<PAGE>
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 30, 2000
OR
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission File Number 30837
GENUITY INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
Delaware 74-2864824
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
</TABLE>
<TABLE>
<S> <C>
3 Van de Graaff Drive, 01803
Burlington, MA (Zip Code)
(Address of principal executive
offices)
</TABLE>
Registrant's telephone number, including area code 781-262-4000
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [_]
The Company had 173,913,000 shares of $0.01 par value Class A common stock
outstanding and 18,256,000 shares of $0.01 par value Class B common stock
outstanding at November 13, 2000.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<C> <S> <C>
PART I--FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Statements of Operations for the Three and Nine
Month Periods Ended September 30, 1999 and 2000................ 3
Consolidated Balance Sheets as of December 31, 1999 and
September 30, 2000............................................. 4
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 1999 and 2000.................................... 5
Consolidated Statements of Changes in Stockholders' Equity for
the Nine Month Periods Ended September 30, 1999 and 2000....... 6
Consolidated Statements of Comprehensive Loss for the Three and
Nine Month Periods Ended September 30, 1999 and 2000........... 7
Notes to Unaudited Consolidated Financial Statements............ 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 20
Item 3. Quantitative and Qualitative Disclosures About Market Risk...... 23
PART II--OTHER INFORMATION
Item 1. Legal Proceedings............................................... 24
Item 2. Changes in Securities and Use of Proceeds....................... 24
Item 3. Defaults upon Senior Securities................................. 24
Item 4. Submission of Matters to a Vote of Security Holders............. 24
Item 5. Other Information............................................... 24
Item 6. Exhibits and Reports on Form 8-K................................ 24
(a) Exhibit 27--Financial Data Schedule
(b) Reports on Form 8-K
SIGNATURES............................................................... 25
</TABLE>
2
<PAGE>
GENUITY INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in Thousands, Except Per Share Data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
1999 2000 1999 2000
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues.......................... $ 181,548 $ 308,142 $ 504,376 $ 823,918
Operating Expenses
Cost of goods sold.............. 206,260 339,316 545,656 931,466
Selling, general and
administrative................. 97,970 139,213 285,271 372,194
Depreciation and amortization... 49,831 81,250 135,071 196,844
--------- --------- --------- ---------
Total operating expenses...... 354,061 559,779 965,998 1,500,504
--------- --------- --------- ---------
Operating Loss.................... (172,513) (251,637) (461,622) (676,586)
Other Income (Expense)
Interest income, net............ 948 27,912 905 26,966
Other, net...................... (336) (4,442) (2,391) (11,772)
--------- --------- --------- ---------
Loss Before Income Taxes.......... (171,901) (228,167) (463,108) (661,392)
Income Taxes...................... 463 715 1,165 2,023
--------- --------- --------- ---------
Net Loss.......................... $(172,364) $(228,882) $(464,273) $(663,415)
========= ========= ========= =========
Basic and Diluted Loss Per Common
Share............................ $ (9.44) $ (1.19) $ (25.43) $ (3.45)
========= ========= ========= =========
Basic and Diluted Weighted-Average
Common Shares Outstanding........ 18,256 192,169 18,256 192,169
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
3
<PAGE>
GENUITY INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in Thousands, except Share Data)
<TABLE>
<CAPTION>
December 31, September 30,
1999 2000
------------ -------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents......................... $ 6,044 $1,582,996
Receivables, less allowances of $5,550 and $9,008,
respectively..................................... 234,440 274,611
Other current assets.............................. 13,627 50,538
---------- ----------
Total current assets............................ 254,111 1,908,145
Property, Plant and Equipment, Net.................. 1,520,934 2,274,971
Goodwill and Other Intangibles, Net................. 537,989 516,865
Other Assets........................................ 30,098 46,414
---------- ----------
Total assets.................................... $2,343,132 $4,746,395
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Short-term obligations, including current
maturities....................................... $ 25,921 $ 36,263
Note payable--GTE................................. 136,484 --
Accounts payable.................................. 172,399 172,403
Accrued compensation and related liabilities...... 49,637 40,368
Accrued circuits.................................. 51,775 134,496
Accrued liabilities............................... 78,937 244,459
Advanced billings................................. 26,320 8,763
---------- ----------
Total current liabilities....................... 541,473 636,752
Long-Term Obligations............................... 112,717 44,853
Other Liabilities................................... 20,836 14,154
---------- ----------
Total liabilities............................... 675,026 695,759
---------- ----------
Stockholders' Equity:
Class A common stock--$0.01 par value;
1,600,000,000 shares authorized; no shares issued
and outstanding December 31, 1999 and 173,913,000
shares issued and outstanding September 30,
2000............................................. -- 1,739
Class B common stock--$0.01 par value; 21,000,000
shares authorized; 18,256,000 shares issued and
outstanding...................................... 183 183
Class C common stock--$0.01 par value; 800,000,000
shares authorized; no shares issued and
outstanding...................................... -- --
Additional paid-in capital........................ 2,972,142 6,018,185
Accumulated other comprehensive income............ 2,696 859
Accumulated deficit............................... (1,306,915) (1,970,330)
---------- ----------
Total stockholders' equity...................... 1,668,106 4,050,636
---------- ----------
Total liabilities and stockholders' equity...... $2,343,132 $4,746,395
========== ==========
</TABLE>
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
4
<PAGE>
GENUITY INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in Thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
---------------------
1999 2000
--------- ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.............................................. $(464,273) $ (663,415)
Adjustments to reconcile net loss to net cash used in
operations:
Depreciation and amortization....................... 135,071 196,844
Changes in current assets and current liabilities:
Receivables--net.................................. (29,744) (40,171)
Other current assets.............................. 10,535 (36,911)
Other current liabilities......................... 45,685 117,198
Other, net.......................................... (36,075) 13,544
Tax benefit on exercise of stock options............ 5,737 2,542
--------- ----------
Net cash used in operating activities.............. (333,064) (410,369)
--------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures.................................. (446,550) (837,878)
Capitalized software.................................. (22,477) (26,035)
--------- ----------
Net cash used in investing activities.............. (469,027) (863,913)
--------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long-term debt........................... (2,531) (37,733)
Principal payments under capital lease obligations.... (18,533) (19,789)
Change in note payable/receivable--GTE................ 56,845 (136,484)
Proceeds from stock offering, net of expenses......... -- 1,831,547
Contributions from GTE................................ 832,072 1,213,693
--------- ----------
Net cash provided by financing activities.......... 867,853 2,851,234
--------- ----------
Net increase in cash and cash equivalents............... 65,762 1,576,952
Cash and cash equivalents, beginning of period.......... 13,883 6,044
--------- ----------
Cash and cash equivalents, end of period................ $ 79,645 $1,582,996
========= ==========
Supplemental Cash Flow Disclosures:
Cash paid during the period for:
Interest.............................................. $ 3,425 $ 3,807
========= ==========
State income taxes.................................... $ 1,316 $ 1,496
--------- ----------
Noncash Investing and Financing Activities:
Capital lease obligation incurred for equipment
purchase............................................. $ 23,374 $ --
========= ==========
Accounts payable--work in process..................... $ 18,769 $ 104,223
========= ==========
</TABLE>
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
5
<PAGE>
GENUITY INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited)
(Dollars and Shares in Thousands)
<TABLE>
<CAPTION>
Class A Class B
Common Common
-------------- ------------
Additional Other
Paid-In Comprehensive Accumulated
Shares Stock Shares Stock Capital Income (Loss) Deficit Total
------- ------ ------ ----- ---------- ------------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31,
1998................... -- $ -- 18,256 $183 $1,990,485 $3,928 $ (659,869) $1,334,727
Tax benefit on exercise
of stock options--
GTE................... -- -- -- -- 5,737 -- -- 5,737
Capital contributions--
GTE................... -- -- -- -- 832,072 -- -- 832,072
Net loss............... -- -- -- -- -- -- (464,273) (464,273)
Other.................. -- -- -- -- -- (786) -- (786)
------- ------ ------ ---- ---------- ------ ----------- ----------
Balance, September 30,
1999................... -- $ -- 18,256 $183 $2,828,294 $3,142 $(1,124,142) $1,707,477
======= ====== ====== ==== ========== ====== =========== ==========
Balance, December 31,
1999................... -- $ -- 18,256 $183 $2,972,142 $2,696 $(1,306,915) $1,668,106
Effect of stock
offering, net of
$75,500 of offering
expenses.............. 173,913 1,739 -- -- 1,829,808 -- -- 1,831,547
Tax benefit on exercise
of stock options--
GTE................... -- -- -- -- 2,542 -- -- 2,542
Capital contributions--
GTE................... -- -- -- -- 1,213,693 -- -- 1,213,693
Net loss............... -- -- -- -- -- -- (663,415) (663,415)
Other.................. -- -- -- -- -- (1,837) -- (1,837)
------- ------ ------ ---- ---------- ------ ----------- ----------
Balance, September 30,
2000................... 173,913 $1,739 18,256 $183 $6,018,185 $ 859 $(1,970,330) $4,050,636
======= ====== ====== ==== ========== ====== =========== ==========
</TABLE>
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
6
<PAGE>
GENUITY INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited)
(Dollars in Thousands)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
1999 2000 1999 2000
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net Loss.......................... $(172,364) $(228,882) $(464,273) $(663,415)
Other Comprehensive Income (Loss),
net of tax:
Foreign currency translation
adjustments.................... (29) 564 299 746
Unrealized loss on securities... (31) (1,058) (1,085) (2,583)
--------- --------- --------- ---------
(60) (494) (786) (1,837)
--------- --------- --------- ---------
Comprehensive Loss................ $(172,424) $(229,376) $(465,059) $(665,252)
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these unaudited consolidated
financial statements.
7
<PAGE>
GENUITY INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL
Basis of Presentation
The unaudited consolidated financial statements of Genuity Inc. ("Genuity"
or the "Company") include the accounts of the Company and its two wholly owned
subsidiaries, Genuity Solutions Inc. and Genuity Telecom Inc. All significant
inter-company amounts have been eliminated. The unaudited consolidated
financial statements of Genuity presented herein, should be read in conjunction
with the audited consolidated financial statements of Genuity as of and for the
year ended December 31, 1999. In the opinion of management, the unaudited
consolidated financial statements presented herein reflect all adjustments
(consisting only of normal recurring adjustments) necessary for a fair
presentation. Interim results are not necessarily indicative of results to be
expected for the entire year.
Genuity prepares its consolidated financial statements in accordance with
generally accepted accounting principles, which require that management make
estimates and assumptions that affect reported amounts. Actual results could
differ from these estimates.
Summary of Significant Accounting Policies
The Company's significant accounting policies are described in more detail
in Note 1 of the Notes to Consolidated Financial Statements included in its
Form S-1 filed with the Securities and Exchange Commission. For interim
reporting purposes, the Company follows the same significant accounting
policies.
Revenue Recognition
Revenue is generally recognized when services are rendered or products are
delivered to customers. The majority of Genuity's contracts consist of separate
agreements to provide Internet access, web-hosting, value added e-business or
transport services to customers.
Income Taxes
Prior to its initial public offering of Class A common stock, Genuity filed
its federal income tax return on a consolidated basis with GTE, now Verizon
Communications Inc. ("Verizon"). Upon completion of the initial public offering
on June 30, 2000, Genuity was deconsolidated from GTE for income tax purposes.
Income tax payments and refunds are determined based on the stand-alone filings
of Genuity. The accompanying consolidated financial statements are presented as
if Genuity was a stand-alone company for all periods presented. As a result of
Genuity's cumulative losses, tax benefits on operating losses of Genuity have
not been recognized.
Genuity computes current and deferred income tax expense on a stand-alone
basis in accordance with Statement of Financial Accounting Standards (SFAS) No.
109 "Accounting for Income Taxes", which requires recognition of deferred tax
liabilities and assets based upon the expected future tax consequences of
events that have been included in the financial statements or tax returns.
Under this method, deferred tax liabilities and assets are determined based on
the difference between the financial statement and tax basis of assets and
liabilities using tax rates in effect for the year in which the differences are
expected to reverse. A valuation allowance has been established to reflect the
likelihood of realization of deferred tax assets.
Goodwill and Other Intangibles
Goodwill and other intangible assets pertain to the acquisitions of BBN
Corporation and Genuity Incorporated, both acquired in 1997, and internal use
software. Goodwill is being amortized on a straight-line
8
<PAGE>
GENUITY INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
basis over the lesser of 20 years or the period benefited. Other intangible
assets include customer bases, trademarks, developed technology and in-place
work forces in connection with the acquisitions, and internal use software.
Customer bases and in-place work forces are amortized in a manner consistent
with historical attrition patterns over 3 to 10 years. Trademarks, developed
technology and internal use software are amortized on a straight-line basis
over 3 to 10 years.
Concentrations of Credit Risk and Significant Customers
Genuity's accounts receivable are subject to some credit risk. Genuity
performs regular credit evaluations of its customers' financial condition and
maintains allowances for potential credit losses. Genuity's risk of loss is
limited due to advanced billings to some of its customers for services and the
ability to terminate service on delinquent accounts. The credit risk is also
mitigated by the large number of customers comprising the customer base, with
the exception of one large customer, America Online, Inc. ("America Online").
Revenues from America Online in relation to Genuity's total revenues were
significant. However, the credit risk associated with America Online is
mitigated by utilization of advanced billings and a history of timely
collections. The average accounts receivable balance of America Online
represented 36% and 25% of Genuity's receivable balance during the nine-month
periods ended September 30, 1999 and 2000, respectively, while revenues from
America Online represented 54% and 43% of Genuity's total revenues for the nine
month periods ended September 30, 1999 and 2000, respectively.
Genuity has been a supplier of network access services in the United States
to America Online since 1995. Genuity entered into a new agreement with America
Online effective as of December 31, 1999, pursuant to which America Online has
agreed to purchase additional dial-up access services from Genuity for a seven-
year term through December 31, 2006. Under the new agreement, America Online
has also agreed to purchase managed digital subscriber line and other broadband
network access services from Genuity for a five-year term through December 31,
2004. This agreement includes provisions for minimum purchase requirements at
fixed monthly fees, subject to market pricing adjustments, service level
requirements and termination provisions. The fixed monthly fees for dial-up
access services will decline on various dates over the contract term with
another decrease commencing in the fourth quarter of 2000.
Under a separate agreement with AOL Japan, Inc. ("AOL Japan"), Genuity has
agreed to provide dial-up network access services to America Online in Japan.
This agreement also includes minimum purchase requirements on the part of AOL
Japan, market pricing adjustments, service level requirements, and termination
provisions.
Stock-Based Compensation
Stock options issued to employees and directors are accounted for in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees", under which there is no charge to earnings for
stock options granted with an exercise price equal to the fair market value of
the common stock on the date of grant.
Loss per Share
Loss per common share is calculated based on the provisions of SFAS No. 128,
"Earnings per Share." Basic earnings or loss per share ("EPS") is measured as
the income or loss attributable to common stockholders divided by the weighted
average outstanding common shares for the period. Diluted EPS presents the
dilutive effect on a per share basis of potential common shares as if they had
been converted at the beginning of the periods presented. Potential common
shares that have an anti-dilutive effect are excluded from diluted EPS.
Contingently issuable shares are included in the calculation of diluted EPS, if
all of the necessary conditions regarding the share issuance have been met as
of the end of the reporting period.
9
<PAGE>
GENUITY INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Recent Accounting Pronouncements
On December 3, 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements". Genuity adopted this accounting guidance in the first quarter of
2000. There was no impact to the Company's consolidated statement of operations
for the adoption of SAB No. 101, as it has been the Company's practice to
recognize installation revenue only to the extent of incurred costs.
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
No. 133, as amended by SFAS No. 138 "Accounting for Certain Derivative
Instruments and Certain Hedging Activities--an Amendment of FASB Statement
No. 133", establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities.
SFAS No. 133, also amended by SFAS No. 137 "Accounting for Derivative
Instruments and Hedging Activities--Deferral of the Effective Date of FASB
Statement No. 133--an Amendment of FASB Statement No. 133", is effective for
all fiscal quarters of all fiscal years beginning after June 15, 2000. The
Company is currently evaluating the future effects of adopting this statement.
Reclassifications
Certain reclassifications have been made to the 1999 financial statements to
conform to the 2000 presentation. Such reclassifications have no effect on
previously reported net loss or stockholders' equity.
2. SIGNIFICANT TRANSACTIONS
Initial Public Offering
The Company completed an initial public offering of its Class A common stock
on June 30, 2000 and the Company's Class A common stock began trading on the
NASDAQ National Market. The Company sold 173,913,000 shares of Class A common
stock at a price of $11 per share.
Recapitalization
Prior to the initial public offering, Genuity was a wholly owned subsidiary
of GTE. On June 22, 2000, Genuity completed a recapitalization. As part of the
recapitalization, Genuity converted 510 shares of common stock issued and
outstanding to 18,256,000 shares of Class B common stock. These shares have
been reflected as if issued on January 1, 1999.
On June 22, 2000, GTE executed a recapitalization agreement in connection
with its receipt of the Class B common stock. The recapitalization agreement
requires Genuity to obtain the consent of Verizon prior to taking actions such
as making acquisitions for consideration that exceeds 20% of Genuity's market
capitalization, making any acquisitions with a purchase price in excess of $100
million or entering into any joint venture with an investment in excess of $100
million that is not closely related to Genuity's business, making any
disposition in excess of 20% of Genuity's market capitalization, and certain
other restrictions on incurring indebtedness and other protective rights.
In connection with the recapitalization, GTE made a capital contribution to
Genuity of $393.5 million to fund accrued compensation amounts, employee
benefit plan obligations and certain other liabilities.
Common Stock
The shares of Genuity's Class A common stock, Class B common stock and Class
C common stock are identical in all respects except for voting rights,
conversion rights and as otherwise described below. The rights,
10
<PAGE>
GENUITY INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
preferences and privileges of holders of Class A common stock, Class B common
stock and Class C common stock are subject to the rights of the holders of
shares of any other class of common stock that Genuity may authorize and issue
and any series of preferred stock that Genuity may designate and issue in the
future.
Voting Rights. Except as required by law or as described below, the holders
of the Class A common stock, Class B common stock and Class C common stock vote
together as a single class on all matters submitted to a vote of Genuity's
shareholders. Each share of Class A common stock entitles the holder to one
vote per share. So long as 50% or more of the shares of Class B common stock
outstanding at the completion of the initial public offering remain
outstanding, no holder or group of holders of Class A common stock may vote any
of their shares in excess of 20% of the aggregate number of the then
outstanding number of shares of Class A common stock.
Each share of Class B common stock entitles the holder to one vote per
share. The holders of Class B common stock, voting separately as a class, are
entitled to elect a Class B director to Genuity's board of directors. Genuity
is also required to obtain the consent of the holders of Class B common stock,
before taking specific actions, including making significant acquisitions or
dispositions, entering into major business combinations, and incurring
indebtedness or issuing additional equity securities in excess of specified
limits. Under the terms of an FCC Memorandum and Order, dated June 16, 2000
(the "FCC order"), Verizon has agreed that it will not consent to Genuity's
acquisition of a traditional voice long-distance provider unless the FCC has
first reviewed and approved the acquisition.
Each share of Class C common stock entitles the holder to five votes per
share.
Conversion. The Class A common stock has no conversion rights. Verizon,
directly or indirectly, owns all of the outstanding shares of Class B common
stock.
Under the terms of the FCC order:
. if Verizon eliminates the applicable restrictions of Section 271 of the
Telecommunications Act of 1996 (the "Section 271 restrictions") as to
100% of Bell Atlantic in-region lines, Verizon could convert the Class B
common stock into 800,000,000 shares of Class A common stock or Class C
common stock;
. if Verizon eliminates the applicable Section 271 restrictions as to 50%
of Bell Atlantic in-region lines and, under circumstances described in
the recapitalization agreement, it first offers its shares to Genuity, it
could transfer its shares of Class B common stock to one or more third
parties that would then be able to convert the Class B common stock into
an aggregate of 800,000,000 shares of Class A common stock;
. if Verizon does not eliminate the applicable Section 271 restrictions as
to at least 50% of Bell Atlantic in-region lines, the Class B common
stock is convertible into shares of Class A common stock, representing
approximately 10% of Genuity's total common stock outstanding after
conversion.
Under the terms of the FCC order, if Verizon has not eliminated the
applicable Section 271 restrictions as to 100% of Bell Atlantic in-region lines
on or before June 30, 2005, which date may be extended under certain
conditions, Verizon's ability to convert the Class B common stock into
800,000,000 shares of Class A common stock or Class C common stock will expire.
If Verizon has satisfied the applicable Section 271 restrictions as to 100% of
Bell Atlantic in-region lines on or before that date, or any extension, its
ability to convert the Class B common stock into 800,000,000 shares of Class A
common stock or Class C common stock will not expire. The Class B common stock
transferred to a third party will not be subject to this expiration limitation.
11
<PAGE>
GENUITY INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Each share of Class C common stock is convertible by the holder at any time
into one share of Class A common stock. Each share of Class C common stock will
automatically convert into one share of Class A common stock if at any time the
aggregate number of outstanding shares of Class C common stock, together with
shares of Class C common stock issuable upon conversion of Class B common
stock, constitutes less than 10% of Genuity's outstanding common stock.
Verizon's Right to Acquire Additional Shares. If at any time during the one
year following conversion by Verizon or its affiliates of any shares of Class B
common stock, Verizon and its affiliates beneficially own shares of Class A
common stock and Class C common stock that in the aggregate exceed 70% of the
total number of shares of outstanding common stock, Verizon may acquire from
Genuity during this one-year period a number of shares of Class A common stock
so that it will own shares of common stock equal to 80% of the total number of
shares of the outstanding common stock.
Genuity Right of First Offer. Under the terms of the FCC order, if Verizon
seeks to sell some or all of its shares of Genuity Class B common stock, or the
shares of Genuity common stock received by it on conversion of all or some of
Genuity's shares of its Class B common stock, after eliminating the applicable
Section 271 restrictions as to at least 50% but less than 95% of Bell Atlantic
in-region lines, Verizon will first offer to sell those shares to Genuity with
the purchase price payable in the form of an unsubordinated, marketable debt
instrument of Genuity with a fair market value equal to its face value.
Genuity's issuance to Verizon of such a debt instrument shall constitute an
exception to any limitation on the aggregate amount of Genuity's debt that
Verizon may hold pursuant to the FCC order. This debt instrument will bear
interest at a commercially reasonable rate, comparable to rates under similar
instruments held by companies with debt ratings comparable to Genuity's, with a
commercially reasonable time for repayment. The purchase price for all of the
shares of Class B common stock will be equal to the lower of (a) the fair
market value of those shares as determined by a nationally recognized
independent investment banker selected jointly by Verizon and Genuity or (b)
the sum of:
. the value of a 10% equity interest in Genuity at the time of such sale,
based on the average of the closing prices of the Class A common stock on
the thirty trading days prior to the date Verizon offers the shares to
Genuity; and
. the amount Verizon would have had on the date of the completion of the
sale if it had taken the amount of its initial investment in Genuity
above a 10% equity interest, based on the initial public offering price
for the Class A common stock, and invested such amount at the time of the
closing of the initial public offering in the S&P 500 Index.
Verizon has agreed to grant any consent necessary for Genuity to be able to
complete the purchase of Verizon's Class B common stock.
Liquidation. In the event of any dissolution, liquidation, or winding up of
Genuity's affairs, whether voluntary or involuntary, the holders of the Class A
common stock, the Class B common stock, and the Class C common stock will be
entitled to share ratably, in proportion to the number of shares they represent
of Genuity's outstanding common stock, in the assets legally available for
distribution to stockholders, in each case after payment of all of Genuity's
liabilities and subject to preferences that may apply to any series of
preferred stock then outstanding. Genuity may not dissolve, liquidate or wind
up its affairs without obtaining the consent of the holders of the outstanding
shares of its Class B common stock.
Mergers and Other Business Combinations. If Genuity enters into a merger,
consolidation or other similar transaction in which shares of its common stock
are exchanged for or converted into securities, cash or any other property, the
holders of each class of Genuity's common stock will be entitled to receive an
equal per share amount of the securities, cash, or any other property, as the
case may be, for which or into which each
12
<PAGE>
GENUITY INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
share of any other class of common stock is exchanged or converted; provided
that in any such merger, consolidation or other similar transaction, the
holders of the shares of Class B common stock shall be entitled to receive, at
their election, either (1) the merger consideration such holders would have
received had they converted their shares of Class B common stock immediately
prior to the consummation of such transaction or (2) a new security that is
convertible into the merger consideration and has substantially identical
voting and other rights as the Class B common stock. In any transaction in
which shares of capital stock are distributed, the shares that are exchanged
for or converted into the capital stock may differ as to voting rights and
conversion rights only to the extent that the voting rights and conversion
rights of Class A common stock, Class B common stock and Class C common stock
differ at that time. The holders of the Class B common stock, voting separately
as a class, must consent to any such merger, consolidation or other similar
transaction.
Agreements with Verizon
Concurrent with the closing of the initial public offering, Genuity executed
agreements with Verizon and certain of its affiliates including transition
services agreements, a purchase, resale and marketing agreement, intellectual
property agreements, a network monitoring agreement and real estate agreements.
The transition services, intellectual property, network monitoring and real
estate agreements involve services provided to and received from Verizon. The
terms of these agreements vary from four to twelve months with rights to
terminate earlier. The fees paid or received from these agreements are fixed
under the agreements and were based on historical costs and comparable market
prices. Under the purchase, resale and marketing agreement, Verizon has agreed
to purchase at least $500 million of Genuity's services over a five-year
period.
3. PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment, net, was comprised of the following (in
thousands):
<TABLE>
<CAPTION>
December 31, September 30,
1999 2000
------------ -------------
<S> <C> <C>
Land............................................ $ 4,705 $ 4,855
Buildings and fixtures.......................... 6,318 7,272
Communications network--fiber-optic cable....... 481,573 584,435
Communications network--data processing
equipment and machinery........................ 728,177 1,039,133
Furniture....................................... 18,653 21,303
Leasehold improvements.......................... 170,420 196,806
Work in progress................................ 402,740 863,082
---------- ----------
Subtotal...................................... 1,812,586 2,716,886
Accumulated depreciation........................ (291,652) (441,915)
---------- ----------
Total......................................... $1,520,934 $2,274,971
========== ==========
</TABLE>
During 1999, Genuity completed its initial buildout of its communications
network in the United States. Costs directly related to the network have been
capitalized, including amounts associated with the indefeasible rights-of-use
(IRUs). Genuity commenced depreciation as individual segments were placed in
service.
Depreciation expense was $36.2 million and $64.8 million for the three
months ended September 30, 1999 and 2000, respectively, and $96.5 million and
$149.6 million for the nine months ended September 30, 1999 and 2000,
respectively.
13
<PAGE>
GENUITY INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. GOODWILL AND OTHER INTANGIBLES, NET
Goodwill and other intangibles, net, was comprised of the following (in
thousands):
<TABLE>
<CAPTION>
December 31, September 30,
1999 2000
------------ -------------
<S> <C> <C>
Goodwill......................................... $ 495,348 $ 495,348
Customer bases................................... 77,000 77,000
Trademarks....................................... 34,000 34,000
Developed technology............................. 19,000 19,000
In-place work forces............................. 9,190 9,190
Internal use software............................ 34,580 60,615
--------- ---------
Subtotal....................................... 669,118 695,153
Accumulated amortization......................... (131,129) (178,288)
--------- ---------
Total.......................................... $ 537,989 $ 516,865
========= =========
</TABLE>
Amortization expense was $13.6 million and $16.5 million for the three
months ended September 30, 1999 and 2000, respectively, and was $38.6 million
and $47.2 million for the nine months ended September 30, 1999 and 2000,
respectively.
5. DEBT
Short-term obligations and long-term obligations were as follows (in
thousands):
<TABLE>
<CAPTION>
December 31, September 30,
1999 2000
------------ -------------
<S> <C> <C>
Note payable--GTE................................. $136,484 $ --
6% convertible subordinated debentures............ -- 11,215
Current portion of capital leases................. 25,921 25,048
-------- -------
Total short-term obligations.................... $162,405 $36,263
======== =======
6% convertible subordinated debentures............ $ 48,948 $ --
Capital leases.................................... 63,769 44,853
-------- -------
Total long-term obligations..................... $112,717 $44,853
======== =======
</TABLE>
The 6% convertible subordinated debentures due 2012 may be converted by the
bondholders into cash at an exchange ratio of $966.67 for each $1,000 in
principal amount of debentures. The debentures are unsecured obligations of
Genuity and are subordinated in right of payment to Genuity's senior
indebtedness, if any. During the nine months ended September 30, 2000, Genuity
paid $37.7 million related to debentures that had been converted by the
bondholders. The remaining balance at September 30, 2000 has been included in
short-term obligations based on an estimate of the timing for the remaining
debt conversions.
On September 5, 2000, the Company entered into a committed and unsecured $2
billion revolving line of credit facility that matures on the earlier of
September 5, 2005 or the date that is three months prior to the scheduled
expiration of the option of Verizon to convert its Class B common stock into
Class C common stock. The facility is guaranteed by our principal operating
subsidiaries. Our credit advances bear interest at a rate equal to either (1)
for base rate advances, the higher of the prime announced by Chase Manhattan
Bank or .50% per annum above the federal funds rates or (2) for LIBOR advances,
LIBOR plus a percentage
14
<PAGE>
GENUITY INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
determined based on our credit rating. The interest on credit advances will be
payable in quarterly installments. The credit facility contains restrictions on
our ability to incur liens and requires that we maintain a minimum debt-to-debt
plus contributed capital ratio. As of September 30, 2000, there were no
outstanding credit advances under this facility.
6. STOCK-BASED COMPENSATION
Long-Term Stock Incentive Plan
The Long-Term Stock Incentive Plan (the "Stock Plan") was approved by the
board of directors on May 22, 2000. The Stock Plan provides for the following
awards based on the Class A common stock: stock options, stock appreciation
rights, stock-based performance bonuses and other stock-based awards. No cash
awards will be permitted under the plan (except in lieu of fractional shares).
Awards may be granted to employees of Genuity or any entity in which it owns at
least a 10% interest. The Stock Plan will be administered by the compensation
committee of the Genuity board of directors. The administrator has the
authority to determine eligibility, grant awards and make all other
determinations under the plan.
Stock options granted under the Stock Plan may have a term of up to 10 years
and may be either incentive stock options, as defined in the Internal Revenue
Code, or nonqualified stock options. Stock options granted may not be assigned
other than by will or by applicable laws. The period or periods during which an
award will be exercisable or remain outstanding, including any periods
following termination of service, the manner of exercise and other details of
awards will be determined by the administrator consistent with the Stock Plan.
There are approximately 87,165,000 shares authorized for award under the
Stock Plan. As of September 30, 2000, approximately 63,876,000 options were
outstanding and none were exercisable.
Outside Directors' Compensation Plan
The Outside Directors' Compensation Plan (the "Directors' Plan") was
approved by the board of directors on May 22, 2000. Pursuant to this plan, non-
employee directors who agreed, prior to the initial public offering, to serve
on the board of directors received a $30,000 annual cash fee and one-time
option to purchase 30,000 shares of Class A common stock at an exercise price
equal to the initial public offering price. In addition, non-employee directors
who agree after the initial public offering to serve on the board of directors
will receive, effective upon election to the board of directors, a $30,000
annual cash fee and options to purchase 30,000 shares of Class A common stock
at an exercise price equal to the fair market value at the time of grant. These
stock options will vest in three equal installments and each installment will
become exercisable on the day prior to the annual meeting of the stockholders.
There are approximately 487,000 shares authorized for award under the
Directors' Plan. As of September 30, 2000, 330,000 options were outstanding and
none were exercisable.
7. EMPLOYEE BENEFIT PLANS
The board of directors of Genuity adopted the Genuity Savings Plan effective
with the initial public offering. Under this Plan, Genuity will provide
matching contributions in either Genuity Class A common stock or a stock
equivalent based on qualified employee contributions. Employees can contribute
between 1% and 20% of their eligible pay, as defined, and are immediately 100%
vested.
15
<PAGE>
GENUITY INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8. EARNINGS PER SHARE
The weighted average common shares outstanding for both basic and diluted
earnings per share were 18,256,000 shares for the three and nine month periods
ending September 30, 1999 and 192,169,000 shares for the three and nine month
periods ending September 30, 2000. Potential common shares were not included in
the computations of weighted average diluted shares outstanding for the quarter
and nine months ended September 30, 2000 because their inclusion would be anti-
dilutive. Contingently issuable shares were not included in the computations of
weighted average diluted shares outstanding for the quarter and nine months
ended September 30, 2000 as the necessary conditions surrounding the share
issuance had not been met.
9. SEGMENT REPORTING
Genuity's operations are reported in three segments: Access, Hosting and
Transport.
Access--Internet access pertains to a variety of global Internet access
services, including dial-up, dedicated, DSL and other broadband, by providing
and managing the underlying scaleable infrastructure. Genuity also provides a
range of customer premise equipment necessary to connect to the Internet,
including routers, channel service units/data service units, modems, software
and other products. Customers receive 24 hours per day, seven days per week
network monitoring and technical support from Genuity's Network Operations
Centers (NOC).
Hosting--Hosting pertains to services that allow customers to successfully
implement their e-business strategies through scaleable, reliable and secure
Web sites, which serve as their e-business storefronts. The e-business model
enables companies to decrease sales costs; accelerate time to market; access
new sales channels; increase revenues, productivity and customer satisfaction;
and gain competitive advantage. Genuity currently operates 11 global data
centers, nine in the U.S., one in Leeds, England and one in Tokyo, Japan.
Through the web hosting operation center, Genuity monitors these systems 24
hours a day, seven days a week.
Transport--Genuity provides a broad range of transport services to customers
through a single point of contact for planning, ordering, installing, billing,
maintaining and managing customers' transport services. Genuity provides
seamless operation of local loops, central office connections and interexchange
carrier transport. Through Genuity's NOC, network faults, intrusion or
environmental alarms are observed, diagnostics are performed, and referrals or
dispatches are initiated as needed.
Value-Added Services / Other--Includes revenue from international
operations, sale of international services and revenue generated from value-
added Internet services of security, virtual private networks and voice-over
IP.
Network costs within Global Network Infrastructure (GNI) which are incurred
to support the Access, Hosting and Transport segments are not allocated to
these segments for management reporting or segment reporting purposes.
Similarly, selling, general and administrative expenses are not allocated to
the segments for management or segment reporting purposes.
Revenues for America Online in relation to Genuity's total revenues were 54%
and 43% for the nine months ended September 30, 1999 and 2000, respectively.
Management utilizes several measurements to evaluate its operations and
allocate resources. However, the principal measurements are consistent with
Genuity's financial statements. The accounting policies of the segments are the
same as those described in Note 1.
16
<PAGE>
GENUITY INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Financial information for Genuity's segments is as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
1999 2000 1999 2000
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues
Access....................... $ 140,953 $ 230,333 $ 401,425 $ 611,305
Hosting...................... 12,004 30,096 33,073 78,910
Transport.................... 17,250 26,995 46,379 72,482
Value-Added Services/Other... 11,341 20,718 23,499 61,221
--------- --------- --------- ---------
Total revenues............. 181,548 308,142 504,376 823,918
Operating Expenses
Cost of goods sold........... 206,260 339,316 545,656 931,466
Selling, general and
administrative.............. 97,970 139,213 285,271 372,194
Depreciation and
amortization................ 49,831 81,250 135,071 196,844
--------- --------- --------- ---------
Total operating expenses... 354,061 559,779 965,998 1,500,504
--------- --------- --------- ---------
Operating Loss................. (172,513) (251,637) (461,622) (676,586)
Other Income (Expense)
Interest income, net......... 948 27,912 905 26,966
Other, net................... (336) (4,442) (2,391) (11,772)
--------- --------- --------- ---------
Loss Before Income Taxes....... $(171,901) $(228,167) $(463,108) $(661,392)
========= ========= ========= =========
Capital Expenditures(1)
Access....................... $ 32,696 $ 233,345 $ 79,669 $ 310,775
Hosting...................... 9,924 53,377 23,625 98,008
Transport.................... 739 -- 2,948 828
GNI.......................... 143,319 135,810 339,010 433,973
Value-Added Services/Other... 17,807 18,797 43,441 98,517
--------- --------- --------- ---------
Total...................... $ 204,485 $ 441,329 $ 488,693 $ 942,101
========= ========= ========= =========
Depreciation and Amortization
Access....................... $ 8,371 $ 13,135 $ 22,508 $ 34,410
Hosting...................... 3,237 7,253 9,153 15,214
Transport.................... 2,021 1,104 5,263 4,660
GNI.......................... 19,851 35,388 52,415 82,273
Value-Added Services/Other... 16,351 24,370 45,732 60,287
--------- --------- --------- ---------
Total...................... $ 49,831 $ 81,250 $ 135,071 $ 196,844
========= ========= ========= =========
International Revenues(2)...... $ 6,232 $ 10,545 $ 15,095 $ 28,182
========= ========= ========= =========
</TABLE>
--------
(1)Includes accruals and capital leases.
(2)Excludes revenues from AOL Japan.
17
<PAGE>
GENUITY INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
<TABLE>
<CAPTION>
December 31, September 30,
1999 2000
------------ -------------
<S> <C> <C>
Property, Plant and Equipment, Net
Access.......................................... $ 180,777 $ 475,435
Hosting......................................... 52,998 144,745
Transport....................................... 26,974 20,754
GNI............................................. 1,162,287 1,514,107
Value-Added Services/Other...................... 97,898 119,930
---------- ----------
Total......................................... $1,520,934 $2,274,971
========== ==========
International
Long-lived assets............................... $ 1,855 $ 8,025
========== ==========
</TABLE>
10. COMMITMENTS AND CONTINGENCIES
Leases
Genuity leases office space and network equipment under long-term capital
and operating leases. These leases have options for renewal with provisions for
increased rent upon renewal.
As of September 30, 2000, the future minimum lease payments under non-
cancelable capital and operating leases with initial or remaining periods in
excess of one year were as follows (in thousands):
<TABLE>
<CAPTION>
Capital Operating
Leases Leases
------- ---------
<S> <C> <C>
2000...................................................... $ 7,274 $ 19,409
2001...................................................... 29,097 67,553
2002...................................................... 25,570 34,457
2003...................................................... 12,058 30,014
2004...................................................... 1,667 26,358
Thereafter................................................ -- 102,210
------- --------
Total minimum lease payments............................ 75,666 $280,001
========
Amount representing interest.............................. (5,765)
-------
Present value of minimum lease payments................. $69,901
=======
</TABLE>
GTE, now Verizon, guarantees some of Genuity's existing real estate leases.
Contract Commitments
Genuity has entered into several agreements for IRUs for its network
infrastructure in the United States. The initial terms of the IRUs are for 20-
25 years, with options to extend the terms. Genuity is obligated to pay
operating and maintenance costs under the contract terms. As of September 30,
2000, the future minimum commitments under these agreements were as follows (in
thousands):
<TABLE>
<S> <C>
2000............................................................... $ 70,000
2001............................................................... 122,000
2002............................................................... 59,000
--------
Total future minimum commitments................................. $251,000
========
</TABLE>
18
<PAGE>
GENUITY INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Genuity has entered into a number of agreements for IRUs to trans-oceanic
cable systems that are either deployed or in the process of being deployed. The
initial terms of the IRUs are for 25 years. As of September 30, 2000, the
outstanding commitments under the agreements totaled approximately $35.2
million.
Genuity has entered into non-cancelable long-term purchase commitments with
circuit providers. The purchase agreements contain provisions that require
Genuity to purchase a minimum amount of services annually. If Genuity does not
purchase the minimum service, it is required to pay the amount of the shortfall
between the minimum commitments and actual purchases. As of September 30, 2000,
future minimum circuit payments under these non-cancelable purchase commitments
were as follows (in thousands):
<TABLE>
<S> <C>
2000............................................................. $12,000
2001............................................................. 38,000
2002............................................................. 30,000
2003............................................................. 26,000
Genuity has entered into long-term network service agreements for the
development of managed modems to be utilized in the dial-up modem services
business. These agreements contain minimum purchase commitments based on the
achievement of various production milestones. These contracts also contain
most-favored customer pricing and business downturn provisions that could
reduce the contractual commitments in the event that market prices for similar
services decrease over the contract term or if there is a material downturn in
customer demand for modem services. As of September 30, 2000, the future
minimum commitments under these agreements were as follows (in thousands):
2000............................................................. $ 0
2001............................................................. 86,000
2002............................................................. 132,000
2003............................................................. 131,000
2004............................................................. 73,000
Thereafter....................................................... 103,000
--------
Total future minimum commitments............................... $525,000
========
</TABLE>
In connection with another agreement, under which we hold IRUs for a major
part of our domestic fiber optic network, restrictions on the sale of excess
capacity and on the sale or swap of fiber IRUs were lifted.
Contingencies
Some claims arising in the ordinary course of business are pending against
the Company. In the opinion of management, these claims are not expected to
have a material effect on operations.
19
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Form 10-Q contains certain forward-looking statements regarding, among
other things, our future financial performance, our anticipated growth
strategies and anticipated trends in our business as well as projections
relating to our capital expenditure requirements, our network expansion plans,
locations of new data centers, network operations centers and points of
presence, expected deployment dates for capacity on trans-oceanic cable, our
plans for transitioning customer traffic from leased capacity to our network,
research and development initiatives and increases in sales and marketing
personnel. Investors are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof and are
predictions based solely on our current expectations and projections about
certain events. In connection with the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995, we caution investors that our future
financial and operating results may differ materially from those projected in
the forward-looking statements. Such forward-looking statements involve known
and unknown risks and uncertainties and, accordingly, there are many factors
that may cause our actual results, level of activity, performance or
achievements to be materially different from any future results, level of
activity, performance of achievements expressed or implied by such forward-
looking statements. Those factors that may cause our actual results, level of
activity, performance or achievements to be materially different from that
expressed or implied by any forward-looking statement include our ability to
maintain or increase our market share and therefore maintain our status as a
Tier 1 Internet backbone provider, maintain and strengthen our relationship
with America Online and other significant customers, obtain additional capital
to fund our operations and the expansion of our capacity and network
infrastructure, successfully maintain and continue to strengthen our brand
recognition, compete effectively for service and enterprise customers, reduce
operating expenses and introduce new services.
The following discussion and analysis should be read in conjunction with the
unaudited consolidated financial statements and related notes included in this
report.
Revenues
<TABLE>
<CAPTION>
Three Months Ended
September 30,
(in thousands)
--------------------------
1999 2000
------------ ------------
Amount % Amount %
-------- --- -------- ---
<S> <C> <C> <C> <C>
Access.............................................. $140,953 77% $230,333 74%
Hosting............................................. 12,004 7 30,096 10
Transport........................................... 17,250 10 26,995 9
Value-Added Services/Other.......................... 11,341 6 20,718 7
-------- --- -------- ---
Total............................................... $181,548 100% $308,142 100%
======== === ======== ===
<CAPTION>
Nine Months Ended
September 30,
(in thousands)
--------------------------
1999 2000
------------ ------------
Amount % Amount %
-------- --- -------- ---
<S> <C> <C> <C> <C>
Access.............................................. $401,425 80% $611,305 74%
Hosting............................................. 33,073 7 78,910 10
Transport........................................... 46,379 9 72,482 9
Value-Added Services/Other.......................... 23,499 4 61,221 7
-------- --- -------- ---
Total............................................... $504,376 100% $823,918 100%
======== === ======== ===
</TABLE>
Revenues for the quarter ended September 30, 2000 increased $127 million, or
70%, and revenues for the first nine months of 2000 increased $320 million, or
63%, over the same periods in 1999.
20
<PAGE>
Access. Access revenues for the quarter ended September 30, 2000 increased
$89 million, or 63%, and for the first nine months of 2000 increased $210
million, or 52%, over the same periods in 1999. This increase was due primarily
to a 65% increase in the number of dial-up access modems deployed since
September 30, 1999, and a 23% increase in the number of dedicated access
connections since September 30, 1999. Also contributing to the increases was an
increase in the number of DSL subscribers from approximately 11,000 as of
September 30, 1999 to approximately 138,000 as of September 30, 2000. These
increases were offset in part by industry-wide price reductions, and pricing
structure changes associated with our new contract with AOL. This agreement
includes provisions for minimum purchase requirements at fixed monthly fees,
subject to market pricing adjustments, service level requirements and
termination provisions. The fixed monthly fees for dial-up access services will
decline on various dates over the contract term with another decrease
commencing in the fourth quarter of 2000.
Hosting. Hosting revenues for the quarter ended September 30, 2000 increased
$18 million, or 151%, and for the first nine months of 2000 increased $46
million, or 139%, over the same periods in 1999, due to increases in the number
of our managed hosting customers and the average monthly revenue associated
with these customers. In addition, the average new deal size for hosting
contracts increased to $284 thousand in the quarter ended September 30, 2000
compared to $187 thousand in the same period in 1999.
Transport. Transport revenues for the quarter ended September 30, 2000
increased $10 million, or 57%, and for the first nine months of 2000 increased
$26 million, or 56%, over the same periods in 1999, due primarily to the sale
of excess capacity on our network as we brought new network segments on line,
as well as increased sales of private line services and ATM services to
telecommunications carriers and Internet service providers.
Value-Added Services/Other. Other revenues for the quarter ended September
30, 2000 increased $9 million, or 83%, and for the first nine months of 2000
increased $38 million, or 161%, over the same periods in 1999. This growth is
primarily due to an increase in revenues from sales of voice over IP services,
sales of Internet access services in international markets and increases in
security services.
Cost of Goods Sold
Cost of goods sold for the quarter ended September 30, 2000 increased $133
million, or 65%, and for the first nine months of 2000 increased $386 million,
or 71%, over the same periods in 1999. The increase for both the quarter and
nine month periods was due to the build-out of our network infrastructure to
provide access to a broader base of customers, support a growing customer base
and to provide increased scope of services to Internet access customers. In
addition, this increase was related to the initial build-out of our network,
utilizing primarily leased capacity, to support our future contractual
obligations with America Online.
Cost of goods sold, as a percentage of total revenues, was 114% and 110% for
the quarters ended September 30, 1999 and 2000, respectively, and 108% and 113%
for the first nine months of 1999 and 2000, respectively. Telecommunications
circuit costs, as a percentage of total revenues, were approximately 80% and
79% for the quarters ended September 30, 1999 and 2000, respectively, and 72%
and 80% for the first nine months of 1999 and 2000, respectively.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the quarter ended September
30, 2000 increased $41 million, or 42%, and for the first nine months of 2000
increased $87 million, or 31%, over the same periods in 1999. This increase was
due primarily to increased selling expenses that were directly attributable to
an increase in the number of sales and sales-related employees, both
domestically and internationally, and to the branding efforts surrounding our
name change. Also contributing to these increases were the hiring of additional
management staff and related operating expenses, expansion of our marketing
organization, increased facilities costs and increased information technology
expenses. Included in selling, general and administrative expenses was a $6.2
million or 218% increase in bad debt expense for the nine months ended
September 30, 2000 over the comparable period in 1999.
21
<PAGE>
Depreciation and Amortization
Depreciation and amortization expenses for the quarter ended September 30,
2000 increased $31 million, or 63%, and for the first nine months of 2000
increased $62 million, or 46%, over the comparable periods in 1999. This
increase reflects the continuing investment in our network infrastructure in
order to support our growth in customers and services.
Income Taxes
We generated pre-tax book losses of $228 million for the quarter ended
September 30, 2000 and $661 million for the first nine months of 2000. Federal
income tax returns were filed on a consolidated basis with GTE through the date
of our initial public offering. The tax provision, however, was computed on a
stand-alone basis. Because we have historically generated net operating losses,
a valuation allowance has been established to reflect the likelihood of
realizing the deferred tax assets.
Net Loss
Net losses increased to $229 million for the quarter ended September 30,
2000 compared to $172 million for the quarter ended September 30, 1999 and to
$663 million for the first nine months of 2000 compared to $464 million in the
same period in 1999.
Liquidity and Capital Resources
We have used cash in our operating and investing activities during all
periods. We have funded these cash requirements principally through permanent
contributions to capital from GTE, borrowings from its affiliates and proceeds
from our initial public offering of Class A common stock.
Net cash used in operating activities was $333 million and $410 million for
the first nine months of 1999 and 2000, respectively. Net cash used in
operating activities for these periods was primarily the result of operating
losses.
Net cash used in investing activities was $469 million and $864 million for
the first nine months of 1999 and 2000, respectively. Net cash used in
investing activities in each of these periods was primarily the result of
capital expenditures for construction of our network infrastructure, as well as
leasehold improvements, furniture, fixtures, computers and other equipment. The
Company currently intends to have capital expenditures of approximately $1.8
billion to $2.0 billion during the year ended December 31, 2000, of which
approximately $1.2 billion is expected to be spent on the continued expansion
of our fiber optic network and approximately $250 million is expected to be
spent on the construction of additional data centers. As of September 30, 2000,
Genuity had $589 million of commitments outstanding for these projected
expenditures. Our capital expenditures program, as currently contemplated, will
require between $9 billion and $11 billion over the four year period ending
2004, the majority of which will be for the expansion of our network
infrastructure.
Net cash received from financing activities was $868 million and $2.9
billion for the nine months ended September 30, 1999 and 2000, respectively.
Capital contributions from GTE amounted to $832 million and $1.2 billion for
the first nine months of 1999 and 2000, respectively. In addition, we received
net proceeds of $1.8 billion as a result of our initial public offering of
Class A common stock in June 2000. The Company should have sufficient liquidity
to address its operating and capital needs through the first quarter of 2001.
As additional sources of liquidity, the Company can access funds through the
$2 billion revolving line of credit facility entered into on September 5, 2000.
In addition, Verizon is permitted, but not obligated, to extend loans to us up
to $2.75 billion for a term not to exceed six months.
22
<PAGE>
Inflation
We do not believe that inflation has had a material adverse impact on our
business or operating results during the periods presented.
Recently Issued Accounting Pronouncements
The Securities and Exchange Commission issued Staff Accounting Bulletin
(SAB) No. 101, "Revenue Recognition in Financial Statements", on December 3,
1999. Genuity adopted this accounting guidance in the first quarter of 2000.
There was no impact to the Company's consolidated statement of operations for
the adoption of SAB No. 101, as it has been the Company's practice to recognize
installation revenue only to the extent of incurred costs.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133, as amended by SFAS No. 138
"Accounting for Certain Derivative Instruments and Certain Hedging Activities--
an Amendment to FASB Statement No. 133", establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments,
embedded in other contracts (collectively referred to as derivatives) and for
hedging activities. SFAS No. 133, also amended by SFAS No. 137 "Accounting for
Derivative Instruments and Hedging Activities--Deferral of the Effective Date
of FASB Statement No. 133--an Amendment to FASB Statement No. 133", is
effective for all fiscal quarters of all fiscal years beginning after June 15,
2000. The Company is currently evaluating the future effects of this statement.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
While our long-term debt bears fixed interest rates, the fair value of our
fixed rate long-term debt is sensitive to changes in interest rates. The
estimated fair value of long-term debt based on a debt pricing model was lower
than its recorded value by approximately $6.6 million as of December 31, 1999.
Currently, we do not use interest rate derivative instruments to manage our
exposure to interest rate changes; however, the Company may utilize derivative
instruments to hedge certain exposures in the future.
23
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are not involved in any legal proceedings which we believe would, if
adversely determined, have a material adverse effect upon our business,
financial condition or results of operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Changes in Securities
None
Use of Proceeds
For the three months ended September 30, 2000, approximately $300 million of
the net proceeds from our initial public offering of Class A common stock was
utilized for operating expenses and capital expenditures in connection with the
expansion of our fiber optic network. The remaining proceeds have been invested
in short-term investments and are included in cash and cash equivalents as of
September 30, 2000.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.0 Financial Data Schedule.
(b) Reports on Form 8-K
Genuity filed a current report on Form 8-K, dated September 7, 2000,
reporting under Item 5 the issuance of a press release discussing the
$2,000,000,000 five-year credit agreement among Genuity Inc., as borrower, the
Chase Manhattan Bank, as administrative agent for the lenders, Chase
Securities, Inc., as arranger, Citibank, N.A, as syndication agent, and Credit
Suisse First Boston and Deutsche Bank AG, as co-documentation agents.
24
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Genuity Inc.
/s/ Daniel P. O'Brien
By: _________________________________
Daniel P. O'Brien
Executive Vice President
and Chief Financial Officer
(Duly Authorized Officer and
Principal Financial and
Accounting Officer)
Dated: November 14, 2000
25
