UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 1999
Commission file number 0-23139
RSL COMMUNICATIONS, LTD.
------------------------
(Exact name of the registrant as specified in its charter)
Bermuda N/A
------- ---
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) identification No.)
Clarendon House
Church Street
Hamilton HM CX Bermuda
----------------------
(Address of principal executive offices)
(441) 295-2832
(Registrant's telephone number)
-------------------------------
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 |_|
As of November 5, 1999, the registrant had 30,628,908 of its Class A common
stock, par value $0.00457 per share, and 24,267,283 of its Class B common stock,
par value $0.00457 per share, outstanding.
<PAGE>
RSL COMMUNICATIONS, LTD.
Table of Contents
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
September 30, 1999 (Unaudited) and December 31, 1998.............. 1
Condensed Consolidated Statements of Operations for the
Three Month and Nine Month Periods Ended September 30, 1999
(Unaudited) and 1998 (Unaudited).................................. 2
Condensed Consolidated Statements of Cash Flows for the Nine Month
Periods Ended September 30, 1999 (Unaudited) and 1998 (Unaudited). 3
Notes to Condensed Consolidated Financial Statements.................. 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ................................... 7
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......21
PART II - OTHER INFORMATION
Item 1. Legal Proceedings...............................................22
Item 2. Change in Securities and Use of Proceeds........................22
Item 4. Submission of Matters to a Vote of Security Holders.............22
Item 5. Other Information...............................................22
Item 6. Exhibits and Reports on Form 8-K................................23
Signatures...................................................................25
Exhibit Index................................................................26
<PAGE>
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements.
RSL COMMUNICATIONS, LTD.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
As of As of
September 30, December 31,
1999 1998
----------- -----------
(unaudited)
<S> <C> <C>
Assets
Cash and Cash Equivalents $ 235,011 $ 367,823
Accounts Receivable, Net 258,994 181,845
Marketable Securities - Available for Sale 102,661 98,637
Prepaid Expenses and Other Current Assets 110,844 77,772
----------- -----------
Total Current Assets 707,510 726,077
----------- -----------
Restricted Marketable Securities - Held to Maturity -- 20,159
Marketable Securities - Available for Sale 12,737 12,911
Property and Equipment 536,806 369,508
Less: Accumulated Depreciation (106,262) (45,785)
----------- -----------
Property and Equipment, Net 430,544 323,723
Investment in Unconsolidated Subsidiaries 16,277 8,446
Goodwill and Other Intangibles, Net 618,915 589,517
Deposits and Other Assets 23,187 33,760
----------- -----------
Total Assets $ 1,809,170 $ 1,714,593
=========== ===========
Liabilities and Shareholders' Equity (Deficit)
Accounts Payable and Other Liabilities $ 513,037 $ 434,797
Short-term Debt 23,289 36,130
----------- -----------
Total Current Liabilities 536,326 470,927
----------- -----------
Total Long-term Debt 1,276,785 1,089,375
Other Liabilities - Noncurrent 69,142 20,807
----------- -----------
Total Liabilities 1,882,253 1,581,109
----------- -----------
Shareholders' Capital 542,796 500,647
Accumulated Deficit (615,879) (367,163)
----------- -----------
Total Shareholders' Equity (Deficit) (73,083) 133,484
----------- -----------
Total Liabilities and Shareholders' Equity (Deficit) $ 1,809,170 $ 1,714,593
=========== ===========
</TABLE>
See notes to condensed consolidated financial statements.
1
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RSL COMMUNICATIONS, LTD.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except loss per share)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues ................................................................ $ 368,831 $ 265,916 $ 1,076,812 $ 564,118
Operating Costs and Expenses:
Cost of Services (exclusive of depreciation and amortization shown
separately below) ................................................. 256,131 210,316 765,009 462,181
Selling, General and Administrative Expenses ....................... 112,573 67,677 323,470 147,494
Non-cash Compensation Expense ...................................... 2,676 -- 5,602 --
Special Charge ..................................................... 30,143 -- 30,143 --
Depreciation and Amortization ...................................... 46,032 22,158 126,115 43,282
----------- ----------- ----------- -----------
Total Operating Costs and Expenses ...................................... 447,555 300,151 1,250,339 652,957
----------- ----------- ----------- -----------
Loss From Operations .................................................... (78,724) (34,235) (173,527) (88,839)
Interest Income ......................................................... 5,408 2,405 16,502 13,239
Interest Expense ........................................................ (35,546) (18,316) (95,820) (51,646)
Other Income - Net ...................................................... 326 241 506 445
Foreign Exchange Transaction Gain (Loss) - Net .......................... (3,468) (8,913) 10,560 (10,621)
Minority Interest ....................................................... (4,791) 1,594 (3,969) 4,322
Loss in Equity Interest of
Unconsolidated Subsidiaries - Net ..................................... (1,184) (1,625) (1,560) (1,625)
Income Tax Expense ...................................................... (918) (92) (1,408) (726)
----------- ----------- ----------- -----------
Loss before extraordinary item .......................................... (118,897) (58,941) (248,716) (135,451)
Extraordinary item ...................................................... -- -- -- (20,800)
----------- ----------- ----------- -----------
Net Loss ................................................................ $ (118,897) $ (58,941) $ (248,716) $ (156,251)
=========== =========== =========== ===========
Loss Per Share of Common Stock
Before Extraordinary Item $ (2.17) $ (1.34) $ (4.63) $ (3.17)
Extraordinary Item Per Share of Common Stock $ -- $ -- $ -- $ (0.49)
Basic and Diluted Net Loss Per Share of Common Stock $ (2.17) $ (1.34) $ (4.63) $ (3.66)
Weighted Average Number of Shares of Common Stock
Outstanding 54,702 44,124 53,676 42,740
</TABLE>
See notes to condensed consolidated financial statements.
2
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RSL COMMUNICATIONS, LTD.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------
1999 1998
---- ----
<S> <C> <C>
Net loss ..................................................... $ (248,716) $ (156,251)
Depreciation and amortization ................................ 126,115 43,282
Working capital change and other ............................. (1,215) (3,398)
----------- -----------
Net cash used in operations ............................. (123,816) (116,367)
----------- -----------
Acquisitions of subsidiaries ................................. (38,209) (271,162)
Purchase of property and equipment ........................... (159,679) (99,882)
Proceeds from maturity of marketable securities .............. 9,715 13,858
Proceeds from maturity of restricted securities .............. 21,150 18,750
Proceeds from sales of restricted securities ................. -- 21,889
Other ........................................................ 307 3,775
----------- -----------
Net cash used in investing activities ................... (166,716) (312,772)
----------- -----------
Proceeds from the issuance of Notes .......................... 169,748 499,090
Payment of offering costs .................................... (256) (5,647)
Retirement of 1996 Notes ..................................... -- (127,493)
Proceeds from short term debt ................................ 40,486 3,189
Payment of short term debt ................................... (37,310) --
Proceeds from issuance of Class A shares ..................... 1,475 538
Principal payment under capital lease obligations ............ (14,970) (2,666)
----------- -----------
Net cash provided by financing activities ............... 159,173 367,011
----------- -----------
Decrease in cash and cash equivalents ........................ (131,359) (62,128)
Effects of foreign currency on cash and cash equivalents ..... (1,453) (570)
Cash and cash equivalents at beginning of period ............. 367,823 144,894
----------- -----------
Cash and cash equivalents at end of period ................... $ 235,011 $ 82,196
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION:
Cash paid for interest ....................................... $ 57,960 $ 22,561
=========== ===========
SUPPLEMENTAL SCHEDULE OF NON-
CASH INVESTING AND FINANCING ACTIVITIES:
Exchange of Class A Common Stock for stock of subsidiaries ... $ 36,783 $ 8,712
=========== ===========
Assets acquired under capital lease obligations .............. $ 12,385 $ 4,986
=========== ===========
Exchange of Class A Common Stock for Distribution Rights ..... $ -- $ 45,000
=========== ===========
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE>
RSL COMMUNICATIONS, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
1. BASIS OF PRESENTATION
The condensed consolidated financial statements of which these notes are part
have been prepared by RSL Communications, Ltd. ("RSL COM") and RSL
Communications PLC, a wholly owned subsidiary of RSL COM ("RSL PLC" and,
together with RSL COM and their direct and indirect subsidiaries, the
"Company"), pursuant to the rules and regulations of the Securities and Exchange
Commission (the "Commission"). Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations; however, in the opinion of management of the Company, the
Condensed Consolidated Financial Statements include all adjustments, consisting
only of normal recurring accruals, necessary to present fairly the financial
information for such periods. These Condensed Consolidated Financial Statements
should be read in conjunction with the Consolidated Financial Statements of RSL
COM and the notes thereto included in the Company's Annual Report on Form 10-K
for the year ended December 31, 1998.
2. CONSENT SOLICITATION
Pursuant to a Consent Solicitation Statement, dated September 13, 1999, the
Company obtained the consent of nearly all of the holders of its outstanding
debt and amended its indentures with respect to such debt (the "Consent
Solicitation"). Such amendments permit the issuance and sale of capital stock of
deltathree.com and the Company's Australian subsidiary in public or private
transactions without restricting the Company's use of proceeds solely to
investments in telecommunications assets and to employees, directors and
consultants pursuant to customary equity compensation and incentive plans. In
connection with the Consent Solicitation, the Company incurred $6.7 million of
fees which have been recorded as a deferred charge in the consolidated balance
sheet. Upon completion of the initial public offering of deltathree.com, the
Company will record such fees as a reduction to additional paid-in capital.
3. COMPREHENSIVE LOSS
Comprehensive loss consists of net loss and other gains and losses affecting
shareholder's equity that, under generally accepted accounting principles, are
excluded from net income. For RSL COM, such items consist of foreign currency
translation gains and losses and unrealized gains and losses on marketable
equity investments.
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The components of total comprehensive loss for interim periods are presented in
the following table:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
--------- --------- --------- ---------
(unaudited)
(in thousands)
<S> <C> <C> <C> <C>
Net Loss ...................................... $(118,897) $ (58,941) $(248,716) $(156,251)
Other Comprehensive Income (Loss)
Foreign currency translation adjustments . 615 289 (1,002) (6,694)
Unrealized loss on securities ............ (523) -- (182) --
--------- --------- --------- ---------
92 289 (1,184) (6,694)
--------- --------- --------- ---------
Total Comprehensive Loss ...................... $(118,805) $ (58,652) $(249,900) $(162,945)
========= ========= ========= =========
</TABLE>
4. NET LOSS PER SHARE
Net loss per share is computed on the basis of the weighted average number of
common shares outstanding during the period. Diluted loss per share amounts are
not presented because the inclusion of these amounts would be anti-dilutive.
5. SUMMARIZED FINANCIAL INFORMATION FOR RSL PLC
The following presents summarized financial information of RSL PLC as of
September 30, 1999 and as of December 31, 1998. RSL PLC had no independent
operations other than serving solely as a foreign holding company for the
Company's North American and European operations. Notes issued by RSL PLC are
fully and unconditionally guaranteed by RSL COM. RSL COM has not presented
separate financial statements and other related disclosures concerning RSL PLC
because management has determined that such information is not material to
shareholders or holders of the notes issued by RSL PLC. RSL COM's financial
statements are, except for RSL COM's capitalization, deltathree.com operations,
Asia/Pacific operations, Latin American operations, corporate overhead expenses
and drawn credit facilities, identical to the financial statements of RSL PLC.
As of As of
September 30, December 31,
1999 1998
---------- ------------
(unaudited)
(in thousands)
Current Assets ........................... $ 656,855 $ 686,727
Non-current Assets ....................... $ 934,706 $ 877,696
Current Liabilities ...................... $ 482,086 $ 411,667
Non-current Liabilities .................. $1,602,380 $1,479,159
5
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Nine Months Ended
September 30,
1999 1998
---- ----
(unaudited)
(in thousands)
Revenues ......................... $ 943,799 $ 473,482
Net Loss ......................... $(187,274) $(138,506)
6. Subsequent Event
On October 8, 1999, Aerotel, Ltd. and Aerotel U.S.A. commenced a suit against
the Company, deltathree.com, Inc. and one of the Company's U.S. subsidiaries in
the United States District Court for the Southern District of New York. Aerotel
alleges infringement of a patent issued to Aerotel in November 1987 by making,
using, selling and offering for sale prepaid telephone card products in the
United States. Aerotel seeks an injunction to stop the use of the technology
covered by this patent, monetary damages in an unspecified amount and
reimbursement of attorneys' fees. The litigation was only recently filed and the
Company is presently evaluating these claims. The Company believes that it has
meritorious defenses to the claims and intends to defend the lawsuit vigorously.
However, the outcome of the litigation is inherently unpredictable and an
unfavorable result may have a material adverse effect on the Company's business,
financial condition and results of operations. Regardless of the ultimate
outcome, the litigation could result in substantial expenses to the Company and
significant diversion of efforts by the Company's managerial and other
personnel.
6
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
The Company is a global, facilities-based telecommunications company that
provides leading edge product and service solutions, with an emphasis on
international long distance voice services, primarily to small and medium-sized
businesses in key markets around the world. The Company's services include
international and national fixed and wireless, frame relay, ATM and other data
services, pre and post-paid calling card, fax, Internet access, voice over
Internet protocol, private line, unified messaging and other value-added
telecommunications services. The Company currently has revenue generating
operations in Australia, Austria, Belgium, Canada, Denmark, Finland, France,
Germany, Italy, Japan, Luxembourg, Mexico, The Netherlands, Portugal, Spain,
Sweden, Switzerland, the United Kingdom, the United States and Venezuela. In
1997, approximately 70% of all international long distance telecommunications
minutes originated in these markets. The Company also provides Internet
telephony services through its subsidiary, deltathree.com and its network of
Internet gateway servers located within key metropolitan areas in target
countries.
Consolidated Results Of Operations For The Three Month And Nine Month Periods
Ended September 30, 1999 Compared To The Three Month And Nine Month Periods
Ended September 30, 1998
Revenues
The Company provides both domestic and international long distance voice
communications and is a seller and reseller of wireless services in certain
countries in which the Company has operations. Revenues are derived from the
number of minutes of use (or fractions thereof) billed by the Company ("revenue
minutes") and are recorded upon completion of calls. The Company also derives
revenues from prepaid calling cards. These revenues are recognized at the time
of usage or upon expiration of the card. The Company maintains local market
pricing structures for its services and generally prices its services at a
discount to the prices charged by the local government-owned post, telegraph and
telephone monopolies ("PTTs") and established carriers. The Company has
experienced, and expects to continue to experience, declining revenue per minute
in all of its markets as a result of increasing competition in
telecommunications, which the Company expects will be offset by increased minute
volumes and decreased operating costs per minute.
Revenues increased to $368.8 million for the three months ended September 30,
1999 compared to $265.9 million for the three months ended September 30, 1998,
an increase of 39%. For the nine months ended September 30, 1999, revenues
increased to $1,076.8 million or an increase of 91%, as compared to $564.1
million for the same period in 1998. This increase is due primarily to the
growth, primarily from acquisitions, in the Company's North American and
European operations.
Cost of Services (exclusive of depreciation and amortization shown separately
below)
The Company's cost of services is comprised of costs associated with gaining
local access and the transport and termination of calls over the Company's
network ("RSL-NET"). The majority of the Company's cost of services are
variable, including local access charges and transmission capacity leased on a
per-minute of use basis. For certain key markets, the Company plans to make
significant investments in indefeasible rights of use ("IRUs"), minimum
investment units ("MIUs") and domestic circuits and, as a result, expects an
increasing amount of its total operating costs will become fixed, as the volume
of the Company's calls carried over its own
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facilities increases. As the Company migrates increasing amounts of traffic from
leased facilities to owned facilities, the Company experiences improving
operating results in those operations where such traffic migration occurs. The
depreciation expense with respect to the Company's MIUs and IRUs is not
accounted for in cost of services. In addition, the Company intends to lower its
variable cost of termination as a percentage of revenues by carrying traffic
pursuant to more of its existing operating agreements and by negotiating
additional operating agreements on strategic routes. The Company has directly
linked certain of its local operators in Europe and the United States utilizing
lines leased on a fixed cost point to point basis and over MIUs and IRUs. To the
extent traffic can be transported between two local operators over MIUs or IRUs,
there is only marginal cost to the Company with respect to the international
portion of a call other than the fixed lease payment or the capital expenditure
incurred in connection with the purchase of the MIUs or IRUs. The Company's cost
of transport and termination will decrease to the extent that it is able to
bypass the settlement rates associated with the transport of international
traffic.
While the Company intends to purchase or construct international transmission
facilities where such facilities are available for purchase or may be
constructed and such investments are cost effective and warranted by traffic
patterns, a significant percentage of its intranational transmission facilities
will continue to be leased on a variable cost basis. Accordingly, variable costs
will continue to be a majority of the Company's cost of services for the
foreseeable future.
The Company's cost of services is primarily affected by the volume of traffic
relative to its owned facilities and facilities leased on a point-to-point fixed
cost basis and capacity leased on a per minute basis with volume discounts. To
the extent that volume exceeds capacity on leased facilities that have been
arranged for in advance, the Company is forced to acquire capacity from
alternative carriers on a spot rate per-minute ("overflow") basis at a higher
cost. Acquiring capacity on an overflow basis has a negative impact on margins,
but enables the Company to maintain uninterrupted service to its customers.
Cost of services increased to $256.1 million for the three months ended
September 30, 1999 from $210.3 million for the three months ended September 30,
1998, an increase of 22%. For the nine months of 1999, cost of services
increased to $765.0 million as compared to $462.2 million for the nine months
ended September 30, 1998, an increase of 66%. This increase is primarily due to
a significant increase in traffic and, to a certain extent, increased rates paid
to the Company's carrier vendors. As a percentage of revenues, cost of services
decreased to 69.4% and 71.0%, respectively, for the third quarter and the nine
months of 1999 as compared to 79.1% and 81.9%, respectively, for the three and
nine month periods ended September 30, 1998. During the third quarter, the
Company recorded a special charge of $32.1 million, $30.1 million of which was
recorded in a separate line item and $2.0 million, representing the write-off
primarily of certain prepaid card inventory, was recorded in cost of sales.
Excluding this item, cost of sales as a percentage of revenues for the third
quarter would have been 68.9%. The decrease in cost of services as a percentage
of revenues is primarily attributable to the increased utilization of the
Company's facilities, increases in higher-volume commercial accounts and an
increase in higher margin wireless subscribers. The decrease in costs of
services as a percentage of revenues is also partially attributable to a
reclassification, in the second quarter of 1999, by the Company's Australia
subsidiary, of $4 million of customer acquisition costs from costs of services
to selling, general and administrative expenses. Excluding the reclassification
as well as the inventory write off in the third quarter, the Company's
normalized cost of services as a percentage of revenues was 71.2% for the nine
months period ended September 30, 1999.
Effect of Deregulation on Costs of Services (exclusive of depreciation and
amortization)
The Company's cost structure varies from country to country and is significantly
impacted by the extent of
8
<PAGE>
regulation in place in each country. In general, the Company's cost structure is
lower in countries that have been substantially deregulated than in those which
are partially deregulated. In countries that are not substantially deregulated,
the Company's access to the local exchange network is through more expensive
means (i.e., leased lines or dial-in access). This results in higher costs to
the Company for carrying international traffic originating within one country
and terminating in another country. In addition, local regulations in many
countries restrict the Company from purchasing capacity on international cable
and fiber systems. The Company must instead either enter into long-term lease
agreements for international capacity at a high fixed cost or purchase
per-minute of use termination rates from the dominant carrier. Further
deregulation in countries in which the Company operates is expected to better
enable the Company to (i) interconnect its switches with the local exchange
network and (ii) purchase its own international facilities. The Company believes
that as a result of further deregulation, particularly in certain countries in
which the Company operates, its cost structure will improve. Deregulation in a
particular country is also expected to permit the Company to terminate
international inbound traffic in such country which the Company expects will
result in an improved cost structure for the Company as a whole.
Selling, General and Administrative Expenses
The Company's selling, general and administrative expenses consist primarily of
costs incurred to support the continued expansion of RSL-NET, the introduction
of new products and services and the provision of ongoing customer service.
These costs are principally comprised of costs associated with employee
compensation, occupancy, insurance, professional fees, sales and marketing
(including sales commissions) and bad debt expenses. In addition, as the Company
commences operations in different countries, it incurs significant start-up
costs, particularly for hiring, training and retention of personnel, leasing of
office space and advertising.
The Company has grown by establishing operations in countries that are in the
process of being deregulated and that originate and terminate large volumes of
international traffic or offer other strategic benefits. Each of the Company's
operations is in a different stage of development. The early stages of
development of a new operation have involved substantial start-up costs in
advance of revenues. Upon the commencement of such operations, the Company
generally has incurred additional fixed costs to facilitate growth. The Company
expects that during periods of significant expansion, selling, general and
administrative expenses will increase materially. Accordingly, the Company's
consolidated results of operations will vary depending on the timing and speed
of the Company's expansion strategy and, during a period of rapid expansion,
will not necessarily reflect the performance of the Company's more established
local operators.
Selling, general and administrative expense for the three months ended September
30, 1999 increased by $44.9 million, or 66%, to $112.6 million from $67.7
million for the three months ended September 30, 1998. For the nine month period
ending September 30, 1999, selling, general and administrative expense increased
by $176.0 million, or 119%, to $323.5 million from $147.5 million as compared to
the same period in 1998. This increase is primarily attributable to start-ups
costs in, and expansion of, the Company's European operations, the hiring of
additional personnel in Europe and acquisitions in North America and Australia.
In addition, in the second quarter of 1999, the Company recognized (i) $4.0
million of marketing, promotion and other expenses incurred by deltathree.com,
the Company's wholly-owned internet telephony subsidiary, as it refocuses its
operation on end users and (ii) $4.0 million of customer acquisition costs by
RSL COM Australia that were reclassified from cost of sales.
Selling, general and administrative expense as a percentage of revenues
increased to 30.5% and 30.0%, respectively, in the third quarter of 1999 and the
first nine months of 1999 as compared to 25.5% and 26.1%,
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<PAGE>
respectively, in the three and nine month periods ended September 30, 1998. The
percentage increase is primarily the result of the inclusion of the results of
Telegate AG ("Telegate"), a directory information provider in Germany, which the
Company began consolidating at the end of 1998. As a directory information
provider, Telegate's cost structure is quite different than the Company's other
operations since its costs are predominantly labor-related with proportionately
lower network costs. Excluding the impact of the reclassification of customer
acquisition costs in the second quarter, selling, general and administrative
expense as a percentage of revenues for the first nine months of 1999 would have
been 29.7%.
Non-cash Compensation Expense
Non-cash compensation expense relates to variable stock incentive awards that
were previously granted to employees in various RSL COM subsidiaries including
deltathree.com. Non-cash compensation expense for the third quarter of 1999 and
for the first nine months of 1999 were $2.7 million and $5.6 million,
respectively. Upon completion of deltathree.com's planned initial public
offering, RSL COM will be required to record additional non-cash compensation
expense.
Special Charge
During the third quarter 1999, the Company recorded a special charge of
approximately $32.1 million, primarily for consolidating locations, streamlining
operations, discontinuing certain prepaid calling card plans and exiting the
telemarketing business. These expenses appear in the accompanying third quarter
1999 and nine months ended September 1999 income statement as $30.1 million in
the Special Charge line item and $2.0 million in the Cost of Services line item.
Depreciation and Amortization Expense
Depreciation and amortization expense increased 108% to $46.0 million for the
three months ended September 30, 1999 from $22.2 million for the three months
ended September 30, 1998. For the first nine months of 1999, depreciation and
amortization expense increased 191% to $126.1 million from $43.3 million in the
same period in 1998. This increase is primarily attributable to the increased
amortization of goodwill and other intangibles recorded as a result of the
Company's acquisitions and higher depreciation due to increased capital
expenditures. Depreciation expense is expected to increase in the future as the
Company continues to expand and enhance its network.
Interest Income
Interest income increased to $5.4 million for the three months ended September
30, 1999 from $2.4 million for the three months ended September 30, 1998. On a
year-to-date basis, interest income increased to $16.5 million from $13.2
million as compared to the same period in 1998. The increase is primarily as a
result of interest earned on the remaining net proceeds from the notes issued
during 1999.
Interest Expense
Interest expense increased to $35.5 million for the three months ended September
30, 1999 from $18.3 million for the three months ended September 30, 1998. On a
year-to-date basis, interest expense increased to $95.8 million from $51.6
million as compared to the same period in 1998. The increase is primarily as a
result of increased debt relating to the notes issued during 1998 and 1999.
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<PAGE>
Foreign Exchange
The Company is exposed to fluctuations in foreign currencies relative to the
U.S. dollar, as its revenues, costs, assets and liabilities are, for the most
part, denominated in local currencies. The results of operations of the
Company's subsidiaries, as reported in U.S. dollars, may be significantly
affected by fluctuations in the value of the local currencies in which the
Company transacts business.
The Company recorded a foreign currency translation adjustment of $5.4 million
as a component of equity as of September 30, 1999. Such amount is recorded upon
the translation of the foreign subsidiaries' financial statements into U.S.
dollars, and is dependent upon the various foreign exchange rates and the
magnitude of the foreign subsidiaries' financial statements.
The Company incurs settlement costs when it exchanges traffic via operating
agreements with foreign correspondents. These costs currently represent a small
portion of total costs; however, as the Company's international operations
increase, it expects that these costs will become a more significant portion of
its cost of services. Such costs are settled by utilizing a net settlement
process with the Company's foreign correspondents comprised of special drawing
rights ("SDRs"). SDRs are the established method of settlement among
international telecommunications carriers. The SDRs are valued based upon a
basket of foreign currencies and the Company believes that this mitigates, to
some extent, its foreign currency exposure. The Company has monitored and will
continue to monitor its currency exposure.
Foreign exchange transaction gain (loss) - net, were $(3.5) million and $10.6
million, for the three months and nine months ended September 30, 1999,
respectively, as compared to $(8.9) million and $(10.6) million, for the three
month and nine month periods ended September 30, 1998, respectively. The gains
through the first half of 1999 compared to the loss in 1998 are primarily a
result of the decline in the value of the Deutsche mark against the U.S. dollar
associated with the Company's 1998 Deutsche mark denominated Senior Discount
Notes in 1999 as opposed to the increase in the Deutsche mark against the U.S.
dollar in 1998. In the third quarter of 1999, the Deutsche mark strengthened
against the U.S. dollar contributing to the foreign exchange transaction loss
during the period.
Loss in Equity Interest of Unconsolidated Subsidiaries - Net
The Company recorded a loss in equity interest of unconsolidated subsidiaries -
net of $1.2 million and $1.6 million for the three months and nine months ended
September 30, 1999, respectively, to reflect the Company's pro-rata allocable
loss in the investments of Maxitel Servicos e Gestao de Telecommunicacoes, S.A.,
a Portugese international telecommunications carrier, MK Telecom Network Inc., a
Canadian microwave telecommunications facilities company and Cetel, a Spanish
international telecommunications carrier.
Net Loss
The net loss increased to $118.9 million for the three months ended September
30, 1999, as compared to the net loss of $58.9 million for the three months
ended September 30, 1998. On a year-to-date basis, the net loss increased to
$248.7 million as compared to a net loss of $156.3 million for the nine months
ended September 30, 1998. The increase is due to the factors described above and
in the following discussion of segment results. Also impacting the comparisons
of the net loss between periods is a special charge and non-cash compensation
expense of $32.1 million and $2.7 million recorded in the three months ended
September 30, 1999, and an extraordinary item of $20.8 million recorded in the
nine months ended September 30, 1998, representing the premium paid to retire
approximately $127 million of the original $300 million of the Company's 1996
Notes.
11
<PAGE>
Segment Information
North American Operations
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
--------- --------- --------- ---------
(unaudited)
(in thousands, except percentage of consolidated revenues)
<S> <C> <C> <C> <C>
Revenues ......................................... $ 132,799 $ 145,851 $ 426,428 $ 304,809
Percentage of consolidated revenues .............. 36% 55% 40% 54%
Operating costs and expenses:
Cost of services (exclusive of depreciation and
amortization shown separately below) ..... 105,033 117,316 343,223 252,784
Selling, general and administrative expenses .. 26,574 25,863 85,318 50,030
Depreciation and amortization ................. 11,113 4,019 33,705 7,873
--------- --------- --------- ---------
142,720 147,198 462,246 310,687
--------- --------- --------- ---------
Loss from operations ............................. $ (9,921) $ (1,347) $ (35,818) $ (5,878)
========= ========= ========= =========
</TABLE>
The Company's North American revenues result primarily from the sale of long
distance voice services on a retail basis to commercial customers, on a bulk
discount basis to distributors of prepaid calling cards, and on a wholesale
basis to other carriers. The Company also generates revenues from data, Internet
and other value-added services in North America. The Company experiences
significant month to month changes in revenues generated by its carrier
customers (i.e. customers who acquire the Company's services for the purpose of
reselling such services on a wholesale basis to other carriers or on a retail
basis to end users). The Company believes such carrier customers will react to
temporary price fluctuations and spot market availability that will impact the
Company's carrier revenues. Over the past two years, the Company has shifted its
marketing focus in the United States to, and continues to focus on, small and
medium-sized businesses and has restructured its pricing of wholesale services
to other carriers.
Revenue from the Company's North American operations decreased to $132.8 million
for the three months ended September 30, 1999 compared to $145.9 for the same
period in 1998, a 9% decrease as a result of the Company's discontinuance of
certain unprofitable prepaid card and telemarketing businesses. On a
year-to-date basis, revenue from the Company's North American operations
increased to $426.4 million as compared to $304.8 million for the same period in
1998, a 40% increase. In July 1998, the Company acquired Westinghouse
Communications which provides voice telephony and data services in the United
States, and Westel Communications Ltd. which provides long distance and enhanced
telecommunications services in Canada. These acquisitions contributed $3.8
million and $81.3 million increase in revenues in the third quarter and first
nine months of 1999, respectively. The increase in the Company's North American
revenues for the first nine months of 1999 compared to the same period in 1998
was also due to an increase in the Company's corporate customers and prepaid
calling card usage.
North American revenues as a percentage of consolidated revenues decreased from
55% and 54% in the third quarter of 1998 and the first nine months of 1998 to
36% and 40% in the third quarter and first nine months of 1999, respectively.
This decline is a result of the Company's effort to reduce its dependence on the
very competitive North American operations and in particular its low margin
wholesale markets and focuses additional efforts on expanding its more
profitable European operations.
12
<PAGE>
Cost of services decreased 10% to $105.0 million in the third quarter of 1999
from $117.3 million in the third quarter of 1998. On a year-to-date basis, cost
of services increased 36% to $343.2 million from $252.8 million over the same
period in 1998. The increase is primarily a result of acquisitions and higher
revenues. Costs of services as a percentage of revenues in the third quarter and
first nine months of 1999 was 79% and 80%, respectively, an improvement from the
80% and 83% as compared to the same periods of time in the third quarter and
first nine months of 1998, respectively, as a result of the focus to more
profitable customer segments.
Selling, general and administrative expense in the third quarter of 1999
increased to $26.6 million from $25.9 million in the third quarter of 1998. For
the first nine months of 1999, selling, general and administrative expense
increased to $85.3 million from $50.0 million as compared to the same period in
1998. Selling, general and administrative expenses as a percentage of revenues,
increased to 20% in the third quarter of 1999 as compared to 18% recorded in the
third quarter of 1998. On a year-to-date basis, selling, general and
administrative expenses as a percentage of revenues, increased to 20% as
compared to 16% recorded in the first nine months of 1998. The increase is
primarily a result of costs incurred to acquire new customers and enhance
customer services.
Depreciation and amortization in the third quarter of 1999 increased to $11.1
million from $4.0 million recorded in the third quarter of 1998. For the first
nine months of 1999, depreciation and amortization increased to $33.7 million
from $7.9 million as compared to the first nine months of 1998. These increases
were primarily attributable to the amortization of intangible assets,
principally goodwill, recorded in connection with several acquisitions made
since the third quarter of 1998. Depreciation expense also increased as a result
of the substantial capital investment made over the past year.
Loss from operations in North America increased from $1.3 million in the third
quarter of 1998 to $9.9 million in the third quarter of 1999. Loss from
operations in North America increased from $5.9 million for the first nine
months in 1998 to $35.8 million in the first nine months of 1999. The increase
is primarily due to higher selling, general and administrative expenses as well
as higher amortization of intangible assets recorded in connection with the
acquisitions made.
European Operations
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
---- ---- ---- ----
(unaudited)
(in thousands, except percentage of consolidated revenues)
<S> <C> <C> <C> <C>
Revenues ......................................... $ 186,958 $ 84,721 $ 517,371 $ 168,672
Percentage of consolidated revenues .............. 51% 32% 48% 30%
Operating costs and expenses:
Cost of services (exclusive of depreciation and
amortization shown separately below) ..... 116,251 66,287 329,188 136,779
Selling, general and administrative expenses 62,999 26,117 172,413 64,118
Depreciation and amortization .............. 17,110 6,067 44,581 14,298
--------- --------- --------- ---------
196,360 98,471 546,182 215,195
--------- --------- --------- ---------
Loss from operations ............................. $ (9,402) $ (13,750) $ (28,811) $ (46,523)
========= ========= ========= =========
</TABLE>
The Company derives its European revenues from the provision of international
and domestic long distance
13
<PAGE>
voice services, including directory information services in Germany and the sale
and resale of wireless services in certain countries in which the Company
operates. The Company plans to introduce several new product groups, such as
data, Internet, value-added services and web based applications and broaden
existing services such as fixed voice and wireless services. Substantially all
revenues from the Company's European operations are derived from commercial
sales to end-users. Sales are targeted towards small to medium-sized corporate
customers, and niche consumer markets (including selected ethnic communities).
To reduce its credit risk to such niche consumer markets, the Company primarily
offers prepaid products to these targeted consumers.
The Company operates in various countries in Europe, each of which is in a
different state of deregulation. In certain of these countries, current
regulatory restrictions limit the Company's ability to offer a broader array of
products and services and limit the availability of those services to customers.
The Company anticipates that deregulation will have a favorable impact on
revenues because (i) customers will be able to access the Company's services
more easily and (ii) the Company will have the ability to provide a broader
array of products and services. The Company believes that, with established or
start-up operations in 14 European countries, it will be well positioned to
benefit from the anticipated continued deregulation of European markets. It is
anticipated that most European countries will further deregulate various aspects
of the telecommunications industry through 2000.
Revenue from the Company's European operations increased by 121% to $187.0
million for the three months ended September 30, 1999 compared to $84.7 million
for the same period in 1998. For the first nine months of 1999, revenue from the
Company's European operations increased by 207% to $517.4 million as compared to
$168.7 million for the same period in 1998. During 1998, the Company made
several acquisitions in Europe, including Motorola Tel.Co, a reseller of
wireless services in the U.K. and Germany, and a majority interest in Telegate
Holding, the parent holding company of Telegate. The Company's European
acquisitions during 1998 contributed $66.5 million and $253.5 million of revenue
in the third quarter and first nine months of 1999, respectively. The increase
in the Company's European revenues was also attributable to a substantial
increase in the number of carrier and corporate customers.
In February 1999, the Company announced that RSL Germany, its German subsidiary,
and Debitel had agreed that Debitel will utilize the Company's fixed wire
network for new telecommunications services that it will be promoting to German
consumers. Through July 1999, the utilization of the Company's network by
Debitel had been below expectation. Under the terms of the agreement, the
Company has been recognizing Debitel's minimum commitments for usage of its
network and, accordingly, for the third quarter and first nine months of 1999,
the Company has recognized $5.2 million and $15.6 million, respectively. On
August 13, 1999, the Company announced that it has agreed to terminate this
agreement with Debitel effective October 31, 1999. As part of the agreement
Debitel paid the Company $11.6 million for network services in addition to the
$5.3 million already paid for services since the beginning of the year.
European revenues as a percentage of consolidated revenues increased from 32%
and 30%, in the third quarter and first nine months of 1998, to 51% and 48% in
the third quarter and first nine months of 1999, respectively. Europe currently
represents the Company's largest market segment surpassing the North American
operations.
Cost of services increased 75% to $116.3 million in the third quarter of 1999
from $66.3 million in the third quarter of 1998. On a year-to-date basis, cost
of services increased 141% to $329.2 million from $136.8 million over the same
period in 1998. Costs of services as a percentage of revenues in the third
quarter of 1999 was 62% reflecting a 21% decrease compared to the 78% recorded
in the third quarter of 1998. For the first nine months of 1999, costs of
services as a percentage of revenues was 64% reflecting a 22% decrease from the
81% recorded in the same period of 1998. The decrease in the cost of services as
a percentage of
14
<PAGE>
revenue is primarily attributable to the Company's ability to carry more traffic
on its own network which is less expensive than leasing capacity from other
carriers. The improved profitability is also due to the continued deregulation
of several European markets, allowing the Company to compete in such markets on
more favorable terms.
Selling, general and administrative expense in the third quarter of 1999
increased to $63.0 million from $26.1 million in the third quarter of 1998. For
the first nine months of 1999, selling, general and administrative expense
increased to $172.4 million from $64.1 million as compared to the same period in
1998. Selling, general and administrative expenses as a percentage of revenue in
the third quarter of 1999 was 34%, as compared to 31% in the third quarter of
1998. For the first nine months of 1999, selling, general and administrative
expenses as a percentage of revenue decreased to 33% from 38% for the same
period in 1998. These reductions were primarily attributable to lower start-up
costs in countries in which operations had already been established in the past
year.
Depreciation and amortization in the third quarter of 1999 increased to $17.1
million from $6.1 million recorded in the third quarter of 1998. For the first
nine months of 1999, depreciation and amortization increased to $44.6 million
from $14.3 million as compared to the same period in 1998. These increases were
primarily attributable to the amortization of intangible assets, principally
goodwill, recorded in connection with several acquisitions made since the second
quarter of 1998. Depreciation expense also increased as a result of the
substantial capital investment made over the past year.
Net loss from European operations in the third quarter of 1999 declined to $9.4
million from $13.8 million recorded in the third quarter of 1998. On a
year-to-date basis, net loss from European operations declined to $28.8 million
as compared to $46.5 million in the same period in 1998. The improvement
reflects the substantially higher revenue partially offset by higher costs and
increased amortization of intangible assets acquired.
Asia/Pacific and Other Operations
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
---- ---- ---- ----
(unaudited)
(in thousands, except percentage of consolidated revenues)
<S> <C> <C> <C> <C>
Revenues ......................................... $ 49,074 $ 35,344 $ 133,013 $ 90,637
Percentage of consolidated revenues .............. 13% 13% 12% 16%
Operating costs and expenses:
Cost of services (exclusive of depreciation and
amortization shown separately below) ..... 32,890 26,713 90,641 72,617
Selling, general and administrative expenses .. 18,703 12,260 54,473 25,994
Depreciation and amortization ................. 8,190 2,578 21,373 4,901
--------- --------- --------- ---------
59,783 41,551 166,487 103,512
--------- --------- --------- ---------
Loss from operations ............................. $ (10,709) $ (6,207) $ (33,474) $ (12,875)
========= ========= ========= =========
</TABLE>
Asia/Pacific and Other operations are comprised primarily of domestic and
international long distance and wireless services operations in Australia. This
segment also includes relatively small start-up operations in deltathree.com and
Venezuela, Mexico and Japan. In May 1999, the Company announced a plan to offer
up to
15
<PAGE>
approximately 20% of the common shares of deltathree.com in an initial public
offering. In September 1999, deltathree.com filed a registration statement with
the Securities and Exchange Commission. Amendments to such registration
statement were filed in October and November 1999. The Company is also
considering strategic financing alternatives, including an initial public
offering, for its operations in Australia.
Revenues from the Company's Asia/Pacific and Other operations increased 39% to
$49.1 million for the three months ended September 30, 1999 compared to $35.3
million for the same period in 1998. For the first nine months of 1999, revenues
from the Company's Asia/Pacific and Other operations increased 47% to $133.0
million from $90.6 million as compared to the same period in 1998. In March
1998, the Company acquired the customer base of two mobile resellers; First
Direct Communications, Pty. Limited and Link Telecommunication, Pty. Ltd. In
July 1998, the Company initiated operations in Japan. These new operations
contributed $13.0 million of additional revenues in the first half of 1999.
Revenues from the Company's Asia/Pacific and Other operations as a percentage of
consolidated revenues declined to 13% and 12%, respectively, in the third
quarter and first nine months of 1999 from 13% and 16% in the third quarter and
first nine months of 1998, respectively. The decline is primarily as a result of
the Company's acquisition of significant businesses in Europe and North America
over the past year.
Cost of services in the third quarter of 1999 increased to $32.9 million from
$26.7 million recorded in the third quarter of 1998 as a result of the higher
revenues. For the first nine months of 1999, cost of services increased to $90.6
million from $72.6 million as compared to the same period in 1998. Cost of
services as a percentage of revenues in the third quarter and first nine months
of 1999 declined to 67% and 68% from 76% and 80% as compared to the same period
in 1998, respectively. The decrease in costs of services is also partially
attributable to a reclassification in the second quarter of 1999 by the
Company's Australia subsidiary of $4 million of customer acquisition costs from
costs of services to selling, general and administrative expenses. Excluding the
reclassification, cost of services as a percentage of revenues was 71% in the
first nine months of 1999.
Selling, general and administrative expense in the third quarter of 1999
increased to $18.7 million from $12.3 million in the third quarter of 1998. For
the first nine months of 1999, selling, general and administrative expense
increased to $54.5 million from $26.0 million as compared to the same period in
1998. These increases were primarily due to the costs to acquire and retain
wireless customers. Selling, general and administrative expenses as a percent of
revenues in the third quarter and first nine months of 1999 increased to 38% and
35% from 35% and 29% as compared to the same periods in 1998, respectively. The
increases are a result of the initial start-up costs incurred in Latin America
and up-front costs incurred to acquire wireless customers. In addition, in the
second quarter of 1999, $4 million of marketing, promotion and other expenses
were incurred by deltathree.com, as it refocuses its operation on end users.
Depreciation and amortization in the third quarter of 1999 increased to $8.2
million from $2.6 million. For the first nine months of 1999, depreciation and
amortization increased to $21.4 million from $4.9 million as compared to the
same period in 1998, primarily as a result of the amortization of intangibles
recorded in connection with the 1998 acquisitions.
The loss from the Asia/Pacific and Other operations for the third quarter of
1999 increased to $10.7 million from $6.2 million recorded in the third quarter
of 1998. On a year-to-date basis, the loss from the Asia/Pacific and Other
operations increased to $33.5 million from $12.9 million as compared to the same
period in 1998. The increased operating losses are primarily due to the start-up
costs incurred in the Company's Latin America operation and higher amortization
of intangibles.
16
<PAGE>
Liquidity and Capital Resources
The Company has incurred significant operating losses, net losses and negative
cash flow from operations, due in large part to the start-up and development of
the Company's operations and the development of "RSL-NET," the Company's
integrated digital telecommunications network. The Company expects that its net
losses and negative cash flow will continue as the Company continues to
implement its growth strategy. Historically, the Company has funded its losses
and capital expenditures through borrowings, capital contributions, and a
portion of the net proceeds of prior securities offerings.
Cash used in operating activities for the nine months ended September 30, 1999
totaled $123.8 million compared with $116.4 million for the same period in 1998
reflecting the use of cash to fund operating losses and working capital
requirements. Capital expenditures, which include assets acquired under capital
lease obligation, for the nine months ended September 30, 1999 were $172.1
million compared with $104.9 million for the comparable period in 1998. These
capital expenditures are principally for switches, fiber, and related
telecommunications equipment. The Company intends to continue to expand and
develop the Company's infrastructure, in part by replacing leased transmission
facilities with owned transmission lines, purchasing IRU and interests in
inter-city fiber routes in certain key markets and installing additional
national and international telephone gateway switches. The Company expects to
invest in the aggregate approximately $250 million in 1999 to expand and enhance
its telecommunications network. Cash expended for acquisitions were $38.2
million during the nine months ended September 30, 1999 primarily reflecting
payments for properties acquired at the end of 1998 as well as the acquisition
of an equity interest in Cetel in Spain for $9.6 million in the second quarter,
compared with $271.2 million for the nine months ended September 30, 1998. At
September 30, 1999, the Company had $171.2 million of working capital as
compared to $255.2 million of working capital at December 31, 1998.
The Company's indebtedness was approximately $1.2 billion at September 30, 1999,
substantially all of which represented long-term debt. Nearly all of the
Company's indebtedness is attributable to the debt securities issued by RSL PLC
and guaranteed by RSL COM.
The Company through RSL PLC has various Senior Notes and Senior Discount Notes
which are due from 2006 through 2009 (the "Notes"), totaling $1.18 billion, net,
as of September 30, 1999. The Notes were issued under indentures containing
certain restrictive covenants which impose limitations on the Company's ability
to, among other things: (i) incur additional indebtedness, (ii) pay dividends or
make certain other distributions, (iii) issue capital stock of certain
subsidiaries, (iv) guarantee debt, (v) enter into transactions with shareholders
and affiliates, (vi) create liens, (vii) enter into sale-leaseback transactions,
and (viii) sell assets.
Under the terms of the Notes, the Company was required to offer to exchange each
of the Notes for substantially identical notes registered under the Securities
Act of 1933. As of September 30, 1999, the Company had successfully completed
all such exchange offers to date, except for the exchange offer relating to the
Notes issued in May 1999.
In connection with the issuance of the 1996 Notes, RSL PLC was required to
purchase and maintain restricted marketable securities, which are held by the
indenture trustee for the 1996 Notes, in order to secure the payment of the
first six scheduled interest payments on the 1996 Notes. The Company had
fulfilled the above requirement and paid the sixth interest payment on September
15, 1999.
17
<PAGE>
Pursuant to the Consent Solicitation, the Company obtained the consent of nearly
all of the holders of its outstanding debt and amended its indentures with
respect to such debt. Such amendments were to permit the issuance and sale of
capital stock of deltathree.com and the Company's Australian subsidiary in
public or private transactions without restricting the use of proceeds solely to
investments in telecommunications assets and to employees, directors and
consultants pursuant to customary equity compensation and incentive plans. In
connection with this Consent Solicitation, total fees were approximately $6.7
million.
The Company, through LDM Systems, Inc., a subsidiary of the Company, has a $10.0
million revolving credit facility. There was $500,000 utilized under this
facility at September 30, 1999. This facility is payable in full on September
30, 2000 and accrues interest at prime rate plus 2.5% per annum (10.25% at
September 30, 1999).
The Company, through Telegate Holding, has a $5.1 million revolving credit
facility, all of which was available at September 30, 1999. This facility is
payable in annual payments through December 31, 2002 and accrues interest at a
variable interest rate not to exceed 5.5% per annum (3.3% at September 30,
1999). Telegate had $11.4 million of overdraft credit facilities with various
banks that accrue interest at a rate of 6.0% to 6.5%. There was $0.3 million
utilized under these facilities at September 30, 1999. Telegate also had two
loans that accrue interest at a rate of 6% from a related party and from a
shareholder of $3.4 million and $4.6 million, respectively, as of September 30,
1999. These loans are payable in four semiannual installments beginning June 30,
2001.
The Company, through RSL COM Canada, has a $6.8 million revolving credit
facility that accrues interest at 7.4% per annum, all of which was available at
September 30, 1999.
One of the Company's primary equipment vendors has provided to certain of the
Company's subsidiaries $75.0 million in vendor financing commitments to fund the
purchase of additional switching and related telecommunications capital
equipment. At September 30, 1999, all available amounts were utilized under this
facility. Borrowings from this equipment vendor accrue interest at a rate of
LIBOR plus either 5.25% or 4.5% depending on the equipment purchased.
The limitation under the Company's most restrictive covenants will likely
prohibit the Company from incurring any significant amount of additional
indebtedness to fund net losses unless the Company completes an equity offering
or generates significant positive cash flow from operations. The Company
believes that the remaining net proceeds from the issuance of the outstanding
notes and the 1998 equity offering, together with availability under its
revolving credit facilities, vendor financing facility and short-term lines of
credit and overdraft facilities from local banks, will be sufficient to fund its
capital expenditures and operations through at least the first half of 2000.
However, the Company may be required to raise additional capital regardless of
market conditions, if the Company's plans or assumptions change or prove to be
inaccurate, if the Company identifies additional required or desirable
infrastructure investments or acquisitions, if the Company experiences
unanticipated costs or competitive pressures or if the net proceeds from the
issuance of its debt and equity securities, together with other sources of
liquidity otherwise prove to be insufficient. Regardless, the Company plans to
raise additional capital in 1999 or in the beginning of 2000 to ensure that
adequate funding is available for capital expenditures and operations for the
year 2000 and beyond.
18
<PAGE>
Effects of Recently Issued Accounting Standards
In June 1998, the FASB issued SFAS No.133, "Accounting for Derivative
Instruments and Hedging Activities", which establishes accounting and reporting
standards for derivative instruments and hedging activities. Generally, it
requires that an entity recognize all derivatives as either an asset or
liability and measure those instruments at fair value, as well as identify the
conditions for which a derivative may be specially designed as a hedge. SFAS
No.133 is effective for fiscal years beginning after June 15, 2000. Management
is currently addressing the financial reporting measures that will be needed in
order to comply with this disclosure. The Company has not participated in any
hedging activities in connection with foreign currency exposure.
Seasonality
The Company's European operations experience seasonality during January, August,
October and December, and, to a lesser extent, March, as these months are
traditional holiday months in most European countries and many European
businesses, which are the Company's principal European customers, are closed
during portions of these months.
Year 2000 Technology Risks
The "Year 2000" problem is the result of computer programs being written using
two digits, rather than the four digits, to define the applicable year. Any of
the programs used in the Company's operations that have time-sensitive software
may recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a major system failure or miscalculations, or other computer
errors, causing disruptions of operations. The potential for failures
encompasses all aspects of the Company's business, including computer systems
and voice networks, and could cause, among other things, a temporary inability
to process transactions, billing and customer service or to engage in similar
normal business activities.
The Company is implementing a comprehensive program of analysis of and/or
changes to its computer systems to ensure that all such systems are, or prior to
the end of 1999 will be, Year 2000 compliant. The Company's Year 2000 project
includes the following phases: (i) conducting a comprehensive inventory of the
Company's internal systems, including information technology systems and
non-information technology systems (which include switching, billing and other
platforms and electrical systems) and the systems acquired or to be acquired by
the Company, (ii) assessing and prioritizing any required remediation, (iii)
remediating any problems by repairing, or, if appropriate, replacing the
non-compliant systems and (iv) testing all remediated systems for Year 2000
compliance. All critical components, which include network switching, billing
and financial systems, have been substantially completed, including two required
upgrades of L.M. Ericsson A.B. ("Ericsson") switches in France, which were
completed in October 1999. Non-critical components, which include administrative
support systems, are scheduled to be completed by November 30, 1999. The Company
will engage in continued operational verification and testing through the end of
the year.
The Company has also retained a Year 2000 solution provider, through the first
quarter of 2000, as a consultant to assist the Company in its assessment and
remediation projects and to manage and coordinate Year 2000 compliance for each
of the Company's local operators on a global basis.
19
<PAGE>
In addition to assessing its own systems, the Company is conducting an external
review of its vendors and suppliers, including equipment and system providers
and other telecommunications service providers, to determine their vulnerability
to Year 2000 problems and any potential impact on the Company. Based on
discussions with Ericsson, the Company's primary equipment vendor, and the
Company's testing of the Ericsson equipment, which is substantially complete,
the Company believes that the equipment provided to the Company by Ericsson will
be Year 2000 compliant. The Company may experience problems to the extent that
other telecommunications carriers whose services are resold by the Company or to
which the Company sends traffic for termination are not Year 2000 compliant.
There can be no assurance that such problems will not have a material adverse
effect on the Company.
The Company has completed numerous acquisitions during recent periods, and is in
the process of integrating the systems of the acquired businesses into the
Company's operations. Those systems are included in the Company's Year 2000
review and remediation project. During the process of evaluating businesses for
potential acquisition, and after any such acquisition, the Company will evaluate
the extent of the Year 2000 problems associated with such acquisitions and the
cost and timing of the remediation. No assurance can be given, however, that the
systems of any acquired business will be Year 2000 compliant when acquired or
will be capable of timely remediation. In August 1998, the Company acquired
Motorola Tel.co, in the United Kingdom and Germany from Motorola Inc. The
acquired assets are expected to be Year 2000 compliant by November 30, 1999.
The Company expects to continue testing its systems for Year 2000 compliance
during the rest of 1999 as a result of upgrades and other changes to our system
and further expects that all of its computer systems will be fully Year 2000
compliant before the end of 1999. There can be no assurance, however, that the
Company will achieve full Year 2000 compliance before the end of 1999 or that
effective contingency plans will be developed or implemented. A failure of the
Company's computer systems or the failure of the Company's vendors or customers
to effectively upgrade their software and systems for transition to the year
2000 could have a material adverse effect on the Company's business, financial
position and results of operations. Through October 31, 1999 the Company has
spent approximately $6.5 million on the Year 2000 program. The Company expects
that it will cost approximately an additional $3.5 million, to be paid through
the first quarter of 2000, to complete its Year 2000 project. These amounts will
be financed through working capital. The Company expenses costs associated with
software modification when they are incurred.
With the substantial completion of the Company's Year 2000 assessment and
remediations, contingency planning, which primarily consists of ongoing
monitoring of successful remediations and remediations of dependent partners, is
in progress. Even if the Company's assessment is completed without identifying
any additional material non-compliant systems operated by, or under the control
of, the Company, or of third parties, the most likely worst case scenario would
be a systems failure beyond the control of the Company to remedy. Such a failure
could materially prevent the Company from operating its business. The Company
believes that such a failure would likely lead to lost revenues, increased
operating costs, loss of customers or other business interruptions of a material
nature, in addition to potential claims against the Company.
20
<PAGE>
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company has not entered into any financial instruments for trading or
hedging purposes.
The Company is exposed to fluctuations in foreign currencies relative to the
U.S. dollar, as its revenues, costs, assets and liabilities are, for the most
part, denominated in local currencies. The results of operations of the
Company's subsidiaries, as reported in U.S. dollars, may be significantly
affected by fluctuations in the value of the local currencies in which the
Company transacts business. The Company recorded a foreign currency translation
adjustment of $5.4 million as a component of equity as of September 30, 1999.
Such amount is recorded upon the translation of the foreign subsidiaries'
financial statements into U.S. dollars, and is dependent upon the various
foreign exchange rates and the magnitude of the foreign subsidiaries' financial
statements. For the nine month period ended September 30, 1999, the Company had
recorded a foreign currency transaction gain of approximately $10.6 million,
primarily as a result of the decrease in the Deutsche mark against the U.S.
dollar in connection with the DM296 million 10% Senior Discount Notes issued
during 1998.
The Company incurs settlement costs when it exchanges traffic via operating
agreements with foreign correspondents. These costs currently represent a small
portion of the total costs of services; however, as the Company's international
operations increase, it expects that these costs will become a more significant
portion of its cost of services. Such costs are settled by utilizing a net
settlement process with the Company's foreign correspondents comprised of
special drawing rights ("SDRs"). SDRs are the established method of settlement
among international telecommunications carriers. The SDRs are valued based upon
a basket of foreign currencies and the Company believes that this mitigates, to
some extent, its foreign currency exposure. The Company has monitored and will
continue to monitor its foreign currency exposure, and, if necessary, may enter
into forward contracts and/or similar instruments to mitigate the potential
impacts of such risks.
The Company is currently not exposed to material future earnings or cash flow
exposures from changes in interest rates on long-term debt obligations since the
majority of the Company's long-term debt obligations are at fixed rates. The
Company is exposed to interest rate risk, as additional financing may be
required due to the large operating losses and capital expenditures associated
with establishing and expanding the Company's networks and facilities. The
interest rate that the Company will be able to obtain on additional financing
will depend on market conditions at that time, and may differ from the rates the
Company has secured on its current debt. The Company does not currently
anticipate entering into interest rate swap and/or similar instruments.
The Company's carrying value of cash and cash equivalents, accounts receivable,
accounts payable, marketable securities available for sale, restricted
marketable securities - held to maturity, accrued expenses and notes payable is
a reasonable approximation of their fair value.
At September 30, 1999, the fair value of the Company's long-term debt was
estimated to be $1.08 billion based on the overall weighted average rate of the
Company's long-term debt of 10.7% and an overall weighted average maturity of
8.6 years compared to terms and rates currently available in long-term financing
markets. Market risk is estimated as the potential decrease in fair value of the
Company's long-term debt resulting from a hypothetical increase of 107 basis
points in interest rates (ten percent of the Company's overall weighted average
borrowing rate). Such an increase in interest rates would result in
approximately a $97.9 million decrease in fair value of the Company's long-term
debt.
21
<PAGE>
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
On October 8, 1999, Aerotel, Ltd. and Aerotel U.S.A. commenced a suit against
the Company, deltathree.com, Inc. and one of the Company's U.S. subsidiaries in
the United States District Court for the Southern District of New York. Aerotel
alleges infringement of a patent issued to Aerotel in November 1987 by making,
using, selling and offering for sale prepaid telephone card products in the
United States. Aerotel seeks an injunction to stop the use of the technology
covered by this patent, monetary damages in an unspecified amount and
reimbursement of attorneys' fees. The litigation was only recently filed and the
Company is presently evaluating these claims. The Company believes that it has
meritorious defenses to the claims and intends to defend the lawsuit vigorously.
However, the outcome of the litigation is inherently unpredictable and an
unfavorable result may have a material adverse effect on the Company's business,
financial condition and results of operations. Regardless of the ultimate
outcome, the litigation could result in substantial expenses to the Company and
significant diversion of efforts by the Company's managerial and other
personnel.
In addition, the Company is, from time to time, a party to other litigation that
arises in the normal course of business. The Company is not presently a party to
any other litigation that it believes would reasonably be expected to have a
material adverse effect on its business or results of operations.
Item 2. Change in Securities and Use of Proceeds
Reference is made to Item 4 "Submission of Matters to a Vote of Security
Holders" for a description of consents obtained from the holders of the
Company's outstanding debt and the modification of the indentures governing such
debt.
Item 4. Submission of Matters to a Vote of Security Holders
Pursuant to a Consent Solicitation Statement, dated September 13, 1999, the
Company obtained the consent of nearly all of the holders of its outstanding
debt and amended its indentures with respect to such debt. Such amendments were
to permit the issuance and sale of capital stock stock of deltathree.com and the
Company's Australian subsidiary in public or private transactions without
restricting use of proceeds solely to investments in telecommunications assets
and to employees, directors and consultants pursuant to customary equity
compensation and incentive plans.
Item 5. Other Information
Forward-Looking Statements
Certain matters discussed in this Report under the heading "Management's
Discussion and Analysis of Financial Condition and Results of Operation -
Liquidity and Capital Resources" contain certain forward-looking statements
which involve risks and uncertainties and depend upon certain assumptions, some
of
22
<PAGE>
which may be beyond the Company's control, including, but not limited to
changing market conditions, competitive and regulatory matters (such as timing
and extent of deregulation of telecommunications market, the size and financial
resources of competitors, etc.), the integration of acquisitions and new
operations, substantial capital requirements, pricing pressures, the
availability of transmission facilities, reliance on sophisticated information
systems, devaluation and currency risks, general economic conditions in the
markets in which the Company operates, risks associated with Year 2000
readiness, as well as other risks referenced from time to time in the Company's
filings with the Securities and Exchange Commission and, accordingly, there can
be no assurance with regard to such statements.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
3.1 Certificate of Incorporation of RSL Communications, Ltd., issued by the
Bermuda Registrar of Companies on March 14, 1996 (incorporated by
reference to Registrant's Registration Statement on Form S-4 (Registration
No.333-25749)).
3.2 Memorandum of Association of RSL Communications, Ltd., filed with the
Bermuda Registrar of Companies on March 14, 1996 (incorporated by
reference to Registrant's Registration Statement on Form S-4 (Registration
No.333-25749)).
3.3 Bye-Laws of RSL Communications, Ltd., as amended to date (incorporated by
reference to Registrant's Quarterly Report on Form 10-Q for the period
ended June 30, 1999).
4.1 Form of Class A Common Share (incorporated by reference to Registrant's
Registration Statement on Form S-1 (Registration No. 333-34281)).
10.1 First Supplemental Indenture, dated as of September 28, 1999, by RSL
Communications PLC and RSL Communications, Ltd. to The Chase Manhattan
Bank, as Trustee, regarding 9 7/8% Senior Notes due 2009 (incorporated by
reference to Registrant's Registration Statement on Form S-4 (Registration
No. 333-90039)).
10.2 First Supplemental Indenture, dated as of September 24, 1999, by RSL
Communications PLC and RSL Communications, Ltd. to The Chase Manhattan
Bank, as Trustee regarding 10 1/2% Senior Notes due 2008 (incorporated by
reference to Registrant's Registration Statement on Form S-4 (Registration
No. 333-90039)).
10.3 First Supplemental Indenture, dated as of September 24, 1999, by RSL
Communications PLC and RSL Communications, Ltd. to The Chase Manhattan
Bank, as Trustee, regarding 9 1/8% Senior Notes due 2008 (incorporated by
reference to Registrant's Registration Statement on Form S-4 (Registration
No. 333-90039)).
10.4 First Supplemental Indenture, dated as of September 28, 1999, by RSL
Communications PLC and RSL Communications, Ltd. to The Chase Manhattan
Bank, as Trustee, regarding 12 1/4% Senior Notes due 2006 (incorporated by
reference to Registrant's Registration Statement on Form S-4 (Registration
No. 333-90039)).
10.5 First Supplemental Indenture, dated as of September 28, 1999, by RSL
Communications PLC and RSL Communications, Ltd. to The Chase Manhattan
Bank, as Trustee, regarding 12% Senior Notes due 2008 (incorporated by
reference to Registrant's Registration Statement on Form S-4 (Registration
No. 333-90039)).
10.6 First Supplemental Indenture, dated as of September 28, 1999, by RSL
Communications PLC and RSL Communications, Ltd. to The Chase Manhattan
Bank, as Trustee, regarding 10 1/8% Senior Discount Notes due 2008
(incorporated by reference to Registrant's Registration Statement on Form
S-4 (Registration No. 333-90039)).
10.7 First Supplemental Indenture, dated as of September 28, 1999, by RSL
Communications PLC and
23
<PAGE>
RSL Communications, Ltd. to The Chase Manhattan Bank, as Trustee,
regarding 10% Senior Discount Notes due 2008 (incorporated by reference to
Registrant's Registration Statement on Form S-4 (Registration No.
333-90039)).
27.1 Financial Data Schedule (filed herewith).
(b) Reports on Form 8-K.
None.
24
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Quarterly Report on Form 10-Q to be signed on
its behalf by the undersigned thereunto duly authorized.
RSL COMMUNICATIONS, LTD.
Date: November 15, 1999 By /s/ Joel S. Beckoff
---------------------------------
Name: Joel S. Beckoff
Title: Vice President - Controller
and Chief Accounting Officer
25
<PAGE>
Exhibit Index
3.1 Certificate of Incorporation of RSL Communications, Ltd., issued by the
Bermuda Registrar of Companies on March 14, 1996 (incorporated by
reference to Registrant's Registration Statement on Form S-4 (Registration
No.333-25749)).
3.2 Memorandum of Association of RSL Communications, Ltd., filed with the
Bermuda Registrar of Companies on March 14, 1996 (incorporated by
reference to Registrant's Registration Statement on Form S-4 (Registration
No.333-25749)).
3.3 Bye-Laws of RSL Communications, Ltd., as amended to date (incorporated by
reference to Registrant's Quarterly Report on Form 10-Q for the period
ended June 30, 1999).
4.1 Form of Class A Common Share (incorporated by reference to Registrant's
Registration Statement on Form S-1 (Registration No. 333-34281)).
10.1 First Supplemental Indenture, dated as of September 28, 1999, by RSL
Communications PLC and RSL Communications, Ltd. to The Chase Manhattan
Bank, as Trustee, regarding 9 7/8% Senior Notes due 2009 (incorporated by
reference to Registrant's Registration Statement on Form S-4 (Registration
No. 333-90039)).
10.2 First Supplemental Indenture, dated as of September 24, 1999, by RSL
Communications PLC and RSL Communications, Ltd. to The Chase Manhattan
Bank, as Trustee regarding 10 1/2% Senior Notes due 2008 (incorporated by
reference to Registrant's Registration Statement on Form S-4 (Registration
No. 333-90039)).
10.3 First Supplemental Indenture, dated as of September 24, 1999, by RSL
Communications PLC and RSL Communications, Ltd. to The Chase Manhattan
Bank, as Trustee, regarding 9 1/8% Senior Notes due 2008 (incorporated by
reference to Registrant's Registration Statement on Form S-4 (Registration
No. 333-90039)).
10.4 First Supplemental Indenture, dated as of September 28, 1999, by RSL
Communications PLC and RSL Communications, Ltd. to The Chase Manhattan
Bank, as Trustee, regarding 12 1/4% Senior Notes due 2006 (incorporated by
reference to Registrant's Registration Statement on Form S-4 (Registration
No. 333-90039)).
10.5 First Supplemental Indenture, dated as of September 28, 1999, by RSL
Communications PLC and RSL Communications, Ltd. to The Chase Manhattan
Bank, as Trustee, regarding 12% Senior Notes due 2008 (incorporated by
reference to Registrant's Registration Statement on Form S-4 (Registration
No. 333-90039)).
10.6 First Supplemental Indenture, dated as of September 28, 1999, by RSL
Communications PLC and RSL Communications, Ltd. to The Chase Manhattan
Bank, as Trustee, regarding 10 1/8% Senior Discount Notes due 2008
(incorporated by reference to Registrant's Registration Statement on Form
S-4 (Registration No. 333-90039)).
10.7 First Supplemental Indenture, dated as of September 28, 1999, by RSL
Communications PLC and RSL Communications, Ltd. to The Chase Manhattan
Bank, as Trustee, regarding 10% Senior Discount Notes due 2008
(incorporated by reference to Registrant's Registration Statement on Form
S-4 (Registration No. 333-90039)).
27.1 Financial Data Schedule (filed herewith).
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