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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 December 31, 1998.
/ / 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.
(Exact Name of Registrant as Specified in its Charter)
Delaware 83-0310464
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
4001 Main Street, Vancouver, Washington 98663
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (360) 356-7100
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 March 29, 1999,
there were outstanding 20 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"). Through GST USA and its operating
subsidiaries, 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 integrated
communications provider ("ICP"), 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"
customer-focused solution to the telecommunications services requirements of its
customers, include local dial tone, long distance, Internet, data transmission
and private line services. With the turn-up of its Virtual Integrated Transport
and Access ("VITA") network in the fiscal year ended December 31, 1998, GST
became one of the first ICPs to develop and deploy a converged network.
ITEM 2. PROPERTIES.
GST USA owns a building comprising 60,000 square feet in Vancouver,
Washington. GST USA leases space containing its principal executive offices at
4001 Main Street, Vancouver, Washington 98663.
ITEM 3. LEGAL PROCEEDINGS.
U S WEST V. THE ACC ET AL.
On or about February 25, 1997, U S WEST filed a declaratory judgment
action against members of the Arizona Corporation Commission ("ACC"), the ACC,
ACSI, Brooks and GST USA in the United States District Court in Arizona. The
District Court consolidated a number of similar lawsuits filed by U S WEST
against other Competitive Local Exchange Companies ("CLECs"), including MFS,
Sprint, MCI and AT&T. U S WEST alleges that the ACC has approved an
interconnection agreement 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, 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
USA, 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 USA, from taking any action to enforce any of the
order's allegedly unlawful provisions. On September 12, 1998, the District Court
dismissed all counts against GST USA. This lawsuit was consolidated with the
following two United States District Court of Arizona lawsuits described below.
A final order has not been issued.
GST TUCSON LIGHTWAVE, INC. ("GST TUCSON") V. THE ACC ET AL.
On or about February 26, 1998, GST Tucson, GST Net (AZ), Inc. ("GST Net
(AZ)") and WorldCom filed a declaratory judgment action against the ACC, members
of the ACC, and U S WEST in the United States District Court in Arizona. GST USA
alleges that the ACC's approval of U S WEST unbundled network elements and
wholesale discount rates was inconsistent with federal law, and failed to set
geographically deaveraged unbundled network element rates as required by federal
law. GST USA
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seeks a declaratory judgment that the ACC's action violates the
Telecommunications Act and an injunction requiring the ACC to adopt compliant
rates. Should GST USA not prevail in its suit, it may be charged unfavorable
rates for U S WEST services. GST USA cannot quantify at this time the potential
effect of an unsuccessful challenge to the ACC's action.
U S WEST V. GST NET (AZ)
On or about April 10, 1998, U S WEST filed a declaratory judgment
action against GST Net (AZ), GST Telecom Inc. ("GST Telecom"), GST Tucson, the
ACC and its members, and other Arizona CLECs in the United States District Court
of Arizona. U S WEST asserts that the ACC adopted a U S WEST permanent unbundled
network element rate order which denies it full compensation for nonrecurring
charges, loop costs, reciprocal compensation for transport and termination of
local traffic, customer transfer charges, and the costs of implementing its
interconnection obligations with CLECs in violation of the Telecommunications
Act and state law. U S WEST seeks a declaratory judgment stating that the ACC's
action violates federal and state law and an injunction preventing all
defendants from taking action to enforce the ACC's rulings. GST USA cannot
quantify at this time the potential effects of a successful U S WEST challenge
to the ACC's order. If U S WEST prevails in its suit, GST USA and other CLECs
may pay more for U S WEST interconnection and services, which could have an
adverse impact on GST USA's operations in Arizona.
U S WEST V. THE ACC ET AL.
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), 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. The state court consolidated the
case with a number of substantially similar lawsuits filed against other CLECs,
including MFS, Sprint, MCI and AT&T. On September 21, 1998, the court dismissed
the case as against all parties. U S WEST has appealed the dismissal to the
Arizona Court of Appeals. Should U S WEST successfully reverse the lower court
ruling, GST USA's regulatory status in Arizona may be changed, which could have
a material adverse effect on GST USA's operations in Arizona.
GST AND GST TELECOM V. GLOBAL LIGHT TELECOMMUNICATIONS, INC., ET AL.
On October 20, 1998, GST and GST Telecom filed a Complaint in the
Superior Court of California, County of Santa Clara, No. CV777408, against GST
Global Telecommunications, Inc., now known as Global Light Telecommunications,
Inc. ("Global") and six GST officers and directors, two of whom are present
directors of GST. The Complaint includes claims for fraud, negligent
misrepresentation, unjust enrichment, and unfair competition primarily related
to the alleged misappropriation of a Mexican business opportunity. The Complaint
seeks an accounting, a constructive trust, and restitution of GST's interest in
the opportunity and also seeks unspecified exemplary and punitive damages and
reimbursement of attorneys' fees. In particular, the Complaint alleges that
Global and the individual defendants misappropriated GST's joint venture
interest in Bestel, S.A. de C.V. ("Bestel"), the owner of a 2,270 kilometer
fiber optic telecommunications network in Mexico. The lawsuit alleges that the
individual defendants caused GST's 49% interest in Bestel to be transferred to
Global, then a shell corporation in which the individuals had secretly invested.
No written agreement
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validated the transfer. GST therefore seeks return of the asset and monetary
compensation to remedy the loss arising from the wrongful transfer.
On December 23, 1998, Defendants filed a motion to stay or dismiss the
action on grounds of inconvenient forum, and four of the individual defendants
filed a motion to dismiss the action for lack of personal jurisdiction. The
Superior Court granted Defendants' motion to stay the proceedings on February 5,
1999, and GST and GST Telecom filed a notice of appeal on February 9, 1999.
WARTA V. GST, GST USA, AND GST TELECOM AND COUNTERCLAIMS
On January 25, 1999, Mr. John Warta filed a Complaint in the Superior
Court of Washington, King County, No. 99-2-02287-4SEA, against GST, GST USA, and
GST Telecom. The Complaint, which relates to the circumstances under which Mr.
Warta ceased to serve as an officer and director of GST, includes claims for
breach of employment agreement, breach of the covenant of good faith and fair
dealing, violation of wage statutes, and indemnity.
On February 23, 1999, GST answered by denying all liability and filed
counterclaims against Mr. Warta, Global and five other current or former
officers and directors for liability with respect to the matters leading to the
termination of Mr. Warta's employment. In particular, GST seeks recovery under
Washington law for matters described in GST and GST Telecom v. Global, et. al,
above, as well as for breaches committed with respect to the wrongful use of GST
funds for the purchase of telecommunications licenses by Mr. Warta through
companies he owns.
GST, GST USA AND GST TELECOM V. IRWIN AND OLSHAN
On December 16, 1998, GST, GST USA and GST Telecom filed a Complaint in
the United States District Court, Southern District of New York, No. 98 CIV.
8865, against Mr. Stephen Irwin and the law firm of Olshan Grundman Frome &
Rosenzweig LLP ("Olshan"). The Complaint, which relates to Mr. Irwin and
Olshan's representation of GST, GST USA and GST Telecom in various matters,
includes claims for professional negligence, breach of fiduciary duty, and
breach of contract, and seeks compensatory damages and reimbursement of
attorneys' fees.
On February 12, 1999, Mr. Irwin filed his Answer to the Complaint.
Olshan filed its Answer and Counterclaims to the Complaint on February 17, 1999.
Olshan counterclaimed against GST, GST USA and GST Telecom for breach of
contract, unjust enrichment, quantum meruit, and "account stated," based on
invoices submitted to GST of approximately $250,000. No trial date has been set.
GST V. SANDER
On February 9, 1999, GST filed a Complaint in the Superior Court for
the State of Washington, Clark County, No. 99-2-00573-6, against Mr. Clifford V.
Sander, the former treasurer and Senior Vice President of GST. The Complaint,
which is based on Mr. Sander's alleged misconduct as an officer of GST, includes
claims for fraud, breach of fiduciary duty, unjust enrichment, and unfair
business practices, and seeks an accounting, imposition of a constructive trust,
compensatory damages, costs of suit, attorneys' fees, and treble damages. In
particular, the Complaint seeks relief based on Mr. Sander's misuse of insider
information in the purchase of Global stock, wrongful disbursements to third
parties, and involvement in a fraudulent release of GST stock from escrow to
three former directors and/or officers of GST. Mr. Sander has not yet responded
to the Complaint.
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GLOBAL AND MEXTEL V. GST AND GST TELECOM
On January 27, 1999, Global and GST Mextel, Inc. ("Mextel") filed a
Complaint in the Supreme Court of British Columbia, No. C990449, against GST and
GST Telecom. The Complaint, which arises from the same matters for which GST and
GST Telecom brought suit against Global et al. in the Superior Court of
California, includes claims for declaratory and injunctive relief to confirm the
ownership of the Mexican business opportunity by Global, and unspecified general
and special damages. In particular, Global seeks a declaration from the court
that it is entitled to retain the equity interest in Bestel, or at least a
judicial determination of the amount Global owes GST. GST intends to vigorously
dispute the allegations in the Complaint.
IRWIN ET AL. V. GST ET AL.
On January 28, 1999, Messrs. Stephen Irwin, Robert Hanson, Peter
Legault, Clifford Sander, and John Warta, all current or former GST officers or
directors, filed a Complaint in the Supreme Court of British Columbia, No.
C990488, against GST, GST Telecom, and four current GST directors. The
Complaint, which arises from the same matters for which GST and GST Telecom
brought suit against Global et al. in the Superior Court of California, includes
claims for oppression and declaratory relief, and seeks unspecified actual and
punitive damages, cost, and attorneys' fees. In particular, the plaintiffs have
asked the Court to declare that the plaintiffs may retain the Global stock they
purchased while fiduciaries of GST and seek to have the Canadian court enjoin
GST from pursuing its claims against them. GST and its directors will vigorously
dispute the allegations in the Complaint.
OTHER MATTERS
GST USA is a party to various other claims and legal actions arising in
the ordinary course of business. GST USA does not anticipate that these items
will materially impact its business. GST USA is a party to various proceedings
before the public utilities commissions of the states in which it provides or
proposes to provide telecommunications services. These proceedings typically
relate to licensure of GST USA or others and to the regulation of the
proposition 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.
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
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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. As a facilities-based integrated communications
provider ("ICP"), 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" customer-focused solution
to the telecommunications services requirements of its customers, include local
dial tone, long distance, Internet, data transmission and private line services.
With the turn-up of its Virtual Integrated Transport and Access ("VITA") network
in the fiscal year ended December 31, 1998, GST became one of the first ICPs to
develop and deploy a converged network.
RECENT DEVELOPMENTS
In February 1998, GST USA sold its remaining 63% interest in NACT
Telecommunications, Inc. ("NACT") for net proceeds of approximately $85.0
million (the "NACT Sale"). NACT produces advanced telecommunications switching
platforms with integrated applications software and network telemanagement
capabilities.
In May 1998, GST Network Funding, Inc. ("GST Network"), a wholly owned
subsidiary of GST USA, sold $500.0 million principal amount at maturity of 10.5%
senior secured discount notes due 2008 (the "1998 Notes") in a private placement
(the "1998 Offering"). The net proceeds of the 1998 Offering of approximately
$288.9 million will be used to finance the purchase and installation of acquired
equipment. Until such time as purchases are made, such net proceeds have been
invested in United States government securities in which the holders have been
granted a first priority security interest.
On June 15, 1998 GST announced that John Warta had retired as Chairman
of the Board and Chief Executive Officer of GST. Effective September 15, 1998,
Mr. Warta resigned as a director of GST. The Board of Directors of GST appointed
Mr. Robert A. Ferchat, a director of GST and the Chairman of the Board and
then-Chief Executive Officer of BCE Mobile Communications, Inc. to the position
of Chairman of the Board of GST on June 15, 1998, and Mr. Joseph A. Basile, Jr.,
the President, Chief Operating Officer and a director of GST, as Chief Executive
Officer on October 20, 1998.
On October 28, 1998, Magnacom, a company controlled by John Warta,
GST's former Chairman and Chief Executive Officer, filed a petition for
reorganization under Chapter 11 of the United States Bankruptcy Code. As of
December 31, 1998, GST had paid Magnacom approximately $14.6 million as
prepayments for future PCS services and had recorded approximately $1.1 million
in other receivables from Magnacom. In September 1998, GST recorded a loss
reserve of $15.7 million for the full amount of the prepayments and receivables
related to Magnacom.
GST, GST USA, GST Equipment Funding, Inc. ("GST Funding") and GST
Network (the "GST Companies") are parties to certain indentures and have issued
or guaranteed notes governed by those indentures. In November 1998, the GST
Companies notified United States Trust Company of New York, as trustee under the
indentures, that certain actions by the GST Companies and their subsidiaries may
not have been in compliance with the technical requirements of the restrictive
covenants contained in the indentures. In particular, the GST Companies
disclosed that a series of transactions involving Global may have resulted in
technical non-compliance with the indentures. The GST Companies are currently
conducting a review of the relevant transactions and intend to vigorously pursue
any necessary action to cure the potential non-compliances.
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GST has initiated litigation against Global and others in an effort to cure any
technical covenant violations that may have resulted from the transactions
involving Global. See "Legal Proceedings."
In February 1999, the trustee informed the note holders of the
potential violations. Pursuant to the definitions contained within the
indentures of each of the notes described above, no default has been declared
and no event of default has occurred. GST USA has not classified the related
debt obligations as current in its consolidated financial statements because
management believes it is probable that, in the event that the holders declared
a default, the GST Companies would be able to take corrective actions to cure
any objectively determinable violations within the prescribed grace period.
While GST USA believes that any non-compliances can be cured, GST USA
cannot offer any assurance that the litigation will be successful or that any
other potential cures will be effected in a timely manner or be sufficient. In
the event that the GST Companies have violated their indentures and do not cure
the violations, the holders of the notes issued under the indentures could
demand repayment of the notes, discontinue disbursements of cash proceeds of the
most recent notes and assert other remedies against the GST Companies. If any of
these events occurred, the GST Companies would not have sufficient liquid assets
to repay the notes.
RESULTS OF OPERATIONS
FISCAL 1998 COMPARED TO THE UNAUDITED YEAR ENDED DECEMBER 31, 1997
Revenues. Total revenue for Fiscal 1998 increased $40.0 million, or
35.6%, to $152.2 million from $112.2 million for the comparable twelve months
ended December 31, 1997. Telecommunications and other services revenues for
Fiscal 1998 increased $64.5 million, or 73.4%, to $152.2 million from $87.7
million for the twelve months ended December 31, 1997. The increase in
telecommunications and other services revenues resulted primarily from strategic
acquisitions, including the acquisitions of ICON Communications Corp. ("ICON")
in April 1998, and from increased local service revenue generated by GST USA's
networks. To a lesser extent, the increase in telecommunications and other
services revenues resulted from increased long distance, Internet, and data
services. The increase was also attributable to a $2.0 million increase in
revenue from the construction of network and fiber systems. Due to the NACT
Sale, product revenue for Fiscal 1998 was $0 compared to $24.5 million for the
twelve months ended December 31, 1997.
Operating Expenses. Total operating expenses for Fiscal 1998 increased
$88.4 million, or 46.0%, to $280.6 million from $192.2 million for the twelve
months ended December 31, 1997. Network expenses, which include direct local and
long distance circuit costs, increased $33.1 million, or 48.4%, to $101.4
million, or 66.6% of telecommunications and other services revenues for Fiscal
1998 compared to $68.3 million, or 77.8% for the comparable period in the
previous year. The decrease in network expenses as a percentage of revenue
resulted from the inclusion of strategic acquisitions and an increase in
revenues for traffic carried on GST USA's network as a percentage of total
telecommunications and other services revenues. Facilities administration and
maintenance expenses for Fiscal 1998 increased $2.5 million, or 21.7%, to $13.9
million, or 9.1% of telecommunications and other services revenues compared to
$11.4 million, or 13.0% for the comparable period ended December 31, 1997. The
primary reason for the decrease in these expenses as a percentage of
telecommunications and other services revenues is the inclusion of revenues from
strategic acquisitions, substantially all of which are not generated on GST
USA's networks.
Cost of product revenues and research and development costs were $0 for
Fiscal 1998 due to the NACT Sale.
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Selling, general and administrative expenses for Fiscal 1998 increased
$15.4 million, or 20.7%, to $90.1 million from $74.7 million for the twelve
months ended December 31, 1997. The increase is due to the expansion of GST
USA's local and enhanced services operations, which resulted in additional
marketing, management information and sales staff, and to selling, general and
administrative expenses related to strategic acquisitions. As a percentage of
total revenue, selling, general and administrative expenses for Fiscal 1998 were
59.2%, compared to 66.5% for the twelve months ended December 31, 1997.
Depreciation and amortization for Fiscal 1998 increased $17.1 million,
or 62.1%, to $44.6 million from $27.5 million for the twelve months ended
December 31, 1997. The increase is attributable to newly-constructed networks
and related equipment being placed into service and to the amortization of
intangible assets related to GST USA's acquisitions. GST USA expects that
depreciation will continue to increase as it expands its networks and longhaul
fiber optic facilities and installs additional switches. Depreciation and
amortization expense was 29.3% of total revenue for Fiscal 1998 compared to
24.5% for the comparable period ended December 31, 1997.
Special charges for Fiscal 1998 consist of (i) a $15.7 million
write-off of amounts paid to Magnacom, (ii) $9.9 million in abandoned assets
related to non-core projects and services, including the write off of submarine
cable projects, equipment rendered obsolete by GST USA's VITA network and fiber
projects outside of GST USA's main service areas, (iii) a $3.9 million
impairment reserve for GST USA's shared tenant services asset and (iv) $1.1
million in costs related to the severance of certain members of former
management.
Other Expenses/Income. For Fiscal 1998, GST USA recorded net other
income of $5.2 million, compared to net other expense of $31.4 million for the
comparable period ended December 31, 1997. For Fiscal 1998, net other income
includes a $61.3 million gain resulting from the NACT Sale. Excluding such gain,
net other expense would have increased $24.7 million for Fiscal 1998 as compared
to the same period in the previous year. The increase in net other expense
related primarily to increased interest expense resulting from the issuance in
May 1998 of the 1998 Notes.
Net Loss. Net loss for Fiscal 1998 increased $11.9 million, or 10.7%,
to $123.2 million from $111.3 million for the twelve months ended December 31,
1997. Excluding the $61.3 million gain on the NACT Sale, net loss would have
been $184.5 million for Fiscal 1998, an increase of $73.2 million as compared to
the twelve months ended December 31, 1997. Such increase in net loss resulted
primarily from a $32.4 million increase in interest expense and a $48.5 million
increase in operating loss.
THE THREE MONTHS ENDED DECEMBER 31, 1997 ("1997 THREE MONTH PERIOD") COMPARED TO
THE UNAUDITED THREE MONTHS ENDED DECEMBER 31, 1996 ("1996 THREE MONTH PERIOD")
Revenues. Total revenue for the 1997 Three Month Period increased $10.0
million, or 43.2%, to $33.2 million from $23.2 million for 1996 Three Month
Period. Telecommunications services revenue for the 1997 Three Month Period
increased $7.5 million, or 40.7%, to $25.9 million from $18.4 million for the
1996 Three Month Period. The increase in telecommunications services revenue
resulted primarily from increased local service revenue generated by GST USA's
networks and from increased long distance service revenue. Additionally, during
the 1997 Three Month Period, GST USA completed a $1.5 million longhaul conduit
sale. To a lesser extent, the increase in revenue resulted from the acquisition
of the Guam operations of Sprint in October 1997. Product revenue for the 1997
Three Month Period increased $2.5
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million, or 52.7%, to $7.3 million from $4.8 million for the 1996 Three Month
Period. The increase in product revenue resulted primarily from increased unit
sales of NACT's STX switch.
Operating Expenses. Total operating expenses for the 1997 Three Month
Period increased $13.5 million, or 33.3%, to $54.2 million from $40.7 million
for the 1996 Three Month Period. Network expenses, which include direct local
and long distance circuit costs, increased $3.6 million, or 23.8%, to $18.4
million, or 70.8% of telecommunications services revenue for the 1997 Three
Month Period compared to $14.8 million, or 80.4% of telecommunications services
revenue for the 1996 Three Month Period. The primary reason for the decrease in
network expenses as a percent of revenue is the increase in on-net revenues
generated at GST USA's network as a percent of total revenues. Facilities
administration and maintenance expenses (consisting primarily of costs related
to personnel providing maintenance, monitoring and technical assistance for GST
USA's networks) for the 1997 Three Month Period decreased $.2 million, or 6.7%,
to $2.9 million, or 11.2% of telecommunications services revenue, compared to
$3.1 million, or 16.9% of telecommunications services revenue, for the 1996
Three Month Period.
Cost of product revenue, which represents the costs associated with
product revenue of NACT, increased $.5 million, or 27.8%, to $2.3 million for
the 1997 Three Month Period from $1.8 million for the 1996 Three Month Period.
Cost of product revenue was 31.9% of product revenue for the 1997 Three Month
Period compared to 38.1% for the 1996 Three Month Period. The decrease in cost
of product revenue as a percentage of product revenue resulted primarily from
economies of scale related to increased unit sales of NACT's STX switch.
Research and development costs for the 1997 Three Month Period increased $.3
million, or 82.0%, to $.7 million from $.4 million for the 1996 Three Month
Period. The increase was due to the addition of 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 the 1997 Three Month
Period increased $5.5 million, or 35.0%, to $21.3 million from $15.8 million for
the 1996 Three Month Period. 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
64.1% of total revenue for the 1997 Three Month Period compared to 68.0% of
total revenue for the 1996 Three Month Period.
Depreciation and amortization for the 1997 Three Month Period increased
$3.8 million, or 81.8%, to $8.5 million from $4.7 million for the 1996 Three
Month Period. The increase was attributable to newly-constructed networks
becoming operational and to the amortization of intangible assets related to GST
USA's acquisitions. GST USA expects that depreciation will continue to increase
as it expands its networks and longhaul fiber optic facilities and installs
additional switches. Depreciation and amortization was 25.6% of total revenue
for the 1997 Three Month Period compared to 20.2% for the 1996 Three Month
Period.
Other Expenses/Income. For the 1997 Three Month Period, net other
expenses increased $9.2 million, or 232.5%, to $13.2 million, or 39.8% of total
revenue, from $4.0 million, or 17.1% of total revenue, for the 1996 Three Month
Period. The primary reason for the increase was the inclusion of interest
expense associated with the 13.25% senior secured notes due 2007 of GST Funding
(the "Secured Notes"). The increase in interest expense was partially offset by
interest income earned on the investment of a portion of the proceeds of the
sale of the Secured Notes. To a lesser extent, net other expenses increased due
to NACT's income tax expense as well as minority interest in the income of NACT.
Net Loss. Net loss for the 1997 Three Month Period increased $12.8
million, or 59.6%, to $34.2
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million from $21.4 million for the 1996 Three Month Period. The increase in net
loss resulted primarily from a $3.5 million increase in operating loss and a
$11.3 million increase in interest expense.
FISCAL 1997 COMPARED TO FISCAL 1996
Revenues. Total revenue for Fiscal 1997 increased $60.9 million, or
147.5%, to $102.2 million from $41.3 million for the fiscal year ended September
30, 1996 ("Fiscal 1996"). Telecommunications services revenue for Fiscal 1997
increased $48.5 million, or 152.9%, to $80.2 million from $31.7 million for
Fiscal 1996. The increase in telecommunications services revenue resulted from
the inclusion of a full year of revenue from strategic acquisitions, including
Call America Business Communications Corp. and affiliated companies
(collectively, "GST Call America") and TotalNet Communications, Inc.
("TotalNet"), as well as 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
$97.2 million, or 119.4%, to $178.6 million from $81.4 million for Fiscal 1996.
Network expenses, which include direct local and long distance circuit costs,
increased $38.1 million, or 143.6%, to $64.7 million for Fiscal 1997 compared to
$26.6 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 networks) for
Fiscal 1997 increased $1.3 million, or 12.9%, to $11.6 million, or 14.5% of
telecommunications services revenue, compared to $10.3 million, or 32.5% of
telecommunications services revenue, for Fiscal 1996. The primary reason for the
decrease in facilities administration and maintenance expenses as a percent of
telecommunications services revenue was the inclusion of revenue from 1996
strategic acquisitions, a significant portion of which was generated off-net.
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
$38.3 million, or 123.8%, to $69.2 million from $30.9 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 67.7% of total
revenue for Fiscal 1997 compared to 74.8% of total revenue for Fiscal 1996.
Depreciation and amortization for Fiscal 1997 increased $15.4 million,
or 185.5%, to $23.7 million from $8.3 million for Fiscal 1996. The increase was
attributable to newly-constructed networks becoming operational and to the
amortization of intangible assets related to GST USA's acquisitions.
Depreciation and amortization was 23.2% of total revenue for Fiscal 1997
compared to 20.1% for Fiscal 1996.
-9-
<PAGE> 12
Other Expenses/Income. For Fiscal 1997, net other expenses increased
$6.7 million, or 43.3%, to $22.1 million, or 21.7% of total revenue, from $15.4
million, or 37.4% 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 $14.1 million over Fiscal 1996.
Such increase primarily resulted from increased interest expense due to the
issuance of the 13.875% senior discount notes due 2005 (the "1995 Notes") in
December 1995 and the issuance of the Secured Notes in May 1997. To a lesser
extent, other expenses increased due to income tax expense attributable to
income of NACT, which as of March 1, 1997 was no longer consolidated for tax
purposes.
Net Loss. Net loss for Fiscal 1997 increased $43.0 million, or 77.4%,
to $98.6 million from $55.6 million for Fiscal 1996. Excluding the $7.4 million
gain on the sale of NACT shares, net loss would have been $106.0 million for
Fiscal 1998, an increase of $50.4 million as compared to the twelve months ended
December 31, 1997. The increase in net loss resulted primarily from a $36.3
million increase in operating loss and a $15.9 million increase in interest
expense.
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 as GST USA emphasizes the development, construction and
expansion of its networks and builds its customer base. Cash provided by GST
USA's operations will not be sufficient to fund the expansion of its networks,
longhaul fiber optic facilities and services.
At December 31, 1998, GST USA had approximately $956.6 million of
indebtedness outstanding. Although GST USA's liquidity was improved as a result
of proceeds received from the sale of the 1995 Notes, the Secured Notes and the
1998 Notes, GST USA has significant debt service obligations. GST USA will be
required to make principal and interest payments of approximately $66.1 million
(of which $35.1 million will be made from funds securing the Secured Notes),
$66.6 million (of which $17.6 million will be made from funds securing the
Secured Notes), $108.2 million, $106.6 million and $131.1 million in 1999, 2000,
2001, 2002, and 2003, respectively. In addition, GST USA anticipates that cash
flow from operations will be insufficient to pay interest in cash on the 1995
Notes when such interest becomes payable in September 2001 and on the Secured
Notes starting in November 2000 once the amount pledged to fund the first six
scheduled interest payments on the Secured Notes is paid and 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 beyond the
control of GST USA. There can be no assurance that GST USA will be able to
improve its operating results or that GST USA will be able to meet its debt
service obligations.
At December 31, 1998, GST USA had cash, cash equivalents, and
investments, including restricted investments of approximately $366.8 million.
GST USA believes that such amounts will be sufficient to fund GST USA's
operations through the end of Fiscal 1999. Divestitures and other management
actions may prolong capital availability into the fiscal year 2000 and beyond.
Thereafter, GST USA expects to require additional financing. The extent of
additional financing will depend on, among other things, the rate of GST USA's
expansion and the success of GST USA's businesses. In the event that GST USA's
plans or assumptions change or prove to be inaccurate, GST USA incurs
significant unexpected expenses, or GST USA's cash resources, together with
borrowings under the current financing arrangements prove to be insufficient to
fund GST USA's growth and operations, or if GST USA consummates additional
-10-
<PAGE> 13
acquisitions, GST USA may be required to seek additional sources of capital (or
seek additional capital sooner than currently anticipated). 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 USA or, if available, that it can be concluded on terms
acceptable to GST USA or within the limitations contained within GST USA's
financing arrangements. Failure to obtain such financing could result in the
delay or abandonment of some or all of GST USA's development or expansion plans
and could have a material adverse effect on GST USA's business. Such failure
could also limit the ability of GST to make principal and interest payments on
its outstanding indebtedness. GST USA has no material working capital or other
credit facility under which it may borrow for working capital and other general
corporate purposes. There can be no assurance that such facility will be
available to GST USA in the future or that if such facility were available, that
it would be available on terms and conditions acceptable to GST USA.
GST USA's net cash used in operating and investing activities was
$425.0 million and $317.6 million for Fiscal 1998 and the twelve months ended
December 31, 1997, respectively. Net cash provided by financing activities from
borrowings and contributions from GST to fund capital expenditures, acquisitions
and operating losses was $313.1 million and $511.9 million for Fiscal 1998 and
the twelve months ended December 31, 1997, respectively.
Capital expenditures for Fiscal 1998 and the twelve months ended
December 31, 1997 were $247.7 million and $214.4 million, respectively. GST USA
estimates capital expenditures of $250 million and $150 million in Fiscal 1999
and Fiscal 2000, respectively. 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, GST USA has also made
cash expenditures for strategic acquisitions. In March 1998, GST USA acquired
Call America-Phoenix, a Phoenix-based reseller of long distance, for
approximately $3.8 million in cash and the business of Whole Earth Networks,
Inc., a San Francisco-based ISP, for approximately $9.1 million in cash and the
assumption of approximately $1.3 million of liabilities. In April 1998, GST USA
acquired ICON, a switch-based reseller of long distance and local service
located in Seattle, for approximately $23.9 million in cash.
In May 1998, GST Network completed the offering of $500.0 million
principal amount at maturity of 1998 Notes. The 1998 Notes fully accrete to face
value on May 1, 2003. From and after May 1, 2003, the 1998 Notes bear interest,
which will be payable in cash, at a rate of 10.5% per annum on each May 1 and
November 1, commencing November 1, 2003. The net proceeds from the sale of the
1998 Notes of approximately $288.9 million are restricted for the purchase of
telecommunications equipment and network infrastructure. The indenture relating
to the 1998 Notes includes restrictive covenants which, among other items, limit
or restrict additional indebtedness incurred by GST Network, investment in
certain subsidiaries, the sale of assets and the payment of dividends. GST
Network is a party to a registration rights agreement relating to the 1998 Notes
whereby it has agreed to consummate an exchange offer for the 1998 Notes
pursuant to an effective registration statement or cause the 1998 Notes to be
registered under the Securities Act of 1933, as amended, pursuant to a shelf
registration statement by November 4, 1998. Although GST Network has filed a
registration statement on Form S-4 with respect to an exchange offer for the
1998 Notes, it has not yet been declared effective. Therefore, in accordance
with the terms of the registration
-11-
<PAGE> 14
rights agreement, interest (in addition to the accrual of original issue
discount and interest otherwise due on the 1998 Notes after such date) on the
1998 Notes will accrue, at an annual rate of 0.5%, from November 4, 1998 and be
payable in cash semiannually in arrears, on each May 1 and November 1,
commencing May 1, 1999 until such exchange offer is consummated or a shelf
registration statement is declared effective.
GST USA may have committed certain technical indenture covenant
violations, and GST USA has notified the indenture trustee in this regard. See
"Recent Developments."
INCOME TAXES AND ADOPTION OF NEW ACCOUNTING STANDARDS
At December 31, 1998 GST USA had a net operating loss carryforward of
approximately $208.9 million 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.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 standardizes the accounting
for derivative instruments, including certain derivative instruments embedded in
other contracts. Under SFAS No. 133, entities are now required to carry all
derivative instruments in the balance sheet at fair value. The accounting for
changes in fair value (i.e., gains and losses) of a derivative instrument
depends on whether it has been designated and qualifies as part of a hedging
relationship and, if so, on the reason for holding it. GST USA must adopt SFAS
No. 133 by January 1, 2000. GST USA has not determined the impact that SFAS No.
133 will have on its financial statements and believes that such determination
will not be meaningful until closer to the date of initial adoption.
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5, Reporting on the Costs of Start-Up Activities
(SOP 98-5). SOP 98-5 requires that costs incurred during start-up activities,
including organization costs, be expensed as incurred and that previously
capitalized costs related to such activities be expensed as a cumulative effect
of a change in accounting principle upon adoption. GST USA will adopt the
provisions of SOP 98-5 at the beginning of 1999 and does not anticipate that
this new standard will have a material impact on future results of operations.
YEAR 2000 PROGRAM
The year 2000 issue is the result of computer-controlled systems using
two digits rather than four to define the applicable year. For example, computer
programs that have time-sensitive software may recognize a date ending in "00"
as the year 1900 rather than the year 2000. This could result in system failure
or miscalculations causing disruptions of operations including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities.
GST USA is currently verifying system readiness for the processing of
date-sensitive information by its information technology ("IT") systems
(applications, hardware, system software and interfaces) and its network
operations. The review of IT systems and network operations is centrally managed
through a year 2000 Program Management Office (PMO).
GST USA's State of Readiness. In general, GST USA's year 2000 project
is divided into three phases: (1) inventory and assessment ("Phase One"), (2)
strategy and contingency planning ("Phase Two"), and (3) conversion and
remediation ("Phase Three").
-12-
<PAGE> 15
GST USA completed its Phase One assessment for IT systems in October
1998. Phase One for network operations is expected to be concluded by the end of
first quarter 1999. GST USA has focused its independent testing activities
principally on those systems whose failure would pose the greatest risk to GST
USA. GST USA may not independently test all of its equipment and will rely upon
vendor representations, if received by GST USA, where tests are not conducted.
There can be no assurance of the accuracy or completeness of such
representations. GST USA is continuing to contact all of its significant
suppliers and large customers to determine the extent to which GST USA's
interface systems are vulnerable to those third parties' failure to remediate
their own year 2000 issues.
With respect to IT systems, GST USA completed Phase Two, wherein
remedial actions were planned and a contingency plan was formulated, in December
1998. GST USA expects to complete Phase Three, wherein remedial actions will be
implemented and tested, by third quarter 1999. GST USA anticipates conclusion of
Phase Two and Phase Three activities for network operations by third quarter
1999.
Costs. The total amount expended on the project through December 31,
1998 was approximately $.5 million. in internal staffing costs. The total cost
of the year 2000 project is estimated to be $3.3 million, including $.3 million
in internal staffing costs, $1.8 million in external staffing costs and $1.2
million in hardware and software upgrade costs. This cost may be reduced if
software and hardware are replaced with compliant systems as a result of other
currently scheduled capital projects. GST USA does not expect remediation costs
to have a material adverse effect on its financial position, results of
operation or cash flows. There can be no assurance, however, that there will not
be a delay in, or increased costs associated with, the implementation of changes
as the program progresses, and failure to implement such changes could have an
adverse effect on future results of operations.
Risks. The failure to correct a material year 2000 problem could result
in an interruption in, or a failure of, certain normal business activities or
operations. Such failures could materially and adversely affect GST USA's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the year 2000 problem, resulting in part from the
uncertainty of the year 2000 readiness of third-party suppliers and customers,
GST USA is unable to determine at this time whether the consequences of year
2000 failures will have a material impact on GST USA's results of operations,
liquidity or financial condition. The year 2000 project is expected to
significantly reduce GST USA's level of uncertainty about the year 2000 problem.
GST USA believes that, with the implementation of new business systems and
completion of the project as scheduled, the possibility of significant
interruptions of normal operations should be reduced.
-13-
<PAGE> 16
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK.
Item 7. (A) QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
INTEREST RATE MARKET RISK - GST USA has fixed income investments consisting
of cash equivalents, short-term investments in U.S. government debt
instruments, and certificates of deposit. See note 1 to the Consolidated
Financial Statements for information about investments in U.S. government
debt instruments, and certificates of deposit.
Interest income earned on GST USA's investment portfolio is affected by
changes in the general level of U.S. interest rates. GST USA believes that
it is not exposed to significant changes in fair value because such
investments are composed of Government debt instruments, certificates of
deposit and commercial paper and the maturities are predominantly
short-term. The fair value of each investment approximates its amortized
cost, and long-term securities
have maturities of less than two years.
The following table provides information about GST USA's risk exposure
associated with changing interest rates. Currently, GST USA does not use
derivative financial instruments to manage its interest rate risk.
<TABLE>
<CAPTION>
EXPECTED MATURITY
(In thousands of dollars)
--------------------------------------------------------------------------------------------
Market
Value at
December 31,
1999 2000 2001 2002 2003 Thereafter Total 1998
------ ------- -------- ------- ------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Long-term Debt:
Fixed rate 140 1,077,449 1,077,589 944,241
Average interest rate 8.50% 12.36%
Variable rate 11,951 17,041 20,216 20,898 21,132 13,487 104,725
Average interest rate
(LIBOR plus) 3.37% 3.26% 3.29% 3.34% 3.34% 3.06%
Capital Leases:
Fixed rate 6,476 5,227 2,279 1,974 1,981 7,453 25,390
Average interest rate 12.36% 12.36% 12.36% 12.36% 12.36% 12.36%
</TABLE>
(1) Includes $251.1 million of unaccreted discount.
MARKET PRICE RISK - The Company has risk exposure associated with the
market price on its publicly traded long-term debt. These bonds are
recorded at book value, which could vary from current market prices.
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.
-14-
<PAGE> 17
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 page S-1.
(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.
#4(d) Indenture dated as of May 4, 1998 by and among GST Telecommunications,
GST USA, Inc., GST Network Funding, Inc. and the United States Trust
Company of New York, as trustee.
##10(a) Stock Purchase Agreement dated December 31, 1997 by and among GST
Telecommunications, Inc., GST USA, Inc. and World Access, Inc.,
incorporated by reference to Exhibit 99.2 to GST's Form 8-K dated
January 6, 1997.
#10(b) Placement Agreement dated April 29, 1998 by and among GST
Telecommunications, Inc., GST USA, Inc., GST Network Funding, Inc., and
several Placement Agents named in Schedule I thereto.
#10(c) Registration Rights Agreement dated May 4, 1998 by and among GST
Telecommunications, Inc., GST USA, Inc., GST Network Funding, Inc. and
Morgan Stanley & Co. Incorporated, Bear, Stearns & Co. Inc., Credit
Suisse First Boston Corporation and SBC Warburg Dillon Read Inc.
#10(d) Collateral Pledge and Security Agreement dated as of May 4, 1998 from
GST Network Funding, Inc. to United States Trust Company of New York,
as trustee.
#10(e) Reimbursement and Commitment Fee Agreement dated May 4, 1998 among GST
Telecommunications, Inc., GST USA, Inc. and GST Network Funding, Inc.
***10(f) Amended and Restated Credit Agreement dated as of April 26, 1995, by
and between GST Pacific Lightwave, Inc. and Tomen America Inc.
**10(g) Collateral Pledge and Security Agreement dated as of May 13, 1997, by
and among GST Equipment Funding, Inc., United States Trust Company of
New York and the holders of the Notes as defined therein.
&10(h) Amended and Restated Master Agreement dated as of May 24, 1996, by and
among Tomen America Inc., the Company, GST Telecom Inc., GST Pacific
Lightwave, Inc., Pacwest Network L.L.C., Pacwest Network Inc., GST
Tucson Lightwave, Inc. and GST New Mexico Lightwave, Inc.
&10(i) Credit Agreement dated as of May 24, 1996, by and between GST New
Mexico Lightwave, Inc. and TM Communications LLC.
&10(j) Credit Agreement dated as of May 24, 1996, by and between GST Tucson
Lightwave, Inc. and TM Communications LLC.
&&10(k) Employment Agreement dated March 3, 1999, effective as of October 20,
1998, by and between GST USA, Inc. and Joseph Basile, Jr.
&&&10(l) Employment Agreement dated February 10, 1997, by and between GST USA,
Inc. and GST Telecom Inc. and Daniel L. Trampush.
&10(m) Reseller Agreement dated as of October 30, 1996, by and between
Magnacom Wireless, L.L.C., and GST Telecom Inc.
&10(n) Equipment Loan and Security Agreement dated December 19, 1996 by and
between NTFC Capital Corporation and GST Equipco.
%10(o) Loan and Security Agreement dated as of September 4, 1996 by and
between Siemens Stromberg-Carlson ("Siemens") and GST Switchco, Inc.
("GST Switchco").
%10(p) Unconditional Continuing Guaranty dated as of September 4, 1996 by and
between Siemens and GST USA, Inc.
%10(q) Unconditional Limited Guaranty Agreement dated as of December 19, 1996
made by GST USA, Inc., in favor of NTFC Capital Corporation.
%%10(r) Credit Agreement dated as of September 30, 1997 by and between GST
Telecom Hawaii, Inc. and TM Communications Hawaii LLC.
%%10(s) Service Agreement dated as of September 30, 1997 by and between Pacwest
Network, Inc. and GST Telecom Hawaii, Inc.
%%10(t) Management Agreement dated as of September 30, 1997 by and between
Pacwest Network, Inc. and GST Telecom Hawaii, Inc.
%%10(u) Agreement dated as of September 30, 1997 by and among GST Telecom
Hawaii, Inc., GST Telecom Inc. and Pacwest Network, Inc.
###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.
# Incorporated by reference to GST's Form 8-K filed May 19, 1998.
## Incorporated by reference to Exhibit 99.2 to GST's Form 8-K dated
January 6, 1998.
### Filed herewith.
& Incorporated by reference to GST Telecommunications, Inc.'s Annual
Report on Form 10-K for the fiscal year ended September 30, 1996.
&& Incorporated by reference to GST Telecommunications, Inc.'s Annual
Report on Form 10-K for the fiscal year ended December 31, 1998.
&&& Incorporated by reference to GST Telecommunications, Inc.'s Quarterly
Report on Form 10-Q for the period ended March 30, 1997.
% Incorporated by reference to GST Telecommunications, Inc.'s Quarterly
Report on Form 10-Q for the period ended December 31, 1996.
%% Incorporated by reference to GST Telecommunications, Inc.'s Form 8-K
dated September 30, 1997.
(b) Reports on Form 8-K: None.
-15-
<PAGE> 18
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
GST USA, INC. PAGE
<S> <C>
Independent Auditors' Report....................................................................... F-2
Consolidated Balance Sheets at December 31, 1998 and 1997.......................................... F-3
Consolidated Statements of Operations for the year ended December 31, 1998, the
three-month period ended December 31, 1997 and the years ended
September 30, 1997 and 1996............................................................... F-4
Consolidated Statements of Shareholder's (Deficit) Equity for the year ended
December 31, 1998, the three-month period ended December 31, 1997 and
the years ended September 30, 1997 and 1996............................................... F-5
Consolidated Statements of Cash Flows for the year ended December 31, 1998, the
three-month period ended December 31, 1997 and the years ended
September 30, 1997 and 1996............................................................... F-6
Notes to Consolidated Financial Statements......................................................... F-8
Independent Auditor's Report on Schedule........................................................... S-1
Schedule of Valuation and Qualifying Accounts...................................................... S-2
</TABLE>
F-1
<PAGE> 19
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 December 31, 1998 and 1997, and the related consolidated
statements of operations, shareholder's (deficit) equity, and cash flows for the
year ended December 31, 1998, the three-month period ended December 31, 1997 and
each of the years in the two-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 December 31, 1998 and 1997, and the results of its operations
and cash flows for the year ended December 31, 1998, the three-month period
ended December 31, 1997 and each of the years in the two-year period ended
September 30, 1997, in conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
Portland, Oregon
March 1, 1999
F-2
<PAGE> 20
GST USA, INC.
and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share amounts)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1998 1997
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 85,482 $ 197,373
Restricted investments 34,107 31,731
Accounts receivable, net 31,946 26,212
Receivable from parent -- 964
Investments -- 7,554
Prepaid and other current assets 11,661 15,763
----------- -----------
163,196 279,597
Restricted investments 247,257 112,719
Property and equipment, net 616,686 406,440
Goodwill, net 47,627 29,941
Other assets, net 45,926 50,319
----------- -----------
Total assets $ 1,120,692 $ 879,016
=========== ===========
LIABILITIES AND SHAREHOLDER'S DEFICIT
Current liabilities:
Accounts payable $ 25,986 $ 14,531
Accrued expenses 36,336 29,851
Payable to parent 341,917 327,138
Deferred revenue 6,030 993
Current portion of capital lease obligations 5,649 6,286
Current portion of long-term debt 12,091 3,212
----------- -----------
428,009 382,011
----------- -----------
Other liabilities -- 1,409
Capital lease obligations, less current portion 19,741 13,994
Long-term debt, less current portion 919,075 591,813
Minority interest -- 12,732
Commitments and contingencies
Shareholder's deficit:
Common shares:
200 shares authorized, 10 shares issued and outstanding, no 78,462 78,462
par value
Accumulated deficit (324,595) (201,405)
----------- -----------
(246,133) (122,943)
----------- -----------
Total liabilities and shareholder's deficit $ 1,120,692 $ 879,016
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 21
GST USA, INC.
and Subsidiaries
Consolidated Statements of Operations
(In thousands)
<TABLE>
<CAPTION>
THREE-MONTH
YEAR ENDED PERIOD ENDED YEARS ENDED
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
-------------------------------
1998 1997 1997 1996
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues:
Telecommunications and other services $ 152,168 $ 25,940 $ 80,234 $ 31,726
Product -- 7,300 21,982 9,573
--------- --------- --------- ---------
Total revenues 152,168 33,240 102,216 41,299
--------- --------- --------- ---------
Operating costs and expenses:
Network expenses 101,355 18,361 64,743 26,580
Facilities administration and maintenance 13,919 2,906 11,643 10,317
Cost of product revenues -- 2,328 7,141 3,974
Selling, general and administrative 90,136 21,322 69,152 30,901
Research and development -- 746 2,289 1,352
Depreciation and amortization 44,585 8,507 23,672 8,291
Special charges 30,580 -- -- --
--------- --------- --------- ---------
Total operating costs and expenses 280,575 54,170 178,640 81,415
--------- --------- --------- ---------
Loss from operations (128,407) (20,930) (76,424) (40,116)
--------- --------- --------- ---------
Other expenses (income):
Interest income (24,047) (4,077) (6,315) (4,927)
Interest expense, net of amounts capitalized 77,809 15,853 34,168 18,334
Gain on sale of subsidiary shares (61,266) -- (7,376) --
Other 2,287 139 139 2,289
--------- --------- --------- ---------
(5,217) 11,915 20,616 15,696
--------- --------- --------- ---------
Loss before minority interest
in (income) loss of subsidiaries (123,190) (32,845) (97,040) (55,812)
--------- --------- --------- ---------
Income tax expense:
Current -- 758 1,802 157
Deferred -- 92 (899) --
--------- --------- --------- ---------
-- 850 903 157
--------- --------- --------- ---------
Loss before minority interest in (income)
loss of subsidiaries (123,190) (33,695) (97,943) (55,969)
Minority interest in (income) loss of subsidiaries -- (472) (612) 411
--------- --------- --------- ---------
Net loss $(123,190) $ (34,167) $ (98,555) $ (55,558)
========= ========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 22
GST USA, INC.
and Subsidiaries
Consolidated Statements of Shareholder's (Deficit) Equity
(In thousands, except share amounts)
<TABLE>
<CAPTION>
TOTAL
COMMON SHARES ACCUMULATED SHAREHOLDER'S
SHARES AMOUNT DEFICIT (DEFICIT) EQUITY
--------- --------- ----------- ----------------
<S> <C> <C> <C> <C>
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 -- -- (55,558) (55,558)
--------- --------- --------- ---------
Balance, September 30, 1996 10 69,957 (68,683) 1,274
Capital transaction, sale of
subsidiary shares -- 8,416 -- 8,416
Net loss -- -- (98,555) (98,555)
--------- --------- --------- ---------
Balance, September 30, 1997 10 78,373 (167,238) (88,865)
Exercise of subsidiary stock
options -- 89 -- 89
Net loss -- -- (34,167) (34,167)
--------- --------- --------- ---------
Balance, December 31, 1997 10 78,462 (201,405) (122,943)
Net loss -- -- (123,190) (123,190)
--------- --------- --------- ---------
Balance, December 31, 1998 10 $ 78,462 $(324,595) $(246,133)
========= ========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 23
GST USA, INC.
and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
<TABLE>
<CAPTION>
THREE-MONTH YEARS ENDED
YEAR ENDED PERIOD ENDED SEPTEMBER 30,
DECEMBER 31, DECEMBER 31, ------------------------
1998 1997 1997 1996
----------- ----------- --------- ---------
<S> <C> <C> <C> <C>
Operations:
Net loss $(123,190) $ (34,167) $ (98,555) $ (55,558)
Adjustments to reconcile net loss to net cash
used in operations:
Minority interest in income (loss) of subsidiary -- 472 612 (411)
Depreciation and amortization 47,755 9,251 25,769 9,382
Deferred income taxes -- 92 (899) --
Accretion and accrual of interest 35,627 5,767 17,099 17,758
Non-cash stock compensation and other expense (343) 374 2,521 574
Loss on disposal of assets 10,139 -- 679 1,012
Loss on impairment of assets 19,549 -- -- --
Equity in losses of investments and joint venture -- -- -- 1,495
Gain on sale of subsidiary shares (61,266) -- (7,376) --
Changes in non-cash operating working capital:
Accounts receivable, net (15,444) (3,528) (10,148) (2,321)
Inventory -- (33) (384) (2,019)
Prepaid, other current and other assets, net 1,023 (2,727) (6,496) (4,176)
Accounts payable and accrued liabilities (1,000) (18,292) 25,672 2,315
Other liabilities 5,557 708 (119) 153
--------- --------- --------- ---------
Cash used in operations (81,593) (42,083) (51,625) (31,796)
--------- --------- --------- ---------
Investments:
Acquisition of subsidiaries, net of cash acquired (35,471) (2,105) (673) (1,441)
Purchase of investments -- (4,307) (3,247) (9,799)
Proceeds from sale of investments 308 -- 5,177 5,493
Purchase of property and equipment (218,027) (46,489) (223,921) (76,126)
Proceeds from sale of property and equipment 3,567 -- 5,774 8
Purchase of other assets (3,249) (1,688) (11,057) (7,575)
Change in investments restricted for the
purchase of property and equipment (170,288) 12,217 (59,776) (16,000)
Proceeds from the sale of subsidiary shares, net 85,048 141 27,105 --
Cash disposed of in sale of subsidiary (5,252) -- -- --
--------- --------- --------- ---------
Cash used in investing activities (343,364) (42,231) (260,618) (105,440)
--------- --------- --------- ---------
Financing:
Proceeds from long-term debt 300,955 7,729 353,258 175,897
Proceeds of debt payable to parent 13,738 214,353 86,828 --
Principal payments on long-term debt and capital (22,380) (10,087) (6,709) (1,544)
leases
Contributions from parent -- -- -- 9,009
Deferred debt financing costs (12,621) (87) (12,004) (8,480)
Change in investments restricted to finance interest
payments 33,374 15,083 (95,974) --
--------- --------- --------- ---------
Cash provided by financing activities 313,066 226,991 325,399 174,882
--------- --------- --------- ---------
Increase (decrease) in cash and cash
equivalents (111,891) 142,677 13,156 37,646
Cash and cash equivalents, beginning of period 197,373 54,696 41,540 3,894
--------- --------- --------- ---------
Cash and cash equivalents, end of period $ 85,482 $ 197,373 $ 54,696 $ 41,540
========= ========= ========= =========
</TABLE>
(Continued)
F-6
<PAGE> 24
GST USA, INC.
and Subsidiaries
Consolidated Statements of Cash Flows, continued
(In thousands)
<TABLE>
<CAPTION>
THREE-MONTH YEARS ENDED
YEAR ENDED PERIOD ENDED SEPTEMBER 30,
DECEMBER 31, DECEMBER 31, ----------------------------
1998 1997 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid for interest $ 50,190 $ 21,684 $ 4,982 $ 1,813
Cash paid for income taxes -- 1,038 638 --
Supplemental schedule of non-cash investing and
financing activities:
Recorded in business combinations:
Assets 45,719 2,605 1,052 45,477
Liabilities 10,248 500 379 11,665
Minority interest -- -- -- (2,686)
Common shares of parent -- -- -- 35,057
Disposition of subsidiary:
Assets 35,480 -- -- --
Liabilities 4,218 -- -- --
Minority interest 12,732 -- -- --
Amounts in accounts payable and accrued
liabilities for the purchase of fixed assets at
end of period 25,945 19,029 19,718 18,291
Assets acquired through capital leases 10,079 480 21,765 --
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE> 25
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except share amounts)
December 31, 1998 and 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF THE COMPANY
GST USA, Inc. (the Company or GST USA) 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, including long
distance, Internet and data services, and constructs telecommunication
networks for other providers. Upon formation of the Company in August
of 1994, GST transferred all of its operating subsidiaries and equity
investments to the Company.
As discussed in note 2, effective January 1, 1998, GST transferred to
the Company the businesses of Call America Business Communications,
Corp. (Call America) and TotalNet Communications, Inc. (TotalNet).
The financial statements included herein have been restated to reflect
the operations of Call America and TotalNet from the dates such
subsidiaries were acquired by GST. The financial statements have been
restated in order to conform with GST's presentation as the entities
are under common control.
CHANGE IN FISCAL YEAR-END
In 1997, the Company changed its fiscal year-end from September 30 to
December 31. Included in the accompanying audited financial statements
are the results of operations for the three-month transition period
ended December 31, 1997. Unaudited results of operations for the
comparable three-month period ended December 31, 1996 are summarized
below:
<TABLE>
<S> <C>
Revenues $ 23,217
Loss from operations (17,432)
Other expenses, net (4,034)
Income tax expense ---
Net loss (21,413)
</TABLE>
BASIS OF CONSOLIDATION
These 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. At December 31, 1998, the Company held no
investments accounted for pursuant to the equity method. All
significant intercompany accounts have been eliminated.
F-8
<PAGE> 26
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
CASH AND CASH EQUIVALENTS
Cash equivalents consist of short-term, highly liquid investments with
original maturities of ninety days or less.
ACCOUNTS AND NOTES RECEIVABLE AND CONCENTRATION OF RISK
Gross trade accounts receivable total $37,220 and $26,113 at December
31, 1998 and 1997, respectively. Notes receivable from customers total
$208 and $4,055 at December 31, 1998 and 1997, respectively. Management
provides an allowance for doubtful accounts and notes based on current
customer information and historical statistics. The allowance for
doubtful accounts was $5,482 and $3,956 at December 31, 1998 and 1997,
respectively.
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 and other
services customers accounted for approximately 16.4%, 17.8%, 21.4% and
46.9% of the Company's consolidated telecommunications and other
services revenue for the year ended December 31, 1998, the three-month
period ended December 31, 1997 and the years ended September 30, 1997
and 1996, respectively.
The Company relies on incumbent local exchange companies for the
provision of local telephone service. In addition, the Company relies
on other carriers to provide transmission and termination services for
a majority of its long distance traffic. The inability of any of these
companies or carriers to fulfill service delivery requirements could
impact the Company's future results.
RESTRICTED AND UNRESTRICTED INVESTMENTS
Restricted investments classified as available-for-sale consist
primarily of U.S. Treasury securities maturing between one and eight
months which are restricted for the purchase and installation of
network assets. Held-to-maturity investments consist of U.S. Treasury
securities and certificates of deposit maturing between four months and
eighteen months which are primarily restricted for interest payments.
Restricted investments are recorded at amortized cost which
approximates fair value for all periods presented.
Unrestricted available-for-sale investments consist U.S. government
securities and certificates of deposit at December 31, 1997.
F-9
<PAGE> 27
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Under Financial Accounting Standards Board (the FASB) Statement of
Financial Accounting Standards (SFAS) No. 115, Accounting for Certain
Investments in Debt and Equity Securities, GST USA classifies its
investments as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1998 1997
----------------------------
<S> <C> <C>
Restricted investments:
Available-for-sale $ 230,014 $ 62,484
Held-to-maturity 51,350 81,966
Unrestricted investments:
Available-for-sale --- 7,554
</TABLE>
MINORITY INTEREST
In March 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.
In February 1998, the Company sold its remaining interest in NACT for
net proceeds of $85,048, which resulted in a gain of $61,266.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost and are depreciated on the
straight-line basis over their estimated useful lives, which are as
follows:
<TABLE>
<S> <C>
Telecommunications networks 20 years
Electronic and related equipment 10 years
Leasehold improvements 10 years
Computer equipment, office equipment and other 3 - 7 years
Buildings 40 years
</TABLE>
F-10
<PAGE> 28
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Construction, engineering and overhead costs directly related to the
development of the Company's networks are capitalized. The Company
capitalizes internal information systems costs in accordance with
Statement of Position 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. The Company begins
depreciating these costs when the assets become operational.
Depreciation expense totaled $29,771, $6,152, $14,844 and $5,559 for
the year ended December 31, 1998, the three-month period ended December
31, 1997 and the years ended September 30, 1997 and 1996, respectively.
GOODWILL
Goodwill is amortized using the straight-line method over periods
ranging from five to ten years. Amortization charged to operations was
$5,804, $944, $3,894 and $1,690 for the year ended December 31, 1998,
the three-month period ended December 31, 1997 and the years ended
September 30, 1997 and 1996, respectively.
ASSET IMPAIRMENT
The Company reviews long-lived assets, goodwill and certain
identifiable intangibles for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable.
During 1998, the Company recorded a non-cash special charge of $3,881
related to the impairment of certain long-lived assets associated with
the Company's shared tenant services operations. The impaired assets
primarily consist of customer lists and electronic and related
equipment. As the projected future cash flows were less than the
assets' carrying value, an impairment loss was recognized. The
impairment loss was measured as the amount by which the carrying amount
of the assets exceeded the estimated fair value of the assets, which
was determined based on current market prices for similar assets.
As discussed in note 11, the Company also recorded a non-cash special
charge of $15,668 during 1998 related to the impairment of a prepaid
reseller agreement and advances to Magnacom Wireless LLC.
REVENUE RECOGNITION
Telecommunication services revenue is recognized monthly as services
are provided. Amounts billed in advance of the service month are
recorded as deferred revenue. Network construction services revenue is
recognized using the percentage of completion method. Accordingly, the
Company recognizes revenues and expenses as construction progresses.
Included in other current assets are costs and income in excess of
billings relating to certain contracts.
F-11
<PAGE> 29
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
NET 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 ten for all periods, loss per share information is not meaningful
and is not presented in the accompanying consolidated financial
statements.
ISSUANCE OF SUBSIDIARY STOCK
Issuances of subsidiary stock are accounted for as capital transactions
in the accompanying consolidated financial statements.
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
basis 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 year
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.
COMPREHENSIVE INCOME
The Company adopted SFAS No. 130, Reporting Comprehensive Income, on
January 1, 1998. Comprehensive income is defined as changes in
stockholders' equity exclusive of transactions with owners such as
capital contributions and dividends. There are no differences between
net loss and comprehensive loss for all periods presented.
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.
F-12
<PAGE> 30
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
ADVERTISING COSTS
The Company expenses advertising costs as incurred.
RECLASSIFICATIONS
Certain reclassifications have been made in the accompanying
consolidated financial statements for December 31, 1997 and September
30, 1997 and 1996 to conform with the December 31, 1998 presentation.
(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.
ICON COMMUNICATIONS CORP. (ICON)
In April 1998, the Company acquired 100% of the outstanding capital
stock of ICON, a Washington company which provides long distance and
ancillary communications services. Consideration paid for this
acquisition consisted of $23,916 in cash. Goodwill of $15,957 was
recorded as a result of this acquisition.
KLP, INC. (D/B/A CALL AMERICA) (CALL AMERICA PHOENIX)
In March 1998, the Company acquired 100% of the outstanding capital
stock of Call America Phoenix, an Arizona company which provides long
distance services. Consideration paid for this acquisition consisted of
$3,838 in cash. Goodwill of $2,405 was recorded as a result of this
acquisition.
WHOLE EARTH NETWORKS, LLC (WHOLE EARTH)
In March 1998, the Company acquired the business of Whole Earth, a
California Internet services provider. Consideration paid for this
acquisition consisted of $9,053 in cash and the assumption of $1,273 in
liabilities. Goodwill of $3,293 was recorded as a result of this
acquisition.
F-13
<PAGE> 31
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
.
PHOENIX FIBER ACCESS, INC. (PHOENIX FIBER)
In December 1996, 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.
CALL AMERICA BUSINESS COMMUNICATIONS, CORP. (CALL AMERICA)
In September 1996, GST acquired 100% of the outstanding capital stock
of Call America, a California company that provides long distance and
ancillary communications services. GST acquired Call America for
consideration of 1,443,505 common shares of GST valued at $16,311.
Additionally, $415 in notes receivable due from the former owners of
Call America will be forgiven if certain operating milestones are met
over the next 8 years. Goodwill of $11,581 was recorded as a result of
this acquisition. Effective January 1, 1998, GST transferred the
ownership of Call America to the Company.
TOTALNET COMMUNICATIONS, INC. (TOTALNET)
In September 1996, GST acquired 100% of the outstanding capital stock
of TotalNet, a long distance service provider. GST acquired TotalNet
for consideration of 703,229 common shares of GST valued at $8,814.
Goodwill of $5,717 was recorded as a result of this acquisition.
Effective January 1, 1998, GST transferred ownership of TotalNet to the
Company.
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
former Chairman and Chief Executive Officer of the Company. Goodwill of
$15,330 was recorded as a result of this acquisition.
F-14
<PAGE> 32
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
OTHERS
In October 1997, the Company purchased the assets of the Guam
operations of Sprint Communications Company L.P. (Sprint) which provide
long distance and ancillary services in Guam. Consideration paid for
this acquisition consisted of $2,000 in cash and $500 in liabilities
for services to be provided to Sprint.
In May 1996, the Company purchased from Tomen America, Inc. (Tomen) the
remaining 10% interest in 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 (Hawaii OnLine), the assets of Texas-Ohio Communications,
Inc. (Texas-Ohio), and 100% of the outstanding capital stock of
Tri-Star Residential Communications, Inc. (Tri-Star). Hawaii OnLine is
an Internet service provider; Texas-Ohio 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 266,519 common shares of GST valued at
$2,463, and $719 of cash. Goodwill of $1,044 was recorded as a result
of these acquisitions.
The unaudited pro forma results shown below reflect results of
operations as if the 1998 and 1997 acquisitions described above
occurred as of the beginning of each of the periods presented.
<TABLE>
<CAPTION>
THREE-MONTH
YEAR ENDED PERIOD ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
1998 1997 1997
------------ ------------ -------------
<S> <C> <C> <C>
Revenues $ 156,407 $ 37,503 $ 120,973
Net loss (123,736) (34,299) (100,388)
</TABLE>
The pro forma results are not necessarily indicative of what actually
would have occurred had the acquisitions been in effect for the entire
periods presented. In addition, they are not intended to be a
projection of future results that may be achieved from the combined
operations.
F-15
<PAGE> 33
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
(3) PROPERTY AND EQUIPMENT
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1998 1997
--------- ---------
<S> <C> <C>
Telecommunications networks $ 178,008 $ 132,028
Electronic and related equipment 181,769 68,380
Leasehold improvements 24,508 21,671
Computer equipment, office equipment and other 40,361 14,777
Buildings 2,803 3,366
Construction in progress 251,353 192,888
--------- ---------
678,802 433,110
Less accumulated depreciation (62,116) (26,670)
--------- ---------
$ 616,686 $ 406,440
========= =========
</TABLE>
Property and equipment includes $251,353 and $192,888 of assets which
had not been placed in service at December 31, 1998 and 1997,
respectively, and accordingly, was not being depreciated. During the
year ended December 31, 1998, the three-month period ended December 31,
1997 and the years ended September 30, 1997 and 1996, $25,920, $3,726,
$15,170 and $2,316 of interest, respectively, was capitalized as part
of property and equipment.
(4) ACCRUED EXPENSES
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1998 1997
------- -------
<S> <C> <C>
Fixed asset purchases $ 9,552 $12,157
Carrier costs 4,885 98
Interest payable 9,098 7,966
Payroll and related liabilities 5,107 2,595
Other 7,694 7,035
------- -------
Total $36,336 $29,851
</TABLE>
F-16
<PAGE> 34
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
(5) LONG-TERM DEBT
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1997
-------- --------
<S> <C> <C> <C>
13.25% senior secured notes due May 1, 2007 $265,000 $265,000
10.5% senior secured discount notes due May 1, 2008 320,997 --
Note payable to Tomen, LIBOR plus 3.0%
(8.1% at December 31, 1998) 45,262 61,793
Note payable to NTFC, LIBOR plus 3.5%
(8.6% at December 31, 1998) 50,000 50,000
Note payable to Siemens, LIBOR plus 3.5 %
(8.6% at December 31, 1998) 9,463 7,889
13.875% senior discount notes due December 15, 2005 240,304 210,136
Other 140 207
-------- --------
931,166 595,025
Less current portion of long-term debt 12,091 3,212
-------- --------
$919,075 $591,813
======== ========
</TABLE>
The schedule of future principal payments on long-term debt is as
follows:
<TABLE>
<S> <C>
Year ending December 31:
1999 $ 12,091
2000 17,041
2001 20,216
2002 20,898
2003 21,132
Thereafter (a) 1,090,936
-----------
Less unaccreted discount (251,148)
-----------
$ 931,166
===========
</TABLE>
(a) Includes $500,000 and $312,448 of 10.5% senior secured discount
notes and 13.875% senior discount notes, respectively, due at maturity.
F-17
<PAGE> 35
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
SENIOR SECURED NOTES
In May 1997, the Company issued $265,000 in senior secured notes (the
Secured Notes) due May 1, 2007. The Secured Notes bear interest at a
rate of 13.25% with semiannual interest payments due beginning November
1, 1997. Approximately $93,790 of the proceeds were set aside to fund
the first six scheduled interest payments. The remainder of the net
proceeds were restricted to finance the cost of design, development,
construction, acquisition, installation and integration of
telecommunications equipment. The Secured Notes are secured by the
assets financed with the proceeds and are subject to certain debt
covenants.
SENIOR SECURED DISCOUNT NOTES
In May 1998, the Company issued $300,000 in 10.5% senior secured
discount notes (the Senior Secured Discount Notes) maturing on May 1,
2008. The Senior Secured Discount Notes were sold at a substantial
discount and there will be no accrual of cash interest prior to May 1,
2003, or payment of interest until November 1, 2003. The Senior Secured
Discount Notes accrete to a total principal amount, due May 1, 2008, of
approximately $500,000. The net proceeds from the sale of the Senior
Secured Discount Notes are restricted to finance the cost of design,
development, construction, acquisition, installation and integration of
telecommunications equipment. The Senior Secured Discount Notes are
secured by the assets financed with the proceeds and are subject to
certain debt covenants.
The Company is a party to a registration rights agreement relating to
the Senior Secured Discount Notes whereby it agreed to consummate an
exchange offer for the Senior Secured Discount Notes pursuant to an
effective registration statement or cause the Senior Secured Discount
Notes to be registered under the Securities Act of 1933, as amended,
pursuant to a shelf registration statement by November 4, 1998.
Although the Company has filed a registration statement on Form S-4
with respect to an exchange offer for the Senior Secured Discount
Notes, it has not yet been declared effective. Therefore, in accordance
with the terms of the registration rights agreement, interest (in
addition to the accrual of original issue discount and interest
otherwise due on the Senior Secured Discount Notes after such date) on
the Senior Secured Discount Notes accrue at an annual rate of 0.5%,
beginning November 4, 1998, and are payable in cash semiannually in
arrears, on each May 1 and November 1, commencing May 1, 1999, until
such exchange offer is consummated or a shelf registration statement is
declared effective. At December 31, 1998, the Company had accrued $396
in additional interest related to the Senior Secured Discount Notes.
F-18
<PAGE> 36
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
TOMEN FACILITY
In October 1994, the Company entered into a master financing agreement
with 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 December 31, 1998, Tomen had provided a total of
$69,468 (of which $45,262 was outstanding at December 31, 1998) in debt
financing to the Company's subsidiaries for construction and operation
of fiber optic networks in southern California, New Mexico, Arizona and
Hawaii. The Tomen financing is secured by equipment at the funded
network locations and is subject to certain debt covenants.
NTFC CAPITAL CORPORATION (NTFC) AGREEMENT
In March 1997, the Company entered into a $50,000 (all of which was
outstanding at December 31, 1998) loan and security agreement with 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
March 1999. The loan is secured by the equipment purchased with the
proceeds and subject to certain debt covenants.
SIEMENS TELECOM NETWORKS (SIEMENS) AGREEMENT
In September 1996, the Company entered into a loan and security
agreement with 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 December 31,
1998, $116,000 was available to the Company and $9,463 was outstanding.
Amounts borrowed under the agreement initially bear interest at LIBOR
plus 4.5% and are 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. 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.
SENIOR DISCOUNT NOTES
In December 1995, 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 is 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, due December 15, 2005, of approximately $312,400 by
December 15, 2000. The Senior Notes rank in right of payment with all
unsubordinated indebtedness of the Company. On or after December 15,
2000, the Senior Notes will be redeemable at the option of the Company.
The Senior Notes are subject to certain debt covenants and are
guaranteed by GST.
F-19
<PAGE> 37
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
GUARANTEE OF PARENT'S DEBT
The Company has guaranteed GST's Convertible Senior Subordinated
Discount Notes (the Convertible Notes) totaling approximately $29,884
at December 31, 1998. The Convertible Notes accrete to a total
principal amount, due December 15, 2005, of approximately $38,856 by
December 15, 2000. On or after December 15, 2000, the Convertible Notes
will be redeemable at the option of the Company and GST. The
Convertible Notes are subject to certain debt covenants.
DEBT COVENANTS AND CLASSIFICATION OF LONG TERM DEBT
In November 1998, the Company informed the Trustee who represents the
holders of the Senior Secured Notes, the Senior Secured Discount Notes,
the Senior Notes, and the Convertible Notes that it may have violated
certain technical covenants contained in the indentures related to each
of the aforementioned debt issuances. In February 1999, the Trustee
informed the note holders of the potential violations. The note holders
have not declared a default, as defined within the indentures of each
of the notes. The Company has classified the related debt obligations
as non-current in the accompanying consolidated balance sheets as
management believes it is probable that, in the event the note holders
declare a default, the Company would be able to take corrective actions
to cure, within the prescribed grace period, those technical violations
deemed objectively-determinable.
(6) SHAREHOLDER'S (DEFICIT) EQUITY
COMMON STOCK
Since inception, GST has owned all of the outstanding shares of the
Company.
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.
STOCK-BASED COMPENSATION
Certain employees of the Company are eligible for stock option and
stock bonus awards of GST's common stock. Pursuant to performance-based
awards, compensation cost recognized in the statements of operations
for the year ended December 31, 1998, the three-month period ended
December 31, 1997 and the years ended September 30, 1997 and 1996
totaled $(447), $374, $2,521 and $574, respectively.
F-20
<PAGE> 38
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
(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 for
the year ended December 31, 1998, the three-month period ended December
31, 1997 and the years ended September 30, 1997 and 1996 as follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1997 1996
------------ ------------ ------------- -------------
<S> <C> <C> <C> <C>
Computed expected income tax expense
(benefit) at statutory rate (34)% (34)% (34)% (34)%
Expected state income tax
expense (benefit) (4) (4) (4) (4)
Increase in valuation allowance 38 37 36 20
Amortization of goodwill 1 1 1 1
Equity method accounting
for joint venture -- -- -- 1
Effect of acquisition of new subsidiaries 1 -- -- 11
Non-deductible interest -- 2 2 2
Other (2) 1 -- 3
--- --- --- ---
Income tax expense --% 3% 1% --%
=== === === ===
</TABLE>
F-21
<PAGE> 39
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
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>
DECEMBER 31,
---------------------
1998 1997
---------- -------
<S> <C> <C>
Deferred tax assets:
Federal and state net operating
loss carryforwards $ 76,201 $ 53,530
Non-deductible interest 39,199 11,998
Other 3,320 4,484
---------- -------
Total gross deferred tax assets 118,720 70,012
Less valuation allowance (109,481) (61,581)
---------- -------
Total deferred tax assets 9,239 8,431
---------- -------
Deferred tax liabilities:
Furniture, fixtures and equipment,
due to differences in depreciation 6,217 5,376
Capitalized software/intangibles 3,022 3,490
---------- -------
Total gross deferred tax
liabilities 9,239 8,866
---------- -------
Net deferred tax liabilities $ --- $ (435)
========== =======
</TABLE>
The valuation allowance for deferred tax assets as of October 1, 1995
was $4,201. The net change in total valuation allowance for the year
ended December 31, 1998, the three-month period ended December 31, 1997
and for the years ended September 30, 1997 and 1996 was an increase of
$47,900, $12,133, $34,062 and $11,185, respectively.
F-22
<PAGE> 40
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
The Company has net operating losses for income tax purposes of
approximately $208,864 available to reduce United States taxable income
of future years, expiring as follows:
<TABLE>
<S> <C>
2006 $ 405
2007 537
2008 2,800
2009 5,020
2010 36,922
2011 64,283
2017 36,600
2018 62,297
---------
$208,864
=========
</TABLE>
Approximately 58% of these net operating losses may be utilized for
state income tax purposes.
Utilization of net operating losses may be subject to limitation in the
event of certain substantial stock ownership changes pursuant to IRC
Section 382 and referred to hereinafter as an ownership change. An
ownership change would limit the utilization of any net operating
losses incurred prior to the change in ownership date. The Company has
completed an analysis under IRC Section 382 and has determined that no
ownership change has occurred.
(8) LEASES
The Company is obligated under capital lease agreements for equipment
and network facilities which expire at various dates during the next
twenty years. Certain of these agreements contain clauses which allow
the lessor to cancel the agreement upon twelve-month written notice.
However, the Company believes that the likelihood of such clauses being
exercised is remote. Gross amounts of assets and related accumulated
amortization recorded under capital leases were as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1998 1997
-------- -------
<S> <C> <C>
Network facilities and equipment $ 33,540 $27,003
Less accumulated amortization (9,307) (6,408)
-------- -------
$ 24,233 $20,595
======== =======
</TABLE>
Amortization of assets held under capital leases is included in
depreciation expense.
F-23
<PAGE> 41
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
The Company also has noncancelable operating leases, primarily for
facilities, which expire over the next five years. Rental expense under
operating leases was $6,159, $1,114, $3,385, and $1,501 for the year
ended December 31, 1998, the three-month period ended December 31, 1997
and the years ended September 30, 1997 and 1996, respectively.
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 December 31, 1998 are:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------- ---------
<S> <C> <C>
Year ending December 31:
1999 $10,661 $ 5,331
2000 7,430 4,266
2001 4,043 3,522
2002 3,476 3,422
2003 3,229 3,217
Thereafter 12,578 9,417
------- -------
Total minimum lease payments 41,417 $29,175
------- =======
Less amounts representing interest (at rates
ranging from 9% to 17%) 16,027
-------
Net minimum lease payments 25,390
Less current portion of obligations under capital leases 5,649
-------
Obligations under capital leases, excluding current
portion $19,741
=======
</TABLE>
F-24
<PAGE> 42
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
(9) COMMITMENTS AND CONTINGENCIES
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.
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with key members of
management. These agreements provide for certain payments in the event
of death, disability and change of control. The agreements also contain
covenants not to compete.
CONSTRUCTION CONTRACTS
The Company has entered into an agreement to jointly construct a
longhaul fiber and conduit network system. Pursuant to the agreement,
the Company is committed to pay approximately $50,000 in construction
costs during 1999. The Company is party to various other construction
contracts arising in the ordinary course of business
(10) LEGAL PROCEEDINGS
(a) GLOBAL AND CURRENT AND FORMER OFFICERS AND DIRECTORS
On October 20, 1998, GST and GST Telecom, filed a Complaint in the
Superior Court of California, County of Santa Clara, against Global and
six current and former GST officers and directors (the Defendants). The
Complaint includes claims for fraud, negligent misrepresentation,
unjust enrichment, and unfair competition primarily related to the
alleged misappropriation of a Mexican business opportunity. The
complaint seeks an accounting, a constructive trust, and restitution of
GST's interest in the opportunity and also seeks unspecified exemplary
and punitive damages and attorneys' fees.
On December 23, 1998, Defendants filed a motion to stay or dismiss the
action on grounds of inconvenient forum, and four of the individual
defendants filed a motion to dismiss the action for lack of personal
jurisdiction. The Superior Court granted Defendants' motion to stay the
proceedings on February 5, 1999, and GST and GST Telecom filed a notice
of appeal on February 9, 1999.
F-25
<PAGE> 43
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
On January 27, 1999, Global and GST Mextel, Inc. ("Mextel") filed a
Complaint in the Supreme Court of British Columbia, against GST and GST
Telecom. The Complaint, which arises from the same matters for which
GST and GST Telecom brought such against Global et al. in the Superior
Court of California, includes claims for declaratory and injunctive
relief and unspecified general and special damages. GST denies
liability, and will vigorously dispute the allegations in the
Complaint.
On January 28, 1999, five current or former GST officers or directors
filed a Complaint in the Supreme Court of British Columbia against GST,
GST Telecom and four current GST directors. The Complaint, which arises
from the same matters for which GST and GST Telecom brought such
against Global, et al, in the Superior Court of California, includes
claims for oppression and declaratory relief, and seeks unspecified
actual and punitive damages, cost, and attorneys' fees. GST and its
directors deny liability, and will vigorously dispute the allegations
in the Complaint.
(b) DIRECTOR AND FORMER COUNSEL
On December 16, 1998, GST, GST USA and GST Telecom filed a Complaint in
the United States District Court, Southern District of New York,
against a current director and a law firm which previously represented
the Company as general counsel. The Complaint includes claims for
professional negligence, breach of fiduciary duty, and breach of
contract, and seeks compensatory damages and attorneys' fees.
On February 12, 1999, the current director filed his Answer to the
Complaint. The law firm filed its Answer and Counterclaims to the
Complaint on February 17, 1999. The law firm counterclaimed against
GST, GST USA and GST Telecom for breach of contract, unjust enrichment,
quantum meruit, and "account stated," based on invoices submitted to
GST of approximately $250. No trial date has been set.
(c) FORMER CHAIRMAN AND CHIEF EXECUTIVE OFFICER
On January 25, 1999, GST's former Chairman and Chief Executive Officer,
filed a Complaint in the Superior Court of Washington, King County,
against GST, GST USA and GST Telecom. The Complaint, which relates to
the circumstances under which the former Chairman and Chief Executive
Officer ceased to serve as an officer and director of GST, includes
claims for breach of employment agreement, breach of the covenant of
good faith and fair dealing, violation of wage statutes, and indemnity.
F-26
<PAGE> 44
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
On February 23, 1999, GST answered by denying all liability and filed
counterclaims against the former Chairman and Chief Executive Officer,
Global and five other current or former officers and directors for
liability with respect to the matters leading to the termination of the
former Chairman and Chief Executive Officer's employment. In
particular, GST seeks recovery under Washington law for matters
described in note 10(a), above, as well as for breaches committed with
respect to the wrongful use of GST funds for the purchase of
telecommunications licenses.
(d) FORMER TREASURER
On February 9, 1999, GST filed a Complaint in the Superior Court for
the State of Washington, Clark County, against the former treasurer of
the Company. The Complaint is based on alleged misconduct and includes
claims for fraud, breach of fiduciary duty, unjust enrichment, and
unfair business practices, and seeks an accounting, imposition of a
constructive trust, compensatory damages, costs of suit, attorneys'
fees, and treble damages. In particular, the Complaint seeks relief
based on misuse of insider information in the purchase of stock,
wrongful disbursements to third parties, and involvement in a
fraudulent release of GST stock from escrow. The defendant has not yet
responded to the Complaint.
Pursuant to the guidance set forth in SFAS 5, Accounting for
Contingencies, the Company has accrued certain loss provisions related
to the legal proceedings detailed above. In the opinion of management,
the ultimate disposition of such matters will not have a material
adverse effect on the Company's consolidated financial position,
results of operations or cash flows.
The Company is also 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 consolidated financial position,
results of operations or cash flows.
F-27
<PAGE> 45
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
(11) RELATED PARTY TRANSACTIONS
MAGNACOM WIRELESS, LLC (MAGNACOM)
In 1996, the Company and Magnacom, a company owned by the Company's
former Chairman and Chief Executive Officer, entered into a reseller
agreement pursuant to which (i) the Company was to become a reseller of
PCS services in markets in which Magnacom had obtained FCC licenses and
(ii) Magnacom was to use the Company to provide switched local and long
distance services in markets where the Company had operational
networks. Pursuant to such agreement, the Company paid Magnacom $200,
$0, $8,403 and $5,997 during the year ended December 31, 1998, the
three months ended December 31, 1997, and the years ended September 30,
1997 and 1996, respectively. In addition, the Company made operating
advances to Magnacom of $925, $91 and $52 during the year ended
December 31, 1998, the three months ended December 31, 1997 and the
year ended September 30, 1997, respectively.
In October 1998, Magnacom filed a petition for reorganization under
Chapter 11 of the United States Bankruptcy Code. As a result, the
Company wrote-off all amounts previously paid to Magnacom in the third
quarter of 1998. The total write-off of approximately $15,668 is
included in special charges in the accompanying consolidated statement
of operations for the year ending December 31, 1998. The transactions
with Magnacom form the basis for certain of the legal proceedings
described in notes 10(b), 10(c) and 10(d).
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 former Chairman and 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.
F-28
<PAGE> 46
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
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 up
front fee of 1.50% of the aggregate principal amount of each project
loan advanced 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 1,586,595 shares
of GST common stock for total cash consideration of $10,400 and holds a
warrant to purchase an additional 75,000 shares of GST common stock at
$12.61 per share, expiring in September 1999.
OTHER
The Company and GST paid approximately $1,929, $104, $2,066 and $2,264
in legal fees during the year ended December 31, 1998, the three-month
period ended December 31, 1997 and the years ended September 30, 1997
and 1996, respectively, to a law firm having a member who is a director
of the Company. As noted in note 10(b), the Company is currently in
litigation with both the director and the related law firm.
Prior to June 1997, the Company's former Chairman and Chief Executive
Officer served as a paid consultant to Tomen. Additionally, Pacwest
received a fee equal to 1% of the aggregate debt and equity financing
provided by Tomen to the Company through October 1997. Such fees
incurred by the Company totaled $437 and $195 during the years ended
September 30, 1997 and 1996.
Receivables from parent are primarily comprised of expenses paid by the
Company on behalf of GST.
Payables to parent represent advances from GST to be used in
constructing and operating the Company's telecommunications networks
and the fair value of net assets transferred in certain business
combinations.
F-29
<PAGE> 47
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
(12) SEGMENTS
The Company has adopted SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. As an integrated communications
provider, the Company has one reportable operating segment. While the
Company's chief decision-makers monitor the revenue streams of various
services, operations are managed and financial performance is evaluated
based upon the delivery of multiple services over common network and
facilities. This allows the Company to leverage its network costs in an
effort to maximize return. As a result, there are many shared expenses
generated by the various revenue streams; because management believes
that any allocation of the expenses to multiple revenue streams would
be impractical and arbitrary, management does not currently make such
allocations internally. The chief decision-makers do, however, monitor
revenue streams at a more detailed level than those depicted in the
Company's historical general purpose financial statements. The
following table presents revenues by service type:
<TABLE>
<CAPTION>
THREE-MONTH YEARS ENDED
YEAR ENDED PERIOD ENDED SEPTEMBER 30,
DECEMBER 31, DECEMBER 31, ------------------
1998 1997 1997 1996
------------ ------------ -------- -------
<S> <C> <C> <C> <C>
Local services $ 48,200 $ 7,034 $ 16,993 $ 3,934
Long distance services 59,919 10,997 42,622 17,205
Data services 8,770 1,100 2,000 --
Internet services 8,404 1,013 3,006 1,311
Longhaul services 23,499 4,883 12,057 9,068
Product -- 7,300 21,982 9,573
Other 3,376 913 3,556 208
-------- ------- -------- -------
Total revenue $152,168 $33,240 $102,216 $41,299
======== ======= ======== =======
</TABLE>
Substantially all of the Company's revenue is attributable to customers
in the United States. Additionally, all significant operating assets
are located within the United States.
(13) SPECIAL CHARGES
Special charges for the year ended December 31, 1998 consist of (i) a
$15,668 write-off of amounts paid to Magnacom (see note 12), (ii)
$13,799 in charges for abandoned and impaired projects resulting from a
change in the Company's strategic direction to focus on its core,
domestic-based business, and (iii) $1,113 in costs related primarily to
the severance of former members of management. Of such items, only the
severance costs are accrued on the Company's balance sheet at December
31, 1998, and the Company expects that such costs will be paid out in
the first quarter of 1999.
F-30
<PAGE> 48
GST USA, INC.
and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
(14) FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts reported in the balance sheet for cash and cash
equivalents, accounts and notes receivable, accounts payable and
accrued expenses approximate fair values due to the short term
maturities of those instruments. The carrying amounts for current and
non-current restricted investments approximate fair value due to the
composition of such investments and the related maturities. The
carrying amount of unrestricted investments is based upon fair value as
determined by quoted market prices.
The following table details the carrying amounts and estimated fair
values of publicly traded long-term debt (the financial instruments for
which carrying value and estimated fair value differ at December 31,
1998):
<TABLE>
<CAPTION>
DECEMBER 31, 1998
---------------------
CARRYING FAIR
AMOUNT VALUE
-------- --------
<S> <C> <C>
Long-term debt:
Senior secured notes, 13.25% $265,000 $273,933
Senior secured discount notes, 10.5% 320,997 239,555
Senior discount notes, 13.875% 240,304 228,415
</TABLE>
The fair value of publicly traded long-term debt is estimated based on
quoted market prices. For substantially all other long-term debt,
carrying amounts approximate fair values as incremental borrowings
available to the Company are at similar rates and 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 impact the
estimates.
F-31
<PAGE> 49
GST USA, INC.
Financial Statement Schedule
December 31, 1998 and 1997
(With Independent Auditors' Report Thereon)
<PAGE> 50
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholder
GST USA, Inc.:
Under date of March 1, 1999, we reported on the consolidated balance sheets of
GST USA, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of operations, shareholder's (deficit) equity, and cash
flows for the year ended December 31, 1998, the three-month period ended
December 31, 1997, and for each of the years in the two-year period ended
September 30, 1997, which are included in the annual report on Form 10-K for the
year ended December 31, 1998. In connection with our audits of the
aforementioned consolidated financial statements, we also have audited the
related consolidated financial statement schedule as listed in the accompanying
index. This financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion on this financial
statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information set forth therein.
/s/ KPMG Peat Marwick LLP
Portland, Oregon
March 1, 1999
<PAGE> 51
GST USA, Inc.
Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
Balance at Charged Written off Balance at
beginning to bad debt against end
Allowance for doubtful accounts of period expense expense of period
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Year ended December 31, 1998 3,956 4,647 3,121 5,482
Three months ended December 31, 1997 3,567 1,541 1,152 3,956
Year ended September 30, 1997 1,264 5,722 3,419 3,567
Year ended September 30, 1996 1,402 1,809 1,947 1,264
</TABLE>
S-2
<PAGE> 52
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 30th day of March, 1999.
GST USA, INC.
By: /s/ Robert A. Ferchat
--------------------------
Robert A. Ferchat
Chairman of the Board
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Robert A. Ferchat, Joseph A. Basile, Jr.,
Jack G. Armstrong and Daniel L. Trampush 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 March 30, 1999.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
/s/ Robert A. Ferchat Chairman of the Board and Director
- - -------------------------------
(Robert A. Ferchat)
/s/ Joseph A. Basile, Jr. President, Chief Executive Officer (Principal
- - ------------------------------- Executive Officer) and Director
(Joseph A. Basile, Jr.)
/s/ Jack G. Armstrong Director
- - -------------------------------
(Jack G. Armstrong)
/s/ Daniel L. Trampush Senior Vice President and Chief Financial
- - ------------------------------- Officer (Principal Financial Officer)
(Daniel L. Trampush)
</TABLE>
<PAGE> 53
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
- - -------
<S> <C>
*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.
#4(d) Indenture dated as of May 4, 1998 by and among GST Telecommunications,
GST USA, Inc., GST Network Funding, Inc. and the United States Trust
Company of New York, as trustee.
##10(a) Stock Purchase Agreement dated December 31, 1997 by and among GST
Telecommunications, Inc., GST USA, Inc. and World Access, Inc.,
incorporated by reference to Exhibit 99.2 to GST's Form 8-K dated
January 6, 1997.
#10(b) Placement Agreement dated April 29, 1998 by and among GST
Telecommunications, Inc., GST USA, Inc., GST Network Funding, Inc., and
several Placement Agents named in Schedule I thereto.
#10(c) Registration Rights Agreement dated May 4, 1998 by and among GST
Telecommunications, Inc., GST USA, Inc., GST Network Funding, Inc. and
Morgan Stanley & Co. Incorporated, Bear, Stearns & Co. Inc., Credit
Suisse First Boston Corporation and SBC Warburg Dillon Read Inc.
#10(d) Collateral Pledge and Security Agreement dated as of May 4, 1998 from
GST Network Funding, Inc. to United States Trust Company of New York,
as trustee.
#10(e) Reimbursement and Commitment Fee Agreement dated May 4, 1998 among GST
Telecommunications, Inc., GST USA, Inc. and GST Network Funding, Inc.
###27 Financial Data Schedule.
</TABLE>
- - -------------------
* 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.
# Incorporated by reference to GST's Form 8-K filed May 19, 1998.
## Incorporated by reference to Exhibit 99.2 to GST's Form 8-K dated
January 6, 1998.
### 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 December 31, 1998 and is qualified in its entirety
by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 85,481,863
<SECURITIES> 34,107,077
<RECEIVABLES> 37,427,647
<ALLOWANCES> (5,481,222)
<INVENTORY> 0
<CURRENT-ASSETS> 163,196,353
<PP&E> 678,801,978
<DEPRECIATION> (62,116,080)
<TOTAL-ASSETS> 1,120,692,900
<CURRENT-LIABILITIES> 428,010,270
<BONDS> 826,300,424
0
0
<COMMON> 0
<OTHER-SE> (324,594,711)
<TOTAL-LIABILITY-AND-EQUITY> 1,120,692,900
<SALES> 152,167,698
<TOTAL-REVENUES> 152,167,698
<CGS> 101,355,391
<TOTAL-COSTS> 280,575,114
<OTHER-EXPENSES> 83,026,376
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 77,809,036
<INCOME-PRETAX> (123,190,076)
<INCOME-TAX> 0
<INCOME-CONTINUING> (123,190,076)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (123,190,076)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
