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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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: 333-37719 )
HERMES EUROPE RAILTEL B.V.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
NETHERLANDS NONE
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
</TABLE>
TERHULPSESTEENWEG 6A
1560 HOEILAART
BELGIUM
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
(322) 658-5200
(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
registrants were required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] [ ]
At October 31, 1999, there were outstanding approximately 199,683 shares of
common stock of the registrant.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C> <C>
PART I Financial Information....................................... 3
Item 1 Financial Statements........................................ 3
Condensed, Consolidated Balance Sheets as of September 30,
1999 and December 31, 1998................................ 4
Condensed, Consolidated Statements of Operations for the
three and nine months ended September 30, 1999 and 1998... 5
Condensed, Consolidated Statements of Cash Flows for the
three and nine months ended September 30, 1999 and 1998... 6
Notes to Condensed, Consolidated Financial Statements....... 7
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 10
Item 3 Quantitative and Qualitative Disclosure About Market Risk... 14
PART II Other Information........................................... 15
Item 1 Legal Proceedings........................................... 15
Item 5 Other Information........................................... 15
Item 6 Exhibits and Reports on Form 8-K............................ 16
Signatures................................................................ 17
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets as of September 30, 1999 and
December 31, 1998
Condensed Consolidated Statements of Operations for the three and nine
months ended September 30, 1999 and 1998
Condensed Consolidated Statements of Cash Flows for the three and nine
months ended September 30, 1999 and 1998
Notes to Condensed Consolidated Financial Statements
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HERMES EUROPE RAILTEL B.V.
CONDENSED, CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(IN THOUSANDS, EXCEPT
SHARE DATA)
<S> <C> <C>
Current assets
Cash and cash equivalents................................. $ 309,590 $130,081
Restricted cash........................................... -- 30,062
Accounts receivable, net.................................. 78,744 48,034
Due from affiliated companies............................. 30,950 2,164
Other assets.............................................. 56,889 29,810
---------- --------
Total current assets.............................. 476,173 240,151
Property and equipment, net................................. 528,487 438,984
Goodwill and intangible assets, net......................... 126,438 50,519
Other non-current assets.................................... 11,705 14,456
---------- --------
TOTAL ASSETS...................................... $1,142,803 $744,110
========== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued expenses..................... $ 69,724 $ 84,047
Due to affiliated companies............................... 23,661 15,976
Deferred income........................................... 63,090 32,255
Current portion of capital lease obligations.............. 20,333 37,135
---------- --------
Total current liabilities......................... 176,808 169,413
Long-term debt............................................ 555,780 265,353
Long term capital leases.................................. 187,898 190,378
Deferred income........................................... 100,907 34,000
Other non-current liabilities............................. 1,405 29,259
---------- --------
TOTAL LIABILITIES................................. 1,022,798 688,403
Commitments and contingencies...............................
Minority interest........................................... -- 27,759
SHAREHOLDERS' EQUITY
Common stock, 1000 guilders par value (297,000 shares
authorized; 199,683 and 196,716 shares issued and
outstanding at September 30, 1999 and December 31, 1998
respectively........................................... 101,518 100,110
Additional paid-in capital................................ 104,180 33,334
Accumulated other comprehensive loss...................... (3,559) (1,300)
Accumulated deficit....................................... (82,134) (104,196)
---------- --------
TOTAL SHAREHOLDERS' EQUITY........................ 120,005 27,948
---------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $1,142,803 $744,110
========== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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HERMES EUROPE RAILTEL B.V.
CONDENSED, CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- --------------------
1999 1998 1999 1998
-------- -------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenues.......................................... $ 90,143 $ 26,997 $213,012 $ 42,933
-------- -------- -------- ---------
Operating costs and expenses:
Telecommunications services..................... 26,149 13,227 64,913 22,259
Selling, general and administrative............. 14,536 6,655 35,940 16,747
Depreciation and amortization................... 18,781 8,725 45,152 18,642
-------- -------- -------- ---------
59,466 28,607 146,005 57,648
-------- -------- -------- ---------
Income (loss) from operations..................... 30,677 (1,610) 67,007 (14,715)
Other income/(expense):
Interest expense................................ (20,195) (7,898) (54,181) (23,419)
Foreign currency losses......................... (653) (2,561) (1,183) (5,227)
Other, net...................................... 7,536 1,368 15,068 7,240
-------- -------- -------- ---------
(13,312) (9,091) (40,296) (21,406)
-------- -------- -------- ---------
Net income (loss) before income taxes............. 17,365 (10,701) 26,711 (36,121)
Income taxes...................................... 979 1,819 4,649 1,819
-------- -------- -------- ---------
Net income (loss)................................. $ 16,386 $(12,520) $ 22,062 $ (37,940)
======== ======== ======== =========
Net income (loss) per share:
Basic........................................... $ 82.06 $ (65.73) $ 111.47 $ (199.19)
======== ======== ======== =========
Diluted......................................... $ 81.75 $ (65.73) $ 110.12 $ (199.19)
======== ======== ======== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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HERMES EUROPE RAILTEL B.V.
CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- --------------------
1999 1998 1999 1998
-------- -------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)............................... $ 16,386 $(12,520) $ 22,062 $(37,940)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization................ 19,394 9,128 47,888 19,666
Change in value of foreign currency
instruments................................ 7,485 18,016 (25,351) 21,240
Minority interest............................ -- 564 468 604
Non-cash compensation........................ 468 214 996
Changes in assets and liabilities:
Accounts receivable........................ (3,570) (3,647) (68,179) (15,477)
Deposits................................... (2,729) (2,644) (5,108) (2,831)
Accounts payable and accrued expenses...... (10,067) 26,817 (10,576) 28,815
Other changes in assets and liabilities.... (7,854) (2,646) 57,809 5,454
-------- -------- --------- --------
Net cash provided by operating
activities............................ 19,045 33,536 19,227 20,527
INVESTING ACTIVITIES
Purchases of property and equipment............. (48,304) (45,102) (111,443) (75,946)
Acquisition, net of cash acquired............... -- -- (15,667) 13,352
Other investing activities...................... -- (314) (446) (314)
Restricted cash................................. 15,078 14,755 30,751 28,367
-------- -------- --------- --------
Net cash used in investing activities... (33,226) (30,661) (96,805) (34,541)
FINANCING ACTIVITIES
Proceeds from debt.............................. -- -- 302,450 --
Repayments of debt.............................. (9,630) (2,231) (26,106) (12,952)
Payment of debt issue costs..................... -- -- (10,164) (825)
Net Proceeds from issuance of common stock...... -- -- 1,249 --
Due to affiliated companies, net.................. (3,794) 14,769 (21,576) 14,270
-------- -------- --------- --------
Net cash (used in) provided by financing
activities............................ (13,424) 12,538 245,853 493
Effect of exchange rate changes on cash and cash
equivalents..................................... (4,623) (5,713) 11,234 (5,772)
-------- -------- --------- --------
Net (decrease) increase in cash and cash
equivalents..................................... (32,228) 9,700 179,509 (19,293)
Cash and cash equivalents at beginning of
period.......................................... 341,818 175,334 130,081 204,327
-------- -------- --------- --------
Cash and cash equivalents at end of period........ $309,590 $185,034 $ 309,590 $185,034
======== ======== ========= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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HERMES EUROPE RAILTEL B.V.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS
1. FINANCIAL PRESENTATION
The financial statements of Hermes Europe Railtel B.V. (the "Company")
included herein are unaudited and have been prepared in accordance with
generally accepted accounting principles for interim financial reporting and
Securities and Exchange Commission regulations. 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. Material intercompany account
transactions have been eliminated. In the opinion of management, the financial
statements reflect all adjustments of a normal and recurring nature necessary to
present fairly the Company's financial position, results of operations and cash
flows for the interim periods. These financial statements should be read in
conjunction with the Company's 1998 audited consolidated financial statements
and the notes related thereto. The results of operations for the three and nine
months ended September 30, 1999 may not be indicative of the operating results
for the full year.
The Company is one of the leading European providers of managed bandwidth
services and related telecommunications services to telecommunications carriers,
Internet service providers and other bandwidth-intensive customers. As of
September 30, 1999, the Company operates a centrally managed fiber optic network
(the "Network") in Europe over approximately 15,300 kilometers connecting 24
cities in 10 European countries, with service to the United States provided
through capacity leased on transatlantic cables. In addition, the Company
operates a Tier 1 Internet backbone network that connects European service
providers to the Internet.
The Company was formed on July 6, 1993 and as of September 30, 1999 was
95.4% owned by GTS Carrier Services, Inc., a wholly owned subsidiary of Global
TeleSystems Group, Inc. ("GTS"), a leading independent provider of
telecommunications services to businesses, other high usage customers and
telecommunications carriers in Europe, Russia and the Commonwealth of
Independent States.
For financial reporting purposes, the Company has reflected the accounting
acquisition effect of the incremental purchases, by GTS Carrier Services, Inc.,
from 1993 through 1999, of the Company's common shares, that were held by
nonaffiliated entities of GTS. Accordingly, the Company's consolidated financial
statements have been retroactively restated for all periods presented to reflect
the acquisition accounting effect, a process generally referred to as "push
down" accounting. The cumulative effect, through September 30, 1999, of the
allocation of the purchase price paid by GTS Carrier Services, Inc. has resulted
in goodwill of approximately $95.8 million, which is being amortized on a
straight line basis. Goodwill resulting from transactions occurring prior to
December 31, 1998, of $24.9 million, is being amortized over five years.
Goodwill resulting from transactions occurring in 1999, of $70.9 million, is
being amortized over twenty years.
2. POLICIES AND PROCEDURES
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
130, "Reporting Comprehensive Income", comprehensive income was $16.6 million
and $19.8 million for the three and nine months ended September 30, 1999,
respectively, and was comprised of net income of $16.4 million and $22.1 million
and a foreign currency translation gain and loss of $0.2 million and $2.3
million, respectively, for the three and nine months ended September 30, 1999,
respectively. Comprehensive loss was $10.7 million and $36.7 million for the
three and nine months ended September 30, 1998, respectively, and was comprised
of net losses of $12.5 million and $37.9 million and foreign currency
translation income of $1.8 million and $1.2 million for the three and nine
months ended September 30, 1998, respectively.
The Company's net income (loss) per share calculation (basic and diluted)
is based upon the weighted average common shares issued. There are no
reconciling items in the numerator of the Company's net income
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HERMES EUROPE RAILTEL B.V.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(loss) per share calculation. The following is a reconciliation of the
denominator of the Company's net income (loss) per share calculation:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Weighted Average Shares Outstanding................ 199,683 190,468 197,911 190,468
Common Stock Equivalents........................... 747 -- 2,436 --
-------- -------- -------- --------
Diluted Shares Outstanding......................... 200,430 190,468 200,347 190,468
======== ======== ======== ========
</TABLE>
As of January 1, 1999, the Company adopted the Euro as its functional
currency.
Certain reclassifications have been made to the September 1998 condensed,
consolidated financial statements in order to conform to the 1999 presentation.
3. ACQUISITION OF MINORITY INTEREST IN SUBSIDIARY
On May 25, 1999, the Company purchased the remaining 25% minority interest
in Ebone A/S ("Ebone") from the Ebone Holding Association ("EHA") for a purchase
price of Euro 35 million. The purchase price was comprised of cash of Euro 15
million and the issuance to EHA of capacity rights on the Network valued at Euro
20 million (the "Rights"). Rights may be applied by members of EHA, in lieu of
cash, to the payment of future invoices related to services provided by the
Company or Ebone on contracts for services entered into through May 31, 2003.
EHA assigned these Rights among its members by October 1, 1999 and once
assigned, the Rights are non-transferable.
The excess of the purchase price over the fair value of the assets acquired
of $9.2 million was allocated to goodwill and is being amortized over twenty
years.
4. DEBT OBLIGATIONS
In January, 1999 the Company issued, through a private placement, aggregate
principal amount $200 million of senior notes due January 15, 2009 (the "Dollar
Notes") and Euro 85 million (approximately $100 million) of senior notes due
January 15, 2006 (the "Euro Notes" and together with the Dollar Notes, the "New
Senior Notes"). The New Senior Notes are general unsecured obligations of the
Company, with interest payable semiannually at a rate of 10.375%. The Company
may redeem the Dollar Notes in whole or in part, any time on or after January
15, 2004 at specific redemption prices. The Company may redeem the Euro Notes,
in whole or in part, any time on or after January 15, 2003 at specific
redemption prices. The Company may also redeem the Dollar Notes and the Euro
Notes at a price equal to 110.375% of the principal amounts prior to January 15,
2002 with net cash proceeds of a public equity offering with gross proceeds of
at least $75 million or in certain other circumstances specified in the
indentures for the Dollar Notes and the Euro Notes provided, however that at
least two-thirds of the principal amount of the Dollar Notes and the Euro Notes
originally issued remain outstanding after each such redemption. Net proceeds
from the issuance of the New Senior Notes was approximately $289.3 million. The
Company filed an S-4 registration statement with the Securities and Exchange
Commission to exchange registered senior notes, with the same terms and
conditions as the New Senior Notes, for the New Senior Notes, which registration
statement became effective in February 1999. The exchange of registered notes
for the New Senior Notes was completed on March 24, 1999.
5. CAPITAL LEASE OBLIGATIONS
During the nine months ended September 30, 1999, in order to expand the
Network, the Company entered into contractual commitments to lease fiber pairs,
including facilities and maintenance. Based on the
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HERMES EUROPE RAILTEL B.V.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
contract provisions, these commitments are currently estimated to aggregate
approximately $51.1 million. The commitments have expected lease terms of ten to
eighteen years.
6. RELATED PARTY TRANSACTIONS
Included in revenues for the three and nine months ended September 30,
1999, respectively, is $12.9 million and $15.4 million of revenue from GTS
affiliates. Included in revenues for the three and nine months ended September
30, 1998, respectively, is $0.2 million and $0.5 million of revenue from GTS
affiliates.
7. SUBSEQUENT EVENTS
On October 15, 1999, GTS entered into an exchange agreement with all of the
minority interest holders of the Company's common shares and grantees of stock
options to purchase common shares of the Company that provides for the
acquisition by GTS of their equity interest in the Company. Specifically, the
agreement provides that GTS will acquire the respective minority interest
holders' common shares in the Company that have been held by them for a period
greater than six months based on the current fair market value of the Company on
the date of the exchange, as determined by a globally-recognized investment
banking firm that is mutually acceptable to the parties to the agreement. The
agreement also provides that GTS would issue its common shares to the Company's
minority interest holders based on the fair market value, as defined in the
exchange agreement, of GTS common shares on the date of the exchange.
Pursuant to this agreement and effective October 15, 1999, GTS exchanged
5,985,930 of its common shares for 6,565 of the Company's common shares. This
transaction resulted in aggregate purchase consideration of approximately $134.2
million and as a result the Company will reflect incremental goodwill of
approximately $133.0 million in the fourth quarter of 1999.
Further, minority interest holders of the Company have additional
beneficial ownership rights in the Company's common shares, and stock options to
purchase common shares, totaling 3,601 common shares. As stated previously, GTS
intends to acquire these Company common shares in the future; however, future
acquisitions will be based on future market values of the Company and GTS.
The Company is currently negotiating a Euro 35 million credit facility with
a bank (the "Facility"). The Facility would be structured in three tranches with
varying maturities of up to five years. Advances under the Facility would be
used to finance the purchase of network assets and equipment and for the
issuance of performance or payment guarantees in the ordinary course of
business.
The Company is engaged in an offering to issue approximately Euro 300
million of general unsecured senior notes pursuant to Rule 144A and Regulation S
of the Securities Act of 1933. GTS is making a $50.0 million capital
contribution to the Company in connection with this offering. The net proceeds
of this offering, together with the $50.0 million capital contribution from GTS
and existing cash balances, will be applied to purchase a dedicated fiber pair
on the FLAG Atlantic-1 transatlantic cable system and related equipment to
upgrade its transmission capacity, build intracity fiber networks and data- and
Web-hosting centers, expand our network, pursue business development
opportunities and for other general corporate purposes.
A notarial deed amending the Company's articles of association to change
the Company's name to Global TeleSystems Europe B.V. was executed on October 22,
1999. The change in the Company's legal name will become effective upon the
issuance by the Dutch Ministry of Justice of a declaration of non-objection,
which is expected on or about November 18, 1999.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis relates to our financial condition
and results of operations as of September 30, 1999 and 1998 and for the three
and nine months ended September 30, 1999 and 1998 and of certain factors that
management believes are likely to affect our prospective financial condition.
The following discussion should be read in conjunction with our Condensed,
Consolidated Financial Statements and the notes related thereto.
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
Certain statements contained in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" including, without limitation,
those concerning (i) projected network demand, (ii) future revenues and costs
and (iii) changes in our competitive environment, contain forward-looking
statements concerning our operations, economic performance and financial
condition. Because such statements involve risks and uncertainties, actual
results may differ materially from those expressed or implied by such
forward-looking statements.
In addition, any statements that express, or involve discussions as to,
expectations, beliefs, plans, objectives, assumptions or future events or
performance (often, but not always, through the use of words or phrases such as
"will likely result," "are expected to," "will continue," "is anticipated,"
"estimated," "intends," "plans," "projection" and "outlook") are not historical
facts and may be forward-looking and, accordingly, such statements involve
estimates, assumptions and uncertainties which could cause actual results to
differ materially from those expressed in the forward-looking statements.
Accordingly, any such statements are qualified in their entirety by reference
to, and are accompanied by, the factors discussed throughout this Report. Among
the key factors that have a direct bearing on our results of operations are the
potential risk of delay in implementing our business plan; the political,
economic and legal aspects of the markets in which we operate; competition and
our need for additional financing. These and other factors are discussed herein
under "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and elsewhere in this Report.
The factors described in this Report could cause actual results or outcomes
to differ materially from those expressed in any forward-looking statements made
by us or on behalf of us, and investors, therefore, should not place undue
reliance on any such forward-looking statements. Further, any forward-looking
statement speaks only as of the date on which such statement is made, and we
undertake no obligation to update any forward-looking statement or statements to
reflect events or circumstances after the date on which such statement is made
or to reflect the occurrence of unanticipated events. New factors may emerge
from time to time, and it is not possible for management to predict all of such
factors. Further, we cannot assess the impact of each such factor on our
business or the extent to which any factor, or combination of factors, may cause
actual results to differ materially from those contained in any forward-looking
statements.
OVERVIEW
We are one of the leading European providers of managed bandwidth services
and related telecommunications services to telecommunications carriers, Internet
service providers and other bandwidth-intensive customers. As of September 30,
1999, we operate a centrally managed fiber optic network in Europe over
approximately 15,300 kilometers connecting 24 cities in 10 European countries,
with service to the United States provided through capacity leased on
transatlantic cables. On September 24, 1998, we acquired a 75% interest in Ebone
A/S ("Ebone"). Ebone operates a Tier 1 Internet backbone network that connects
European service providers to the Internet. We purchased the remaining 25%
interest on May 25, 1999. The results of Ebone have been included in the
accompanying consolidated financial statements from the date of acquisition.
RESULTS OF OPERATIONS
Revenue. Our consolidated revenues for the three and nine months ended
September 30, 1999 were $90.1 million and $213.0 million, respectively, as
compared to $27.0 million and $42.9 million for the
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comparable periods in 1998. The growth in revenue is attributable to the
continued deployment of our network.
Telecommunications Services. Our telecommunications services costs for the
three and nine months ended September 30, 1999 were $26.1 million and $64.9
million, respectively, as compared to $13.2 million and $22.3 million for the
comparable periods in 1998. The increase in telecommunications services costs
for the three and nine months ended September 30, 1999 was primarily due to
increased costs related to operating and maintaining the network as it continues
to be deployed, as well as the increase in local access costs, which directly
corresponds to the increase in revenue.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the three and nine months ended September 30, 1999
were $14.5 million and $35.9 million, respectively, as compared to $6.7 million
and $16.7 million for the same periods in 1998. The increase in selling, general
and administrative expenses is reflective of the growth of our business
operations and support personnel. At September 30, 1999 we had 380 employees as
compared to 208 employees at September 30, 1998.
Depreciation and Amortization. Depreciation and amortization expense for
the three and nine months ended September 30, 1999 was $18.8 million and $45.2
million, respectively, as compared to $8.7 million and $18.6 million for the
comparable periods in 1998. The increase in depreciation and amortization
expense is attributable to an increase in depreciation of network assets due to
the continued deployment of our network, as well as goodwill amortization
attributable to the push down accounting.
Interest. Interest expense for the three and nine months ended September
30, 1999 was $20.2 million and $54.2 million, respectively, as compared to $7.9
million and $23.4 million for the comparable periods in 1998. The increase was
primarily attributable to the interest and related costs associated with the
issuance in January 1999 of $200 million aggregate principal amount of 10.375%
senior notes due 2009 ("Senior Notes due 2009) and Euro 85 million aggregate
principal amount of 10.375% senior notes due 2006 ("Senior Notes due 2006").
Interest income for the three and nine months ended September 30, 1999 was
$7.5 million and $15.5 million, respectively, as compared to $1.9 million and
$7.8 million in the comparable periods in 1998. The increase is due to the
interest earned through our short-term investments that have increased as a
result of the investment of the proceeds from the issuance of the Senior Notes
due 2009 and the Senior Notes due 2006.
LIQUIDITY AND CAPITAL RESOURCES
The primary sources of our funding through September 30 1999, have been net
proceeds of $251.3 million from the issuance in 1997 of the $265 million
aggregate principal amount of 11.5% senior notes in 1997 ("Senior Notes due
2007"), net proceeds of $289.3 million from the issuance in January 1999 of the
Senior Notes due 2009 and Senior Notes due 2006 and cash equity contributions of
$103.2 million in 1997. The Senior Notes due 2009 and the Senior Notes due 2006
are general unsecured obligations and have substantially the same terms as the
Senior Notes due 2007.
We are currently engaged in an offering in which we expect to issue
approximately Euro 300 million of general unsecured senior notes (the "Notes").
The terms of the Notes will be substantially similar to the Senior Notes due
2007, the Senior Notes due 2006 and the Senior Notes due 2009. GTS has agreed to
make a $50.0 million capital contribution to us in connection with the offering
of the Notes. In addition, we are currently evaluating entering into, through a
wholly owned subsidiary, a new credit facility (the "New Credit Facility") with
one or more institutional lenders in an aggregate amount of up to approximately
$750 million in the first quarter of 2000. It is currently contemplated that
borrowings under the New Credit Facility would be structurally senior to the
Senior Notes due 2007, the Senior Notes due 2006, the Senior Notes due 2009 and
the Notes.
Development of our fiber optic network has been capital intensive. We
currently expect that we will incur, in the fourth quarter of 1999 through
December 31, 2000, between $750 million to $850 million in capital expenditures,
including capital lease obligations, to expand the reach and capacity of our
network, construct intracity fiber networks and data- and Web-hosting centers in
our target metropolitan markets and purchase a
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dedicated fiber pair on the FLAG Atlantic-1 transatlantic cable system and
related equipment to upgrade its capacity. We believe that the net proceeds from
the issuance of the Notes, combined with existing cash balances, the $50 million
GTS capital contribution and our projected internally generated funds, should be
sufficient to fund our currently identified capital expenditures, at least
through December 31, 2000, including payments on the long-term fiber lease
arrangements. However, the actual amount and timing of our future requirements
may differ materially from our estimates. Any failure to obtain necessary
financing may require that we delay or abandon our plans for expanding the reach
and capacity of our network, constructing our planned intracity fiber networks
and data- and Web-hosting centers and purchasing a dedicated fiber pair on the
FLAG Atlantic-1 transatlantic cable system and related equipment to upgrade its
capacity and could jeopardize our viability.
We had positive working capital of $299.4 million and $70.7 million as of
September 30, 1999 and December 31, 1998, respectively. We had cash and cash
equivalents of $309.6 million and $130.1 million at September 30, 1999 and
December 31, 1998 respectively. We did not have restricted cash as of September
30, 1999. We had $30.1 million of restricted cash at December 31, 1998. The
restricted cash at December 31, 1998 primarily represented our obligation to
place into escrow the first four scheduled semi-annual interest payments on the
1997 senior notes. The final escrow interest payment of $15.1 million on the
Senior Notes due 2007 was made in August 1999.
During the three months and nine months ended September 30, 1999, operating
activities provided cash of $19.0 million and $19.2 million, respectively, and
provided $33.5 million and $20.5 million, respectively, for the comparable
period in 1998. Investing activities used cash of $33.2 million and $96.8
million for the three and nine months ended September 30, 1999 as compared to
using cash of $30.7 million and $34.5 million for the comparable periods in
1998.
We have developed risk management policies that establish guidelines for
managing foreign exchange risk. We continuously evaluate the materiality of
foreign exchange exposures in different countries and the financial instruments
available to mitigate this exposure. We have designed reporting processes to
monitor the potential exposure on an ongoing basis. We have limited our foreign
currency exposure by entering into a foreign currency swap agreement. We find it
impractical to hedge all foreign currency exposure and as a result, will
continue to experience foreign currency gains and losses.
YEAR 2000 COMPLIANCE
The "Year 2000" issue is the result of computer programs using two digits
rather than four to define the applicable year. Because of this programming
convention, software, hardware or firmware may recognize a date using "00" as
the year 1900 rather than the year 2000. Use of non-year 2000 compliant programs
could result in system failures, miscalculations or errors causing disruptions
of operations or other business problems, including, among others, a temporary
inability to process transactions and invoices or engage in similar normal
business activities.
Issues Posed by the Year 2000 Issue. We are exposed to the Year 2000 issue
in a number of ways. Among other things, the Year 2000 issue might affect our:
(i) computer hardware and software; (ii) telecommunications equipment and other
systems with embedded logic (among other things, this includes our fire
detection, access control systems, heating, ventilation and air conditioning,
and uninterruptible power supply) (iii) operating partners and organizations
upon which we are dependent; (iv) local access connections, upon which we are
dependent; and (v) supply chain.
Year 2000 Compliance Program. We have initiated a Year 2000 compliance
program to address the aforementioned risks which the Year 2000 issue poses and
to avoid any material loss or impact to us or our customers due to these risks.
The object of the Year 2000 compliance program is to ensure that neither the
performance nor functionality of our operations is affected by dates, prior to,
during and after 2000. The scope of the Year 2000 compliance program includes
all of the business functions, locations and resources that are essential. The
resources that are within the scope of the Year 2000 compliance program are,
among other things, our computer systems, software, vendor supplied software,
telecommunications equipment, third party telecommunications partners and other
network service suppliers, environmental and building control systems,
12
<PAGE> 13
internal communications systems and other interfaces with third party services.
As explained below, our efforts to assess systems as well as non-system areas
related to Year 2000 compliance involve (i) a wide-ranging assessment of the
Year 2000 problems that may affect us, (ii) the development of remedies to
address the problems discovered in the assessment phase and (iii) testing of the
remedies.
Assessment Phase. The assessment phase includes internal and third party
review of potential risks associated with the availability, integrity and
reliability of operational systems necessary to conduct business. During the
assessment phase we have identified substantially all of our major hardware and
software platforms, applications, telecommunications equipment and other non-IT
resources that support the business functions. The assessment phase of the Year
2000 compliance program further identified the internal and external technical
interfaces, third party business relationships and internally developed systems
that might be materially impacted by Year 2000 issues. Our observations from the
assessment phase during the third and fourth quarters of 1998 is that most of
our telecommunications equipment and software has been purchased within the last
three years and the majority is already compliant or can be made compliant with
minor upgrades. We completed the assessment phase of our Year 2000 readiness in
the fourth quarter of 1998.
Remediation, Prevention and Testing Phase. Based on those resources
identified in the assessment phase, we developed a detailed plan in the fourth
quarter of 1998, that was followed by an upgrade, remediation, prevention and
testing phases in early 1999. All important upgrades were performed on our
systems by the end of the second quarter. The remaining actions, including some
upgrades on non-critical systems and the installation of the latest Year 2000
patches on certain systems, were completed by the end of the third quarter of
1999. Testing will continue through the fourth quarter of 1999.
Assessment of Third Party Compliance. As noted above, we have also
undertaken our Year 2000 compliance program to assess and monitor the progress
of third party vendors in resolving Year 2000 issues. To ensure the compliance
of vendors of hardware and software applications used by us, we are obtaining
confirmations from its primary telecommunications vendors, business partners and
hardware and software vendors as to what plans, if any, are being developed or
are already in place to address their ability to process transactions in the
Year 2000. We have received responses from approximately 84% of our vendors,
including all critical ones. We have not received any responses that indicate
material problems that would require our follow-up.
Worst Case Scenario for the Company. Our worst case scenario would be the
failure of our telecommunications equipment, power providers and/or interfaces
with other telecommunication vendors. These cases would create business
interruption of our operations and would adversely affect our revenues. However,
we have operations that are geographically diversified; therefore, it is not
anticipated that the worst case scenario would affect all operations at the same
time. Additionally, if power failures occur, we currently have diesel generators
at almost all of our sites and expect to install diesel generators in the
remaining sites in 1999. Based on our assessment during the third and fourth
quarters of 1998, we do not foresee a material loss due to these conditions.
However, there can be no assurance that Year 2000 non-compliance by our systems
or the systems of vendors, customers, partners or others will not result in a
material adverse effect.
Contingency Plans. We have developed a contingency plan to address our
worst case scenario; however, certain of the initiatives are subject to
execution risk. This risk would include the ability to have access to diesel
fuel should power failures occur, the ability to quickly replace
telecommunications equipment and the ability to contract with alternative
telecommunications providers at reasonable terms.
Costs related to the Year 2000 Issue. We expect that we will incur
approximately $0.8 million to complete the assessment, detailed planning,
redemption prevention and testing phases, including costs to be incurred in our
Crisis Command Center, of which approximately $0.6 million has been incurred
through September 30, 1999. These costs will be funded from operating cash flows
and expensed as incurred. In addition, the preceding cost estimate does not
include amounts associated with the accelerated acquisition of replacement
systems, as none are included in the initial assessment during the third and
fourth quarters of 1998. We do not expect that the costs of addressing our Year
2000 readiness will have a material effect on our financial condition or results
of operations. However, there can be no assurance that Year 2000 non-
13
<PAGE> 14
compliance by our systems or the systems of vendors, customers, partners or
others will not result in a material adverse effect.
Crisis Command Center. We expect to operate a twenty-four hour Crisis
Command Center beginning December 30, 1999 to assist in the detection of
problems and to facilitate internal and external communication. It is
anticipated that the Crisis Command Center will remain open until at least
January 7, 2000.
Risks Related to the Year 2000 Issue. Although our efforts to be Year 2000
compliant are intended to minimize the adverse effects of the Year 2000 issue on
our business and operations, the actual effects of the issue will not be known
until 2000. Difficulties in implementing the redemption or prevention phases or
our failure to fully implement the planning or redemption phases or the failure
of our major vendors, third party network service providers, and other material
service providers and customers to adequately address their respective Year 2000
issues in a timely manner would have a material adverse effect on our business,
results of operations, and financial condition.
INTRODUCTION OF THE EURO
On January 1, 1999, eleven of the fifteen member countries of the European
Union, including Belgium, The Netherlands, Ireland, France, Germany, Italy and
Spain, where we have our headquarters and the majority of our subsidiaries and
operations, established fixed conversion rate between their existing sovereign
currencies and a new currency called the "Euro." These countries adopted the
Euro as their common legal currency on that date. The Euro trades on currency
exchanges and is available for non-cash transactions. Hereafter and until
January 1, 2002, the existing sovereign currencies will remain legal tender in
these countries. On January 1, 2002, the Euro is scheduled to replace the
sovereign legal currencies of these countries.
We have significant operations within the European Union including many of
the countries that have adopted the Euro. We continue to evaluate the impact the
Euro will have on our continuing business operations and no assurances can be
given that the Euro will not have material adverse affect on our business,
financial condition and results of operations. However, we do not expect the
Euro to have a material effect on our competitive position as a result of price
transparency within the European Union as we have always operated as a
pan-European business with transparent pricing in ECU for the majority of our
customers. Moreover, we have evaluated our ability to update our information
systems to accommodate the adoption of the Euro and we do not expect to incur
material costs in the updating of such systems. In addition, we cannot
accurately predict the impact the Euro will have on currency exchange rates or
on our currency exchange risk.
We adopted the Euro as our functional currency on January 1, 1999.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to market risk from changes in interest rates on long-term
obligations and as a global company, we also face exposure to adverse movements
in foreign currency exchange rates. A portion of the our debt obligations are
denominated in currencies which expose us to risks associated with changes in
foreign exchange rates. We have developed risk management policies that
establish guidelines for managing foreign exchange risk and periodically
evaluates the materiality of foreign exchange exposures and the financial
instruments available to mitigate this exposure.
We entered into a foreign currency swap agreement in 1998 in order to
mitigate its exposure on US dollar denominated debt. We also attempt to mitigate
this and other exposures from debt obligations denominated in exposed currencies
by maintaining assets in the exposed currency wherever possible. We find it
impractical to hedge all foreign currency exposure and as a result will continue
to experience foreign currency gains and losses. The introduction of the Euro as
a common currency for members of the European Union occurred on January 1, 1999.
We have not determined what impact, if any, the Euro will have on our foreign
exchange exposure.
The only significant change since December 31, 1998 is the issuance in
January 1999 of the Senior Notes due 2006 which exposes us to changes in
interest rates, and the Senior Notes due 2009 which exposes us to
14
<PAGE> 15
changes in interest and foreign exchange rates. The Notes will also expose us to
changes in interest and foreign exchange rates.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Interactive Communications Services (ICS) has brought a claim against our
wholly owned subsidiary, GTS Carrier Services (Ireland) Limited, for damages
alleged to exceed Euro 2.9 million. Proceedings were issued on October 11, 1999
and a detailed claim has not yet been served. ICS has obtained an injunction
preventing GTS Carrier Services (Ireland) Limited from suspending or terminating
certain telecommunications services provided to ICS. However, the injunction was
discharged on October 26, 1999, because ICS failed to pay L267,000 to GTS
Carrier Services (Ireland) Limited, which was a condition for the injunction to
remain in place. From evidence before the court connection with that injunction,
it appears that ICS's damages claim relates to an alleged breach of contract in
GTS Carrier Services (Ireland) Limited not commissioning or connecting
telecommunications circuits as quickly as ICS claims GTS Carrier Services
(Ireland) Limited was contracted to do. We believe that ICS's claim is without
merit.
On March 26, 1999, we opposed the license fee imposed by the French
regulator as, among other things, contrary to Article 11 of EC Directive 97/13
which requires license fees to cover only the administrative cost of managing
the license. On September 23, 1999 the French regulator informed us that they
rejected our position. We intend to bring the matter before the French
administrative tribunal. Under French law, we would not be required to pay the
license fee and the French regulator does not have the right to terminate our
license until such time as a ruling by the French administrative tribunal is
issued. If our claim is rejected in a final non-appealable judgment, we will be
required to pay our license fee in France.
Based on the information currently available, we believe that none of such
current claims or proceedings, individually or in the aggregate, will have a
material adverse effect on our financial condition or results of operations,
although there can be no assurance that this will remain the case.
ITEM 5. OTHER INFORMATION
See Note 7 to our unaudited Condensed, Consolidated Financial Statements
included in this report.
In order to reinforce our position as the leading provider of managed
bandwidth and related telecommunications services to telecommunications
carriers, Internet service providers and other bandwidth-intensive customers, we
have announced the following initiatives designed to extend our network closer
to our customers and offer new and enhanced services:
- Develop City Enterprise Networks. In order to offer end-to-end
transmission services to our carrier and other bandwidth-intensive
customers, we intend to build intracity fiber networks or City Enterprise
Networks in major European cities. In September 1999, through
subsidiaries, our parent GTS began commercial operation of a City
Enterprise Network in Berlin and completed operational testing of a City
Enterprise Network in Paris. We expect to have deployed intracity fiber
networks in twelve additional cities by year-end 2001. The following are
cities in which we plan to build City Enterprise Networks:
- Geneva
- Frankfurt
- London
- Amsterdam
- Madrid
- Milan
We are also evaluating construction of City Enterprise Networks in the
following additional cites:
- Stockholm
- Brussels
- Zurich
- Vienna
- Munich
- Barcelona
- Stuttgart
- Dusseldorf
15
<PAGE> 16
Each City Enterprise Network will be designed to connect, within a
city, the major telecommunications transmission centers, including points
of presence on our network, points of presence of our affiliates in such
city, telehouses, Internet protocol exchange points and, where
economically feasible our existing customers' points of presence in that
city. This will allow us to reach our customers without relying on
third-party local access providers.
- Expand and enhance the transatlantic capacity of our network. We
currently lease transatlantic capacity from third parties. We are
investing in our own transatlantic capacity infrastructure through the
acquisition of a dedicated fiber pair on the FLAG Atlantic-1
transatlantic fiber optic link. By owning this fiber pair, we will
acquire capacity of 70 gigabits per second upgradeable up to a maximum of
400 gigabits per second of fully protected capacity from the New York
City area directly to our European network. We expect to commence service
on this fiber pair in the first quarter of 2001. In addition, we are
planning to enter into arrangements to obtain network capacity connecting
several key U.S. markets by the end of 2000.
- Open Data- and Web-hosting centers. We intend to open data- and
Web-hosting centers in London, Amsterdam, Frankfurt and Paris, each
containing in excess of 25,000 square feet. Our data- and Web-hosting
center in London is expected to be operational by year-end 1999, with the
remaining three centers scheduled to be operational by mid-2000. These
centers are a natural extension of our strategy to meet the end-to-end
needs of customers in the Internet- and multimedia-related segments of
our target markets in Europe.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<S> <C> <C>
27 Financial Data Schedule
</TABLE>
B. Reports on Form 8-K
<TABLE>
<CAPTION>
DATE OF REPORT SUBJECT OF REPORT
-------------- -----------------
<S> <C> <C>
None
</TABLE>
16
<PAGE> 17
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrants have duly caused this report to be signed on their behalf by the
undersigned thereunto duly authorized.
HERMES EUROPE RAILTEL B.V.
(Registrant)
By: /s/ MIKEL WILLIAMS
------------------------------------
Name: Mikel Williams
Title: Acting Vice President --
Chief Financial Officer
(Principal Financial and
Accounting Officer)
Date: November 3, 1999
17
<PAGE> 18
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM UNAUDITED
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 309,590
<SECURITIES> 0
<RECEIVABLES> 78,744
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 476,173
<PP&E> 590,174
<DEPRECIATION> 61,687
<TOTAL-ASSETS> 1,142,803
<CURRENT-LIABILITIES> 176,808
<BONDS> 764,011
0
0
<COMMON> 101,518
<OTHER-SE> 18,487
<TOTAL-LIABILITY-AND-EQUITY> 1,142,803
<SALES> 0
<TOTAL-REVENUES> 213,012
<CGS> 0
<TOTAL-COSTS> 64,913
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 54,181
<INCOME-PRETAX> 26,711
<INCOME-TAX> 4,649
<INCOME-CONTINUING> 22,062
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 22,062
<EPS-BASIC> 111.47
<EPS-DILUTED> 110.12
</TABLE>
