10-Q 1 0001.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [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 Commission file number: 000-29828 NORTHPOINT COMMUNICATIONS GROUP, INC. (Exact name of Registrant as Specified in its Charter) DELAWARE 52-2147716 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 303 Second Street, South Tower San Francisco, California 94107 (Address of Principal Executive Offices) Registrant's telephone number, including area code: (415) 403-4003 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. [X] Yes [_] No The number of shares of Common Stock, par value $.001 per share, of NorthPoint Communications Group, Inc. outstanding as of October 31, 2000 was 133,452,767. TABLE OF CONTENTS PART I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements............................................................. 2 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......... 10 Item 3. Quantitative and Qualitative Disclosures About Market Risk.................................... 32 PART II. OTHER INFORMATION Item 1. Legal Proceedings............................................................................. 33 Item 2. Changes in Securities and Use of Proceeds..................................................... 33 Item 3. Defaults Upon Senior Securities............................................................... 33 Item 4. Submission of Matters to a Vote of Security Holders........................................... 33 Item 5. Other Information............................................................................. 33 Item 6. Exhibits and Reports on Form 8-K.............................................................. 34
NorthPoint Communications Group, Inc. and Verizon Communications will file a joint proxy statement/prospectus and other documents regarding the proposed business combination transaction referenced in the following information with the Securities and Exchange Commission. Investors and security holders are urged to read the proxy statement/prospectus, when it becomes available, because it will contain important information. A definitive joint proxy statement/prospectus will be sent to stockholders of NorthPoint Communications Group, Inc. seeking their approval of the proposed transaction. Investors and security holders may obtain a free copy of the definitive joint proxy statement/prospectus (when it is available) and other documents filed by NorthPoint Communications Group, Inc. and Verizon Communications with the Commission at the Commission's web site at www.sec.gov. The definitive joint proxy statement/prospectus and these other documents may also be obtained for free by NorthPoint stockholders by directing a request to: NorthPoint Communications Group, Inc., 303 Second Street, South Tower, San Francisco, CA 94107, Attn: Investor Relations, (415) 403-4003, email: investorrelations@northpoint.net. 1 PART 1. FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS. NORTHPOINT COMMUNICATIONS GROUP, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Amounts in 000's, except share and per share amounts)
(Unaudited) September 30, December 31, -------------- ------------- 2000 1999 --------- --------- ASSETS Current assets: Cash and cash equivalents $ 52,690 $ 95,019 Short-term investments 97,636 115,034 Accounts receivable, net of an allowance of $12,864 and $834, respectively 14,914 6,829 Amounts due from affiliated companies 15,133 -- Unbilled revenue 7,465 3,729 Inventories 7,574 4,439 Prepaid expenses and other assets 35,700 19,555 --------- --------- Total current assets 231,112 244,605 Property and equipment: Networking equipment 271,951 117,625 Central office collocation space improvements 106,006 61,637 Computers and software 112,965 40,739 Leasehold improvements 23,055 14,176 Furniture, fixtures and office equipment 12,624 10,192 --------- --------- Total property and equipment 526,601 244,369 Less accumulated depreciation and amortization (71,628) (17,245) --------- --------- Property and equipment, net 454,973 227,124 Long-term investments 51,691 6,740 Deposits 435 691 --------- --------- Total assets $ 738,211 $ 479,160 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable, including related party payables of $0 and $6,161, respectively $ 53,842 $ 56,004 Accrued expenses and other liabilities 35,888 26,023 Capital lease obligations, current portion, net of unamortized debt discount of $265 and $265, respectively 2,377 1,027 --------- --------- Total current liabilities 92,107 83,054 Capital lease obligations, long-term portion, net of unamortized debt discount of $133 and $332, respectively 3,560 1,653 Deferred long-term credits 11,914 1,392 Notes payable 400,000 -- Term loan 85,000 85,000 --------- --------- Total liabilities 592,581 171,099 --------- --------- Commitments and contingencies (Note 3) Stockholders' equity: Convertible preferred stock, $0.001 par value; 24,276,843 and 101,250,000 shares authorized at September 30, 2000 and December 31, 1999, respectively; 150,000 and 0 shares issued and outstanding at September 30, 2000 and December 31, 1999, respectively (liquidation preference of $150,000 at September 30, 2000) -- -- Common stock, $0.001 par value; 281,250,000 shares authorized at September 30, 2000 and December 31, 1999; 133,321,089 and 126,469,210 shares issued and outstanding at September 30, 2000 and December 31, 1999, respectively (the December 31, 1999 shares issued and outstanding includes 2,466,724 shares of Class B common stock that converted into common stock in March 2000) 133 126 Warrants 2,619 8,701 Additional paid-in capital 690,572 525,294 Deferred stock compensation (8,704) (12,405) Accumulated other comprehensive income 3,312 330 Accumulated deficit (542,302) (213,985) --------- --------- Total stockholders' equity 145,630 308,061 --------- --------- Total liabilities and stockholders' equity $ 738,211 $ 479,160 ========= =========
The accompanying notes are an integral part of these condensed consolidated financial statements. 2 NORTHPOINT COMMUNICATIONS GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in 000's, except share and per share amounts)
(Unaudited) (Unaudited) Three Months Ended Nine Months Ended September 30, September 30, ------------- ------------- 2000 1999 2000 1999 ---- ---- ---- ---- Revenues $ 23,955 $ 5,734 $ 68,329 $ 9,521 Operating expenses: Network expenses 48,925 13,547 123,357 25,280 Selling, marketing, general and administrative (excludes stock compensation expense of $1,264, $1,404, $3,726 and $4,211, respectively) 65,946 34,158 176,419 72,398 Amortization of deferred stock compensation 1,264 1,404 3,726 4,211 Depreciation and amortization 25,914 5,226 54,616 9,426 ------------ ------------ ------------ ----------- Total operating expenses 142,049 54,335 358,118 111,315 ------------ ------------ ------------ ----------- Loss from operations (118,094) (48,601) (289,789) (101,794) Interest income 2,551 4,709 12,399 7,973 Interest expense (17,121) (2,554) (44,733) (13,825) Equity in net loss of affiliated companies (3,031) -- (5,061) -- Taxes and other expenses (622) (45) (1,132) (99) ------------ ------------ ------------ ----------- Net loss (136,317) (46,491) (328,316) (107,745) ------------ ------------ ------------ ----------- Cumulative dividend on convertible preferred stock (938) -- (938) -- ------------ ------------ ------------ ----------- Net loss applicable to common stockholders $ (137,255) $ (46,491) $ (329,254) $ (107,745) ============ ============ ============ =========== Net loss per common share - basic and diluted $(1.03) $(.37) $(2.51) $(1.37) ============ ============ ============ =========== Weighted average shares used in computing net loss per common share - basic and diluted 132,989,264 124,486,783 131,378,001 78,867,684 ============ ============ ============ ===========
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 NORTHPOINT COMMUNICATIONS GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in 000's)
(Unaudited) Nine Months Ended September 30, ------------------------ 2000 1999 ---- ---- Cash flows from operating activities: Net loss $(328,316) $(107,745) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 54,616 9,426 Amortization of deferred stock compensation 3,726 4,211 Amortization of debt discount 199 4,414 Equity in net loss of affiliated companies 5,061 -- Changes in assets and liabilities: Accounts receivable (8,085) (2,810) Amounts due from affiliated companies (15,133) -- Unbilled revenue (3,736) (1,227) Inventories (3,135) (2,778) Prepaid expenses and other assets (16,145) (8,845) Deposits 256 (201) Accounts payable (2,162) (4,185) Accrued expenses and other liabilities 9,865 22,075 Deferred charges 10,522 (189) --------- --------- Net cash used in operating activities (292,467) (87,854) Cash flows from investing activities: Sale (purchase) of short-term investments 17,059 (167,125) Purchase of long-term investments (42,191) (5,000) Purchase of property and equipment (277,907) (101,310) --------- --------- Net cash used by investing activities (303,039) (273,435) Cash flows from financing activities: Proceeds from issuance of common and preferred stock 154,677 482,667 Borrowings on line of credit -- 55,000 Payments on line of credit borrowings -- (55,725) Proceeds from notes payable 400,000 5,600 Principal payments on capital lease obligations (1,500) (957) --------- --------- Net cash provided by financing activities 553,177 486,585 Net increase (decrease) in cash and equivalents (42,329) 125,296 Cash and equivalents at beginning of period 95,019 10,955 --------- --------- Cash and equivalents at end of period $ 52,690 $ 136,251 ========= ========= Supplemental cash flow information and noncash activities: Fixed assets obtained through capital leases $ 4,559 $ -- ========= ========= Warrants issued for bridge loan, capital lease and with issuance of equity $ -- $ 4,530 ========= ========= Conversion of convertible promissory note to Class B common stock $ -- $ 5,600 ========= ========= Common stock issued for investment $ 4,500 $ -- ========= ========= Income taxes paid $ 40 $ 12 ========= ========= Interest paid $ 37,264 $ 8,113 ========= =========
The accompanying notes are an integral part of these condensed consolidated financial statements. 4 NORTHPOINT COMMUNICATIONS GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Organization and Basis of Presentation The Company NorthPoint Communications, Inc. was formed in May 1997 to provide high speed network and data transport services, allowing network service providers, including Internet service providers, broadband data service providers and long distance and local phone companies (collectively, network service providers or NSPs) to meet the rapidly increasing information needs of small and medium-sized businesses, people who work in home offices and telecommuters. Basis of Presentation The condensed consolidated financial statements include the accounts of NorthPoint Communications Group, Inc. and its wholly-owned subsidiary NorthPoint Communications, Inc., together with its wholly-owned subsidiary NorthPoint Communications of Virginia, Inc. Effective March 22, 1999, NorthPoint Communications, Inc. consummated a reorganization pursuant to which it became a wholly-owned subsidiary of NorthPoint Communications Group, Inc., a newly created holding company. The reorganization was effected by a merger of NorthPoint Communications, Inc., with and into NorthPoint Merger Sub, Inc., a wholly-owned subsidiary of NorthPoint Communications Group, Inc., with NorthPoint Communications, Inc., as the surviving corporation of such merger. As a result of the reorganization, the stockholders of NorthPoint Communications, Inc. immediately before the reorganization became the only stockholders of NorthPoint Communications Group, Inc. immediately after the reorganization. All material intercompany accounts and transactions have been eliminated. The accompanying financial data as of September 30, 2000 and for the three and nine months ended September 30, 2000 and September 30, 1999, have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The December 31, 1999 balance sheet was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 1999. In the opinion of management, the accompanying condensed consolidated financial statements reflect all adjustments (consisting of only normal recurring adjustments) considered necessary for a fair statement of the Company's financial condition, the results of its operations and its cash flows for the periods indicated. The results of operations for the three and nine months ended September 30, 2000 are not necessarily indicative of the operating results for the full year. 2. Summary of Significant Accounting Policies Business risks and credit concentrations The Company's operations are subject to significant risks and uncertainties including competitive, financial, developmental, operational, technological, regulatory and other risks associated with an emerging business. The Company sells its services on a wholesale basis to network service providers. For the three months ended September 30, 2000, two network service provider customers accounted for 23% of revenue. These two customers accounted for 7% of accounts receivable at September 30, 2000. The Company is dependent upon a small number of major suppliers and service providers. Reclassifications Certain prior year balances have been reclassified to conform with the current year presentation. 5 NORTHPOINT COMMUNICATIONS GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Unaudited) Cash and cash equivalents The Company considers all highly liquid investments, primarily commercial paper, with an original maturity of three months or less at the date of purchase to be cash equivalents. A portion of the Company's cash deposits is restricted since it supports letters of credit that the Company has provided to secure office space. The balance of restricted cash at September 30, 2000 and December 31, 1999 was $4,040,400 and $4,365,400, respectively. Short-term and long-term investments Short-term and long-term investments are accounted for in accordance with Statement of Financial Accounting Standards No. 115 Accounting for Certain Investments in Debt and Equity Securities. This statement requires that securities be classified as "held to maturity," "available-for-sale" or "trading," and the securities in each classification be accounted for at either amortized cost or fair market value, depending upon their classification. The Company classifies its investments as held-to-maturity and available-for-sale. Held-to-maturity securities are reported at amortized cost. Available-for- sale securities are carried at fair value, with the unrealized gains and losses, net of tax, reported as other comprehensive income, a separate component of stockholders' equity. At the time of sale, any gains or losses will be recognized as a component of operating results. The Company recorded an increase in other comprehensive income of $2,982,000 for the nine month period ended September 30, 2000 related to the net unrealized gains of certain available-for- sale investments. Inventories Inventories consist of communications equipment that will be installed at subscriber locations. Inventories are accounted for using the first-in first-out method at the lower of cost or market. Property and equipment Property and equipment, including property and equipment under capital leases, are recorded at cost and are depreciated using the straight-line method over the shorter of their useful lives or, for leased assets, the remaining lease term. The estimated useful life is three years for software, and five years for all other property and equipment. Maintenance and repairs are charged to expense as incurred, and improvements and betterments are capitalized. When assets are retired or otherwise disposed of, the cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in operations in the period in which they are realized. Revenues Revenues from transport services are recognized when the services are provided. Payments received in advance of providing services are recorded as deferred revenue until the period such services are provided. Revenues related to installation services are recognized when the installation is completed. Recognition of revenue is also deferred in certain other circumstances, as described in footnote 8. Earnings (loss) per share The Company computes net loss per share pursuant to Statement of Financial Accounting Standards No. 128, Earnings Per Share. Basic net loss per share is computed by dividing income or loss applicable to common stockholders by the weighted average number of shares of the Company's common stock outstanding during the period after having given consideration to shares subject to repurchase. Diluted net loss per share is determined in the same manner as basic net loss per share except that the number of shares is increased assuming exercise of dilutive stock options and warrants using the treasury stock method and conversion of the Company's convertible preferred stock. See the Condensed Consolidated Statements of Operations for computed amounts. The dilutive effect of options and warrants has not been considered as their effect would be antidilutive for all periods presented. 6 NORTHPOINT COMMUNICATIONS GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (Unaudited) Recently issued accounting pronouncements In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial Statements. SAB 101 provides guidance for revenue recognition under certain circumstances. Implementation of SAB 101 has been delayed by the Securities and Exchange Commission until the fourth quarter of the fiscal year beginning after December 15, 1999. The Securities and Exchange Commission issued a "Frequently Asked Questions and Answers" document (the "FAQ") in October 2000. Accordingly, the Company is continuing to evaluate the impact of SAB 101 and the FAQ on its financial statements and related disclosures. In April 2000, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation - an interpretation of APB Opinion No. 25" (the "Interpretation"). This Interpretation clarifies the application of Opinion 25 for certain stock compensation issues including the definition of employee for purposes of applying Opinion 25, the criteria for determining whether a plan qualifies as a noncompensatory plan, the accounting consequence of various modifications to the terms of a previously fixed stock option, and the accounting for an exchange of stock compensation awards in a business combination. This Interpretation is effective July 1, 2000. The adoption of FASB Interpretation No. 44 did not have a significant effect on the financial condition or results of operations. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivatives and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. In July 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133." SFAS No. 137 deferred the effective date of SFAS No. 133 until fiscal years beginning after June 15, 2000. The Company will adopt SFAS No. 133 during its year ending December 31, 2001. The Company is currently evaluating the impact of adopting SFAS No. 133 on its financial statements and is unable to predict the impact at this time. 3. Commitments and Contingencies The Company is subject to state public utilities commission, Federal Communications Commission and court decisions as they relate to the interpretation and implementation of the Telecommunications Act, the interpretation of competitive local exchange carrier ("CLEC") interconnection agreements in general and the Company's interconnection agreements in particular. In some cases the Company may be bound by the results of ongoing proceedings of these bodies or the legal outcomes of other contested interconnection agreements that are similar to the Company's agreements. The Company cannot estimate the effect, if any, of these proceedings. The Company together with, in some instances, some of its directors and officers, may from time to time be the subject of claims or named as a defendant or co-defendant in various legal actions involving breach of contract and various other claims incident to the conduct of its businesses. At this time, management does not expect the Company to suffer any material liability by reason of such actions, nor does it expect that such actions will have a material effect on the Company's liquidity or operating results. 4. Common Stock From July 1, 2000 to September 30, 2000, the Company granted to employees options to purchase an aggregate of 1,425,610 shares of common stock at exercise prices from $8.8125 to $11.813 per share, which was at fair market value at the time of grant. 5. Convertible Preferred Stock On September 5, 2000, the Company issued an aggregate of 150,000 shares of non-voting Series A 9% convertible preferred stock in a private placement to Bell Atlantic Corporation (d/b/a Verizon Communications) ("Verizon") for an aggregate purchase price of $150,000,000. 7 NORTHPOINT COMMUNICATIONS GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 6. Stock Warrants Contingent warrants The Company has issued warrants to purchase up to 212,568 shares of its common stock at a price of $1.5689 per share to one of its shareholders, which are exercisable upon the achievement of certain milestones by the holder of the warrants. The value of the warrants will be determined using a Black-Scholes model and will be recorded once the milestones have been reached and the warrants are no longer contingent. 7. Business Developments On August 7, 2000, Verizon, Verizon Ventures I Inc. ("Parent"), a wholly- owned subsidiary of Verizon, Verizon Ventures II Inc. ("Merger Subsidiary"), a direct, wholly-owned subsidiary of Parent, and NorthPoint Communications Group, Inc. ("NorthPoint") entered into an Agreement and Plan of Merger (the "Merger Agreement"). Pursuant to the terms of the Merger Agreement, Verizon will contribute its DSL business to Parent, consisting of the assets, equipment, installed lines, employees and contracts, among other things, used in its digital subscriber line ("DSL") business, and $800 million in cash in exchange for shares of Parent common stock. Of the cash investment, $450 million will be used to fund Parent's capital expenditures and operations and $350 million will be distributed to NorthPoint stockholders. At the effective time of the Merger ("Effective Time"), Merger Subsidiary will merge (the "Merger") with and into NorthPoint. Each share of NorthPoint common stock issued and outstanding immediately prior to the Effective Time will be cancelled and converted into one share of Parent common stock and outstanding NorthPoint warrants and options will be converted into warrants and options of Parent. In addition to the conversion of their shares of NorthPoint common stock into Parent common stock, holders of issued and outstanding NorthPoint common stock at the Effective Time will receive a total of $350 million, payable to such stockholders on a pro rata basis, or approximately $2.50 per share. As a result of these transactions, Verizon will hold 55% of the common stock of Parent and the stockholders of issued and outstanding NorthPoint common stock immediately prior to the Effective Time will hold the remaining 45% of Parent common stock. The transactions contemplated by the Merger Agreement are subject to the approval of the stockholders of NorthPoint and other customary closing conditions, such as regulatory approvals. Parent will use the "NorthPoint" name and brand and will be publicly traded on Nasdaq. Concurrently with entering into the Merger Agreement, Verizon issued to NorthPoint a commitment letter pursuant to which Verizon is obligated to provide to NorthPoint a $200 million senior secured debt facility on January 1, 2001 if the transactions contemplated by the Merger Agreement have not been consummated by that date. On September 5, 2000, Verizon purchased $150 million of non- voting 9% Convertible Preferred Stock of NorthPoint ("NorthPoint Preferred Stock"). Upon termination of the waiting period pursuant to the Hart-Scott- Rodino Antitrust Improvements Act of 1976 (the "Act"), the NorthPoint Preferred Stock will obtain voting rights. The NorthPoint Preferred Stock will automatically convert to NorthPoint common stock at the time of the closing of the Merger and is convertible into NorthPoint common stock at any time following the termination of the waiting period pursuant to the Act at Verizon's option. The Merger Agreement further provides that, following the closing of the Merger, upon the exercise of any NorthPoint option or warrant that was outstanding at the Effective Time (all of which will be converted into Parent options and warrants), Parent will issue to Verizon such number of shares of common stock as are necessary to allow Verizon to maintain its percentage ownership as of the Effective Time. The transactions contemplated by the Merger Agreement are subject to the receipt of regulatory approvals, the satisfaction of all conditions set forth in the Merger Agreement, including termination of the waiting period pursuant to the Act, and compliance with other closing conditions customarily included in similar merger transactions. 8. Business Risks and Uncertainties The Company markets its services through network service providers for resale to their business and consumer end-users. Two customers accounted for 23% of the Company's revenues in the quarter ended September 30, 2000. Recently, a number of the Company's privately held, consumer-focused network service provider customers, including large customers, have experienced significant difficulties in raising the capital necessary to operate and grow their businesses and are not current in their payment for the Company's services. Prior to the Company's third quarter earnings release on October 26, 2000, the Company did not recognize revenue earned from certain network service provider customers during the third quarter which could not satisfy the Company's revenue recognition standards. The Company received additional facts after the October 26, 2000 third quarter earnings release that indicated certain of its privately-held, consumer-focused internet service providers, including Flashcom, Inc., did not have sufficient long-term financial resources to assure the Company that they would be able to make timely payment for its services. Therefore, the Company has revised its third quarter results as required by SEC regulations. The Company's revenue for the third quarter was reduced to $23,955,000 compared to the $30,092,000 reported on October 26, 2000 as a result of the Company's decision not to recognize revenue from sales to these delinquent network service provider customers. 8 NORTHPOINT COMMUNICATIONS GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Revenue related to customers that do not demonstrate the ability to pay for services in a timely manner will be recorded as revenue only when all previous accounts receivable for these customers have been paid and when cash is received for new services. It is possible that additional network service provider customers may experience significant difficulties in raising the capital necessary to operate and grow their businesses and may be unable to pay for the Company's services in the future on a timely basis. The Company's network service provider customers' inability to pay these past due amounts, and to make timely payments for our services in the future, may materially and adversely affect the Company's operating results and financial condition. 9. Related Parties The Company provides operations support systems and associated services to the NorthPoint Canada Communications and VersaPoint joint ventures for fees specified in the agreements with those joint ventures. Amounts due from these affiliated companies primarily represent the fees associated with providing the operations support systems and also include reimbursement for certain other expenses paid by the Company on behalf of the joint ventures. The Company charged $15,132,923 to the joint ventures for the nine months ended September 30, 2000, which also represents the amounts due from these affiliates at September 30, 2000. In June 2000, the Company made an equity investment in Communication Technology Services Inc. ("CTS"). CTS provides installation services for the Company. The Company paid CTS a total of $3,414,316 for services provided during the three months ended September 30, 2000. As of September 30, 2000, $908,695 in additional charges were accrued. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion and analysis of NorthPoint's financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this report. In the discussion below, we refer to the period from inception (May 16, 1997) to December 31, 1997 as "1997". Certain statements set forth below constitute "forward-looking statements." Such forward-looking statements involve certain risks and uncertainties including, but not limited to, those discussed herein under "Risk Factors" that may cause actual results to differ materially from those expressed or implied in any forward-looking statement. Investors and prospective investors are cautioned not to place undue reliance on such forward-looking statements. We disclaim any obligation to update the forward-looking statements contained herein to reflect future events or developments. See "Forward-Looking Statements." Overview We are a national provider of high speed, local data network services. Our networks use digital subscriber line, or DSL, technology to enable data transport over telephone company copper lines at guaranteed speeds up to 25 times faster than common dial-up modems. We market our network and data transport services to internet service providers, long-distance and local telephone companies and data service providers, which we collectively call network service providers. Our customers can use our fast, secure and reliable data networks to provide continuously connected, economical Internet access and other data- intensive applications to end users. These end users are typically small- and medium-sized businesses with up to 500 employees, people who work in home offices, and telecommuters. We offer network and data transport services for residential end users as well. As of September 30, 2000, we provided services in 54 metropolitan areas, spanning 109 metropolitan statistical areas, in the United States and we intend to offer service in a total of over 60 metropolitan areas, spanning 110 metropolitan statistical areas by the end of 2000. We have been and expect to be the first, or one of the first, to offer DSL services in these markets. Our networks consist principally of digital communications equipment that we own and install in telephone company offices known as "central offices" and existing copper telephone lines that we lease to connect our equipment with end users' premises. We will initially install our equipment in the central offices with the highest density of small- and medium-sized businesses in our targeted markets. As of September 30, 2000, we had secured space in over 1,800 central offices and were providing services from 1,624 of those central offices. We plan to offer service from an additional 76 central offices by the end of 2000 to allow us to achieve blanket coverage in our 54 markets as well as 6 additional targeted markets. In addition, we deployed a fully redundant point- to-point national ATM backbone connection between NorthPoint's local DSL networks. We intend to expand the coverage of our networks in these markets over time by installing equipment in additional central offices. We are currently providing or have entered into agreements to provide our services to more than 175 network service providers. As of September 30, 2000, we had connected 87,300 of their end users to our networks. Upon completion of our planned expansion, our networks will be able to reach approximately 5.5 million businesses and 45 million households, including more than 80% of the small- and medium-sized businesses in our 60 markets. Since inception on May 16, 1997, our principal activities have included: . developing our business plans; . procuring governmental authorizations and space in central offices; . raising capital and hiring management and other key personnel; . working on the design and development of our network architecture and operations support systems; . acquiring equipment and facilities; . negotiating interconnection agreements; and . selling and marketing our services to network service providers. As a result of our development activities, we have experienced operating losses. We expect to experience increasing operating losses as we expand our operations. 10 Financial performance varies from market to market, and the time when we will achieve positive EBITDA, if at all, will depend on factors such as: . the size of the addressable market; . the level of upfront sales and marketing expenses; . the number and sequencing of central offices built out; . the cost of the necessary infrastructure; . the timing of market entry; . the commercial acceptance of our services; and . the rate at which we can provision lines. EBITDA is a measure of financial performance commonly used in the telecommunications industry. It is defined as earnings before net interest, taxes, amortization of deferred stock compensation, depreciation and amortization. Other companies' definition of EBITDA may differ from ours. You should not construe it as an alternative to operating income as an indicator of our operating performance or as an alternative to cash flows from operating activities as a measure of liquidity. Assuming the closing of the proposed Merger occurred on December 31, 2000, the combined DSL operations of NorthPoint and Verizon are expected to include the following: . a broadband network, comprised of more than 3,000 unique operational central offices, passing approximately 63 million homes and businesses in 163 metropolitan statistical areas (MSAs); . more than 600,000 DSL lines; . wholesale relationships with Verizon Online, AOL, UUNET and Genuity and strategic marketing relationships with RadioShack, Microsoft, Staples, Blockbuster and other industry leaders; . approximately 3,000 employees; and . broadband ventures in Europe through VersaPoint and Canada through NorthPoint Canada Communications. We expect to consummate the Merger by mid-2001. Factors Affecting Future Operations Revenues. We derive our revenues from monthly recurring and nonrecurring charges to internet service providers, long-distance and local telephone companies and data service providers, which we collectively call network service providers. Monthly recurring revenues consist of end user line fees, based upon the number of installed lines, for the network service providers' end users connected to our networks and interconnection fees for each connection to our metropolitan node in each market. Nonrecurring revenues include charges for the installation of new end users and in some cases, for end-user modems or other electronic equipment. Prior to the quarter ended September 30, 1999, we had sold only minimal amounts of end-user modems or other electronic equipment. Currently we sell a significant amount of such equipment to support the needs of our growing network service provider partner base. We seek to price our services competitively in relation to those of the traditional telephone companies and other competitive telecommunications companies in each market. Current standard end user line prices that we charge to our network service providers for our business class services generally range from $75 per month for 144 kilobits per second service to $250 per month for 1.5 megabits per second service, before volume discounts. Pricing for residential class service is approximately $40 per month. Although pricing will be an important part of our strategy, we believe that customer relationships, customer care and consistent quality will be the key to generating customer loyalty. During the past several years, market prices for many telecommunications services have been declining, which is a trend that we believe will likely continue. As prices decline for any given speed of service, we expect that the 11 total number of end users and the proportion of our end users purchasing our higher-speed, higher-priced services will increase. The cost to upgrade an end user's speed is generally minimal. Network Expenses. Our network expenses consist of nonrecurring and monthly recurring charges for the commodity transport elements we choose to lease rather than own. Nonrecurring network expenses include transport and loop installation fees. We expect these costs will be largely related to the activation of new central offices and new end users. Monthly recurring network expenses include loop fees, rent, power and other fees charged by traditional telephone companies, competitive telecommunications companies and other providers. As our customer and end user base grows, we expect the largest element of network expenses to be traditional telephone company charges for leased copper lines, which have historically been $3 to $40 per line per month, depending on the identity of the traditional telephone company and the location of the lines. Although our current network buildout will be largely completed by the end of 2000, further development and expansion of our business will require significant expenditures. The principal capital expenditures we incur when we enter any market include: . the establishment of a metropolitan node-a facility at which we aggregate and disseminate data traffic in each metropolitan area-and the purchase and installation of electronic switching equipment for that node; . the procurement, design and construction of the collocation cage in each central office; . the purchase and installation of the network management and network test equipment in those cages; and . the capitalized cost of the installation of such equipment. In addition, once we have deployed our network in a market, we will incur additional expenditures during the buildout phase of any market, many of which will be dependent upon orders to connect new end users. These success-based capital expenditures include DSL line cards, incremental digital subscriber line access multiplexer and network test equipment, and line cards for our electronic switches in our metropolitan node. These network expenditures will continue to increase as we add installed lines and end users. However, once a market is fully built out, a substantial majority of the capital expenditures in that market will be tied to incremental customer and end-user growth. We will also incur capital expenditures for building additional metropolitan nodes in certain markets and for expanding our network control center in the San Francisco Bay Area. In addition to the capital expenditures required to enter a market, we will be required to fund each market's cash flow deficit as we build our customer base. In addition to developing our networks, we will use our capital to cover our operations, sales and market development expenses incurred in developing and servicing our networks. Selling, Marketing, General and Administrative Expenses. Our selling, marketing, general and administrative expenses primarily consist of costs related to selling, marketing, customer care, provisioning, billing, regulatory, corporate administration, network engineering and maintenance. On occasion, we will participate in various sales promotions with our customers by advancing market development funds to assist in their marketing efforts, particularly for new markets. These costs are deferred and amortized over the estimated duration of the promotion's effect in those markets. Additionally, we incur other costs associated with administrative overhead, office leases and bad debt. In general, we reserve for bad debt expense based upon our experience and estimates of collectability. Because our history is limited it is possible that, on occasion, we may have to increase our bad debt reserves in excess of our past experience. The timing of these increases if any, could affect future quarterly results. We expect that our selling, marketing, general and administrative costs will grow significantly as we expand our operations and that administrative overhead will be a large portion of these expenses during the start-up phase of our business. However, we expect these expenses to decline as a percentage of our revenues as we build our customer base and the number of end users connected to our networks increases. We plan to employ a regional sales team in each market we enter. To attract and retain a highly qualified sales force, we plan to offer our sales and customer care personnel a compensation package consisting of commissions and stock options. We expect to incur significant selling and marketing costs as we continue to expand our operations. In addition, we plan to offer sales promotions, especially in the first few years as we establish our market presence. Amortization of Deferred Stock Compensation. Stock compensation arises as a result of the granting of stock options to employees with exercise prices below the fair values at the date of grant. The deferred compensation is being amortized over the vesting period of the associated options. Depreciation and Amortization. We expect depreciation and amortization expense to increase significantly as more of our 12 network becomes operational and as we increase capital expenditures to expand our network. Depreciation and amortization expense includes: . depreciation of network infrastructure equipment; . depreciation of information systems, furniture and fixtures; . amortization of improvements to central offices, network control center facilities and corporate facilities; . amortization of central office collocation space improvements; and . amortization of software. Taxation. We have not generated any taxable income to date and therefore have not paid any federal income taxes since inception. State taxes are limited to nominal amounts. Use of our net operating loss carryforwards, which begin to expire in 2003, may be subject to limitations under Section 382 of the Internal Revenue Code of 1986, as amended. We have recorded a full valuation allowance on the deferred tax asset, consisting primarily of net operating loss carryforwards, because of uncertainty regarding its recoverability. Recent Developments Recently, a number of our privately held, consumer-focused network service provider customers have experienced significant difficulties in raising the capital necessary to operate and grow their businesses and are not current in their payment for our services. Prior to our third quarter earnings release on October 26, 2000, we did not recognize revenue earned from certain network service provider customers during the third quarter which could not satisfy our revenue recognition standards. We received additional facts after the October 26, 2000 third quarter earnings release that indicated certain of our privately- held, consumer-focused internet service providers, including Flashcom, Inc., did not have sufficient long-term financial resources to assure us that they would be able to make timely payment for our services. Therefore, we have revised our third quarter results as required by SEC regulations. Our revenue for the third quarter was reduced to $23,955,000 compared to the $30,092,000 reported on October 26, 2000 as a result of our decision not to recognize revenue from sales to these delinquent network service provider customers. In addition, we recognized increased bad debt and other operating expenses related to these network service provider customers. As a result, our EBITDA loss for the quarter ended September 30, 2000 was increased to $90,916,000 million compared to the $79,210,000 reported on October 26, 2000. These network service provider customers account for approximately 26,700 of our 87,300 installed lines at September 30, 2000. We have halted the installation of in-process lines ordered by these customers and we may also decide to disconnect end users that are purchasing their services from delinquent network service provider customers. If this occurs, we cannot assure you that these end users will continue to purchase our services through another one of our network service provider customers and we may lose the lines served by such end users. We will recognize additional revenue from these customers only when all previous accounts receivable balances for these customers have been paid and when cash is received for new services. We are continuing our efforts to obtain payments, but we cannot assure you that these efforts will be successful. It is possible that additional network service provider customers may experience significant difficulties in raising the capital necessary to operate and grow their businesses and may be unable to pay for our services in the future on a timely basis. Our network service provider customers' inability to pay these past due amounts, and to make timely payments for our services in the future, may materially and adversely affect our business, operating results and financial condition. We are also currently attempting to arrange for the direct transfer of lines serviced by delinquent network service provider customers to other well- financed, publicly-traded network service provider customers and considering a variety of other alternatives with respect to these delinquent network service provider customers, such as the discontinuation of adding new end users, requiring prepayments for future services and sending notices of termination of service. We note, however, that should any of our network service provider customers become subject to reorganization or bankruptcy proceedings, we cannot assure you that we will ultimately collect sums owed to us by these customers and it remains uncertain what consequence, if any, bankruptcy proceedings would have on lines installed for such customers. Moreover, should the particular network service provider customer become subject to reorganization or bankruptcy proceedings, we cannot assure you that we will be able to retain payments or other consideration received by us prior to such reorganization or bankruptcy proceeding. Even if we are able to move these end users to other network service provider customers, it will require a significant amount of our resources, which may impair our ability to install new lines as they are ordered. Any of these circumstances could adversely affect our business, operating results and financial condition. 13 Results of Operations As a result of the development and rapid growth of the Company's business during the periods presented, the period-to-period comparisons of the Company's results of operations are not necessarily meaningful and should not be relied upon as an indication of future performance. Revenues. Revenues for the quarter ended September 30, 2000 were approximately $23,955,000, 57% of which consisted of recurring revenues. Revenues for the quarter ended September 30, 1999 were approximately $5,734,000, 53% of which consisted of recurring revenues. For the nine months ended September 30, 2000 and September 30, 1999, revenues were $68,329,000 and $9,521,000, respectively, of which 56% consisted of recurring revenues for the nine months ended September 30, 2000 and 60% consisted of recurring revenues for the nine months ended September 30, 1999. The increase in revenues is due to the expansion of our installed end user base that has occurred over the past year. We expect that non-recurring revenues as a percentage of total revenues will decrease over time as we add end users to our networks. Recently, a number of our privately held, consumer-focused network service provider customers, including large customers, have experienced significant difficulties in raising the capital necessary to operate and grow their businesses and are not current in their payment for our services. Prior to our third quarter earnings release on October 26, 2000, we did not recognize revenue earned from certain network service provider customers during the third quarter which could not satisfy our revenue recognition standards. We received additional facts after the October 26, 2000 third quarter earnings release that indicated certain of our privately-held, consumer-focused internet service providers, including Flashcom, Inc., did not have sufficient long-term financial resources to assure us that they would be able to make timely payment for our services. Therefore, we have revised our third quarter results as required by SEC regulations. Our revenue for the third quarter was reduced to $23,955,000 compared to the $30,092,000 reported on October 26, 2000 as a result of our decision not to recognize revenue from sales to these delinquent network service provider customers. Total services for which we did not recognize equivalent revenue for these delinquent network service provider customers in the third quarter were $8,977,000. We will recognize additional revenue from these customers only when all previous accounts receivable balances for these customers have been paid and when cash is received for new services. Network Expenses. Network expenses were approximately $48,925,000 for the quarter ended September 30, 2000 and $13,547,000 for the quarter ended September 30, 1999. For the nine months ended September 30, 2000 and September 30, 1999, network expenses were $123,357,000 and $25,280,000, respectively. These costs consisted primarily of monthly rental costs for lines between end users and central offices, between central offices and our metropolitan nodes, between our metropolitan nodes and our network service providers, end user line installation costs, costs of end user modems, and costs charged to us by the traditional telephone companies. The increase in network expenses reflects the growth in our network as we expand into new markets, connect new end users and interconnect existing partners to our network. Selling, Marketing, General and Administrative Expenses. Selling, marketing, general and administrative expenses were approximately $65,946,000 for the quarter ended September 30, 2000 and $34,158,000 for the quarter ended September 30, 1999. For the nine months ended September 30, 2000 and September 30, 1999, selling, marketing, general and administrative expenses were $176,419,000 and $72,398,000, respectively. These expenses consisted primarily of salaries and related expenses for the development of our business, network architecture and software, the establishment of our management team and the development of corporate identification, promotional and advertising materials. As the staffing levels and operations of the Company have expanded over the past year, so have these operating expenses to support such growth. These expenses during the quarter ended September 30, 2000 also included an increase of $2,453,000 in the reserve for bad debts and a write-off of $3,750,000 in pre-paid marketing expenses. Amortization of Deferred Stock Compensation. Amortization of deferred stock compensation was $1,264,000 for the quarter ended September 30, 2000 and $1,404,000 for the quarter ended September 30, 1999. For the nine months ended September 30, 2000 and September 30, 1999, amortization of deferred stock compensation was $3,726,000 and $4,211,000, respectively. This reduction in deferred stock compensation expense is due to the attrition of those employees to whom such options were granted. The unamortized balance of $8,704,000 at September 30, 2000 will be amortized over the remaining vesting period of each grant. Depreciation and Amortization. Depreciation and amortization expenses were approximately $25,914,000 for the quarter ended September 30, 2000 and $5,226,000 for the quarter ended September 30, 1999. For the nine months ended September 30, 2000 and September 30, 1999, depreciation and amortization was $54,616,000 and $9,426,000, respectively. Such expenses consisted primarily of depreciation of network equipment, information systems, office equipment, furniture and fixtures and amortization of leasehold improvements. The increase in depreciation and amortization is primarily due to the additional property and equipment that has been acquired and placed into service as we continue to build out our networks. Interest Income and Expense. The interest income for the quarter ended September 30, 2000 was $2,551,000 and was earned primarily from the proceeds raised in the sale of our preferred stock in September 2000. Interest income for the quarter ended September 30, 1999 was $4,709,000. This interest income was earned primarily from the proceeds raised in the initial public offering in May 1999. Interest income was $12,399,000 for the nine months ended September 30, 2000 and $7,973,000 for the nine months ended September 30, 1999. Interest expense for the quarter ended September 30, 2000 was $17,121,000 and primarily represents the interest associated 14 with our senior notes sold in February 2000 and also our senior credit facilities, which we closed in December 1999. Interest expense for the quarter ended September 30, 1999 was approximately $2,554,000. Interest expense for the quarter ended September 30, 1999 primarily represents the interest associated with our senior credit facility. Interest expense was $44,733,000 for the nine months ended September 30, 2000 and $13,825,000 for the nine months ended September 30, 1999. Equity in Net Loss of Affiliated Companies. There was no equity in net loss of affiliates during 1999 as there were no investments in affiliates. For the quarter ended September 30, 2000, equity in net loss of affiliates was $3,031,000. For the nine months ended September 30, 2000, equity in net loss of affiliates was $5,061,000. This net loss primarily represents our shares of the net losses of the European and Canadian joint ventures that were formed during the first quarter of 2000. Taxes and Other Expenses. Taxes and other expenses were approximately $622,000 for the quarter ended September 30, 2000 and $45,000 for the quarter ended September 30, 1999. For the nine months ended September 30, 2000 and September 30, 1999, taxes and other expenses were $1,132,000 and $99,000, respectively. These taxes primarily represent state corporation, business and jurisdictional taxes that have been paid or accrued. Liquidity and Capital Resources Our operations have required substantial capital investment for the procurement, design and construction of our central office collocation space improvements and cages, the purchase of telecommunications equipment and the design and development of our networks. Capital expenditures were approximately $277,907,000 for the nine months ended September 30, 2000 and $101,310,000 for the nine months ended September 30, 1999. Although we have no material commitments for capital expenditures for the remainder of 2000, we plan to make total capital expenditures in 2000 estimated at approximately $325,000,000 to develop our network. We expect that our capital expenditures related to the purchase of infrastructure equipment necessary for the development and expansion of our networks and the development of new regions will be less in future periods while capital expenditures related to the addition of subscribers in existing regions will increase. We will also incur capital expenditures for building additional metropolitan nodes in certain markets and for expanding our network control center in the San Francisco Bay Area. As of September 30, 2000, we had an accumulated operating deficit of $542,302,000 and cash, cash equivalents and short-term investments of $150,326,000. Net cash used in operating activities was $292,467,000 for the nine months ended September 30, 2000 and $87,854,000 for the nine months ended September 30, 1999. The net cash used in operations for the nine months ended September 30, 2000 was primarily due to net losses. The net cash used in operations for the nine months ended September 30, 1999 was primarily due to net losses, offset in part by increases in accrued expenses. Net cash used in investing activities was $303,039,000 for the nine months ended September 30, 2000 and $273,435,000 for the nine months ended September 30, 1999. Investing activities were principally acquisitions of property and equipment in 2000. Investing activities were principally purchases of securities and acquisitions of property and equipment in 1999. Net cash provided by financing activities was approximately $553,177,000 for the nine months ended September 30, 2000 and relates to the proceeds from the sale of our senior notes and the sale of common and preferred stock. Net cash provided by financing activities was approximately $486,585,000 for the nine months ended September 30, 1999, of which $482,667,000 related to the issuance of common and preferred stock, $55,000,000 related to borrowings, and $5,600,000 related to proceeds from a convertible promissory note, offset primarily by the repayment of a $50,000,000 bridge loan. Concurrently with entering into the Merger Agreement, Verizon issued to NorthPoint a commitment letter pursuant to which Verizon is obligated to provide to NorthPoint a $200 million senior secured debt facility on January 1, 2001 if the transactions contemplated by the Merger Agreement have not been consummated by that date. In addition, on September 5, 2000, Verizon purchased $150 million of non- voting 9% Convertible Preferred Stock of NorthPoint ("NorthPoint Preferred Stock"). Upon termination of the waiting period pursuant to the Hart-Scott- Rodino Antitrust Improvements Act of 1976 (the "Act"), the NorthPoint Preferred Stock will obtain voting rights. The NorthPoint Preferred Stock will automatically convert to NorthPoint common stock at the time of the closing of the Merger and is convertible into NorthPoint common stock at any time following the termination of the waiting period pursuant to the Act at Verizon's option. Pursuant to the Merger Agreement, at the time of closing of the Merger, Verizon will invest $450 million in NorthPoint. Any amounts previously funded by Verizon pursuant to the commitment letter or the purchase of preferred stock will be offset against the $450 million payable at closing. On February 3, 2000, we issued senior notes in the aggregate principal amount of $400 million. These notes bear interest at a 15 fixed annual rate of 12 7/8% to be paid in cash every six months and mature on February 15, 2010. Net proceeds from these notes were approximately $387.5 million. On December 9, 1999 we entered into a secured credit facility with a syndicate of lenders. The secured credit facility consists of the following: . Revolving credit facility in an amount up to $55,000,000. The revolving credit facility is used for general corporate purposes. As of the date of this report, we have not borrowed any amount under the revolving credit facility. . Delayed draw term loan facility in the amount of $110,000,000. As of the date of this report, we have not borrowed any amount of the delayed draw term loan facility but we are required to borrow the entire facility on or before December 9, 2000. . Term loan facility in the amount of $85,000,000. We borrowed the entire term loan facility amount on December 9, 1999. The secured credit facility also provides for the issuance of letters of credit on our behalf by the lenders. Borrowings under the secured credit facility are collateralized by a first priority lien against substantially all of our assets. Our obligations under the secured credit facility are guaranteed by all of our subsidiaries and collateralized by a first priority lien on the assets of those subsidiaries. We further pledged to the lenders under the secured credit facility all of the capital stock of NorthPoint Communications, Inc. held by us. The lenders under the secured credit facility have agreed that the liens collateralizing the secured credit facility may also collateralize an additional $50,000,000 of additional borrowings in the event the secured credit facility is extended, but the lenders have no obligation to provide such additional financing. Loans under the facilities bear interest at floating rates based on the prime rate or the London Interbank Offered Rate (LIBOR) plus, in each case, an additional interest rate margin. In March and April 1999, we issued and sold an aggregate of 3,968,174 shares of Series D-1 preferred stock with total proceeds of approximately $38,800,000. Purchasers of our Series D-1 preferred stock included ICG Services, Inc. (an affiliate of ICG Communications, Inc.), Excite@Home, Verio Inc., Cable & Wireless USA, Inc., Concentric Network Corporation, ALC Communications Corporation (an affiliate of Global Crossing Holdings Limited), Network Plus Corporation and Netopia, Inc. In May 1999, we sold 17,250,000 shares of our common stock at $24 per share in our initial public offering. Net of underwriting discounts and commissions, the proceeds to us were $388,500,000. Microsoft Corporation and Tandy Corporation purchased $30,000,000 and $20,000,000, respectively, of our stock in this offering. We believe that our current capital resources and lines of credit will be sufficient for the funding and working capital requirements needed for the deployment of our networks in our 60 targeted markets and to support operating needs through the end of 2001. However, we may decide to seek additional capital depending upon the demand for our services and regulatory, technological and competitive developments, including additional financial market developments and new opportunities, in our industry. Our future cash requirements for developing, deploying and enhancing our networks and operating our business, as well as our revenues and our need for additional financing, will depend on a number of factors, including: . alterations to the schedule, targets or scope of our network rollout plan, including the number of markets entered and the services offered; . changes to our plans or projections or such plans or projections prove to be inaccurate; . the rate at which customers purchase and pay for our services and the pricing of such services; . the financial condition of our customers; . unanticipated opportunities, including acquisitions of or investments in other companies or businesses; . the level of marketing required to acquire and retain customers and to attain a competitive position in the marketplace; . the rate at which we invest in engineering and development with respect to existing and future technology; or . the timing and closing of the proposed merger with Verizon's DSL business. We may obtain additional financing through commercial bank borrowings, equipment financing or the private or public sale of equity or debt securities. We may be unsuccessful in raising sufficient additional capital. We believe that current capital market conditions, particularly for our industry, reduce our ability to obtain such additional financing. In addition, the revenue recognition issues that we 16 are reporting in this report may make it more difficult for us to access the capital markets. We may be unable to raise additional capital on terms that we consider acceptable, that are within the limitations contained in our financing agreements and that will not impair our ability to develop our business. If we fail to raise sufficient funds, we may need to modify, delay or abandon some of our planned future expansion or expenditures, which could have a material adverse effect on our business, prospects, financial condition and results of operations. Year 2000 Compliance We believe that our computer systems and software are year 2000 compliant. We have inventoried and tested our enterprise application systems, including internally-developed and vendor-developed applications and off-the- shelf software and hardware relating to our internal information systems, and believe that such systems are year 2000 compliant. We requested assurances regarding year 2000 compliance from our equipment and software vendors and the traditional telephone companies. We have also learned that the traditional telephone companies have informed the Federal Communications Commission that they are year 2000 compliant. We requested that they provide assurances of their year 2000 compliance directly to us. Furthermore, we have not experienced any year 2000 problems and we have not been informed of any material year 2000 problems by our customers and vendors. Our aggregate historical costs for year 2000 analysis, planning and remediation have not been material to date and, based on the tests we have performed on our computer systems and software and assurances received from our vendors and the traditional telephone companies, we do not expect to incur material costs to resolve year 2000 issues in the future. Recently Issued Accounting Pronouncements In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial Statements. SAB 101 provides guidance for revenue recognition under certain circumstances. Implementation of SAB 101 has been delayed by the Securities and Exchange Commission until the fourth quarter of the fiscal year beginning after December 15, 1999. The Securities and Exchange Commission issued a "Frequently Asked Questions and Answers" document (the "FAQ") in October 2000. Accordingly, NorthPoint is continuing to evaluate the impact of SAB 101 and the FAQ on its financial statements and related disclosures. In April 2000, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation - an interpretation of APB Opinion No. 25" (the "Interpretation"). This Interpretation clarifies the application of Opinion 25 for certain stock compensation issues including the definition of employee for purposes of applying Opinion 25, the criteria for determining whether a plan qualifies as a noncompensatory plan, the accounting consequence of various modifications to the terms of a previously fixed stock option, and the accounting for an exchange of stock compensation awards in a business combination. This Interpretation is effective July 1, 2000. The adoption of FASB Interpretation No. 44 did not have a significant effect on the financial condition or results of operations. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivatives and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. In July 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133." SFAS No. 137 deferred the effective date of SFAS No. 133 until fiscal years beginning after June 15, 2000. The Company will adopt SFAS No. 133 during its year ending December 31, 2001. The Company is currently evaluating the impact of adopting SFAS No. 133 on its financial statements and is unable to predict the impact at this time. Forward Looking Statements The statements contained in this report which are not historical facts may be deemed to contain forward-looking statements, including but not limited to deployment of NorthPoint's network in new and existing regions and the timing and breadth of coverage in each region. Actual results may differ materially from those anticipated in any forward-looking statements as a result of certain risks and uncertainties. Some of these risks and uncertainties include, without limitation: . our dependence on strategic third parties to market and resell our services; . intense competition for our service offerings; . our ability to collect receivables from certain key customers; . our ability to retain end users that are serviced by delinquent network service provider customers; 17 . dependence on growth in demand for DSL-based services; . our ability to raise additional capital; . the failure to close the proposed merger with Verizon Communications' DSL business in a timely manner; . Verizon Communications' right to terminate the merger agreement in the event that we fail to satisfy any of the conditions to closing; . our potential inability to obtain, or meet conditions imposed for, requisite governmental approvals for closing the proposed merger; . the failure of our stockholders to approve the merger; . costs related to the merger; . the risk that NorthPoint's and Verizon's DSL businesses will not be integrated successfully; . our failure to realize anticipated benefits of the merger; and . other economic, business, competitive and/or regulatory risks and uncertainties detailed herein and in our other Securities and Exchange Commission filings. All written and oral forward-looking statements made in connection with this report on Form 10-Q which are attributable to us or persons acting on our behalf are expressly qualified in their entirety by the "Risk Factors" and other cautionary statements set forth herein and included in our other Securities and Exchange Commission filings. Prospective investors are cautioned not to place undue reliance on such forward-looking statements. We disclaim any obligation to update information contained in any forward-looking statement. 18 Risk Factors In addition to the other information contained herein, you should carefully consider the following risk factors in evaluating our company. Because We Have a Limited Operating History, It Is Difficult to Evaluate Our Business We were formed in May 1997 and began offering commercial services in the San Francisco Bay Area in March 1998. Because of our limited operating history, you have limited operating and financial data about our company upon which to base an evaluation of our performance and an investment in our company. You should consider the risks, expenses and difficulties we may encounter, including those frequently encountered by early stage companies in new and rapidly evolving industries. As a result, we may be unable to: . develop our operational support systems and other information technology systems; . obtain central office space and suitable copper wire loops; . expand our customer base; . raise additional capital; . maintain adequate control of our expenses; . attract and retain qualified personnel; . enter into and implement interconnection agreements with traditional telephone companies, some of which are our competitors or potential competitors; . expand the geographic coverage of our network; . obtain governmental authorizations to operate as a competitive telecommunications company in new markets; . continue to upgrade our technologies and enhance our product features; and . respond to technological changes and competitive industry conditions. We Expect Our Losses and Negative Cash Flow to Continue To date, we have incurred substantial operating losses, net losses and negative cash flow on both an annual and quarterly basis. For the year ended December 31, 1999, we had operating losses of approximately $168,426,000, net losses of $183,698,000, and negative cash flow from operating and investing activities of $439,571,000. For the nine months ended September 30, 2000, we had operating losses of approximately $289,789,000, net losses of $328,316,000, and negative cash flow from operating and investing activities of $595,506,000. We cannot assure our investors that we will ever achieve profitability or generate positive cash flow. We expect our operating expenses will increase, especially in the areas of operations, sales and marketing, as we develop and expand our business and, as a result, we will need to increase our revenue to become profitable. If our revenue does not grow as expected or increases in our expenses are not in line with our plans, there could be a material adverse effect on our business, prospects, financial condition and results of operations. 19 We Cannot Predict Whether We Will be Successful Because Our Business Model Is Unproven and Our Industry Is Developing Our business strategy is unproven. To be successful, we must, among other things, develop and market data networks and services that are widely accepted by our customers and their end users at prices that will yield a profit. Because our business and the overall demand for high speed data communications services are in the early stages of development, we are unsure whether or when our DSL services will achieve commercial acceptance. Our Failure to Achieve or Sustain Market Acceptance at Desired Pricing Levels Could Impair Our Ability to Achieve Profitability or Positive Cash Flow Prices for digital communication services have fallen historically, a trend we expect will continue. Accordingly, we cannot predict to what extent we may need to reduce our prices to remain competitive or whether we will be able to sustain future pricing levels as our competitors introduce competing services or similar services at lower prices. Our failure to achieve or sustain acceptance at desired pricing levels could impair our ability to achieve profitability or positive cash flow, which would have a material adverse effect on our business, prospects, financial condition and results of operations. Our Quarterly Operating Results Are Likely to Fluctuate Significantly, Causing Our Stock Price to be Volatile or to Decline We cannot accurately forecast our revenue because of our limited operating history and the emerging nature of the data communications industry in our markets. Our revenue could fall short of our expectations if we experience delays or cancellations by even a small number of our customers. A number of factors are likely to cause fluctuations in our operating results, including: . the rate at which we are able to attract and retain customers, and whether larger customers fulfill their volume commitments to us; . the ability of our customers to generate significant end user demand; . the timing and willingness of traditional telephone companies to provide and construct the required central office facilities; . the timing and willingness of traditional telephone companies to provide suitable copper wire loops at favorable prices; . the prices our customers and, in turn, their end users pay for our services; . availability of financing to continue to fund our expansion; . increases in provisions for bad debts; . our ability to deploy our services on a timely basis to satisfy end user demand; . the mix of line orders between lower priced and higher priced lines; . the amount and timing of capital expenditures and operating costs as we expand our network; . the announcement or introduction of new or enhanced services by our competitors; and . technical difficulties or network downtime. As a result, it is likely that in some future quarters our operating results will be below the expectations of securities analysts and investors. If this happens, the trading price of our common stock would likely be materially adversely affected. We May Be Unable to Meet Conditions to the Closing of the Proposed Merger of Our Business with the DSL Business of Verizon Communications Our proposed merger with Verizon's DSL business has been approved by the boards of directors of both NorthPoint and Verizon. However, the merger agreement is subject to numerous conditions, including approval by the stockholders of NorthPoint, expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, and FCC and state 20 regulatory approvals. In addition, Verizon will not be required to complete the transactions if any event has occurred which has had or is reasonably likely to have a material adverse effect on NorthPoint or its business, operations, properties, financial condition, assets or liabilities. We cannot assure you that NorthPoint will not suffer a material adverse effect prior to the closing of the merger. We also cannot assure you that we will be able to obtain or meet all of the conditions to Verizon's obligations to complete the merger, including receipt of all necessary regulatory approvals, and that the merger will be consummated. We May Fail to Realize the Anticipated Benefits of the Transactions The success of the transactions will depend, in part, on our ability to realize the anticipated economies of scale, growth opportunities and synergies from combining our business with Verizon's DSL business. If we do not recognize these anticipated benefits as a result of the transactions, the value of our stock may decline. To realize the anticipated benefits of the transactions, our management team must develop strategies and implement a business plan that will: . effectively manage new market entrance and network development; . effectively manage the marketing and sales of the services of our combined DSL businesses; . successfully retain and attract key employees, including management, during a period of transition and in light of the highly competitive employment market; . maintain adequate focus on existing business and operations while working to integrate our combined DSL businesses; and . continue to develop our DSL networks and attract and retain customers. Integrating the operations and personnel of our respective DSL businesses will be a complex process, and we are uncertain that we can complete the integration rapidly or will achieve the anticipated benefits of the transactions. The successful integration of our businesses will require, among other things, integration of finance, human resources and sales and marketing groups and coordination of development efforts. In addition, commercial and technological advances resulting from the integration of technologies used by our respective DSL networks and network support systems may not be achieved as successfully or as rapidly as we currently anticipate, if at all. Some of the factors contributing to the risks attendant to integration faced by us are: . the difficulties and expenses of integrating our operations, technology, information systems, networks and personnel while preserving the goodwill of each business; . the expenses associated with separating Verizon's DSL business from its other data services operations; . the difficulties of creating and maintaining uniform standards, controls, procedures and policies for the two businesses being integrated; . the impairment of our relationships with our customers, some of which compete with Verizon's retail Internet service provider business; . the ability of our management to manage the substantial expansion of the aggregate employee base and the integration of teams that have not previously worked together, while dealing with the potential loss of key employees of both businesses; . the impairment of relationships with employees as a result of changes in management, the introduction of unionized employees and modifications to any collective bargaining agreements; and . the different geographic locations of our respective principal operations. The diversion of attention of our management and any difficulties encountered in the process of combining our DSL businesses could cause a disruption of our business activities. The Costs of Completing the Transactions Are Substantial and May Make it More Difficult for Us to Achieve Profitability We will incur substantial costs in connection with the proposed transactions which may make it more difficult to achieve profitability in the future. We estimates that we will indirectly incur costs associated with the transactions, consisting of transaction 21 fees for investment bankers, attorneys, accountants and other related costs incurred by us (such nonrecurring transaction costs being recorded as goodwill upon completion of the transactions) and additional nonrecurring restructuring charges. There can be no assurance that we will not incur further additional charges to reflect costs associated with the transactions, including the costs of integrating our respective DSL operations. The Loss of a Significant Customer Could Harm Our Business We currently provide or have agreements to provide data transport solutions to more than 175 network service providers. For the year ended December 31, 1999, our two largest customers accounted for 32% of our revenues. For the three months ended September 30, 2000, our two largest customers accounted for 23% of our revenues. These two customers accounted for 7% of accounts receivable at September 30, 2000. We anticipate that, as we expand our business, we will continue to rely upon a limited number of customers for a high percentage of our revenue and end-user lines. As a result of this concentration of our customer base, a loss of or decrease in business from one or more of our customers could have a material adverse effect on our business, prospects, financial condition and results of operations. Similarly, if our customers are unsuccessful in competing for end users in their own intensely competitive markets or experience other financial or operating difficulties, our business, prospects, financial condition and results of operations would be materially adversely affected. Many of our agreements with our customers are non-exclusive, and many of our customers are also customers of, or have invested in, our competitors. To the extent our significant customers strengthen their commercial relationships with our competitors, our business would be materially adversely affected. Our Business Will Suffer if Our Customers Are Not Successful in Marketing and Selling Our Services We exclusively market our services through network service providers for resale to their business and consumer end users. A significant reduction in the number of end users or revenues provided by one or more of our key network service providers could materially harm our operating results in any given period. Market or other conditions that adversely affect our network service provider customers could result in slower revenue growth. Our agreements with our customers are generally non-exclusive. Many of our customers also resell services offered by our competitors. In addition, a number of our customers have committed to provide large numbers of end-users in exchange for price discounts. If our customers do not meet their volume commitments or otherwise do not sell our services to as many end users as we expect, our business will suffer. In addition, these and future relationships we may establish with other third parties may not result in significant line orders or revenues. Our Business Has Suffered Because of Our Customers' Recent Financial Difficulties and Failure to Pay for Our Services Recently, a number of our privately held, consumer-focused network service provider customers have experienced significant difficulties in raising the capital necessary to operate and grow their businesses and are not current in their payment for our services. Prior to our third quarter earnings release on October 26, 2000, we did not recognize revenue earned from certain network service provider customers during the third quarter which could not satisfy our revenue recognition standards. We received additional facts after the October 26, 2000 third quarter earnings release that indicated certain of our privately- held, consumer-focused internet service providers, including Flashcom, Inc., did not have sufficient long-term financial resources to assure us that they would be able to make timely payment for our services. Therefore, we have revised our third quarter results as required by SEC regulations. Our revenue for the third quarter was reduced to $23,955,000 compared to the $30,092,000 reported on October 26, 2000 as a result of our decision not to recognize revenue from sales to these delinquent network service provider customers. In addition, we recognized increased bad debt and other operating expenses related to these network service provider customers. As a result, our EBITDA loss for the quarter ended September 30, 2000 was increased to $90,916,000 million compared to the $79,210,000 reported on October 26, 2000. These delinquent network service provider customers account for approximately 26,700 of our 87,300 installed lines at September 30, 2000. We have halted the installation of in-process lines ordered by these customers and we may also decide to disconnect end users that are purchasing their services from delinquent network service provider customers. If this occurs, we cannot assure you that these end users will continue to purchase our services through another one of our network service provider customers and we may lose the lines served by such end users. We will recognize additional revenue from these customers only when all previous accounts receivable balances for these customers have been paid and when cash is received for new services. We are continuing our efforts to obtain payments, but we cannot assure you that these efforts will be successful. It is possible that additional network service provider customers may experience significant difficulties in raising the capital necessary to operate and grow their businesses and may be unable to pay for our services in the future on a timely basis. Our network service provider customers' inability to pay these past due amounts, and to make timely payments for our services in the future, may materially and adversely affect our business, operating results and financial condition. We are also currently attempting to arrange for the direct transfer of lines serviced by delinquent network service provider customers to other well- financed, publicly-traded network service provider customers and considering a variety of other alternatives with respect to these delinquent network service provider customers, such as the discontinuation of adding new end users, requiring prepayments for new services and sending notices of termination of service. We note, however, that should any of our network service provider customers become subject to reorganization or bankruptcy proceedings, we cannot assure you that we will ultimately collect sums owed to us by these customers and it remains uncertain what consequence, if any, bankruptcy proceedings would have on lines installed for such customers. Moreover, should the particular network service provider customer become subject to reorganization or bankruptcy proceedings, we cannot assure you that we will be able to retain payments or other consideration received by us prior to such reorganization or bankruptcy proceeding. Even if we are able to move these end users to other network service provider customers, it will require a significant amount of our resources, which may impair our ability to install new lines as they are ordered. Any of these circumstances could adversely affect our business, operating results and financial condition. 22 We May Not Be Able to Continue to Grow Our Business If We Do Not Obtain Significant Additional Funds We believe our current capital resources will be sufficient for the funding and working capital requirements needed for the deployment of our networks in our 60 targeted markets. If we decide to accelerate the timing of the buildout of our networks or target additional markets, we may need significant additional funds. We expect that the actual amount and timing of our future capital requirements, if any, will depend upon the demand for our services and regulatory, technological and competitive developments, including additional developments and new opportunities in our industry. These future capital requirements may be substantial. In addition, we may seek additional financing if: . we make alterations to the schedule, targets or scope of our network rollout plan, including the number of markets entered and the services offered; . there are changes to our plans or projections or such plans or projections prove to be inaccurate; . our customers purchase and pay for fewer of our services or the pricing of such services decreases; . the financial condition of our customers continues to deteriorate; . we have unanticipated opportunities, including acquisitions of or investments in other companies or businesses; . the level of marketing required to acquire and retain customers and to attain a competitive position in the marketplace increases; . the rate at which we invest in engineering and development with respect to existing and future technology increases; or . the proposed merger with Verizon's DSL business closes later than expected or not at all. We may be unsuccessful in raising sufficient additional capital at all or on terms that we consider acceptable. We believe that current capital market conditions, particularly for our industry, reduce our ability to obtain such additional financing. In addition, the revenue recognition issues that we are reporting in this report may make it more difficult for us to access the capital markets. If we are unable to obtain adequate funds on acceptable terms, our ability to deploy and operate our networks, fund our expansion or respond to competitive pressures could be significantly impaired. Such limitation could have a material adverse effect on our business, prospects, financial condition or results of operations. Our Existing Debt May Need to be Refinanced on Possibly Less Favorable Terms Completion of the transactions will trigger specific affirmative obligations under our debt agreements, including among others: . Under our existing bank credit facility, the lenders will have the right to accelerate the payment of the principal amount and accrued and unpaid interest on any amounts outstanding under such facility upon completion of the transactions. As of September 30, 2000, the principal amount plus accrued and unpaid interest under the bank credit facility was $86,079,246. . Under the indenture related to our 12 7/8% senior notes due 2010 with principal amount of $400 million, within ten days after the completion of the transactions, the "new" NorthPoint will be obligated to offer to purchase all of the outstanding notes at a price equal to 101% of the principal amount plus accrued and unpaid interest. As of September 30, 2000, the aggregate principal amount plus accrued and unpaid interest on the outstanding notes was $406,631,507. 23 These provisions will require the "new" NorthPoint to raise additional funds through the issuance of additional debt or equity or through an amendment to its debt facility or indenture on terms that may not be as favorable as under its current debt arrangements. A failure to raise such additional funds would have a material adverse effect on the "new" NorthPoint. Our Business Activities and Our Ability to Raise Additional Funds Are Limited by Covenants Contained in Our Financing Agreements and the Indenture Our debt agreements, including our secured credit facility, the indenture governing our senior notes and other financing agreements contain and will contain restrictions on our activities and financial covenants with which we will be required to comply. If we fail to comply with these requirements, or if we experience a material adverse effect on our business, operations, properties, financial condition, assets or liabilities, we would be in default and our debt could be declared immediately due and payable. We may be unable to make such required payments, or to raise sufficient funds from other sources. In addition, the terms of proposed new indebtedness or other funding may not be permitted by the terms of our current financing agreements, including our secured credit facility and the indenture. This may impair our ability to develop our business. If we fail to raise sufficient funds, we may be required to modify, delay or abandon some of our expansion plans, which could have a material adverse effect on our business, prospects, financial condition and results of operations. We Need to Make Significant Capital Expenditures, and the Amounts, Timing and Returns are Uncertain In 2001, we expect to make significant capital expenditures, estimated at approximately $125,000,000, to develop our business and deploy our services and systems. This estimate does not take into account any necessary changes in our plans as a result of the closing of the Verizon merger. We may also need to make additional capital expenditures in connection with our broadband ventures in Europe and Canada and the acquisition of other companies. In addition, the amount and timing of these expenditures are uncertain and will depend upon our ability to execute our plans in a timely and cost-effective manner. We will need to increase our revenue in order to earn a return from our capital expenditures. If our revenue does not grow as expected, or capital expenditures exceed our estimates, there could be a material adverse effect on our business, prospects, financial condition and results of operations. Our Failure to Manage Our Growth Effectively Could Impair Our Business If we are successful in implementing our business plan, our operations will expand rapidly. This rapid expansion could place a significant strain on our management, financial and other resources. Our ability to manage future growth, if it occurs, will depend upon our ability to: . control costs; . maintain regulatory compliance; . implement and significantly expand our financial and operating systems; . maintain our operations support systems; and . expand, train and manage our employee base. We may be unable to do these things successfully. In addition, we may not successfully obtain, integrate and use our employees and management, operating and financial resources. Our business, prospects, financial condition and results of operations will be materially adversely affected if we are unable to manage our growth effectively. The Data Communications Industry Is Undergoing Rapid Technological Changes and New Technologies May Be Superior to the Technology We Use The data communications industry is subject to rapid and significant technological change, including continuing developments in DSL technology, which does not presently have widely accepted standards, and alternative technologies for providing high speed data communications such as cable modem technology. As a consequence: . we will rely on third parties, including some of our competitors and potential competitors, to develop and provide us with access to communications and networking technology; . our success will depend on our ability to anticipate or adapt to new technology on a timely basis; and . we expect that new products and technologies will emerge that may be superior to, or may not be compatible with, our products and technologies. If we fail to adapt successfully to technological changes or obsolescence or fail to obtain access to important technologies, our business, prospects, financial condition and results of operations could be materially adversely affected. 24 Our Success in Attracting and Retaining Customers Significantly Depends on Our Ability to Obtain Central Office Space from Traditional Telephone Companies As we grow, we may be unable to secure central office space for our equipment in the central offices of traditional telephone companies on a timely basis or at all. In some cases, although physical central office space is available, traditional telephone companies have claimed that they must refurbish space to make it suitable for our equipment--for example, by adding separate entrances, removing asbestos or obsolete machinery, or increasing power supply and air conditioning--which in some cases has made the cost to obtain that physical central office space prohibitively expensive. We expect physical central office space to become increasingly scarce due to increasing demand from a growing number of competitive telecommunications companies. Even when space is available, we may face delays ranging from four months to more than a year after we place an order before space for our equipment is made available. If our applications for physical central office space are rejected, or the costs or delays associated with obtaining central office space become too expensive, our expansion plans could be adversely affected, which could have a material adverse effect on our business, prospects, financial condition and results of operations. Broad service availability is also important to our customers and potential customers that want to provide Internet access or other data services on a national or regional basis. Our inability to obtain physical central office space in a timely manner could have a material adverse effect on our ability to attract and retain customers. Any disputes with traditional telephone companies over the types of equipment we seek to install in the central office space could also delay our installation and even impair our ability to provide service in the manner we deem appropriate. These delays or refusals could have a material adverse effect on our business, prospects, financial condition and results of operations. Our Success Depends on Interconnection Agreements With Traditional Telephone Companies in Each of Our Markets The success of our strategy depends on our ability to enter into and renew interconnection agreements with traditional telephone companies in each of our target markets on a timely basis. Delays in obtaining additional interconnection agreements would postpone our entry into a market, which could have a material adverse effect on our business, prospects, financial condition and results of operations. Interconnection agreements have limited terms of two to three years and we cannot assure you that existing or new agreements will be extended or negotiated on terms favorable to us. Interconnection agreements are also subject to state commission, FCC and judicial oversight. These government bodies may modify the terms or prices of our interconnection agreements in ways that adversely affect our business, prospects, financial condition and results of operations. In addition, as the FCC modifies, changes and implements rules related to unbundling and collocation, we generally have to renegotiate our interconnection agreements with the traditional telephone companies in order to implement those new or modified rules. We may be unable to timely renegotiate these agreements, or we may be forced to arbitrate and litigate with the traditional telephone company agreement terms that fully comply with FCC rules. As a result, although the FCC may implement rules or policies designed to speed or improve our ability to provide services, we may not be able to timely implement those rules or policies. Our Business Could Suffer if High Quality Copper Lines Are Not Available or Cost Us More Than We Expect We significantly depend on the quality of the copper lines and the traditional telephone companies' maintenance of such lines. We cannot assure you that we will be able to obtain the copper lines and the services we require from the traditional telephone companies at quality levels, prices, terms and conditions satisfactory to us. Our failure to do so would have a material adverse effect on our business, prospects, financial condition and results of operations. Under federal law, traditional telephone companies have an obligation to negotiate with us in good faith to enter into interconnection agreements, including agreements on the price at which we can obtain suitable lines from these telephone companies. If no agreement can be reached, either side may petition the applicable state commission to arbitrate remaining disagreements. These arbitration proceedings can last up to nine months. Moreover, the state commission must approve any interconnection agreement resulting from negotiation or arbitration, and any party may appeal an adverse decision by the state commission to federal district court. The potential cost in resources and delay from this process could harm our ability to compete in certain markets, and there is no guarantee that a state commission would resolve disputes, including pricing disputes, regarding our access to suitable lines in our favor. Moreover, the FCC rules governing pricing standards for access to the networks of the traditional telephone companies are currently being challenged in federal court. One federal court has overturned the FCC's pricing methodology in part. Requests for Supreme Court review of this decision are pending. If the challenge to the FCC's pricing rules is upheld by the courts, the FCC may adopt a new pricing methodology that would require us to pay a higher price to traditional telephone companies for access to suitable lines. This could 25 have a detrimental effect on our business. We have not yet established a history of ordering and obtaining the provisioning and repair of very large volumes of lines from any traditional telephone company. We also depend on cooperation from traditional telephone companies for repair of transmission facilities. The traditional telephone companies in turn rely significantly on unionized labor. Labor-related issues and actions on the part of the traditional telephone companies have in the past, and may in the future, adversely affect traditional telephone companies' provision of services and network components that we order. Our dependence on the traditional telephone companies has caused and could continue to cause us to encounter delays in establishing our networks, provisioning lines and upgrading our services. These delays could adversely affect our relationships with our customers, harm our reputation or otherwise have a material adverse effect on our business, prospects, financial condition and results of operations. We Depend on Market Acceptance for DSL-Based Services The demand for small- and medium-sized business, telecommuter and residential Internet access is in the early stages of development. Because we offer services to a new and evolving market and because current and future competitors are likely to introduce competing services, it is difficult for us to predict the rate at which the demand for our services will grow. Various providers of high-speed digital communications services are testing products from various suppliers for various applications, and it is unclear if DSL will offer the same or more attractive price-performance characteristics. If the demand for our services fail to develop, grow more slowly than anticipated or become saturated with competitors, our business, prospects, financial condition and results of operations could be materially adversely affected. We Depend on Our Billing, Customer Service and Information Support Systems, Which Need Further Development Sophisticated information and processing systems are vital to our growth and ability to monitor costs, bill customers, process customer orders and achieve operating efficiencies. Our plans for the development and implementation of our operations support systems rely, for the most part, on acquiring products and services offered by third-party vendors and integrating those products and services in-house to produce efficient operational solutions. However, we may not successfully identify all of our information and processing needs or implement these systems on a timely basis or at all, and these systems may not perform as expected. If our plans for the development and implementation of our operations support systems do not proceed as expected, or if these systems, once implemented, fail to perform as expected, our business prospects, financial condition and results of operations could be materially adversely affected. In addition, our right to use these systems is dependent upon license agreements with third-party vendors. Some of those agreements may be cancelable by the vendor and the cancellation or nonrenewal of these agreements may have a material adverse effect on our business, prospects, financial condition and results of operations. Similar issues are applicable to the operations support systems and other systems of our customers, and to the interface between our systems and those of our customers. Therefore, failures at our customers could also have a material adverse effect on our business, prospects, financial condition and results of operations. We May Be Unable to Expand Our Network Services Effectively and Provide High Performance to a Substantial Number of End Users Due to the limited deployment of our services, the ability of our DSL network to connect and manage a substantial number of end users at high transmission speeds is still unknown. While peak digital data transmission speeds across our DSL network to and from the central office and the end user can exceed 1.5 megabits per second, the actual data transmission speeds over our network could be significantly slower due to: . the type of DSL technology deployed; . the distance an end user is located from a central office; . the configuration of the telecommunications line being used; . the gauge of the copper lines; and . the presence and severity of interfering transmissions on nearby lines. 26 For example, we are not certain whether we can successfully deploy higher DSL speeds through digital loop carrier systems which, because they connect copper lines to a fiber link, currently limit DSL service to a maximum speed of 144 kilobits per second. Because we rely on traditional telephone companies to overcome technical limitations associated with loop carrier systems, we cannot assure you that we will be able to successfully deploy high speed DSL service to all areas in which we provide service. As a result, our network may not be able to achieve and maintain the highest possible digital transmission speed. Our failure to achieve or maintain high speed digital transmissions would have a material adverse effect on our business, prospects, financial condition and results of operations. Our Success Depends on Our Retention of Executive Officers and Other Key Personnel and Our Ability to Hire Additional Key Personnel We are managed by a small number of executive officers. Competition for qualified executives in the data communications services industry is intense, and there are a limited number of persons with comparable experience. We depend upon our executive officers because we believe there are few managerial personnel with qualifications to swiftly implement a business plan integrating DSL technology with the existing telephone infrastructure. Any of our executive officers may terminate his or her employment with us at any time. We do not have "key person" life insurance policies on any of our executive officers. The loss of these key individuals could have a material adverse effect on our business, prospects, financial condition and results of operations. We believe that our success will depend in large part on our ability to retain and attract qualified technical, marketing, managerial and other personnel. Additionally, we believe an effective sales force is critical to our success. The industry in which we compete is characterized by a high level of employee mobility and aggressive recruiting of skilled personnel. We may be unable to hire or retain necessary personnel in the future. Our inability to attract and retain key personnel would have a material adverse effect on our business, prospects, financial condition and results of operations. The Industry in Which We Operate is Highly Competitive, and We May Not Be Able to Compete Effectively, Especially Against Established Competitors With Significantly Greater Financial Resources We face competition from many competitors with significantly greater financial resources, well-established brand names and larger customer bases. We also expect competition to intensify in the future. We expect significant competition from traditional and new telephone and telecommunications companies, including national long distance carriers, cable modem service providers, Internet service providers, on-line service providers, and wireless and satellite data service providers. Other Competitive Telecommunications Companies, Some With Greater Financial Resources, Compete in the Same Areas for the Same Customers. Other competitive telecommunications companies have entered and may continue to enter the industry and offer high speed data services using a business strategy similar to ours. Some competitors, including those focusing on data transport such as Rhythms NetConnections Inc., HarvardNet Inc., @Link Networks L.L.C., New Edge Networks, Covad Communications Group, Inc., BlueStar Communications, JATO, Telocity, Vitts Network, DSL.net and Network Access Solutions Corporation, have begun to offer DSL-based access services, and others are likely to do so in the future. Finally, traditional voice-based telephone companies such as BTI Telecom, Hyperion, MCG, McLeod Communications, Allegiance and Network Plus, are starting to offer high speed data services. Certain of our customers have made investments in our competitors, which may enhance their relationships with these competitors at our expense. The Telecommunications Act of 1996 specifically grants any competitive local exchange carrier, or competitive telecommunications company, the right to negotiate interconnection agreements with traditional telephone companies, or incumbent local exchange carriers. The Telecommunications Act also allows competitive telecommunications companies to enter into interconnection agreements which are identical in all respects to ours. In addition, some competitive telecommunications companies have extensive fiber networks in many metropolitan areas primarily providing high speed digital and voice circuits to large corporations, and have interconnection agreements with traditional telephone companies pursuant to which they have acquired space in traditional telephone companies' central offices in many of our markets. As a result, our customers may contract with other competitive telecommunications companies, which may decrease our customers' demand for our services. Traditional Telephone Companies With Greater Resources Than Ours May Directly Compete in Our Service Areas. The traditional telephone companies have an established brand name and reputation for high quality in their service areas, possess significant capital to deploy DSL equipment rapidly, have their own copper lines and can bundle digital data services with their existing analog voice services to achieve economies of scale in serving customers. In addition, most traditional telephone companies have established or are establishing their own Internet service provider businesses, and all of the largest traditional telephone companies that are present in our target markets are conducting market trials of or have commenced offering DSL-based access services. For example, Verizon Communications, BellSouth, Cincinnati Bell, Pacific Bell and Southwestern Bell are offering services in some territories in which we offer services, U S WEST is offering commercial DSL services and Ameritech has announced commercial DSL services in some areas of Michigan and Illinois. We recognize that the traditional telephone 27 companies have the potential to quickly deploy DSL services and are in a position to offer service from central offices where we may be unable to secure space in traditional telephone companies' central offices. In addition, the FCC is considering establishing requirements for separate subsidiaries through which the traditional telephone companies could provide DSL service on a largely deregulated basis. As a result, we expect traditional telephone companies to be strong competitors in each of our target markets. National Long Distance Carriers May Begin to Compete for Our Small- and Medium-Sized Business Customers. Many of the leading traditional national long distance carriers, including MCI WorldCom, Inc., AT&T Corp. and Sprint Corporation, are expanding their capabilities to support high speed, end-to-end data networking services. They also have interconnection agreements with many of the traditional telephone companies and a number of spaces in traditional telephone companies' central offices from which they could begin to offer competitive DSL services. The newer national long distance carriers, such as Level 3 Communications, Inc., The Williams Companies, Inc. and Qwest Communications International, Inc. are building and managing high speed fiber- based national data networks and partnering with Internet service providers to offer services directly to the public. These companies could modify their current business focus to include small- and medium-sized business customers using DSL or other technologies in combination with their current fiber networks. Sprint has already launched services in Las Vegas and Charlotte. Cable Modem Service Providers May Offer High Speed Internet Access at More Competitive Rates Than Ours, Forcing Us to Lower Our Prices. Cable modem service providers, such as At Home Corporation and Road Runner, Inc. (with their cable partners), are deploying high speed internet access services over hybrid fiber coaxial cable networks. Where deployed, these networks provide similar and in some cases higher speed Internet access than we provide. They also offer these services at lower price points than our services. Actual or prospective cable modem service provider competition may have a significant negative effect on our ability to secure customers and may create downward pressure on the prices we can charge for our services. Internet Service Providers, Our Targeted Customers, May Begin to Provide DSL Services Directly. Internet service providers, such as Verio Inc., Genuity, UUNET (a subsidiary of MCI WorldCom, Inc.), Sprint, Concentric Network Corporation, MindSpring Enterprises, Inc. and PSINet, Inc., provide Internet access to residential and business customers, generally using the existing telephone system. Some regional Internet service providers, such as HarvardNet Inc., BlueStar Communications, New Edge Networks, @Link Networks L.L.C., InterAccess Co., Vitts Networks Inc. and Prism Solutions, Inc., have begun offering DSL-based services. Internet service providers could become competing high speed data service providers if they attain certification as competitive telecommunications companies in the states in which they planned to operate. On-line Service Providers, Our Targeted Customers, May Begin to Provide DSL Services Directly. On-line service providers, such as America Online, Inc., Compuserve (a subsidiary of America Online), Microsoft Network, Prodigy, Inc., and WebTV Networks, Inc. (a subsidiary of Microsoft), provide, over the Internet and on proprietary on-line services, content and applications ranging from news and sports to consumer video conferencing. These services are designed for broad consumer access over telecommunications-based transmission media, which enable digital services to be provided to the significant number of consumers who have personal computers with modems. In addition, on-line service providers provide Internet connectivity, ease-of-use and consistency of environment. Many of these on-line service providers have developed their own access networks for modem connections. AOL has announced that it will purchase DSL services from Verizon Communications and SBC Communications. If these on-line service providers were to extend their owned access networks to DSL, they would be our competitors. Wireless and Satellite Data Service Providers May Begin to Offer Wireless and Satellite-Based Internet Connectivity, Also Competing Against Us. Wireless and satellite data service providers are developing wireless and satellite-based Internet connectivity. We may face competition from terrestrial wireless services, including multi-channel multipoint distribution systems, local multipoint distribution systems, wireless communication service and point-to- point microwave systems. The FCC had adopted new rules to permit multi-channel multipoint distribution system licensees to use their systems to offer two-way services, including high speed data, rather than solely to provide one-way video services. The FCC also has auctioned local multipoint distribution system licenses in all markets for wireless systems, which can be used for high speed data services. In addition, companies such as Teligent, Inc., Advanced Radio Telecom Corp., NEXTLINK and WinStar Communications, Inc. hold point-to-point and/or point-to-multipoint microwave licenses to provide fixed wireless services such as voice, data and video conferencing. We also may face competition from satellite-based systems. Motorola Satellite Systems, Inc., Hughes Communications, Inc. (a subsidiary of General Motors Corporation), Teledesic LLC and others have filed applications with the FCC for global satellite networks which can be used to provide broadband voice and data services. In January 1997, the FCC allocated 300 MHz of spectrum in the 5 GHz band for unlicensed devices to provide short-range, high speed wireless digital communications. These frequencies must be shared with incumbent users without causing interference. Although the allocation is designed to facilitate the creation of new wireless local area networks, it is too early to predict what kind of equipment might ultimately be manufactured and for what purposes it might be used. 28 The telecommunications industry is subject to rapid and significant changes in technology, and we cannot predict the effect of technological changes on our business, such as continuing developments in DSL technology and alternative technologies for providing high speed data communications. These technological developments in the telecommunications industry could have a material adverse effect on our competitive position and therefore on our business, prospects, financial condition and results of operations. Industry Consolidation Could Make Competing More Difficult Consolidation of companies offering high speed local data transport is occurring through acquisitions, joint ventures and licensing arrangements involving our competitors and our customers' competitors. As a company with limited operating history, we cannot assure that we will be able to compete successfully in an increasingly consolidated industry. Any heightened competitive pressures that we may face may have a material adverse effect on our business, prospects, financial condition and results of operations. Additionally, because we rely on our customers' marketing channels to provide our services to business and residential end users, if our customers are adversely affected by consolidation and integration in the market, our business, prospects, financial condition and results of operations could be materially adversely affected. Our Services Are Subject to Uncertain Government Regulation, and Changes in Current or Future Laws or Regulations Could Restrict the Way We Operate Our Business We are subject to federal, state and local regulation of our telecommunications business. With the passage of the Telecommunications Act in 1996, Congress sought to foster competition in the telecommunications industry and to promote the deployment of advanced telecommunications technology. Implementation of the Telecommunications Act is the subject of ongoing administrative proceedings at the federal and state levels, litigation in federal and state courts, and legislation in federal and state legislatures. We cannot predict the outcome of the various proceedings, litigation and legislation or whether or to what extent these proceedings, litigation and legislation may adversely affect our business, prospects, financial condition and results of operations. As a competitive telecommunications company, we are subject to FCC regulation for our contractual, or interconnection, arrangements with the traditional telephone companies, or incumbent local exchange carriers, in our markets, but the scope of this regulation is uncertain because it is the subject of ongoing court and administrative proceedings. Several parties have brought court challenges to the FCC's interconnection rules, including the rules that establish the terms under which a competitive telecommunications company may use portions of a traditional telephone company's network. Although the Supreme Court held that the FCC has the authority to adopt interconnection rules and specifically upheld several of these rules, other rules are still being considered by the courts. If a rule that is beneficial to our business is struck down, it could harm our ability to compete. In particular, the Eighth Circuit has overturned in part the methodology that the FCC established to determine the price that competitive telecommunications companies would have to pay traditional telephone companies for use of the traditional telephone companies' networks. The requests for Supreme Court review are pending. If challenges to the FCC's pricing rules are upheld, the FCC may establish a new pricing methodology. This may result in our having to pay a higher price to traditional telephone companies if we were to use a portion of their networks in providing our services, and this could have a detrimental effect on our business. The FCC is continually revisiting rules and regulations that are critical to our ability to provide service and to exploit access to unbundled copper loops and shared copper loops. In the last several years, as part of a proceeding examining the availability of advanced data services, the FCC has passed several rules that enhance the ability of competitive DSL companies like NorthPoint to, among other things, access DSL-capable unbundled copper loops, access and utilize various forms of central office collocation space, provide a variety of DSL services to end-users by setting open rules for spectrum compatibility, and access "shared-lines" by requiring the traditional telephone companies to provide access to the high-frequency portion of existing voice service lines to DSL competitive companies like NorthPoint for the provision of high speed DSL services. The decision with respect to shared- lines is still subject to review by the courts and implementation of line sharing capabilities, including technical and operational trials, are still underway at the incumbent Local Exchange Carriers Final pricing rules for shared lines, which we anticipate and depend upon to be lower than the rates for stand-alone lines, are yet to be finalized by State Commissions. As a result, the benefits of the FCC's line sharing decision may be diluted or delayed if the implementation processes are protracted or frustrated through legal challenges, arbitrations, or other actions in any given state. Our Debt Creates Financial and Operating Risk That Could Limit the Growth of Our Business As of September 30, 2000, we had approximately $491,335,000 of indebtedness and $145,630,000 of stockholders' equity. The degree to which we are leveraged could have important consequences to holders of our common stock, including, but not limited to, the following: 29 . our ability to obtain additional financing or refinancing in the future for capital expenditures, repayment of outstanding indebtedness, working capital, acquisitions, general corporate or other purposes may be materially limited or impaired; . our cash flow, if any, may be unavailable for building our business, as a substantial portion of our cash flow may be dedicated to the payment of principal and interest on our indebtedness or other indebtedness that we may incur in the future, and our failure to generate sufficient cash flow to service such indebtedness could result in a default; . our debt agreements will contain restrictions and financial covenants which, if we fail to meet them, could result in our indebtedness being declared due prematurely, at a time when we could not make the required payments; . our leverage may make us more vulnerable to economic downturns, may limit our ability to withstand competitive pressures and may reduce our flexibility in responding to changing business and economic conditions; and . we may from time to time be more highly leveraged than many of our competitors, which may place us at a competitive disadvantage. We Rely on Our Intellectual Property Which We May Be Unable to Protect, or We May Be Found to Infringe the Rights of Others Our success depends in part on our ability to protect our proprietary intellectual property. In addition, we may be sued over intellectual property rights. These lawsuits, or our inability to protect our intellectual property rights, could have a material adverse effect on our business, prospects, financial condition and results of operations. In April 1999, we received a letter from one of our competitors, Covad Communications Group, Inc., indicating that it had been informed of allowance of a United States patent application. According to Covad's letter, their patent application related to digital subscriber loop implementations supporting (a) a bandwidth of 128 kbps or 144 kbps combined with (b) a bandwidth greater than 128 or 144 kbps. The patent described in Covad's letter has now issued. We have received a copy of the patent. We have not yet evaluated fully the validity or relevance of the patent to our business. If the patent is valid, and if we infringe this patent, we could be required to obtain a license under the patent. While Covad has indicated that we may be interested in obtaining a license from them at the appropriate time, we cannot be certain that such a license, if needed, would be available on commercially acceptable terms. A System Failure or Breach of Network Security Could Delay or Interrupt Service to Our Customers The reliability of our transmission services in our markets would be impaired by a natural disaster or other unanticipated interruption of service or damage at any of our facilities. Additionally, failure of a traditional telephone company or other service provider to provide communications capacity required by us, as a result of a natural disaster, operational disruption or for any other reason, could cause interruptions in our services. Damage or failure that causes interruptions in our services could have a material adverse effect on our business, prospects, financial condition and results of operations. Our network may be vulnerable to unauthorized access, computer viruses and other disruptive problems. Unauthorized access could also potentially jeopardize the security of confidential information stored in the computer systems of our customers, which might result in liability to our customers, and also might deter potential customers. Although we intend to implement security measures that are standard within the telecommunications industry, we may be unable to implement such measures in a timely manner or, if and when implemented, our security measures may be circumvented. Eliminating computer viruses and alleviating other security problems may require interruptions, delays or cessation of service to our customers and these customers' end users. Any of the foregoing factors relating to network security could have a material adverse effect on our business, prospects, financial condition and results of operations. Our Business Could Suffer from a Reduction or Interruption from Our Equipment Suppliers or Other Third Parties on Whom We Rely for Installation and Provision of Field Service We plan to purchase all of our equipment from various vendors and outsource the installation and field service of our networks to third parties. We also depend on the availability of fiber optic transmission facilities from third parties to connect our equipment within and between metropolitan areas. Any reduction of or interruption from our equipment suppliers, such as Copper Mountain Network, Inc., from which we purchase most of our digital subscriber line access equipment, or interruption in service from any significant installer or field service provider, such as Lucent Technologies, Inc., which has installed and maintained our equipment in all of our markets, could have a disruptive effect on our business, prospects, financial condition and results of 30 operations. In addition, the pricing of the equipment we purchase may substantially increase over time, increasing the costs we pay in the future, or decrease over time, providing later entrants to our industry with a cost advantage over us. The availability and pricing of the equipment we purchase would be adversely affected if our suppliers were to compete with us, or if our competitors enter into exclusive or restrictive arrangements with our suppliers. It could take a significant period of time to establish relationships with alternative suppliers for each of our technologies and substitute their technologies into our network. Uncertain Federal and State Tax and Other Surcharges on Our Services May Increase Our Payment Obligations Telecommunications providers are subject to a variety of complex federal and state surcharges and fees on their gross revenues from interstate and intrastate services, including regulatory fees, and surcharges related to the support of universal service. A finding that we misjudged the applicability of the surcharges and fees could increase our payment obligations and have a material adverse effect on our business, prospects, financial condition and results of operations. Claims of Interference Could Harm Our Ability to Deploy Our Services Certain technical laboratory tests and field experience indicate that some types of DSL, in particular, asymmetrical DSL-in which data transport to the end user is faster than transport from the end user-may cause interference with and be interfered with by other signals present in a traditional telephone company copper plant. Citing this potential interference, some traditional telephone companies have imposed restrictions on the use of DSL technology over their copper lines. However, we do not believe that our symmetrical DSL technology equipment, which permits the same speed of data transport to and from the end user, poses interference risks. If traditional telephone companies were to restrict our use of our technology or equipment in the future, our business, prospects, financial condition and results of operations could be materially adversely affected. Our Stock Price May Be Volatile The trading price of our common stock has been and is likely to continue to be highly volatile. Our stock price is likely to be volatile and may fluctuate substantially due to factors such as: . our historical and anticipated quarterly and annual operating results; . variations between our actual results and analyst and investor expectations; . announcements by us or others and developments affecting our business; . investor perceptions of our company and comparable public companies; and . conditions and trends in the data communications and Internet- related industries. In particular, the stock market has from time to time experienced significant price and volume fluctuations affecting the common stocks of technology companies, which may include data communications and Internet-related companies. These fluctuations may result in a material decline in the market price of our common stock. The Sale of Shares or the Perception of Future Sales Could Depress Our Stock Price Sales of a large number of shares of common stock in the market or the perception that sales may occur could cause the market price of our common stock to drop. As of September 30, 2000, we had 133,321,089 shares of common stock outstanding. Of these common shares, substantially all are freely tradeable, except for any such shares held at any time by an "affiliate" of NorthPoint, as defined under Rule 144 under the Securities Act. These shares may be sold in the future without registration under the Securities Act to the extent permitted by Rule 144 or an exemption under the Securities Act. In addition, holders of shares of common stock representing approximately 51% of the currently outstanding shares of common stock have agreed to vote their shares in support of the merger with Verizon Communications' DSL business and not to sell any shares, subject to limited exceptions, until the closing. 31 Our Principal Stockholders and Management Own a Significant Percentage of NorthPoint, and Will Be Able to Exercise Significant Influence Our executive officers and directors and principal stockholders together beneficially own approximately 50% of our common stock. These stockholders, if they vote together, will be able to exercise significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. Upon consummation of the proposed merger with Verizon's DSL business, Verizon will own 55% of the common stock of the new NorthPoint. This concentration of ownership may also delay or prevent a change in control of NorthPoint. Our Certificate of Incorporation and Bylaws Contain Provisions That Could Delay or Prevent a Change In Control of NorthPoint Certain provisions of our certificate of incorporation and bylaws could make it more difficult for a third party to acquire control of NorthPoint, even if a change in control would be beneficial to stockholders. Our certificate of incorporation allows our board of directors to issue, without stockholder approval, preferred stock with terms set by the board of directors. The preferred stock could be issued quickly with terms that delay or prevent a change in control of NorthPoint or make removal of management more difficult. Also, the issuance of preferred stock may cause the market price of the common stock to decrease. If Unexpected Year 2000 Issues Arise, We May Incur Significant Costs and Our Business Could Suffer The year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. As a result, computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. Although we have not experienced any year 2000 problems and have not been informed of any material year 2000 problems by our customers and vendors, we cannot assure you that our systems or the systems of other companies on whose services we depend or with whom our systems interconnect will not experience unexpected year 2000 problems during the course of the year. This could result in system failures or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices or engage in similar normal business activities. This could, in turn, have a material adverse effect on our business, prospects, financial condition and results of operations. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. We are currently exposed to the impact of interest rate changes and changes in market values of investments through our investment portfolio. The majority of our debt is in the form of fixed interest rate obligations. Our principal exposure to financial market fluctuations relates to our secured credit facility, which is floating rate debt. We do not believe a hypothetical 10% adverse rate change in our variable rate debt obligations would be material to our results of operations. We believe our market risk exposure with regard to marketable debt securities in our investment portfolio is limited to changes in quoted market prices for such securities. Based upon the composition of our marketable debt securities at September 30, 2000, we do not believe a hypothetical 10% adverse change in quoted market prices would be material to our results of operations. 32 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. We are not currently involved in any pending legal proceedings that individually, or in the aggregate, are material to us. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. (c) Recent Sales of Unregistered Securities: During the three month period ended September 30, 2000, we have issued and sold unregistered securities as follows: We issued an aggregate of 150,000 shares of Series A 9% convertible preferred stock in a private placement on September 5, 2000 to Verizon Communications for an aggregate purchase price of $150,000,000. The shares we issued constitute restricted securities within the meaning of Rule 144 promulgated under the Securities Act of 1933. No underwriters were used in connection with these sales and issuances. The issuance of these securities was exempt from registration under the Securities Act pursuant to Section 4(2) thereof, on the basis that the transaction did not involve a public offering. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. ITEM 5. OTHER INFORMATION. None. 33 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits: The following exhibits are included as part of this Report: Exhibit No. Description of Exhibit --- ---------------------- 3.3 Certificate of Designation of 9% Convertible Preferred Stock of NorthPoint Communications Group, Inc. 10.43 Amendment to Credit Agreement dated as of August 29, 2000 among NorthPoint Communications, Inc., NorthPoint Communications Group, Inc., Certain Subsidiaries of NorthPoint Communications, Inc., as Guarantors, Various Lenders, Goldman Sachs Credit Partners, L.P., Canadian Imperial Bank of Commerce, and Newcourt Commercial Financial Corporation 27.1 Financial Data Schedule for the three months ended September 30, 2000. (b) Reports on Form 8-K: Form 8-K filed August 8, 2000, Item Nos. 5 and 7, announcement of entering into an Agreement and Plan of Merger dated as of August 8, 2000, among Bell Atlantic Corporation (d/b/a Verizon Communications), Verizon Ventures I Inc., Verizon Ventures II, Inc. and NorthPoint Communications Group, Inc. Form 8-K filed August 15, 2000, Item Nos. 5 and 7, attaching the Agreement and Plan of Merger dated as of August 8, 2000, among Bell Atlantic Corporation (d/b/a Verizon Communications), Verizon Ventures I Inc., Verizon Ventures II, Inc. and NorthPoint Communications Group, Inc. 34 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. NORTHPOINT COMMUNICATIONS GROUP, INC. Registrant Dated: November 20, 2000 By: /s/ ELIZABETH A. FETTER -------------------------------------- Elizabeth A. Fetter Chief Executive Officer and President Dated: November 20, 2000 By: /s/ MICHAEL P. GLINSKY -------------------------------------- Michael P. Glinsky Executive Vice President and Chief Financial Officer 35