SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
/ X / ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended SEPTEMBER 30, 1997
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________to______________
Commission file number 333-33601-02
GST USA, INC.
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(Exact Name of Registrant as Specified in its Charter)
Delaware 83-0310464
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(State or other jurisdiction of (IRS Employer Identification
incorporation or organization Number)
4001 Main Street, Vancouver, Washington 98663
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (360) 906-7100
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
None
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I(1)(A)
AND (B) OF FORM 10-K AND IS THEREFORE FILING THIS FORM 10-K WITH THE
REDUCED DISCLOSURE FORMAT CONTEMPLATED THEREBY.
Indicate by check mark whether the Registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. Yes /X/ No / /
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Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. /X/
Indicate the number of shares outstanding of each of the
Registrant's classes of common stock, as of the latest practicable date: At
January 7, 1998, there were outstanding 10 shares of the Registrant's common
stock, no par value per share.
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ITEM 1. BUSINESS
OVERVIEW
GST USA, Inc. ("GST USA") is a wholly-owned subsidiary of GST
Telecommunications, Inc. ("GST"). GST USA was formed to hold the capital stock
of the consolidated operating subsidiaries of GST. In December 1995, GST USA
issued its 137/8% Senior Discount Notes due 2005 (the "Senior Notes"), which are
unconditionally guaranteed by GST (the "Guarantee") and GST issued its 137/8%
Convertible Senior Subordinated Notes due 2005 (the "Convertible Notes" and
together with the Senior Notes, the "1995 Notes") which are unconditionally
guaranteed by GST USA (the "Convertible Notes Guarantee") in a private placement
(the "1995 Notes Offering"). In May 1996, GST USA consummated an exchange offer
for the Senior Notes. The net proceeds of the 1995 Notes Offering were used to
fund capital expenditures and for working capital.
GST USA also purchases equipment from its wholly-owned subsidiary, GST
Equipment Funding, Inc. ("GST Funding") and leases such equipment to the
operating subsidiaries of GST and GST USA. GST USA is obligated to assume the 13
1/4% Senior Secured Notes due 2007 of GST Funding (the "Secured Notes") as soon
as GST USA is permitted to do so pursuant to the terms of the indenture relating
to the Senior Notes. At such time GST is obligated to guarantee the Secured
Notes. GST Funding issued the Secured Notes in a private placement in May 1997
(the "Secured Notes Offering"). Of the $255.8 million of net proceeds from the
Secured Notes Offering, as of September 30, 1997 approximately $93.8 million was
used to purchase securities pledged to fund the first six interest payments on
the Secured Notes and approximately $91.3 million was used to purchase
telecommunications equipment ($41.5 million of which was used to refinance
intercompany indebtedness).
GST provides a broad range of integrated telecommunications products
and services, primarily to business customers located in the western continental
United States and Hawaii. As a facilities-based competitive local exchange
carrier, GST operates state-of-the-art, digital telecommunications networks that
represent an alternative to incumbent local exchange carriers. GST's full line
of products, which offer a "one-stop" solution to customers' telecommunications
services requirements, include long distance, Internet, data transmission and
private line services, and local dial tone services, which were recently
introduced.
GST's digital networks currently serve 39 markets in Arizona,
California, Hawaii, Idaho, New Mexico, Texas and Washington. In addition, GST
has networks under construction which, when completed, will serve three
additional markets and expand its regional footprint to Oregon. GST also
constructs, markets and manages longhaul fiber optic facilities, principally in
Arizona, California and Hawaii. GST's longhaul fiber optic facilities currently
extend approximately 600 route miles and an additional 1,100 route miles are
expected to become operational over the next 12 months.
ITEM 2. PROPERTIES.
GST USA neither owns nor leases material physical properties.
ITEM 3. LEGAL PROCEEDINGS.
On August 24, 1995, Aerotel, Ltd. and Aerotel U.S.A., Inc.
(collectively, "Aerotel") commenced an action against NACT Telecommunications,
Inc. ("NACT") and a customer of NACT in the United States District Court,
Southern District of New York, alleging that telephone systems manufactured and
sold by
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NACT incorporating prepaid debit card features infringe upon Aerotel's patent
which was issued in November 1987 (the "Aerotel Patent"). The initial complaint
further alleged defamation and unfair competition as a result of a Special
Report disseminated by NACT to its customers and tortious interference with
prospective business relations, alleging that NACT induced third parties to
abandon licensing negotiations with Aerotel. Aerotel sought injunctive relief,
damages in an unspecified amount, damages of up to three times the damages found
for willful infringement of the Aerotel Patent and an order requiring NACT to
publish a written apology to Aerotel. NACT filed an answer and Counterclaim in
which it denied infringement of the Aerotel Patent and sought judgment that the
Aerotel Patent is invalid and unenforceable and that Aerotel has misused its
patent in violation of antitrust laws. NACT also denied that it had committed
defamation, unfair competition or tortious interference with prospective
business relations. On May 3, 1996, NACT served its motion for summary judgment.
The Court has indicated it will deny such motion, although the actual ruling has
not yet been received. In August 1997, Aerotel amended its complaint to include
as defendants GST and GST USA as well as Kyle Love, the former President of NACT
and Dr. Thomas E. Sawyer, a director of GST and NACT and the former Chairman and
Chief Executive Officer of NACT. The amended pleadings seek in excess of $18.7
million in damages and allege that GST and GST USA have infringed the Aerotel
patent, aided and abetted infringement by others, including NACT, and
participated in, and aided and abetted, alleged tortious conduct by NACT. GST,
GST USA, Dr. Sawyer and Mr. Love have served answers denying all material
allegations and intend to defend vigorously. Pretrial discovery has commenced
and is scheduled to be completed in 1998. The case is not expected to be tried
until late 1998 at the earliest. NACT's patent counsel believes that NACT has
valid defenses to the Aerotel claims. If upheld, these defenses would also be
valid for all defendants. An unfavorable decision in this action could have a
material adverse effect on GST USA and GST.
On July 5, 1994, the Tucson City Council (the "Council") awarded GST
Tucson Lightwave, Inc. ("GST Tucson") a non-exclusive fiber optic communication
license that permits GST Tucson, for a period of 25 years, to conduct, maintain
and operate in and across designated portions of city-owned rights-of-way. On
June 12, 1995, the Council approved the City of Tucson Competitive
Telecommunications Code (the "Tucson Code"), which was subsequently amended on
July 10, 1995. The Tucson Code now provides, among other things, (i) that the
City of Tucson grant licenses for a period of 15 years, (ii) for an increase
from 2% to 5 1/2% of gross revenues to be paid by licensees and (iii) for
cancellation of a license in certain events. The Council subsequently refused to
permit GST Tucson to modify the route plans previously approved in order to
construct connections between its customers and the network, asserting that GST
Tucson's existing license does not permit such action and requiring GST Tucson
to receive an amended license under the Tucson Code to modify its route plans.
After trying to negotiate a settlement with the City of Tucson with respect to
its license, GST Tucson commenced an action in the Superior Court of Arizona,
County of Pima, against the City of Tucson. The Court ruled in favor of the City
that the City Engineer does not have the authority to grant modifications from
the route map, that such route modifications must be approved by the Council and
that the City could condition GST Tucson's application for a franchise for
intrastate service on a relinquishment of GST Tucson's existing license. GST
Tucson appealed the Superior Court's rulings and subsequently filed a petition
for review in the Arizona Supreme Court. On May 13, 1996, GST Tucson instituted
an action in the United States District Court for the District of Arizona
against the City of Tucson seeking a declaratory judgment and injunctive relief
arising out of the City of Tucson's failure to manage its public rights-of-way
in a competitively neutral and nondiscriminatory manner in violation of the
Telecommunications Act of 1996 (the "Telecommunications Act"). The Court
dismissed GST Tucson's action. GST Tucson filed a Notice of Appeal to the United
States Court of Appeals for the Ninth Circuit on January 16, 1997. On August 5,
1997, the Tucson City Council approved a settlement agreement that resolves the
Superior Court action. Under the terms of the settlement agreement, GST Tucson
has agreed to pay the City the annual license fee called for by the Tucson Code
that amounts to 5 1/2% of gross revenues, and the City has permitted GST Tucson
to modify its current route map and to serve customers throughout the City
limits. While dismissing the pending state court appeal, the parties agreed to
allow the United States Court of Appeals for the Ninth Circuit to decide the
pending legal issue relating to whether companies like GST Tucson
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enjoy a private right of action to assert right-of-way claims under Section
253(c) of the Telecommunications Act in the United States District Courts.
On or about February 25, 1997, U S WEST Communications, Inc. ("U S
WEST") filed a declaratory judgment action against members of the Arizona
Corporation Commission (the "ACC"), the ACC, ACSI, Brooks Fiber Properties Inc.
("Brooks") and GST in the United States District Court in Arizona. GST
understands that one or more substantially similar lawsuits have been filed
against other CLECs, including MFS Communications Company, Inc. ("MFS"), Sprint
Corporation ("Sprint"), MCI Communications Corporation ("MCI") and AT&T Corp
("AT&T"). U S WEST alleges that the ACC has entered into an interconnection
order that unlawfully requires U S WEST to resell services below cost, imposes
resale restrictions and denies U S WEST recovery for construction and
implementation costs, unlawfully treats the cost recovery of access revenues for
interim number portability, requires U S WEST to obtain additional rights of way
or build additional facilities solely to provide access to GST, and amounts to a
taking of U S WEST's property without just compensation. U S WEST seeks a
declaratory judgment stating that the ACC has violated the Telecommunications
Act and that the ACC has taken U S WEST's property without providing just
compensation. U S WEST also seeks an injunction prohibiting all defendants,
including GST, from taking any action to enforce any of the order's allegedly
unlawful provisions. GST's time to answer or move against the complaint has been
extended indefinitely by U S WEST, pending a decision with respect to a motion
filed by MFS to dismiss the complaint. Should U S WEST prevail in its suit, it
could have an adverse impact on GST's operations in Arizona.
On or about April 8, 1997, U S WEST filed a state court proceeding
against the ACC, individual members of the ACC, and GST Net (AZ), Inc. ("GST Net
(AZ)") which holds a Certificate of Convenience and Necessity ("CCN") to provide
local exchange service in Arizona. In its complaint appealing the ACC's February
6, 1997 decision and order granting GST Net (AZ) its CCN, U S WEST alleges that
the ACC's action violates certain requirements of the Arizona Constitution
relating to rate of return regulation, carrier of last resort obligations, and
equal protection. The appeal seeks to subject GST Net (AZ) and U S WEST to
identical forms of regulation, treating both carriers as either traditional
monopoly carriers or as co-equal competitive companies. GST Net (AZ) answered U
S WEST's complaint on August 6, 1997, alleging, among other things, that U S
WEST's complaint is preempted by the Telecommunications Act. Should U S WEST
prevail in its appeal, it could have an adverse impact on GST's operations in
Arizona; however, the magnitude thereof is uncertain at this time.
GST USA is not a party to any other material legal proceedings, nor, to
the knowledge of GST USA, are any material legal proceedings threatened against
GST USA. GST USA's subsidiaries are a party to various proceedings before the
public utilities commissions of the states in which they provide or propose to
provide telecommunications services. These proceedings typically relate to
licensure of such subsidiaries or others and to the regulation of the provision
of telecommunications service.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not required.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS .
There is no established public trading market for GST USA's common
equity. All of the issued and outstanding shares of such common equity are owned
by GST.
ITEM 6. SELECTED FINANCIAL DATA.
Not required.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following management's discussion and analysis of financial
condition and results of operations contains forward looking statements that
involve risks and uncertainties. GST USA's actual results could differ
materially from those anticipated in these forward looking statements as a
result of certain factors discussed herein.
OVERVIEW
GST provides a broad range of integrated telecommunications products
and services, primarily to business customers located in the western continental
United States and Hawaii. GST's digital networks currently serve 39 markets in
Arizona, California, Hawaii, Idaho, New Mexico, Texas and Washington. In
addition, GST has networks under construction which, when completed, will serve
three additional markets and expand its regional footprint to Oregon. GST also
constructs, markets and manages longhaul fiber optic facilities, principally in
Arizona, California and Hawaii. GST's longhaul fiber optic facilities currently
extend approximately 600 route miles and an additional 1,100 route miles are
expected to become operational over the next 12 months. GST's full line of
products, which offer a "one-stop" solution to customers' telecommunications
services requirements, include long distance, Internet, data transmission, and
private line services, and local dial tone services, which were recently
introduced.
GST has invested significant capital and effort in developing its
telecommunications business. This capital has been invested in the development
of GST's networks and longhaul fiber optic facilities, for the hiring and
development of an experienced management team, the development and installation
of operating systems, the introduction of services, marketing and sales efforts
and for acquisitions. GST expects to make increasing capital expenditures to
expand its networks and longhaul fiber optic facilities and broaden its service
offerings and may consummate additional acquisitions. Proper management of GST's
growth will require GST to maintain quality control over its services and to
expand GST's internal management, technical and accounting systems, all of which
will require substantial investment.
GST and GST USA are changing their fiscal year to December 31st in
order to align financial reporting with regulatory reporting and to the
reporting of others in GST's industry sector. GST will provide to investors
audited financial information for the three month transition period ending
December 31, 1997 and for the subsequent 12-month periods ending December 31st.
As a result of the limited revenues and significant expenses associated with the
expansion and development of its networks and services, GST's operating results
could vary significantly from period to period.
LOCAL SERVICES. To facilitate its entry into local services, GST has in
service five high capacity digital switches, has installed and is currently
testing seven additional high capacity digital switches and is planning to
deploy an additional two such switches through early 1998. As demand warrants,
GST plans to continue to install switching equipment in its operational
networks, in markets where it is constructing networks and in certain other
cities where GST will rely on the incumbent local exchange carrier ("ILEC")
facilities for transmission. Once a switch is operational, where regulatory
conditions permit, GST intends to offer local dial tone, in addition to enhanced
services such as ISDN, Centrex, voice mail and other custom calling features.
GST expects negative EBITDA from its switched services during the 24 to
36 month period after a switch is deployed. For switches operating in
conjunction with GST's networks, GST expects operating margins to improve as the
network is expanded and larger volumes of traffic are carried on GST's network.
For switches operating in cities where GST will rely on ILEC facilities for
transmission, GST will experience lower or negative operating margins under
current ILEC pricing tariffs. Although under the
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Telecommunications Act, the ILECs will be required to unbundle local tariffs,
permitting GST to purchase only the origination and termination services it
needs, thereby decreasing operating expenses, there can be no assurance that
such unbundling will be effected in a timely manner and result in prices
favorable to GST.
LONG DISTANCE SERVICES. GST offers basic and enhanced long distance
services, such as toll free, calling card, prepaid calling card and
international call back services, targeting primarily business customers
purchasing between $200 and $15,000 of services per month as well as resellers
and other carriers. As part of its strategy, GST has acquired long distance
carriers and intends to continue to pursue acquisitions of long distance
carriers in the future. GST purchases long distance capacity under agreements
with certain major long distance carriers that provide GST capacity at rates
that vary with the monthly traffic generated by GST. GST is obligated to satisfy
certain minimum monthly usage requirements of an aggregate of $1.6 million per
month as of October 1, 1997, increasing to a maximum of $6.1 million per month
over the next three years. If such requirements are not satisfied, GST may be
required to pay an underutilization fee in addition to its monthly bill.
INTERNET SERVICES. GST presently offers Internet-related services in
most of its markets, such as dedicated Internet services, Web site development
and hosting, provides access and upstream transport for local ISPs, EDI and
electronic commerce services and is in the process of developing various
Internet software applications. GST also offers dial-up Internet services to
customers in Portland (Oregon), Vancouver (Washington), the State of Hawaii and
select markets in California and intends to begin offering such services in the
Los Angeles, San Francisco and Houston metropolitan areas in 1998. Management
believes that these services will become an important component of GST's overall
product offerings and intends to continue to expand its Internet access and
service business to other markets.
DATA SERVICES. GST offers national and international frame relay
services on its own frame relay network and through interconnection agreements
with other data service providers. Under these agreements, GST and such data
service providers have agreed to link their data networks and terminate one
another's traffic. GST has deployed Cascade Communications frame relay switches
in 21 markets in the western United States. Such switches can provide both frame
relay and Internet services.
GST is leveraging its infrastructure and network experience to offer
data networking services such as asynchronous transfer mode ("ATM"), high speed
LAN connectivity, video conferencing, multimedia networking, frame relay and
high capacity access to the Internet. GST has one ATM switch commercially
operational in each of Los Angeles and Ontario, California.
NETWORK OPERATIONS. The development, construction and expansion of
GST's networks requires significant capital, a large portion of which is
invested before any revenue is generated. GST has experienced, and expects to
continue to experience, increasing negative EBITDA and losses while it expands
its network operations and builds its customer base. None of GST's existing
networks is generating EBITDA. Based on its experience to date and that of its
competitors, GST estimates that a new network will generate EBITDA within 30 to
36 months after commencement of commercial operations. Construction periods and
operating results will vary from network to network. There can be no assurance
that GST will be able to establish a sufficient revenue-generating customer base
or achieve EBITDA in any particular market or on a consolidated basis.
Management estimates that the total costs associated with the purchase
and installation of fiber optic cable and high-speed electronic transmission
equipment, including capitalized engineering costs, will range from $10.0
million to $25.0 million per network, depending upon the size of the market
served and the scope and complexity of the network. Actual costs may vary
significantly from this range. The amounts and timing of these expenditures are
subject to a variety of factors that may vary significantly by the geographic
and demographic characteristics of each market. In addition to capital
expenditure
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requirements, upon commencement of the construction phase of a network, GST
begins to incur direct operating costs for such items as salaries and rent. As
network construction progresses, GST incurs rights-of-way costs and increased
sales and marketing expenses. Certain direct preoperating costs for new networks
are capitalized until the network becomes operational and are thereafter
expensed as incurred.
The initial development of a network may take as long as six months,
depending upon the size and complexity of the network and a variety of factors,
including the time required to obtain rights-of-way and other governmental
approvals, such as franchise agreements. Once actual construction commences, it
may take from two to six months to complete the initial backbone segment of a
network. The time required during the construction phase is significantly
influenced by the number of route miles involved, the mix of aerial versus
underground fiber deployment, possible delays in receiving fiber optic cable,
electronic equipment and required permits and other factors.
MANUFACTURING. In September 1993, GST purchased a 52% interest in NACT,
which produces advanced telecommunications switching platforms with integrated
applications software and network telemanagement capabilities. During the
thirteen moths ended September 30, 1994 ("Fiscal 1994"), GST acquired in a
series of transactions an additional 28% interest in NACT. The aggregate
consideration paid for GST's 80% interest in NACT was $5.8 million, consisting
of $3.2 million in cash and 451,536 Common Shares of GST, without par value
("Common Shares"). On January 5, 1995, GST purchased the remaining 20% interest
in NACT for consideration consisting of $.9 million in cash and notes payable
and 504,747 Common Shares (valued at $2.2 million). In the third quarter of the
fiscal year ended September 30, 1996 ("Fiscal 1996"), NACT introduced the STX,
the first of a new generation of switches. In a public offering (the "NACT
Offering"), GST USA and NACT sold one million and two million shares,
respectively, of NACT's common stock, resulting in net proceeds to GST USA and
NACT of $9.0 million and $18.1 million, respectively. As a result of the NACT
Offering, GST USA's interest in NACT has been reduced to approximately 63%. On
December 31, 1997, GST and GST USA executed an agreement with World Access, Inc.
("World Access") to sell its remaining interest in NACT for approximately $89.4
million, consisting of cash and common stock of World Access.
GST USA. The majority of GST's business is performed through GST USA
and its subsidiaries, however a portion of the long distance business of GST is
performed through direct wholly owned subsidiaries of GST that were not wholly
owned by GST USA as of the periods presented below.
RESULTS OF OPERATIONS
FISCAL 1997 COMPARED TO FISCAL 1996
REVENUES. Total revenue for the fiscal year ended September 30, 1997
("Fiscal 1997") increased $28.8 million, or 76.4%, to $66.5 million from $37.7
million for Fiscal 1996. Telecommunications services revenue for Fiscal 1997
increased $16.4 million, or 58.3%, to $44.6 million from $28.2 million for
Fiscal 1996. The increase in telecommunications services revenue primarily from
increased CLEC service revenue generated by GST USA's networks. To a lesser
extent, the increase in telecommunications services revenue resulted from
increased Internet, shared tenant and data services. Product revenue for Fiscal
1997 increased $12.4 million, or 129.6%, to $22.0 million from $9.6 million for
Fiscal 1996. The increase in product revenue resulted from the introduction in
April 1996 of NACT's STX switch and subsequent increased unit sales.
OPERATING EXPENSES. Total operating expenses for Fiscal 1997 increased
$60.5 million, or 78.0%, to $138.1 million from $77.6 million for Fiscal 1996.
Network expenses, which include direct local and long distance circuit costs,
increased $18.8 million, or 75.3%, to $43.7 million for Fiscal 1997 compared to
$25.0 million for Fiscal 1996. Facilities administration and maintenance
expenses (consisting primarily of costs related to personnel providing
maintenance, monitoring and technical assistance for GST USA's
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networks) for Fiscal 1997 increased $1.2 million, or 11.4%, to $11.5 million, or
25.8% of telecommunications services revenue, compared to $10.3 million, or
36.7% of telecommunications services revenue, for Fiscal 1996. These expenses
increased primarily as a result of the continuing rollout of the local service
at GST USA's network locations.
Cost of product revenue, which are costs associated with product
revenue of NACT, increased $3.1 million, or 79.7%, to $7.1 million for Fiscal
1997 from $4.0 million for Fiscal 1996. Cost of product revenue was 32.5% of
product revenue for Fiscal 1997 compared to 41.5% for Fiscal 1996. The decrease
in cost of product revenue as a percentage of product revenue resulted from
economies of scale related to increased unit sales of NACT's STX switch.
Research and development costs for Fiscal 1997 increased $1.0 million, or 69.3%,
to $2.3 million from $1.3 million for Fiscal 1996. The increase was due to the
addition of NACT personnel to enhance the current switch product line and to
facilitate the development of new switching products and applications.
Selling, general and administrative expenses for Fiscal 1997 increased
$26.5 million, or 90.6%, to $55.8 million from $29.3 million for Fiscal 1996.
The increase is due to the expansion of GST USA's CLEC and enhanced services
operations and the hiring of a significant number of marketing, management
information and sales personnel to implement GST USA's integrated services
strategy. Selling, general and administrative expenses were 83.8% of total
revenue for Fiscal 1997 compared to 77.6% of total revenue for Fiscal 1996.
Depreciation and amortization for Fiscal 1997 increased $9.9 million,
or 128.1%, to $17.6 million from $7.7 million for Fiscal 1996. The increase was
attributable to newly-constructed networks becoming operational. GST USA expects
that depreciation will continue to increase as it expands its networks and long
haul fiber optic facilities and installs additional switches. Depreciation and
amortization was 26.5% of total revenue for Fiscal 1997 compared to 20.5% for
Fiscal 1996.
OTHER EXPENSES/INCOME. For Fiscal 1997, net other expenses increased
$6.3 million, or 41.5%, to $21.6 million, or 32.5% of total revenue, from $15.3
million, or 40.5% of total revenue, for Fiscal 1996. Fiscal 1997 net other
expenses included a $7.4 million gain recognized on the sale of one million of
GST USA's shares of NACT in February 1997. If the gain had been excluded, other
expenses for Fiscal 1997 would have increased $13.8 million over Fiscal 1996.
Such increase primarily resulted from increased interest expense due to the
issuance of the 1995 Notes in December 1995 and the issuance of the Secured
Notes in May 1997. GST USA expects that interest expense will increase due to
the issuance and sale of the Secured Notes. To a lesser extent, other expenses
increased due to income tax expense attributable to income of NACT, which as of
March 1, 1997 is no longer consolidated for tax purposes.
FISCAL 1996 COMPARED TO FISCAL 1995
REVENUES. Total revenues for Fiscal 1996 increased $19.0 million, or
101.9%, to $37.7 million from $18.7 million for the fiscal year ended September
30, 1995 ("Fiscal 1995"). Telecommunications services revenues for Fiscal 1996
increased $17.0 million, or 153.2%, to $28.1 million from $11.1 million for
Fiscal 1995. The increase in telecommunications services revenues resulted from
the continuing growth of long distance (including revenues associated with
Fiscal 1995 and 1996 acquisitions), local, Internet and data services.
Acquisitions (primarily the acquisition of International Telemanagement Group,
Inc. ("ITG") but also the acquisitions of businesses of Reservations, Inc.
d/b/a/ Hawaii On Line ("Hawaii On Line") and Texas-Ohio Communications, Inc. and
affiliated companies (collectively, "Texas-Ohio")) accounted for $11.5 million
of the increase in such revenues. Telecommunications products revenues for
Fiscal 1996 increased $2.0 million, or 26.6%, over Fiscal 1995. The increase in
telecommunications products revenues resulted from the introduction by NACT of
the STX product line in the third quarter of Fiscal 1996.
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OPERATING EXPENSES. Total operating expenses for Fiscal 1996 increased
$48.6 million, or 168.1%, to $77.6 million from $28.9 million for Fiscal 1995.
Network expenses, which include direct local and long distance circuit costs,
increased $14.9 million to $25.0 million from $10.1 million for Fiscal 1995, due
to an expanded customer base and increased usage. As a percentage of
telecommunications services revenues, network expenses decreased from 90.9% for
Fiscal 1995 to 88.7% for Fiscal 1996. Facilities administration and maintenance
expenses for Fiscal 1996 increased $8.2 million to $10.3 million from $2.1
million for Fiscal 1995. As a percentage of telecommunications services
revenues, facilities administration and maintenance expenses increased from
18.9% for Fiscal 1995 to 36.7% for Fiscal 1996. The increase related to
additional personnel and facility costs required by continuing network
expansion, a substantial portion of which are incurred before the realization of
revenues.
Cost of product revenues at NACT for Fiscal 1996 increased $.9 million
to $4.0 million from $3.1 million for Fiscal 1995. As a percentage of
telecommunications products revenues for Fiscal 1996, cost of product revenues
increased nominally as compared to Fiscal 1995 due to initial lower margins
resulting from the discontinuance of NACT's former switch product line as it
began to offer the new STX to existing customers. Research and development costs
increased nominally for Fiscal 1996 relative to Fiscal 1995 as GST USA moved to
more rapidly develop an improved billing system product and to maintain ongoing
research and development of GST USA's existing hardware and software product
lines.
Selling, general and administrative expenses increased $19.3 million,
or 192.4%, to $29.3 million from $10.0 million for Fiscal 1995. The increase was
due to the expansion of GST USA's CLEC and enhanced services operations, and to
a lesser extent, the acquisitions during Fiscal 1996 of Tri-Star Residential
Communications Corp. ("Tri-Star") and the businesses of Hawaii On Line and
Texas-Ohio. The implementation of GST USA's integrated services strategy has
resulted in additional marketing, management information and sales staff.
Depreciation and amortization for Fiscal 1996 increased $5.4 million to
$7.7 million from $2.4 million for Fiscal 1995 due to increased depreciation
resulting from newly constructed networks becoming operational. To a lesser
extent, the increase in depreciation and amortization was also due to increased
amortization of intangible assets resulting from acquisitions.
OTHER EXPENSES/INCOME. Net other expenses (income) for Fiscal 1996
increased $16.1 million to $15.3 million from $(.8) million for Fiscal 1995. The
increase was principally the result of additional interest expense associated
with the 1995 Notes, offset by interest income resulting from the investment of
the proceeds of the sale of the 1995 Notes.
LIQUIDITY AND CAPITAL RESOURCES
GST USA has incurred significant operating and net losses as a result
of the development and operation of its networks. GST USA expects that such
losses will continue to increase as GST USA emphasizes the development,
construction and expansion of its networks and builds its customer base. Cash
provided by operations will not be sufficient to fund the expansion of its
networks, longhaul fiber optic facilities and services.
At September 30, 1997, GST USA had cash, cash equivalents, and
investments, including restricted cash and investments, of approximately $229.7
million, compared to $62.6 million at September 30, 1996. GST USA's net cash
used in operating and investing activities was $311.8 million, $137.4 million
and $40.3 million for Fiscal 1997, Fiscal 1996 and Fiscal 1995, respectively.
Net cash provided by financing activities from borrowings and contributions from
GST to fund capital expenditures, acquisitions and operating losses was $325.0
million, $174.9 million and $42.9 million for Fiscal 1997, Fiscal 1996 and
Fiscal 1995, respectively.
-8-
<PAGE>
Capital expenditures for Fiscal 1997, Fiscal 1996 and Fiscal 1995 were
$224.1 million, $96.8 million and $33.9 million, respectively. GST USA estimates
capital expenditures of approximately $286 million from October 1, 1997 to
December 31, 1998. The majority of these expenditures is expected to be made for
the construction of network and longhaul fiber optic facilities and the purchase
of switches and related equipment to facilitate the offering of GST USA's
services. Continued significant capital expenditures are expected to be made
thereafter. In addition, GST USA expects to continue to incur operating losses
while it expands its business and builds its customer base. Actual capital
expenditures and operating losses will depend on numerous factors, including the
extent of future expansion, acquisition opportunities and other factors beyond
GST USA's control, including economic conditions, competition, regulatory
developments and the availability of capital.
In addition to GST USA's capital expenditures in Fiscal 1996, GST USA
acquired the business of Texas-Ohio for a purchase price of $.6 million and the
assumption of certain liabilities. All other acquisitions consummated by GST USA
in Fiscal 1996 (Hawaii On Line and Tri-Star) were in consideration of Common
Shares. In the first quarter of Fiscal 1997, GST USA acquired the remaining 50%
interest in Phoenix Fiber Acess, Inc. ("Phoenix Fiber") owned by ICG Telecom
Group, Inc. ("ICG") in consideration of (i) the repayment to ICG at closing of
approximately $2.1 million of intercompany indebtedness and the repayment, under
certain circumstances, of up to an additional $2.0 million of such intercompany
indebtedness and (ii) the indemnification of ICG in respect of all indebtedness
of Phoenix Fiber to GST USA and third parties, other than certain liabilities of
Phoenix Fiber that were assumed by ICG. Prior to the acquisition of the
remaining 50% interest, GST USA had contributed an aggregate of $5.0 million to
Phoenix Fiber.
In September 1996, GST Switchco, Inc. ("GST Switchco") a wholly owned
subsidiary of GST USA entered into a Loan and Security Agreement (the "Siemens
Loan Agreement") with Siemens Stromberg-Carlson ("Siemens"), which provides for
loans by Siemens of up to an aggregate of $226.0 million to finance the purchase
of Siemens equipment and certain equipment from other suppliers. At September
30, 1997, $116.0 million of such facility was available to GST Switchco (of
which $5.8 million had been provided). GST Switchco may seek to increase the
amount of such facility up to $226.0 million on an as needed basis, subject to
the negotiation and execution of mutually satisfactory documentation. In
December 1996, GST Equipco, Inc. ("GST Equipco") a wholly owned subsidiary of
GST USA entered into an equipment loan and security agreement (the "NTFC Loan
Agreement") with NTFC Capital Corporation ("NTFC"), which provides for $50.0
million of equipment financing to finance the purchase of equipment and products
from Northern Telecom Inc. ("Nortel") (of which $44.6 million had been provided
as of September 30, 1997).
In March 1997, NACT completed the NACT Offering of its common stock
pursuant to which GST USA and NACT sold one million and two million shares,
respectively, of NACT's common stock, resulting in net proceeds to GST USA and
NACT of approximately $9.0 million and $18.1 million, respectively.
In May 1997, GST Funding completed the Secured Notes Offering of $265.0
million principal amount of Secured Notes. Of the $255.8 million of net proceeds
from the issuance of the Secured Notes, as of September 30, 1997 approximately
$93.8 million had been used to purchase securities pledged to fund the first six
interest payments on the Secured Notes and approximately $91.3 million had been
used to purchase equipment, including approximately $41.5 million that had been
used to refinance indebtedness of GST USA incurred to purchase equipment. The
indentures relating to the 1995 Notes and the Secured Notes include restrictive
covenants which, among other items, limit or restrict additional indebtedness
incurred by GST USA and GST, investment in certain subsidiaries, the sale of
assets and the payment of dividends.
In November 1997 GST completed a stock and debt offering (the "1997
Offering") which yielded net proceeds of approximately $211.2 million. The net
proceeds of the 1997 Offering will be used by GST
-9-
<PAGE>
to fund the expansion of its infrastructure, the expansion of its products and
service offerings and for working capital and general corporate purposes.
As of September 30, 1997, GST USA had approximately $608.2 million of
indebtedness outstanding. In addition, as of September 30, 1997, GST USA had
$25.0 million of availability under the Tomen Facility, $110.2 million of
availability under the Siemens Loan Agreement and $5.4 million of availability
under the NTFC Loan Agreement. Although GST USA's liquidity was substantially
improved as a result of the proceeds received from the sale of the 1995 Notes
and the Secured Notes and from the 1997 Offering, GST USA will have significant
debt service obligations. GST USA will be required to make principal and
interest payments of approximately $56.6 million (of which $35.1 million will be
made from funds securing the Secured Notes), $63.7 million (of which $35.1
million will be made from funds securing the Secured Notes), $66.4 million (of
which $17.6 million will be made from funds securing the Secured Notes), $109.2
million and $107.1 million in 1998, 1999, 2000, 2001 and 2002, respectively.
However, GST USA will need to refinance a substantial amount of such
indebtedness. In addition, GST USA anticipates that cash flow from operations
will be insufficient to repay the 1995 Notes and the Secured Notes in full and
that such notes will need to be refinanced. The ability of GST USA to effect
such refinancings will be dependent upon the future performance of GST USA,
which will be subject to prevailing economic conditions and to financial,
business and other factors, including factors beyond the control of GST USA.
There can be no assurance that GST USA will be able to improve its earnings
before fixed charges or that GST USA will be able to meet its debt service
obligations.
At September 30, 1997, GST USA had cash, cash equivalents, and
investments, including restricted cash and investments, of approximately $229.7
million. GST and GST USA believe that the net proceeds of the 1997 Offering,
together with cash on hand (including the remaining proceeds from the Secured
Notes Offering available to purchase equipment), and borrowings expected to be
available under the Tomen Facility and the equipment financing agreements with
Siemens and NTFC will provide sufficient funds for GST and GST USA to expand its
business as presently planned and to fund its operating expenses through March
2000. Thereafter, GST and GST USA expect to require additional financing. In the
event that GST and GST USA's plans or assumptions change or prove to be
inaccurate, or its cash resources, together with borrowings under the current
financing arrangements prove to be insufficient to fund GST and GST USA's growth
and operations, or if GST or GST USA consummates additional acquisitions, they
may be required to seek additional sources of capital (or seek additional
capital sooner than currently anticipated). GST and GST USA may also seek to
raise additional capital to take advantage of favorable conditions in the
capital markets. There can be no assurance that additional financing will be
available to GST and GST USA or, if available, that it can be concluded on terms
acceptable to GST and GST USA or within the limitations contained within GST and
GST USA's financing arrangements. Failure to obtain such financing could result
in the delay or abandonment of some or all of GST and GST USA's development or
expansion plans and could have material adverse effect on GST and GST USA's
business. Such failure could also limit the ability of GST and GST USA to make
principal and interest payments on its outstanding indebtedness. GST and GST USA
have no material working capital or other credit facility under which they may
borrow for working capital and other general corporate purposes. There can be no
assurance that such a facility will be available to such companies in the future
or that if such a facility were available, that it would be available on terms
and conditions acceptable to GST and/or GST USA.
INCOME TAXES AND ADOPTION OF NEW ACCOUNTING STANDARDS
At September 30, 1997, GST USA had a U.S. net operating loss
carryforward of approximately $110.1. While such loss carryforwards are
available to offset future taxable income of GST USA, GST USA does not expect to
generate sufficient taxable income so as to utilize all or a substantial portion
of such loss carryforwards prior to their expiration. Further, the utilization
of net operating loss carryforwards against future taxable income is subject to
limitation if GST USA experiences an "ownership change" as defined in Section
382 of the Internal Revenue Code of 1986, as amended (the "Code").
-10-
<PAGE>
In June 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 131, "Disclosure about Segments of an Enterprise and Related
Information" ("SFAS No. 131"), which changes the way public companies report
information about operating segments. SFAS No. 131, which is based on the
management approach to segment reporting, establishes requirements to report
selected segment information quarterly and to report entity-wide disclosures
about products and services, major customers, and the material countries in
which the entity holds assets and reports revenue. Management has not yet
evaluated the effects of this change on its reporting of segment information.
GST USA will adopt SFAS No. 131 in the fiscal year ending December 31, 1998.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not applicable.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Not required.
ITEM 11. EXECUTIVE COMPENSATION.
Not required.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Not required.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Not required.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K.
(a)(1) Financial Statements: see the Index to Financial Statements.
(2) Financial Statement Schedules: see the Index to Financial Statements.
(3) Exhibits:
*3(a) Certificate of Incorporation of GST USA, as amended.
*3(b) By-Laws of GST USA.
**4(a) Indenture dated as of May 13, 1997, by and among GST Funding, GST, GST
USA and United States Trust Company of New York.
***4(b) Senior Notes Indenture dated as of December 19, 1995, by and among GST,
GST USA and United States Trust Company of New York.
***4(c) Convertible Notes Indenture dated as of December 19, 1995, by and among
GST, GST USA and United States Trust Company of New York.
****27 Financial Data Schedule.
- -------------------------
* Incorporated by reference to GST USA's Registration Statement on Form
S-4 (No. 333-33601-02).
** Incorporated by reference to GST's Quarterly Report on Form 10-Q for
the period ended June 30, 1997.
-11-
<PAGE>
*** Incorporated by reference to GST's Annual Report on Form 20-F for the
fiscal year ended September 30, 1995.
**** Filed herewith.
(b) Reports on Form 8-K: None.
-12-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of Vancouver, State of Washington, on the 7th day of January, 1998.
GST USA, INC.
By: /S/ JOHN WARTA
--------------------------
John Warta,
Chairman of the Board
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints John Warta, Stephen Irwin, Daniel
Trampush and Clifford V. Sander his true and lawful attorney-in-fact, each
acting alone, with full power of substitution and resubstitution for him and in
his name, place and stead, in any and all capacities to sign any and all
amendments to this report, and to file the same, with all exhibits thereto, and
other documents in connection therewith, with the Securities and Exchange
Commission, hereby ratifying and confirming all that said attorneys-in-fact or
their substitutes, each acting alone, may lawfully do or cause to be done by
virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been duly signed by the following persons in the
capacities on January 7, 1998.
SIGNATURE TITLE
--------- -----
/S/ JOHN WARTA
- --------------------------- Chairman of the Board, Chief Executive Officer
(John Warta) (Principal Executive Officer) and Director
/S/ DANIEL L. TRAMPUSH Senior Vice President and Chief Financial
- --------------------------- Officer (Principal Financial Officer)
(Daniel L. Trampush)
/S/ CLIFFORD V. SANDER Senior Vice President, Treasurer and Assistant
- -------------------------- Secretary (Principal Accounting Officer)
(Clifford V. Sander) and Director
/S/ STEPHEN IRWIN Senior Vice President, Secretary and Director
- --------------------------
(Stephen Irwin)
<PAGE>
INDEX TO FINANCIAL STATEMENTS
GST USA, Inc.
Independent Auditors' Report of KPMG Peat Marwick LLP.....................F-2
Consolidated Balance Sheets at September 30, 1996 and 1997................F-3
Consolidated Statements of Operations for the years
ended September 30, 1995, 1996 and 1997..................................F-4
Consolidated Statements of Shareholders' Equity for
the years ended September 30, 1995, 1996 and 1997........................F-5
Consolidated Statements of Cash Flows for the years
ended September 30, 1995, 1996 and 1997..................................F-6
Notes to Consolidated Financial Statements................................F-7
F - 1
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Consolidated Financial Statements
September 30, 1997 and 1996
(With Independent Auditors' Report Thereon)
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
GST USA, Inc.:
We have audited the accompanying consolidated balance sheets of GST USA, Inc.
and subsidiaries as of September 30, 1997 and 1996, and the related consolidated
statements of operations, shareholder=s (deficit) equity, and cash flows for
each of the years in the three-year period ended September 30, 1997. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of GST USA, Inc. and
subsidiaries as of September 30, 1997 and 1996, and the results of its
operations and cash flows for each of the years in the three-year period ended
September 30, 1997, in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
-------------------------
KPMG Peat Marwick LLP
Portland, Oregon
November 26, 1997
F - 2
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share amounts)
<TABLE>
<CAPTION>
SEPTEMBER 30,
-----------------------
ASSETS 1997 1996
------ ---- ----
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 54,657 $ 41,420
Restricted cash and investments 50,039 16,000
Accounts receivable, net 16,232 7,186
Receivable from parent 964 988
Investments 3,247 5,177
Inventory, net 2,790 2,406
Other current assets 10,100 4,329
---------- ----------
138,029 77,506
Restricted investments 121,711 -
Property and equipment, net 359,976 124,545
Goodwill, net 19,846 21,394
Other assets, net 42,098 22,943
---------- ----------
Total assets $ 681,660 $ 246,388
========== ==========
LIABILITIES AND SHAREHOLDER'S (DEFICIT) EQUITY
----------------------------------------------
Current liabilities:
Accounts payable $ 16,369 $ 8,635
Accrued expenses 40,528 21,588
Payable to parent 85,775 -
Current portion of capital lease obligations 5,892 286
Current portion of long-term debt 2,521 3,091
Other current liabilities 607 686
---------- ----------
151,692 34,286
---------- ----------
Other liabilities 1,088 158
Capital lease obligations, less current portion 14,343 541
Long-term debt, less current portion 585,405 209,544
Minority interest 12,208 182
Commitments and contingencies
Shareholder=s (deficit) equity:
Common stock: 200 shares authorized, 10 shares
issued and outstanding, no par value 78,373 69,957
Accumulated deficit (161,449) (68,280)
------- ----------
(83,076) 1,677
---------- ----------
Total liabilities and shareholder's (deficit) equity $ 681,660 $ 246,388
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
F - 3
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Consolidated Statements of Operations
(In thousands)
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
--------------------------------------
1997 1996 1995
Revenue:
<S> <C> <C> <C>
Telecommunications services $ 44,566 $ 28,148 $ 11,118
Product 21,982 9,573 7,563
---------- --------- ------------
Total revenue 66,548 37,721 18,681
---------- --------- ------------
Operating costs and expenses:
Network expenses 43,746 24,955 10,103
Facilities administration and maintenance 11,495 10,317 2,096
Cost of product revenues 7,141 3,974 3,096
Selling, general and administrative 55,773 29,259 10,008
Research and development 2,289 1,352 1,270
Depreciation and amortization 17,639 7,733 2,369
---------- --------- ---------
Total operating costs and expenses 138,083 77,590 28,942
---------- --------- ---------
Loss from operations (71,535) (39,869) (10,261)
---------- --------- ---------
Other expenses (income):
Interest income (6,315) (4,927) (241)
Interest expense, net of amounts capitalized 33,849 18,263 805
Loss from joint venture - 1,495 661
Other, net (7,415) 794 159
---------- --------- ----------
20,119 15,625 1,384
---------- --------- ---------
Loss before minority interest in (income)
loss of subsidiary and income tax (91,654) (55,494) (11,645)
---------- --------- ---------
Income tax expense:
Current 1,802 72 70
Deferred (899) - 96
---------- --------- ---------
903 72 166
---------- --------- ---------
Loss before minority interest in (income)
loss of subsidiary (92,557) (55,566) (11,811)
Minority interest in (income) loss of subsidiary (612) 411 2,364
---------- --------- ---------
Net loss $ (93,169) $ (55,155) $ (9,447)
========== ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
F - 4
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Consolidated Statements of Shareholder's (Deficit) Equity
(In thousands, except share amounts)
<TABLE>
<CAPTION>
Total
Common Shares shareholder's
--------------------- Accumulated (deficit)
Shares Amount deficit equity
------ ------ ------- ------
<S> <C> <C> <C> <C> <C> <C>
Balance, September 30, 1994 10 $16,340 $ (3,678) $ 12,662
Cash contributions from parent - 24,675 - 24,675
Non-cash contributions from parent - 6,894 - 6,894
Net loss - - (9,447) (9,447)
--- -------- ---------- ---------
Balance, September 30, 1995 10 47,909 (13,125) 34,784
Cash contributions from parent - 9,009 - 9,009
Non-cash contributions from parent - 13,039 - 13,039
Net loss - - (55,155) (55,155)
--- -------- ---------- ----------
Balance, September 30, 1996 10 69,957 (68,280) 1,677
Capital transaction, sale of subsidiary
shares - 8,416 - 8,416
Net loss - - (93,169) (93,169)
--- --------- ---------- ----------
Balance, September 30, 1997 10 $78,373 $(161,449) $ (83,076)
=== ========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
F - 5
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
<TABLE>
<CAPTION>
Years Ended September 30,
-----------------------------------------
1997 1996 1995
---- ---- ----
Operations:
<S> <C> <C> <C>
Net loss $ (93,169) $ (55,155) $ (9,447)
Items not involving cash:
Minority interest in income (loss) of subsidiary 612 (411) (2,364)
Depreciation and amortization 19,469 8,821 2,819
Deferred income taxes (899) - 96
Deferred compensation - 7 151
Accretion of interest 17,099 17,758 -
Stock compensation and other expense 2,521 574 -
Loss on disposal of assets 679 1,012 122
Loss on investments and joint venture - 1,495 766
Gain on sale of subsidiary shares (7,376) - -
Changes in non-cash operating working capital:
Accounts receivable, net (9,696) (2,274) (1,522)
Inventory (382) (2,019) (13)
Other current and other assets, net (5,718) (4,162) (1,848)
Accounts payable and accrued liabilities 24,667 1,909 (298)
Other current liabilities 130 146 262
---------- ---------- --------
Cash used in operations (52,063) (32,299) (11,276)
---------- ---------- ------
Investing:
Acquisition of subsidiaries, net of cash acquired (673) (1,466) 207
Purchase of investments (3,247) (9,799) (28)
Proceeds from sales of investments 5,177 5,493 -
Purchase of fixed assets (221,540) (75,698) (27,713)
Proceeds from sale of fixed assets 5,774 8 -
Purchase of other assets (10,359) (7,628) (2,150)
Change in cash and investments restricted for the purchase
of property and equipment (61,960) (16,000) -
Proceeds from sale of subsidiary shares, net 27,105 - 615
---------- ---------- --------
Cash used in investing activities (259,723) (105,090) (29,069)
------- ------- ------
Financing:
Proceeds from long-term debt 352,850 175,897 19,923
Proceeds of debt payable to parent 82,879 - -
Principal payments on long-term debt and capital leases (4,912) (1,511) (816)
Contributions from parent - 9,009 24,675
Deferred debt financing costs (12,004) (8,480) (853)
Purchase of restricted securities to finance interest payments (93,790) - -
---------- ---------- -------
Cash provided by financing activities 325,023 174,915 42,929
---------- ---------- --------
Increase in cash and cash equivalents 13,237 37,526 2,584
Cash and cash equivalents, beginning of year 41,420 3,894 1,310
---------- ---------- --------
Cash and cash equivalents, end of year $ 54,657 $ 41,420 $ 3,894
========== ========== ========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 4,564 $ 1,813 $ 364
Cash paid for income taxes 638 - 264
Supplemental schedule of non-cash investing and financing activities:
Recorded in business combinations:
Assets acquired $ 1,052 $ 12,817 $ 17,081
Liabilities assumed 379 3,037 7,706
Minority interest - (2,686) 1,797
Common shares of parent - 12,465 7,241
Amounts in accounts payable and accrued liabilities for the
purchase of fixed assets at year-end 19,718 18,291 4,363
Assets acquired through capital leases 21,241 - 128
</TABLE>
See accompanying notes to consolidated financial statements.
F - 6
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
September 30, 1997 and 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) DESCRIPTION OF THE COMPANY
GST USA, Inc. (the Company) is a wholly-owned subsidiary of GST
Telecommunications, Inc. (GST), a Canadian company, and is engaged in the
business of providing competitive local exchange services primarily in
the western United States. In addition, the Company provides a range of
telecommunications services which include long distance, Internet access
and data services. The Company also manufactures telecommunications
switching equipment. The Company was formed in August of 1994, and GST
transferred all of its operating subsidiaries and equity investments to
the Company.
(b) BASIS OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts
of the Company and its greater than 50% owned subsidiaries. The Company=s
investments in unconsolidated companies owned 20% or more are accounted
for using the equity method.
(c) CASH AND CASH EQUIVALENTS
Cash equivalents consist of short-term, highly liquid investments with
original maturities of ninety days or less.
(d) ACCOUNTS AND NOTES RECEIVABLE
The Company maintains a security interest in the telecommunications
systems it sells until the Company is paid in full. Management provides
an allowance for doubtful accounts and notes based on current customer
information and historical statistics. The allowance for doubtful
accounts was $3,451 and $1,183 at September 30, 1997 and 1996,
respectively.
(Continued)
F - 7
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
(e) RESTRICTED CASH AND INVESTMENTS
The Company adopted the provisions of Statement of Financial Accounting
Standards (SFAS) No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND
EQUITY SECURITIES. Accordingly, the Company classifies its investments,
consisting of $170,675 in U.S. Treasury securities and $1,075 in
certificates of deposit, as available-for-sale and held-to-maturity.
Held-to-maturity investments, recorded at amortized cost, totaling
$97,049 and maturing between one and three years, are restricted for
interest payments. Available-for-sale investments, totaling $74,701 and
maturing between one month and two years, are restricted for equipment
purchases. Available-for-sale securities are recorded at amortized cost
which approximates the market value of such securities at September 30,
1997.
(f) INVENTORY, NET
Inventory is stated at the lower of cost (first-in, first-out) or market
(net realizable value) and consists of the following at September 30:
1997 1996
---- ----
Raw materials $ 1,065 $ 378
Work in process 499 346
Finished and refurbished goods 1,226 1,682
-------- -------
Inventory, net $ 2,790 $ 2,406
======== =======
(g) PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost and is depreciated on the
straight-line basis over their estimated useful lives, which are as
follows:
Telecommunications networks 20 years
Electronic and related equipment 10 years
Leasehold improvements 10 years
Furniture, office equipment and other 3 - 7 years
Building 40 years
Construction, engineering and overhead costs directly related to the
development of the Company's networks are capitalized. The Company begins
depreciating these costs when the networks become commercially
operational.
(Continued)
F - 8
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
(h) GOODWILL
Goodwill is amortized, using the straight-line method, over periods
ranging from five to twenty years. The Company assesses the carrying
amount of goodwill for impairment whenever events or changes in
circumstances indicate that the carrying amount may not be recoverable.
Measurement of any impairment includes a comparison of estimated future
operating cash flows anticipated to be generated during the remaining
life of the goodwill to the net carrying value. Amortization charged to
operations was $2,385, $1,528 and $389 for the years ended September 30,
1997, 1996 and 1995, respectively.
(i) REVENUE RECOGNITION
Telecommunication services revenue is recorded upon placing of calls or
rendering of other related services. Product revenue is recorded upon
shipment of product and is presented in the accompanying consolidated
statements of operations net of product returns.
Deferred revenue consists of monthly service contract payments received
in advance, warranty payments received in advance and research and
development advances, and is included in other current liabilities in the
accompanying consolidated balance sheets. Advance warranty payments are
amortized over the length of warranty on the system sold, which is
typically one year.
(j) LOSS PER SHARE
The Company does not have any equity instruments which are considered
common stock equivalents, and as weighted average common shares total
only 10 for all periods, loss per share information is not meaningful and
is not presented in the accompanying consolidated financial statements.
(k) ISSUANCE OF SUBSIDIARY STOCK
Issuances of subsidiary stock are accounted for as capital transactions
in the accompanying consolidated financial statements.
(Continued)
F - 9
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
(l) MINORITY INTEREST
In the second quarter of 1997, the Company's then wholly-owned
subsidiary, NACT Telecommunications, Inc. (NACT), completed an initial
public offering of its common stock, pursuant to which the Company and
NACT sold one and two million shares, respectively, of NACT's common
stock, resulting in net proceeds of approximately $9,000 and $18,100,
respectively. As a result of the offering, the Company's ownership was
reduced to 63%.
Minority interest represents the non-Company owned shareholder interest
in NACT's equity resulting from the 1997 offering.
(m) CONCENTRATION OF CREDIT RISK
For purposes of segment reporting, the Company is presently operating
100% in the telecommunications industry in the United States and results
of operations are derived from United States operations and
substantially all assets reside in the United States. The Company is
exposed to concentration of credit risk principally from accounts
receivable. The Company=s five largest telecommunications services
customers accounted for approximately 38.5%, 52.9% and 26.8% of the
Company=s consolidated telecommunications services revenue for the years
ended September 30, 1997, 1996 and 1995, respectively.
(n) INCOME TAXES
The Company accounts for income taxes under the asset and liability
method. Under the asset and liability method, deferred income taxes
reflect the future tax consequences of differences between the tax bases
of assets and liabilities and their financial reporting amounts at each
year-end. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in the tax
rates is recognized in income in the period that includes the enactment
date. Valuation allowances are established when necessary to reduce
deferred tax assets to the amounts expected to be realized.
(Continued)
F - 10
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
(o) FINANCIAL INSTRUMENTS
The carrying amounts reported in the balance sheet for cash and cash
equivalents, receivables, short-term investments, short-term borrowings
and accounts payable and accrued liabilities approximate fair values due
to the short maturity of those instruments.
The carrying amount of the Company's long-term debt approximates its fair
value. The fair value of the Company=s long-term debt was determined
based on quoted market prices for similar issues or on current rates
available to the Company for debt of the same remaining maturities and
similar terms.
Fair value estimates are made at a specific point in time, based on
relevant market information about the financial instrument. These
estimates are subjective in nature and involve uncertainties and matters
of significant judgment and therefore cannot be determined with
precision. Changes in assumptions could significantly affect the
estimates.
(p) USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
(q) ADVERTISING COSTS
The Company expenses advertising costs as incurred.
(r) RECLASSIFICATIONS
Certain reclassifications have been made in the accompanying consolidated
financial statements for 1996 and 1995 to conform with the 1997
presentation.
(Continued)
F - 11
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
(2) ACQUISITIONS
The Company has made the acquisitions set forth below, each of which was
accounted for as a purchase. The consolidated financial statements
include the operating results from the effective date of acquisition.
(a) PHOENIX FIBER ACCESS, INC. (PHOENIX FIBER)
In the first quarter of 1997, the Company paid $2,000 in cash to acquire
the remaining 50% of Phoenix Fiber, previously 50% owned by the Company
through a joint venture with ICG Telecom Group, Inc. (ICG). In addition,
the Company assumed the repayment of up to $2,000 of intercompany
indebtedness, under certain circumstances, and indemnified ICG in respect
of all indebtedness of Phoenix Fiber to the Company and third parties,
other than certain liabilities of Phoenix Fiber that were assumed by ICG.
Phoenix Fiber is an Arizona company engaged in providing competitive
local exchange services in the Phoenix metropolitan area.
(b) GST TELECOM, INC. (GST TELECOM)
In a series of transactions between 1994 and 1996, the Company purchased
100% of the outstanding shares of GST Telecom, which develops, constructs
and operates competitive local exchange networks and other communications
systems. Consideration paid for GST Telecom consisted of 2,100,000 common
shares of GST valued at $15,447, which shares were paid to Pacwest, LLC
(Pacwest), an entity controlled by the Chief Executive Officer of the
Company. Goodwill of $15,330 was recorded as a result of this
acquisition.
(c) OTHERS
In May 1996, the Company purchased from Tomen America, Inc. the remaining
10% interest in the GST Pacific Lightwave, Inc., a GST Telecom subsidiary
which operates a fiber optic competitive local exchange network in
southern California. The consideration paid for this acquisition
consisted of $1,250 in cash, which was recorded as goodwill.
During 1996, the Company acquired the assets of Reservations, Inc. dba
Hawaii Online (HOL), the assets of Texas-Ohio Communications, Inc. (TOC),
and 100% of the outstanding capital stock of Tri-Star Residential
Communications, Inc. (Tri-Star). HOL is an Internet service provider; TOC
is a long distance service provider; and Tri-Star provides shared tenant
services consisting of long distance, cable television and security
service to tenants of multi-dwelling apartment units. Consideration paid
for these acquisitions consisted of 175,333 common shares of GST valued
at $1,559, a commitment to issue approximately 66,223 common shares of
GST valued at $907 over the next year and $719 of cash. Goodwill of
$1,103 was recorded as a result of these acquisitions.
(Continued)
F - 12
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
The consolidated results of operations for the fiscal year ended
September 30, 1997 reflect each of the acquisitions discussed above for a
full year. As a result, pro forma information is not presented.
(3) PROPERTY AND EQUIPMENT
<TABLE>
<CAPTION>
September 30, September 30,
1997 1996
---- ----
<S> <C> <C>
Telecommunications networks $ 95,447 $ 25,551
Electronic and related equipment 57,925 29,951
Leasehold improvements 8,439 3,495
Furniture, office equipment and other 11,780 7,465
Building 3,366 2,134
Construction in progress 202,545 62,658
---------- ----------
379,502 131,254
Less accumulated depreciation (19,526) (6,709)
---------- ----------
$ 359,976 $ 124,545
========== ==========
</TABLE>
Property and equipment includes $202,545 and $62,658 of equipment which had
not been placed in service at September 30, 1997 and 1996, respectively,
and accordingly is not being depreciated. During the years ended September
30, 1997 and 1996, $15,170 and $2,316 of interest, respectively, was
capitalized as part of telecommunications networks and networks in
progress.
(4) ACCRUED EXPENSES
<TABLE>
<CAPTION>
September 30, September 30,
1997 1996
---- ----
<S> <C> <C>
Fixed asset purchases $ 11,531 $ 14,153
Carrier costs 2,113 2,659
Accrued interest 17,998 413
Payroll and related liabilities 2,752 1,468
Other 6,134 2,895
---------- ----------
Total $ 40,528 $ 21,588
========= =========
</TABLE>
(Continued)
F - 13
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
(5) LONG-TERM DEBT
<TABLE>
<CAPTION>
September 30, September 30,
1997 1996
---- ----
<S> <C> <C>
Senior secured notes, 13.25%, due May 1,
2007 $ 265,000 $ -
Note payable to Tomen, LIBOR plus 3%
(8.8% at September 30, 1997) 69,137 31,771
Note payable to NTFC, LIBOR plus 3.5%
(9.3% at September 30, 1997) 44,634 -
Note payable to Siemens, LIBOR plus 4.5%
(10.3% at September 30, 1997) 5,846 -
Senior discount notes, 13.875%, due
December 15, 2005 203,280 177,760
Other 29 3,104
---------- ----------
587,926 212,635
Less current portion of long-term debt 2,521 3,091
---------- ----------
$ 585,405 $ 209,544
========== ==========
</TABLE>
The schedule of future principal payments on long-term debt is as follows:
Year ending September 30:
1998 $ 2,521
1999 12,897
2000 18,506
2001 21,943
2002 22,001
Thereafter 510,058
----------
$ 587,926
==========
(Continued)
F - 14
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
(a) SENIOR SECURED NOTES
In the third quarter of 1997, GST Equipment Funding, Inc., a subsidiary of
the Company, completed a private placement under an indenture (the
Indenture) of $265,000 of senior secured notes (the notes). The notes bear
interest at a rate of 13.25% with semiannual interest payments due
beginning November 1, 1997. Approximately $93,790 of the proceeds are
restricted to fund the first six schedules interest payments. The remainder
of the net proceeds are restricted to the purchase and installation of
telecommunications equipment. Pursuant to the Indenture, all purchased
equipment will be sold to the Company for use in its telecommunications
operations. The notes are secured by a first priority security interest in
the equipment and the restricted investment securities held for the payment
of interest. The notes are subject to certain debt covenants.
The Indenture provides that the Company will assume and become a direct
obligor on the notes and GST will guarantee the notes on May 13, 2000, or
earlier if permitted by the terms of their existing debt. Once assumed, the
notes will be secured senior indebtedness of the Company. The note
guarantee will be senior unsecured indebtedness of GST.
The notes are redeemable at the option of the Company, in whole or in part,
at any time, on or after May 1, 2002, initially at 106.625% of their
principal amount, plus accrued and unpaid interest, declining ratably to
100% on or after May 1, 2004. If on May 13, 2000, the Company is prohibited
from assuming all of the notes, the Company will redeem the portion of the
notes that cannot be assumed at 101% of their principal amount plus accrued
interest at the date of redemption.
(b) TOMEN AMERICA, INC. FACILITY
In the first quarter of 1995, the Company entered into a master financing
agreement with Tomen America, Inc. (Tomen). Under the agreement, Tomen will
loan up to $100,000 to subsidiaries of the Company for development and
construction of network projects. As of September 30, 1997, Tomen has
agreed to provide a total of $74,950 in debt financing to the Company=s
subsidiaries for construction and operation of its fiber optic networks in
Southern California, New Mexico, Arizona and Hawaii. The Tomen financing is
secured by the equipment purchased with the proceeds and subject to certain
debt covenants.
(Continued)
F - 15
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
(c) NTFC CAPITAL CORPORATION AGREEMENT
In the first quarter of 1997, the Company entered into a $50,000 loan and
security agreement with NTFC Capital Corporation (NTFC) to finance the
purchase of certain equipment from Northern Telecom, Inc. Amounts borrowed
under the agreement bear interest at LIBOR plus 3.5% and will be repaid in
twenty quarterly installments beginning in January 1999. The loan is
secured by the equipment purchased with the proceeds and subject to certain
debt covenants.
(d) SIEMENS STROMBERG-CARLSON AGREEMENT
In the fourth quarter of 1996, the Company entered into a loan and security
agreement with Siemens Stromberg-Carlson (Siemens). Under the terms of the
agreement, Siemens will loan up to $226,000 to the Company for the purchase
and installation of telecommunications switching and related equipment. At
September 30, 1997, $116,000 was available to the Company. Amounts borrowed
under the agreement initially bear interest at LIBOR plus 4.5% and will be
secured by the equipment. Such interest decreases to LIBOR plus 3.5% at the
time each initial loan is converted to a term loan, which conversion occurs
at the first calendar quarter following the initial loan. The Company is
committed to purchase a minimum of $16,600 in equipment over three years.
Amounts borrowed under the agreement will be repaid in twenty-four
quarterly installments beginning five quarters after the initial loan is
converted to a term loan. The loan is subject to certain debt covenants.
(e) SENIOR DISCOUNT NOTES
In the first quarter of 1996, the Company issued approximately $160,000 in
13.875% Senior Discount Notes (the senior notes) maturing on December 15,
2005. The senior notes were sold at a substantial discount and there will
be no accrual of cash interest prior to December 15, 2000 or payment of
interest until June 15, 2001. The senior notes accrete to a total principal
amount of approximately $312,400 by December 15, 2000. The senior notes
will rank in right of payment with all unsubordinated indebtedness of the
Company and are subject to certain debt covenants. The senior notes are
guaranteed by GST.
(f) GUARANTEE OF PARENT'S DEBT
The Company has guaranteed GST's convertible senior subordinated discount
notes totaling approximately $25,410 at September 30, 1997. Such debt
matures on December 15, 2005 at a fully-accreted value of approximately
$39,100. On or after December 15, 2000, the senior and convertible notes
will be redeemable at the option of the Company and GST.
(Continued)
F - 16
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
(6) SHAREHOLDER'S (DEFICIT) EQUITY
(a) COMMON STOCK
Since inception, GST has owned all of the outstanding shares of the
Company.
(b) NON-CASH CONTRIBUTIONS FROM PARENT
Non-cash contributions from parent consist primarily of GST stock issued
in connection with the Company=s acquisition of certain subsidiaries.
(c) STOCK OPTION PLANS AND STOCK BONUS AGREEMENT
Certain employees of the Company are eligible for stock option awards of
GST common stock under various stock option plans. In addition, certain
members of management are eligible to receive stock awards of GST common
stock upon achievement of certain milestones. Given that senior operating
and executive management are employees of the Company, compensation
expense is recognized in the financial statements of the Company. Stock
compensation totaled $2,521, $574 and $-0- for the years ended September
30, 1997, 1996 and 1995, respectively.
(7) INCOME TAXES
The provision for income taxes differs from the amount computed by
applying the statutory income tax rate to net income before taxes as
follows:
<TABLE>
<CAPTION>
Years Ended September 30,
------------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Computed expected income tax expense
(benefit) at statutory rate (34)% (34)% (34)%
Expected state income tax expense (benefit) (4) (4) (5)
Increase in valuation allowance 36 25 37
Amortization of goodwill 1 1 7
Minority interest - - (9)
Effect of inability to offset losses of
subsidiaries - - 2
Equity method accounting for joint venture - 1 2
Effect of acquisition of new subsidiaries - 5 1
Non-deductible interest 2 2 -
Other - 4 1
---- --- ---
Income tax expense 1 % - % 2 %
== === =
</TABLE>
(Continued)
F - 17
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. The tax
effects of significant items comprising the Company=s deferred tax asset
and liability are as follows:
<TABLE>
<CAPTION>
September 30, September 30,
1997 1996
---- ----
<S> <C> <C>
Deferred tax assets:
Federal and state net operating
loss carryforwards $ 40,106 $ 16,378
Non-deductible interest 13,757 4,608
Other 3,692 2,063
--------- ---------
Total gross deferred tax assets 57,555 23,049
Less valuation allowance (51,501) (18,438)
------ ------
Deferred tax liabilities:
Furniture, fixtures and equipment,
due to differences in depreciation 4,918 2,110
Capitalized software/intangibles 1,479 2,501
--------- ---------
Total gross deferred tax liabilities 6,397 4,611
-------- ---------
Net deferred tax liabilities $ (343) $ -
========= ========
</TABLE>
The valuation allowance for deferred tax assets as of October 1, 1994 was
$713. The net change in total valuation allowance for the years ended
September 30, 1997, 1996 and 1995 was an increase of $33,063, $14,237 and
$3,488, respectively.
(Continued)
F - 18
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
The Company has net operating losses for income tax purposes of
approximately $110,063 available to reduce United States taxable income of
future years, expiring as follows:
2007 $ 405
2008 537
2009 2,800
2010 5,020
2011 36,922
2012 64,379
---------
$ 110,063
=========
Utilization of net operating losses may be subject to limitation in the
event of certain substantial stock ownership changes having occurred
pursuant to IRC Section 382 and referred to hereinafter as an ownership
change. The Company may have incurred an ownership change under IRS
Section 382. This potential ownership change would limit the utilization
of any net operating losses incurred prior to the change in ownership
date. The Company intends to complete an analysis under IRC Section 382 to
determine if an ownership change has occurred.
(8) LEASES
The Company is obligated under capital leases for equipment which expire
at various dates during the next five years. At September 30, 1997 and
1996, the gross amounts of equipment and related accumulated amortization
recorded under capital leases were as follows:
1997 1996
---- ----
Equipment $ 24,030 $ 924
Less accumulated amortization 3,541 249
--------- ----
$ 20,489 $ 675
========= ====
The Company also has noncancelable operating leases, primarily for
facilities, which expire over the next five years. Rental expense under
operating leases was $2,822, $1,443 and $800 for the years ended September
30, 1997, 1996 and 1995, respectively.
(Continued)
F - 19
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
Future minimum lease payments under noncancelable leases (with initial or
remaining lease terms in excess of one year) and future minimum capital
lease payments as of September 30, 1997 are:
Capital Operating
Leases Leases
------ ------
Year ending September 30:
1998 $ 8,173 4,132
1999 3,965 3,679
2000 2,772 3,103
2001 2,772 2,337
2002 2,772 2,211
Thereafter 13,149 7,045
------- -------
Total minimum lease payments 33,603 $22,507
=======
Less amount representing interest (at rates
ranging from 10% to 17%) 13,368
-------
Net minimum lease payments 20,235
Less current installments of obligations under
capital leases 5,892
Obligations under capital leases, excluding
current installments $14,343
=======
(9) COMMITMENTS AND CONTINGENCIES
(a) PENSION AND PROFIT SHARING PLANS
In 1995, the Company adopted a defined contribution 401(k) plan (the Plan).
Employees are eligible to participate in the Plan upon commencement of
service. Participants may defer up to 15% of eligible compensation.
Currently, the Company does not provide matching contributions for the
Plan.
(Continued)
F - 20
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
(b) LONG DISTANCE CARRIERS
The Company is party to various contracts with long distance carriers
pursuant to which the Company is committed to minimum service fees. The
average monthly minimum commitments range from $1,600 to $6,100 per month
over the next three years. The Company may be required to pay the carriers
for differences between the commitment amounts and the actual amounts
billed.
(c) LEGAL PROCEEDINGS
On August 24, 1995, Aerotel, Ltd. and Aerotel U.S.A., Inc. (collectively,
"Aerotel") filed a patent infringement suit against NACT alleging that
telephone systems manufactured and sold by NACT incorporate prepaid calling
features which infringe upon a patent issued to Aerotel in November 1987.
The complaint further alleges defamation and unfair competition by NACT and
seeks various damages. NACT has filed an Answer and Counterclaim denying
patent infringement, committing defamation or unfair competition and seeks
judgment that the Aerotel patent is invalid and that Aerotel has misused
its patent in violation of antitrust laws. On May 3, 1996, NACT served its
motion for summary judgment, which the Court has not yet ruled upon.
Aerotel amended its complaint to include as defendants the Company and GST.
The amended pleadings allege that the Company and GST have infringed the
Aerotel patent, aided and abetted infringement by others, including NACT,
and participated in, and aided and abetted alleged tortious conduct by
NACT. The Company and GST have served answers denying all material
allegations and intend to defend vigorously. Pretrial discovery has
commenced and is scheduled to be completed in 1998. The case is not
expected to be tried until late 1998 at the earliest. NACT=s patent counsel
believes that NACT has valid defenses to the Aerotel claims. If upheld,
these defenses would also be valid for all defendants. An unfavorable
decision in this action could have a material adverse effect on the
Company. Based on information currently available, the Company=s management
is of the opinion that there will be no material impact of the Company=s
financial position, results of operations, or cash flows as a result of
this suit. Accordingly, no provision for loss has been provided in the
accompanying consolidated financial statements.
The Company is involved in various other claims and legal actions arising
in the ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material effect on
the Company=s financial position, results of operations or cash flows.
(Continued)
F - 21
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
(d) REPURCHASE AGREEMENT
NACT is guarantor for financing transactions executed under a repurchase
agreement with Zions Credit Corporation (Zions) for a maximum of $3,482 at
September 30, 1997. Zions provides lease financing to NACT customers on a
recourse basis.
(e) EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with key members of
management. These agreements provide for payments based upon death,
disability and change of control. The agreements also contain covenants not
to compete.
(10) RELATED PARTY TRANSACTIONS
(a) MAGNACOM WIRELESS, LLC (MAGNACOM)
Magnacom, a company 99% owned by Pacwest Network, Inc. (PNI), which is in
turn controlled by the Chief Executive Officer of the Company, and the
Company have entered into a twelve-year reseller agreement (the Magnacom
Reseller Agreement) pursuant to which (i) the Company has been designated a
non-exclusive reseller of PCS telephone services in the markets in which
Magnacom has obtained licenses, and (ii) Magnacom has agreed to use the
Company on an exclusive basis to provide switched local and long distance
services, and other enhanced telecommunications services, to all of
Magnacom=s resellers in markets where the Company has operational networks.
Magnacom agreed to sell PCS minutes to the Company at five cents per
minute, subject to downward adjustment to equal the most favorable rates
offered to Magnacom=s other resellers (but in no event less than Magnacom=s
cost). In connection with the Magnacom Reseller Agreement, the Company has
paid a total of approximately $14,000 as pre-payments for future PCS
services.
In addition, the Company has been granted a conditional option to acquire
up to PNI's entire interest in Magnacom (currently 99%), conditioned upon
Magnacom and the Company entering into an agreement for the construction
and/or operation of Magnacom's facilities. The condition precedent to such
option has not yet been met. Such option, if and when the condition
precedent is met. shall be subject to compliance with all applicable FCC
regulations relating to prior approval of any transfer of control of PCS
licenses, including those relating to foreign ownership or control and
requirements regarding the ownership of C and F block licenses.
Accordingly, until such time as FCC regulations or administrative action
permit the Company to own in excess of 25% of Magnacom, the option by its
terms is limited to a 24% interest in Magnacom.
(Continued)
F - 22
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
(b) PACWEST NETWORK, INC. (PNI)
The operations of the Company's Hawaiian microwave network require the use
of radio licenses from the FCC. Such licenses are owned by PNI, a company
controlled by the Company's Chief Executive Officer. Under agreements
between the Company and PNI, (1) the Company pays a monthly fee to PNI to
utilize PNI's licenses for its communications traffic and (2) PNI pays an
equal monthly fee to the Company for the right to utilize the Company's
facilities for other communications traffic using up to 10% of PNI's
license capacity.
(c) TOMEN
Under the Tomen facility, Tomen has the right to act as procurement agent
for each network project it finances. The Company has purchased equipment
through Tomen at competitive prices. Additionally, an upfront fee of 1.50%
of the aggregate principal amount of each project loan advance and a
commitment fee of .50% per annum on the unused portion of each project loan
is payable to Tomen.
Pursuant to the Tomen agreements, Tomen has purchased 1,579,902 shares of
GST common stock for total cash consideration of $10,400 and holds warrants
to purchase an additional 246,155 shares of GST common stock at prices
ranging from $12.61 to $12.96 per share. Such warrants expire at various
times between May 1998 and September 1999.
(d) OTHER
The Company's Chief Executive Officer serves as a consultant to Tomen for
which he is paid a fee. Additionally, Pacwest receives a fee equal to 1% of
the aggregate debt and equity financing provided by Tomen to the Company.
Such fees incurred by the Company totaled $437, $195 and $221 in 1997, 1996
and 1995, respectively.
Receivables from parent are primarily comprised of expenses paid by the
Company of behalf of GST.
The payable to parent, totaling $85,775 at September 30, 1997 represents
advances from GST to be used in constructing and operating the Company=s
telecommunications networks.
(Continued)
F - 23
<PAGE>
GST USA, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
(11) SUBSEQUENT EVENTS (UNAUDITED)
On December 31, 1997, the Company and GST executed an agreement with World
Access, Inc. (World Access) to sell its interest in NACT for approximately
$89,400 consisting of cash and common stock of World Access.
F - 24
<PAGE>
EXHIBIT INDEX
EXHIBIT
*3(a) Certificate of Incorporation of GST USA, as amended.
*3(b) By-Laws of GST USA.
**4(a) Indenture dated as of May 13, 1997, by and among GST Funding, GST, GST
USA and United States Trust Company of New York.
***4(b) Senior Notes Indenture dated as of December 19, 1995, by and among GST,
GST USA and United States Trust Company of New York.
***4(c) Convertible Notes Indenture dated as of December 19, 1995, by and among
GST, GST USA and United States Trust Company of New York.
****27 Financial Data Schedule.
- --------------------
* Incorporated by reference to GST USA's Registration Statement on Form
S-4 (No. 333-33601-02).
** Incorporated by reference to GST's Quarterly Report on Form 10-Q for
the period ended June 30, 1997.
*** Incorporated by reference to GST's Annual Report on Form 20-F for the
fiscal year ended September 30, 1995.
**** Filed herewith.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from GST USA's
Form 10-K for the year ended September 30, 1997 and is qualified in its entirety
by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1997
<PERIOD-END> SEP-30-1997
<CASH> 54,656,905
<SECURITIES> 53,286,773
<RECEIVABLES> 19,683,095
<ALLOWANCES> (3,450,694)
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0
0
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</TABLE>
