) In re ) Chapter 11 ) XO COMMUNICATIONS, INC., ) Case No. 0_- ( ) ) Debtor. ) )

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1 UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK ) In re ) Chapter 11 ) XO COMMUNICATIONS, INC., ) Case No. 0_- ( ) ) Debtor. ) ) APPLICATION OF DEBTOR FOR ORDER AUTHORIZING EMPLOYMENT AND RETENTION OF HOULIHAN LOKEY HOWARD & ZUKIN CAPITAL AS ITS FINANCIAL ADVISOR PURSUANT TO 327 AND 328(a) OF THE BANKRUPTCY CODE TO: THE HONORABLE JUDGES OF THE UNITED STATES BANKRUPTCY COURT FOR THE SOUTHERN DISTRICT OF NEW YORK XO Communications, Inc., the above-captioned debtor and debtor in possession ( XO or the Debtor ), respectfully represents: BACKGROUND 1. On June 17, 2002 (the Petition Date ), the Debtor filed a voluntary petition for relief under chapter 11 of title 11 of the United States Code (the Bankruptcy Code ). The Debtor intends to continue in the possession of its property and the management of its business as debtor in possession pursuant to sections 1107 and 1108 of the Bankruptcy Code. 2. No official creditors committee has yet been appointed by the United States Trustee. No trustee or examiner has been appointed in this chapter 11 case.

2 3. XO, through its predecessor entities, was formed in XO is primarily a holding company, which owns, manages and controls, directly or indirectly, more than 60 subsidiaries (the Operating Subsidiaries, and collectively with XO, the Company ) that provide high-quality telecommunications services to business customers in over 20 states and the District of Columbia, including most of the largest metropolitan areas in the U.S. Services provided by the Company include local and long distance voice, Internet access, Virtual Private Networking ( VPN ), high-capacity data network services (including dedicated wavelength and Ethernet services), website hosting services, and integrated voice and data services. 4. From 1996, when Federal legislation first was enacted to promote local telecommunications competition, until 2001, most emerging competitive telecommunications companies, including XO, were able to access funding required by their businesses in the capital markets. Since inception, XO and its predecessors have raised billions of dollars in capital, including approximately $840 million through sales of common stock 2 and $1.7 billion through sales of preferred stock. XO also incurred substantial amounts of secured and unsecured debt, of which approximately $5.7 billion of indebtedness was outstanding as of April 30, XO was originally organized in 1994 as a Washington limited partnership, which in 1995 merged into a Washington limited liability company, and following several name changes became known as NEXTLINK Communications, L.L.C. In January 1997, NEXTLINK Communications, L.L.C. merged into NEXTLINK Communications, Inc., a Washington corporation, which in June 1998 reincorporated in Delaware under the same name. On June 16, 2000, in connection with the Company s merger with Concentric Network Corporation, NEXTLINK Communications, Inc. merged with XO (then known as NM Acquisition Corp.) and changed its name to NEXTLINK Communications, Inc. On October 25, 2000, XO changed its name to XO Communications, Inc. 2 This figure excludes proceeds from the sale of common stock through employee plans. 2

3 5. XO s debt as of April 30, 2002 includes $1 billion in principal amount of outstanding borrowings under its secured senior credit facility (the Senior Credit Facility ), approximately $4.2 billion in aggregate principal amount and accreted value of discount notes outstanding under its ten issues of senior unsecured notes (the Senior Notes ), approximately $557 million of which is held by a subsidiary of XO, and $517.5 million in principal amount outstanding under one issue of convertible subordinated notes issued in 2001 (the Subordinated Notes ). 3 As of March 31, 2002, XO also had outstanding eight classes of preferred stock, with an aggregate liquidation preference of approximately $2.1 billion, approximately $490 million of which is held by a subsidiary of XO. In addition, as of that date, XO had two classes of common stock, of which the largest holders are Eagle River Investments, LLC ( Eagle River ), Wendy P. McCaw, and Forstmann Little & Co. Equity Partnership - VI, L.P. Three partnerships sponsored by Forstmann Little & Co. ( Forstmann Little ), Forstmann Little & Co. Equity Partnership - VI, L.P., Forstmann Little & Co. Subordinated Debt and Equity Management Buyout Partnership - VII, L.P. and FL Fund, L.P. (collectively with Forstmann Little & Co. Equity Partnership - VI, L.P., the Forstmann Little Partnerships ) each of which hold preferred stock that is convertible into, and votes on an as converted basis with, the common stock on all matters in which holders of common stock are entitled to vote other than the election of directors. 6. As of April 30, 2002, XO s unaudited stand-alone books and records reflected total assets of approximately $8.7 billion 4 and total liabilities and long-term obligations, 3 A complete list of the issuances of Senior Notes and Convertible Subordinated Notes is annexed as Exhibit E to the Affidavit of Wayne M. Rehberger pursuant to Local Bankruptcy Rule and in support of First-Day Motions, filed with the Court contemporaneously herewith. 4 Approximately $7.0 billion of total assets represents intercompany receivables from XO s Operating Subsidiaries. 3

4 including the debt and preferred stock obligations discussed above, of approximately $8.5 billion. At April 30, 2002, the Company had approximately $554.8 million in cash and marketable securities on hand (net of outstanding checks). 7. Although the Company has implemented stringent measures designed to conserve cash and reduce operating expenses and capital expenditures, it remains in need of a significant cash infusion (either alone or in combination with a substantial reduction of its debt service and related obligations) to fund the operating expenses, capital expenditures and debt service necessary to bring its operations to profitability on a company-wide basis. In light of the significant declines in market valuations of the debt and equity securities of telecommunications companies in the third and fourth quarters of 2001, and XO s funding requirements in order to achieve profitability, the Company engaged in discussions with several prospective investors regarding possible investment and restructuring opportunities. After these discussions failed to result in any significant financing proposals, in October 2001, XO retained Houlihan Lokey Howard & Zukin Capital ( Houlihan Lokey ) as its outside financial advisor to assist it in exploring a variety of investment and deleveraging alternatives, including a stand-alone restructuring and third-party investment scenarios. As the market conditions in the telecommunications sector continued to decline during the fourth quarter of 2001, the alternatives under consideration were expanded to include restructuring and investment scenarios that could be implemented under chapter 11 of the Bankruptcy Code. 8. At the Company s request, Houlihan Lokey prepared solicitation materials and, beginning in November, 2001, contacted over fifty potential investors, both strategic and financial, in an effort to raise required new capital. To assure proper focus, Houlihan Lokey and the Company continued to engage in discussions with previously identified investors and 4

5 approached potential third-party investors that had previously made investments in the telecommunications industry and/or had the financial ability to make at least a $500 million investment in the Company alone or in connection with financial partners. On November 21, 2001, Forstmann Little, submitted a draft term sheet contemplating a $700 million equity investment in the Company proposed by two Forstmann Little affiliated investment partnerships (together, the Forstmann Little Investors ) 5 and a then-unnamed third-party investor (later to be identified as Télefonos de México S.A. de C.V. ( Telmex, and collectively with the Forstmann Little Investors, the Investors )) conditioned, among other things, on a substantially deleveraged balance sheet. 9. Following extensive discussion and negotiation with the Investors, on November 28, 2001, XO entered into a non-binding term sheet with the Investors, with respect to an $800 million investment in XO (the Term Sheet ) and, on January 15, 2002, having received no investment proposals from any other prospective investor despite intensive solicitations, XO entered into a Stock Purchase Agreement, dated January 15, 2002, by and among XO, the Forstmann Little Investors and Telmex (the Investment Agreement ). In connection with the Investment Agreement, XO held discussions with representatives of the senior secured lenders (the Senior Secured Lenders ) under its $1 billion Senior Credit Facility, who had formed a steering committee (the Senior Lenders Committee ), regarding the terms and conditions necessary to obtain their support for the restructuring. After extensive negotiations among Forstmann Little, the Senior Lenders Committee and XO, an agreement in principle was reached under which the Senior Lenders Committee would support the Investment Agreement and certain 5 Specifically, the two investment funds are Forstmann Little & Co. Equity Partnership VII, L.P., a Delaware limited partnership, and Forstmann Little & Co. Subordinated Debt and Equity Management Buyout Partnership VIII, L.P., a Delaware limited partnership. 5

6 related amendments to the Senior Credit Facility (the Amended Senior Credit Facility ) would be implemented. Concurrently, certain holders of Senior Notes formed an informal committee (the Senior Note Committee ) to discuss the terms of the proposed restructuring with XO and the Investors. From January 2002 through March 2002, XO and the Investors held extensive discussions and negotiations with representatives of the Senior Note Committee, its legal counsel and financial advisors in an effort to reach agreement on a restructuring proposal. Ultimately, the Investors and the Senior Note Committee were unable to reach an agreement On March 8, 2002, in connection with the rejection by the Senior Note Committee of the Investors most recent proposal, certain Senior Noteholders made a preliminary investment and restructuring proposal contemplating a $500 million investment in exchange for secured and unsecured debt of XO in lieu of the Investment Agreement. After careful review and analysis, the board of directors of XO (the Board ) concluded that this preliminary proposal was not a feasible alternative and rejected the proposal, but the parties continued further discussions concerning alternative investment and capital restructuring proposals. 11. On March 22, 2002, XO received a preliminary term sheet from Chelonian Corp., an affiliate of Mr. Carl Icahn (collectively, the Icahn Group ) and the Senior Noteholder Committee contemplating a revised alternate restructuring proposal and a $500 million equity investment in the Company for an indirect 50% ownership interest in the Company. The Board, 6 Prior to the Petition Date, certain holders of the Subordinated Notes formed an informal noteholder committee (the Subordinated Noteholder Committee ) to discuss the terms of the proposed restructuring with XO. Although representatives of the Company have met with the representatives of the Subordinated Noteholder Committee and its legal counsel, no agreement has been reached with the Subordinated Noteholder Committee. Under the Plan, the contractual subordination provisions of the indenture to the Subordinated Note will be enforced. 6

7 with the assistance of its financial and legal advisors, carefully reviewed this proposal and concluded that it represented an inferior proposal to the Investment Agreement. On March 27, 2002, XO delivered a letter to the Icahn Group and the Senior Note Committee containing the terms and conditions necessary for a proposal to be superior to the investment contemplated by the Investment Agreement. 12. After further discussions among XO, the Icahn Group and the Senior Note Committee, on April 1, 2002, the Icahn Group, which represented to XO that it had the support of the Senior Note Committee, submitted a revised draft term sheet contemplating an investment of $550 million in cash equity (the proposal contemplated by such term sheet, as modified to reflect the discussions among the various parties subsequent to its delivery, the Icahn Proposal ) and a plan of reorganization that provided for, among other things, a greater percentage of equity distribution to the holders of Senior Notes than provided under the Investment Agreement. The investment and corporate reorganization transactions contemplated by the Icahn Proposal would have been contingent upon the approval of the Senior Secured Lenders, including their consent to longer maturities and extension of prepayment dates, as well as significant modifications to their rights, including changes in a number of financial and operational covenants. Throughout April and into May 2002, XO and the Icahn Group engaged in negotiations with the Senior Note Committee and the Senior Lenders Committee. In early May, 2002, these negotiations ended without an agreement. 13. Subsequently, the Senior Lenders Committee asked XO to prepare a modified business plan contemplating a stand-alone restructuring. In late May of 2002, XO and the Senior Lenders Committee discussed a standalone restructuring plan under which $500 million principal amount of senior secured loans would be converted into all of the equity of 7

8 Reorganized XO, subject to dilution from a $250 million rights offering to junior securityholders, warrants to be distributed to senior noteholders and holders of General Unsecured Claims (as defined in the Plan (defined below)) in certain events and management options. To the extent the rights offering raised less than $200 million, a senior secured exit facility of up to $200 million also was contemplated. 14. Recognizing both the superior financial terms of the transactions contemplated by the Investment Agreement and the uncertainty inherent in the conditions contained therein, the Company and the Senior Lenders Committee concluded that the most appropriate course of action would be to advance a plan of reorganization contemplating the consummation of the transactions contemplated by the Investment Agreement, which could be converted to a restructuring on a standalone basis if the transactions contemplated by the Investment Agreement are not completed. In support of this approach, on or about June 13, 2002, holders of outstanding loans under the Senior Credit Facility delivered agreements (the Support Agreements ) to XO binding them to vote to accept a plan of reorganization based on the Investment Agreement and agreeing to the proposed amendments to the Senior Credit Facility under the Amended Senior Credit Facility. The Company also received a letter from the Administrative Agent under the Senior Credit Facility indicating that the Senior Lenders Committee is prepared to support and recommend to the Senior Lenders the restructuring transactions contemplated by a term sheet (the Stand-Alone Term Sheet ), a copy of which is attached to the Plan, if the transactions contemplated by the Investment Agreement are not completed. 15. The Debtor has developed a proposed plan of reorganization (as the same may be amended, the Plan ) and related disclosure statement, both of which are being filed with 8

9 the Court contemporaneously herewith, with the input and support of the Senior Lenders Committee. The Plan implements the terms of the Investment Agreement and also includes the transactions contemplated by the Stand-Alone Term Sheet. The Investment Agreement currently remains in full force and effect, but is subject to a number of conditions, and is terminable in certain events. The Investors have advised the Company that they believe the conditions to their obligations under the Investment Agreement cannot be satisfied, but have not thus far asserted or purported to exercise any right of termination. If the Investment Agreement is terminated or XO, after discussions with the Administrative Agent, determines that the transactions under the Investment Agreement will not be completed, XO presently intends to implement the transactions contemplated by the Stand-Alone Term Sheet, unless a superior alternative emerges. 16. In order to preserve value in the Company and enhance its long-term viability and continued success, the Company, with the support of the Senior Lenders Committee, determined that the restructuring of its obligations as contemplated by the Plan could best be achieved through a chapter 11 filing and, accordingly, has filed this chapter 11 case. Numerous communications companies have sought bankruptcy protection recently, which together with the substantial quantity of communications network facilities held by communications companies in operation, has severely depressed -- or in some cases eliminated -- the market for telecommunication assets, making this a wholly unfavorable environment for liquidation. Consequently, and in light of the significant revenues that the Company s operations generate, the Company believes that restructuring its capitalization as contemplated by the Investment Agreement and the Plan will generate substantially more value (and thus greater recoveries for its creditors) than would a liquidation. 9

10 17. This Court has jurisdiction of this application pursuant to 28 U.S.C. 157 and 1334 and the Standing Order of Referral of Cases to Bankruptcy Judges, dated July 10, 1984, issued by District Court Judge Robert J. Ward. Venue of this proceeding and the within application in this district is proper pursuant to 28 U.S.C and The statutory predicates for the relief sought herein are sections 327(a) and 328 of the Bankruptcy Code. RELIEF REQUESTED 18. By this application (the Application ), the Debtor seeks entry of an order, pursuant to sections 327 and 328(a) of the Bankruptcy Code, Rule 2014 of the Federal Rules of Bankruptcy Procedure (the Bankruptcy Rules ), and Local Bankruptcy Rule , authorizing the employment and retention of Houlihan Lokey Howard & Zukin Capital ( Houlihan Lokey ) as its financial advisor under a general retainer. The facts and circumstances supporting this application (the Application ) are set forth in the Affidavit of David Hilty, a Managing Director of Houlihan Lokey, in support of the Application, sworn to June 17, 2002 (the Hilty Affidavit ), and attached hereto as Exhibit A. The Debtor requests that the Court enter an Order authorizing the Debtor to employ and retain Houlihan Lokey pursuant to the terms of an engagement letter as amended by this Application, a copy of which is annexed hereto as Exhibit B (the Engagement Letter ), effective as of the Petition Date, as the Debtor s financial advisor to represent them in all phases of this chapter 11 case. APPLICABLE AUTHORITY 19. Bankruptcy Code section 327(a) provides, in relevant part, as follows: Except as otherwise provided in this section, the trustee, with the court s approval, may employ one or more attorneys, accountants, appraisers, auctioneers, or other professional persons, that do not hold or represent an interest adverse to the estate, and that are disinterested persons, to 10

11 11 U.S.C. 327(a). represent or assist the trustee in carrying out the trustee s duties under this title. 20. Bankruptcy Code section 328(a) provides, in relevant part, as follows: 11 U.S.C. 328(a). The trustee... with the court s approval, may employ or authorize the employment of a professional person under section of this title... on any reasonable terms and conditions of employment, including on a retainer, on an hourly basis, or on a contingent fee basis. 21. Bankruptcy Rule 2014 provides, in relevant part, as follows: Fed R. Bankr. P An order approving the employment of financial advisors... or other professionals pursuant to of the Code shall be made only on application of the trustee or committee. 22. Local Bankruptcy Rule provides, in relevant part, as follows: S.D.N.Y. L.B.R An application for the employment of a professional person pursuant to 327 and 328 of the Bankruptcy Code shall state the specific facts showing the reasonableness of the terms and conditions of the employment, including the terms of any retainer, hourly fee or contingent fee arrangement. HOULIHAN LOKEY S QUALIFICATIONS 23. Houlihan Lokey is a nationally recognized investment banking and financial advisory firm, with 9 offices, and more than 275 professionals. Houlihan Lokey s Financial Restructuring Group, which has more than 80 professionals, is one of the leading advisors and investment bankers to debtors, bondholder groups, secured and unsecured creditors, acquirers and other parties-in-interest involved in financially troubled companies, both in and outside of bankruptcy. In this role, Houlihan Lokey has been, and is involved in some of the largest restructuring matters in the United States, including representing the company or the 11

12 debtor in Covad Communications, Inc., Dairy Mart Convenience Stores, Inc., Worldtex, Inc., Global Telesystems, Inc., McLeodUSA and Stage Stores, Inc., while representing official creditor committees in Enron Corporation, Armstrong Holdings, Inc., Owens Corning, Inc., Pillowtex Corp., Laidlaw, Inc. and AMF Worldwide, Inc. to name a few of its engagements. The Debtor has selected Houlihan Lokey to act as financial advisors in this case based on Houlihan Lokey s global presence and extensive knowledge and expertise in bankruptcy and corporate reorganization. In addition, Houlihan Lokey has provided financial advisory and investment banking services to over 100 telecommunications and media companies in both the public and private sectors, including Global TeleSystems, McLeodUSA, Covad Communications, GST Telecommunications, and NorthPoint Communications, while representing the official unsecured creditors committee of ICG Communications, Williams Communications, and the largest creditor of World Access. 24. The Debtor believes that Houlihan Lokey s employment is in the best interests of this estate. Houlihan Lokey already has provided substantial assistance to the Debtor in connection with evaluating strategic alternatives, identifying and soliciting interest of potential sources of additional funding, determining the value of the Debtor s and the non-debtor operating subsidiaries enterprise, and undertaking negotiations with the lenders under the Senior Credit Facility and the unofficial committee of senior noteholders respecting a potential restructuring of the Debtor s debt. In addition, Houlihan Lokey has undertaken, evaluated, and assisted in the negotiations of the Investment Agreement. Houlihan Lokey also has been managing a process to solicit alternative proposals to the proposed Investment Agreement in order to enable the Debtor to maximize the value of its assets for the benefit of all creditors. The Debtor continues to require the services of Houlihan Lokey to help guide the Debtor s 12

13 reorganization to a successful completion. Because of Houlihan Lokey s experience in business reorganizations, the Debtor believes that Houlihan Lokey is exceptionally well qualified to serve as its financial advisors in this case. SERVICES TO BE PROVIDED BY HOULIHAN LOKEY 25. Pursuant to the Engagement Letter, it is expected that Houlihan Lokey will provide the following services to the Debtor in this chapter 11 case: 7 Advise the Debtor generally as to effecting a material change to the Debtor s outstanding balance sheet and/or effect material changes to any of the Debtor s outstanding redeemable preferred stock each as of the date of the Engagement Letter through (i) an exchange offer; (ii) merger, consolidation, reorganization, recapitalization or sale of all or substantially all of the Debtor s assets; or (iii) any other transaction in which the requisite consents to a reorganization or restructuring are obtained (collectively, a Transaction ); Advise the Debtor of available capital restructuring and financing alternatives, including recommendations of specific courses of action, and assist the Debtor with the design of Transaction structures and any debt and equity securities to be issued in connection with a Transaction; Assist the Debtor in its discussions with lenders, bondholders and other interested parties regarding the Debtor s operations and prospects and any Transaction; Assist the Debtor in valuing the Debtor and/or, as appropriate, valuing the Debtor s assets or operations; provided that any real estate or fixed asset appraisals needed would be executed by outside appraisers; Provide expert advise and testimony relating to financial matters related to a Transaction, including the valuation of any securities issued in connection with a Transaction; To the extent requested by the Debtor, advise the Debtor as to potential mergers or acquisitions, and the sale or other disposition of any of the Debtor s assets or businesses; To the extent requested by the Debtor, advise the Debtor and act as placement agent, as to potential financings, either debt or equity, including 7 Capitalized terms used but not defined herein have the meanings ascribed to such terms in the Engagement Letter. 13

14 debtor-in-possession financing, including raising the up to $200 million of secured financing and up to $250 million of equity as part of the potential standalone plan of reorganization; Assist the Debtor in preparing proposals to creditors, employees, shareholders and other parties-in-interest in connection with any Transaction; Assist the Debtor s management with presentations made to the Debtor s Board of Directors regarding potential transactions and/or other issues related thereto; and Render such other financial advisory and investment banking services as may be mutually-agreed upon by Houlihan Lokey and the Debtor. 26. The Debtor requires knowledgeable financial advisors to render these essential professional services. As noted above, Houlihan Lokey has substantial expertise in all these areas, and as a result, Houlihan Lokey is well qualified to perform these services and represent the Debtor s interests in this chapter 11 case. CONSIDERATION TO HOULIHAN LOKEY 27. Subject to the Court s approval, Houlihan Lokey will be entitled to the following consideration for its services pursuant to the Engagement Letter as amended as outlined below: Monthly Fee. The Company shall pay Houlihan Lokey a monthly fee (the Monthly Fee ) of $250,000 on each monthly anniversary of the Effective Date of the Engagement Letter. The Monthly Fees shall be fully credited against any Transaction Fee. Transaction Fee. Houlihan Lokey shall be entitled to a transaction fee (the Transaction Fee ) equal to the sum of (i).40% of XO s debt (excluding the Senior Credit Facility) and the liquidation preference of XO s Preferred Stock (with certain exclusions) up to $2,000,000,000 that is restructured, modified, amended, forgiven or otherwise compromised, plus (ii).60% of the outstanding balance of XO s debt (excluding the Senior Credit Facility) in excess of $2,000,000,000 that is restructured, modified, amended, forgiven or otherwise compromised, plus (iii).10% of the outstanding balance of XO s debt under the Senior Credit Facility that is restructured, modified, amended, forgiven or otherwise compromised. Based on discussions with the Debtor s senior management and discussions with certain creditors in the restructuring 14

15 process, Houlihan Lokey has agreed that the Transaction Fee is capped at $20 million. Reimbursement of Expenses. In addition to any other payments and regardless of whether any Transaction is consummated, Houlihan Lokey shall be reimbursed for all out-of-pocket expenses that are reasonably incurred in connection with its services hereunder. Such fees and expenses will include, but not be limited to, travel expenses, communications charges, database charges, copying expenses, and delivery and distribution charges. The out-of-pocket expenses shall not exceed $250,000 without the Debtor s prior consent. Tail Period. Notwithstanding any termination of the Engagement Letter, Houlihan Lokey shall be entitled to full payment, in cash, of the Transaction Fees so long as a Transaction is consummated that (a) incorporates significant and unique elements of a structure proposed or designed by Houlihan Lokey, or (b) in the case of any Transaction involving a merger with or acquisition by an Acquirer with whom Houlihan Lokey had contact on behalf of the Company during the term of the Engagement Letter within six months after the termination of the Engagement Letter (the six month period being referred to herein as the Tail Period ). Notwithstanding the foregoing, if the Engagement Letter is terminated by the Company based on its good faith determination that Houlihan Lokey is not performing the services contemplated by the Engagement Letter in a manner that is satisfactory to the Company and, following such termination, the Company retains one or more other financial advisors to provide advisory services in connection with the Transaction, the Transaction Fee shall be reduced by an amount equal to the amount of the fees payable to such other financial advisor(s). All fees due and payable in accordance with this subparagraph shall be in addition to those other fees payable under the Engagement Letter. Indemnification. The Engagement Letter also provides for the Debtor and its affiliates to indemnify Houlihan Lokey as follows: To the fullest extent lawful, from and against any and all losses, claims, damages or liabilities (or actions in respect thereof), joint or several, arising out of or related to the Engagement Letter, any actions taken or omitted to be taken by an Indemnified Party (as defined in the Engagement Letter), or any Transaction or proposed Transaction contemplated thereby. In addition, the Debtor agrees to reimburse the Indemnified Parties for any legal or other expenses reasonably incurred by them in respect thereof at the time such expenses are incurred; provided, however, the Debtor shall not be liable under the foregoing indemnity and reimbursement agreement for any loss, claim, damage or liability which is finally judicially determined to have resulted primarily from the bad faith, self dealing, breach of fiduciary duty, if any, willful misconduct or gross negligence of any Indemnified Party. 15

16 The Debtor or its estate shall not effect any settlement or release from liability in connection with any matter for which an Indemnified Party would be entitled to indemnification from the Debtor or its estate, unless such settlement or release contains a release of the Indemnified Parties reasonably satisfactory in form and substance to Houlihan Lokey. The Debtor and/or its estate shall not be required to indemnify any Indemnified Party for any amount paid or payable by such party in the settlement or compromise of any claim or action without the Debtor s prior written consent. The Debtor and/or its estate further agree that neither Houlihan Lokey nor any other Indemnified Party shall have any liability, regardless of the legal theory advanced, to the Debtor and/or its estate related to or arising out of Houlihan Lokey s engagement, except for any liability for losses, claims, damages, liabilities or expenses incurred by the Debtor and/or its estate which is finally judicially determined to have resulted primarily from the bad faith, self dealing, willful misconduct or gross negligence of any Indemnified Party. The indemnity, reimbursement, contribution and other obligations and agreements of the Debtor and/or its estate shall apply to any modifications of the Engagement Letter, and shall survive the consummation of any Transaction and any termination of the Engagement Letter. All requests of any Indemnified Parties for payment of indemnity, contribution or otherwise pursuant to the Engagement Letter shall be made by means of an Interim and Final Fee Application and shall be subject to the approval by the Bankruptcy Court pursuant to the Bankruptcy Code, Bankruptcy Rules, and Local Rules and Orders of the Bankruptcy Court. 28. The terms of the Engagement Letter were fully negotiated between the Debtor and Houlihan Lokey, and reflect the Debtor s evaluation of the extensive work that will be performed by Houlihan Lokey and its expertise. DISCLOSURE CONCERNING CONFLICTS OF INTEREST 29. To the best of the Debtor s knowledge, information, and belief, other than as set forth herein or in the Hilty Affidavit, Houlihan Lokey has not represented and has no relationship with: (i) the Debtor, (ii) its creditors or equity security holders, (iii) any other parties-in-interest in this case, (iv) the respective attorneys and accountants of any of the foregoing, or (v) the United States Trustee or any person employed in the Office of the United States Trustee, in any matter relating to this case. 16

17 30. As set forth in the Hilty Affidavit, the principals and professionals of Houlihan Lokey (a) do not have any connection with the Debtor, its creditors, or any party-ininterest, or their respective attorneys; (b) do not hold or represent an interest adverse to the estate; and (c) are disinterested persons within the meaning of Bankruptcy Code section 101(14). 31. The Debtor believes that the employment of Houlihan Lokey would be in the best interests of the Debtor, this bankruptcy estate, and the creditors of this estate. FEE APPLICATIONS AND INTERIM PAYMENTS 32. Prior to the Petition Date, Houlihan Lokey had received approximately $2,417, from the Debtor for monthly fees and reimbursement of expenses, including a payment of $250,000 for services to be rendered through July 14, Houlihan Lokey has received no other compensation from the Debtor or any other party-in-interest in connection with this chapter 11 case. 33. Pursuant to section 331 of the Bankruptcy Code, the Bankruptcy Rules, the Local Rules and the Orders of this Court, Houlihan Lokey will apply to the Court for the interim and final allowance of compensation and reimbursement of expenses. Because Houlihan Lokey will be compensated on a fixed monthly fee and certain transaction fees, Houlihan Lokey shall not be required to file time records in accordance with the United States Trustee Guidelines, but shall present in such applications filed with the Court, weekly descriptions of those services provided on behalf of the Debtor, the approximate time expended in providing those services and the individuals who provided professional services on behalf of the Debtor. 17

18 PROCEDURE 34. The Debtor is providing notice of this Application to: (i) the Office of the United States Trustee for the Southern District of New York; (ii) counsel for lenders under the Senior Credit Facility; (iii) each of the Indenture Trustees under XO s indenture agreements; (iv) counsel to the two unofficial bondholder committees; and (v) the Debtor s top thirty largest unsecured creditors. The Debtor submits that given the circumstances and the notice of the relief requested herein, no other or further notice is required. 35. Because this Application raises no novel issues of law, the Debtor requests that the Court waive the requirement of Local Bankruptcy Rule (b) that a memorandum of law be submitted herewith. 36. No previous application for the relief requested herein has been made to this or any other court. 18

19 CONCLUSION WHEREFORE, the Debtor respectfully requests that the Court enter an order, substantially in the form attached hereto, authorizing the Debtor to retain and employ Houlihan Lokey, as of the Petition Date on an interim basis, and after notice on a final basis, as its financial advisor in the Debtor s chapter 11 case, and granting the Debtor such other relief as is appropriate. Dated: New York, New York June 17, 2002 XO COMMUNICATIONS, INC., Debtor and Debtor in Possession By: /s/ Wayne M. Rehberger Name: Wayne M. Rehberger Title: Chief Financial Officer & Senior Vice President 19