ii) the consideration received by Pathnet or the relevant Restricted Subsidiary
in respect of such Asset Sale consists of at least 75% cash or Cash Equivalents;
provided, however, that for purposes of this covenant, "Cash Equivalents" shall
include (i) the amount of any liabilities (other than liabilities that are by
their terms subordinated to the notes) of Pathnet or such Restricted Subsidiary
(as shown on Pathnet's or such Restricted Subsidiary's most recent balance sheet
or in the notes thereto) that are assumed by the transferee of any such assets
or other property in such Asset Sale or are no longer a liability of Pathnet or
any Restricted Subsidiary (and excluding any liabilities that are incurred in
connection with or in anticipation of such Asset Sale), but only to the extent
that such assumption is effected on a basis under which there is no further
recourse to Pathnet or any of its Restricted Subsidiaries with respect to such
liabilities and (ii) any securities, notes or other obligations received by
Pathnet or any such Restricted Subsidiary in connection with such Asset Sale
that are converted by Pathnet or such Restricted Subsidiary into cash within 60
days of receipt.
(b) If Pathnet or any Restricted Subsidiary engages in an Asset Sale,
Pathnet may use the Net Cash Proceeds thereof, within 12 months after such Asset
Sale, to (i) permanently repay or prepay the notes or any then outstanding
Indebtedness of Pathnet that ranks equally with the notes or Indebtedness of any
Restricted Subsidiary or permanently reduce (without making any prepayment) the
amount that is at the time available to be borrowed under the notes or any
Indebtedness of Pathnet ranking equally with the notes or any Indebtedness of a
Restricted Subsidiary or (ii) invest (or enter into a legally binding agreement
to invest) in properties and assets to replace the properties and assets that
were the subject of the Asset Sale or in properties and assets that are or will
be used in the Telecommunications Business of Pathnet or a Restricted
Subsidiary, as the case may be. If any such legally binding agreement to invest
such Net Cash Proceeds is terminated, then Pathnet may, within 60 days of such
termination or within 12 months of such Asset Sale, whichever is later, apply or
invest such Net Cash Proceeds as provided in clause (i) or (ii) (without regard
to the parenthetical contained in such clause (ii)) above. The amount of such
Net Cash Proceeds not so used as set forth above in this paragraph (b)
constitutes "Excess Proceeds."
(c) When the aggregate amount of Excess Proceeds exceeds $10 million,
Pathnet will, within 15 business days, make an offer to purchase (an "Excess
Proceeds Offer"), on a proportional basis, the notes and Indebtedness described
in the second succeeding sentence, in accordance with the procedures set forth
below, the maximum principal amount of notes (expressed as a multiple of $1,000)
and such other Indebtedness that may be purchased with the Excess Proceeds. Any
Excess Proceeds Offer shall include a pro rata offer under similar circumstances
to purchase all other Indebtedness of Pathnet ranking equally with the notes
which Indebtedness contains similar provisions requiring Pathnet to purchase
such Indebtedness. The offer price as to each note (the "Excess Proceeds Offer
Price") will be payable in cash in an amount equal to 100% of the principal
amount of such note, plus accrued and unpaid interest, if any, thereon to the
date of purchase. To the extent that the aggregate principal amount of notes
validly tendered and not withdrawn by holders thereof pursuant to an Excess
Proceeds Offer is less than the Excess Proceeds, Pathnet may use such deficiency
for general corporate purposes. If the aggregate principal amount of notes
validly tendered and not withdrawn by holders thereof pursuant to an Excess
Proceeds Offer exceeds the Excess Proceeds, notes to be purchased will be
selected on a proportional basis. Upon completion of such Exceeds Proceeds
Offer, the amount of Excess Proceeds shall be reset to zero. (Section 1017)
If an Excess Proceeds Offer were made, there can be no assurance that
Pathnet would have available funds sufficient to pay an Excess Proceeds Offer
Price for all of the notes that might be
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delivered by holders of the notes seeking to accept an Excess Proceeds Offer.
The failure of Pathnet to make or consummate the Excess Proceeds Offer would
result in an Event of Default and would give the trustee and the holders of the
notes the rights described under "Events of Default."
LIMITATION ON DIVIDEND AND OTHER PAYMENT RESTRICTIONS AFFECTING RESTRICTED
SUBSIDIARIES. Pathnet will not, and will not permit any Restricted Subsidiary
to, directly or indirectly, create or otherwise cause or suffer to exist or
become effective any encumbrance or restriction of any kind on the ability of
any Restricted Subsidiary to:
(a) pay dividends, in cash or otherwise, or make any other
distributions on or in respect of any Capital Stock of such Restricted
Subsidiary owned by Pathnet or any other Restricted Subsidiary;
(b) pay any Indebtedness owed to Pathnet or any other Restricted
Subsidiary;
(c) make Investments in Pathnet or any other Restricted Subsidiary;
(d) transfer any of its property or assets to Pathnet or any other
Restricted Subsidiary; or
(e) guarantee any Indebtedness of Pathnet or any other Restricted
Subsidiary, except for such encumbrances or restrictions existing under or
by reason of (i) any agreement in effect on the Issue Date, (ii) applicable
law, (iii) customary non-assignment provisions in leases entered into in
the ordinary course of business and other agreements of Pathnet or any
Restricted Subsidiary, (iv) any agreement or other instrument of a Person
acquired by Pathnet or any Restricted Subsidiary in existence at the time
of such acquisition (but not created in contemplation thereof), which
encumbrance or restriction is not applicable to any Person, or the
properties or assets of any Person, other than the Person, or the property
or assets of the Person, so acquired, (v) customary restrictions on
transfers of property contained in any security agreement (including a
capital lease obligation) securing Indebtedness of Pathnet or a Restricted
Subsidiary otherwise permitted under the indenture, (vi) any encumbrance or
restriction with respect to a Restricted Subsidiary of Pathnet entered into
for the sale or disposition of all or substantially all of the Capital
Stock or assets of such Restricted Subsidiary permitted under the
"Limitation on Sale of Assets" covenant, (vii) any agreement or instrument
governing or relating to Indebtedness under any senior financing facility
permitted to be incurred under clause (g), (j) or (m) of the definition of
"Permitted Indebtedness" if such encumbrance or restriction applies only
(A) to amounts which at any point in time (other than during such periods
as are described in the following clause (B)) (1) exceed scheduled amounts
due and payable (or which are to become due and payable within 30 days) in
respect of the notes or the indenture for interest, premium and principal
less the amount of cash that is otherwise available to Pathnet at such time
for the payment of interest, premium and principal due and payable in
respect of the notes or the indenture or (2) if paid, would result in an
event described in the following clause (B) of this sentence, or (B) during
the pendency of any event that causes, permits or, after notice or lapse of
time, would cause or permit the holder or holders of such Indebtedness to
declare such Indebtedness to be immediately due and payable or to require
cash collateralization or cash cover for such Indebtedness for so long as
such cash collateralization or cash cover has not been provided; (viii) any
encumbrance or restriction under the Vendor Credit Facility; (ix) any
encumbrance or restriction relating to transfer of property or assets
comprising an Initial System pursuant to an Incumbent Agreement, and (x)
any encumbrance or restriction under any agreement that extends, renews,
refinances or replaces agreements containing the encumbrances or
restrictions in the foregoing clauses (i) through (vi) and (viii), so long
as the board of directors of Pathnet determines in good faith that the
terms and conditions of any such encumbrances or restrictions, taken as a
whole, are no less favorable to Pathnet, any Restricted
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Subsidiary and the holders of the notes than those so extended, renewed,
refinanced or replaced. (Section 1018)
PROVISION OF FINANCIAL STATEMENTS AND REPORTS. (a) Pathnet will file on a
timely basis with the SEC, to the extent such filings are accepted by the SEC
and whether or not Pathnet has a class of securities registered under the
Exchange Act, the annual reports, quarterly reports and other documents that
Pathnet would be required to file if it were subject to Section 13 or 15 of the
Exchange Act.
(b) Pathnet will also be required (i) to file with the trustee, and provide
to each holder of notes, without cost to such holder, copies of such reports and
documents within 15 days after the date on which Pathnet files such reports and
documents with the SEC or the date on which Pathnet would be required to file
such reports and documents if Pathnet were so required, and (ii) if filing such
reports and documents with the SEC is not accepted by the SEC or is prohibited
under the Exchange Act, to supply at Pathnet's cost copies of such reports and
documents to any prospective holder promptly upon request. (Section 1009)
CONSOLIDATION, MERGER AND SALE OF ASSETS. Pathnet will not, in a single
transaction or a series of transactions, consolidate with or merge with or into
any other Person or sell, assign, convey, transfer, lease or otherwise dispose
of all or substantially all of its properties and assets to any other Person or
Persons, and Pathnet will not permit any Restricted Subsidiary to enter into any
such transaction or series of transactions if such transaction or series of
transactions, in the aggregate, would result in the sale, assignment,
conveyance, transfer, lease or other disposition of all or substantially all of
the properties and assets of Pathnet and its Restricted Subsidiaries on a
consolidated basis to any other Person or Persons, unless at the time and
immediately after giving effect thereto:
(i) either (a) Pathnet will be the continuing corporation or (b) the
Person (if other than Pathnet) formed by such consolidation or into which
Pathnet or such Restricted Subsidiary is merged or the Person that acquires
by sale, assignment, conveyance, transfer, lease or disposition all or
substantially all the properties and assets of Pathnet and its Restricted
Subsidiaries on a consolidated basis, as the case may be (the "Surviving
Entity"), (1) will be a corporation organized and validly existing under
the laws of the United States of America, any state thereof or the District
of Columbia and (2) will expressly assume, by a supplemental indenture to
the indenture in form satisfactory to the trustee, Pathnet's obligations
pursuant to the notes for the due and punctual payment of the principal of,
premium, if any, and interest on all the notes and the performance and
observance of every covenant of the indenture on the part of Pathnet to be
performed or observed;
(ii) immediately before and immediately after giving effect to such
transaction or series of transactions on a pro forma basis (and treating
any obligation of Pathnet or any Restricted Subsidiary incurred in
connection with or as a result of such transaction or series of
transactions as having been incurred at the time of such transaction), no
Default or Event of Default will have occurred and be continuing;
(iii) immediately after giving effect to such transaction or series of
transactions on a pro forma basis (on the assumption that the transaction
or series of transactions occurred on the first day of the two fiscal
quarter period ending immediately prior to the consummation of such
transaction or series of transactions, with the appropriate adjustments
with respect to the transaction or series of transactions being included in
such pro forma calculation), Pathnet (or the surviving entity if Pathnet is
not the continuing obligor under the indenture) could incur at least $1.00
of additional Indebtedness (other than Permitted Indebtedness) under the
provisions of the "Limitation on Indebtedness" covenant; and
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(iv) Pathnet or the Surviving Entity shall have delivered to the
trustee, in form and substance reasonably satisfactory to the trustee, an
officers' certificate (attaching the computations to demonstrate compliance
with clause (iii) above) and an opinion of counsel, each stating that such
consolidation, merger, sale, assignment, conveyance, transfer, lease or
other disposition, and if a supplemental indenture is required in
connection with such transaction, such supplemental indenture, comply with
the requirements of the indenture and that all conditions precedent therein
provided for relating to such transaction have been complied with. (Section
801)
Upon any consolidation or merger, or any sale, assignment, conveyance,
transfer, lease or disposition of all or substantially all of the properties and
assets of Pathnet in accordance with the immediately preceding paragraphs in
which Pathnet is not the continuing obligor under the indenture, the Surviving
Entity shall succeed to, and be substituted for, and may exercise every right
and power of, Pathnet under the indenture with the same effect as if such
successor had been named as Pathnet therein. When a successor assumes all the
obligations of its predecessor under the indenture, the predecessor shall be
released from those obligations; provided that, in the case of a transfer by
lease, the predecessor shall not be released from the payment of principal of,
premium, if any, and interest on the notes. (Section 802)
EVENTS OF DEFAULT
The following are "Events of Default" under the indenture:
(i) default in the payment of interest or Liquidated Damages, if any,
on any note when it becomes due and payable, and continuance of such
default for a period of 30 days or more (provided that such 30-day grace
period shall not be applicable to the first four interest payments due on
the notes);
(ii) default in the payment of principal of or premium, if any, on any
note at its Maturity (upon acceleration, optional redemption, required
purchase or otherwise);
(iii) (A) default in the performance, or breach, of any covenant or
agreement of Pathnet contained in the indenture (other than a default in
the performance, or breach, of a covenant or agreement which is
specifically dealt with in the immediately preceding clause (i) or (ii) or
in clause (B), (C) or (D) of this clause (iii)) and continuance of such
default or breach for a period of 30 days after written notice shall have
been given to Pathnet by the trustee or to Pathnet and the trustee by the
holders of at least 25% in aggregate principal amount of the notes then
outstanding; (B) default in the performance or breach of the provisions of
the "Limitation on Sale of Assets" covenant; (C) default in the performance
or breach of the provisions of the "Consolidation, Merger and Sale of
Assets" covenant; and (D) default in the performance or breach of the
provisions of the "Purchase of Notes upon a Change of Control" covenant;
(iv) (A) one or more defaults in the payment of principal of or
premium, if any, or interest on Indebtedness of Pathnet or any Significant
Subsidiary aggregating $7.5 million or more, when the same becomes due and
payable at the Stated Maturity thereof, and such default or defaults shall
have continued after any applicable grace period and shall not have been
cured or waived or (B) Indebtedness of Pathnet or any Significant
Subsidiary aggregating $7.5 million or more shall have been accelerated or
otherwise declared due and payable, or required to be prepaid or
repurchased (other than by regularly scheduled required prepayment), prior
to the Stated Maturity thereof);
(v) one or more final judgments, orders or decrees of any court or
regulatory agency shall be rendered against Pathnet or any Significant
Subsidiary or their respective properties for the payment of money, either
individually or in an aggregate amount, in excess of $7.5 million and
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either (A) an enforcement proceeding shall have been commenced by any
creditor upon such judgment or order or (B) there shall have been a period
of 30 days during which a stay of enforcement of such judgment or order, by
reason of a pending appeal or otherwise, was not in effect;
(vi) the occurrence of certain events of bankruptcy, insolvency or
reorganization with respect to Pathnet or any Significant Subsidiary; or
(vii) if the Pledge Agreement ceases to be in full force and effect
before payment in full of the obligations thereunder. (Section 501)
If an Event of Default (other than an Event of Default arising from an
event of bankruptcy, insolvency or reorganization as specified in clause (vi)
above) occurs and is continuing, the trustee or the holders of not less than 25%
in aggregate principal amount of the notes then outstanding, by written notice
to Pathnet (and to the trustee if such notice is given by the holders), may, and
the trustee upon the written request of such holders shall, declare the
principal of, premium, if any, and accrued and unpaid interest and Liquidated
Damages, if any, on all outstanding notes immediately due and payable, and upon
any such declaration all such amounts payable in respect of the notes shall
become immediately due and payable. If an Event of Default arising from an event
of bankruptcy, insolvency or reorganization as specified in clause (vi) or (vii)
above occurs and is continuing, then the principal of, premium, if any, and
accrued and unpaid interest and Liquidated Damages, if any, on all of the
outstanding notes will ipso facto become immediately due and payable without any
declaration or other act on the part of the trustee or any holder of notes.
(Section 502)
At any time after a declaration of acceleration under the indenture, but
before a judgment or decree for payment of the money due has been obtained by
the trustee, the holders of a majority in aggregate principal amount of the
outstanding notes, by written notice to Pathnet and the trustee, may rescind or
annul such declaration and its consequences if (a) Pathnet has paid or deposited
with the trustee a sum sufficient to pay (i) all overdue interest and Liquidated
Damages, if any, on all outstanding notes, (ii) all unpaid principal of and
premium, if any, on any outstanding notes that have become due otherwise than by
such declaration of acceleration, together with interest on such unpaid
principal at the rate borne by the notes, (iii) to the extent that payment of
such interest is lawful, interest upon overdue interest and Liquidated Damages,
if any, and overdue principal at the rate borne by the notes, (iv) all sums paid
or advanced by the trustee under the indenture and the reasonable compensation,
expenses, disbursements and advances of the trustee, its agents and counsel; and
(b) all Events of Default, other than the non-payment of amounts of principal
of, premium, if any, or interest and Liquidated Damages, if any, on the notes
that have become due solely by such declaration of acceleration, have been cured
or waived. No such rescission shall affect any subsequent default or impair any
right consequent thereon. (Section 502)
The holders of not less than a majority in aggregate principal amount of
the outstanding notes may, on behalf of the holders of all the notes, waive any
past defaults under the indenture, except a default in the payment of the
principal of, premium, if any, or interest and Liquidated Damages, if any, on
any note, or in respect of a covenant or provision which under the indenture
cannot be modified or amended without the consent of the holder of each note
outstanding. (Section 513)
If a Default or an Event of Default occurs and is continuing and is known
to the trustee, the trustee will mail to each holder of the notes notice of the
Default or Event of Default within five days after the earlier of receipt from
Pathnet of notice of the occurrence thereof or the date when such Default or
Event of Default becomes known to the trustee. Except in the case of a Default
or an Event of Default in the payment of the principal of, premium, if any, or
interest on any notes, the trustee may withhold the notice to the holders of
such notes if a committee of its trust officers in good faith determines that
withholding such notice is in the interests of the holders of the notes.
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Pathnet is required to furnish to the trustee annual and quarterly
statements as to the performance by Pathnet of its obligations under the
indenture and as to any default in such performance. Pathnet is also required to
notify the trustee within five days of the occurrence of any Default or Event of
Default.
DEFEASANCE OR COVENANT DEFEASANCE OF INDENTURE
Pathnet may, at its option and at any time, terminate its obligations with
respect to the outstanding notes ("defeasance"). This means that Pathnet will be
deemed to have paid and discharged the entire Indebtedness represented by the
outstanding notes and to have satisfied all its other obligations under such
Notes, except for:
(i) the rights of holders of outstanding notes to receive payments in
respect of the principal of, premium, if any, and interest and Liquidated
Damages, if any, on the notes when such payments are due;
(ii) Pathnet's obligations to issue temporary notes, register the
transfer or exchange of any such notes, replace mutilated, destroyed, lost
or stolen notes, maintain an office or agency for payments in respect of
the notes and segregate and hold such payments in trust;
(iii) the rights, powers, trusts, duties and immunities of the
trustee; and
(iv) the defeasance provisions of the indenture.
In addition, Pathnet may, at its option and at any time, terminate its
obligations with respect to certain covenants set forth in the indenture, and
any omission to comply with such obligations will not constitute a Default or an
Event of Default with respect to the notes ("covenant defeasance"). (Sections
1301, 1302 and 1303)
In order to exercise either option:
(i) Pathnet must irrevocably deposit or cause to be deposited with the
trustee, in trust, specifically pledged as security for, and dedicated
solely to, the benefit of the holders of the notes, cash in United States
dollars, Government Securities, or a combination or both, that, in the
opinion of a nationally recognized firm of independent public accountants,
will be sufficient to pay and discharge the principal of, premium, if any,
and interest on the outstanding notes on the Stated Maturity (or upon
redemption, if applicable) of such principal, premium, if any, or
installment of interest and Liquidated Damages, if any;
(ii) no Default or Event of Default with respect to the notes can have
occurred and be continuing on the date of such deposit or, insofar as an
event of bankruptcy under clause (vi) of "Events of Default" above is
concerned, at any time during the period ending on the 123rd day after the
date of such deposit;
(iii) Pathnet's termination of its obligations must not result in a
breach or violation of, or constitute a default under any material
agreement or instrument (other than the indenture) to which Pathnet is a
party or by which it is bound;
(iv) in the case of termination of its obligations with respect to the
outstanding notes, Pathnet must have delivered to the trustee an opinion of
counsel stating that Pathnet has received from, or there has been published
by, the IRS a ruling, or since the date of this prospectus there has been a
change in applicable federal income tax law, in either case to the effect
that, and based thereon such opinion shall confirm that, the holders of the
outstanding notes will not recognize income, gain or loss for U.S. federal
income tax purposes as a result of Pathnet's termination of its obligations
under the notes and will be subject to United States
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federal income tax on the same amounts, in the same manner and at the same
times as would have been the case if such termination had not occurred;
(v) in the case of termination of its obligations under certain
covenants, Pathnet must have delivered to the trustee an opinion of counsel
to the effect that the holders of the notes outstanding will not recognize
income, gain or loss for United States federal income tax purposes as a
result of the termination of its obligations under such covenants and will
be subject to United States federal income tax on the same amounts, in the
same manner and at the same times as would have been the case if such
termination had not occurred; and
(vi) Pathnet must deliver to the trustee an officers' certificate and
an opinion of counsel, each stating that all conditions precedent provided
for relating to either the termination of its obligations under the notes,
or the termination of its obligations with respect to certain covenants, as
the case may be, have been complied with. (Section 1304)
SATISFACTION AND DISCHARGE
The indenture will cease to be of further effect (except as to surviving
rights of registration of transfer or exchange of the notes as expressly
provided for in the indenture), and the trustee, at the expense of Pathnet, will
execute proper instruments acknowledging satisfaction and discharge of the
indenture when:
(i) either (A) all the notes that have previously been authenticated
and delivered (other than destroyed, lost or stolen notes which have been
replaced or paid and notes for whose payment money has previously been
deposited in trust or segregated and held in trust by Pathnet, or
discharged) to the trustee for cancellation or (B) all notes not previously
delivered to the trustee for cancellation that (x) have become due and
payable, (y) will become due and payable at their Stated Maturity within
one year or (z) are to be called for redemption within one year under
arrangements satisfactory to the trustee for the giving of notice of
redemption by the trustee in the name, and at the expense, of Pathnet, and
Pathnet has irrevocably deposited or caused to be deposited with the
trustee as trust funds in trust for such purpose an amount sufficient to
pay and discharge the entire Indebtedness on the notes not previously
delivered to the trustee for cancellation, for the principal of, premium
and Liquidated Damages, if any, and interest on the notes to the date of
such deposit (in the case of notes which have become due and payable) or to
the Stated Maturity or date of redemption, as the case may be;
(ii) Pathnet has paid or caused to be paid all sums payable by it
under the indenture; and
(iii) Pathnet has delivered to the trustee an officers' certificate
and an opinion of counsel, each stating that all conditions precedent
provided in the indenture relating to the satisfaction and discharge of the
indenture have been complied with. (Section 401)
MODIFICATION AND WAIVER
The indenture may be modified or amended by a supplemental indenture
entered into by Pathnet and the trustee with the consent of the holders of a
majority in aggregate outstanding principal amount of the notes; provided, that
no modification or amendment can do any of the following, without the consent of
the holder of each outstanding note affected by such modification or amendment:
(i) change the Stated Maturity of the principal of, or any installment
of interest on, any note, or reduce the principal amount of any note or
premium, if any, or the rate of interest on such note, alter any redemption
provision with respect to any note or change the coin or currency in which
the principal of any note or any premium or the interest thereon is
payable, or impair
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the right to institute suit for the enforcement of any such payment after
the Stated Maturity of any notes (or, in the case of redemption, on or
after the date of redemption);
(ii) amend, change or modify Pathnet's obligation to make and
consummate an Excess Proceeds Offer with respect to any Asset Sale in
accordance with the "Limitation on Sale of Assets" covenant or Pathnet's
obligation to make and consummate a Change of Control Offer in the event of
a Change of Control in accordance with the "Purchase of Notes Upon a Change
of Control" covenant, including, in each case, amending, changing or
modifying any definition relating to such obligations;
(iii) reduce the percentage of the principal amount of outstanding
notes the consent of whose holders is required for any such supplemental
indenture or the consent of whose holders is required for any waiver of
compliance with certain provisions and defaults of the indenture and their
consequences provided for in the indenture;
(iv) modify any of the provisions relating to supplemental indentures
requiring the consent of holders or relating to the waiver of past defaults
or relating to the waiver of certain covenants, except to increase the
percentage of the aggregate principal amount of outstanding notes required
for such actions or to provide that certain other provisions of the
indenture cannot be modified or waived without the consent of the holder of
each notes affected thereby;
(v) except as otherwise permitted under "Consolidation, Merger and
Sale of Assets," consent to the assignment or transfer by Pathnet of any of
their rights or obligations under the indenture; or
(vi) release any Lien created by the pledge agreement, except in
accordance with the terms of the pledge agreement. (Sections 901 and 902)
Notwithstanding the foregoing, without the consent of any holder of
the notes, Pathnet and the trustee may modify or amend the indenture:
(a) to evidence the succession of another Person to Pathnet or any
other obligor on the notes, and the assumption by any such successor of
the covenants of Pathnet or such obligor in the indenture and in the
notes in accordance with "Consolidation, Merger and Sale of Assets;"
(b) to add to the covenants of Pathnet or any other obligor upon
the notes for the benefit of the holders of the notes or to surrender
any right or power conferred upon Pathnet or any other obligor upon the
notes, as applicable, in the indenture or in the notes;
(c) to cure any ambiguity, or to correct or supplement any
provision in the indenture or in the notes that may be defective or
inconsistent with any other provision in the indenture or in the notes,
or make any other provisions with respect to matters or questions
arising under the indenture or the notes; provided that, in each case,
such action will not adversely affect the interests of the holders of
the notes;
(d) to comply with the requirements of the SEC in order to effect
or maintain the qualification, if any, of the indenture under the Trust
Indenture Act;
(e) to evidence and provide the acceptance of the appointment of a
successor trustee under the indenture;
(f) to mortgage, pledge, hypothecate or grant a security interest
in favor of the trustee for the benefit of the holders of the notes as
additional security for the payment and performance of Pathnet's
obligations under the indenture, in any property or assets, including
any of which are required to be mortgaged, pledged or hypothecated, or
in which
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a security interest is required to be granted to the trustee pursuant to
the Indenture or otherwise; or
(g) to add a guarantor of the notes under the indenture. (Section
901)
The holders of a majority in aggregate principal amount of the notes
outstanding may waive compliance with certain restrictive covenants and
provisions of the indenture. (Section 1019)
GOVERNING LAW
The indenture, the notes and the pledge agreement are governed by, and
construed in accordance with, the laws of the State of New York.
THE TRUSTEE
The indenture provides that, except during the continuance of an Event of
Default, the trustee will perform only the duties that are specifically set
forth in the Indenture. If an Event of Default has occurred and is continuing,
the trustee will exercise such rights and powers vested in it under the
indenture and use the same degree of care and skill in its exercise as a prudent
person would exercise under the circumstances in the conduct of their own
affairs.
The indenture and provisions of the Trust Indenture Act, which are
incorporated into the indenture by reference, contain limitations on the rights
of the trustee, should it become a creditor of Pathnet, to obtain payment of
claims in certain cases or to realize on certain property received by it in
respect of any such claims, as security or otherwise. The trustee is permitted
to engage in other transactions; provided, however, that if it acquires any
conflicting interest (as defined) it must eliminate such conflict or resign.
(Sections 601 and 603)
CERTAIN DEFINITIONS
"Accounts Receivable Subsidiary" means any Restricted Subsidiary that is,
directly or indirectly, wholly owned by Pathnet (other than directors'
qualifying shares) and organized for the purpose of and engaged in (i)
purchasing, financing and collecting accounts receivable obligations of
customers of Pathnet or its Restricted Subsidiaries, (ii) the sale or financing
of accounts receivable or interests therein and (iii) other activities directly
related thereto.
"Acquired Indebtedness" means Indebtedness of a Person (a) existing at the
time such Person becomes a Restricted Subsidiary or (b) assumed in connection
with an acquisition of assets from such Person, in each case, other than
Indebtedness incurred in connection with, or in contemplation of, such Person
becoming a Restricted Subsidiary or such acquisition.
"Affiliate" means, with respect to any specified Person, (i) any other
Person directly or indirectly controlling or controlled by, or under direct or
indirect common control with, such specified Person or (ii) any other Person
that owns, directly or indirectly, 10% or more of such specified Person's Voting
Stock or any executive officer or director of any such specified Person or other
Person or, with respect to any natural Person, any other Person in such Person's
immediate family. For the purposes of this definition, "control," when used with
respect to any specified 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. Notwithstanding the
foregoing, no individual shall be deemed to be an Affiliate of a Person solely
by reason of (a) such Person being party to an Incumbent Agreement or (b) such
Person owning an interest in a Restricted Subsidiary pursuant to, or as the
result of, an Incumbent Agreement.
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"Asset Sale" means any sale, issuance, conveyance, transfer, lease or other
disposition (including, without limitation, by way of merger, consolidation or
sale and leaseback transaction) (collectively, a "transfer"), directly or
indirectly, in one or a series of related transactions, of (i) any Capital Stock
of any Subsidiary; (ii) all or substantially all of the properties and assets of
Pathnet or any Subsidiary; or (iii) any other properties or assets of Pathnet or
any Subsidiary, other than in the ordinary course of business (it being
understood that the ordinary course of business includes, but is not restricted
to, any transfer or sale of, or the grant of a right to use, an asset to an
Incumbent pursuant to (x) an Incumbent Agreement, (y) applicable law or (z) an
agreement to which such Incumbent is a party which exists on the date of, and is
not entered into in contemplation of, such Incumbent Agreement). For the
purposes of this definition, the term "Asset Sale" shall not include any
transfer of properties or assets (A) that is governed by the provisions of the
indenture described under "Consolidation, Merger and Sale of Assets," (B) of
Pathnet to any Restricted Subsidiary, or of any Restricted Subsidiary to Pathnet
or any other Restricted Subsidiary in accordance with the terms of the
Indenture, (C) having an aggregate Fair Market Value of less than $2 million in
any given fiscal year, (D) by Pathnet or a Restricted Subsidiary to a Person who
is not an Affiliate of Pathnet in exchange for Telecommunications Assets (or not
less than 66 2/3% of the outstanding Voting Stock of a Person that becomes a
Restricted Subsidiary, the assets of which consist primarily of
Telecommunications Assets) or related telecommunications services where, in the
good faith judgment of the board of directors of Pathnet evidenced by a board
resolution, the Fair Market Value of such Telecommunications Assets (or such
Voting Stock) or services so received is at least equal to the Fair Market Value
of the properties or assets disposed of or, if less, the difference is received
by Pathnet in cash in an amount at least equal to such difference, (E)
constituting Capital Stock of an Unrestricted Subsidiary or other Investment
that was permitted under the "Limitation on Restricted Payments" covenant when
made, (F) constituting accounts receivable of Pathnet or a Restricted Subsidiary
to an Accounts Receivable Subsidiary or in consideration of Fair Market Value
thereof, to Persons that are not Affiliates of Pathnet or any Subsidiary of
Pathnet in the ordinary course of business, including in connection with
financing transactions, (G) in connection with a Sale-Leaseback Transaction
otherwise permitted to be incurred under the "Limitation on Indebtedness"
covenant, (H) to a Permitted Telecommunications Joint Venture if such transfer
of properties or assets is permitted under the definition of "Permitted
Investments," (I) in connection with a Permitted Telecommunications Asset Sale
or (J) to an Unrestricted Subsidiary if permitted under the "Limitation on
Restricted Payments" covenant.
"Average Life" means, as of the date of determination with respect to any
Indebtedness, the quotient obtained by dividing (a) the sum of the products of
(i) the number of years from the date of determination to the date or dates of
each successive scheduled principal payment (including, without limitation, any
sinking fund requirements) of such Indebtedness multiplied by (ii) the amount of
each such principal payment by (b) the sum of all such principal payments.
"Capital Stock" means, with respect to any Person, any and all shares,
interests, partnership interests, participations, rights in or other equivalents
(however designated and whether voting or non-voting) in equity of such Person,
including, without limitation, all common stock or Preferred Stock, and any
rights (other than debt securities convertible into capital stock), warrants or
options exchangeable for or convertible into such capital stock, whether now
outstanding or issued after the Issue Date.
"Capitalized Lease Obligation" means, with respect to any Person, any
obligation of such Person under a lease of (or other agreement conveying the
right to use) any property (whether real, personal or mixed) that is required to
be classified and accounted for as a capital lease obligation under GAAP, and,
for the purposes of the indenture, the amount of such obligation at any date
shall be the capitalized amount thereof at such date, determined in accordance
with GAAP.
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"Cash Equivalents" means (a) any evidence of Indebtedness with a maturity
of 180 days or less issued or directly and fully guaranteed or insured by the
United States of America or any agency or instrumentality thereof (provided that
the full faith and credit of the United States of America is pledged in support
thereof); (b) certificates of deposit or acceptances with a maturity of 180 days
or less of any financial institution that is a member of the Federal Reserve
System, in each case having combined capital and surplus and undivided profits
of not less than $500 million; (c) commercial paper with a maturity of 180 days
or less issued by a corporation that is not an Affiliate of Pathnet and is
organized under the laws of any state of the United States or the District of
Columbia and rated at least A-1 by S&P or at least P-l by Moody's; and (d) money
market mutual funds that invest substantially all of their assets in securities
of the type described in the preceding clauses.
"Change of Control" means any of the following events:
(a) any "person" or "group" (as such terms are used in Sections 13(d)
and 14(d) of the Exchange Act), other than Permitted Holders, is or becomes
the "beneficial owner" (as defined in Rules 13d-3 and l3d-5 under the
Exchange Act, except that a Person shall be deemed to have "beneficial
ownership" of all securities that 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 50% of the total outstanding
Voting Stock of Pathnet;
(b) Pathnet consolidates with, or merges with or into, another Person
or conveys, transfers, leases or otherwise disposes of all or substantially
all of its assets to any Person, or any Person consolidates with, or merges
with or into, Pathnet, in any such event pursuant to a transaction in which
the outstanding Voting Stock of Pathnet is converted into or exchanged for
cash, securities or other property, other than any such transaction
(i) where the outstanding Voting Stock of Pathnet is not converted
or exchanged at all (except to the extent necessary to reflect a change
in the jurisdiction of incorporation of Pathnet) or is converted into or
exchanged for (A) Voting Stock (other than Redeemable Capital Stock) of
the surviving or transferee corporation or (B) cash, securities and
other property (other than Capital Stock of the Surviving Entity) in an
amount that could be paid by Pathnet as a Restricted Payment as
described under the "Limitation on Restricted Payments" covenant; and
(ii) immediately after such transaction, no "person" or "group" (as
such terms are used in Sections 13(d) and 14(d) of the Exchange Act),
other than Permitted Holders, is the "beneficial owner" (as defined in
Rules 13d-3 and 13d-5 under the Exchange Act, except that a Person shall
be deemed to have "beneficial ownership" of all securities that 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 50% of the total outstanding Voting Stock of the surviving
or transferee corporation;
(c) during any consecutive two-year period, individuals who at the
beginning of such period constituted the board of directors of Pathnet
(together with any new directors whose election to such board of directors,
or whose nomination for election by the stockholders of Pathnet, was
approved by a vote of 66 2/3% of the directors then still in office who
were either directors at the beginning of such period or whose election or
nomination for election was previously so approved) cease for any reason to
constitute a majority of the board of directors of Pathnet then in office;
or
(d) Pathnet is liquidated or dissolved or adopts a plan of liquidation
or dissolution other than in a transaction which complies with the
provisions described under "Consolidation, Merger and Sale of Assets."
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"Consolidated Adjusted Net Income" means, for any period, the consolidated
net income (or loss) of Pathnet and all Restricted Subsidiaries for such period
as determined in accordance with GAAP, adjusted by excluding, without
duplication,
(a) any net after-tax extraordinary gains or losses (less all fees and
expenses relating thereto),
(b) any net after-tax gains or losses (less all fees and expenses
relating thereto) attributable to asset dispositions other than in the
ordinary course of business,
(c) the portion of net income (or loss) of any Person (other than
Pathnet or a Restricted Subsidiary), including Unrestricted Subsidiaries,
in which Pathnet or any Restricted Subsidiary has an ownership interest,
except to the extent of the amount of dividends or other distributions
actually paid to Pathnet or any Restricted Subsidiary in cash dividends or
distributions during such period,
(d) the net income (or loss) of any Person combined with Pathnet or
any Restricted Subsidiary on a "pooling of interests" basis attributable to
any period prior to the date of combination,
(e) the net income of any Restricted Subsidiary to the extent that the
declaration or payment of dividends or similar distributions by such
Restricted Subsidiary is not at the date of determination permitted,
directly or indirectly, by operation of the terms of its charter or any
agreement, instrument, judgment, decree, order, statute, rule or
governmental regulation applicable to such Restricted Subsidiary or its
stockholders (except, for purposes of determining compliance with the
"Limitation on Indebtedness" covenant, any restriction permitted under
clause (vii) or (viii) of "Limitations on Dividend and other Payment
Restrictions Affecting Restricted Subsidiaries"), and
(f) any net income (or loss) from any Restricted Subsidiary that was
an Unrestricted Subsidiary at any time during such period other than any
amounts actually received from such Restricted Subsidiary.
"Consolidated Indebtedness" means, with respect to any period, the
aggregate amount of Indebtedness of Pathnet and its Restricted Subsidiaries
outstanding at the date of determination as determined on a consolidated basis
in accordance with GAAP.
"Consolidated Indebtedness to Consolidated Operating Cash Flow Ratio"
means, at any date of determination, the ratio of (i) Consolidated Indebtedness
to (ii) Consolidated Operating Cash Flow for the two preceding fiscal quarters
for which financial information is available immediately prior to the date of
determination multiplied by two; provided that any Indebtedness incurred or
retired by Pathnet or any of its Restricted Subsidiaries during the fiscal
quarter in which the transaction date occurs shall be calculated as if such
Indebtedness were so incurred or retired on the first day of the fiscal quarter
in which the date of determination occurs (provided that, in making any such
computation, the aggregate amount of Indebtedness under any revolving credit or
similar facility will be deemed to include an amount of funds equal to the
average daily balance of such Indebtedness during such two fiscal quarter
period); and provided further that (x) if the transaction giving rise to the
need to calculate the Consolidated Indebtedness to Consolidated Operating Cash
Flow Ratio would have the effect of increasing or decreasing Consolidated
Indebtedness or Consolidated Operating Cash Flow in the future, Consolidated
Indebtedness and Consolidated Operating Cash Flow shall be calculated on a pro
forma basis as if such transaction had occurred on the first day of such two
fiscal quarter period preceding the date of determination; (y) if during such
two fiscal quarter period, Pathnet or any of its Restricted Subsidiaries shall
have engaged in any Asset Sale in respect of any company, entity or business,
Consolidated Operating Cash Flow for such period shall
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be reduced by an amount equal to the Consolidated Operating Cash Flow (if
positive), or increased by an amount equal to the Consolidated Operating Cash
Flow (if negative), directly attributable to Pathnet, entity or business that is
the subject of such Asset Sale and any related retirement of Indebtedness as if
such Asset Sale and any related retirement of Indebtedness had occurred on the
first day of such period; or (z) if during such two fiscal quarter period
Pathnet or any of its Restricted Subsidiaries shall have acquired any company,
entity or business, Consolidated Operating Cash Flow shall be calculated on a
pro forma basis as if such acquisition and related financing had occurred on the
first day of such period.
"Consolidated Interest Expense" means, for any period, without duplication,
the sum of (a) the interest expense of Pathnet and its Restricted Subsidiaries
for such period, including, without limitation, (i) amortization of debt
discount, (ii) the net cost of Interest Rate Agreements (including amortization
of discounts), (iii) the interest portion of any deferred payment obligation,
(iv) accrued interest, (v) the consolidated amount of any interest capitalized
by Pathnet and (vi) amortization of debt issuance costs, plus (b) the interest
component of Capitalized Lease Obligations of Pathnet and its Restricted
Subsidiaries paid, accrued and/or scheduled to be paid or accrued during such
period; excluding, however, any amount of such interest of any Restricted
Subsidiary if the net income of such Restricted Subsidiary is excluded in the
calculation of Consolidated Adjusted Net Income pursuant to clause (e) of the
definition thereof (but only in the same proportion as the net income of such
Restricted Subsidiary is excluded from the calculation of Consolidated Adjusted
Net Income pursuant to clause (e) of the definition thereof); provided that in
making such computation, (x) the Consolidated Interest Expense attributable to
interest on any Indebtedness computed on a pro forma basis and (A) bearing a
floating interest rate shall be computed as if the rate in effect on the date of
computation had been the applicable rate for the entire period and (B) which was
not outstanding during the period for which the computation is being made but
which bears, at the option of Pathnet, a fixed or floating rate of interest,
shall be computed by applying, at the option of Pathnet, either the fixed or
floating rate, (y) the Consolidated Interest Expense attributable to interest on
any Indebtedness under a revolving credit facility computed on a pro forma basis
shall be computed based upon the average daily balance of such Indebtedness
during the applicable period and (z) the interest rate with respect to any
Indebtedness covered by an Interest Rate Agreement shall be deemed to be the
effective interest rate with respect to such Indebtedness after taking into
account such Interest Rate Agreement.
"Consolidated Operating Cash Flow" means, with respect to any period, the
Consolidated Adjusted Net Income for such period (a) increased by (to the extent
deducted in computing Consolidated Adjusted Net Income) the sum of (i) the
Consolidated Tax Expense for such period (other than taxes attributable to
extraordinary, unusual or non-recurring gains or losses); (ii) Consolidated
Interest Expense for such period; (iii) depreciation of Pathnet and the
Restricted Subsidiaries for such period, determined on a consolidated basis in
accordance with GAAP; (iv) amortization of Pathnet and its Restricted
Subsidiaries for such period, determined on a consolidated basis in accordance
with GAAP; and (v) any other non-cash charges that were deducted in computing
Consolidated Adjusted Net Income (excluding any non-cash charge which requires
an accrual or reserve for cash charges for any future period) of Pathnet and its
Restricted Subsidiaries for such period in accordance with GAAP and (b)
decreased by any non-cash gains that were included in computing Consolidated
Adjusted Net Income.
"Consolidated Tax Expense" means, for any period, the provision for U.S.
federal, state, provincial, local and foreign income taxes of Pathnet and all
Restricted Subsidiaries for such period as determined on a consolidated basis in
accordance with GAAP.
"Credit Facilities" means, with respect to Pathnet or its Restricted
Subsidiaries, one or more debt facilities or commercial paper facilities with
banks or other institutional lenders providing for
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revolving credit loans, term loans, receivables financing (including through the
sale of receivables to such lenders or to special purpose entities formed to
borrow from such lenders against such receivables) or letters of credit, in each
case, as amended, restated, modified, renewed, refunded, replaced or refinanced
in whole or in part from time to time.
"Currency Agreement" means any spot or forward foreign exchange agreements
and currency swap, currency option or other similar financial agreements or
arrangements entered into by Pathnet or any of its Restricted Subsidiaries.
"Debt Securities" means any debt securities (including any Guarantee of
such securities) issued by Pathnet and/or any Restricted Subsidiary in
connection with a public offering (whether or not underwritten) or a private
placement (provided that such private placement is underwritten for resale
pursuant to Rule 144A, Regulation S or otherwise under the Securities Act or
sold on an agency basis by a broker-dealer or one of its Affiliates to 10 or
more non-affiliated beneficial holders); it being understood that the term "Debt
Securities" shall not include any evidence of indebtedness under the Vendor
Credit Facility, any financing by a Restricted Subsidiary similar to the Vendor
Credit Facility or any Credit Facility or other commercial bank borrowings, any
vendor equipment financing facility or any similar financings, recourse
transfers of financial assets, capital leases or other types of borrowings
incurred in a manner not customarily viewed as a "securities offering."
"Default" means any event which is, or after notice or passage of time or
both would be, an Event of Default.
"Disinterested Director" means, with respect to any transaction or series
of transactions in respect of which the board of directors of Pathnet is
required to deliver a resolution thereof under the indenture, a member of the
board of directors of Pathnet who does not have any material direct or indirect
financial interest in or with respect to such transaction or series of
transactions. For purposes of this definition, no Person shall be deemed not to
be a Disinterested Director solely because such Person or an Affiliate of such
Person holds or beneficially owns Capital Stock of Pathnet or any of its
Restricted Subsidiaries.
"Escrow Account" means an account established with the trustee in its name
as trustee pursuant to the terms of the Pledge Agreement for the deposit of the
Pledged Securities purchased by Pathnet as described herein.
"Event of Default" has the meaning set forth under "Events of Defaults"
herein.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Fair Market Value" means, with respect to any asset or property, the sale
value that would be obtained in an arm's length transaction between an informed
and willing seller under no compulsion to sell and an informed and willing buyer
under no compulsion to buy. Unless otherwise specified in the indenture, Fair
Market Value shall be determined by the board of directors of Pathnet acting in
good faith and as of the date on which such determination is made.
"GAAP" means generally accepted accounting principles in the United States
that are in effect on the date of the indenture.
"Government Securities" means direct obligations of, or obligations
guaranteed by, the United States of America for the payment of which obligations
or guarantees the full faith and credit of the United States of America is
pledged which, in any case, are not callable or redeemable at the option of the
issuer of the issuer thereof.
"Guarantee" or "guarantee" means, as applied to any obligation, (a) a
guarantee (other than by endorsement of negotiable instruments for collection in
the ordinary course of business), direct or indirect, in any manner, of any part
or all of such obligation and (b) an agreement, direct or indirect,
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contingent or otherwise, the practical effect of which is to assure in any way
the payment or performance (or payment of damages in the event of
non-performance) of all or any part of such obligation, including, without
limiting the foregoing, the payment of amounts drawn down by letters of credit.
When used as a verb, "Guarantee" or "guarantee" shall have a corresponding
meaning.
"Incumbent" means any railroad, utility, governmental entity, pipeline or
other licensed owner (which ownership is determined immediately prior to any
transaction with Pathnet or a Restricted Subsidiary) of Telecommunications
Assets to be used in Pathnet's network pursuant to an Incumbent Agreement (and
any subsidiary or affiliate of such Person that is a party to an Incumbent
Agreement for the sole purpose of receiving payments from Pathnet or a
Restricted Subsidiary pursuant to such agreement).
"Incumbent Agreement" means an agreement between an Incumbent and Pathnet
or a Restricted Subsidiary pursuant to which, among other things, such Incumbent
receives a payment equal to a percentage of Pathnet's or such Restricted
Subsidiary's revenues, if any, attributable, in whole or in part, to
Telecommunications Assets transferred or leased, or with respect to which a
right of use has been granted, by such Incumbent to Pathnet or such Restricted
Subsidiary and upon or with respect to which Pathnet or such Restricted
Subsidiary has constructed or intends to construct a portion of its network.
"Incur" or "incur" means, with respect to any Indebtedness, to incur,
create, issue, assume, guarantee or otherwise become directly or indirectly
liable or responsible for the payment of, or otherwise incur, such Indebtedness,
contingently or otherwise; provided that neither the accrual of interest nor the
accretion of original issue discount shall be considered an incurrence of
Indebtedness. With respect to Indebtedness to be borrowed under a binding
commitment previously entered into that provides for Pathnet to Incur
Indebtedness on a revolving basis, Pathnet shall be deemed to have Incurred the
greater of (a) the Indebtedness actually Incurred or (b) all or a portion of the
amount of such unborrowed commitment that Pathnet shall have so designated to be
Incurred in an officer's certificate delivered to the trustee (in which case
Pathnet shall not be deemed to incur such unborrowed amount at the time or times
it is actually borrowed).
"Indebtedness" means, with respect to any Person at any date of
determination, without duplication:
(a) all liabilities, contingent or otherwise, of such Person: (i) for
borrowed money (including overdrafts), (ii) in connection with any letters
of credit and acceptances issued under letter of credit facilities,
acceptance facilities or other similar facilities (including reimbursement
obligations with respect thereto), (iii) evidenced by bonds, notes,
debentures or other similar instruments, (iv) for the deferred and unpaid
purchase price of property or services or created or arising under any
conditional sale or other title retention agreement with respect to
property acquired by such Person or (v) for Capitalized Lease Obligations
(including any Sale-Leaseback Transaction);
(b) all obligations of such Person under or in respect of Interest
Rate Agreements and Currency Agreements;
(c) all Indebtedness referred to in (but not excluded from) the
preceding clauses of other Persons and all dividends of other Persons, the
payment of which is secured by (or for which the holder of such
Indebtedness has an existing right, contingent or otherwise, to be secured
by) any Lien upon or with respect to any property (including, without
limitation, accounts and contract rights) owned by such Person, whether or
not such Person has assumed or become liable for the payment of such
Indebtedness (the amount of such obligation being deemed to be the lesser
of (i) the Fair Market Value of such property or asset and (ii) the amount
of such obligation so secured);
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(d) all guarantees by such Person of Indebtedness referred to in this
definition of any other Person; and
(e) all Redeemable Stock of such Person valued at the greater of its
voluntary or involuntary maximum fixed repurchase price, plus accrued and
unpaid dividends.
The amount of Indebtedness of any Person at any date will be the
outstanding balance at such date (or, in the case of a revolving credit or other
similar facility, the total amount of funds outstanding and/or designated as
incurred and certified by an officer of Pathnet to have been Incurred on such
date pursuant to clause (b) of the last sentence of the definition of "Incur")
of all unconditional obligations as described above and, with respect to
contingent obligations, the maximum liability upon the occurrence of the
contingency giving rise to the obligation; provided (i) that the amount
outstanding at any time of any Indebtedness issued with original issue discount
equals the face amount of such Indebtedness less the remaining unamortized
portion of the original issue discount of such Indebtedness at such time as
determined in conformity with GAAP and (ii) that Indebtedness shall not include
any liability for U.S. federal, state, local or other taxes owed by such Person.
For purposes hereof, the "maximum fixed repurchase price" of any Redeemable
Capital Stock which does not have a fixed repurchase price shall be calculated
in accordance with the terms of such Redeemable Capital Stock as if such
Redeemable Capital Stock were purchased on any date on which Indebtedness shall
be required to be determined pursuant to the Indenture, and if such price is
based upon, or measured by, the Fair Market Value of such Redeemable Capital
Stock, such Fair Market Value will be determined in good faith by the board of
directors of the issuer of such Redeemable Capital Stock. Notwithstanding the
foregoing, trade accounts and accrued liabilities arising in the ordinary course
of business will not be considered Indebtedness for purposes of this definition.
"Initial System" means all property, rights and assets necessary to own and
operate an Incumbent's base microwave network system and shall include, without
limitation, the initial microwave radio and protect microwave radio, software,
antennae, waveguide, multiplexors, towers, shelters, licenses (including Federal
Communications Commission and Federal Aviation Administration licenses),
permits, leases, rights-of-way, easements and other related assets. An Initial
System shall not include any additional microwave radios and related equipment
installed as part of an expansion of an Initial System.
"Interest Rate Agreement" means any interest rate protection agreements and
other types of interest rate hedging agreements or arrangements (including,
without limitation, interest rate swaps, caps, floors, collars and other similar
agreements).
"Invested Capital" means the sum of (a) 75% of the aggregate net cash
proceeds received by Pathnet from the issuance of (or capital contributions with
respect to) any Qualified Capital Stock subsequent to the Issue Date, other than
the issuance of Qualified Capital Stock to a Restricted Subsidiary of Pathnet,
and (b) 75% of the aggregate net cash proceeds from sales of Redeemable Capital
Stock of Pathnet or Indebtedness of Pathnet convertible into Qualified Capital
Stock of Pathnet, in each case upon such redemption or conversion thereof into
Qualified Capital Stock.
"Investment" means, with respect to any Person, any direct or indirect
advance, loan or other extension of credit 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, acquisition or
ownership by such Person of any Capital Stock, bonds, notes, debentures or other
securities or evidences of Indebtedness issued or owned by, any other Person and
all other items that would be classified as investments on a balance sheet
prepared in accordance with GAAP. In addition, the portion (proportionate to
Pathnet's equity interest in such Subsidiary) of the Fair Market Value of the
net assets of any Subsidiary at the time that such Subsidiary is designated an
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Unrestricted Subsidiary shall be deemed to be an Investment made by Pathnet in
such Unrestricted Subsidiary at such time and the portion (proportionate to
Pathnet's equity interest in such Subsidiary) of the Fair Market Value of the
net assets of any Subsidiary at the time that such Subsidiary is designated a
Restricted Subsidiary shall be considered a reduction in outstanding
Investments. "Investments" shall exclude extensions of trade credit on
commercially reasonable terms in accordance with normal trade practices.
"Issue Date" means the date of the Indenture.
"Lien" means any mortgage, charge, pledge, lien (statutory or otherwise),
privilege, security interest, hypothecation, assignment for security, claim, or
preference or priority or other encumbrance upon or with respect to any property
of any kind, real or personal, movable or immovable, now owned or hereafter
acquired. A Person shall be deemed to own subject to a Lien any property which
such Person has acquired or holds subject to the interest of a vendor or lessor
under any conditional sale agreement, capital lease or other title retention
agreement.
"Maturity" means, with respect to any note, the date on which any principal
of such note becomes due and payable as provided therein or in the indenture,
whether at the Stated Maturity with respect to such principal or by declaration
of acceleration, call for redemption or purchase or otherwise.
"Moody's" means Moody's Investors Service, Inc. and its successors.
"Net Cash Proceeds" means: (a) with respect to any Asset Sale, the proceeds
thereof in the form of cash or Cash Equivalents, including payments in respect
of deferred payment obligations when received in the form of, or stock or other
assets when disposed of for, cash or Cash Equivalents (except to the extent that
such obligations are financed or sold with recourse to Pathnet or any Restricted
Subsidiary), net of (i) brokerage commissions and other fees and expenses
(including fees and expenses of legal counsel and investment banks) related to
such Asset Sale, (ii) provisions for all taxes payable as a result of such Asset
Sale, (iii) payments made to retire Indebtedness where payment of such
Indebtedness is secured by the assets or properties which are the subject of
such Asset Sale, (iv) amounts required to be paid to any Person (other than
Pathnet or any Restricted Subsidiary) owning a beneficial interest in the assets
subject to the Asset Sale and (v) appropriate amounts to be provided by Pathnet
or any Restricted Subsidiary, as the case may be, as a reserve required in
accordance with GAAP against any liabilities associated with such Asset Sale and
retained by Pathnet or any Restricted Subsidiary, as the case may be, after such
Asset Sale, including, without limitation, pension and other post-employment
benefit liabilities, liabilities related to environmental matters and
liabilities under any indemnification obligations associated with such Asset
Sale, all as reflected in an officers' certificate delivered to the trustee; and
(b) with respect to any issuance or sale of Capital Stock or options, warrants
or rights to purchase Capital Stock, or debt securities or Redeemable Capital
Stock that has been converted into or exchanged for Qualified Capital Stock, as
referred to under the "Limitation on Restricted Payments" covenant, the proceeds
of such issuance or sale in the form of cash or Cash Equivalents, including
payments in respect of deferred payment obligations when received in the form
of, or stock or other assets when disposed for, cash or Cash Equivalents (except
to the extent that such obligations are financed or sold with recourse to
Pathnet or any Subsidiary of Pathnet), net of fees, commissions and expenses
actually incurred in connection with such issuance or sale and net of taxes paid
or payable as a result thereof.
"Permitted Holder" means Spectrum Equity Investors, L.P., New Enterprise
Associates VI, Limited Partnership, Onset Enterprise Associates II, L.P., FBR
Technology Venture Partners L.P., Toronto Dominion Capital (USA), Inc. and
Grotech Partners IV, L.P., any general partner of any such Person on the Issue
Date, any Person controlled by any such general partner, David Schaeffer or
Richard A. Jalkut.
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"Permitted Indebtedness" means:
(a) Indebtedness of Pathnet pursuant to the notes or of any Restricted
Subsidiary pursuant to a Guarantee of the notes;
(b) Indebtedness of Pathnet or any Restricted Subsidiary outstanding
on the Issue Date;
(c) Indebtedness of Pathnet owing to any Restricted Subsidiary (but
only so long as such Indebtedness is held by such Restricted Subsidiary);
provided that any Indebtedness of Pathnet owing to any such Restricted
Subsidiary is subordinated in right of payment from and after such time as
the notes shall become due and payable (whether at Stated Maturity, by
acceleration or otherwise) to the payment and performance of Pathnet's
obligations under the notes; and provided further that any transaction
pursuant to which any Restricted Subsidiary to which such Indebtedness is
owed ceases to be a Restricted Subsidiary shall be deemed to be an
incurrence of Indebtedness by Pathnet that is not permitted by this clause
(c);
(d) Indebtedness of any Restricted Subsidiary to Pathnet or of any
Restricted Subsidiary to another Restricted Subsidiary;
(e) Indebtedness of Pathnet or any Restricted Subsidiary in respect of
performance, surety or appeal bonds or under letter of credit facilities
provided in the ordinary course of business and, in the case of letters of
credit, under which recourse to Pathnet is limited to the cash securing
such letters of credit;
(f) Indebtedness of Pathnet under Currency Agreements and Interest
Rate Agreements entered into in the ordinary course of business; provided
that such agreements are designed to protect Pathnet or any Restricted
Subsidiary against, or manage exposure to, fluctuations in currency
exchange rates and interest rates, respectively, and that such agreements
do not increase the Indebtedness of the obligor outstanding at any time
other than as a result of fluctuations in foreign currency exchange rates
or interest rates or by reason of fees, indemnities and compensation
payable thereunder;
(g) Telecommunications Indebtedness and any Indebtedness issued in
exchange for, or the net proceeds of which are used to refinance or refund
such Telecommunications Indebtedness in an amount not to exceed the amount
so refinanced or refunded (plus premiums, accrued interest, and reasonable
fees and expenses);
(h) Indebtedness of Pathnet or any Restricted Subsidiary consisting of
guarantees, indemnities or obligations in connection with
Telecommunications Indebtedness, Indebtedness permitted under clause (j) or
(m) of the "Permitted Indebtedness" definition or in respect of purchase
price adjustments in connection with the acquisition of or disposition of
assets, including, without limitation, shares of Capital Stock;
(i) Indebtedness of Pathnet not to exceed, at any time outstanding,
2.0 times the Net Cash Proceeds from the issuance and sale after the Issue
Date, other than to a Restricted Subsidiary, of Qualified Capital Stock of
Pathnet, to the extent such Net Cash Proceeds have not been used to make
Restricted Payments pursuant to clause (a)(3)(B) or clauses (b)(ii) and
(iii) of the "Limitation on Restricted Payments" covenant to make a
Restricted Payment or to make any Permitted Investments under clause (h) of
the definition of Permitted Investments; provided that such Indebtedness
does not mature prior to the Stated Maturity of the notes and has an
Average Life longer than the notes;
(j) Indebtedness of Pathnet or any Restricted Subsidiary under one or
more Credit Facilities; provided that the aggregate principal amount of any
Indebtedness incurred pursuant to this clause (j) (including any amounts
refinanced or refunded under this clause (j)) does not exceed at any time
outstanding the greater of (x) 80% of eligible accounts receivable of
Pathnet
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as of the last fiscal quarter for which financial statements are prepared
or (y) $50.0 million; and any Indebtedness issued in exchange for, or the
net proceeds of which are used to refinance or refund, Indebtedness issued
under this clause (j) in an amount not to exceed the amount so refinanced
or refunded (plus premiums, accrued interest, and reasonable fees and
expenses);
(k) Indebtedness of Pathnet or a Restricted Subsidiary issued in
exchange for, or the net proceeds of which are used to refinance or refund,
then outstanding Indebtedness of Pathnet or a Restricted Subsidiary,
incurred under the ratio test set forth in clause (i) or (ii) of the
"Limitation on Indebtedness" covenant or under clauses (b) through (f),
(h), (i) and (m) of this definition of "Permitted Indebtedness," and any
refinancings thereof in an amount not to exceed the amount so refinanced or
refunded (plus premiums, accrued interest, and reasonable fees and
expenses); provided that such new Indebtedness shall only be permitted
under this clause (k) if (A) in case the notes are refinanced in part, or
the Indebtedness to be refinanced ranks equally with the notes, such new
Indebtedness, by its terms or by the terms of any agreement or instrument
pursuant to which such new indebtedness is issued or remains outstanding,
is expressly made to rank equally with, or subordinate in right of payment
to, the remaining notes, (B) in case the Indebtedness to be refinanced is
subordinated in right of payment to the notes, such new Indebtedness, by
its terms or by the terms of any agreement or instrument pursuant to which
such new Indebtedness is issued or remains outstanding, is expressly made
subordinate in right of payment to the notes at least to the same extent
that the Indebtedness to be refinanced is subordinated to the notes and (C)
such new Indebtedness, determined as of the date of incurrence of such new
Indebtedness, does not mature prior to the Stated Maturity of the
Indebtedness to be refinanced or refunded, and the Average Life of such new
Indebtedness is at least equal to the remaining Average Life of the
Indebtedness being refinanced or refunded; provided further that no
Indebtedness incurred under this clause (k) in exchange for, or the
proceeds of which refinance or refund any Indebtedness incurred under the
ratio test set forth under clause (i) or (ii) of the "Limitation on
Indebtedness" covenant will mature prior to the Stated Maturity of the
notes or have an Average Life shorter than the notes; provided further that
in no event may Indebtedness of Pathnet be refinanced by means of any
Indebtedness of any Restricted Subsidiary issued pursuant to this clause
(k);
(l) Indebtedness arising by reason of the recharacterization of a sale
of accounts receivable to an Accounts Receivable Subsidiary; and
(m) Indebtedness of Pathnet or any Restricted Subsidiary in addition
to that permitted to be incurred pursuant to clauses (a) through (l) above
in an aggregate principal amount not in excess of $30.0 million at any time
outstanding.
"Permitted Investment" means any of the following:
(a) Investments in Cash Equivalents; provided that the term "with a
maturity of 180 days or less" in clauses (a), (b) and (c) of the definition
of "Cash Equivalents" is changed to "with a maturity of one year or less"
for the purposes of this definition of "Permitted Investments" only;
(b) Investments in Pathnet or any Restricted Subsidiary;
(c) Investments by Pathnet or any Restricted Subsidiary in another
Person if, as a result of such Investment, (i) such other Person becomes a
Restricted Subsidiary or (ii) such other Person is merged or consolidated
with or into, or transfers or conveys all or substantially all of its
assets to, Pathnet or a Restricted Subsidiary;
(d) Investments in the form of intercompany Indebtedness to the extent
permitted under clauses (c) and (d) of the definition of "Permitted
Indebtedness;"
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(e) Investments in existence on the Issue Date;
(f) Investments in the Pledged Securities to the extent required by
the Pledge Agreement;
(g) Investments in an amount not to exceed $1.0 million at any one
time outstanding;
(h) Investments in an aggregate amount not to exceed the sum of (1)
Invested Capital, (2) the Fair Market Value of Qualified Capital Stock of
Pathnet, Redeemable Capital Stock of Pathnet, or Indebtedness of Pathnet
convertible into Qualified Capital Stock of Pathnet, in the latter two
cases upon such redemption or conversion thereof into Qualified Capital
Stock of Pathnet, issued by Pathnet or any Restricted Subsidiary of Pathnet
as consideration for any such Investments made pursuant to this clause (h),
and (3) in the case of the disposition or repayment of any Investment made
pursuant to this clause (h) after the Issue Date (including by
redesignation of an Unrestricted Subsidiary of Pathnet to a Restricted
Subsidiary of Pathnet), an amount equal to the lesser of the return of
capital with respect to such Investment and the initial amount of such
Investment, in either case, less the cost of the disposition of such
Investment; provided, however, that the amount of any Permitted Investments
under this clause (h) shall be excluded from the computation of the amount
of any Restricted Payment under the "Limitation on Restricted Payments"
covenant;
(i) Investments in trade receivables, prepaid expenses, negotiable
instruments held for collection and lease, utility and worker's
compensation, performance and other similar deposits or escrow;
(j) Loans, advances and extensions of credit to employees made in the
ordinary course of business of Pathnet not in excess of $500,000 in any
fiscal year;
(k) Bonds, notes, debentures or other securities received as a result
of Asset Sales permitted under the covenant described in "Certain Covenants
Limitation on Asset Sales";
(l) Endorsements for collection or deposit in the ordinary course of
business by such Person of bank drafts and similar negotiable instruments
of such other person received as payment for ordinary course of business
trade receivables;
(m) Investments deemed to have been made as a result of the
acquisition of a Person that at the time of such acquisition held
instruments constituting Investments that were not acquired in
contemplation of, or in connection with, the acquisition of such Person;
(n) Investments in or acquisitions of Capital Stock, indebtedness,
securities or other property of Persons (other than Affiliates of Pathnet)
received by Pathnet or any of its Restricted Subsidiaries in the bankruptcy
or reorganization of or by such Person or any exchange of such Investment
with the issuer thereof or taken in settlement of or other resolution of
claim or disputes, and, in each case, extensions, modifications and
renewals thereof;
(o) Investments in any Person to which Telecommunications Assets used
in an Initial System have been transferred and which person has provided to
Pathnet or a Restricted Subsidiary the right to use such assets pursuant to
an Incumbent Agreement; provided that, in the good faith determination of
the Board of Directors, the present value of the future payments expected
to be received by Pathnet in respect of any such Investment plus the Fair
Market Value of any capital stock or other securities received in
connection therewith is at least equal to the Fair Market Value of such
Investment; and
(p) Investments in one or more Permitted Telecommunications Joint
Ventures; provided that the total original cost of all such Permitted
Telecommunications Joint Ventures plus the cost or Fair Market Value, as
applicable, of all additions thereto less the sum of all amounts received
as returns thereon shall not exceed $20.0 million.
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"Permitted Liens" means:
(a) Liens existing on the Issue Date;
(b) Liens on any property or assets of a Restricted Subsidiary granted
in favor of Pathnet or any Restricted Subsidiary;
(c) Liens on any property or assets of Pathnet or any Restricted
Subsidiary securing the notes or any Guarantees thereof;
(d) any interest or title of a lessor under any Capitalized Lease
Obligation or operating lease permitted by the Indenture;
(e) Liens securing Indebtedness incurred under clauses (g), (j) or (m)
of the definition of "Permitted Indebtedness";
(f) statutory Liens of landlords and carriers, warehousemen,
mechanics, suppliers, materialmen, repairmen or other like Liens arising in
the ordinary course of business of Pathnet or any Restricted Subsidiary and
with respect to amounts not yet delinquent or being contested in good faith
by appropriate proceeding, if a reserve or other appropriate provision, if
any, as required in conformity with GAAP shall have been made therefor;
(g) Liens for taxes, assessments, government charges or claims that
are being contested in good faith by appropriate proceedings promptly
instituted and diligently conducted and if a reserve or other appropriate
provision, if any, as shall be required in conformity with GAAP shall have
been made therefor;
(h) Liens incurred or deposits made to secure the performance of
tenders, bids, leases, statutory obligations, surety and appeal bonds,
government contracts, performance bonds, escrows and other obligations of a
like nature incurred in the ordinary course of business (other than
contracts for the payment of money);
(i) easements, rights-of-way, restrictions and other similar charges
or encumbrances not interfering in any material respect with the business
of Pathnet or any Restricted Subsidiary incurred in the ordinary course of
business;
(j) Liens arising by reason of any judgment, decree or order of any
court so long as such Lien is adequately bonded and any appropriate legal
proceedings that may have been duly initiated for the review of such
judgment, decree or order shall not have been finally terminated or the
period within which such proceedings may be initiated shall not have
expired;
(k) Liens securing Acquired Indebtedness created prior to (and not in
connection with or in contemplation of) the incurrence of such Indebtedness
by Pathnet or any Restricted Subsidiary; provided that such Lien does not
extend to any property or assets of Pathnet or any Restricted Subsidiary
other than the assets acquired in connection with the incurrence of such
Acquired Indebtedness;
(l) Liens securing obligations of Pathnet under Interest Rate
Agreements or Currency Agreements permitted to be incurred under clause (f)
of the definition of "Permitted Indebtedness" or any collateral for the
Indebtedness to which such Interest Rate Agreements or Currency Agreements
relate;
(m) Liens incurred or deposits made in the ordinary course of business
in connection with workers' compensation, unemployment insurance and other
types of social security;
(n) Liens securing reimbursement obligations of Pathnet or any
Restricted Subsidiary with respect to letters of credit that encumber
documents and other property relating to such letters of credit and the
products and proceeds thereof;
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(o) Liens arising from purchase money mortgages and purchase money
security interests; provided that (i) the related Indebtedness shall not be
secured by any property or assets of Pathnet or of any Restricted
Subsidiary other than the property and assets so acquired and (ii) the Lien
securing such Indebtedness shall be created within 60 days of such
acquisition;
(p) Liens securing the Escrow Account, the Pledged Securities and the
proceeds thereof and the security interest created by the Pledge Agreement;
(q) any extension, renewal or replacement, in whole or in part, of any
Lien described in the foregoing clauses (a) through (o); provided that any
such extension, renewal or replacement shall be no more restrictive in any
material respect than the Lien so extended, renewed or replaced and shall
not extend to any additional property or assets;
(r) Liens with respect to the equipment and related assets of Pathnet
installed on its network in favor of Persons that have licensed, leased,
transferred or granted to Pathnet or any Restricted Subsidiary a right to
use Telecommunications Assets or financed the purchase of
Telecommunications Assets or securing the obligations of Pathnet or such
Restricted Subsidiary under an Incumbent Agreement; provided that such
Liens will (1) be created on terms that Pathnet reasonably believes to be
no less favorable to Pathnet than Liens granted under clause (e) of this
definition and (2) not secure any Indebtedness in excess of the Fair Market
Value of the equipment and assets so secured;
(s) Liens relating to revenues of Pathnet or any Restricted Subsidiary
arising as a result of obligations under an Incumbent Agreement; and
(t) Liens on the property or assets or Capital Stock of Accounts
Receivable Subsidiaries and Liens arising out of any sale of Accounts
Receivable in the ordinary course of business (including in connection with
a financing transaction) to or by an Accounts Receivable Subsidiary or to
Persons that are not Affiliates of Pathnet.
"Permitted Telecommunications Asset Sale" means any transfer, conveyance,
sale, lease or other disposition of a capital asset that is a Telecommunications
Asset, the proceeds of which are treated as revenues (including deferred
revenues) by Pathnet in accordance with GAAP.
"Permitted Telecommunications Joint Venture" means a corporation,
partnership or other entity engaged in one or more Telecommunications Businesses
in which Pathnet owns, directly or indirectly, an equity interest.
"Person" means any individual, corporation, limited liability company,
partnership, joint venture, association, joint-stock company, trust, business
trust, unincorporated organization or government or any agency or political
subdivision thereof.
"Pledge Agreement" means the Pledge Agreement initially dated as of the
Issue Date and as amended on the date of consummation of our reorganization, by
and between the trustee and Pathnet, governing the disbursement of funds from
the Escrow Account.
"Pledged Securities" means the securities purchased by Pathnet, which shall
consist of Government Securities, to be deposited in the Escrow Account.
"Preferred Stock" means, with respect to any Person, any and all shares,
interests, participations, rights or other equivalents (however designated,
whether voting or non-voting) of such Person's preferred or preference stock,
whether now outstanding or issued after the Issue Date, including, without
limitation, all series and classes of such preferred or preference stock of such
Person.
"Public Equity Offering" means an offer and sale of Common Stock (which is
Qualified Capital Stock) of Pathnet pursuant to a registration statement that
has been declared effective by the SEC pursuant to the Securities Act (other
than a registration statement on Form S-8 or otherwise relating
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to equity securities issuable under any employee benefit plan of Pathnet) and
resulting in Net Cash Proceeds to Pathnet of not less than $45 million.
"Qualified Capital Stock" means, with respect to any Person, any and all
Capital Stock of such Person other than Redeemable Capital Stock.
"Redeemable Capital Stock" means any class or series of Capital Stock that,
either by its terms, by the terms of any security into which it is convertible
or exchangeable or by contract or otherwise, is or, upon the happening of an
event or passage of time would be, required to be redeemed prior to the final
Stated Maturity of the notes or is redeemable at the option of the holder
thereof at any time prior to such final Stated Maturity, or is convertible into
or exchangeable for debt securities at any time prior to such final Stated
Maturity; provided that any Capital Stock that would not otherwise constitute
Redeemable Capital Stock but for provisions 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
Stated Maturity of the notes shall not constitute Redeemable Capital Stock if
the "asset sale" or "change of control" provisions applicable to such Capital
Stock are no more favorable in any material respect to holders of such Capital
Stock than the provisions contained in the "Limitation on Asset Sales" and
"Purchase of Notes upon a Change of Control" covenants are to holders of the
notes, and such Capital Stock specifically provides that such Person will not
repurchase or redeem any such Capital Stock pursuant to any such provision prior
to Pathnet's repurchase of such notes as are required to be repurchased pursuant
to the "Limitation on Asset Sales" and "Purchase of Notes upon a Change of
Control" covenants.
"Restricted Subsidiary" means any Subsidiary of Pathnet other than an
Unrestricted Subsidiary.
"S&P" means Standard and Poor's Ratings Services, a division of
McGraw-Hill, Inc., and its successors.
"Sale-Leaseback Transaction" means any direct or indirect arrangement, or
series of related arrangements, with any Person (other than Pathnet or a
Restricted Subsidiary) or to which any Person (other than Pathnet or a
Restricted Subsidiary) is a party, providing for the leasing to Pathnet or to a
Restricted Subsidiary of any property for an aggregate term exceeding three
years, whether owned by Pathnet or by any Subsidiary of Pathnet at the Issue
Date or later acquired, which has been or is to be sold or transferred by
Pathnet or such Restricted Subsidiary to such Person or to any other Person from
whom funds have been or are to be advanced by such Person on the security of
such property; provided that the transfer by Pathnet or any Restricted
Subsidiary of Telecommunications Assets to, and the leasing by Pathnet or any
Restricted Subsidiary of such assets from, a Permitted Telecommunications Joint
Venture shall not constitute a Sale-Leaseback Transaction.
"Significant Subsidiary" means, at any date of determination, any
Restricted Subsidiary that, together with its Subsidiaries, (i) for the most
recent fiscal year of Pathnet, accounted for more than 10% of the consolidated
revenues of Pathnet and its Restricted Subsidiaries, (ii) as of the end of such
fiscal year, was the owner of more than 10% of the consolidated assets of
Pathnet and its Restricted Subsidiaries, or (iii) owns one or more FCC licenses
the aggregate cost or Fair Market Value of which represents 5% or more of the
net asset value of Pathnet and its Restricted Subsidiaries on a consolidated
basis as of the end of such fiscal year, in the case of (i), (ii) or (iii) as
set forth on the most recently available consolidated financial statements of
Pathnet for such fiscal year.
"Stated Maturity" means, when used with respect to any note or any
installment of interest thereon, the date specified in such note as the fixed
date on which the principal of such note or such installment of interest is due
and payable, and, when used with respect to any other Indebtedness, means the
date specified in the instrument governing such Indebtedness as the fixed date
on which the principal of such Indebtedness, or any installment of interest
thereon, is due and payable.
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"Subsidiary" means any Person a majority of the equity ownership or Voting
Stock of which is at the time owned, directly or indirectly, by Pathnet or by
one or more other Subsidiaries or by Pathnet and one or more other Subsidiaries.
"Telecommunications Assets" means, with respect to any Person, assets
(including, without limitation, rights of way, trademarks and licenses) other
than current assets that are utilized by such Person, directly or indirectly,
for the design, development, construction, installation, integration or
provision of Pathnet's network, including, without limitation, any businesses or
services in which Pathnet is currently engaged and including any computer
systems used in a Telecommunications Business. Telecommunications Assets shall
also include 66 2/3% of the Voting Stock of another Person, provided that
substantially all of the assets of such other Person consist of
Telecommunications Assets, and provided further such Voting Stock shall be held
by Pathnet or a Restricted Subsidiary, such other Person either is, or
immediately following the relevant transaction shall become, a Restricted
Subsidiary of Pathnet pursuant to the Indenture or a Permitted
Telecommunications Joint Venture subject to the limitations set forth under
clause (p) of the definition of "Permitted Investment." The determination of
what constitutes Telecommunications Assets shall be made by the Board of
Directors and evidenced by a board resolution delivered to the Trustee.
"Telecommunications Business" means the business of (i) transmitting, or
providing services relating to the transmission of, voice, video or data through
owned or leased transmission facilities, (ii) constructing, creating,
developing, acquiring or marketing Telecommunication Assets or other
communications related network equipment, software and other devices for use in
a telecommunications business or (iii) evaluating, participating or pursuing any
other activity or opportunity that is primarily related to those identified in
clause (i) or (ii) above; provided that the determination of what constitutes a
Telecommunications Business shall be made in good faith by the board of
directors of Pathnet.
"Telecommunications Indebtedness" means Indebtedness of Pathnet or any
Restricted Subsidiary incurred at any time within 315 days of, and for the
purpose of financing all or any part of the cost of, the construction,
expansion, installation, acquisition or improvement by Pathnet or any Restricted
Subsidiary of any new Telecommunications Assets; provided that the proceeds of
such Indebtedness are expended for such purposes within such 315-day period; and
provided further that the Net Cash Proceeds from the issuance of such
Indebtedness does not exceed, as of the date of incurrence thereof, 100% of the
lesser of the cost or Fair Market Value of such Telecommunications Assets;
provided further that, to the extent an Incumbent Agreement is characterized as
a Capitalized Lease Obligation, it shall be considered Telecommunications
Indebtedness.
"Trust Indenture Act" means the Trust Indenture Act of 1939, as amended.
"Unrestricted Subsidiary" means (a) any Subsidiary that at the time of
determination shall be an Unrestricted Subsidiary (as designated by the board of
directors of Pathnet, as provided below) and (b) any Subsidiary of an
Unrestricted Subsidiary. The board of directors of Pathnet may designate any
Subsidiary (including any newly acquired or newly formed Subsidiary) to be an
Unrestricted Subsidiary so long as (i) neither Pathnet nor any other Subsidiary
is directly or indirectly liable for any Indebtedness of such Subsidiary, (ii)
no default with respect to any Indebtedness of such Subsidiary would permit
(upon notice, lapse of time or otherwise) any holder of any other Indebtedness
of Pathnet or any Restricted Subsidiary to declare a default on such other
Indebtedness or cause the payment thereof to be accelerated or payable prior to
its Stated Maturity, (iii) any Investment in such Subsidiary made as a result of
designating such Subsidiary an Unrestricted Subsidiary will not violate the
provisions of the "Limitation on Restricted Payments" covenant, (iv) neither
Pathnet nor any Restricted Subsidiary has a contract, agreement, arrangement,
understanding or obligation of any kind, whether written or oral, with such
Subsidiary other than those that might be obtained at the time from persons who
are not Affiliates of Pathnet, and
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(v) neither Pathnet nor any other Subsidiary has any obligation (1) to subscribe
for additional shares of Capital Stock or other equity interest in such
Subsidiary, or (2) to maintain or preserve such Subsidiary's financial condition
or to cause such Subsidiary to achieve certain levels of operating results. Any
such designation by the board of directors of Pathnet shall be evidenced to the
trustee by filing a board resolution with the trustee giving effect to such
designation. The board of directors of Pathnet may designate any Unrestricted
Subsidiary as a Restricted Subsidiary if, immediately after giving effect to
such designation, there would be no Default or Event of Default under the
Indenture and Pathnet could incur $1.00 of additional Indebtedness (other than
Permitted Indebtedness) pursuant to the "Limitation on Indebtedness" covenant.
"Vendor Credit Facility" means, collectively, (i) the revolving credit
facility to be entered into by and among Pathnet, the Finance Subsidiary and
NEC, substantially in the form outlined by the commitment letter dated October
14, 1997; (ii) the revolving credit facility to be entered into by and among
Pathnet, the Finance Subsidiary and Andrew, substantially in the form outlined
by the commitment letter dated December 8, 1997; and (iii) the takeout credit
facility substantially in the form of the Commitment Letters dated October 7,
1997 and October 8, 1997, among Pathnet, the Finance Subsidiary and each of the
financial institutions party thereto.
"Voting Stock" means, with respect to any Person, any class or classes of
Capital Stock pursuant to which the holders thereof have the general voting
power under ordinary circumstances to elect at least a majority of the board of
directors, managers or trustees of any Person (irrespective of whether or not,
at the time, stock of any other class or classes shall have, or might have,
voting power by reason of the happening of any contingency).
"Wholly Owned" means, with respect to the Subsidiary of any Person, the
ownership of all of the outstanding Capital Stock of such Subsidiary (other than
any director's qualifying shares or Investments by foreign nationals mandated by
applicable law) by such Person or one or more Wholly Owned Subsidiaries of such
Person.
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DESCRIPTION OF OTHER INDEBTEDNESS AND OTHER FINANCING ARRANGEMENTS
PROPOSED CREDIT FACILITY WITH LUCENT
Pathnet has been negotiating with Lucent Technologies, Inc., over the terms
of a senior secured credit facility that would provide us with vendor financing
for fiber optic cable purchases. The credit facility would be executed in
connection with a fiber optic cable purchase agreement where we agree to make
Lucent our exclusive provider of fiber optic cable. Neither party has signed the
definitive agreements governing the proposed financing, but we expect to execute
definitive agreements in the next several weeks. We describe below the material
terms of the proposed Lucent credit facility, based on the current drafts of the
agreements. We cannot assure you that we will enter into any financing
agreements with Lucent, or that any agreements that we execute will be on these
terms. However, we currently expect that we will enter into a vendor financing
agreement with Lucent on terms similar to those outlined below.
The first tranche of the proposed facility will be $60 million and will be
available to be drawn after the facility becomes effective until January 31,
2001. The proceeds of any loans by Lucent must be used to finance fiber optic
cable that we purchase under the fiber optic cable purchase agreement between us
and Lucent. The loans will not cover the entire invoice cost of those purchases.
Under the Lucent credit facility, we will be required to pay various customary
arrangement, commitment and other fees. To preserve exclusivity, Lucent must
offer additional tranches on similar terms to the first tranche.
If executed as currently drafted, we expect the proposed credit facility
with Lucent to have these terms:
- The first tranche loans would mature on December 31, 2005;
- Mandatory prepayments are required in connection with dark fiber sales
and other dispositions;
- Lucent's obligation to loan any funds under the facility is conditioned
on, among other things:
-- We must purchase and pay for a specified minimum dollar value of
Lucent products;
-- A newly-formed vendor financing subsidiary of Pathnet or Pathnet
Telecom would be the borrower under the credit facility and must be
capitalized with assets having a value of at least $60 million;
-- We must obtain the necessary permits (including any required rights of
way) required to build the network segment in which the financed fiber
will be installed; and
- The loans would bear interest at floating rates based on an index plus a
specified margin.
The indebtedness outstanding under the Lucent credit facility is expected
to be guaranteed by the borrower (a newly formed vendor financing subsidiary of
Pathnet or Pathnet Telecom). The indebtedness will be secured by all property
and assets owned by, and all capital stock of and inter-company indebtedness
owed to, the borrower.
We anticipate that the Lucent credit facility will contain various
covenants typical for facilities of this nature. Some of those covenants will
restrict the vendor financing subsidiary and its subsidiaries, if any, from,
among other things:
- Incurring indebtedness;
- Entering into merger or consolidation transactions;
- Disposing of their assets;
- Acquiring assets; and
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- Making certain restricted payments;
- Paying interest or principal on the notes if excess cash is available at
Pathnet Telecom or Pathnet for note repayment;
- Creating any liens on its assets;
- Making investments;
- Entering into sale and leaseback transactions; and
- Entering into non-arms'-length basis transactions with affiliates.
As currently drafted, the Lucent credit facility also requires that the
vendor financing subsidiary comply with various customary financial covenants,
including required ratios for:
- Consolidated indebtedness to total capitalization;
- Consolidated indebtedness to consolidated EBITDA;
- Consolidated EBITDA to consolidated debt service;
- Consolidated EBITDA to consolidated interest expense; and
- Minimum annual revenues to the vendor financing subsidiary.
The draft Lucent credit facility contains a number of events of default,
including:
- Nonpayment of principal, interest, fees or other amounts;
- The occurrence of a default on other material indebtedness of the vendor
financing subsidiary and its subsidiaries (if any) and, in certain
circumstances, of Pathnet Telecom and our subsidiaries including a
termination by Lucent as the result of our default on the fiber supply
agreement with Lucent;
- Failure to comply with certain covenants, conditions or provisions under
the credit facility;
- The existence of certain judgments;
- The occurrence of any default under material agreements that could result
in a material adverse effect on the vendor financing subsidiary;
- The breach of representations or warranties;
- Commencement of reorganization, bankruptcy, insolvency or similar
proceedings;
- The occurrence of certain ERISA events; and
- A change of control of Pathnet Telecom or the vendor financing
subsidiary.
If the borrowing subsidiary defaults on its obligations under the Lucent
credit facility, all of those obligations could be declared to be immediately
due and payable. Upon a payment default or upon any acceleration of the
obligations under the Lucent credit facility, assuming those obligations
exceeded $7.5 million, any amounts then owing under the notes would become
immediately due and payable.
Under the Lucent credit facility, the vendor financing subsidiary is not
permitted to offer any guarantee of any indebtedness of Pathnet Telecom or
Pathnet. In addition to the Lucent credit facility, we intend to enter into
similar financing arrangements with other of our equipment vendors. We expect
that other vendor financing participants will demand similar restrictions.
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DESCRIPTION OF CAPITAL STOCK
The following summary describes the material structure and terms of our
capital stock. You should refer to our certificate of incorporation and bylaws
for more information. See "WHERE YOU CAN FIND MORE INFORMATION" to locate copies
of those documents.
GENERAL
Our capital stock consists of 60 million shares of common stock, $.01 par
value per share, and 39,620,860 shares of preferred stock, $.01 par value per
share.
OUR CAPITAL STOCK
<TABLE>
<CAPTION>
ISSUED AND
AUTHORIZED SHARES OUTSTANDING SHARES*
----------------- -------------------
<S> <C> <C>
COMMON STOCK:....................................... 60,000,000 2,977,593
---------- ----------
PREFERRED STOCK:
Series A Convertible Preferred Stock........... 2,899,999 2,899,999
Series B Convertible Preferred Stock........... 4,788,030 4,788,030
Series C Convertible Preferred Stock........... 8,176,686 8,176,686
Series D Convertible Preferred Stock........... 9,250,000 8,511,607
Series E Convertible Preferred Stock........... 4,506,145 1,729,631**
Blank Check Preferred Stock.................... 10,000,000 --
---------- ----------
Total Preferred Stock.......................... 39,620,860 26,105,953
---------- ----------
TOTAL OF ALL STOCK........................ 99,620,860 29,083,546
========== ==========
</TABLE>
- ---------------
* After close of our reorganization.
** Assuming no additional series E convertible preferred shares are issued under
the Colonial option agreement. Subsequent to the initial closing, and upon
receipt of the $25 million cash payment from Colonial upon the completion of
the Chicago-Aurora fiber build, we will issue 1,137,915 shares of our series
E stock. At that time, an aggregate of 2,867,546 shares of our series E stock
will be issued and outstanding (again, assuming no additional series E shares
have been issued under the Colonial option agreement).
We describe in the sections below the important terms our capital stock and
our certificate of incorporation and bylaws.
COMMON STOCK
Our common stockholders are entitled to one vote per share of common stock
on all matters to be voted upon by the stockholders generally. Holders of common
stock also will be entitled to receive dividends, if any, declared from time to
time by the board of directors out of funds legally available for dividends. If
we are liquidated, dissolved or wound-up, holders of common stock will share
proportionately in all assets available for distribution. However, both dividend
and distribution rights of our common stockholders are subject to the rights of
our preferred stockholders as described below. Our common stockholders have no
preemptive or conversion rights (other than the preemptive rights granted to Mr.
Schaeffer under our stockholders agreement). Our common stock does not have
cumulative voting rights. There are no redemption or sinking fund provisions
applicable to our common stock.
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BLANK CHECK PREFERRED STOCK
Subject to the limitations described below, our certificate of
incorporation gives our board of directors the authority, without further
stockholder action, to issue up to 10 million shares of preferred stock in one
or more series and to fix the relative powers, preferences, rights,
qualifications, limitations or restrictions of our preferred stock, including:
- Dividend rates;
- Conversion rights;
- Voting powers;
- Terms of redemption;
- Redemption prices;
- Amounts payable upon liquidation; and
- The number of shares constituting any series or the designation of those
series.
Our issuance of preferred stock may have the effect of delaying, deferring
or preventing our "change in control" and may adversely affect the voting and
other rights of our common and preferred stockholders. These effects may include
the loss of voting control to others. Other than our issuance of our preferred
stock in the reorganization (including shares that may be issued under the
Colonial option agreement), we currently have no plans to issue any shares of
preferred stock. In addition, our certificate of incorporation forbids us from
issuing any equity security, other than as set forth in the stockholders
agreement, without the affirmative vote or written consent of 67% of the
outstanding shares of all preferred stock, voting as a single class.
SERIES A, B, C, D AND E CONVERTIBLE PREFERRED STOCK
References in this discussion to "our preferred stockholders" mean the
holders of any of our preferred stock, and "our preferred stock" means any of
our preferred stock.
VOTING. Our preferred stock is voted on an "as converted" basis with our
common stock. This means that each share of our preferred stock will initially
have one vote, representing the number of votes that those shares would have if
they were converted into shares of our common stock. In the event that the
number of shares of common stock into which the shares of any series of
preferred stock may be converted is adjusted in the future, the number of votes
which shares of that series of preferred stock may exercise will be adjusted
accordingly. Upon the closing of our reorganization, our preferred stock will
together represent approximately 90% of our total outstanding voting stock.
VETO RIGHTS. The consent of holders of 67% of our preferred stock voting
together as a single class is required for actions that:
- Redeem or otherwise acquire for value any shares of our capital stock or
capital stock of our subsidiaries, except for certain redemption rights
provided in our certificate of incorporation for the holders of our
series E preferred stock and other redemptions in accordance with
stockholders agreements, option agreements or employment agreements
approved by our board of directors;
- Issue any equity securities or securities convertible into our equity
securities other than as provided in our stockholders agreement;
- Increase or decrease the total number of authorized shares of preferred
stock, other than by conversion as permitted under the certificate of
incorporation;
- Pay or declare any dividends on any capital stock;
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- Enter into a merger, consolidation, reorganization or recapitalization
transaction;
- Amend our certificate of incorporation or bylaws in any way that
adversely affects the rights or preferences of our preferred
stockholders; or
- Incur indebtedness, other than indebtedness existing on the completion of
our reorganization, indebtedness of $5 million or less or indebtedness
incurred in the ordinary course of business.
DIVIDENDS. We cannot pay any dividends on our common stock unless we have
first paid a corresponding dividend on our preferred stock.
LIQUIDATION PREFERENCE. Our preferred stockholders are entitled to a
liquidation preference equal to their initial purchase price for their preferred
shares (as adjusted for stock splits, stock dividends, recapitalizations and
similar events) plus any declared but unpaid dividends. Our series E preferred
stock ranks prior to all of our other shares of capital stock upon liquidation,
including the other shares of all preferred stock. Following payment to the
holders of our series E preferred stock, the remaining shares of all preferred
stock are ranked prior to our common stock, and on a parity with each other.
This preference currently entitles our stockholders to payments of the following
amounts upon our liquidation:
- $0.34 for each share of series A preferred stock;
- $1.13 for each share of series B preferred stock;
- $3.67 for each share of series C preferred stock;
- $21.97 for each share of series D preferred stock; and
- $21.97 for each share of series E preferred stock.
REDEMPTION. The holders of our series E preferred stock have the right to
require us to redeem some or all of their shares of series E preferred stock at
a price equal to the original purchase price paid for our series E preferred
stock if we have not either undergone an IPO, listed our common stock for
trading on a national securities exchange, or had our stock traded in an
over-the-counter market and quoted in an automated quotation system of the
National Association of Securities Dealers, Inc. on or before November 3, 2001.
(In each case, we will also need to meet certain proceeds and valuation
requirements as well.) This right is subject to the limitations on redemptions
contained in the indenture and proposed to be contained in the supplemental
indenture, which will prohibit our making this redemption for so long as this
prohibition is in effect and the notes are outstanding.
Except in circumstances involving an acquisition, merger or similar
transaction in which the holders of the shares of series A, B, C or D preferred
stock would receive as consideration for their shares payment of an amount less
than their applicable liquidation preference, we are not required to redeem our
series A, B, C or D preferred stock. Accordingly, the holders of Pathnet's
series A, B, and C preferred stock who agreed to exchange their Pathnet stock
for our stock in connection with our reorganization transaction will lose their
existing redemption rights under the Pathnet certificate of incorporation,
except in respect to such extraordinary transactions. These existing Pathnet
redemption rights are currently subject to the same contractual restrictions
under the indenture, and Pathnet cannot effect the redemption of any of its
shares so long as this covenant remains in effect and the notes are outstanding.
In addition to the redemption rights described in the preceding paragraph, our
series E shares have similar rights to elect to have their shares redeemed in
the event of an extraordinary corporate transaction for consideration less than
the applicable liquidation preference.
CONVERSION AND ANTI-DILUTION. Our preferred stockholders may convert each
share of their preferred stock at any time into one share of our common stock.
The conversion ratio may be
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increased or decreased as a result of stock splits, dividends, recapitalizations
and similar events. If we issue shares of our common stock for prices less than
the applicable conversion prices (which, immediately following the closing of
our reorganization, will be equal to the liquidation preferences indicated
above), anti-dilution provisions in our certificate of incorporation will
increase the number of shares of our common stock into which each share of the
affected series of preferred stock would be converted. The shares of series E
preferred stock possess more favorable conversion rights than do the series A,
B, C and D preferred stock. In the event of any sale of shares of our common
stock (or securities convertible into shares and our common stock) at a price
less than the applicable conversion price, the conversion formula for the shares
of series E preferred stock will adjust on a so-called "full ratchet" basis.
This means that holders of shares of series E preferred stock will be able to
convert their shares of series E preferred stock into that number of shares of
common stock that would have been available to those holders if they had
originally purchased their shares of series E stock for any reduced price at
which we issue any shares of our common stock or securities convertible into
common stock.
The shares of our series A, B, C and D preferred stock also have
anti-dilution protection, which provides for adjustments based on a
volume-adjusted weighted average of any issue of our shares of common stock (or
securities convertible into common stock) at a price lower than the applicable
conversion price for the shares of that series. You can review this formula in
the copy of our certificate of incorporation attached as an exhibit to the
registration statement filed in connection with this offering. If we were to
sell shares of our common stock (or securities convertible into common stock) at
a price lower than the applicable conversion value for any of the series of
convertible preferred stock, the dilutive effect (on the shares of our common
stock or any shares of preferred stock not participating in an adjustment) of an
anti-dilution adjustment under this formula may be substantially more pronounced
than the more commonly employed "weighted average" anti-dilution formula. Under
our volume-adjusted weighted average approach, we take account of the dilutive
effect of the "full ratchet" anti-dilution protection afforded to our series E
shares, so that even a small issue of new shares of common stock at a low price
will have a significant effect on the conversion ratios of any of our series A,
B, C or D preferred shares for which the conversion ratio is also adjusted. The
anti-dilution provisions generally will not apply to our issue of common stock
pursuant to the exercise of employee stock options or the Pathnet warrants that
we plan to assume. See "Warrants" below.
Our preferred stock automatically converts into common stock if we complete
an IPO or if our common stock is either listed for trading on a national
securities exchange or is traded in an over-the-counter market and quoted in an
automated quotation system of the National Association of Securities Dealers,
Inc. and, in each case, we satisfy certain proceeds and valuation requirements.
REGISTRATION RIGHTS. We have granted registration rights to some holders
of our common stock, preferred stock, options and warrants for the shares of our
common stock already held or to be acquired upon conversion or exercise of these
securities. See "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS -- Our
Stockholders Agreement" for a description of these registration rights.
OTHER PROVISIONS OF THE PATHNET TELECOM CERTIFICATE OF INCORPORATION AND BYLAWS
Our certificate of incorporation and bylaws contain a number of provisions
relating to our governance and internal operations, including these provisions:
- Following our issuance of the applicable classes of capital stock, the
holders of our series A preferred stock will be entitled to elect two
directors by a separate class vote, the holders of our series B preferred
stock will be entitled to elect one director by a separate class vote;
the holders of our series C preferred stock will be entitled to elect one
director by a separate class
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vote; and the holders of our series D preferred stock and our series E
preferred stock will be entitled to elect three directors, voting
together as a single class;
- Our CEO will also serve as a director;
- Subject to the rights of the holders of our preferred stock to elect
directors by class, the directors in office will fill any vacancy or
newly created directorship on our board of directors, with any new
director to serve until his or her successor is elected and qualified;
- Directors may be removed by the vote of stockholders holding a majority
of the voting power of our issued and outstanding capital stock, except
that, if directors are elected by a voting group of stockholders, only
that voting group may participate in the vote to remove them. In
addition, the board of directors may remove one or more directors for
cause (as defined in our bylaws) by a majority vote of all other
directors; and
- Special meetings of stockholders may be called by our board of directors,
the Chairman of our board of directors, our President or, at any time
before a public offering, by stockholders holding shares entitled to cast
at least 25% of the total votes cast by all stockholders at a meeting of
the stockholders, and the business permitted to be conducted at a special
meeting is limited to the business stated in the notice of the special
meeting or business that is related to the purpose of the special meeting
that is brought before the meeting by our board of directors.
The provisions of our certificate of incorporation and bylaws described
above relating to the removal of directors may discourage or make the
acquisition of control of us by means of a tender offer, open market purchase or
proxy contest more difficult. These provisions may also discourage specific
types of coercive takeover practices and inadequate takeover bids and may
encourage persons seeking to acquire control of us to first negotiate with our
board of directors. We believe that these provisions will benefit us and our
stockholders by enhancing our ability to negotiate with the proponent of any
unfriendly or unsolicited proposal to acquire or restructure us. We also believe
that the benefits of discouraging these proposals outweighs the disadvantages of
doing so, because, among other things, negotiation of these proposals could
result in better terms for our stockholders.
WARRANTS
In April 1998, Pathnet issued warrants entitling the holders to purchase
1,116,500 shares of its common stock (after accounting for adjustments and
splits) to the initial purchasers of the notes. In a separate and private
transaction that Pathnet proposes to conduct only with the qualified
institutional buyers permitted to hold those warrants, Pathnet will propose to
amend and obtain waivers of the terms of the existing warrants to clarify that
upon the closing of our reorganization, we will assume Pathnet's obligations
under the warrants and they will become exercisable for shares of our common
stock. If Pathnet fails to obtain the required consent of the holders of the
Pathnet warrants to amend and waive the terms of the warrants as proposed, the
Pathnet warrants will remain outstanding and will be exercisable upon the
closing of our reorganization. In that case, individual holders of the Pathnet
warrants may exercise "tag along" rights under the warrant agreements that will
permit the electing holders to exchange their Pathnet warrants for our warrants
upon the closing of our reorganization.
Pathnet's warrants currently permit the holders to purchase a total of
1,116,500 shares of Pathnet common stock at $0.01 per share. If Pathnet obtains
the consent of the qualified institution buyers permitted to holds its warrants,
or if all of the holders of the Pathnet warrants elect to exercise their tag
along rights, we will have outstanding warrants permitting the holders to
purchase a total of 1,116,500 shares of our common stock at $0.01 per share.
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DIVIDEND POLICY
Pathnet has never declared or paid any cash dividends on its capital stock.
We have no plans to pay dividends on our common stock in the future, and
presently intend to retain any earnings to fund the growth of our business. Our
board of directors will determine the payment of any future dividends in light
of conditions then existing, including the results of our operations, financial
condition, cash requirements, restrictions in financing agreements, business
conditions and other factors. However, covenants contained in the indenture (and
those proposed to be contained in the supplemental indenture) significantly
restrict our ability to pay dividends.
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FEDERAL INCOME TAX CONSEQUENCES
The following is a general discussion of the material anticipated federal
income tax consequences under present law to holders of the notes and to Pathnet
if the proposed indenture amendments are approved, the waivers are obtained and
Pathnet pays the consent fee to holders who are entitled to receive the fee. The
description of federal income tax law and federal income tax consequences
contained in this section constitutes the opinion of Covington & Burling, tax
counsel to Pathnet in connection with the proposed indenture amendments, except
as to matters upon which they have expressly declined to express an opinion, as
disclosed below. Covington's opinions are subject to the assumptions and
qualifications set forth in their opinion letter, a copy of which is included as
an exhibit to the registration statement of which this prospectus is a part.
The following discussion is based on the provisions of the tax code, final
and temporary Treasury regulations issued under the tax code, and administrative
and judicial interpretations of the tax code and regulations, all as in effect
as of the date of this prospectus and all of which are subject to change
(possibly on a retroactive basis). Legislative, judicial, or administrative
changes or interpretations could alter or modify the tax discussion set forth
below. This discussion does not purport to deal with all aspects of federal
income taxation that may be relevant to holders of the notes. The discussion
does not address any aspects of state, local or foreign taxation. Finally,
substantial uncertainties resulting from the lack of definitive judicial or
administrative authority and interpretations apply to various tax issues
addressed in this section, including certain tax consequences arising in
connection with the waivers, the proposed indenture amendments and payment of
the consent fee pursuant to this solicitation. Pathnet has not sought, nor does
it intend to seek, any rulings from the IRS relating to such issues or any other
issues.
This discussion does not attempt to address all issues that may be relevant
to a particular holder of the notes in light of such holder's personal
investment circumstances and does not apply to holders subject to special
treatment under the federal income tax laws such as financial institutions,
broker-dealers, insurance companies, foreign persons and entities, tax-exempt
organizations or taxpayers subject to the alternative minimum tax. This
discussion assumes that holders hold their notes as a "capital asset"
(generally, property held for investment) within the meaning of Section 1221 of
the tax code.
THE TAX TREATMENT OF A HOLDER OF THE NOTES MIGHT BE SUBJECT TO SPECIAL
RULES NOT DISCUSSED BELOW. ACCORDINGLY, EACH HOLDER OF THE NOTES SHOULD CONSULT
SUCH HOLDER'S OWN TAX ADVISOR AS TO THE SPECIFIC FEDERAL, STATE, LOCAL AND
FOREIGN TAX CONSEQUENCES TO SUCH HOLDER THAT MAY ARISE IN CONNECTION WITH THIS
SOLICITATION.
PROPOSED WAIVERS AND INDENTURE AMENDMENTS
Under general principles of tax law, the modification of a debt instrument
creates a deemed exchange (upon which gain or loss is realized) if the modified
debt instrument differs materially either in kind or in extent from the original
debt instrument.
Under the tax regulations, the modification of a debt instrument is a
"significant" modification (i.e., a modification upon which gain or loss is
realized) if, based on all the facts and circumstances and taking into account
all modifications of the debt instrument collectively, the legal rights or
obligations that are altered and the degree to which they are altered are
"economically significant." A modification that adds a guarantor or pledges
collateral on a recourse debt is not a significant modification unless such
modification results in a change in payment expectations. The addition of a
guarantor or pledge of collateral results in a change in payment expectations if
it results in a substantial enhancement of the obligor's capacity to meet the
payment obligations under the debt instrument, and that capacity was primarily
speculative prior to the guarantee or pledge and is
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adequate after the guarantee or pledge. In addition, a change in the yield of a
debt instrument is a significant modification under the tax regulations if the
yield of the modified instrument (determined by taking into account any payments
made to the holder as consideration for the modification) varies from the yield
on the unmodified instrument (determined as of the date of the modification) by
more than the greater of 1/4 of one percent (25 basis points) or five percent of
the annual yield of the unmodified instrument.
As discussed above, the proposed indenture amendments would change several
terms of the notes, and the holders would waive certain rights in connection
with the solicitation. Whether the legal rights or obligations that would be
altered and the degree to which they would be altered by the proposed indenture
amendments and the waivers would be "economically significant" is not
specifically addressed by existing guidance and therefore is uncertain. However,
the legal rights and obligations that would be changed (other than the changes
resulting from the Pathnet Telecom guarantees, the pledge of collateral to
secure the October 16, 2000 interest payment on the notes following the
consummation of our reorganization and the payment of the consent fee discussed
below) as a result of the proposed indenture amendments principally would impose
new obligations on Pathnet Telecom and generally would change Pathnet's
obligations and rights only in minor respects. Similarly, although it is
uncertain, Pathnet intends to take the position that the one time waiver of the
Excess Proceeds Offer obligation and the Change of Control repurchase obligation
does not constitute an economically significant modification. Hence, Pathnet
intends to take the position that the waivers and the proposed indenture
amendments (other than the guarantees, the pledge of collateral and payment of
the consent fee described below) would not collectively result in a deemed
exchange of the notes for "new" notes ("New Notes"). Due to the inherently
factual nature of this determination and the lack of specific guidance, however,
Covington is unable to render an opinion that a deemed exchange will not occur.
It is the opinion of Covington that the payment of the consent fee will not
change the yield of the notes by an amount that will cause a significant
modification under the tax regulations. The effect of the Pathnet Telecom
guarantees and the pledge of collateral to secure the October 16, 2000 interest
payment on the notes following the consummation of the reorganization is less
clear. It is likely that the addition of the Pathnet Telecom guarantees and the
pledge of collateral will enhance Pathnet's capacity to meet its payment
obligations under the notes. Whether Pathnet's capacity to meet the payment
obligations will change from "primarily speculative" prior to the Pathnet
Telecom guarantees and the pledge of collateral to "adequate" after the
guarantees and the pledge of collateral is a question of fact that cannot be
answered in advance with certainty. Accordingly, Covington expresses no opinion
on whether Pathnet's capacity to meet the payment obligations will change from
"primarily speculative" to "adequate." It is the opinion of Covington that if
Pathnet's capacity to meet the payment obligations under the notes does not
change from "primarily speculative" to "adequate," the Pathnet Telecom
guarantees and the pledge of collateral will not create a deemed exchange of the
notes for New Notes. In such case, a holder will not recognize any gain or loss
as a result of the addition of the Pathnet Telecom guarantees and the pledge of
collateral.
It is possible that Pathnet's capacity to meet the payment obligations will
change from "primarily speculative" to "adequate," thereby creating a deemed
exchange of the notes for New Notes. In the opinion of Covington, even if a
deemed exchange results, the deemed exchange of the notes for New Notes will be
characterized as a tax-free recapitalization under section 368(a)(1)(E) of the
tax code provided, as discussed below, both the notes and the New Notes
constitute securities within the meaning of Section 354 of the tax code. In such
case, except as described below with respect to the consent fee, it is
Covington's opinion that a holder will not recognize gain or loss as a result of
the deemed exchange.
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Whether a debt instrument constitutes a "security" within the meaning of
Section 354 of the tax code depends upon the terms, conditions and other facts
and circumstances relating to the instrument. Generally, instruments with terms
to maturity of ten years or more are treated as securities, and instruments with
terms to maturity of five years or less are generally not treated as securities.
Nevertheless, the IRS and the courts have taken the position that the term to
maturity is not the sole determinative factor, and other factors must be
considered, including the degree of participation and continuing interest in the
business, the extent of proprietary interest compared with the similarity of the
debt to a cash payment, the purposes of the advances, the degree of
subordination of the debt, the debt's exposure to the risks of the enterprise,
and other factors. Based upon an evaluation of these and other factors, Pathnet
intends to take the position that the notes and the New Notes constitute
securities within the meaning of Section 354 of the tax code. However, Covington
has advised Pathnet that, due to the lack of specific guidance and the
inherently factual nature of this determination, Covington is unable to render
an opinion that the notes and the New Notes are securities.
It is Covington's opinion that if an exchange were deemed to occur under
general principles of tax law or under the standards set forth in the tax
regulations, and if either the notes or the New Notes did not constitute
securities within the meaning section 354 of the tax code, then a holder
generally will recognize gain or loss in an amount equal to the difference
between the holder's amount realized and the holder's adjusted tax basis in the
notes deemed to have been exchanged. The holder's amount realized generally will
be the "issue price" of the New Notes. The "issue price" of the New Notes will
equal the stated redemption price at maturity of the New Notes, assuming neither
the notes nor the New Notes are "publicly traded" within the meaning of the tax
regulations. It is uncertain whether the notes or the New Notes will be
considered publicly traded because, among other things, certain events after the
date of the deemed exchange could cause the New Notes to satisfy the publicly
traded test set forth in the tax regulations. Such events would include the
appearance of price information regarding the New Notes, in the form of recent
price quotations or actual prices of recent sales transactions, on a quotation
system of general circulation within 30 days after the New Notes are issued.
Accordingly, Covington expresses no opinion on whether the notes or the New
Notes will be publicly traded within the meaning of the tax regulations. If the
notes or the New Notes are publicly traded, it is Covington's opinion that the
issue price of the New Notes will be equal to their fair market value at the
time of the deemed exchange. All or a portion of any gain from the deemed
exchange will constitute ordinary income to the extent the holder purchased the
notes at a market discount, i.e., at an amount less than the stated redemption
price at maturity of the notes.
If a deemed exchange occurs, regardless of whether both the notes and the
New Notes constitute securities within the meaning of section 354 of the tax
code, the New Notes may be treated as issued with original issue discount. The
New Notes generally will have original issue discount if they have an issue
price that is less than their stated redemption price at maturity. As discussed
above, the issue price of the New Notes will depend in part on whether the notes
or the New Notes are "publicly traded" within the meaning of the tax
regulations. If there is a deemed exchange and the notes or the New Notes are
publicly traded, the New Notes likely will have significant original issue
discount. If the New Notes are treated as issued with original issue discount,
holders of the New Notes will be required to include such discount in income as
it accrues, in advance of the receipt of cash attributable to such income. In
addition, a corporate holder may be entitled to claim a dividends received
deduction with respect to a portion of such original issue discount in the event
that the New Notes qualify as "applicable high yield discount obligations" under
Section 163 of the tax code. If a holder's tax basis in the New Notes deemed
received exceeds the stated redemption price at maturity of the notes that are
deemed to be exchanged for the New Notes, a holder generally may elect to
amortize such premium.
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TAX CONSEQUENCES TO HOLDERS THAT DO NOT CONSENT
Provided that holders of a majority in principal amount of the notes
provide the necessary consents and waivers, the proposed indenture amendments
and waivers will apply to all holders -- not merely those who consent.
Accordingly, the federal income tax consequences to holders that do not consent
will be the same as those described above for holders that provide their
consent.
RECEIPT OF CONSENT FEE
Because there is no authority specifically addressing the issue, Covington
is unable to render an opinion as to whether the consent fee will be treated as
a fee paid to the holders for their consent or, alternatively, as a premium that
is part of a deemed exchange. Pathnet intends to treat the consent fee as a fee
paid to the holders for their consent. It is Covington's opinion that if this
treatment is correct, the holders will recognize ordinary income for federal
income tax purposes in an amount equal to the consent fee to which they are
entitled, when the consent fee is received or accrued, in accordance with their
method of accounting. However, if a deemed exchange occurs and the exchange
constitutes a tax-free recapitalization, the IRS might treat the consent fee as
part of the recapitalization exchange rather than as a separate fee. In this
event, it is Covington's opinion that a holder receiving a consent fee will
recognize taxable gain to the extent of the lesser of (1) the consent fee
received or (2) the gain realized by the holder on the deemed exchange.
BACKUP WITHHOLDING
The receipt of a consent fee by a holder may be subject to backup
withholding at a rate of 31% of the consent fee payable to a particular holder
of a note unless (1) the holder is a corporation or comes within certain other
exempt categories and, when required, demonstrates this fact, or (2) the holder
provides a taxpayer identification number, certifies as to no loss of exemption
from backup withholding and otherwise complies with applicable requirements of
the backup withholding rules. The amount of any backup withholding from a
payment to a holder generally will be allowed as a credit against such holder's
federal income tax liability.
TAX CONSEQUENCES TO PATHNET
Assuming the waivers, the proposed indenture amendments and payment of the
consent fee do not constitute a significant modification of the notes resulting
in a deemed exchange for federal income tax purposes of the notes for New Notes,
Pathnet will not recognize any gain or loss as a result of the waivers, the
amendments and payment of the consent fee. As discussed above, Covington
expresses no opinion as to whether a deemed exchange will occur. Pathnet intends
to take the position that a deemed exchange will not occur. If a deemed exchange
does occur, it is Covington's opinion that Pathnet will not recognize gain or
loss except that Pathnet will recognize cancellation of indebtedness income to
the extent that the "issue price" of the New Notes is less than the principal
amount of the notes. As discussed above, the issue price of the New Notes will
depend, among other things, upon whether the notes or the New Notes are publicly
traded within the meaning of the tax regulations. If the notes or the New Notes
are publicly traded, the issue price of the New Notes could be significantly
less than the principal amount of the notes. It is Covington's opinion that in
this event, Pathnet will recognize a substantial amount of cancellation of
indebtedness income. Moreover, we cannot assure you that Pathnet's net operating
losses in prior years could be used to offset such income and thereby reduce any
taxes payable with respect to such income.
If, as discussed above, the notes bear original issue discount as a result
of the deemed exchange, Pathnet will have additional interest deductions
available to it by reason of such original issue discount. However, Pathnet's
ability to deduct the original issue discount may be deferred (or even
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disallowed in part) if the New Notes have significant original issue discount
and satisfy other requirements set forth in Section 163 of the Code with respect
to "applicable high yield discount obligations." The New Notes will have
significant original issue discount as a result of the waivers, the proposed
Indenture amendments, and payment of the consent fee only if there is a deemed
exchange of the notes for New Notes, and the notes or the New Notes are publicly
traded within the meaning of the tax regulations.
HOLDERS OF NOTES SHOULD CONSULT THEIR OWN TAX ADVISORS TO DETERMINE THE
SPECIFIC TAX CONSEQUENCES TO SUCH HOLDERS OF THIS SOLICITATION, INCLUDING THE
LIKELIHOOD THAT THE WAIVERS, THE PROPOSED INDENTURE AMENDMENTS OR THE RECEIPT OF
THE CONSENT FEE WILL RESULT IN A DEEMED EXCHANGE OF THE NOTES, AS WELL AS THE
APPLICATION AND EFFECT OF STATE, LOCAL, FOREIGN AND OTHER TAX LAWS.
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PLAN OF DISTRIBUTION
Pathnet will solicit consents from and offer payment of the consent fee to
all holders of the notes, and will purchase and pledge, for the benefit of the
holders of the notes, additional securities sufficient to cover the October 16,
2000 interest payment on the notes, in each case contingent upon Pathnet's
receipt of the requisite consents. If the consent solicitation is successful and
Pathnet obtains, before the expiration of the consent solicitation process, the
required consents from the holders of a majority in outstanding principal amount
of the notes, we will execute the supplemental indenture and issue our
guarantees to all holders of the notes.
LEGAL MATTERS
Certain legal matters relating to the guarantees offered in this prospectus
will be passed upon on our behalf by Covington & Burling. Covington has from
time to time represented, and may continue to represent, us and our affiliates
in certain legal matters.
EXPERTS
The Pathnet, Inc. financial statements as of December 31, 1999 and 1998 and
for each of the three years in the period ended December 31, 1999 included in
this prospectus have been so included in reliance on the report of
PricewaterhouseCoopers LLP, independent public accountants, given on the
authority of the firm as experts in accounting and auditing.
The Pathnet Telecommunications, Inc. financial statements as of December
31, 1999 and for the period November 1, 1999 (date of inception) to December 31,
1999 included in this prospectus have been so included in reliance on the report
of PricewaterhouseCoopers LLP, independent public accountants, given on the
authority of the firm as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549, a registration statement on Form S-1 under
the Securities Act regarding the offering. As permitted by the rules and
regulations of the SEC, this prospectus does not contain all the information
contained in the registration statement. For further information about us and
the offering, you can read the registration statement and the exhibits and
financial schedules filed with the registration statement. You can read a copy
of each contract or other document filed as an exhibit to the registration
statement.
Pathnet is currently subject to the informational reporting requirements of
the Exchange Act and files periodic reports and other information with the SEC.
We are filing an appropriate form to become a reporting company under the
Exchange Act. As a reporting company, we will file periodic reports and other
information with the SEC. Pathnet plans to deregister as a reporting company
under the rules of the SEC when possible.
You can inspect the registration statement and the exhibits and schedules
to the registration statement, as well as the periodic reports, proxy statements
and other information we file with the SEC, without charge at the Public
Reference Section of the SEC located at Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549. You may obtain information on the
operation of the Public Reference Section of the SEC by calling the SEC at
1-800-SEC-0330. You can also inspect and copy these filings at the regional
offices of the SEC located at Seven World Trade Center, 13th Floor, New York,
New York 10048 and the Citicorp Center, 500 West Madison
156
<PAGE> 159
Street, Suite 1400, Chicago, Illinois 60661. You can obtain copies of all or any
portion of these filings from the Public Reference Section of the SEC upon
payment of prescribed fees. The SEC also maintains an Internet site at
http://www.sec.gov that contains reports and information statements regarding
issues, including Pathnet Telecom, that file electronically with the SEC.
Pathnet is required under the terms of the indenture to provide the
periodic reports it files with the SEC to each holder of the notes and to the
trustee under the indenture. Upon the effectiveness of the supplemental
indenture, we will be required to provide the periodic reports to holders of the
notes and the trustee, and Pathnet will be relieved of these obligations,
subject to the requirements of applicable law.
157
<PAGE> 160
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PATHNET INC. AND SUBSIDIARIES -- AUDITED FINANCIAL
STATEMENTS
Report of Independent Accountants......................... F-2
Consolidated Balance Sheets as of December 31, 1999 and
1998................................................... F-3
Consolidated Statements of Operations for the years ended
December 31, 1999, 1998 and 1997 and for the period
August 25, 1995 (date of inception) to
December 31, 1999...................................... F-4
Consolidated Statements of Comprehensive Loss for the
years ended December 31, 1999, 1998 and 1997, and for
the period August 25, 1995 (date of inception) to
December 31, 1999...................................... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998 and 1997, and for the period
August 25, 1995 (date of inception) to
December 31, 1999...................................... F-6
Consolidated Statements of Stockholders' Equity (Deficit)
for the period August 25, 1995 (date of inception) to
December 31, 1999 and for the years ended December 31,
1997, 1998 and 1999.................................... F-7
Notes to Consolidated Financial Statements................ F-8
PATHNET TELECOMMUNICATIONS, INC. -- AUDITED FINANCIAL
STATEMENTS
Report of Independent Accountants......................... F-24
Balance Sheet as of December 31, 1999..................... F-25
Statement of Operations for the period November 1, 1999
(date of inception) through December 31, 1999.......... F-26
Statement of Cash Flow for the period November 1, 1999
(date of inception) through December 31, 1999.......... F-27
Statement of Stockholders' Equity for the period November
1, 1999 (date of inception) through December 31,
1999................................................... F-28
Notes to Financial Statements............................. F-29
</TABLE>
F-1
<PAGE> 161
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
Pathnet, Inc.
In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Pathnet, Inc. and its subsidiaries (a development stage enterprise)
(the Company) at December 31, 1999 and 1998, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1999, 1998 and 1997 and for the period August 25, 1995 (date of inception)
to December 31, 1999, in conformity with accounting principles generally
accepted in the United States. 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 auditing standards generally accepted in the
United States, 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
McLean, Virginia
February 22, 2000
F-2
<PAGE> 162
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1999 1998
------------- ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents................................... $ 90,661,837 $ 57,321,887
Note receivable............................................. -- 3,206,841
Interest receivable......................................... 1,048,417 3,848,753
Marketable securities available for sale, at market......... 42,651,836 97,895,773
Prepaid expenses and other current assets................... 1,437,464 205,505
------------- ------------
Total current assets.................................... 135,799,554 162,478,759
Property and equipment, net................................. 131,928,365 47,971,336
Deferred financing costs, net............................... 9,649,680 10,508,251
Restricted cash............................................. 16,452,916 10,731,353
Marketable securities available for sale, at market......... 5,088,458 71,899,757
Pledged marketable securities held to maturity.............. 21,265,206 61,824,673
Other assets................................................ 351,808 --
------------- ------------
Total assets............................................ $ 320,535,987 $365,414,129
============= ============
LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
Accounts payable............................................ $ 18,543,195 $ 10,708,263
Accrued interest............................................ 8,932,293 8,932,294
Accrued expenses and other liabilities...................... 3,113,181 639,688
------------- ------------
Total current liabilities............................... 30,588,669 20,280,245
12 1/4% Senior Notes, net of unamortized bond discount of
$3,378,375 and $3,787,875................................. 346,621,625 346,212,125
Other noncurrent liabilities................................ 3,092,779 --
------------- ------------
Total liabilities....................................... 380,303,073 366,492,370
------------- ------------
Series A convertible preferred stock, $0.01 par value,
1,000,000 shares authorized, issued and outstanding at
December 31, 1999 and 1998, respectively (liquidation
preference $1,000,000).................................... 1,000,000 1,000,000
Series B convertible preferred stock, $0.01 par value,
1,651,046 shares authorized, issued and outstanding at
December 31, 1999 and 1998, respectively (liquidation
preference $5,033,367).................................... 5,008,367 5,008,367
Series C convertible preferred stock, $0.01 par value,
2,819,549 shares authorized, issued and outstanding at
December 31, 1999 and 1998, respectively (liquidation
preference $30,000,052)................................... 29,961,272 29,961,272
------------- ------------
Total mandatorily redeemable preferred stock............ 35,969,639 35,969,639
------------- ------------
Common stock, $0.01 par value, 60,000,000 shares authorized,
3,068,218 and 2,902,358 shares issued and outstanding at
December 31, 1999 and 1998, respectively.................. 30,682 29,024
Deferred compensation....................................... (441,760) (978,064)
Additional paid-in capital.................................. 6,264,362 6,156,406
Accumulated other comprehensive (loss) income............... (90,240) 208,211
Deficit accumulated during the development stage............ (101,499,769) (42,463,457)
------------- ------------
Total stockholders' equity (deficit).................... (95,736,725) (37,047,880)
------------- ------------
Total liabilities, mandatorily redeemable preferred
stock and stockholders' equity (deficit)............... $ 320,535,987 $365,414,129
============= ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 163
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE PERIOD
AUGUST 25, 1995
FOR THE YEAR ENDED DECEMBER 31, (DATE OF INCEPTION)
----------------------------------------- TO DECEMBER 31,
1999 1998 1997 1999
------------ ------------ ----------- -------------------
<S> <C> <C> <C> <C>
Revenue................................ $ 3,311,096 $ 1,583,539 $ 162,500 $ 5,058,135
------------ ------------ ----------- -------------
Operating expenses:
Cost of revenue...................... 12,694,909 7,547,620 -- 20,242,529
Selling, general and
administrative.................... 14,669,747 9,615,867 4,247,101 30,295,096
Reorganization expenses.............. 1,022,998 -- -- 1,022,998
Depreciation expense................. 6,204,381 732,813 46,642 6,993,212
------------ ------------ ----------- -------------
Total operating expenses.......... 34,592,035 17,896,300 4,293,743 58,553,835
------------ ------------ ----------- -------------
Operating loss......................... (31,280,939) (16,312,761) (4,131,243) (53,495,700)
Interest expense....................... (41,010,069) (32,572,454) -- (73,997,880)
Interest income........................ 13,111,953 13,940,240 159,343 27,227,189
Write-off of initial public offering
costs................................ -- (1,354,534) -- (1,354,534)
Other income (expense), net............ 142,743 2,913 (5,500) 140,156
------------ ------------ ----------- -------------
Net loss.......................... $(59,036,312) $(36,296,596) $(3,977,400) $(101,480,769)
============ ============ =========== =============
Basic and diluted net loss per common
share................................ $ (20.14) $ (12.51) $ (1.37)
============ ============ ===========
Weighted average number of common
shares outstanding................... 2,931,644 2,902,029 2,900,000
============ ============ ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 164
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
<TABLE>
<CAPTION>
FOR THE PERIOD
AUGUST 25, 1995
FOR THE YEAR ENDED DECEMBER 31, (DATE OF INCEPTION)
----------------------------------------- TO DECEMBER 31,
1999 1998 1997 1999
------------ ------------ ----------- -------------------
<S> <C> <C> <C> <C>
Net loss............................... $(59,036,312) $(36,296,596) $(3,977,400) $(101,480,769)
Other comprehensive (loss) income:
Net unrealized (loss) gain on
marketable
securities available for sale........ (298,451) 208,211 -- (90,240)
------------ ------------ ----------- -------------
Comprehensive loss..................... $(59,334,763) $(36,088,385) $(3,977,400) $(101,571,009)
============ ============ =========== =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 165
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE YEAR ENDED AUGUST 25, 1995
DECEMBER 31, (DATE OF INCEPTION)
------------------------------------------ TO DECEMBER 31,
1999 1998 1997 1999
------------ ------------- ----------- -------------------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $(59,036,312) $ (36,296,596) $(3,977,400) $(101,480,769)
Adjustment to reconcile net loss to net cash used in
operating activities:
Depreciation expense.................................... 6,204,381 732,813 46,642 6,993,212
Amortization of deferred financing costs................ 1,138,722 842,790 -- 1,981,512
Loss on sale of equipment............................... 17,370 -- 5,500 22,870
Gain on sale of marketable securities................... (157,983) -- -- (157,983)
Write-off of deferred financing costs................... -- 581,334 -- 581,334
Interest expense resulting from amortization of discount
on the bonds payable.................................. 409,500 307,125 -- 716,625
Amortization of premium on pledged securities........... 537,251 -- -- 537,251
Amortization of deferred compensation................... 536,304 701,295 -- 1,237,599
Interest expense for beneficial conversion feature of
bridge loan........................................... -- -- -- 381,990
Accrued interest satisfied by conversion of bridge loan
to series B convertible preferred stock............... -- -- -- 33,367
Changes in assets and liabilities:
Interest receivable..................................... 3,370,552 (4,846,952) -- (1,476,400)
Prepaid expenses and other current assets............... (1,583,767) (156,935) (46,876) (1,789,272)
Accounts payable........................................ 689,533 6,709 386,106 3,683,391
Accrued interest........................................ -- 8,932,294 -- 8,932,293
Accrued expenses and other liabilities.................. 2,816,674 339,688 269,783 3,456,361
------------ ------------- ----------- -------------
Net cash used in operating activities................. (45,057,775) (28,856,435) (3,316,245) (76,346,619)
------------ ------------- ----------- -------------
Cash flows from investing activities:
Expenditures for network in progress...................... (79,378,740) (33,619,342) (1,739,782) (117,224,107)
Expenditures for property and equipment................... (910,668) (2,769,076) (381,261) (4,116,561)
Proceeds from sale of equipment........................... 5,624 -- -- 5,624
Sale of marketable securities available for sale.......... 170,446,259 51,542,384 -- 221,988,643
Purchase of marketable securities available for sale...... (48,531,491) (221,129,703) -- (269,661,194)
Purchase of pledged marketable securities held to
maturity................................................ -- (83,097,655) -- (83,097,655)
Maturity of pledged marketable securities held to
maturity................................................ 39,452,000 22,271,181 -- 61,723,181
Restricted cash........................................... (5,721,563) (9,971,142) (760,211) (16,452,916)
Issuance of note receivable to incumbent.................. -- (3,206,841) -- (3,206,841)
Repayment of note receivable.............................. 3,206,841 9,000 -- 3,215,841
------------ ------------- ----------- -------------
Net cash provided by (used in) investing activities..... 78,568,262 (279,971,194) (2,881,254) (206,825,985)
------------ ------------- ----------- -------------
Cash flows from financing activities:
Issuance of voting and non-voting common stock............ -- -- -- 1,000
Proceeds from sale of preferred stock..................... -- 19,999,998 12,000,054 35,000,052
Proceeds from sale of series B convertible preferred stock
representing the conversion of committed but undrawn
portion of bridge loan to series B convertible preferred
stock................................................... -- -- -- 300,000
Proceeds from bond offering............................... -- 350,000,000 -- 350,000,000
Proceeds from bridge loan................................. -- -- -- 700,000
Exercise of employee common stock options................. 109,614 81 -- 109,695
Payment of issuance costs for preferred stock offerings... -- -- (38,780) (63,780)
Payment of deferred financing costs....................... (280,151) (11,681,947) (250,428) (12,212,526)
------------ ------------- ----------- -------------
Net cash (used in) provided by financing activities..... (170,537) 358,318,132 11,710,846 373,834,441
------------ ------------- ----------- -------------
Net increase in cash and cash equivalents................... 33,339,950 49,490,503 5,513,347 90,661,837
Cash and cash equivalents at the beginning of period........ 57,321,887 7,831,384 2,318,037 --
------------ ------------- ----------- -------------
Cash and cash equivalents at the end of period.............. $ 90,661,837 $ 57,321,887 $ 7,831,384 $ 90,661,837
============ ============= =========== =============
Supplemental disclosure:
Cash paid for interest.................................... $ 43,081,220 $ 22,271,234 $ -- $ 65,352,454
============ ============= =========== =============
Noncash investing and financing transactions:
Conversion of bridge loan plus accrued interest to
series B convertible preferred stock.................. $ -- $ -- $ -- $ 733,367
------------ ------------- ----------- -------------
Conversion of non-voting common stock to voting common
stock................................................. $ -- $ -- $ -- $ 500
------------ ------------- ----------- -------------
Issuance of voting and non-voting common stock.......... $ -- $ -- $ -- $ 9,000
------------ ------------- ----------- -------------
Acquisition of network equipment financed by accounts
payable and other long-term obligations............... $ 20,359,001 $ 10,200,650 $ 5,092,013 $ 20,359,001
------------ ------------- ----------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE> 166
PATHNET INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
NOTE OTHER
COMMON STOCK RECEIVABLE ADDITIONAL COMPREHENSIVE
--------------------- FROM DEFERRED PAID-IN INCOME
SHARES AMOUNT STOCKHOLDER COMPENSATION CAPITAL (LOSS)
---------- -------- ----------- ------------ ---------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT AUGUST 25, 1995 (date of
inception)................................. -- $ -- $ -- $ -- $ -- $ --
Issuance of Voting common stock.............. 1,450,000 14,500 (4,500) -- -- --
Issuance of Non-voting common stock.......... 1,450,000 14,500 (4,500) -- -- --
Net loss..................................... -- -- -- -- -- --
---------- -------- ------- ----------- ---------- --------
BALANCE AT DECEMBER 31, 1995................. 2,900,000 29,000 (9,000) -- -- --
Cancellation of Non-voting common stock...... (1,450,000) (14,500) -- -- -- --
Issuance of Voting common stock.............. 1,450,000 14,500 -- -- -- --
Interest expense for beneficial conversion
feature of bridge loan..................... -- -- -- -- 381,990 --
Net loss..................................... -- -- -- -- -- --
---------- -------- ------- ----------- ---------- --------
BALANCE AT DECEMBER 31, 1996................. 2,900,000 29,000 (9,000) -- 381,990 --
Net loss..................................... -- -- -- -- -- --
---------- -------- ------- ----------- ---------- --------
BALANCE AT DECEMBER 31, 1997................. 2,900,000 29,000 (9,000) -- 381,990 --
Exercise of stock options.................... 2,358 24 -- -- 57 --
Repayment of note receivable................. -- -- 9,000 -- -- --
Deferred compensation expense related to
issuance of employee common stock
options.................................... -- -- -- (1,679,359) 1,679,359 --
Amortization of deferred compensation expense
related to issuance of employee common
stock options.............................. -- -- -- 701,295 -- --
Fair value of warrants to purchase common
stock...................................... -- -- -- -- 4,095,000 --
Net unrealized gain on marketable securities
available for sale......................... -- -- -- -- -- 208,211
Net loss..................................... -- -- -- -- -- --
---------- -------- ------- ----------- ---------- --------
BALANCE AT DECEMBER 31, 1998................. 2,902,358 29,024 -- (978,064) 6,156,406 208,211
Exercise of stock options.................... 165,860 1,658 107,956
---------- -------- ------- ----------- ---------- --------
Amortization of deferred compensation expense
related to issuance of employee common
stock options.............................. -- -- -- 536,304 -- --
Net unrealized gain on marketable securities
available for sale......................... -- -- -- -- -- (298,451)
Net loss..................................... -- -- -- -- -- --
---------- -------- ------- ----------- ---------- --------
BALANCE AT DECEMBER 31, 1999................. 3,068,218 $ 30,682 $ -- $ (441,760) $6,264,362 $(90,240)
========== ======== ======= =========== ========== ========
<CAPTION>
DEFICIT
ACCUMULATED
DURING
DEVELOPMENT
STAGE TOTAL
------------- ------------
<S> <C> <C>
BALANCE AT AUGUST 25, 1995 (date of
inception)................................. $ -- $ --
Issuance of Voting common stock.............. (9,500) 500
Issuance of Non-voting common stock.......... (9,500) 500
Net loss..................................... (426,826) (426,826)
------------- ------------
BALANCE AT DECEMBER 31, 1995................. (445,826) (425,826)
Cancellation of Non-voting common stock...... -- (14,500)
Issuance of Voting common stock.............. -- 14,500
Interest expense for beneficial conversion
feature of bridge loan..................... -- 381,990
Net loss..................................... (1,743,635) (1,743,635)
------------- ------------
BALANCE AT DECEMBER 31, 1996................. (2,189,461) (1,787,471)
Net loss..................................... (3,977,400) (3,977,400)
------------- ------------
BALANCE AT DECEMBER 31, 1997................. (6,166,861) (5,764,871)
Exercise of stock options.................... -- 81
Repayment of note receivable................. -- 9,000
Deferred compensation expense related to
issuance of employee common stock
options.................................... -- --
Amortization of deferred compensation expense
related to issuance of employee common
stock options.............................. -- 701,295
Fair value of warrants to purchase common
stock...................................... -- 4,095,000
Net unrealized gain on marketable securities
available for sale......................... -- 208,211
Net loss..................................... (36,296,596) (36,296,596)
------------- ------------
BALANCE AT DECEMBER 31, 1998................. (42,463,457) (37,047,880)
Exercise of stock options.................... 109,614
------------- ------------
Amortization of deferred compensation expense
related to issuance of employee common
stock options.............................. -- 536,304
Net unrealized gain on marketable securities
available for sale......................... -- (298,451)
Net loss..................................... (59,036,312) (59,036,312)
------------- ------------
BALANCE AT DECEMBER 31, 1999................. $(101,499,769) $(95,736,725)
============= ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
<PAGE> 167
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY
Pathnet, Inc. (Company) is a wholesale telecommunications provider building
a nationwide network designed to provide other wholesale and retail
telecommunications service providers with access to underserved and second and
third tier markets throughout the United States. The Company's network will
enable its customers including existing local telephone companies, long distance
companies, Internet service providers, competitive telecommunications companies,
cellular operators and other telecommunications service providers to offer
additional services to new and existing customers in these markets without
having to expend their own resources to build, expand, or upgrade their own
networks.
During 1999, Pathnet continued to construct and deploy digital networks
utilizing both wireless and fiber-optic technologies. Pursuant to its agreement
with Worldwide Fiber USA (WFI), the Company began to construct and market a
multi-conduit fiber-optic network between Chicago, Illinois and Denver, Colorado
during the second quarter. In August 1999, the Company announced it will
co-develop a 400 mile fiber network connecting Grand Junction, Colorado to
Albuquerque, New Mexico with Tri-State Generation and Transmission Association,
Inc. (Tri-State).
As of December 31, 1999, the Company's network consisted of over 6,300
wireless route miles providing wholesale transport services to 30 cities and 500
miles of installed fiber. The Company is constructing an additional 600 route
miles of fiber network, which is scheduled for completion in the first half of
2000.
Since inception, the Company's business has been funded primarily through
equity investments by the Company's stockholders and $350.0 million aggregate
principal amount of 12 1/4% Senior Notes due 2008 (Senior Notes) which have been
registered under the Securities Act.
A substantial portion of the Company's initial activities involved
developing strategic relationships with co-developers such as railroads,
pipelines and utilities and building its network. Accordingly, most of its
earlier revenues reflected only project management and advisory services in
connection with the design, development and construction of its network.
Revenues from the sale of telecommunication services along the Company's digital
network are approximately 51% to date. The Company has experienced significant
operating and net losses and negative operating cash flow to date and expects to
continue to experience operating and net losses and negative operating cash flow
until such time as it is able to generate revenue sufficient to cover its
operating losses.
2. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF ACCOUNTING
The Company recently commenced providing telecommunication services to
customers and recognizing the revenue from the sale of such telecommunication
services. The Company's principal activities to date have been securing
contractual alliances with its co-development partners, designing and
constructing network path segments, obtaining capital and planning its proposed
service. Accordingly, the Company's consolidated financial statements are
presented as a development stage enterprise, as prescribed by Statement of
Financial Accounting Standards No. 7, "Accounting and Reporting by Development
Stage Enterprises." As a development stage enterprise, the Company has been
relying on the issuance of equity and debt securities, rather than recurring
revenues, for its primary sources of cash since inception.
F-8
<PAGE> 168
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONSOLIDATION
The consolidated financial statements include the accounts of Pathnet, Inc.
and its wholly owned subsidiaries, Pathnet Finance I, LLC, Pathnet/Idaho Power
License, LLC, Pathnet Fiber Optics, LLC and Pathnet/BNSF Equipment, LLC. All
material intercompany accounts and transactions have been eliminated in
consolidation.
USE OF ESTIMATES
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reported period. The estimates involve judgments with
respect to, among other things, various future factors which are difficult to
predict and are beyond the control of the Company. Actual amounts could differ
from these estimates.
LOSS PER SHARE
Basic earnings (loss) per share is computed by dividing net income (loss)
by the weighted average number of shares of Common Stock outstanding during the
applicable period. Diluted earnings (loss) per share is computed by dividing net
income (loss) by the weighted average common and potentially dilutive common
equivalent shares outstanding during the applicable period. For each of the
periods presented, basic and diluted loss per share are the same. The exercise
of 2,675,597 employee Common Stock options, the exercise of warrants to purchase
1,116,500 shares of Common Stock, and the conversion of 5,470,595 shares of
Series A, B and C convertible preferred stock into 15,864,715 shares of Common
Stock as of December 31, 1999, which could potentially dilute basic earnings per
share in the future were not included in the computation of diluted loss per
share for the periods presented because to do so would have been antidilutive in
each case.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company believes that the carrying amount of certain of its financial
instruments, which include cash equivalents and accounts payable, approximate
fair value due to the relatively short maturity of these instruments. As of
December 31, 1999, the fair value of the Company's 12 1/4% Senior Notes was
approximately $220.5 million.
CASH EQUIVALENTS
The Company considers all highly liquid instruments with an original
maturity of three months or less to be cash equivalents.
CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk consist of cash and cash equivalents, marketable
securities and associated interest receivable, note receivable, and restricted
cash. Marketable securities and associated interest receivable include U.S.
Treasury securities and debt securities of U.S. Government agencies,
certificates of deposit and money market funds, and corporate debt securities.
The Company has invested its excess cash in a money market fund with a
commercial bank. The money market fund is collateralized by the
F-9
<PAGE> 169
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
underlying assets of the fund. The Company's restricted cash is maintained in an
escrow account (see Note 7) at a major bank. The Company has not experienced any
losses on its cash and cash equivalents and restricted cash.
MARKETABLE SECURITIES
Management determines the appropriate classification of its investments in
marketable securities at the time of purchase and reevaluates such
determinations at each balance sheet date. Debt securities are classified as
held to maturity when the Company has the positive intent and ability to hold
the securities to maturity. The Company has classified certain securities as
held to maturity pursuant to a pledge agreement. Held to maturity securities are
stated at amortized cost. Debt securities for which the Company does not have
the intent or ability to hold to maturity are classified as available for sale,
along with any investments in equity securities. Securities are classified as
current or noncurrent based on the maturity date. Securities available for sale
are carried at fair value based on quoted market prices at the balance sheet
date, with unrealized gains and losses reported as part of accumulated other
comprehensive income (loss).
The amortized cost of debt securities is adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization and interest
are included in interest income or expense. Realized gains and losses are
included in other income (expense), net in the consolidated statements of
operations. The cost of securities sold is based on the specific identification
method. The Company's investments in debt and equity securities are diversified
among high credit quality securities in accordance with the Company's investment
policy.
PROPERTY AND EQUIPMENT
Property and equipment, consisting of network in progress, communications
network, office and computer equipment, furniture and fixtures and leasehold
improvements, is stated at cost. Network in progress costs incurred during
development, including interest, are capitalized. Depreciation of the completed
communications network commences when the network equipment is ready for its
intended use and is computed using the straight-line method with estimated
useful lives of network assets ranging between three to twenty years.
Depreciation of the office and computer equipment and furniture and fixtures is
computed using the straight-line method, generally over three to five years,
based upon estimated useful lives, commencing when the assets are available for
service. Leasehold improvements are amortized over the lesser of the useful
lives of the assets or the lease term. Expenditures for maintenance and repairs
are expensed as incurred. When assets are retired or disposed, the cost and the
related accumulated depreciation are removed from the accounts, and any
resulting gain or loss is recognized in operations for the period.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company periodically evaluates the recoverability of its long-lived
assets. This evaluation consists of a comparison of the carrying value of the
assets with the assets' expected future cash flows, undiscounted and without
interest costs. Estimates of expected future cash flows represent management's
best estimate based on reasonable and supportable assumptions and projections.
If the expected future cash flow, undiscounted and without interest charges,
exceeds the carrying value of the asset, no impairment is recognized. Impairment
losses are measured as the difference between the carrying value of long-lived
assets and their fair value.
F-10
<PAGE> 170
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DEFERRED INCOME TAXES
The Company uses the liability method of accounting for income taxes.
Deferred income taxes result from temporary differences between the tax bases of
assets and liabilities and their financial reporting amounts at each year-end,
based on enacted laws and statutory tax rates applicable to the periods in which
the differences are expected to affect taxable income. Valuation allowances are
established when necessary, to reduce net deferred tax assets to the amount
expected to be realized. The provision for income taxes consists of the
Company's current provision for federal and state income taxes and the change in
the Company's net deferred tax assets and liabilities during the period.
REVENUE RECOGNITION
The Company earns revenue from the sale of telecommunication capacity and
for project management and consulting services. Revenue from the sale of
telecommunications capacity is earned when the service is provided. Revenue for
project management and consulting services is recognized over the related
project period as milestones are achieved. The Company defers revenue when
contractual payments are received in advance of the performance of services.
Revenue from the sale of telecommunications capacity includes revenue
earned under indefeasible right to use agreements. The Company recognizes
revenue earned under such agreements on a straight-line basis over their term.
DEFERRED FINANCING COSTS
The Company has incurred costs related to the Debt Offering together with
costs associated with obtaining future debt financing arrangements. Such costs
are amortized over the term of the debt or financing arrangement other than when
financing has not been obtained, in which case, the costs are expensed
immediately.
SEGMENT REPORTING
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures About Segments of an Enterprise and Related Information" (SFAS No.
131). SFAS No. 131 changes the way public companies report segment information
in annual financial statements and also requires those companies to report
selected segment information in interim financial reports to stockholders. It
also establishes standards for related disclosures about products and services,
geographic areas, and major customers. Management believes the Company's current
operations comprise only one segment, the sale of telecommunications capacity,
and as such, adoption of SFAS No. 131 does not impact the disclosures made in
the Company's financial statements.
NEW ACCOUNTING PRONOUNCEMENT
In July 1999, the Financial Accounting Standards Board (FASB) issued FIN
43, "Real Estate Sales, an interpretation of FASB Statement No. 66". The Company
is still assessing the impact of FIN 43 on its future operations. Specifically,
the Company is assessing the impact of the requirement that title transfer in
order to use sale type lease accounting for IRU arrangements. Under FIN 43 if
title does not transfer then the arrangement is accounted for as an operating
lease. For the year ended December 31, 1999 there has been no revenue generated
from sales of IRU arrangements.
F-11
<PAGE> 171
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. MARKETABLE SECURITIES
The Company's marketable securities are considered "available for sale,"
and, as such, are stated at market value. The net unrealized gains and losses on
marketable securities are reported as part of accumulated other comprehensive
income (loss). Realized gains or losses from the sale of marketable securities
are based on the specific identification method.
The following is a summary of the investments in marketable securities at
December 31, 1999:
<TABLE>
<CAPTION>
GROSS UNREALIZED
------------------------------------------------
COST GAINS LOSSES MARKET VALUE
------------ -------- ------- ------------
<S> <C> <C> <C> <C>
Available for sale securities:
U.S. Treasury securities and debt
securities of U.S. Government
agencies........................... $ 19,363,417 $ -- $59,490 $ 19,303,927
Corporate debt securities............. 26,959,695 8,880 30,088 26,938,407
Debt securities issued by foreign
governments........................ 1,507,422 -- 9,462 1,497,960
------------ -------- ------- ------------
$ 47,830,534 $ 8,800 $99,040 $ 47,740,294
============ ======== ======= ============
</TABLE>
Gross realized gains on sales available for sale securities were
approximately $158,000 during the year ended December 31, 1999. Gross realized
gains and gross realized losses on sales of available for sale securities were
immaterial during the year ended December 31, 1998.
The amortized cost and market value of available for sale securities by
contractual maturity at December 31, 1999 is as follows:
<TABLE>
<CAPTION>
COST MARKET VALUE
----------- ------------
<S> <C> <C>
Due in one year or less..................................... $42,688,416 $42,651,835
Due after one year through two years........................ 5,142,118 5,088,459
----------- -----------
$47,830,534 $47,740,294
=========== ===========
</TABLE>
Expected maturities may differ from contractual maturities because the
issuers of the securities may have the right to prepay obligations without
prepayment penalties.
In addition to marketable securities, the Company has investments in
pledged marketable securities that are pledged as collateral for repayment of
interest on the Company's Senior Notes through April 2000 (see note 8) and are
classified as non-current assets on the consolidated balance sheet. As of
December 31, 1999 pledged marketable securities consisted of U.S. Treasury
securities classified as held to maturity with an amortized cost of
approximately $20.8 million, interest receivable on the pledged marketable
securities of approximately $356,000 and cash and cash equivalents of
approximately $112,000. All of the investments contractually mature March 31,
2000.
4. NOTE RECEIVABLE
In 1998, under the terms of a promissory note with an incumbent, the
Company agreed to advance up to $10.0 million principal for the purpose of
funding the incumbent's equipment expenditures under a Fixed Point Microwave
Services agreement. Equipment expenditures initially incurred by the Company
were recharged at cost to the incumbent as principal under the promissory note.
The principal amount of the promissory note was paid during 1999.
F-12
<PAGE> 172
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. PROPERTY AND EQUIPMENT
Property and equipment, stated at cost, is comprised of the following at
December 31, 1999 and 1998:
<TABLE>
<CAPTION>
1999 1998
------------ -----------
<S> <C> <C>
Network in progress........................................ $ 63,123,322 $38,669,088
Communications network..................................... 71,604,029 6,890,686
Office and computer equipment.............................. 2,262,934 2,267,647
Furniture and fixtures..................................... 1,555,771 766,013
Leasehold improvements..................................... 337,181 166,733
------------ -----------
138,883,237 48,760,167
Less: accumulated depreciation............................. (6,954,872) (788,831)
------------ -----------
Property and equipment, net................................ $131,928,365 $47,971,336
============ ===========
</TABLE>
Network in progress includes (i) all direct material and labor costs
together with related allocable interest costs, necessary to construct
components of a high capacity digital wireless and fiber optic network and (ii)
network related inventory parts and equipment. The network in progress balance
as of December 31, 1999 includes approximately $36.8 million for costs incurred
under the Company's agreement with WFI to construct a digital fiber optic
network and $2.7 million for a right of use under an agreement with Northern
Border Pipeline for microwave access. When a portion of the network has been
completed and made available for use by the Company, the accumulated costs are
transferred from network in progress to communications network and depreciated.
6. DEFERRED FINANCING COSTS
During 1998, the Company incurred total issuance costs of approximately
$11.3 million in connection with the Debt Offering. For the year ended December
31, 1999 and 1998, amortization of the costs of approximately $1.1 million and
$843,000 was charged to interest expense, respectively.
7. RESTRICTED CASH
Restricted cash comprises amounts held in escrow to collateralize the
Company's obligations under certain of its development agreements. The funds in
each escrow account are available only to fund the projects to which the escrow
is related. Generally, funds are released from escrow to pay project costs as
incurred. During the year ended December 31, 1999, the Company deposited
approximately $13.4 million in escrow and $7.7 million was released from escrow.
During the year ended December 31, 1998, the Company deposited approximately
$10.3 million in escrow and no funds were released from escrow.
8. LONG-TERM DEBT
During 1998, the Company completed the Debt Offering for total gross
proceeds of $350.0 million less total issuance costs of approximately $11.3
million. Upon issuance, approximately $345.9 million of the gross proceeds was
allocated to the Senior Notes and approximately $4.1 million was allocated to
the Warrants based upon estimated fair values. The Warrants expire on April 15,
2008. The estimated value attributed to the Warrants has been recorded as a
discount on the face value of the Senior Notes and as additional paid-in
capital. This discount is amortized as an increase to interest expense and the
carrying value of the debt over the related term using the interest method.
F-13
<PAGE> 173
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company has recorded approximately $410,000 and $307,000 of expense for the
years ended December 31, 1999 and 1998, respectively, related to the
amortization of this discount. Interest on the Senior Notes accrues at an annual
rate of 12 1/4%, payable semiannually, in arrears, beginning October 15, 1998,
with principal due in full on April 15, 2008. For the years ended December 31,
1999 and 1998, interest on the Senior Notes was approximately $42.9 million and
$31.3 million, respectively, of which approximately $3.6 million and $362,000,
respectively, was capitalized as network under development. The Company used
approximately $81.1 million of the proceeds related to the Debt Offering to
purchase U.S. Government debt securities, which are restricted and pledged as
collateral for repayment of all interest due on the Senior Notes through April
15, 2000. The Senior Notes are redeemable, in whole or part, at any time on or
after April 15, 2003 at the option of the Company, at the following redemption
prices plus accrued and unpaid interest (1) on or after April 15, 2003; 106% of
the principal amount, (2) on or after April 15, 2004; 104% of the principal
amount, (3) on or after April 15, 2005; 102% of the principal amount and (4) on
or after April 15, 2006; 100% of the principal amount. In addition, at any time
prior to April 15, 2001, the Company may redeem within sixty days, with the net
cash proceeds of one or more public equity offerings, up to 35% of the aggregate
principal amount of the Senior Notes at a redemption price equal to 112.25% of
the principal amount plus accrued and unpaid interest provided that at least 65%
of the original principal amount of the Senior Notes remain outstanding. Upon a
change in control, as defined, each holder of the Senior Notes may require the
Company to repurchase all or a portion of such holder's Senior Notes at a
purchase price of cash equal to 101% of the principal amount plus accrued and
unpaid interest and liquidated damages if any.
The Senior Notes contain certain covenants which restrict the activities of
the Company including limitations of indebtedness, restricted payments,
issuances and sales of capital stock, affiliate transactions, liens, guarantees,
sale of assets and dividends.
9. CAPITAL STOCK TRANSACTIONS
COMMON STOCK
The initial capitalization of the Company, on August 25, 1995, occurred
through the issuance by the Company of 1,450,000 shares of voting common stock
and 1,450,000 shares of non-voting common stock.
On May 8, 1998, the Company filed a registration statement with the SEC for
an initial public offering of common stock (Initial Public Offering). The
Company subsequently postponed the Initial Public Offering. In relation to the
postponement of the Initial Public Offering, the Company wrote off approximately
$1.4 million in expenses, consisting primarily of legal and accounting fees,
printing costs, and SEC and NASDAQ Stock Market fees. On July 24, 1998, the
Company's stockholders approved a 2.9-for-1 stock split which was effected on
August 3, 1998, the record date. All share information has been adjusted for
this stock split for all periods presented.
PREFERRED STOCK
As part of its initial capitalization on August 25, 1995, the Company
initiated a private offering of 1 million shares of Series A convertible
preferred stock for $1 million. Pursuant to the terms of the Investment and
Stockholders' Agreement by and among the Company and certain stockholders of the
Company (Investment and Stockholders Agreement), the offering closed in two
phases of $500,000 each. As of the signing of the Investment and Stockholders
Agreement, the Company received
F-14
<PAGE> 174
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$500,000, representing the first closing on this offering in 1995. In addition,
the offering provided for a convertible bridge loan in the amount of $1 million.
The bridge loan carried an interest rate of 12% per annum and was due and
payable in full on the earlier to occur of the anniversary date of the bridge
loan issuance or the closing date of the Company's next equity financing. The
bridge loan was converted into Series B preferred stock at 73% of the price of
the Series B convertible preferred stock issued in the next equity financing.
In February 1996, the Company issued 500,000 shares of Series A convertible
preferred stock to the original investors in exchange for $500,000, representing
the second closing under the Investment and Stockholders Agreement. In August
1996, the Company drew $700,000 on a bridge loan with the original investors.
On December 23, 1996, the Company consummated a private offering of 609,756
shares of Series B convertible preferred stock for $2 million less issuance
costs of $25,000 pursuant to the Investment and Stockholders Agreement. In
addition, simultaneously, the $700,000 bridge loan plus $33,367 of accrued
interest was converted into 306,242 shares of Series B convertible preferred
stock. The Company recognized $271,107 of interest expense to account for the
beneficial conversion feature of the bridge loan. In addition, $300,000
representing the committed but undrawn portion of the bridge loan, was paid to
the Company for the sale of 125,292 shares of Series B convertible preferred
stock at a discounted rate. The Company recognized $110,883 of interest expense
to account for the beneficial conversion feature of the committed but undrawn
bridge loan. On June 18, 1997, pursuant to the Investment and Stockholders
Agreement, the Company received an additional $2 million in a second closing in
exchange for 609,756 shares of Series B convertible preferred stock. There were
no issuance costs associated with the second closing.
On October 31, 1997, pursuant to the Investment and Stockholders Agreement,
the Company consummated a private offering of 939,850 shares of Series C
convertible preferred stock for approximately $10 million, less issuance costs
of $38,780. On April 8, 1998, pursuant to the Investment and Stockholders
Agreement, the Company consummated a second closing of 1,879,699 shares of
Series C convertible preferred stock for an aggregate purchase price of
approximately $20.0 million. There were no issuance costs associated with the
second closing.
Each share of Series A, Series B and Series C convertible preferred stock
entitles each holder to a number of votes per share equal to the number of
shares of Common Stock into which each share of Series A, Series B and Series C
convertible preferred stock is currently convertible.
The holders of the Series A, Series B and Series C convertible preferred
stock are entitled to receive dividends in preference to and at the same rate as
dividends are paid with respect to the common stock. In the event of any
liquidation, dissolution or winding up of the Company, whether voluntary or
involuntary, holders of each share of Series A, Series B and Series C
convertible preferred stock outstanding are entitled to be paid before any
payment shall be made to the holders of any class of common stock or any stock
ranking on liquidation junior to the convertible preferred stock, an amount, in
cash, equal to the original purchase price paid by such holder plus any declared
but unpaid dividends.
In the event the assets of the Company are insufficient to pay liquidation
preference amounts, then all of the assets available for distribution shall be
distributed pro rata so that each holder receives that portion of the assets
available for distribution as the number of shares of convertible
F-15
<PAGE> 175
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
preferred stock held by such holder bears to the total number of shares of
convertible preferred stock then outstanding.
Shares of the Series A, Series B, and Series C convertible preferred stock
may be converted at any time, at the option of the holder, into voting common
stock. The number of shares of voting common stock entitled upon conversion is
the quotient obtained by dividing the face value of the Series A, Series B and
Series C convertible preferred stock by the Applicable Conversion Rate, defined
as the Applicable Conversion Value of $0.34, $1.13 or $3.67 per share,
respectively.
Each share of convertible preferred stock shall automatically be converted
into the number of shares of voting common stock which such shares are
convertible upon application of the Applicable Conversion Rate immediately upon
the closing of a qualified underwritten public offering covering the offer and
sale of capital stock which is defined as: (1) the Company is valued on a
pre-money basis at greater than $50 million, (2) the gross proceeds received by
the Company exceed $20 million, and (3) the Company uses a nationally recognized
underwriter approved by holders of a majority interest of the Series A, Series B
and Series C convertible preferred stock voting together.
If the Company issues any additional shares of common stock of any class at
a price less than the Applicable Conversion Value, in effect for the Series A,
Series B or Series C convertible preferred stock immediately prior to such
issuance or sale, then the Applicable Conversion Value shall be adjusted
accordingly.
In the event a qualified public offering has not occurred prior to December
23, 2000, the holder of shares of Series A or Series B preferred stock can
require the Company to redeem the shares of Series A and Series B convertible
preferred stock. After receipt from any one holder of an election to have any
shares redeemed, the Company is required to send a notice to the Series A and
Series B preferred stockholders on December 24, 2000 of the redemption price. If
after sending the redemption notice to Series A and Series B preferred
stockholders, the Company receives requests for redemption on or prior to
January 11, 2001, from the holders of at least 67% of the Series A and Series B
convertible preferred stock taken together, the Company must redeem all shares
of Series A and Series B convertible preferred stock. Payment of the redemption
price is due on January 23, 2001, for a cash price equal to the original
purchase price paid by such holders for each share of Series A and Series B
convertible preferred stock as adjusted for any stock split, stock distribution
or stock dividends with respect to such shares. The successful completion of a
qualified public offering is not within the control of the Company. Therefore,
the Company does not present the Series A and Series B preferred stock as a
component of stockholders' equity.
In the event that a qualified public offering has not occurred prior to
November 3, 2001, the holder of shares of Series C preferred stock can require
the Company to redeem the shares of Series C convertible preferred stock. After
receipt from any one holder of an election to have any shares redeemed, the
Company is required to send a notice to the Series C preferred stockholders on
November 4, 2001 of the redemption price. If after sending the redemption notice
to Series C preferred stockholders, the Company receives requests for redemption
on or prior to November 21, 2001, from the holders of at least 67% of the Series
C convertible preferred stock, the Company must redeem all shares of Series C
convertible preferred stock. Payment of the redemption price is due on December
3, 2001 for a cash price equal to the original purchase price paid by such
holders for each share of Series C convertible preferred stock as adjusted for
any stock split, stock distribution or stock dividends with respect to such
shares. The successful completion of a qualified public offering is not
F-16
<PAGE> 176
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
within the control of the Company. Therefore, the Company does not present the
Series C preferred stock as a component of stockholders' equity.
Notwithstanding the provisions for optional redemption described above,
pursuant to a Consent Waiver and Amendment effective March 24, 1998 among the
Company and certain stockholders of the Company, the holders of the Series A,
Series B and Series C convertible preferred stock agreed that no optional
redemption of the Series A, Series B or Series C convertible preferred stock may
be made by the Company prior to 90 days after (1) the final maturity dated of
the Senior Notes (2) or such earlier date (after the redemption date specified
for such preferred stock) as the Senior Notes shall be paid in full.
10. STOCK OPTIONS
On August 25, 1995, the Company adopted the 1995 Stock Option Plan (1995
Plan), under which incentive stock options and non-qualified stock options could
be granted to the Company's employees and certain other persons and entities in
accordance with law. The Compensation Committee, which administers the 1995
Plan, determined the number of options granted, the vesting period and the
exercise price of each award made under the 1995 Plan. The 1995 Plan will
terminate August 28, 2005 unless terminated earlier by the Board of Directors.
During 1998, the Compensation Committee determined that no further awards would
be granted under the 1995 Plan.
Options granted to date under the 1995 Plan generally vest over a three
period and expire either 30 days after termination of employment or 10 years
after date of grant. As of December 31, 1999, a total of 70,731 non-qualified
stock options and 353,662 incentive stock options were issued at an exercise
price of $0.03 per share, an amount estimated to equal or exceed the per share
fair value of the common stock at the time of grant. As of December 31, 1999,
the options issued at an exercise price of $0.03 had a weighted average
contractual life of 5.7 years. As of December 31, 1999, 424,393 of the options
issued at an exercise price of $0.03 were exercisable.
On August 1, 1997, the Company adopted the 1997 Stock Incentive Plan (1997
Plan), under which incentive stock options, non-qualified stock options, stock
appreciation rights, restricted stock, performance awards and certain other
types of awards may be granted to the Company's employees and certain other
persons and entities in accordance with the law. To date, only non-qualified
stock options have been granted under the 1997 Plan. The Compensation Committee,
which administers the 1997 Plan, determines the number of options granted, the
vesting period and the exercise price of each award granted under the 1997 Plan.
The 1997 Plan will terminate July 31, 2007 unless earlier terminated by the
Board of Directors.
Options granted under the 1997 Plan generally vest over a three to seven
year period and expire: (1) ten years after the date of grant, (2) two years
after the date of the participant's termination without cause, disability or
death, (3) three months after the date of the participant's resignation, (4) on
the date of the participant's termination with cause or (5) on the date of any
material breach of any confidentiality or non-competition covenant or agreement
entered into between the participant and the Company.
The options issued on October 31, 1997, at $3.67, vest on October 31, 2004
provided, however (1) if the Company has met 80% of its revenue and Earnings
Before Interest, Taxes, Depreciation and Amortization (EBITDA) budget for the
calendar year ended December 31, 1998, which budget is approved by the Board of
Directors of the Company, 50% of the shares covered by the options
F-17
<PAGE> 177
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
shall vest and become exercisable on January 1, 1999, (2) if the Company has met
80% of its revenue and EBITDA budget for the calendar year ended December 31,
1999, which budget is approved by the Board of Directors of the Company, the
remaining 50% of the shares covered by the options shall vest and become
exercisable on January 1, 2000, and (3) in the event that the first 50% of the
shares covered by the options did not vest on January 1, 1999 as set forth in
(1) above and the Company not only meets 80% of its revenue and EBITDA budget
for the year ended December 31, 1999 but exceeds 80% of its revenue and EBITDA
budget for the year ended December 31, 1999, which budget is approved by the
Board of Directors of the Company, in an amount at least equal to the deficiency
that occurred in the year ended December 31, 1998, 100% of the shares covered by
the options shall vest and become exercisable on January 1, 2000. Unvested and
uncancelled options issued at $3.67 immediately become fully vested and
exercisable upon a change of control or a qualified public offering, as defined
in the option agreement. In an agreement dated November 4, 1999, 107,389 options
became fully vested at $3.67 per share and the remaining options were cancelled.
The options issued at $1.13 vest ratably over three or four consecutive
years subject to certain acceleration provisions set forth in an employment
agreement such as the immediate vesting upon a change in control or a qualified
initial public offering. Under certain circumstances and subject to the terms of
the Senior Notes, upon the election of the employee upon termination of
employment, the Company will be required to pay the employee the fair value of
the vested options held on the date of such termination.
As of December 31, 1999, a total of 2,251,204 non-qualified options were
issued and outstanding, 1,119,957 at an exercise price of $1.13 per share,
197,110 at an exercise price of $3.67 per share and 934,137 at an exercise price
of $5.20 per share. As of December 31, 1999, a total of 976,785 non-qualified
options were exercisable, 761,921 at an exercise price of $1.13 per share,
129,818 at an exercise price of $3.67 per share and 85,046 at an exercise price
of $5.20 per share. As of December 31, 1999, the weighted average contractual
life of the options issued at $1.13, $3.67 and $5.20 was 7.7 and 8.1 and 9.2
years, respectively.
During the year ended December 31, 1998, 667,373, 89,721 and 350,000
options were issued at an exercise price of $1.13, $3.67 and $5.20 per share,
respectively. The estimated fair value of the Company's underlying common stock
in each case was determined to be $1.99, $16.00 and $5.20 per share,
respectively. Accordingly, the Company calculated deferred compensation expense
of approximately $1.7 million related to the options to be recognized as
compensation expense over their vesting period. The compensation expense
recognized during the years ended December 31, 1999 and 1998 was approximately
$536,000 and $701,000, respectively.
During the year ended December 31, 1999, 726,450 options were issued at an
exercise price of $5.20 per share representing the estimated fair value of the
Company's underlying common stock.
F-18
<PAGE> 178
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Stock option activity was as follows:
<TABLE>
<CAPTION>
1995 PLAN 1997 PLAN
------------------------------ -----------------------
NON- NON- WEIGHTED
INCENTIVE QUALIFIED QUALIFIED AVERAGE
STOCK STOCK STOCK EXERCISE
OPTIONS OPTIONS PRICE OPTION PRICE PRICE
--------- --------- ------ --------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding, December
31, 1996................... 424,395 77,805 $0.034 -- -- $ 0.034
Granted...................... -- -- -- 1,289,167 $1.13-$3.67 $ 1.980
Exercised.................... -- -- -- -- -- --
Canceled..................... -- -- -- -- -- --
------- ------ ---------
Options outstanding, December
31, 1997................... 424,395 77,805 $0.034 1,289,167 $1.13-$3.67 $ 1.430
Options granted.............. -- -- -- 1,107,094 $1.13-$5.20 $ 2.622
Options exercised............ -- (2,358) $0.034 -- -- --
Options cancelled............ -- (4,716) $0.034 (5,554) $1.13-$5.20 $ 3.145
------- ------ ---------
Options outstanding at
December 31, 1998.......... 424,395 70,731 $0.034 2,390,707 $1.13-$5.20 $ 1.888
Options granted.............. -- -- -- 726,450 $5.20 $5.2000
Options exercised............ (70,733) -- $0.034 (95,127) $0.03-$1.13 $0.6609
Options cancelled............ -- -- -- (770,826) $1.13-$5.20 $2.9313
------- ------ ------ ---------
Options outstanding at
December 31, 1999.......... 353,662 70,731 $0.034 2,251,204 $1.13-$5.20 $2.5636
======= ====== =========
</TABLE>
The Company measures compensation expense for its employee stock-based
compensation using the intrinsic value method and provides pro forma disclosures
of net loss as if the fair value method had been applied in measuring
compensation expense. Under the intrinsic value method of accounting for
stock-based compensation, when the exercise price of options granted to
employees is less than the fair value of the underlying stock on the date of
grant, compensation expense is to be recognized over the applicable vesting
period.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1999 1998 1997
----------- ----------- ----------
<S> <C> <C> <C>
Net loss as reported............................. $59,036,312 $36,296,596 $3,977,400
Pro forma net loss............................... $59,222,962 $36,859,594 $3,978,164
Basic and diluted net loss per share as
reported....................................... $ (20.14) $ (12.51) $ (1.37)
Pro forma basic and diluted net loss per share... $ (20.20) $ (12.70) $ (1.37)
</TABLE>
The fair value of each option is estimated on the date of grant using a
type of Black-Scholes option pricing model with the following weighted average
assumptions used for grants during the years ended December 31, 1998 and 1997,
respectively: dividend yield of 0%, expected volatility of 0%, risk-free
interest rate of 5.18% and 6.55% and expected terms of 5.5 and 5.0 years. The
following weighted average assumptions were used for grants during the year
ended December 31, 1999: dividend yield of 0%, expected volatility of 0%,
risk-free interest rate of 5.16% and expected terms of 5.8 years.
F-19
<PAGE> 179
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As of December 31, 1999 and 1998, the weighted average remaining
contractual life of the options is 7.9 years and 8.6 years, respectively.
11. VENDOR AGREEMENTS
Pursuant to a Master Agreement entered into by the Company and NEC on
August 8, 1997, as amended, the Company has the option to acquire, by March 31,
2003, a total of $200 million worth of certain equipment, services and licensed
software to be used by the Company in its network under pricing and payment
terms that the Company believes are favorable. In addition, NEC has agreed,
subject to certain conditions, to warranty equipment purchased by the Company
from NEC for three years, if defective, to repair or replace certain equipment
promptly and to maintain a stock of critical spare parts for up to 15 years. The
Company's agreement with NEC provides for fixed prices during the first three
years of its term. As of December 31, 1999, the Company had purchased $51.9
million of equipment under this agreement.
Pursuant to a supply agreement entered into by the Company and Lucent
Technologies (Lucent) on December 18, 1998, the Company agreed that Lucent
should be its exclusive supplier of fiber optic cable for its nationwide, voice
and data network. Lucent may provide financing of up to approximately $400
million of fiber purchases for the construction of the Company's network and may
provide or arrange financing for future phases of the fiber portion of the
Company's network. The total amount of financing over the life of this
seven-year agreement is not to exceed $1.8 billion. Certain material terms of
the Company's transactions with Lucent are currently under review by Lucent and
the Company. There can be no assurance that the financing contemplated by the
supply agreement will be consummated or, if consummated, consummated on the
terms and conditions described above. The supply agreement provides that Lucent
will provide the Company with a broad level of support, including fiber optic
equipment, network planning and design, technical and marketing support, and
financing. As of December 31, 1999, no purchases were made by the Company under
this agreement.
12. COMMITMENTS AND CONTINGENCIES
The Company maintains office space in Washington, D.C., Virginia, Kansas
and Texas. The most significant leases relate to the Company's new headquarters
facilities in Reston, Virginia and Washington, D.C.
On December 30, 1998, the Company entered into a lease agreement for the
lease of tower site space, sufficient to perform its obligations under a fixed
point microwave agreement (FPMA) with an incumbent. Under the terms of the
lease, the Company is obligated to rent of $130,000 per month for a period
expiring on the later of (1) the expiration of the FPMA as to that site, or (2)
ten years from the effective date of the agreement. The agreement provides for
an increase in the rent payable commencing on December 1, 1999 and on each
succeeding year thereafter to December 1, 2008, by an amount equal to 4 percent
of the rent then in effect.
F-20
<PAGE> 180
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company's future minimum rental payments under noncancellable operating
leases are as follows:
<TABLE>
<CAPTION>
<S> <C>
2000........................................................ $ 3,388,583
2001........................................................ 3,216,376
2002........................................................ 3,284,920
2003........................................................ 3,205,368
2004 and thereafter......................................... 19,097,648
-----------
Total............................................. $32,192,895
===========
</TABLE>
Rent expense for the years ended December 31, 1999, 1998 and 1997 was
approximately $821,000, $390,000, and $115,000, respectively.
The Company earns microwave telecommunication capacity revenue under an
indefeasible right of use (IRU) agreement dated December 1, 1998, of $137,000
per month commencing December 1998 and expiring on the later of (1) the
expiration of the FPMA as to that site, or (2) ten years from the effective date
of the agreement. The IRU agreement provides for an increase in the rent
receivable commencing on December 1, 1999 and on each succeeding year thereafter
to December 1, 2008, by an amount equal to 4 percent of the rent then in effect.
As of December 31, 1999, the Company had capital commitments of
approximately $89.9 million relating to purchases of telecommunications and
transmission equipment under its agreements with WFI, Tri-States and CapRock
(See note 14).
During 1999, the Company entered into a contractual agreement that provided
for extended payment terms over a four-year period for the purchase of
approximately $2.7 million in network equipment. Accordingly, such amount has
been included in other noncurrent liabilities in the Company's consolidated
balance sheet as of December 31, 1999.
From time to time, the Company is subject to claims arising in the ordinary
course of business. In the opinion of management, no such matter individually or
in the aggregate, exists which is expected to have a material effect on the
results of operations, cash flows or financial position of the Company.
F-21
<PAGE> 181
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. INCOME TAXES
The tax effect of temporary differences that give rise to significant
portions of the net deferred tax asset at December 31, 1999 and 1998, is as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1999 1998
------------ ------------
<S> <C> <C>
Deferred revenue.......................................... $ 3,646 $ 949
Capitalized start-up costs................................ 1,005,353 1,370,937
Capitalized research and development costs................ 48,482 66,111
Depreciation.............................................. (2,844,859) --
Net operating loss carryforward........................... 40,571,930 15,325,484
Other timing differences.................................. 110,078 --
------------ ------------
38,894,630 16,763,481
Less valuation allowance.................................. (38,894,630) (16,763,481)
------------ ------------
Net deferred tax asset.................................... $ -- $ --
============ ============
</TABLE>
Capitalized costs represent expenses incurred in the organization and
start-up of the Company. For federal income tax purposes, these costs are being
amortized over sixty months.
The ultimate realization of deferred tax assets is dependent upon the
generation of future taxable income in the periods in which those temporary
differences are deductible. The Company has provided a valuation allowance
against its deferred tax assets as they are long-term in nature and their
ultimate realization cannot be determined.
14. FIBER AGREEMENTS
In March 1999, the Company entered into a co-development agreement with WFI
for the design, engineering and construction by WFI of a multiple conduit
fiber-optic system. One of the conduits will contain a fiber optic cable
consisting of a specified number of fiber optic strands. The conduits and any
installed strands will be equally divided between the parties, and the cost to
construct the route will be shared equally by the Company and WFI. In addition,
the Company will pay WFI a management fee equal to 10% of the Company's share of
the development costs. The total shared projected costs for the project is in
excess of $100 million. The system will be approximately 1,100 route miles long,
between Aurora, Colorado (a suburb of Denver) and Chicago, Illinois. The first
segment, Chicago, Illinois to Omaha, Nebraska, was completed in the fourth
quarter 1999, and the second segment, Omaha to Aurora, is scheduled to be
completed by the end of the second quarter of 2000. In connection with the co-
development agreement, the Company entered into a joint marketing agreement with
WFI under which both WFI and the Company will attempt to sell certain inactive
fiber optic strands on the route, and will share the revenues from such sales.
The joint marketing agreement also permits each party to retain fiber optic
strands for its own use, subject to certain restrictions on resale, and to swap
a certain number of the fiber optic strands to third parties.
In August 1999, the Company entered into a co-development agreement with
Tri-State and four regional electric cooperatives for design, engineering and
construction of an aerial fiber system, approximately 420 route miles long,
between Albuquerque, New Mexico and Grand Junction, Colorado. This system,
constructed on power transmission lines, will contain a specified number of
fiber optic strands. The cost to construct the system will be borne equally
between the Company and the other parties. The total projected combined cost for
this route is approximately $48 million. In
F-22
<PAGE> 182
PATHNET, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
connection with the co-development agreement, the Company entered into a joint
marketing agreement under which each party will reserve a portion of the fiber
strands for its own operations, a subset of which will be available for swaps
with third parties, the remaining fiber strands will be jointly sold, with the
Company as the exclusive marketing agent.
Any revenues derived from the sale of those fiber strands will be shared
equally between the Company and Tri-State, after deduction of a Company
marketing fee. We expect this system to be completed in the second half of 2000.
15. REORGANIZATION
On November 4, 1999, the Company, together with Pathnet Telecommunications
Inc. (PTI) a Delaware company formed on November 1, 1999, entered into
agreements providing for strategic investments from Colonial Pipeline Company,
Burlington Northern and Santa Fe Corporation and CSX Corporation to PTI. Upon
the closing of this transaction, PTI will receive the right to develop over
12,000 miles of the investors' rights of way with an estimated value of $187.0
million in return for 8,511,607 shares of PTI's Series D convertible preferred
stock. In addition to providing a portion of the right of way access, Colonial
Pipeline will pay $68.0 million of cash to PTI comprised of $38.0 million at the
initial closing for 1,729,631 shares of PTI's Series E redeemable preferred
stock, $25.0 million for 1,137,915 shares of PTI's Series E redeemable preferred
stock (upon the completion of a fiber optic network segment build that the
Company expects to complete during the second calendar quarter of 2000), $1.0
million for the issuance of an option to purchase 1,593,082 shares of PTI's
Series E redeemable preferred stock for $21.97 per share and shares of PTI's
common stock in connection with an initial public offering and $4.0 million for
rights in 2,200 conduit miles of our future network. Further, upon the closing
of this transaction, all of the Company's common stock will be exchanged for
common stock of PTI resulting in the Company becoming a wholly-owned subsidiary
of PTI. In addition, all of the Company's 5,470,595 shares of mandatorily
redeemable preferred stock will be converted into 15,864,715 of PTI's
convertible preferred stock. The new investors collectively will receive an
approximate one-third equity stake in PTI, as well as proportionate
representation on the PTI Board of Directors. As part of this transaction and
the reconstitution of the Pathnet Board, Dave Schaeffer, former Chairman of
Pathnet and an existing director, resigned from the Company's Board of Directors
effective November 4, 1999.
The terms of the strategic investment transaction require that consents be
obtained from the holders of a majority of the Company's existing Senior Notes
in exchange for a proposed payment of approximately $8.8 million. As a result,
on November 22, 1999, PTI filed a preliminary prospectus with the SEC, to offer
all holders of the Senior Notes a guarantee of the obligations of the Company to
make interest and principal payments. Concurrent with this offer, the Company is
seeking consents from the holders of the Senior Notes to the waiver and the
amendment of certain provisions of the indenture. On March 10, 2000, the Company
expects to file an amendment to its preliminary prospectus with the SEC. The
Company expects to close this transaction immediately following receipt of the
required consents and other required regulatory approvals. For the year ended
December 31, 1999, the Company had expensed $1,022,998 of fees related to this
transaction.
F-23
<PAGE> 183
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Pathnet Telecommunications, Inc.
In our opinion, the financial statements listed in the accompanying index
present fairly, in all material respects, the financial position of Pathnet
Telecommunications, Inc. (a development stage enterprise) (the Company) at
December 31, 1999, and the results of its operations and its cash flows for the
period November 1, 1999 (date of inception) to December 31, 1999, in conformity
with accounting principles generally accepted in the United States. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
auditing standards generally accepted in the United States, which require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for the opinion expressed above.
PRICEWATERHOUSECOOPERS LLP
McLean, Virginia
March 13, 2000
F-24
<PAGE> 184
PATHNET TELECOMMUNICATIONS, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31,
1999
------------
<S> <C>
ASSETS
Total current assets...................................... $ --
Total assets.............................................. $ --
======
LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
Total current liabilities................................. $ --
Total liabilities......................................... --
Series E convertible preferred stock, par value $0.01
per share, 4,506,145 shares authorized, 0 shares
issued and outstanding................................ --
Total mandatorily redeemable preferred stock.............. --
Series D convertible preferred stock, par value $0.01
per share, 9,250,000 shares authorized, 0 shares
issued and outstanding................................ --
Common stock, $0.01 par value, 60,000,000 shares
authorized, 0 shares issued and outstanding........... --
Total stockholders' equity (deficit)...................... --
Total liabilities, mandatorily redeemable preferred stock
and stockholders' equity (deficit)..................... $ --
======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-25
<PAGE> 185
PATHNET TELECOMMUNICATIONS, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE PERIOD
NOVEMBER 1, 1999
(DATE OF INCEPTION)
TO DECEMBER 31,
1999
-------------------
<S> <C>
Revenue..................................................... $ --
-------------
Operating expenses.......................................... --
-------------
Operating loss.............................................. --
Net loss.................................................... $ --
=============
Basic and diluted net loss per common share................. $ --
Weighted average number of common shares outstanding........ --
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-26
<PAGE> 186
PATHNET TELECOMMUNICATIONS, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE PERIOD
NOVEMBER 1, 1999
(DATE OF
INCEPTION)
TO DECEMBER 31,
1999
----------------
<S> <C>
Cash flows from operating activities:
Net loss.................................................. $ --
-----------
Net cash provided by (used in) operating activities....... --
-----------
Net cash provided by (used in) investing activities....... --
-----------
Net cash provided by (used in) financing activities....... --
-----------
Net increase (decrease) in cash and cash equivalents........ --
Cash and cash equivalents at the beginning of period........ --
-----------
Cash and cash equivalents at the end of period.............. $ --
===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-27
<PAGE> 187
PATHNET TELECOMMUNICATIONS, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
DEFICIT
ACCUMULATED
PREFERRED STOCK COMMON STOCK ADDITIONAL DURING
--------------------- --------------------- DEFERRED PAID-IN DEVELOPMENT
SHARES AMOUNT SHARES AMOUNT COMPENSATION CAPITAL STAGE
---------- -------- ---------- -------- ------------ ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT NOVEMBER 1, 1999 (date of
inception)........................ -- $ -- -- $ -- $ -- $ -- $ --
Net loss............................ -- -- -- -- -- -- --
---------- -------- ---------- -------- ----------- ---------- -------------
BALANCE AT DECEMBER 31, 1999........ -- $ -- -- $ -- $ -- $ -- $ --
========== ======== ========== ======== =========== ========== =============
<CAPTION>
TOTAL
------------
<S> <C>
BALANCE AT NOVEMBER 1, 1999 (date of
inception)........................ $ --
Net loss............................ --
------------
BALANCE AT DECEMBER 31, 1999........ $ --
============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-28
<PAGE> 188
PATHNET TELECOMMUNICATIONS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
1. THE COMPANY
Pathnet Telecommunications, Inc. (PTI) was formed on November 1, 1999, in
order to give effect to the reorganization transaction (see Note 3) with
Pathnet, Inc. (Pathnet).
Pathnet was formed on August 25, 1995. Since inception, Pathnet has
operated as a development stage enterprise, and its operations have resulted in
cumulative net losses of $101.5 million through December 31, 1999. PTI and
Pathnet are wholesale telecommunications providers building a nationwide network
designed to provide other wholesale and retail telecommunications service
providers with access to underserved and second and third tier markets
throughout the United States.
2. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF ACCOUNTING
As of December 31, 1999, PTI has no assets, liabilities, stockholders'
equity (deficit), revenue or expenses and no principal activities. In addition,
PTI has not yet issued any equity securities. Accordingly, the PTI's financial
statements are presented as a development stage enterprise, as prescribed by
Statement of Financial Accounting Standards No. 7, "Accounting and Reporting by
Development Stage Enterprises."
USE OF ESTIMATES
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reported period. The estimates involve judgments with
respect to, among other things, various future factors which are difficult to
predict and are beyond the control of PTI. Actual amounts could differ from
these estimates.
LOSS PER SHARE
Basic earnings (loss) per share is computed by dividing net income (loss)
by the weighted average number of shares of Common Stock outstanding during the
applicable period. Diluted earnings (loss) per share is computed by dividing net
income (loss) by the weighted average common and potentially dilutive common
equivalent shares outstanding during the applicable period. For the period
presented, basic and diluted loss per share are the same since PTI has no net
income (loss) and has issued no shares as of December 31, 1999.
3. REORGANIZATION
On November 4, 1999, PTI, together with Pathnet, entered into agreements
providing for strategic investments from Colonial Pipeline Company, Burlington
Northern and Santa Fe Corporation and CSX Corporation to PTI. Upon the closing
of this transaction, PTI will receive the right to develop over 12,000 miles of
the investors' rights of way with an estimated value of $187.0 million in return
for 8,511,607 shares of PTI's Series D convertible preferred stock. In addition
to providing a portion of the right of way access, Colonial Pipeline will pay
$68.0 million of cash to PTI comprised of $38.0 million at the initial closing
for 1,729,631 shares of PTI's Series E redeemable preferred stock, $25.0 million
for 1,137,915 shares of PTI's Series E redeemable preferred stock (upon the
completion of a fiber optic network segment build that Pathnet expects to
complete during
F-29
<PAGE> 189
PATHNET TELECOMMUNICATIONS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
the second calendar quarter of 2000), $1.0 million for the issuance of an option
to purchase 1,593,082 shares of PTI's Series E redeemable preferred stock for
$21.97 per share and shares of PTI's common stock in connection with an initial
public offering and $4.0 million for rights in 2,200 conduit miles of our future
network. Further, upon the closing of this transaction, all of Pathnet's common
stock will be exchanged for common stock of PTI resulting in Pathnet becoming a
wholly-owned subsidiary of PTI. In addition, all of Pathnet's 5,470,595 shares
of mandatorily redeemable preferred stock will be converted into 15,864,715 of
PTI's convertible preferred stock. The new investors collectively will receive
an approximate one-third equity stake in PTI, as well as proportionate
representation on the PTI Board of Directors.
The terms of the strategic investment transaction require that consents be
obtained from the holders of a majority of Pathnet's existing Senior Notes in
exchange for a proposed payment of approximately $8.8 million. As a result, on
November 22, 1999, PTI filed a preliminary prospectus with the SEC, to offer all
holders of the Senior Notes a guarantee of the obligations of Pathnet to make
interest and principal payments. Concurrent with this offer, Pathnet is seeking
consents from the holders of the Senior Notes to the waiver and the amendment of
certain provisions of the indenture. On March 10, 2000, Pathnet filed an
amendment to its preliminary prospectus with the SEC. Pathnet expects to close
this transaction immediately following receipt of the required consents and
other required regulatory approvals. For the year ended December 31, 1999,
Pathnet had expensed $1,022,998 of fees related to this transaction.
F-30
<PAGE> 190
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------------------------------------------------------
THROUGH AND INCLUDING APRIL 23, 2000 (THE 40TH DAY AFTER THE DATE OF THIS
PROSPECTUS), THE SOLICITATION AGENT AND ANY OTHERS EFFECTING TRANSACTIONS IN
THESE SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED
TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE SOLICITATION AGENT'S
OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT
TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. THIS IS IN ADDITION TO A
SOLICITATION AGENT'S OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS AN
UNDERWRITER AND WITH RESPECT TO AN UNSOLD ALLOTMENT OR SUBSCRIPTION.
------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary..................... 1
Risk Factors........................... 7
Use of Proceeds........................ 26
Capitalization......................... 27
Selected Consolidated Financial and
Operating Data....................... 29
Business............................... 31
Management's Discussion and Analysis of
Financial Condition and Results of
Operations........................... 51
Management............................. 60
Certain Relationships and Related
Transactions......................... 73
Security Ownership of Certain
Beneficial Owners and Management..... 77
Description of Our Reorganization...... 80
The Pathnet Senior Noteholder Waivers
and Other Proposed Indenture
Amendments........................... 91
Description of the Guarantees.......... 105
Description of the Consent Solicitation
Process.............................. 106
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Description of the Notes and the
Indenture............................ 109
Description of Other Indebtedness and
Other Financing Arrangements......... 143
Description of Capital Stock........... 145
Federal Income Tax Consequences........ 151
Plan of Distribution................... 156
Legal Matters.......................... 156
Experts................................ 156
Where You Can Find More Information.... 156
Index to Financial Statements.......... F-1
</TABLE>
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[PATHNET LOGO]
PATHNET TELECOMMUNICATIONS, INC.
SENIOR GUARANTEES OF PATHNET, INC.
12 1/4% SENIOR NOTES DUE 2008
------------------
PROSPECTUS
------------------
March 14, 2000
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