<PAGE> 1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER:
---------------------
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
incorporation or organization) Identification Nos.)
</TABLE>
TERHULPSESTEENWEG 6A
1560 HOEILAART
BELGIUM
(Address of principal executive offices)
(322) 658-5200
(Registrant's telephone number)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
None
---------------------
Indicate by check mark whether the registrants (1) have 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) have been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained in this Form 10-K, and will not be
contained, to the best of the registrants' knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [X] Not Applicable.
On March 15, 1999, there were outstanding 196,716 shares of Common Stock of
Hermes Europe Railtel B.V., of which 13,610 shares were held by non-affiliates.
There is no established market for the registrant's voting stock. Accordingly,
the registrant is unable to estimate the value of shares held by non-
affiliates.
<TABLE>
<CAPTION>
ITEM OF FORM 10-K DOCUMENT INCORPORATED BY REFERENCE
----------------- ----------------------------------
<S> <C>
Part IV, Item 14(c) Exhibits
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
HERMES EUROPE RAILTEL B.V.
FORM 10-K
YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
PART I
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
Item 1. Business.................................................... 1
Introduction................................................ 1
Industry Overview........................................... 1
Business Summary............................................ 3
Business Strategy........................................... 3
Managed Bandwidth Services.................................. 3
Internet Access and IP Transport............................ 4
Marketing Strategy.......................................... 5
Pricing and Distribution.................................... 6
Customers................................................... 7
Network Design.............................................. 8
Network Capacity............................................ 9
Network Agreements.......................................... 9
Local Access................................................ 10
Competition................................................. 10
Licenses and Regulatory Issues.............................. 10
Employees................................................... 14
Risk Factors................................................ 14
Item 2. Properties.................................................. 21
Item 3. Legal Proceedings........................................... 22
Item 4. Submission of Matters to a Vote of Security Holders......... 22
PART II
Item 5. Market for the Company's Common Equity and Related
Stockholder Matters......................................... 22
Item 6. Selected Financial Data..................................... 23
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of
Operations.................................................. 24
Item 7A. Quantitative and Qualitative Disclosure About Market Risk... 28
Item 8. Financial Statements and Supplementary Information for the
Company..................................................... 30
Item 9. Changes In and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 47
PART III
Item 10. Directors and Executive Officers of the Company............. 47
Item 11. Executive Compensation...................................... 51
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 56
Item 13. Certain Relationships and Related Transactions.............. 56
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 57
Signatures ............................................................ 60
</TABLE>
<PAGE> 3
PART I
ITEM 1. BUSINESS
INTRODUCTION
We are one of the leading providers of telecommunications services to other
telecommunications carriers. We operate a centrally managed fiber optic network
that is designed to carry high volumes of telecommunications traffic across
national borders in Europe and to the United States. At March 3, 1999, the
network operated over approximately 12,200 kilometers connecting 19 cities in 10
countries. We expect the network to extend approximately 25,000 kilometers with
points of presence, or equipment for switching or relaying traffic, in
approximately 50 cities in 20 European countries by the end of 2000.
Capacity on our network is sold to public telecommunications operators,
other carriers, Internet service providers, resellers of unused
telecommunications capacity and other telecommunication service providers. We
believe that we are able to provide our customers a service that is superior to
other services currently available through public telecommunications operators
or through other independent providers.
At March 3, 1999, we operated our network in Belgium, The Netherlands, the
United Kingdom, France, Germany, Switzerland, Italy, Denmark, Sweden and Spain,
linking the following 19 cities: Brussels, Antwerp, Rotterdam, Amsterdam,
London, Paris, Frankfurt, Strasbourg, Zurich, Geneva, Stuttgart, Dusseldorf,
Munich, Milan, Berlin, Copenhagen, Stockholm, Hamburg and Madrid. If completed
as expected by the end of 2000, our network will extend approximately 25,000
kilometers. During 1999, we plan to extend our network through France to
Barcelona and commence operating in Austria, the Czech Republic, Luxembourg and
Portugal.
We currently lease capacity on transatlantic cables linking the network
with North America and are exploring various interconnectivity options to
Russia. At March 3, 1999, 54 customers were under contract for service on our
network, and at December 31, 1998 our customers were contractually obligated to
pay us an aggregate of $418 million for future services, provided we perform in
accordance with contractual specifications.
We intend to continue to build our network using cost-efficient access to
an infrastructure of railways, motorways, pipeline companies, waterways and
power companies. We have a flexible approach to the network plan and intend to
fine-tune the scope, route and design of the network based on our evaluation of
customer demand. We have entered into agreements for the construction and/or
lease of fiber optic routes for the network in the countries where we currently
operate. We continue to negotiate rights-of-way and other infrastructure
arrangements in order to extend the network. We expect to incur approximately
$750 million in additional capital expenditures, including capital lease
obligations, through 2000 in connection with the build-out of the network.
In June 1998, we acquired our 75% interest in Ebone, a Danish company which
connects European Internet service providers to the Internet over its own
network. As of December 31, 1998, Ebone served 83 customers in 25 countries. As
part of the transaction, Ebone purchased approximately $100 million of long-
term capacity rights on Hermes Railtel's network. It will provide Ebone with
capacity of up to 622 megabits per second between the majority of European
cities that Ebone serves. Many of Ebone's existing customers own a portion of
Ebone's shares through an association.
INDUSTRY OVERVIEW
EUROPEAN TELECOMMUNICATIONS MARKET
Liberalization in the European telecommunications markets has proceeded
rapidly since the late 1980's. Historically, the European public
telecommunications operators monopolized the provision of telecommunications
services in their home markets and designed their networks according to national
rather than continental and international considerations. Between 1990 and 1997,
however, the European Union implemented a series of directives designed to open
up the telecommunications markets to competition. These directives required
<PAGE> 4
member states to implement legislation liberalizing their respective
telecommunications markets to permit alternative telecommunications companies
both to provide telecommunications services and to access the existing
telecommunications infrastructure controlled by these national and regional
providers. In response to these European regulatory changes, a number of new
interests, including our company, have emerged to compete with the European
public telecommunications operators. For a discussion of the risks we face with
public telecommunications operators, see "-- Risk Factors -- Competitors with
greater resources may adversely affect our revenues" and "-- Our competitive
position may be compromised by our dependence on other telecommunications
providers."
INTERNET INDUSTRY
The Internet is a global collection of interconnected computer networks
that allows commercial organizations, educational institutions, government
agencies and individuals to communicate, access and share information and
conduct business electronically. The Internet originated with the ARPAnet, a
restricted network that was created in 1969 by the United States Department of
Defense Advanced Research Projects Agency to provide efficient and reliable long
distance data communications among the disparate computer systems used by
government-funded researchers and academic organizations. The networks that
comprise the Internet, or its backbone, are connected in a variety of ways,
including by public switched telephone networks and by high speed, dedicated
leased lines. Communications on the Internet are enabled by Internet Protocol or
IP, which is a market-based standard computer language broadly adopted on the
Internet and elsewhere that allows computers with different architectures and
operating systems software to communicate with each other on the Internet.
Over time, as businesses have begun to utilize e-mail, file transfer and,
more recently, intranet and extranet services, commercial usage has become a
major component of Internet traffic. In 1989, the U.S. government effectively
ceased directly funding any part of the Internet backbone. In the mid-1990s,
contemporaneous with the increase in commercial usage of the Internet, a new
type of provider called an Internet service provider became more prevalent.
Internet service providers offer access, e-mail, customized content and other
specialized services and products aimed at allowing both commercial and
residential customers to obtain information from, transmit information to, and
utilize resources available on the Internet.
Internet service providers generally operate networks composed of dedicated
lines leased from public telecommunications operators, local access providers
and internet service providers using IP-based switching and routing equipment
and server-based applications and databases. Customers are connected to the
Internet service provider switching equipment by facilities obtained by the
customer or the Internet service provider from either public telecommunications
operators or local access providers through a dedicated access line or the
placement of a circuit-switched local telephone to the Internet service
provider.
IP COMMUNICATIONS TECHNOLOGY
There are two widely used switching technologies in currently deployed
communications networks: circuit-switching systems and packet-switching systems.
Circuit-switch based communications systems establish a dedicated channel for
each communication (such as a telephone call for voice or fax), maintain the
channel for the duration of the call and disconnect the channel at the
conclusion of the call. Packet-switch based communications systems format the
information to be transmitted, such as e-mail, voice, fax and data, into a
series of shorter digital messages called "packets." Each packet consists of a
portion of the complete message plus the addressing information to identify the
destination and return address.
Packet-switch based systems offer several advantages over circuit-switch
based systems, particularly the ability to commingle packets from several
communications sources together simultaneously onto a single channel. For most
communications, particularly those with bursts of information followed by
periods of "silence," the ability to commingle packets provides for superior
network utilization and efficiency, resulting in more information being
transmitted through a given communication channel. There are, however, some
disadvantages to packet-switch based systems as currently implemented. Rapidly
increasing demands for data, in part driven by the Internet traffic volumes, are
straining capacity and contributing to latency (delays) and
2
<PAGE> 5
interruptions in communication transmissions. In addition, there are concerns
about the adequacy of the security and reliability of packet-switch based
systems as currently implemented.
Initiatives are under way to develop technology to address these
disadvantages of packet-switch based systems. We believe that the evolving IP
standard will remain a primary focus of these development efforts. We expect the
benefits of these efforts to be improved communications, reduced latency and
declining networking hardware costs.
BUSINESS SUMMARY
At March 3, 1999, we operated approximately 12,200 kilometers of fiber
optic cable connecting 19 cities in 10 countries in Europe. When completed by
the end of 2000, our network will extend approximately 25,000 kilometers with
points of presence, or locations with equipment for switching or relaying
traffic, in approximately 50 cities in 20 European countries. At March 3, 1999,
we had 54 customers which included public telecommunications operators and other
carriers, global consortia, Internet service providers, resellers and other
service providers. We believe that we are able to provide our customers with a
service offering that is superior to comparable services currently available
through public telecommunications operators or through other independent
telecommunications providers.
Our services are characterized by high transmission quality and
reliability, flexibility and competitive pricing. We offer our customers a wide
range of capacity levels for contract periods ranging from one to ten years. In
1998, we began upgrading our network with dense wavelength division multiplexing
technology. This is a cost-effective technology that substantially increases the
transmission capacity of an existing fiber optic network by multiplying the
number of signals that it can carry simultaneously. In February 1999, we
announced our plan to introduce a network platform that will apply IP technology
directly over dense wavelength division multiplexing by the end of the second
quarter of 1999. We expect this to enhance the efficiency of our network and its
capacity to carry IP-based traffic. We initially plan to deploy this platform in
six European countries.
BUSINESS STRATEGY
We intend to make our service offerings more attractive to our carrier
customers by expanding the geographic reach and reliability of our core network.
We are continuing to build our network by extending its coverage to include
approximately 50 cities throughout Europe by the end of 2000 and by putting in
place a high speed, cost-efficient transatlantic link through the FLAG Atlantic
Limited joint venture, in which one of our affiliates participates. We are also
deploying dense wavelength division multiplexing technology that will permit
significant expansion of the core network's transmission capacity and allow us
to upgrade the reliability and efficiency of the network.
MANAGED BANDWIDTH SERVICES
We provide primarily large capacity cross-border European circuits and
transatlantic services to carriers and service providers over an integrated,
managed network. Our network, based on dense wavelength division multiplexing
and synchronous digital hierarchy technology (a form of packet switched
transmission technology), provides digital transmission capability upon which a
broad range of advanced functionality may be built. Our network offers network
availability, flexibility, bandwidth speeds and error performance not otherwise
available to carriers for transport of telecommunications traffic across
national borders in Western and Central Europe. Our network is designed to
provide customers with a wide variety of bandwidth speeds, ranging from a data
transmission rate of 2.048 Mbps (or millions of bits per second) to a data
transmission rate of 2.5 gigabits per second (or billions of bits per second).
For more information on technology in the telecommunications industry, see
"-- Industry Overview -- IP Communications Technology."
Point-to-Point Transmission Capacity. The current market for cross-border
transport is also served by international private leased circuits provided by
public telecommunications operators. Traditionally, such private leased circuits
are formed by combining half-circuits from two public telecommunications
operators between customer locations, often with additional public
telecommunications operators providing transit
3
<PAGE> 6
segments. Under such private leased circuits, overall service quality guarantees
generally are not provided and only a limited range of bandwidth is available,
usually only at a data transmission rate of 2.048 Mbps, and in certain
instances, at a data transmission rate of 34 Mbps. We provide a Point-to-Point
Transmission Capacity service to our customers. We believe this service is a
significant improvement to private leased circuits because it provides a greater
range of bandwidths from 2,048 Mbps to multiples of 140 Mbps or 155 Mbps and
allows customers to choose a service level agreement which provides service
guarantees appropriate for their applications, including guarantees for on-time
service delivery and service availability.
Our point-to-point transmission capacity consists of "integrated" and
"node-to-node" services. Our network integrated service provides an end-to-end
service between customer-specified locations where we arrange for the connection
between the network node location and the customer's location. The node-to-node
service can be selected when the customer prefers to provide its own connection
to the local network node location. In node-to-node service, we guarantee
service only on our network and not from our network node to the customer's
location. Our network prices for both services are competitive relative to
current service offerings. Our customers can choose flexible contract terms from
one to ten years in duration, with discount schemes designed to ensure that we
remain a cost-effective solution.
Virtual Network Transmission Services. As the European marketplace
liberalizes and carriers and other telecommunications service providers plan to
expand their operations across Europe, a need arises for a flexible and
cost-effective means of telecommunications transport. Such service providers
have traditionally obtained international transport service by leasing
international private leased circuits. Leasing private leased circuits requires
a carrier to lease channels on a segment-by-segment basis from multiple public
telecommunications operators, linking the target cities under arrangements
having a fixed capacity and pricing structure for each segment of the carrier's
network. Private leased circuits have several disadvantages, including (1)
difficulty in obtaining discount/volume pricing schemes since there is no single
provider of pan-European coverage, (2) delays in implementation due to numerous
contractual negotiations and the need to interconnect numerous leased circuits,
(3) limited opportunities to lease high-bandwidth pan-European capacity and (4)
variability of quality due to the absence of a centrally managed single uniform
network. Telecommunications carriers could also construct their own network,
which is expensive, time-consuming and complex and which may not be justified by
traffic volume.
Our network transmission service provides a new solution and an attractive
alternative to leasing circuits or building infrastructure. This service enables
our customers to obtain a uniform pan-European or cross-border network under one
service agreement by allowing the customer to select any number of cities along
our network with a pricing structure based on the overall amount of leased
capacity for the customer's entire network.
Ring Service. Most medium to large carriers and operators purchase network
capacity in excess of actual requirements and prefer to have control over the
physical configuration of their networks. This service connects multiple
customer locations with multiple paths in a ring configuration. We provide the
customer with reliable and direct control over the paths dedicated to its
traffic within the ring and exclusive control over the routing. We can add
additional ring capacity with no service interruption and additional customer
locations with minimal service interruption. We can provide this ring service at
a very competitive rate compared to other point-to-point services. For a
discussion of the risks associated with the Hermes Railtel network technology,
see "-- Risk Factors -- The technology of our network could become obsolete."
INTERNET ACCESS AND IP TRANSPORT
Ebone Internet Access Services. Internet service providers, which are
companies that provide Internet access to end-users, have purchased Internet
access from Ebone since 1991. Ebone has one of the largest installed bases of
Internet service provider customers in Europe. Building on the expertise
developed since the advent of the Internet in Europe, Ebone now offers Internet
service providers a high quality Internet access service with the following
significant features:
- Reliable access to Internet service throughout Ebone's network, which is
made possible by always dedicating excess bandwidth capacity on its
network;
4
<PAGE> 7
- Access to other Internet networks through links with major Internet
backbone providers in Europe and in the United States; and
- Access speeds ranging up to 620 Mbps.
IP Transport Services. We are developing IP transport services for service
providers that focus on building their own Internet backbone, Intranet or voice
over IP services. This IP traffic has been traditionally supported by a
combination of managed bandwidth services (like the ring or the point-to-point
services of Hermes Railtel's network) and Internet network services (like
Ebone's Internet services).
Today, large service providers building their Internet networks demand the
speed offered by fiber infrastructure, the reliability of managed bandwidth
services and the flexibility of Internet network services.
We intend to carry the international Internet traffic of service providers
between their private points of presence and/or Internet exchange points. We
expect these services to combine high quality transmission services with the
ability to upgrade transmission capacity and speed and to control configurations
which are the strengths of large Internet network providers. For a discussion of
the risks associated with the Hermes Railtel network technology, see "-- Risk
Factors -- The technology of our network could become obsolete."
MARKETING STRATEGY
Our overall strategy is to offer public telecommunications operators and
other carriers pan-European cross-border telecommunications transport services.
Our network provides a vehicle through which a carrier can compete in markets
where it does not own infrastructure. Our primary service offering is the sale
of large capacity cross-border circuits to our customers. Our network's focus on
carriers is designed to complement and not compete with such carriers' own
business objectives in providing services to their end-users.
As a result of our acquisition of Ebone, we are now accelerating our plans
to become a leading player in the provision of seamless transatlantic
city-to-city services in order to take advantage of the increased market demand
for low cost transatlantic city-to-city services. In 1998, we contracted for
long-term leased capacity on transatlantic cables linking the Hermes Railtel
network to North America. In addition, we intend to further increase our
transatlantic capacity through the purchase of capacity from the FLAG Atlantic
Limited joint venture in which our affiliate has a 50% interest. We also intend
to invest further in extending and increasing the capacity of our network.
To establish ourselves as the leading provider of telecommunications
services to carriers within Europe, we offer our customers significantly higher
quality transmission and advanced network capabilities at a competitive price by
focusing on the following:
- High Capacity Cross-Border Network Facilities. Our network is designed to
offer our customers high capacity network facilities outside their
domestic markets, providing cross-border capabilities without requiring
customers to invest in network infrastructure or being constrained by a
narrow range of capacity offerings. By utilizing dense wavelength
division multiplexing technology over our network, we anticipate that,
once fully deployed, this technology will enable our network to provide a
minimum speed of 800 gigabits per second on all major routes. Options are
in place to expand fiber capacity further on a number of routes.
- Uniform Network Architecture. Our network is designed to offer managed
transport services from country to country and across multiple countries
utilizing a single uniform network, in contrast to services currently
available that use multiple providers over several networks with varying
technologies under the control of separate, not necessarily compatible,
network control systems. Our network's uniform technology enhances
service by providing quality and reliability as well as uniformity of
features throughout the network.
- Diverse Routing. We have designed our network over multiple routes to
provide high levels of reliability so that if a failure occurs on one
route, traffic can be diverted to an alternate route. The network is
designed to provide availability of over 99.9% for most routes and to
provide customers with
5
<PAGE> 8
a wide range of telecommunications transmission capacity. We believe that
to achieve this level of reliability without the use of a network similar
to our network, carrier customers would need to purchase additional
dedicated circuits.
- Rapid Provisioning. Our customers can quickly obtain additional capacity
on our network. This ability to rapidly provide service is largely due to
our development of capacity substantially in excess of our forecasted
requirements.
- Flexibility. Our services provide customers flexibility across our
network so that the customer may minimize risk by enabling network
rerouting, eventually even under customer direct control.
- Advanced Technology. We are deploying dense wavelength division
multiplexing and synchronous digital hierarchy technology that can be
upgraded and will permit significant expansion of transmission capacity
without increasing the number of fiber pairs on a network. This
technology also provides the basis for structuring advanced operating
features, such as virtual private network services and IP-based services.
- Innovative Pricing. We believe that the price of high-bandwidth circuits
on transborder European routes is artificially high and not necessarily
related to the cost of such circuits. We offer competitive pricing with
tailored contract terms and volume discounts. This allows our customers
to plan more efficiently the fixed costs of their service portfolio. Our
customers can select varying capacity, access, guaranteed availability
and contract terms at competitive prices. Customers purchasing capacity
from public telecommunications operators generally choose from a narrow
set of capabilities under inflexible pricing plans.
For a discussion of the risks associated with our marketing strategy, see
"-- Risk Factors."
PRICING AND DISTRIBUTION
We primarily conduct sales of our services through Hermes Europe Railtel
(Ireland) Limited, a subsidiary.
Currently, the price of cross-border pan-European calls is often
significantly higher than the underlying cost of transport and termination of
such calls and higher than the price of intra-country calls or transborder calls
to and from liberalized markets. The low cost of operating our network enables
us to attractively and competitively price services even as overall tariffs for
telecommunication services decline. Our low cost basis is a result of, among
other things, the application of new technologies to our network, which allows
us to operate our network with fewer employees than legacy networks.
The term of a typical customer agreement currently ranges from one to three
years in length. The customer agrees to purchase, and we agree to provide,
cross-border transmission capacity. In general, the customer agrees to pay
certain non-recurring charges upfront and recurring charges on an annual basis,
payable in twelve monthly installments. If the customer terminates the service
order prior to the end of the contract term, the customer is generally required
to pay us a cancellation charge equal to three months' service for every twelve
months remaining in the contract term. We guarantee transmission services to a
certain service level. If such levels are not met or we fail to deliver service
by the committed delivery date, the customer is eligible for a credit against
charges otherwise payable for the failed link.
6
<PAGE> 9
CUSTOMERS
At March 3, 1999, 54 customers were under contract for service on our
network, including public telecommunications operators and other carriers,
global consortia, Internet service providers and resellers. As of December 31,
1998, our customers were contractually obligated to pay us an aggregate of $418
million for future services, provided our network performs in accordance with
contractual specifications. We believe that the type and quality of our
customers validate our business plan and network concept and illustrate the type
of customers we expect to be attracted to the full network. The success of our
network to date also demonstrates the demand for cross-border transport
services. We are targeting seven major market segments or customer groups, which
can be characterized as follows:
- Existing Public Telecommunications Operators. This customer segment
consists of the traditional European public telecommunications operators
that generally participate in the standard bilateral agreements for
cross-border connectivity. We provide a vehicle for public
telecommunications operators to compete in non-domestic markets. As of
January 1, 1998, all public telecommunications traffic can be transported
by carriers other than the domestic public telecommunications operator,
thus vastly expanding the potential demand from public telecommunications
operators for our services.
- Global Consortia of Telecommunications Operators. Many of the largest
public telecommunications operators and international carriers have
pooled resources and formed consortia in order to compete more
effectively in important telecommunications markets such as those in
Western Europe, particularly outside their home markets. Prior to
liberalization of the provision of switched voice services in Western
European markets, one of the primary objectives of these consortia was to
provide pan-European services to multinational business customers,
including X.25/frame relay (high speed data network) service and voice
services for a closed user group. We believe that we provide an
attractive alternative at better pricing in those environments where such
a consortium does not already own its infrastructure. Furthermore, we
believe that we are well-positioned to provide cross-border connectivity
between different domestic infrastructures of these alliances.
- International Carriers. This customer segment consists of non-European
carriers with traffic between European and other international gateways.
Existing customers in this segment include Teleglobe and targeted future
customers include the United States regional Bell operating companies. We
can provide these customers a pan-European distribution network to gather
and deliver traffic to and from their own and other hubs.
- Other Carriers. This segment consists of other European carriers
competing with existing public telecommunications operators, cable TV and
mobile carriers and competitive access providers. These other carriers
have chosen to compete with the incumbent public telecommunications
operators in their respective countries. We believe that these other
carriers will prefer to use the services of independent carriers such as
ourselves to meet their cross-border telecommunication transport needs.
- Internet Backbone Networks. Internet backbone networks are providers of
large capacity international connectivity services between Internet nodes
(points of interconnection between local Internet service providers).
These networks are a fast-emerging segment and are expected to generate
significant demand for the services we offer. The Internet segment is
experiencing significant growth in demand for transmission capacity.
- Resellers. Resellers are telecommunications service providers that do
not own transmission facilities, but obtain communications services from
other carriers for resale to the public. Resellers are a growing segment
of the market and are expected to increase in conjunction with the
liberalization of the European telecommunications market. In the United
States, for example, resellers were a significant factor in the expansion
of competition.
- Other Service Providers. We also target data communications systems in
which special service features enhance the basic data transmission
facilities offered to customers. Many of these networks are targeted to
the data transfer requirements of specific international customer
segments such as airlines and financial institutions. Their basic network
transmission requirement is to connect data
7
<PAGE> 10
switches or processors, and they currently purchase their own
international circuits and build additional resiliency into their network
infrastructure. We expect to allow them to meet these needs cost-
effectively and to extend their services to new markets or customers
without substantial capital investment.
We expect that additional demand for alternative service providers will
come from increased usage of dedicated circuits for Internet access, private
lines for the deployment of wide-area networks by large corporations,
single-source local and long distance services for small and medium-sized
businesses and emerging broadband applications such as cable TV programming
distribution (other than broadcast) to the end-user.
NETWORK DESIGN
Network Architecture. Our network design is based on a layered architecture
that separates physical, optical and telecom layers of our network with standard
interfaces in order to optimize design and operation and provide flexibility for
introducing new technologies, such as IP.
Physical Layer. The physical layer of our network is based on a mesh of
routes comprised of dark fiber, or fiber optic cable that is not yet equipped or
activated for commercial use. When the network is completed, the physical layer
will interconnect cities on the network via at least two or three different
paths to minimize service interruptions when fiber or equipment failures occur.
In each major city, we intend to locate two additional customer access sites for
maximum reliability.
Optical Layer. The optical layer of our network is based on dense
wavelength division multiplexing. This is a cost-effective technology that
substantially increases the capacity of an existing fiber optic network by
multiplying the number of signals that it can carry simultaneously.
Specifically, this layer:
- supports the provision of optical services directly to customers at 2.5
gigabits per second, representing the speed for digital signal
transmission expressed in billions of bits per second; and
- provides for the operation of multiple synchronous digital hierarchy
transmission networks and/or IP systems to run concurrently on a single
fiber pair in a highly cost-efficient manner. Ciena 40 wavelength systems
are currently installed on our network in five countries with a potential
capacity of 100 gigabits per second on a fiber pair.
Telecom Layer. The synchronous digital hierarchy layer of our network,
running via dense wavelength division multiplexing channels in the core of the
network, and directly on fiber elsewhere, supports the provision of
point-to-point services to customers at speeds of 2 Mbps up to 155 Mbps. The
synchronous digital hierarchy layer is itself a multi-layered architecture
consisting of multiple synchronous digital hierarchy rings, or cables, which are
optimized for different telecommunications traffic characteristics. Each
synchronous digital hierarchy ring supports fully automatic re-routing of
traffic in the case of a break in the ring.
We expect to add an IP layer to our network starting in the second quarter
of 1999. This layer will support high capacity IP routers, or computer devices
for routing packet-switched data traffic, which can deliver IP services to
customers at speeds up to 2.5 gigabits per second. These routers will be
supported on the dense wavelength division multiplexing layer of the network
directly and/or through asynchronous transfer mode technology in the core of our
network and on top of the synchronous digital hierarchy layer elsewhere. These
changes will also enhance the services that Ebone can offer to its Internet
service provider customers. We plan to extend our enhanced IP transport
capabilities to all cities on our network by 2000. This layer will be able to
handle failures independently of the lower layers by re-routing at the IP level.
Our network is controlled by a single active network operations center in
Brussels, Belgium. We maintain a backup center in Amsterdam, The Netherlands
that has equivalent management systems continuously synchronized with the
primary center.
8
<PAGE> 11
Our network operations center can pinpoint potential service problems and
deal with service re-routing much more effectively than other networks that are
controlled by multiple operators in different countries. Our advanced
operational support systems also provide comprehensive support for:
- managing the large number of network components and local repair
organizations required for an extensive international network of our
size; and
- providing advanced customer support for customer operational activities.
Overall, our combination of backup paths and management components enable
recovery from individual failures at the optical, synchronous digital hierarchy
and IP layers. Our resilient approach provides for a high level of network
performance and reliability. As a result, we are able to enter into strong
performance commitments with our customers, and services on most routes of our
network have performed at or above 99.9% availability.
We expect to operate our network and to own substantially all of our
network equipment as well as some segments of the fiber optic cable. A
substantial portion of the fiber is leased from third parties on a long-term
basis. Long-term leases for fiber are advantageous to us because they reduce or
eliminate the costly burden of building large quantities of capacity before they
can be fully utilized. Where we lease dark fiber, the owner of such fiber will
generally be responsible for maintaining such fiber optic cable. In general, we
will enter into agreements with equipment vendors and infrastructure providers
and other third parties to supply and/or maintain the necessary equipment for
our network. For a discussion of the risks associated with our network
technology, see "-- Risk Factors -- The technology of our network could become
obsolete."
NETWORK CAPACITY
We are building our network to include Ciena 40 dense wavelength division
multiplexing systems on a majority of our routes. This allows for synchronous
digital hierarchy and IP systems of 2.5 gigabits per second to be installed only
when required, thus providing for efficient management of capital investment.
Should capacity be required beyond the initial 100 gigabits per second on
the first fiber pair, we can bring additional fiber pair(s) into operation that
utilize either higher capacity dense wavelength division multiplexing systems at
2.5 gigabits per second or at 10 gigabits per second. Such systems have been
available on some routes on our network since 1998. The remaining routes are
planned to have this upgrade in 1999. We plan to have a minimum of two fiber
pairs on all routes. This approach will extend capacity as we implement it on
new paths and on selected existing paths over time.
NETWORK AGREEMENTS
We have entered into agreements and letters of intent with various
infrastructure providers for construction and/or leasing of dark fiber for
portions of our network. Our agreements for leases of portions of our network
typically require the infrastructure provider to provide a certain number of
pairs of dark fiber and in some cases facilities along our network route
commencing on dates we provide. The term of a lease agreement typically ranges
from 10 to 18 years. An agreement typically contains optical specification
standards for the fiber and methods of testing. We are allowed to use the cable
for the transmission of messages and other purposes, including increasing
capacity. The infrastructure provider is responsible for maintenance of the
cable facilities. The infrastructure provider may also provide space for the
location of our equipment and related maintenance. The agreements typically
provide for termination by the parties only for material breach, but allow the
breaching party 90 days to cure their breach. The agreements typically contain a
transition period after termination of the agreement to allow us to continue to
serve our customers until we can reach agreement with an alternative
infrastructure provider. In certain areas of our network where it is not
possible to lease dark fiber, we have signed agreements or letters of intent for
the right to use managed bandwidth. The terms of these agreements typically
range from 10 to 25 years.
We are also deploying our network along the rights-of-way of a variety of
alternative sources, including railways, motorways, waterways, pipelines and
utilities. We constantly evaluate multiple alternative infrastructure suppliers
in order to maximize our flexibility. Many portions of our network utilize
long-term right-of-way
9
<PAGE> 12
agreements with landowners. As a result of our network development activities to
date, we have gained access to infrastructure for our network routes which we
believe will be difficult for competitors to duplicate.
LOCAL ACCESS
We expect to provide customer access to our network primarily through the
Access Services line of business conducted by our affiliates using synchronous
digital hierarchy access lines in those cities where Access Services will be
present and our network has nodes. Arrangements with our affiliate's Access
Services line of business are expected to be on an arms length basis. In each
city, as one of our points of presence is deployed, we may contract with one or
more suppliers to provide local access service to customer locations. Currently,
we have contracted with a number of unaffiliated local access providers to
connect our network to intra-city networks. Pursuant to these agreements, we can
offer our carrier customers service from their premises in one city to their
premises in another city. Various local access network suppliers may also be
interested in linking the business centers in which they are active to our
network. Therefore, we believe that the relationships between ourselves and
local access network suppliers can benefit both parties.
COMPETITION
The success of our network depends upon our ability to compete with a
variety of other telecommunications providers offering or seeking to offer
cross-border services, including (1) the respective public telecommunications
operator in each country in which our network operates, (2) global alliances
among some of the world's largest telecommunications carriers, and (3) global
operators. We expect that some of these current and future competitors may also
become our customers. We also believe that the ongoing liberalization of the
European telecommunications market will attract additional entrants to the
carrier's carrier market and increase the intensity of competition. Competitors
in this market compete primarily on the basis of price and quality. We intend to
focus on these factors and on service innovation as well. We anticipate
substantial direct and indirect competition. See "-- Risk Factors -- Competitors
with greater resources may adversely affect our revenues."
Various telecommunications companies, including MCI WorldCom, Inc., Viatel,
Inc., KPN-Qwest, Deutsche Telekom AG, France Telecom S.A., Global Crossing Ltd.,
and British Telecommunications plc, have announced plans to construct, have
begun to construct or are operating fiber optic networks across various European
countries. Some of these networks include, or their promoters have expressed
their intentions to include, transatlantic connectivity.
LICENSES AND REGULATORY ISSUES
OVERVIEW
The regulation of the European telecommunications industry is in the midst
of significant changes. Starting in 1987, a policy document, the EC Green Paper
on Telecommunications, charted the course for the current changes in the EU
telecommunications industry by advancing principles such as separation of
operators from regulators, transparency of procedures and information, cost
orientation of tariffs, access to monopoly public telephone operator
infrastructure networks and the liberalization of services. The Green Paper
formed the basis of subsequent liberalization and harmonization EU directives.
In 1990, the EU member states approved two directives that established these
principles in EU law: the Open Network Provision Framework Directive and the EU
Services Directive. Combined, these two directives set forth the basic rules for
access to public telephone networks and the liberalization of the provision of
all telecommunications services within the EU except for certain selected
services, including voice telephony.
In 1992, the EU approved the Open Network Provision Leased Line Directive,
which required the incumbent operators to lease lines to competitors and end
users, and to establish cost accounting systems for these products by the end of
1993. The national regulatory authorities were to use this cost information to
set cost-orientated tariffs for leased lines. Even though most EU member states
have established regulatory frameworks requiring public telecommunications
operators to lease lines to competitors and end users, we believe that, in some
EU member states, such lines are not yet being offered at cost-orientated
prices.
10
<PAGE> 13
In 1996, the EU issued the Full Competition Directive, which requires EU
member states to permit the provision of telecommunications services, other than
certain selected services, including voice telephony, over networks established
by the provider of the services, over network infrastructure provided by third
parties or by means of sharing of networks from July 1996. Since then, there has
been an increasing supply of such capacity offered at attractive prices from
such alternative suppliers. The Full Competition Directive also established
January 1, 1998 as the date by which all EU member states must establish a legal
framework which removes all remaining restrictions on the provision of
telecommunications services, including voice telephony. However, the following
EU member states were granted a delay in implementing this liberalization
directive: (1) Greece, through December 31, 2000; (2) Ireland, through January
1, 2000; (3) Luxembourg, through July 1, 1998; (4) Portugal, through January 1,
2000; and (5) Spain, until November 30, 1998. Ireland implemented the Full
Competition Directive in December 1998. Subject to the foregoing, each EU member
state is obliged, under EU law, to enforce the terms of the Full Competition
Directive in such a manner so as to ensure that its aim and purpose is carried
out. Enforceability of the Full Competition Directive may be challenged at the
EU level or at the EU member state level. Furthermore, in practice,
implementation and enforcement of the directive has been and may also continue
to be delayed on a country by country basis.
As a complement to the Full Competition Directive, the European Parliament
and Council of Ministers in June 1997 adopted a directive which governed the
manner in which public network operators and service providers interconnect with
the public telecommunications operators' public networks. Among other things,
this directive requires EU member states to ensure that public
telecommunications operators with significant market power should provide
interconnection on the basis of cost-oriented charges.
In April 1997, the European Parliament and the Council of Ministers adopted
a directive on a common framework for general authorizations and individual
licenses in the field of telecommunications services, including networks.
Licenses must be awarded through open, non-discriminatory and transparent
procedures and applications will be required to be dealt with in a timely
fashion. The number of licenses may be restricted only to the extent required to
ensure the efficient use of radio frequencies or for the time necessary to make
available sufficient numbers in accordance with EC law.
In February 1998, the European Parliament and the Council of Ministers
adopted a directive on the application of the Open Network Provision to voice
telephony and on universal service.
Despite these regulatory initiatives supporting the liberalization of the
telecommunications market, most EU member states are still in the initial stages
of liberalizing and harmonizing their telecommunications markets and
establishing competitive regulatory structures to replace the monopolistic
environment in which the public telecommunications operators previously
operated. For example, most EU member states have only recently established a
national regulatory authority. In addition, the implementation, interpretation
and enforcement of these EU directives differs significantly among the EU member
states. While some EU member states have embraced the liberalization process and
achieved a high level of openness, others have delayed the full implementation
of the directives and maintain several levels of restrictions on full
competition.
Member states of the EU are also bound as a matter of international law to
comply with certain multilateral trade rules and regulations. On February 15,
1997, over 60 members of the World Trade Organization committed to open their
telecommunications markets for basic telecommunications services to foreign
competition and ownership and to adopt regulatory measures designed to protect
foreign telecommunications providers against anticompetitive behavior by
domestic public telecommunications operators. For most signatories to this World
Trade Organization Telecommunications Agreement, these commitments took effect
on February 5, 1998 (including the EU member states). We believe that the World
Trade Organization Telecommunications Agreement will primarily impact call
termination charges outside the EU. For a discussion of the regulatory risks
involved, see "-- Risk Factors -- Delays in liberalization of the EU
telecommunications market may adversely affect execution of our business
strategy," and "-- Delays in obtaining regulatory licenses and approvals could
adversely affect our plans to offer services in our targeted markets."
As a multinational telecommunications company, we are subject to varying
degrees of regulation in each of the jurisdictions in which we provide our
services. Local laws and regulations and the interpretation of such
11
<PAGE> 14
laws and regulations differ significantly among the jurisdictions in which we
operate. For a discussion of the regulatory risks we face, see "-- Risk
Factors -- Delays in obtaining regulatory licenses and approvals could adversely
affect our plans to offer services in our targeted markets."
A summary discussion of the regulatory framework in certain countries where
we have developed and are developing our network is set forth below. This
discussion is intended to provide a general outline, rather than a comprehensive
discussion, of the more relevant regulations and current regulatory posture of
the various jurisdictions.
National authorities in individual member states of the EU are responsible
for regulating the construction and operation of telecommunications
infrastructure. We believe that the adoption of the Full Competition Directive
and the various related directives adopted by the European Parliament and the
Council of the EU have resulted in the removal of most regulatory barriers to
the construction and operation of telecommunications infrastructure in the
countries of the EU where we currently operate.
Hermes Railtel requires licenses, authorizations or registrations in almost
all countries to operate the network. Licenses, authorizations or registrations
have been obtained in Belgium, France, Germany, Italy, Luxembourg, The
Netherlands, Spain, Sweden, Switzerland, the UK and the United States. No
license or authorization is required to operate a network in Denmark. Hermes
Railtel intends to file applications in other countries in anticipation of
service launch in accordance with the network roll-out plan.
Belgium. Belgium has implemented the "alternative infrastructure" provider
provision of the Full Competition Directive. Most of the EC telecommunications
liberalization package was adopted at the end of December 1997. The implementing
legislation (Royal Decrees) regarding the licensing regimes for the provision of
voice telephony services and the establishment of public network infrastructure
was approved by the Council of Ministers at the end of June 1998. The official
publication and the entry into force of that implementing legislation took place
in July 1998. Until such entry into force, the Belgian Telecommunication
Authority continued to work with the system of provisional licenses. Hermes
Railtel has already obtained, through a wholly owned subsidiary, a license in
February 1997 from the Belgian regulatory authority to build infrastructure
between major Belgian population centers and the relevant border crossings.
Hermes Railtel also has an authorization to provide liberalized services using
alternative infrastructure. The liberalization legislation requires all
previously licenced operators to apply for new licenses or authorizations.
Hermes Railtel applied for a new license in October 1998 and was granted its
license to build and operate its network under the new regulatory framework on
January 26, 1999.
Denmark. With the liberalization of infrastructure as of July 1, 1997,
Denmark has fully liberalized its telecommunications markets in accordance with
the requirements of the relevant EC Directives. According to the Danish rules,
Hermes Railtel will not require any regulatory approval in order to install or
operate the network in Denmark.
France. A new regulatory agency, the Autorite de Regulation des
Telecommunications, was established in France effective January 1, 1997. In
1996, France approved legislation to implement the Full Competition Directive
and to remove all remaining restrictions on competition from January 1998. In
October 1997, Hermes Railtel obtained authorization to operate its network in
specific regions of France. In August 1998, Hermes Railtel was granted an
extension of its license in order to extend its network in France to reach Italy
and Spain. Such authorization requires prior notification to and approval of the
Autorite de Regulation des Telecommunications of any substantial changes in the
capital of Hermes Railtel or its controlling shareholder.
Germany. Germany has approved legislation to implement the Full Competition
Directive and remove all remaining restrictions on competition from August 1996.
Hermes Railtel was granted a license by the German regulatory authorities on
July 18, 1997. The license permits Hermes Railtel to operate the portions of the
network in Germany connecting Dusseldorf, Frankfurt and Stuttgart; Dusseldorf to
the Dutch border; and Stuttgart to the French border. In 1998, Hermes Railtel
was granted extensions to its license to include operation of routes linking
Hamburg, Hanover, Munich and Berlin and of routes to Denmark.
Italy. Although in the past Italy has been dilatory in implementing EC
liberalization measures, Italy enacted legislation on July 31, 1997 creating an
independent national regulatory authority for the telecommu-
12
<PAGE> 15
nications and audiovisual sectors. On September 19, 1997, Italy enacted a
regulation implementing all EC directives in the telecommunications sector and
since then specific laws relating to licensing and interconnection and universal
service have been approved. Hermes Railtel was granted a license by the Italian
authorities in August 1998, enabling the development of its network in the
northwest region of Italy and the offering of services in Milan.
Luxembourg. A new Telecommunication Act entered into force in April 1997,
and a Royal Decree on licensing conditions entered into force in July 1998.
Hermes Railtel applied to the Luxembourg regulatory authority for a license to
build and operate its network in Luxembourg in October 1998. On February 11,
1999, we were granted a license to build and operate a public telecommunications
network.
The Netherlands. On July 1, 1997, the Dutch government abolished the
prohibition on the use of fixed infrastructure for the provision of public voice
telephony, thereby complying with the requirements of the Full Competition
Directive six months ahead of schedule. On August 1, 1996, Hermes Railtel was
granted an authorization for the installation, maintenance and use of a fixed
telecommunications infrastructure.
A new Telecommunications Act came partly into force on December 15, 1998.
The new Act confirms the full liberalization of the telecommunications market
according to European Community standards. When the new Telecommunications Act
entered into force, the authorization held by Hermes Railtel ceased to exist.
Under the new Telecommunications Act, Hermes Railtel has an obligation to
register its activities. A request for registration with the Dutch regulatory
authority ("OPTA") was filed in February 1999 and the OPTA granted Hermes
Railtel its registration as a public telecommunications operator on March 3,
1999.
Spain. Under the Full Competition Directive, Spain was granted the right to
request a delay of up to five years in liberalizing fully its telecommunications
market. In April 1998, Spain adopted the LGT, its new telecommunications law.
The LGT was implemented through the use of secondary legislation. The LGT and
the secondary legislation resulted in the full liberalization of the Spanish
telecommunications market on December 1, 1998. On December 3, 1998, the Spanish
regulatory authority began to issue licenses under the new regime. Hermes
Railtel was granted a license to install and operate a telecommunications
network in Spain on January 14, 1999.
Sweden. Full liberalization of the Swedish telecommunications market
occurred in 1993. A new Telecommunications Act was passed in 1997 to reinforce
the powers of the national regulatory authority, to ensure conformity with EC
Directives and to supplement the pre-existing licensing regime with a general
authorization regime for certain services. Hermes Railtel registered with
Swedish authorities has been able to provide service in Sweden since July 1998.
Switzerland. The Swiss Parliament has passed a Telecommunications Law which
entered into force on January 1, 1998. Although Switzerland is not a Member
State of the EU, the effect of the law is largely to mirror the EC
telecommunications liberalization directives. From that date, voice telephony
monopoly was abolished and services fully liberalized. In September 1998, the
Swiss regulatory authority granted Hermes Railtel a definitive concession
(replacing an earlier provisional concession) to build and operate its network
in Switzerland.
United Kingdom. Since the elimination in 1991 of the UK telecommunications
duopoly consisting of British Telecommunications and Mercury, it has been the
stated goal of Oftel, the UK telecommunications regulatory authority, to create
a competitive marketplace from which detailed regulation could eventually be
withdrawn. The UK has already liberalized its market beyond the requirements of
the Full Competition Directive, and most restrictions on competition have been
removed in practice as well as in law. Hermes Railtel has received a license
from the Secretary of State for Trade and Industry dated December 18, 1996 which
grants it the right to run a telecommunications system or systems in the UK
connected to an overseas telecommunications system and to provide international
services over such systems. Like the licenses granted to other providers of
international facilities-based services, the license granted to Hermes Railtel
was for an initial six months' duration and thereafter is subject to revocation
on one month's notice in writing. The short duration of these initial licenses
was adopted for administrative convenience to facilitate reforms to the
licensing regime which are expected in 1999. The Department of Trade and
Industry has confirmed that it
13
<PAGE> 16
intends to replace the initial licenses with new licenses and that it would not
revoke an initial license without replacing it with another license giving an
equivalent authorization. The Department of Trade and Industry is currently
discussing with license holders the arrangements to put these new licenses into
effect. Although the Department of Trade and Industry has indicated that the new
licenses are expected to be of 25 years' duration, we cannot assure you that
this will be the case or that the new licenses will not contain terms or
conditions unfavorable to Hermes Railtel.
United States. Hermes Railtel was granted a license by the FCC pursuant to
section 214 of the Communications Act of 1934 authorizing it to provide limited
global facilities-based and global resale services (subject to the terms and
conditions imposed by the law and authorization), effective October 23, 1998.
The 214 authorization does not allow Hermes Railtel to offer US services to
Hungary, Poland, the Czech Republic, Romania, Monaco, Russia, Ukraine,
Kazakhstan, Uzbekistan, Azerbaijan, China and India.
In addition to the discussion above, Hermes Railtel intends to file
applications in other countries (including Austria, Croatia, Czech Republic,
Hungary, Poland, Portugal, Slovakia and Russia) in anticipation of service
launch in accordance with the Hermes Railtel network roll-out plan. With the
exception of Austria and Portugal, which are members of the EU and whose laws
must comply with EC Directives, these countries have not generally liberalized
their telecommunications sector. We cannot assure you that they will do so in a
timely manner or at all. In addition, the terms and conditions of Hermes
Railtel's licenses, authorizations or registrations may limit or otherwise
affect Hermes Railtel's scope of operations. We cannot assure you that Hermes
Railtel will be able to obtain, maintain or renew licenses, authorizations or
registrations to provide the services it currently provides and plans to
provide, that such licenses, authorizations or registrations will be issued or
renewed on terms or with fees that are commercially viable, or that the
licenses, authorizations or registrations required in the future can be obtained
by Hermes Railtel. The loss of, or failure to obtain, these licenses,
authorizations or registrations or a substantial limitation upon the terms of
these licenses, authorizations or registrations could have a material adverse
effect on Hermes Railtel.
EMPLOYEES
On December 31, 1998, we employed a total of 265 persons. We believe our
future success will depend on its continued ability to attract and retain highly
skilled and qualified employees. We believe that our relations with our
employees are good.
RISK FACTORS
RISKS RELATING TO THE EXPANSION OF OUR NETWORK
Our ability to achieve our strategic objectives will depend in large part
on our successful, timely and cost-effective completion of our network and the
continued market demand for Internet Protocol services. Although our network
currently links 19 cities, the development of the remainder of the network may
be adversely affected by a variety of factors. Many of these factors, such as
strikes, natural disasters and other casualties, are beyond our control. In
addition, we will need to negotiate and conclude additional agreements with
various parties. These agreements are necessary to establish rights-of-way and
to develop and maintain our network infrastructure and equipment.
For development of the network to be successful we need to obtain and
maintain a number of agreements, including:
- additional long-term leases of dark fiber;
- rights-of-way and other permits from railroads, utilities and
governmental authorities to install fiber optic cable; and
- transatlantic capacity.
In addition, we already depend on third parties for leases of dark fiber for
substantial portions of our network.
14
<PAGE> 17
We cannot assure you that we will be able to maintain all of our existing
agreements, rights and permits or that we will be able to obtain and maintain
the additional agreements, rights and permits needed to implement our business
plan on acceptable terms. In addition, we may not be able to conclude such
agreements, rights or permits on time. Any delay in concluding or failure to
conclude or maintain these agreements could adversely affect the operation
and/or expansion of our network. This, in turn, could have a negative effect on
our financial condition, including our ability to make payments to you on the
notes.
The successful and timely completion of our network will also depend on,
among other things:
- the timely performance of independent contractors hired to engineer,
design and construct portions of our network; and
- our ability to obtain and maintain applicable government approvals to
build and operate our network.
Further development of our network might cost more or take longer than our
current estimates. Although we believe that our cost estimates and schedule are
reasonable, we cannot assure you that the actual construction costs or time
required to complete the expansion of our network will not be greater than we
currently expect. Delays or increased costs in developing the network could have
a negative effect on our financial condition.
WE MAY BE UNABLE TO MEET OUR SUBSTANTIAL DEBT OBLIGATIONS
We have incurred substantial debt and may incur substantial additional debt
to implement our business plans.
As a result of our current high level of debt, we:
- will need significant cash to service our debt, which will reduce funds
available for operations, future business opportunities and investments
in new or developing technologies and make us more vulnerable to adverse
economic conditions;
- may not be able to refinance our existing debt or raise additional
financing to fund future working capital, capital expenditures, debt
service requirements, acquisitions or other general corporate
requirements;
- may be less flexible in planning for, or reacting to, changes in our
business and in the telecommunications industry that affect how we
implement our financing, construction or operating plans; and
- will have more debt than some of our competitors, which may place us at
a competitive disadvantage with respect to such competitors.
If we fail to make the required payments or to comply with our debt
covenants we will default on our debt. A default would permit our debtholders to
accelerate the maturity of the debt, which in turn would cause defaults under
our other indebtedness.
COVENANTS IN OUR DEBT AGREEMENTS RESTRICT OUR OPERATIONS
The covenants in our currently outstanding debt may materially and
adversely affect our ability to finance our future operations or capital needs
or to engage in other business activities. Among other things, these covenants
limit our ability to:
- incur additional indebtedness;
- pay dividends or make certain other restricted payments;
- limit our ability to use our assets as collateral for loans;
- dispose of our assets; or
- enter into transactions with affiliates.
15
<PAGE> 18
SUBSTANTIAL ADDITIONAL CAPITAL IS REQUIRED TO EXPAND OUR NETWORK
We will require significant amounts of capital to develop and expand our
network. We expect to incur approximately $750 million in additional capital
expenditures, including capital lease obligations through 2000 to expand our
network. We believe that the net proceeds that we received from the issuance of
the outstanding 10 3/8% senior notes due 2009 and 10 3/8% senior notes due 2006
and the outstanding 11 1/2% senior notes due 2007, combined with the funds we
expect to generate internally, will be sufficient to fund our these future
capital expenditures. However, the actual amount and timing of our future
capital requirements may differ from our estimates. Thus, additional financing
may be needed to construct our network. We cannot assure you that such
additional financing will be available on terms acceptable to us or at all. If
we fail to obtain this financing, we might have to delay or abandon our plans
for expanding the remainder of our network. Delaying or abandoning these plans
could have a negative effect on our financial condition.
Our revenues and the costs of expanding our network and operating our
business depends upon a variety of factors, including:
- efficiently manage the expansion of our network and operations;
- negotiate favorable contracts with suppliers;
- obtain additional licenses, regulatory approvals, rights-of-way and
infrastructure contracts to complete and operate our network;
- access markets and attract a sufficient number of customers; and
- provide and develop services to which our customers will subscribe.
Our revenues and costs are also dependent upon factors that are not within our
control, including:
- regulatory changes;
- changes in technology;
- increased competition;
- strikes;
- weather; and
- performance by third-parties, including our vendors and customers, in
connection with the development of our network.
Due to the uncertainty of these factors, our actual costs and revenues may vary
from what we expect them to be and our future capital requirements might
increase. Accordingly, we cannot assure you that the amount of funds required to
complete our network will not be greater than anticipated. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
WE HAVE A LIMITED OPERATING HISTORY AND HAVE SUSTAINED SUBSTANTIAL NET LOSSES
We have a limited operating history and have historically sustained
substantial operating and net losses. We cannot assure you that our operations
will achieve or sustain profitability or positive cash flow in the future. For
the following periods, we reported net losses of:
<TABLE>
<CAPTION>
PERIOD NET LOSS
- ------ -------------
<S> <C>
Year ended December 31, 1996................................ $16.0 million
Year ended December 31, 1997................................ $29.7 million
Year ended December 31, 1998................................ $45.0 million
Inception through December 31, 1998......................... $97.4 million
</TABLE>
16
<PAGE> 19
Our operations, infrastructure and customer base have grown significantly
in the last three years as we have expanded into new European markets. In
addition, we intend to enter additional European markets and offer new
telecommunications services. You should evaluate our prospects in light of the
risks, costs and time constraints that we face in establishing operations and
introducing new telecommunications services in newly liberalizing markets.
COMPETITORS WITH GREATER RESOURCES MAY ADVERSELY AFFECT OUR REVENUES
We compete primarily on the basis of price and on the type and quality of
services offered. Competitors may force us to lower our prices or modify our
services offerings to remain competitive. We cannot assure you that we will be
able to effectively market our expanded service offerings, keep prices at a
profitable level or attract and retain customers. We expect our prices for
services to continue to decrease for the foreseeable future. Many competitors
have established customer bases and extensive brand name recognition and have
greater financial, management and other resources.
Various telecommunications companies, including MCI WorldCom, Inc., Viatel,
Inc., KPN N.V., Qwest Communications International, Inc., Deutsche Telekom AG
and France Telecom S.A., Global Crossing Ltd. and British Telecommunications
plc, have announced plans to construct, have begun to construct or are operating
fiber optic networks across various European countries which do or will compete
with our network.
Our "point-to-point" transborder service offering also competes with
circuits currently provided by large established national carriers, through
international private leased circuits. The liberalization of the European
telecommunications market has coincided with technological innovation to create
an increasingly competitive market, characterized by still-dominant public
telecommunications operators as well as an increasing number of new market
entrants. In addition, these carriers own and operate fully built networks and
infrastructure which provide them with significant cost advantages. Since we
utilize these networks in part to provide many of our services, our failure to
gain economical access to these networks could have a material adverse effect on
our business, results of operations and financial condition.
OUR COMPETITIVE POSITION MAY BE COMPROMISED BY OUR DEPENDENCE ON OTHER
TELECOMMUNICATIONS SERVICE PROVIDERS
We need to enter into interconnection agreements with large established
national carriers and other local service providers operating in our target
markets. We may also need to enter into agreements which permit us to place our
equipment at the facilities of such third parties and/or lease
telecommunications transport capacity from such third parties. We cannot assure
you that we will be able to enter into these interconnection and other
agreements on satisfactory terms.
The terms and conditions of interconnection to the networks operated by
government-run or recently privatized local telecommunications providers will
have a material effect on our competitive position. We can offer no assurance
that such EU members and regulated carriers in those countries will implement
the EU liberalization directive in a timely and consistent manner or that we
will have economical access to and termination on those networks. Accordingly,
customers' ability to access our services may be restricted in some EU
countries.
OUR INFRASTRUCTURE MAY NOT KEEP PACE WITH OUR RAPID GROWTH
Our operating and financial control systems and infrastructure may not be
adequate to maintain and effectively manage future growth. If we fail to
continuously upgrade our administrative, operating and financial control systems
or unexpected expansion difficulties arise, our business, results of operations
and financial condition could suffer a material adverse effect. We must also
purchase additional telecommunications facilities and expand, train and manage
the employee base. Inaccuracies in our forecasts of market demand could result
in insufficient or excessive telecommunications facilities and fixed expenses
that are not in line with our operations. As we proceed with our development and
expansion, there will be additional demands on our customer support, sales and
marketing and administrative resources and network infrastructure.
17
<PAGE> 20
WE MAY FACE DIFFICULTIES IN INTEGRATING, MANAGING AND OPERATING NEW TECHNOLOGY
Our operations depend on our ability to successfully integrate new and
emerging technologies and equipment. These include the technology and equipment
required for dense wavelength division multiplexing, which allows multiple
signals to be carried simultaneously and IP transmission using dense wavelength
division multiplexing technology. Integrating these new technologies could
increase the risk of system failure and result in further strains. Additionally,
any damage to our network management center could harm our ability to monitor
and manage the network operations.
THE TECHNOLOGY OF OUR NETWORK COULD BECOME OBSOLETE
The telecommunications industry is subject to rapid and significant changes
in technology and such technological advances may reduce the relative
effectiveness of existing technology and equipment. The cost of implementation
of emerging and future technologies could be significant.
Development and operation of our network are also subject to certain
technological risks. Our network has been designed to utilize dense wavelength
division multiplexing and synchronous digital hierarchy technology and will be
extended to support IP Services in 1999. While the current operational network
segment has performed at or above design specifications since November 1996,
there can be no assurance that our network will achieve the technical
specifications for which we designed it or that we will be able to upgrade our
network as technological improvements in telecommunications equipment are
introduced.
SYSTEM FAILURES OR INTERRUPTIONS IN OUR NETWORK MAY CAUSE LOSS OF CUSTOMERS
Our success depends on the seamless uninterrupted operation of our network
and on the management of traffic volumes and route preferences over our network.
Furthermore, as we continue to expand our network to increase both its capacity
and reach, and as traffic volume continues to increase, we will face increasing
demands and challenges in managing our circuit capacity and traffic management
systems. Any prolonged failure of our communications network or other systems or
hardware that causes significant interruptions to our operations could seriously
damage our reputation and result in customer attrition and financial losses.
OUR RELATIONSHIP WITH OUR MAJORITY SHAREHOLDER COULD RESULT IN CONFLICTS OF
INTEREST
As of the date hereof, Global TeleSystems Group, Inc., through its wholly
owned subsidiary GTS Carrier Services, Inc., beneficially owns 89.9% of our
company. Global TeleSystems Group therefore has the ability to strongly
influence and/or control our affairs and our business. Circumstances may occur
in which the interests of Global TeleSystems Group could be in conflict with our
interests. In addition, Global TeleSystems Group may have an interest in
pursuing transactions that may involve risks to our company. We cannot assure
you that any such conflicts of interest will be resolved in our favor. We expect
to enter into capacity arrangements on an arms' length basis with other
subsidiaries. See Item 12. "Security Ownership of Certain Beneficial Owners and
Management."
Global TeleSystems Group plans to offer a broad range of integrated
telecommunications services to businesses and other high usage customers in
certain European metropolitan markets. These services could compete with the
services we offer to customers as an independent carriers' carrier. The
offerings of competing services by Global TeleSystems Group could affect the
perception that we are an independent operator and could negatively impact our
ability to attract and retain customers.
WE MAY ENCOUNTER DELAYS IN IMPLEMENTING KEY ELEMENTS OF OUR BUSINESS STRATEGY
Our ability to achieve our strategic objectives will depend in large part
on the successful, timely and cost-effective realization of numerous elements of
our business plan, including:
- our plan to develop and offer IP services;
- the execution of agreements with various parties regarding, among other
things, rights-of-way and development and maintenance of infrastructure
and equipment; and
18
<PAGE> 21
- the timely performance by third parties of their contractual obligations
to engineer, design and construct the infrastructure underlying our IP
services and planned additional transatlantic capacity.
We cannot assure you that we will execute such actions. In addition, any delays
in concluding such agreements would materially and adversely affect the speed or
successful realization of our business plan.
We believe that our cost estimates and the build-out schedule are
reasonable with respect to these projects. However, the actual construction
costs or time required to complete the plans could substantially exceed current
estimates. Any significant delay or increase in the costs to develop such plans
could have a material adverse effect on our operations.
DELAYS IN LIBERALIZATION OF THE EU TELECOMMUNICATIONS MARKET MAY ADVERSELY
AFFECT EXECUTION OF OUR BUSINESS STRATEGY
A substantial portion of our strategy depends on the timely implementation
of regulatory liberalization of the EU telecommunications market. We may
implement our business plan and make capital expenditures in a given country in
anticipation of regulatory liberalization which may not occur. This
liberalization is occurring in accordance with existing European Commission
directives. Although EU member states had a legal obligation to liberalize their
markets in accordance with these directives by January 1, 1998, Greece and
Portugal have been granted a delay in implementing the Full Competition
Directive. In addition, Croatia, Czech Republic, Hungary, Poland, Slovakia,
Switzerland and Russia are not members of the EU and are not subject to its
directives, including the liberalization directive. This and similar delays
could limit, constrain or otherwise adversely affect our ability to provide
certain services. Even if an EU member state promptly adopts liberalization
measures in a timely fashion, established national or regional
telecommunications operators, regulators, trade unions and other sources may
resist implementing such measures. Further, our provision of services in Europe
and the implementation of our business plan may be materially adversely affected
if any EU member state imposes greater restrictions on international services
between the EU member state and non-EU countries.
DELAYS IN OBTAINING REGULATORY LICENSES AND APPROVALS COULD ADVERSELY AFFECT OUR
PLANS TO OFFER SERVICES IN OUR TARGETED MARKETS
Because we plan to provide, through each of our lines of business, an
expanded array of telecommunications services in Europe, we will become subject
to significant additional regulation at the EU, national and local levels. In
particular, we must obtain additional agreements for the long-term lease of dark
fiber, rights-of-way and other permits to install fiber optic cable from
railroads, utilities and governmental authorities (known as infrastructure
providers) to build out the network. We cannot assure you that we will be able
to obtain or maintain the necessary lease agreements, regulatory approvals,
rights and permits on a timely basis or that we will not be adversely affected
by regulatory developments, which could have a material adverse effect on these
planned businesses. Delays in receiving regulatory approvals, or the enactment
of adverse regulations or regulatory requirements, may delay or prevent us from
offering one or more of our lines of business in their applicable targeted
markets.
DECREASES IN OUR GROSS MARGINS COULD RESULT IN A REDUCTION OF OUR PRICES
Our gross margins have decreased over the past few years because prices in
the European long distance industry have declined over that period. Further, we
expect that prices will continue to decline as competition increases. This will
result in continuing price cuts in certain retail markets and will decrease the
gross margins of our customers. This, in turn, could create pressure on us to
reduce our prices. If there are not increases in volume and reductions in cost
in the services we provide to offset these lower prices our future gross margins
will decrease.
INTEGRATION OF EBONE ACQUISITION
In June 1998, we completed our acquisition of a 75% interest in Ebone A/S.
We cannot assure you that this acquisition or other acquisitions that we may
consummate in the future will achieve the benefits we
19
<PAGE> 22
expect. In order to integrate the business, systems and culture of Ebone or such
other acquired businesses into ours, we must continue to develop our financial
and management controls and information systems and retrain existing personnel.
If this diverts significant resources or if we fail to achieve the benefits we
expect from these acquisitions, it could have a negative effect on our business.
OUR DEPENDENCE ON SIGNIFICANT CUSTOMERS
Our customers are, and will continue to be, telecommunications companies.
For that reason, we may become dependent on a small number of significant
customers. The loss of a significant customer could significantly decrease our
revenues and, hence, adversely affect our financial condition.
CURRENCY AND EXCHANGE RISKS
Our functional and reporting currencies are the Belgian franc and the US
dollar, respectively. We adopted the Euro as our functional currency on January
1, 1999. Still, we conduct, and will continue to conduct, business transactions
in currencies other than our functional and reporting currencies; for this
reason, appreciation or depreciation in the value of other currencies as
compared to our functional or reporting currency could result in a material
transaction or translation gain or loss to us.
We have entered into hedging transactions to limit our exposure to foreign
currency fluctuations; however, we find it impractical to protect ourselves
against all of this exposure and as a result we will continue to experience
foreign currency gains and losses. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources."
Stage III of the European Economic and Monetary Union commenced on January
1, 1999, in the following member states of the EU: Austria, Belgium, Finland,
France, Germany, Ireland, Italy, Luxembourg, The Netherlands, Portugal and
Spain. Part of Stage III involves the locking of exchange rates and the
introduction of a single Euro currency, which is intended to replace the
national currencies of the EU member states participating in Stage III, and the
transfer of authority for conducting monetary policy for such EU member states
to the European Central Bank. However, we cannot assure you that the Euro will
maintain its value relative to other currencies.
LOSS OF KEY PERSONNEL COULD NEGATIVELY AFFECT OUR BUSINESS
Our operations are managed by a small number of key executive officers. The
loss of any of these officers could have a negative effect on our business. We
believe that our growth and future success will depend in large part on our
continued ability to attract and retain highly skilled and qualified personnel.
The competition for qualified personnel in the telecommunications industry is
intense. We cannot assure you that we will be able to hire or retain necessary
personnel. The loss of senior management or the failure to recruit additional
qualified personnel in the future could significantly impede our financial
plans, network development, marketing and other objectives. Although we have
designed incentive and compensation programs to retain key employees and have
entered into employment agreements with certain executive officers, we cannot
assure you as to the continued availability of qualified key executive officers.
See "Directors and Executive Officers of the Company."
COUNTRY AND EUROPEAN COMMUNITY ECONOMIC, POLITICAL AND LEGAL CONSIDERATIONS
The majority of our investments are, and will continue to be, in Europe.
Risks to these investments include the loss of or damage to property from
terrorism and other political risks (such as increased taxes or changes in law
or governmental regulation).
FAILURE OF OUR COMPUTER SYSTEMS TO RECOGNIZE THE YEAR 2000 COULD DISRUPT OUR
BUSINESS AND OPERATIONS
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. This could result in system failures,
20
<PAGE> 23
miscalculations or errors causing disruptions of operations or other business
problems, including among others, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities.
We are undertaking a comprehensive program to address the Year 2000 issue
with respect to the following:
- our information technology systems;
- our non-information technology systems;
- our business partners;
- the systems of our telecommunications, hardware and software vendors;
and
- our customers.
Our Year 2000 program involves four phases:
(1) a wide ranging assessment of Year 2000 problems that might affect us;
(2) the development and implementation of remedies to address discovered
problems;
(3) preventing future Year 2000 problems from arising; and
(4) the testing of our system.
We completed the first phase at the end of the fourth quarter of 1998. We
began the last three phases of this program during the first quarter of 1999.
These phases are expected to be completed during the second quarter of 1999.
We are taking steps to determine whether third parties significant to our
business will be Year 2000 compliant and are also working towards Year 2000
compliance. We cannot assure you that our Year 2000 program or the programs of
third parties who do business with us will be effective or that our estimates
about the timing and cost of completing our program will be accurate. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Year 2000 Compliance."
We have spent approximately $0.2 million for our Year 2000 compliance
through December 31, 1998, and expect to spend approximately an additional $0.6
million through the end of calendar year 1999. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Year 2000
Compliance."
ITEM 2. PROPERTIES
We own substantially all of the telecommunications equipment required for
our business; however, a substantial part of the fiber is leased on a long-term
basis. Our installed fiber optic cable is laid under the various rights-of-way
held by us. Other fixed assets are located at various leased locations in
geographic areas served.
Our administrative offices and Network Operations Center are located in two
adjacent buildings in Hoeilaart, Belgium, just outside Brussels. The leases on
both the buildings expire on June 30, 2005. One of the buildings has an option
to cancel on January 1, 2002 with a penalty of six months rent. In addition, we
have a short-term lease expiring on February 28, 2000 in Rixensart, Belgium. We
have negotiated leases for two additional buildings in the same complex as its
principal offices. The buildings are currently under construction and are
expected to be ready for occupation in January 2000. The leases run through
January 2009 but may be terminated after six years with six months notice plus
six months rental penalty.
In addition to the offices in Belgium, we have a leased office space in
Dublin, Ireland, which expires on October 2, 2022 and in London, United Kingdom,
which expires in August 2002. We also lease various offices on a short-term
basis for regional sales and service personnel.
21
<PAGE> 24
ITEM 3. LEGAL PROCEEDINGS
We are subject to various claims and proceedings in the ordinary course of
business. Based on 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 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
During the fourth quarter, our shareholders approved by unanimous written
consent the sale of 6,551 shares of our common stock by AB Swed Carrier to GTS
Carrier Services, Inc. and the issuance of 6,248 shares of our common stock
pursuant to the exercise of stock options.
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common equity is privately held and not traded on any United States or
foreign exchange or market.
As of March 15, 1999, our common equity was held by three holders of
record.
We have not paid any dividend on our common stock and do not intend to pay
dividends in the foreseeable future. In addition, the indentures governing our
11 1/2% senior notes due 2007, 10 3/8% senior notes due 2006 and 10 3/8% senior
notes due 2009 contain restrictions on the making of restricted payments (in the
form of the declaration of certain dividends or distributions, the purchase,
redemption or other acquisition of any of our capital stock, the payments of
principal on any subordinated indebtedness, as defined in such indentures, prior
to any scheduled payment or maturity, unless (A) no default or event of default,
as defined in the indentures, shall have occurred and be continuing, (B) we are
able immediately after giving effect to such a restricted payment to satisfy an
incurrence of indebtedness test and (C) such restricted payments do not exceed
certain amounts. In addition, we and certain of our operating subsidiaries may
enter into future financings, the terms of which may include dividend
restrictions.
During the year ended December 31, 1998 we issued stock which was not
registered under the Securities Act of 1933, as amended (the "Securities Act"),
pursuant to the exercise of options to purchase 6,248 shares of our common
stock.
22
<PAGE> 25
ITEM 6. SELECTED FINANCIAL DATA
The following is a summary of selected financial data as of and for the
five years ended December 31, 1998. The historical financial data as of December
31, 1998 and 1997 and for the years ended December 31, 1998, 1997 and 1996 have
been derived from our financial statements, which financial statements have been
audited by Ernst & Young Reviseurs d'Entreprises S.C.C., independent public
accountants, as indicated in their report elsewhere herein. The selected
financial data presented below should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the audited Consolidated Financial Statements and related notes thereto
appearing elsewhere in this document.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1998 1997 1996 1995 1994
-------- --------- -------- ------- -----
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues........................................ $ 85,251 $ 5,373 $ 48 $ -- $ --
Operating costs and expenses:
Telecommunication Services.................... 41,848 6,842 4,694 -- --
Selling, general and Administration........... 28,273 17,868 9,894 6,626 183
Depreciation and amortization................. 24,674 3,755 658 11 --
Loss from operations............................ (9,544) (23,092) (15,198) (6,637) (183)
Other income/(expense):
Interest income............................... 9,997 6,596 508 125 18
Interest expense.............................. (30,852) (12,826) (153) (9) --
Foreign currency (losses) gains............... (11,308) (367) (1,126) 19 (55)
Net loss........................................ (44,971) $ (29,689) $(15,969) $(6,502) $(220)
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------------------------------------
1998 1997 1996 1995 1994
-------- --------- -------- ------- -----
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA (AT END OF PERIOD):
Total current assets............................ $240,151 $ 249,325 $ 7,528 $ 6,430 $ 908
Property and equipment, net..................... 438,984 204,944 20,303 4,671 47
Total assets.................................... 726,058 495,850 27,831 11,101 955
Total current liabilities....................... 169,413 61,744 11,915 6,785 90
Long-term debt, less current portion............ 265,353 265,383 499 10 --
Long-term portion of capital lease
obligations................................... 190,378 117,645 -- -- --
Total liabilities............................... 688,403 445,008 12,414 6,795 90
Shareholders' loans............................. -- -- 34,863 8,353 --
Shareholders' equity............................ 9,896 50,842 (19,446) (4,047) 866
OTHER DATA (IN THOUSANDS):
EBITDA(1)....................................... 15,130 (19,337) (14,540) (6,626) (233)
Net cash provided by (used in) operating
activities.................................... 44,957 (4,417) (11,540) (2,655) (167)
Net cash used in investing activities........... (92,758) (107,466) (20,781) (4,405) (52)
Net cash (used in) provided by financing
activities.................................... (21,463) 317,500 28,924 11,644 1,028
</TABLE>
- ---------------
(1) EBITDA is earnings (loss) from operations before foreign currency gains
(losses) interest, taxes, depreciation and amortization. EBITDA is a measure
of a company's performance commonly used in the telecommunications industry,
but should not be construed as an alternative to net income (loss)
determined in accordance with GAAP as an indicator of operating performance
or as an alternative to cash from operating activities determined in
accordance with GAAP as a measure of liquidity.
23
<PAGE> 26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following is a discussion of our financial condition and results of
operations as of December 31, 1998, 1997 and 1996 and for the years ended
December 31, 1998, 1997, and 1996. The following discussion should be read in
conjunction with our 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 traffic volume, (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 substantial financing. These and other factors are
discussed herein under "Business," "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 continuing to develop and operate a pan-European high capacity fiber
optic network. We began delivering services to customers in November 1996 when
the Brussels-Amsterdam route came into operation. The cities of London, Paris,
Antwerp and Rotterdam came into commercial operation during 1997 and during
1998, Frankfurt, Strasbourg, Zurich, Geneva, Stuttgart, Dusseldorf, Munich,
Milan, Berlin, Copenhagen and Stockholm were added to the network. On June 24,
1998, we acquired a 75% interest in Ebone A/S ("Ebone"), a Tier 1 Internet
backbone provider, principally serving as a carriers' carrier for European
Internet service providers. The results of Ebone have been included in the
accompanying consolidated financial statements from the date of acquisition.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 VS. DECEMBER 31, 1997
Revenue. Our consolidated revenue for the year ended December 31, 1998 was
$85.3 million as compared to $5.4 million for the comparable period in 1997. The
growth in revenue is attributable to the
24
<PAGE> 27
continued deployment of our network as well as the inclusion of Ebone, whose
revenue was $17.7 million for the period from the date of acquisition through
December 31, 1998.
Telecommunication Services. Our telecommunication services costs for the
year ended December 31, 1998 were $41.8 million compared to $6.8 million for the
comparable period in 1997. The increase in cost of revenue for the year ended
December 31, 1998 was primarily due to increased costs related to operating and
maintaining the network as it is continued to be deployed, as well as the
increase in local access costs.
Selling, General and Administrative. Selling, general and administrative
expenses for the year ended December 31, 1998 were $28.3 million as compared to
$17.9 million for the comparable period in 1997. The increase in selling,
general and administrative expenses is reflective of the growth of our business
operations and support personnel as the number of employees grew to 265 at
December 31, 1998 from 130 at December 31, 1997.
Depreciation and Amortization. Depreciation and amortization expense for
the year ended December 31, 1998 was $24.7 million as compared to $3.8 million
in 1997. 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.
Interest. Interest expense for the year ended December 31, 1998 was $30.9
million as compared to $12.8 million for the comparable period in 1997. The
increase was primarily the result of incurring a full year of interest and
related costs associated with our issuance in August 1997 of $265 million
aggregate principal amount of 11.5% Senior Notes due 2007 (the "Senior Notes")
in 1998 as compared to only five months of interest and costs in 1997.
Interest income for the year ended December 31, 1998 was $10.0 million as
compared to $6.6 million for the comparable period in 1997. The increase in
interest income was the result of investing the excess cash generated from the
issuance of the Senior Notes in various highly liquid investments.
Foreign Currency Losses. Foreign currency losses were $11.3 million for the
year ended December 31, 1998 as compared to $0.4 million for the comparable
period in 1997. The losses in 1998 were primarily the result of foreign exposure
from the issuance of the Senior Notes in U.S. dollars and other U.S. dollar cash
and payables balances, the weakening of the dollar versus European currencies in
the third and fourth quarter and losses on several forward exchange contracts.
YEAR ENDED DECEMBER 31, 1997 VS. DECEMBER 31, 1996
Revenue. Our consolidated revenue for the year ended December 31, 1997 was
$5.4 million. The revenues for the year ended December 31, 1996 were minimal.
Our first route, Brussels-Amsterdam, began to generate revenues in the fourth
quarter of 1996 and in the fourth quarter of 1997, the Amsterdam-London-Paris
routes came into operation and began to generate revenues.
Telecommunication Services. Our telecommunication services costs for the
years ended December 31, 1997 and 1996 were $6.8 million and $4.7 million,
respectively. The increase in cost of revenues in 1997 as compared with 1996 was
associated with the costs related to operating and maintaining the network
routes and local access costs.
Selling, General and Administrative. Selling, general and administrative
expenses for the years ended December 31, 1997 and 1996, were $17.9 million and
$9.9 million, respectively. The increase in operating expenses was reflective of
the growth of our business operations and support personnel. We had 130
employees as of December 31, 1997 as compared to 101 employees as of December
31, 1996.
Depreciation and Amortization. Depreciation and amortization expense for
the year ended December 31, 1997 was $3.8 million as compared to $0.7 million in
1996. The increase in depreciation and amortization expense is attributable to
an increase in depreciation on network assets due to the continued deployment of
our network.
25
<PAGE> 28
Interest. Interest expense for the years ended December 31, 1997 and 1996
was $12.8 million and $0.2 million, respectively. The increase in interest
expense in 1997 is attributable to the interest and related costs associated
with the Senior Notes.
Interest income for the years ended December 31, 1997 and 1996 was $6.6
million and $0.5 million, respectively. The increase in 1997 was the result of
investing the excess cash generated from the issuance of the Senior Notes in
various highly liquid investments.
LIQUIDITY AND CAPITAL RESOURCES
The primary sources of our funding through December 31, 1998 have been net
proceeds of $251.3 million from the issuance of the Senior Notes and cash equity
contributions of $103.2 million in 1997.
Development of our fiber optic network is capital intensive. We have spent
approximately $192 million in cash on network capital expenditures through
December 31, 1998 and expect to incur an additional $598 million through 2000 in
order to complete the build-out of the network and enhance our capacity through
the implementation of dense wave multiplexing technology. In addition, as of
December 31, 1998, $271 million has been capitalized in connection with
long-term fiber lease arrangements and an additional $152 million is expected to
be capitalized through 2000 in order to complete the build-out of the network.
In January 1999, we completed the issuance of $200 million aggregate principal
amount of 10.375% senior notes due 2009 and Euro 85 million (approximately $100
million) aggregate principal amount of 10.375% senior notes due 2006 (together,
the "New Senior Notes"). The New Senior Notes are general unsecured obligation
and have substantially the same terms as the Senior Notes. We believe that the
net proceeds from the Senior Notes and the New Senior Notes, combined with
projected internally generated funds, should be sufficient to fund expected
capital expenditures as well as 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 deploying the
remainder of the network and would jeopardize our viability.
We had a positive working capital of $70.7 million and $187.6 million as of
December 31, 1998 and 1997, respectively. We had cash and cash equivalents of
$130.1 million and $204.3 million at December 31, 1998 and 1997 respectively. We
had $30.1 million and $57.8 million of restricted cash at December 31, 1998 and
1997, respectively. The restricted cash at December 31, 1998 and 1997 primarily
represents our obligation to place into escrow the first four scheduled
semi-annual interest payments on the Senior Notes.
During the year ended December 31, 1998, we provided $45.0 million cash for
operating activities compared with using $4.4 million for the comparable period
in 1997. Investing activities used cash of $92.8 million for the year ended
December 31, 1998 as compared to using cash of $107.5 million for the comparable
period in 1997.
We have developed risk management policies that establish guidelines for
managing foreign exchange risk. We are currently evaluating the materiality of
foreign exchange exposures in different countries and the financial instruments
available to mitigate this exposure. We are designing reporting processes to
monitor the potential exposure on an ongoing basis and expects to implement this
process by the end of the first quarter of 1999. We have limited its 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 (the "Year 2000 Issue"). 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.
26
<PAGE> 29
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.
Hermes Europe Railtel 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 "Year 2000 Compliance Program"). 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, 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 will then be followed by an upgrade, a remediation, a
prevention and a testing phase in early 1999. These phases are expected to be
completed during the second 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 intend to continue follow-up with any vendors who indicate any
material problems in their replies. We expect to receive statements of intended
compliance by mid-1999.
Worst Case Scenario for the Company. Our worst case scenario would be the
failing of its telecommunications equipment, power providers and/or interfaces
with other telecommunication vendors. These cases would create business
interruption at some 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 its assessment during the third and fourth
quarters of 1998, we do not foresee a material loss due to these conditions and
we are hopeful that its remediation and testing efforts will ensure that we have
addressed our Year 2000 readiness. 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.
27
<PAGE> 30
Contingency Plans. We are considering 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,
remediation prevention and testing phases, of which approximately $0.2 million
has been incurred for the year ended December 31, 1998. 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-compliance by our systems or the systems of
vendors, customers, partners or others will not result in a material adverse
effect.
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 remediation or prevention phases or
our failure to fully implement the planning or remediation 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 are currently evaluating 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 are evaluating our ability to update our information
systems to accommodate the adoption of the Euro but we do not expect to incur
material costs in either the evaluating or 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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Our treasury function manages our funding, liquidity, and exposure to
interest rate and foreign exchange rate risks. Our treasury operations are
conducted within a framework of policies and guidelines authorized by our Board
of Directors. In accordance with our policy, we do not enter into any
transactions of a speculative nature.
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 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
28
<PAGE> 31
exchange risk and periodically evaluate the materiality of foreign exchange
exposures and the financial instruments available to mitigate this exposure.
We have entered into a foreign currency swap agreement in order to mitigate
our 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 following table provides information about our debt obligations that
are sensitive to changes in interest rates.
<TABLE>
<CAPTION>
FAIR VALUE
1999 2000 2001 2002 2003 THEREAFTER TOTAL 12/31/98
---- ---- ---- ---- ---- ---------- -------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
LONG-TERM DEBT, INCLUDING CURRENT PORTION:
Fixed rate...................................... -- --.. -- -- -- $265,000 $265,000 $285,538
Avg. interest rate.............................. -- -- -- -- -- 11.5% -- --
</TABLE>
The following tables provide information about our derivative financial
instruments and other financial instruments by functional currency and where
applicable, presents such information in US dollar equivalents. The tables
summarize information on instruments that are sensitive to foreign currency
exchange rates, including a foreign currency swap agreement and foreign currency
denominated debt obligations.
<TABLE>
<CAPTION>
FAIR VALUE
1999 2000 2001 2002 2003 THEREAFTER TOTAL 12/31/98
------- ------- ------- -------- -------- ---------- -------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
LONG-TERM DEBT, INCLUDING
CURRENT PORTION:
US Dollars
Fixed rate.................... -- -- -- -- -- $265,000 $265,000 $285,538
Avg. interest rate............ -- -- -- -- -- 11.5% -- --
CURRENCY SWAP AGREEMENTS RELATED
TO LONG-TERM DEBT:
Receipt of USD
Notional amount............... -- $30,475 $30,475 $295,475 -- -- $356,425 $330,689
Avg. contract rate............ 1.82 1.82 1.82
Receipt of DEM
Notional amount............... $22,000 -- -- -- -- -- $ 22,000 $ 23,882
Avg. contract rate............ 0.55
</TABLE>
29
<PAGE> 32
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
HERMES EUROPE RAILTEL B.V.
INDEX TO FINANCIAL STATEMENTS
YEAR END FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Ernst & Young Reviseurs d'Entreprises S.C.C.,
Independent Auditors...................................... 31
Consolidated Balance Sheets as of December 31, 1998 and
1997...................................................... 32
Consolidated Statements of Operations for the three years
ended December 31, 1998................................... 33
Consolidated Statements of Cash Flows for the three years
ended December 31, 1998................................... 34
Consolidated Statements of Shareholders' Equity for the
three years ended December 31, 1998....................... 35
Notes to Consolidated Financial Statements.................. 36
</TABLE>
30
<PAGE> 33
REPORT OF ERNST & YOUNG REVISEURS D'ENTREPRISES S.C.C.
INDEPENDENT AUDITORS
To the Board of Directors and the Shareholders of
Hermes Europe Railtel B.V.
We have audited the accompanying consolidated balance sheets of Hermes
Europe Railtel B.V. as of December 31, 1998 and 1997, and the related
consolidated statements of operations, cash flows, and shareholders' equity for
each of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Hermes Europe
Railtel B.V. at December 31, 1998 and 1997, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles
in the United States.
Ernst & Young Reviseurs d'Entreprises S.C.C.
Represented by
M. Guns
Partner
Brussels, Belgium
February 26, 1999
31
<PAGE> 34
HERMES EUROPE RAILTEL B.V.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1997
-------- --------
<S> <C> <C>
Current assets
Cash and cash equivalents................................. $130,081 $204,327
Restricted cash........................................... 30,062 29,539
Accounts receivable, net of allowance for doubtful account
of $887 at December 31, 1998........................... 48,034 2,129
Due from affiliated companies............................. 2,164 49
Other assets.............................................. 29,810 13,281
-------- --------
Total current assets.............................. 240,151 249,325
Property and equipment, net................................. 438,984 204,944
Goodwill and intangible assets, net of accumulated
amortization of $3,799 and $438 at December 31, 1998 and
1997, respectively........................................ 32,467 13,310
Restricted cash............................................. -- 28,271
Other non-current assets.................................... 14,456 --
-------- --------
TOTAL ASSETS...................................... $726,058 $495,850
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued expenses..................... $ 84,047 $ 37,457
Due to affiliated companies............................... 15,976 1,311
Deferred income........................................... 32,255 1,436
Current portion of capital lease obligations.............. 37,135 21,540
-------- --------
Total current liabilities......................... 169,413 61,744
Long-term debt, less current portion........................ 265,353 265,383
Long-term portion of capital lease obligations.............. 190,378 117,645
Deferred income............................................. 34,000 --
Other non-current liabilities............................... 29,259 236
-------- --------
TOTAL LIABILITIES................................. 688,403 445,008
Commitments and contingencies
Minority interest........................................... 27,759 --
SHAREHOLDERS' EQUITY
Common stock, 1000 guilders par value; 297,000 shares
authorized; 196,716 and 190,468 shares issued and
outstanding at December 31, 1998 and 1997, respectively... 100,110 96,757
Additional paid-in capital.................................. 8,437 10,130
Accumulated other comprehensive loss........................ (1,300) (3,665)
Accumulated deficit......................................... (97,351) (52,380)
-------- --------
TOTAL SHAREHOLDERS' EQUITY........................ 9,896 50,842
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $726,058 $495,850
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
32
<PAGE> 35
HERMES EUROPE RAILTEL B.V.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Revenues.................................................... $ 85,251 $ 5,373 $ 48
-------- -------- --------
Operating costs and expenses:
Telecommunication Services................................ 41,848 6,842 4,694
Selling, general and administrative....................... 28,273 17,868 9,894
Depreciation and amortization............................. 24,674 3,755 658
-------- -------- --------
94,795 28,465 15,246
-------- -------- --------
Loss from operations........................................ (9,544) (23,092) (15,198)
Other income/(expense):
Interest income........................................... 9,997 6,596 508
Interest expense.......................................... (30,852) (12,826) (153)
Foreign currency losses................................... (11,308) (367) (1,126)
-------- -------- --------
(32,163) (6,597) (771)
-------- -------- --------
Net loss before income taxes and minority interest.......... (41,707) (29,689) (15,969)
Income taxes................................................ 2,343 -- --
-------- -------- --------
Net loss before minority interest........................... (44,050) (29,689) (15,969)
Minority interest........................................... (921) -- --
-------- -------- --------
Net loss.................................................... $(44,971) $(29,689) $(15,969)
======== ======== ========
Net loss per share.......................................... $ (0.23) $ (0.33) $(199.61)
======== ======== ========
Weighted average common shares outstanding.................. 191,790 89,957 80
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
33
<PAGE> 36
HERMES EUROPE RAILTEL B.V.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
--------- --------- --------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss................................................... $ (44,971) $ (29,689) $(15,969)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization............................ 25,957 4,257 683
Fair value adjustment for foreign currency instruments... 28,650 -- --
Other.................................................... 2,362 2,651 130
Changes in assets and liabilities:
Accounts receivable................................... (37,543) (2,116) (87)
Deposits.............................................. 5,537 (9,807) (627)
Accounts payable and accrued expenses................. 28,737 30,991 4,336
Other changes in assets and liabilities............... 36,228 (704) (6)
--------- --------- --------
Net cash provided by (used in) operating
activities..................................... 44,957 (4,417) (11,540)
INVESTING ACTIVITIES
Purchases of property and equipment...................... (131,866) (51,830) (16,807)
Acquisitions -- cash acquired............................ 13,352 -- --
Restricted cash.......................................... 27,774 (55,636) (3,974)
Other investing activities............................... (2,018) -- --
--------- --------- --------
Net cash used in investing activities............ (92,758) (107,466) (20,781)
FINANCING ACTIVITIES
Proceeds from debt......................................... -- 268,678 564
Repayments of debt......................................... (32,523) -- --
Payment of debt issue costs................................ (825) (14,139) --
Net proceeds from exercise of stock options and issuance of
common stock............................................. 600 50,993 --
Proceeds from shareholders' loans.......................... -- 13,205 27,358
Due to affiliated companies, net........................... 11,285 (1,237) 1,002
--------- --------- --------
Net cash (used in) provided by financing
activities..................................... (21,463) 317,500 28,924
Effect of exchange rate changes on cash and cash
equivalents.............................................. (4,982) (3,303) (374)
--------- --------- --------
Net (decrease) increase in cash and cash equivalents....... (74,246) 202,314 (3,771)
Cash and cash equivalents at beginning of year............. 204,327 2,013 5,784
--------- --------- --------
Cash and cash equivalents at end of year................... $ 130,081 $ 204,327 $ 2,013
========= ========= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
34
<PAGE> 37
HERMES EUROPE RAILTEL B.V.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(IN THOUSANDS EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER TOTAL
------------------ PAID-IN COMPREHENSIVE ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT CAPITAL LOSS DEFICIT EQUITY
------- -------- ---------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31,
1995........................ 80 $ 45 $ 2,884 $ (254) $ (6,722) $ (4,047)
Translation adjustment........ -- -- -- 570 -- 570
Net loss...................... -- -- -- -- (15,969) (15,969)
------- -------- ------- ------- -------- --------
Comprehensive loss............ (15,399)
--------
BALANCE AT DECEMBER 31,
1996........................ 80 45 2,884 316 (22,691) (19,446)
Recapitalization, net of
tax......................... 190,388 96,712 4,633 -- -- 101,345
Compensatory stock options.... -- -- 2,613 -- -- 2,613
Translation adjustment........ -- -- -- (3,981) -- (3,981)
Net loss...................... -- -- -- -- (29,689) (29,689)
------- -------- ------- ------- -------- --------
Comprehensive loss............ (33,670)
--------
BALANCE AT DECEMBER 31,
1997........................ 190,468 $ 96,757 $10,130 $(3,665) $(52,380) $ 50,842
Proceeds from exercise of
stock options............... 6,248 3,353 (2,753) -- -- 600
Compensatory stock options.... -- -- 1,060 -- -- 1,060
Translation adjustment........ -- -- -- 2,365 -- 2,365
Net loss...................... -- -- -- -- (44,971) (44,971)
------- -------- ------- ------- -------- --------
Comprehensive loss............ (42,606)
--------
BALANCE AT DECEMBER 31,
1998........................ 196,716 $100,110 $ 8,437 $(1,300) $(97,351) $ 9,896
======= ======== ======= ======= ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
35
<PAGE> 38
HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: NATURE OF BUSINESS OPERATIONS
Hermes Europe Railtel B.V. ("the Company") is a provider of centrally
managed telecommunications transmission capacity across national borders in
Europe and to the United States to telecommunications companies including
traditional public telecommunications operators and new entrants, such as
alternative carriers, global consortia of telecommunications operators,
international carriers, Internet backbone networks, resellers, value-added
networks and other service providers. The Company began commercial operations in
November 1996 and as of December 31, 1998 operated in Belgium, the Netherlands,
the United Kingdom, France, Germany, Switzerland, Italy, Denmark and Sweden. As
of December 31, 1998 the high capacity fiber optic network ("the Network")
linked the cities of Brussels, Antwerp, Rotterdam, Amsterdam, London, Paris,
Frankfurt, Strasbourg, Zurich, Geneva, Stuttgart, Dusseldorf, Munich, Milan,
Berlin, Copenhagen and Stockholm. The Company intends to continue to build the
Network using an accessible and cost-efficient infrastructure of railways,
motorways, pipeline companies, waterways and power companies.
The Company was formed on July 6, 1993 and is 89.9% owned by GTS Carrier
Services, Inc. (formerly GTS-Hermes, 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.
On June 24, 1998, the Company completed the acquisition of a 75% interest
in Ebone A/S ("Ebone") for ECU 90 million (approximately $99.5 million). See
Note 11, "Acquisition."
Subsequent to year-end, the Company issued aggregate principal amount $200
million of 10.375% senior notes due 2009 and Euro 85 million (approximately $100
million) of 10.375% senior notes due 2006 (together, the "New Senior Notes").
See Note 13, "Subsequent Events."
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Hermes Europe
Railtel B.V., all wholly-owned subsidiaries and its majority-owned subsidiary
where the Company has unilateral operating and financial control. All
significant intercompany accounts and transactions are eliminated upon
consolidation.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1997 and 1996 consolidated
financial statements in order to conform to the 1998 presentation.
CASH AND CASH EQUIVALENTS
The Company classifies cash on hand and deposits in banks, including
commercial paper, money market accounts and any other investments with an
original maturity of three months or less, that the Company may hold from time
to time, as cash and cash equivalents. The Company had $30.1 million and $57.8
million of restricted cash at December 31, 1998 and 1997, respectively. The
restricted cash is primarily related to cash held in escrow for interest
payments (see Note 4, "Debt Obligations").
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation, which includes the
amortization of assets recorded under capital leases, is calculated on a
straight-line basis over the lesser of the estimated lives ranging from five to
ten years for telecommunications equipment and five to ten years for furniture,
fixtures and equipment and other property, or their contractual term. A
substantial part of the property and equipment balance is construction in
process, which is currently related to the configuration and buildout of the
network.
36
<PAGE> 39
HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
These costs are transferred to telecommunications equipment in service as
construction is completed and/or equipment is placed in service. Depreciation is
recorded commencing with the first full month that assets are placed into
service. Maintenance and repairs are charged to expense as incurred.
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
34, "Capitalization of Interest Costs," the Company capitalizes material
interest costs associated with the construction of capital assets for business
operations and amortizes the costs over the assets' useful lives. The Company
capitalized $4.9 million of interest costs in 1998. The Company did not
capitalize any interest in 1997.
GOODWILL AND INTANGIBLE ASSETS
Goodwill represents the excess of acquisition costs over the fair market
value of the net assets of acquired businesses and is being amortized on a
straight-line basis over the estimated useful life of five years. Intangible
assets, primarily deferred financing costs and licenses are amortized on a
straight-line basis over the lesser of their estimated useful lives or their
contractual term, generally three to ten years. In accordance with APB 17,
"Intangible Assets," the Company continues to evaluate the amortization period
to determine whether events or circumstances warrant revised amortization
periods. Additionally, the Company considers whether the carrying value of such
assets should be reduced based on the future benefits of its deferred financing
costs.
LONG-LIVED ASSETS
In accordance with SFAS No. 121, long-lived assets to be held and used by
the Company are reviewed to determine whether any events or changes in
circumstances indicate that the carrying amount of the asset may not be
recoverable. For long-lived assets to be held and used, the Company bases its
evaluation on such impairment indicators as the nature of the assets, the future
economic benefit of the assets, any historical or future profitability
measurements, as well as other external market conditions or factors that may be
present. If such impairment indicators are present or other factors exist that
indicate that the carrying amount of the asset may not be recoverable, the
Company determines whether an impairment has occurred through the use of an
undiscounted cash flow analysis of assets at the lowest level for which
identifiable cash flows exist. If an impairment has occurred, the Company
recognizes a loss for the difference between the carrying amount and the
estimated value of the asset. The fair value of the asset is measured using
quoted market prices or, in the absence of quoted market prices, fair value is
based on an estimate of discounted cash flow analysis. Based on its analysis for
the years ended December 31, 1998 and 1997, the Company determined that there
was not an impairment of its long-lived assets.
INCOME TAXES
The Company uses the liability method of accounting for income taxes.
Deferred income taxes result from temporary differences between the tax basis of
assets and liabilities and the basis as reported in the consolidated financial
statements.
FOREIGN CURRENCY TRANSLATION
The Company follows a translation policy in accordance with SFAS No. 52,
"Foreign Currency Translation," (as amended by SFAS No. 130, "Reporting
Comprehensive Income"). The functional currency for the Company has been
determined to be the Belgian franc. In most instances, either the local currency
or the ECU is considered the functional currency for the Company's subsidiaries.
The accounting records of the subsidiaries are remeasured into Belgian franc
equivalents, consolidated and then translated into U.S. dollars for the purpose
of preparing the accompanying financial statements in accordance with accounting
principles generally accepted in the United States. Assets and liabilities are
translated at the rates of exchange at the balance sheet date. Income and
expense accounts are translated at average monthly rates of exchange. The
37
<PAGE> 40
HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
resultant translation adjustments are included in accumulated other
comprehensive loss, a separate component of shareholders' equity. Gains and
losses from foreign currency transactions are included in operations.
REVENUE RECOGNITION
The Company's revenue is associated with its customers' right to use the
network and is recognized on a straight-line basis over the terms of the
customer contracts. Billings received in advance of service being performed are
deferred and recognized as revenue as the service is performed.
NET LOSS PER SHARE
Basic and diluted loss per share is calculated in accordance with SFAS No.
128, "Earnings Per Share." The Company's net loss per share calculation (basic
and diluted) is based upon the weighted average common shares issued. There are
no reconciling items in the numerator or denominator of the Company's net loss
per share calculation. Employee stock options (see Note 5, "Employee Benefits")
have been excluded from the net loss per share calculation because their effect
would be anti-dilutive.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts for cash, accounts receivable, accounts payable, and
accrued liabilities approximate their fair value. The fair value of the
long-term debt is determined based on quoted market rates. At December 31, 1998,
the fair value of the $265.0 million 11.5% Senior Notes, due 2007, was $285.5
million.
OFF BALANCE SHEET RISK AND CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of cash and cash equivalents and accounts
receivable. At December 31, 1998 and 1997, the Company maintained most of its
cash and cash equivalents in high quality U.S. and European financial
institutions. The Company extends credit to various customers and establishes an
allowance for doubtful accounts for specific customers that it determines to
have significant credit risk.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company has developed risk management policies that establish
guidelines for managing foreign exchange risk and periodically evaluates the
materiality of foreign exchange exposures in different countries and the
financial instruments available to mitigate this exposure. The Company finds it
impractical to hedge all foreign currency exposures and as a result, will
continue to experience foreign currency gains and losses.
The Company currently accounts for its existing derivative under SFAS No.
52, "Foreign Currency Translation." In June 1998, the FASB issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." The Company
expects to adopt the new statement effective January 1, 2000. The statement will
require the Company to recognize all derivatives on the balance sheet at fair
value. The Company does not anticipate that the adoption of the statement will
have a significant effect on its results of operations or financial position.
STOCK BASED COMPENSATION
SFAS No. 123, "Accounting for Stock-Based Compensation," establishes a fair
value method of accounting for employee stock options and similar equity
instruments. The fair value method requires compensation cost to be measured at
the grant date based on the value of the award and is recognized over the
service period. SFAS No. 123 allows companies to either account for stock-based
compensation under the new provisions of SFAS No. 123 or under the provisions of
APB No. 25, "Accounting for Stock Issued to Employees." The Company has elected
to account for its stock-based compensation in accordance with the
38
<PAGE> 41
HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
provisions of APB No. 25 and presents pro forma disclosures of net loss as if
the fair value method had been adopted.
USES OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of these consolidated financial statements, in conformity
with generally accepted accounting principles, requires management to make
estimates and assumptions that affect amounts in the financial statements and
accompanying notes and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
NOTE 3: SUPPLEMENTAL BALANCE SHEET INFORMATION
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1997
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Other assets consists of:
VAT receivable............................................ $ 15,841 $ 1,184
Deposit................................................... 4,858 9,577
Other assets.............................................. 9,111 2,520
-------- --------
Total other assets.......................................... $ 29,810 $ 13,281
======== ========
Property and equipment, net consists of:
Telecommunications equipment in service................... $374,959 $198,723
Furniture, fixtures and equipment......................... 7,085 3,409
Leasehold improvements.................................... 1,319 840
Construction in process................................... 84,168 6,255
-------- --------
467,531 209,227
Less: accumulated depreciation....................... 28,547 4,283
-------- --------
Total property and equipment, net................. $438,984 $204,944
======== ========
Accounts payable and accrued expenses consists of:
Trade accounts payable.................................... $ 57,587 $ 19,678
Accrued interest.......................................... 11,435 11,621
Other accrued expenses.................................... 15,025 6,158
-------- --------
Total accounts payable and accrued expenses....... $ 84,047 $ 37,457
======== ========
</TABLE>
NOTE 4: DEBT OBLIGATIONS
Company debt consists of:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1997
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Senior notes, due August 15, 2007 at 11.5% interest payable
semiannually.............................................. $265,000 $265,000
Other financing agreements.................................. 410 433
-------- --------
Total debt outstanding...................................... 265,410 265,433
Less: debt maturing within one year......................... 57 50
-------- --------
Total long-term debt.............................. $265,353 $265,383
======== ========
</TABLE>
39
<PAGE> 42
HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On August 15, 1997, the Company issued aggregate principal amount $265.0
million of senior notes due August 15, 2007 (the "Senior Notes"). The Senior
Notes are general unsecured obligations of the Company, with interest payable
semiannually at a rate of 11.5%. Approximately $56.6 million of the net proceeds
of the offering was placed in escrow for the first four semiannual interest
payments commencing on February 15, 1998. The Company may redeem the Senior
Notes, in whole or in part, any time on or after August 15, 2002 at specific
redemption prices. The Company may also redeem the Senior Notes at a price equal
to 111.5% of the principal amount prior to August 15, 2000 with net cash
proceeds of a public equity offering with gross proceeds of at least $75.0
million or in certain other circumstances specified in the indenture for the
Senior Notes, provided, however, that at least two-thirds of the principal
amount of the Senior Notes originally issued remain outstanding after each such
redemption.
Aggregate maturities of long-term debt, as of December 31, 1998, are as
follows: 1999 -- $0.06 million, 2000 -- $0.06 million, 2001 -- $0.06 million,
2002 -- $0.07 million, 2003 -- $0.07 million, and $265.1 million thereafter.
NOTE 5: EMPLOYEE BENEFITS
The Company established a defined benefit pension plan in 1995 that covers
substantially all of its employees upon twenty-five years of age and at least
one year of service. The benefits are based on years of service and the
employee's compensation. The Company has entered into an arrangement, an
investment contract, with an insurance company for the provision of a group
insurance policy ("the Policy"). Premium payments for the Policy are partly paid
by the employee, based on specified terms that consider the employee's annual
salary, with the remaining premium paid by the employer. The Company's pension
costs for 1998, 1997 and 1996 were $1.0 million, $0.7 million and $0.4 million,
respectively.
In the fourth quarter of 1997, the Company implemented a stock option plan
for its key officers and employees (the "Stock Option Plan"). The ownership
dilution caused by the Stock Option Plan will be approximately 13%. As a result
of issuing options under the Stock Option Plan, the Company incurred a non-cash
charge of approximately $3.7 million, of which $2.6 million was recorded during
the fourth quarter of 1997 and the remaining $1.1 million was recognized over
1998.
The Company applies the provisions of APB No. 25 in accounting for its
stock option incentive plans. The effect of applying SFAS No. 123 on the net
loss as reported is not representative of the effects on reported net loss for
future years due to the vesting period of the stock options and the fair value
of additional stock options in future years. Had compensation expense been
determined in accordance with the methodology of SFAS No. 123, the Company's net
loss for the year ended December 31, 1998 and 1997, respectively would have been
approximately $45.1 million and $29.9 million. The fair value of options granted
during 1997 was estimated between $51.80 and $456.63 per share using the
Black-Scholes option pricing with the following assumptions: expected volatility
of .50, dividend yield 0%, risk free interest rate of 5.79% and an expected life
of five years.
The Company maintains the Stock Option Plan, with the maximum number of
shares of common stock available for grant under the Stock Option Plan of
24,760. All options granted under the Stock Option Plan were at exercise prices
that were at least equal to the fair market value of common stock at the date of
grant. Generally, all options granted under the Stock Option Plan vest over a
three-year period from the date of grant and expire ten years from the date of
grant. There were a few exceptions in which the granting of options had
instantaneous vesting rights.
40
<PAGE> 43
HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Additional information with respect to stock option activity is summarized
as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1998 1997
----------------- -----------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
SHARES PRICE SHARES PRICE
------ -------- ------ --------
<S> <C> <C> <C> <C>
Outstanding at beginning of year................. 10,166 $379.92 -- $ --
Options granted.................................. -- -- 10,166 379.92
Options exercised................................ (6,248) 107.20 -- --
Options canceled or expired...................... -- -- -- --
------ ------
Outstanding at end of year....................... 3,918 815.68 10,166 379.92
====== ======
Options exercisable at year end.................. 2,967 $421.01 6,244 $107.20
</TABLE>
The following table summarizes information about stock options outstanding:
<TABLE>
<CAPTION>
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE PRICE AT NUMBER CONTRACTUAL LIFE EXERCISE NUMBER EXERCISE
DECEMBER 31, 1998: OUTSTANDING (IN YEARS) PRICE EXERCISABLE PRICE
- ------------------ ----------- ---------------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
$83.12............................ 1,603 7 $ 83.12 1,603 $ 83.12
$100.00 to $191.31................ 729 7 117.64 729 117.64
$378.43 to $2,887.62.............. 1,586 8 1,876.21 635 1,622.55
----- -----
3,918 7 $ 815.68 2,967 $ 421.01
===== =====
</TABLE>
In June 1998, certain employees of the Company received an aggregated
restricted stock award of 30,000 shares of GTS common stock, which vest annually
over two years. The Company will incur a non-cash charge of $1.3 million based
on the market price of the GTS common stock of $43.50 at date of grant, of which
$0.4 million was recognized in 1998 and the remaining $0.9 million will be
recognized in 1999 and 2000.
During the fourth quarter of 1998, the Company established the Ebone Value
Creation Plan (the "Ebone Plan"), in order to allow the employees of Ebone to
benefit from any increase in the fair value of Ebone. Under terms of the Ebone
Plan, an aggregate 15,000 units, whose maximum value is $1,000 per unit, may be
allocated to the employees over the term of the plan, which is through July 1,
2001. The units will be valued on July 1, 1999, 2000 and 2001 based on the fair
value of Ebone as determined by a third-party investment bank. Payout to the
employees will be made in two equal payments within sixty days of July 1, 2001
and July 1, 2002 and will either be in cash or in shares of GTS common stock at
the discretion of the Company and with the approval of GTS. As of December 31,
1998, 1,375 units had been allocated to the employees and a compensation charge
of $1.0 million was recognized for the year ended December 31, 1998.
NOTE 6: INCOME TAXES
The components of loss before income taxes were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Pretax loss:
Domestic (the Netherlands)......................... $(28,653) $ (7,154) $ (608)
Foreign............................................ (13,054) (22,535) (15,361)
-------- -------- --------
$(41,707) $(29,689) $(15,969)
======== ======== ========
</TABLE>
41
<PAGE> 44
HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A deferred tax asset is recorded on temporary differences between earnings
as reported in the financial statements and earnings for income tax purposes.
The following table summarizes major components of the Company's deferred tax
assets:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1997
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards.......................... $ 32,600 $ 16,918
-------- --------
Total deferred tax asset.......................... 32,600 16,918
Less: valuation allowance................................. (32,600) (16,918)
-------- --------
Total............................................. $ -- $ --
======== ========
</TABLE>
As of December 31, 1998, the Company had net operating loss carry forwards
for Belgian, Dutch and Irish income tax purposes of approximately $117.4
million, which are recoverable from profits for an unlimited period of time.
NOTE 7: SUPPLEMENTAL CASH FLOW INFORMATION
The following table summarizes non-cash investing and financing activities
for the years ended December 31, 1998 and 1997, respectively:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997
---------- ----------
(IN THOUSANDS)
<S> <C> <C>
Capitalization of leases.................................... $120,556 $139,135
Transfer of shareholders' loans to equity................... -- 48,491
Contribution of fiber optic cable lease..................... -- 1,989
</TABLE>
There were no significant non-cash activities in 1996.
The Company paid interest of $36.0 million, $1.2 million and $0.01 million
in 1998, 1997 and 1996, respectively. The Company paid income taxes of $2.8
million in 1998. The Company did not pay taxes in 1997 and 1996.
NOTE 8: COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
The Company has various operating leases for office space, equipment and
car rental. The obligations extend through 2022. Beginning in 2002, certain of
the leases have options to cancel upon payment of certain penalties.
Rental expense aggregated approximately $2.0 million, $1.0 million and $0.7
million for the years ended December 31, 1998, 1997 and 1996, respectively.
42
<PAGE> 45
HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CAPITAL LEASES
Assets and liabilities under capital leases are included in the
consolidated balance sheets as follows :
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1997
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Telecommunications equipment in service..................... $271,343 $150,787
Less: accumulated amortization.............................. 9,837 482
-------- --------
$261,506 $150,305
======== ========
</TABLE>
Future minimum payments, by year and in the aggregate, under the capital
leases and other non-cancelable operating leases with initial or remaining terms
in excess of one year as of December 31, 1998 were as follows :
<TABLE>
<CAPTION>
CAPITAL LEASES OPERATING LEASES
-------------- ----------------
(IN THOUSANDS)
<S> <C> <C>
December 31, 1999....................................... $ 51,907 $ 2,981
2000.................................... 25,836 3,713
2001.................................... 27,077 3,394
2002.................................... 27,253 3,058
2003.................................... 27,231 1,870
Thereafter.............................................. 230,618 9,012
-------- -------
Total minimum lease payments............................ 389,922 $24,028
=======
Less amount representing interest....................... 162,409
--------
Present value of net minimum lease payments............. 227,513
Less current portion of capital lease obligations....... 37,135
--------
Long-term portion of capital lease obligations.......... $190,378
========
</TABLE>
MAJOR CUSTOMERS
In 1998 the Company had two major customers, representing $9.5 million and
$9.3 million or 11.1% and 10.9% of revenue, respectively. In 1997, the Company
had two major customers, representing $1.8 million and $1.2 million or 34.2% and
21.7% of revenue, respectively. There were no major customers in 1996.
OTHER MATTERS
In the ordinary course of business, the Company may be party to various
legal and tax proceedings, and subject to claims, certain of which relate to the
regulatory environments in which the Company currently operates or intends to
operate. In the opinion of management, the Company's liability, if any, in all
pending litigation, or other legal proceeding or other matter other than what is
discussed above, will not have a material effect upon the financial condition,
results of operations or liquidity of the Company.
NOTE 9: RELATED PARTY TRANSACTIONS
On October 31, 1998, GTS Carrier Services, Inc. acquired AB Swed Carrier's
ownership interest of 6,551 common shares in the Company for approximately $5.8
million. In connection with this purchase, GTS Carriers Services, Inc. paid
approximately $5.3 million to a company, which is affiliated with a board member
for negotiating with AB Swed Carrier and SNCB/NMBS on behalf of GTS Carrier
Services, Inc. to purchase their respective ownership interest in the Company.
43
<PAGE> 46
HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
For the year ended December 31, 1998, the Company, through Ebone, earned
$6.8 million from and incurred $5.1 million of costs to individual members of
the association that owns the minority interest in Ebone (see note 10,
"Acquisition").
NOTE 10: FOREIGN CURRENCY TRANSACTIONS
On April 19, 1998, the Company entered into a foreign currency swap
transaction agreement (the "Swap") with Rabobank International in order to
minimize the foreign currency exposure resulting from issuance in August 1997 of
the Senior Notes (see Note 4, "Debt Obligations"). The Company has marked the
Swap to its fair value as of December 31, 1998 and the resulting adverse change
in the fair value of $27.8 million has been recorded as an Other Non-Current
Liability on the balance sheet and recognized as a foreign currency loss in the
statement of operations. The foreign currency loss recognized on marking the
Swap to its fair value has been offset in the statement of operations by a $15.3
million gain on the remeasurement of the Senior Notes.
NOTE 11: ACQUISITION
On June 24, 1998, the Company completed the acquisition for ECU 90 million
(approximately $99.5 million) of a 75% interest in Ebone. The Company funded the
acquisition with proceeds of a short-term bank loan, which has been repaid.
Ebone is a Tier 1 Internet backbone provider, principally serving as a carriers'
carrier for European Internet service providers. As part of the transaction,
Ebone will purchase, under a transmission capacity agreement, long-term capacity
rights on the Company's network valued at ECU 90 million. In addition to the
majority interest held by the Company, Ebone's new ownership structure will
continue to include many of Ebone's existing customers, which own the balance of
Ebone's shares through an association. The members of the association were
offered the right to buy shares of Ebone in the third quarter of 1998; however,
the Company's ownership interest in Ebone was not reduced as a result of the
acceptances of this offer.
The acquisition has been accounted for using the purchase method of
accounting. The excess purchase price over the fair value of assets acquired of
$19.7 million was allocated to goodwill and is being amortized over 5 years. The
results of Ebone have been included in the accompanying consolidated financial
statements from the date of acquisition.
The following summarized unaudited pro forma financial information assumes
the acquisition had occurred on January 1 of each year:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-----------------------
1998 1997
---------- ----------
(IN THOUSANDS,
EXCEPT LOSS PER SHARE)
<S> <C> <C>
Revenues.................................................... $ 95,634 $ 26,504
Net loss.................................................... (43,976) (30,827)
Net loss per share.......................................... (0.23) (0.34)
</TABLE>
The pro forma results include amortization of the goodwill, elimination of
intercompany revenue and costs of revenues on transactions between the Company
and Ebone and the recording of the 25% minority interest. The pro forma data is
for informational purposes only and does not purport to be necessarily
indicative of the results that would have been obtained had this acquisition
actually occurred at the beginning of the periods presented, nor is it intended
to be a projection of the results which may be achieved in the future.
44
<PAGE> 47
HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12: CERTAIN GEOGRAPHICAL DATA
The Company has adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information", effective for fiscal years beginning after
December 31, 1997. SFAS No. 131 supersedes SFAS No. 14, "Financial Reporting for
Segments of a Business Enterprise" SFAS No. 131 changes current practice under
SFAS No. 14 by establishing a new framework on which to base segment reporting
and also requires interim reporting of segment information.
The Company operates in one segment, Carrier Services, which is used by
management to measure profitability of the business. The Company markets its
services to telecommunications companies throughout Europe and in the United
States.
The following table summarizes revenue and gross long-lived asset
information by geographic area.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
-------------------
1998 1997
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Revenue
United Kingdom............................................ $ 19,619 $ 739
The Netherlands........................................... 17,065 3,947
Switzerland............................................... 11,555 --
Belgium................................................... 8,609 314
Other..................................................... 28,403 373
-------- --------
Total............................................. $ 85,251 $ 5,373
======== ========
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------
1998 1997
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Long-lived assets
France.................................................... $ 94,609 $ 41,393
Germany................................................... 89,177 46,966
Switzerland............................................... 49,678 42,588
Belgium................................................... 40,995 21,090
Other..................................................... 193,072 57,190
-------- --------
Total............................................. $467,531 $209,227
======== ========
</TABLE>
Revenue was attributed to individual countries based on customer billing
location.
NOTE 13: SUBSEQUENT EVENTS
In January, 1999 the Company issued, through a private placement, the New
Senior Notes comprised of aggregate principal amount $200 million of senior
notes due January 15, 2009 (the "Dollar Notes") and Euro85 million
(approximately $100 million) of senior notes due January 15, 2006 (the "Euro
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-third of the
principal amount of the Dollar Notes and the Euro Notes originally issued remain
45
<PAGE> 48
HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
outstanding after each such redemption. Net proceeds from the issuance of the
New Senior Notes was approximately $289.7 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 became effective in February 1999.
On a pro-forma basis, assuming the New Senior Notes had been outstanding as
of January 1, 1998, the Company's net loss would have been $77.3 million for
1998, as a result of interest expense of $31.1 million and amortization expense
of $1.2 million related to amortizing $10.1 million of deferred financing fees
over the terms of the New Senior Notes.
Subsequent to December 31, 1998, the Company further entered into
contractual commitments to lease fibre pairs, including facilities and
maintenance and utilizing the partial routes for laying fiber optic cable. Based
on the contract provisions, these commitments are currently estimated to
aggregate approximately $32.4 million. The commitments have expected lease terms
of ten to fifteen years.
On March 4, 1999, GTS acquired substantially all of the outstanding
ordinary shares and American Depository Shares of Esprit Telecom Group plc
("Esprit"). In conjunction with this business combination the Company may incur
significant charges resulting from shutdowns due to duplication in the capacity
requirements of the combined networks of the Company and Esprit.
On January 1, 1999, the Company adopted the Euro as its functional
currency.
46
<PAGE> 49
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.
MEMBERS OF THE BOARD OF SUPERVISORY DIRECTORS AND THE BOARD OF MANAGING
DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The Members of the Board of Supervisory Directors and the Board of Managing
Directors and executive officers and their respective ages as of December 31,
1998 and positions are set forth below.
BOARD OF SUPERVISORY DIRECTORS
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Gerald W. Thames....................... 52 President, Chief Executive Officer and Director of Global
TeleSystems Group, Inc.
Bernard J. McFadden.................... 65 Director of Global TeleSystems Group, Inc., GTS Carrier Services,
Inc. representative on the Board of Supervisory Directors of
HER
Bo C. O. Hamnell....................... 58 Former Senior Vice President and Director of Finance of the
Swedish State Railway and Former Chief Executive Officer of AB
Swedcarrier
Lars Stig M. Larsson................... 66 Retired President and Director General of the Swedish State
Railway
Joseph Surmont......................... 62 Director of Information Technology of SNCB/NMBS and President of
Board of Directors of HIT Rail
Bruno d'Avanzo......................... 57 Executive Vice President and Chief Operating Officer of Global
TeleSystems Group, Inc.
Mikel H. Williams...................... 41 Vice-President -- Finance Operations of Global TeleSystems Group,
Inc.
</TABLE>
BOARD OF MANAGING DIRECTORS
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Jan Loeber............................. 55 Managing Director
Grier C. Raclin........................ 47 Director
William H. Seippel..................... 42 Director
</TABLE>
EXECUTIVE OFFICERS OF THE COMPANY
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Jan Loeber............................. 55 Managing Director (Principal Executive Officer)
Jim Reynolds........................... 47 President
Gerard J. Caccappolo................... 56 Corporate Director of Marketing and Sales
Peter Magnus........................... 37 Corporate Director of Strategy and Planning
Bruce C. Rudy.......................... 43 Corporate Director of Business Development and Regulatory
John Allan Shearing.................... 49 Corporate Operations and Engineering Director
Jan De Wispelaere...................... 39 Corporate Legal Director
Steven Andrews......................... 52 Corporate Administration Director
Francois Note.......................... 39 Corporate Financial Director -- Chief Financial Officer
(Principal Financial and Accounting Officer)
</TABLE>
47
<PAGE> 50
BOARD OF SUPERVISORY DIRECTORS
Our general affairs and business and the executive board which manages the
company (the "Board of Managing Directors") (Directie) are supervised by a board
appointed by the general meeting of shareholders (the "Board of Supervisory
Directors") (Raad van Commissarissen).
Our Articles of Association (the "Articles of Association") provide for at
least four and no more than ten supervisory directors who must be natural
persons ("Supervisory Directors") to serve on the Board of Supervisory
Directors. Under the law of the Netherlands, a member of the Board of
Supervisory Directors of a company cannot be a member of the Board of Managing
Directors of the same company. The members of the Board of Supervisory Directors
are appointed by the general meeting of shareholders. The Board of Supervisory
Directors elects a chairman from among its members. See "Certain Relationships
and Related Transactions." Under the Shareholders Agreement, resolutions of the
Board of Supervisory Directors require the approval of a majority of the
Supervisory Directors present. The quorum for a valid meeting is a majority of
the members of the Supervisory Board with a minimum of four members. The Board
of Supervisory Directors meets four times a year and also upon the request of
its chairman or the Board of Managing Directors. Pursuant to the Articles of
Association, Supervisory Directors may be suspended or dismissed by the general
meeting of shareholders. The remuneration or compensation of the Supervisory
Directors is determined by the general meeting of shareholders.
While the Board of Managing Directors is the executive body of the company
and is responsible for managing its affairs and representing the company in its
dealings with third parties, the primary responsibility of the Board of
Supervisory Directors is to supervise the policies enacted by the Board of
Managing Directors and the general course of our affairs. The Board of
Supervisory Directors advises the Board of Managing Directors. In the fulfilment
of their duties, members of the Board of Supervisory Directors are required to
act in our best interests.
The members of the Board of Supervisory Directors are as follows:
Gerald W. Thames. Mr. Thames is Executive Vice Chairman of Global
TeleSystems Group, Inc. Mr. Thames joined Global TeleSystems Group, Inc. as
Chief Executive Officer in February 1994, and has served as a director of
Global TeleSystems Group, Inc. since February 1994. From 1990 to 1994, Mr.
Thames was President and Chief Executive Officer for British Telecom North
America and Syncordia, a joint venture company focused on the international
outsourcing market. Mr. Thames has spent over 18 years in senior positions
with telecommunications companies, where he was responsible for developing
start-up telecommunications companies, including 15 years with AT&T, where
he rose to the position of General Manager of Network Services for the
Northeast Region of AT&T Communications.
Bernard J. McFadden. Mr. McFadden has served as a director of Global
TeleSystems Group, Inc. since February 1994. Mr. McFadden currently serves
as an independent consultant to Global TeleSystems Group, Inc. Prior to
1994, Mr. McFadden worked for 32 years with ITT Corporation, where he
served as President and Chief Executive Officer of ITT's Telecom
International Group. Mr. McFadden's career in international
telecommunications includes a four and one-half year assignment as
President and Chief Operating Officer of Alcatel Trade International, S.A.
Bo C. O. Hamnell. Mr. Hamnell was formerly Senior Vice President and
Director of Finance of SJ, the Swedish State Railway, a position he held
since June 1993. Mr. Hamnell also served as Chief Executive Officer of AB
Swedcarrier, a holding company for the SJ investments. Previously, Mr.
Hamnell has served as Chief Financial Officer starting in the early 1970s
for Bull General Electric and later Honeywell Bull and Compagnie Des
Machines Bull in both Scandinavia and in France. In the mid-1980's, Mr.
Hamnell served as Vice President and President for the Swedish Finance
Group, Finax, with operations in Sweden and Western Europe. Mr. Hamnell
also served as part owner and vice president of a group of companies in the
electronics and finance business. Mr. Hamnell has University degrees in
Economics and business administration. Mr. Hamnell is Chairman of the
finance company SJ Invest AB and of the captive insurance company SweRe AB
and a board member of Scandlines AB,
48
<PAGE> 51
Svelast AB, Swedcarrier AB, TGOJ AB, Combitrans Sweden AB, Rail-Combi AB
and Eurofima S/A in Basel, Switzerland.
Lars Stig M. Larsson. Mr. Larsson was formerly President and Director
General of SJ, the Swedish State Railway, a position he held since February
1988. After receiving a Master of Science Engineering degree from
Gothenburg Technical University, where he is also a Doctor honoris causa,
he joined the Ericsson Group in 1960. From 1960 to 1987 he held different
posts within the Ericsson Group and its subsidiaries, including that of
Development Director for road and rail signaling systems as well as the
telephone system AXE. In 1979 Mr. Larsson was appointed President of RIFA,
the Ericsson subsidiary company specializing in the development, production
and marketing of electronic components. In 1985 he was named President of
Ericsson Information Systems. In 1988 Mr. Larsson was appointed President
and Director General of SJ. After several years in positions of
responsibility within the Union Internationale des Chemins de Fer ("UIC")
framework, including as Chairman of the Strategy Committee, Mr. Larsson was
appointed Vice-Chairman of UIC in charge of coordinating all rail
cooperation in Europe in September 1993. On November 1, 1996 he was
appointed Chairman of UIC. Mr. Larsson is also Chairman of the Board of AB
Swedcarrier, SweFerry AB, Rail Combi ABi, Royal Viking Hotel AB, Stockholm
Water Foundation and the Swedish Travel & Tourist Council. He is a board
member of the Royal Academy of Engineering Sciences (IVA) section XI for
Education and Research, the Swedish Transport Research Commission (TFK),
the National Agency for Government Employees, the Taxpayers' Association,
the Stockholm Water Festival and the environmental organization, the
Natural Step.
Joseph Surmont. Mr. Surmont is Director of Information Technology of
SNCB/NMBS, the Belgian Railway company, a position he has held since
February 1987. He joined the Belgian Railways in September 1960. In
addition, he is the President of the Board of Supervisory Directors of HIT
Rail.
Bruno d'Avanzo. Mr. d'Avanzo has served as Executive Vice President
and Chief Operating Officer of Global TeleSystems Group, Inc. since August
1996. He previously served as Executive Vice President and Chief Operating
Officer at Intelsat. From 1991 to 1994, Mr. d'Avanzo held senior management
positions at Olivetti Corporation, serving as Vice President and General
Manager -- Europe, and Vice President -- U.S., Canada and South America. He
also spent 15 years with Digital Equipment Corporation, a diversified
computer manufacturer, where he rose to become Vice President -- European
Sales and Marketing.
Mikel H. Williams. Mr. Williams has served as Vice
President -- Finance Operations of Global TeleSystems Group, Inc. since
November 1996. From 1990 to 1996, he was Managing Director -- Finance and
Administration of Burson-Marsteller, Washington Region. Mr. Williams served
as Chief Financial Officer of Black, Manafort, Stone & Kelly from 1985 to
1990. Previously, he was a Manager with Price Waterhouse.
BOARD OF MANAGING DIRECTORS
The Board of Managing Directors, consisting of three members, is charged
with the management of the Company in accordance with our business plan under
the supervision of the Board of Supervisory Directors. Jan Loeber acts as
Managing Director. Under the Articles of Association, the Board of Managing
Directors must obtain the approval of the Board of Supervisory Directors in
order to take the following actions: (a) to adopt and amend our business plan
and annual budget; (b) to incur expenses in excess of the adopted or amended
annual budget; (c) to incur loans outside of our ordinary business, except
draw-downs of amounts previously approved on our account with a bank designated
by the Board of Supervisory Directors; (d) to lend sums which exceed the amounts
previously approved by the Board of Supervisory Directors outside our ordinary
business; (e) to commit us to guarantee debts of third parties outside our
ordinary business; (f) to extend our business into a new line of business and to
discontinue our business; and (g) to alienate a considerable part of our assets.
The Articles of Association provide that the Board of Managing Directors
shall consist of one or more members. The members of the Board of Managing
Directors are appointed by the general meeting of
49
<PAGE> 52
shareholders. The general meeting of shareholders may suspend or dismiss a
member of the Management Board by a vote of a majority of votes cast in a
meeting in which at least four-fifths of the issued capital is present or
represented. The compensation and other terms and conditions of employment of
the members of the Board of Managing Directors is determined by the general
meeting of shareholders.
The members of the Board of Managing Directors are as follows:
Jan Loeber, Managing Director. Mr. Loeber has overall responsibility for
our development and operations. Mr. Loeber joined Global TeleSystems Group, Inc.
in January 1995. From October 1992 to December 1994, Mr. Loeber was a Managing
Director of BT Securities Corporation, where he was responsible for investment
banking for telecommunications clients. From April 1990 to September 1992, Mr.
Loeber held positions as Managing Director of Unitel Ltd. (now Mercury One 2
One) in the United Kingdom, Group President of Nokia North America Inc., Vice
President of ITT Corporation and Marketing and Product Management Director of
ITT Europe. Mr. Loeber also spent almost ten years with AT&T, where his last
position was Executive Director, Bell Laboratories. Mr. Loeber has over 22 years
of experience in the telecommunications industry and an additional nine years of
experience in information technology with the Pentagon, IBM and Chemical Bank of
New York.
Grier C. Raclin, Senior Vice President and General Counsel of Global
TeleSystems Group, Inc. Mr. Raclin joined Global TeleSystems Group, Inc. as its
Senior Vice President and General Counsel in September 1997, and was elected
Corporate Secretary of the Company in December 1997. Prior to joining Global
TeleSystems Group, Inc., Mr. Raclin served as Vice-Chairman and a Managing
Partner of the Washington, D.C. office of Gardner, Carton & Douglas, a
250-attorney, corporate law firm based in Chicago, Illinois, where his practice
was concentrated in the area of international telecommunications. Mr. Raclin
received his undergraduate and law degrees from Northwestern University and
attended the University of Chicago School of Business Executive Program.
William H. Seippel, Executive Vice President of Finance and Chief Financial
Officer of Global TeleSystems Group, Inc. Mr. Seippel joined Global TeleSystems
Group, Inc. as Executive Vice President of Finance and Chief Financial Officer
in October 1996. From July 1992 to October 1996, Mr. Seippel was Vice
President -- Finance and Chief Financial Officer of Landmark Graphics
Corporation. From August 1990 to July 1992, Mr. Seippel was Director of Finance
for Covia, Inc., an affiliate of United Airlines. From April 1984 to August
1990, Mr. Seippel held the positions of Group Business Controller (1989 to
1990), Group Controller Sales/Marketing (1986 to 1989), and Product Line
Controller (1984 to 1986) with Digital Equipment Corporation, a diversified
computer manufacturer.
EXECUTIVE OFFICERS OF THE COMPANY
Mr. Loeber's background is described above under "Board of Managing
Directors."
Jim Reynolds, President of Hermes Europe Railtel B.V. Mr. Reynolds joined
Hermes Railtel in March 1999. Mr. Reynolds was formerly chief operating officer
of Esprit Telecom. His experience and track record extends over 26 years in the
information technology and telecommunications field. Previously Director of
Products and Services at Mercury Communications, Mr. Reynolds was responsible
for the rationalization and development of the Mercury service portfolio during
the period when Mercury was focusing on making major improvements to service
delivery and profit. As part of this role he managed the Mercury Enterprise
businesses disposing of a number of these and integrating others into the main
company. Before joining Mercury in 1992 he led the first Digital Equipment
product group outside the United States and spent 15 years with ITT Corporation.
Gerard J. Caccappolo, Corporate Director of Marketing and Sales. Mr.
Caccappolo joined Hermes Railtel in January 1995 as Director of Marketing and
Sales, responsible for market and customer segmentation, services development,
and pricing and sales strategies. Prior to joining Hermes Railtel, from
September 1988 to December 1994, he was Vice President of Marketing and
Sales -- International Carriers at Ascom Timeplex Equipment (Telecommunications)
Manufacturer.
50
<PAGE> 53
Peter Magnus, Corporate Director of Strategy and Planning. Mr. Magnus
joined Hermes Railtel in January 1995 as Financial Director -- Chief Financial
Officer, responsible for treasury, financing, accounting and budgets, and served
in that capacity until October 1997, when he was appointed to his current
position. Prior to joining Hermes Railtel, from January 1992 to December 1994,
he was Controller of the Belgian operations of Cargill N.V.
Bruce C. Rudy, Corporate Director of Business Development and
Regulatory. Mr. Rudy joined Hermes Railtel in 1996 and is Director of Business
Development, Planning and Regulatory Affairs, responsible for business planning,
financial modeling, shareholder relations and development. Mr. Rudy previously
worked for Lochridge & Company, Inc. Management Consultants in Boston, where he
was a senior consultant from September 1989 to December 1995.
John Allan Shearing, Corporate Operations and Engineering Director. Mr.
Shearing joined Hermes Railtel in November 1995 as Director of Operations, with
responsibility for network operations, customer service and information systems.
Before joining Hermes Railtel, Mr. Shearing spent eight years at S.W.I.F.T. as
Network Operations Director and also managing the acceptance and implementation
of a new generation of network systems and applications.
Jan De Wispelaere, Corporate Legal Director. Mr. De Wispelaere joined
Hermes Railtel as a consulting attorney in 1995 and has since been promoted to
the position of Legal Director -- Corporate Secretary and General Counsel. Prior
to joining Hermes Railtel, from January 1994 to November 1995, Mr. De Wispelaere
had been with Stanbrook & Hooper -- European Community Lawyers. Prior to that,
he was with Scott Paper Company and SD Warren Group as Senior Counsel for five
years. He has held since 1993 positions as a member of the Board of Directors
and Management Board of the German Scott -- Feldmuhle HQ Company, as well as
several Scott Paper operating entities in Europe.
Steven Andrews, Corporate Administration Director. Mr. Andrews joined
Hermes Railtel in September 1997, assuming responsibility for human resources;
corporate, press and shareholder communications; quality and
facilities-purchasing. Before joining Hermes Railtel, Mr. Andrews was an
executive of US West with recent assignment as president of Media One and
president of US West Spectrum Enterprises International.
Francois Note, Corporate Financial Director -- Chief Financial Officer. In
his position at Hermes Railtel, Mr. Note is responsible for treasury, financing,
accounting and budgets. Prior to joining Hermes Railtel in April 1998, Mr. Note
was employed by Sandoz AG where he held different positions in the financial
area. Since 1995 he was Head of Group Controlling at Sandoz and held this
position after the merger of Ciba Geigy and Sandoz, which resulted in the
survivor company Novartis International.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION OF DIRECTORS
The directors on the Board of Supervising Directors and the Board of
Managing Directors receive no fees from the Company for serving as directors.
Mr. McFadden currently serves as an independent consultant to Global TeleSystems
Group, Inc. pursuant to a consulting agreement, under which he receives a
consulting fee of $100,000 per annum. One of his duties under the consulting
agreement is to serve as a member of the Board of Supervisory Directors of
Hermes Railtel.
EXECUTIVE COMPENSATION
The following table sets forth each component of compensation paid or
awarded to, or earned by, the chief executive officer (who is the Managing
Director of Hermes Railtel) and the four most highly
51
<PAGE> 54
compensated executive officers other than the chief executive officer during the
fiscal year ended December 31, 1998
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL LONG-TERM COMPENSATION AWARDS
COMPENSATION -------------------------------------
------------------- OTHER ANNUAL RESTRICTED STOCK SECURITIES ALL OTHER
NAME AND SALARY BONUS COMPENSATION AWARD(S) UNDERLYING OPTIONS COMPENSATION
PRINCIPAL POSITION YEAR $ ($) ($) ($) (#) ($)
- ------------------ ---- -------- -------- ------------ ---------------- ------------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Jan Loeber(1)........... 1998 $310,000 $119,400 $101,840(2) -0- 150,000(12) $178,565(11)
Managing Director 1997 235,000 78,608 46,598(2) -0- 4,812(4) 179,450(11)
1996 235,000 78,608 42,806(2) (3) 3.5(4) 12,986(11)
Gerard J.
Caccappolo(1)......... 1998 191,042 52,500 83,125(6) -0- 61,000(12) 4,000(5)
Corporate Director of 1997 173,750 80,000 32,043(6) -0- 1,714(4) 4,000(5)
Marketing and Sales... 1996 160,000 40,000 42,108(6) -0- 1.5(4) 3,750(5)
Bruce Rudy(1)........... 1998 158,417 55,800 73,017(9) -0- 55,000(12) 4,000(5)
Corporate Director of 1997 140,500 13,500 15,096(9) -0- 476(4) 3,850(5)
Business Development 1996 135,000 13,509 18,416(9) 0.5 (4) 2,532(5)
and Regulatory
John Shearing........... 1998 147,051(7) 44,260(7) --(8) -0- 34,000(12) -0-
Corporate Operations 1997 186,678(7) 31,491(7) (8) -0- 476(4) -0-
Director 1996 173,594(7) 35,163(7) (8) -0- -- -0-
Steven Andrews(1)....... 1998 187,000 18,700 67,794(10) -0- -- 2,337(5)
Corporate
Administration 1997 62,333 -- 9,200(10) -0- 952(4) --
Director 1996 -- -- -- -- -- --
</TABLE>
- ---------------
(1) The terms of the named executive officer's employment are included in an
agreement between the named executive officer and an affiliate of Global
TeleSystems Group, Inc. Such named executive officer is seconded to Hermes
Railtel for a fee.
(2) For 1998, the amount listed represents the sum of a cost of living
allowance of $21,700, a tax equalizing payment of $58,613 that compensates
Mr. Loeber for the higher taxes he pays because he resides in Belgium
instead of the United States, use of a company car and gross-up payment for
certain tax liabilities in the amount of $21,527. For 1997, the amount
listed represents the sum of a cost of living allowance of $16,450, a tax
equalization payment of $13,953 that compensates Mr. Loeber for the higher
taxes he pays because he resides in Belgium instead of the United States,
use of a company car and a gross-up payment for certain tax liabilities in
the amount of $11,648. For 1996, the amount listed represents the sum of a
cost of living allowance of $16,450, paid home leave of 9,031, use of a
company car and a gross-up payment of $12,778 for certain tax liabilities.
(3) Mr. Loeber has been granted a restricted stock award of 30,000 shares of
Global TeleSystems Group, Inc. common stock which vests in equal thirds,
beginning in January 2, 1997.
(4) For 1997, represents stock options awarded under The Key Employee Stock
Option Plan of Hermes Europe Railtel B.V. (the "Hermes Railtel Stock Option
Plan") For 1996, represents stock options granted under the GTS-Hermes,
Inc. 1994 Stock Option Plan (the "GTS-Hermes Plan"). The stock options
granted in 1997 are in substitution for the stock options granted in 1996,
which have been cancelled. No stock options were granted in 1998.
(5) These named executive officers participate in the GTS 401(k) plan to which
GTS contributed the amounts indicated for 1998, 1997 and 1996.
(6) Mr. Caccappolo received a cost of living allowance of $13,373, $12,163 and
$11,200 in 1998, 1997 and 1996, respectively, and resides in a company
apartment which the company paid the equivalent of $16,595, $16,109 and
$17,928 per year in rent in 1998, 1997 and 1996, respectively. In 1998, Mr.
Caccappolo also received a tax equalization payment of $42,278, paid home
leave of $3,660 and a gross-up payment for certain tax liabilities of
$1,011. In addition, we provided Mr. Caccappolo with the use of a company
car in 1998, 1997 and 1996.
52
<PAGE> 55
(7) Converted from Belgian Francs to U.S. Dollars at an exchange rate of
BF34.57=$1.00, BF35.77=$1.00 and BF32.04=$1.00 in 1998, 1997 and 1996,
respectively.
(8) Perquisites and other personal benefits paid to Mr. Shearing during 1998,
1997 and 1996 were less than the lesser of $50,000 and 10 percent of the
total of annual salary and bonus reported for the named executive officer.
(9) Mr. Rudy received a housing allowance of $14,904, $15,096 and $16,855
during 1998, 1997 and 1996, respectively. In 1998, Mr. Rudy also received a
tax equalization payment of $32,501, paid home leave of $16,822, tuition
reimbursement of $1,932 and a gross-up for certain tax liabilities of
1,059. In addition, we provided Mr. Rudy with the use of a company car in
1998,1997 and 1996.
(10) Mr. Andrews received a cost of living allowance of $13,090 and $4,363 and a
housing allowance $16,548 and $4,124 during 1998 and 1997, respectively. In
1998, Mr. Andrews also received a tax equalization payment of $21,583 and
paid home leave of $5,427. In addition, we provided Mr. Andrew with the use
of a company car in 1998 and 1997.
(11) This amount represents premiums paid by Global TeleSystems Group for
$1,000,000 in term life insurance for Mr. Loeber and contributions to Mr.
Loeber's account by Global TeleSystems Group under the 401(k) Plan. For
1998 and 1997, the amount also includes $156,700 which represents the value
as of December 31, 1998 and 1997 of 10,000 shares of Global TeleSystems
Group restricted common stock which vested in each of 1998 and 1997.
(12) For 1998, represents stock option for Global TeleSystems Group common stock
awarded under the Global TeleSystems Group Stock Option Plan.
OPTION GRANTS IN THE LAST FISCAL YEAR --
GLOBAL TELESYSTEMS GROUP STOCK OPTION PLAN
<TABLE>
<CAPTION>
NUMBER OF SECURITIES % OF TOTAL OPTIONS EXERCISE OR
UNDERLYING GRANTED TO EMPLOYEES BASE PRICE EXPIRATION GRANT DATE
NAME OPTIONS GRANTED(#) IN FISCAL YEAR ($/SHARE) DATE PRESENT VALUE($)(3)
---- -------------------- -------------------- ----------- ---------- -------------------
<S> <C> <C> <C> <C> <C>
Jan Loeber........... 150,000(1) 4.0 $25.75 10-14-08 $2,476,905
Gerard J.
Caccappolo......... 25,000(2) 0.6 46.75 03-31-08 763,660
36,000(1) 0.9 25.75 10-14-08 594,457
------- --- ----------
Total...... 61,000 1.5 1,358,117
Bruce Rudy........... 25,000(2) 0.6 46.75 03-31-08 763,660
30,000(1) 0.8 25.75 10-14-08 495,381
------- --- ----------
Total...... 55,000 1.4 1,259,041
John Shearing........ 10,000(2) 0.3 46.75 03-31-08 305,464
24,000(1) 0.6 25.75 10-14-08 396,305
------- --- ----------
Total...... 34,000 0.9 701,769
Steven Andrews....... -- -- -- -- --
</TABLE>
- ---------------
(1) All these options in Global TeleSystems Group common stock would vest in
February 2005, when financial results for 2004 are expected to be publicly
announced. If certain performance targets are met or exceeded, these options
could be fully exercisable in February 2002, when financial results for 2001
are expected to be publicly announced.
(2) The options in Global TeleSystems Group common stock vest one-fourth on each
of the first four anniversaries of the date of grant.
(3) The present value of each grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions: dividend yield 0%, expected volatility of 0.75, risk-free
interest rate of 4.23% and expected life of five years.
53
<PAGE> 56
AGGREGATED OPTION EXERCISES IN THE LAST FISCAL YEAR AND
FISCAL YEAR-ENDED OPTION VALUES
<TABLE>
<CAPTION>
SHARES NUMBER OF SECURITIES VALUE OF UNEXERCISED
ACQUIRED VALUE UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
ON REALIZED OPTIONS AT FY-END(#) AT FY-END($)(3)
NAME EXERCISE(#)(1) ($)(2) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- -------------- ---------- ------------------------- -------------------------
<S> <C> <C> <C> <C>
Jan Loeber.............. 3,209 $2,129,793 1,603/-0- 1,292,928/-0-
Gerard J. Caccappolo.... 1,143 739,389 571/-0- 460,673/-0-
Bruce Rudy.............. 318 179,754 158/-0- 112,042/-0-
John Shearing........... 159 99,359 159/158 84,448/84,237
Steven Andrews.......... -- -- 317/635 225,987/512,063
</TABLE>
- ---------------
(1) These shares are held by Stichting Administratiekantoor Hermes Foundation,
which in turn issued to the named executive officers depositary receipts
representing beneficial ownership in the shares.
(2) Based on the difference between fair value price on the date of exercise and
the option exercise price.
(3) Based on a valuation price of $889.61 per share of Hermes Railtel common
stock at December 31, 1998. This valuation was determined by the valuation
per common share that GTS Carrier Services paid to AB Swed Carrier for
acquiring all of its minority interest in Hermes Railtel on October 31,
1998.
AGGREGATED OPTION EXERCISES IN THE LAST FISCAL YEAR AND
FISCAL YEAR-ENDED OPTION VALUES -- GLOBAL TELESYSTEMS GROUP
STOCK OPTION PLAN
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FY-END(#) AT FY-END($)(2)
NAME EXERCISABLE/UNEXERCISABLE(1) EXERCISABLE/UNEXERCISABLE
---- ---------------------------- -------------------------
<S> <C> <C>
Jan Loeber...................................... 0/150,000 $0/$4,500,000
Gerard J. Caccappolo............................ 0/61,000 0/ 1,830,000
Bruce Rudy...................................... 0/55,000 0/ 1,650,000
John Shearing................................... 0/34,000 0/ 1,020,000
</TABLE>
- ---------------
(1) No options were exercised during the year ended December 31, 1998.
(2) Based on the closing price of $55.75 on the Nasdaq Stock Market of the
Global TeleSystems Group Common Stock on December 31, 1998.
KEY EMPLOYEE STOCK OPTION PLAN OF HERMES EUROPE RAILTEL B.V.
We has adopted the Key Employee Stock Option Plan of Hermes Railtel. (the
"New Plan"). Under the New Plan certain employees of Hermes Railtel will be
granted stock options to purchase its common stock. Subject to adjustment in the
event of certain changes in capitalization, a maximum of 24,760 shares of Hermes
Railtel common stock are authorized for grant under the New Plan which, upon
exercise, shall be issued to Stichting Administratiekantoor Hermes Foundation,
which in turn issues depository receipts (each a "Receipt") to the grantees who
have exercised options. Each Receipt will represent a beneficial interest in one
share of Hermes Railtel common stock that is subject to stock options under the
New Plan.
The New Plan is administered by a committee composed of three members of
the Board of Supervising Directors which will have broad discretion to determine
who shall receive awards under the New Plan, the terms of such awards and
interpret the New Plan. The New Plan shall become effective upon its adoption by
the Board of Supervising Directors and shall continue in effect until 2004,
unless terminated earlier by the Board of Supervising Directors.
Each stock option granted under the New Plan shall have a term of ten
years, except those granted in 1997 reflected in the table above. The exercise
price of each such stock option will be determined at the time
54
<PAGE> 57
of grant. In addition the stock options granted under the New Plan will become
exercisable at such times and under such conditions as determined by the
committee.
The Board of Supervising Directors may amend or terminate the New Plan at
any time, provided that the rights of participants are not impaired.
PENSION PLAN
In 1995, we established a defined benefit pension plan (the "Pension Plan")
that covers substantially all of its employees that are at least twenty-five
years of age and have at least one year of service. The benefits are based on
years of service and the employee's compensation at retirement. Mr. Shearing
participates in the Pension Plan. Each participant in the Pension Plan will
receive a lump sum at retirement equal to 450% of final annual salary up to a
specified ceiling which changes every year (in 1997 the ceiling was BF1,352,000)
plus 910% of the excess multiplied by the years of service divided by 35. The
maximum years of service taken into account under the formula is 35. The normal
retirement age is 60. We have entered into an agreement with an insurance
company for the provision of a group insurance policy (the "Policy"). Premium
payments for the Policy are partly paid by the employee based on specified terms
that consider the employee's annual salary, with the remaining premium paid by
us. Premiums are intended to provide not only for benefits attributed to service
to date but also for those expected to be earned in the future. (See Note 5 to
the Notes to Consolidated Financial Statements). Upon termination of employment
prior to retirement age, employer contributions cease and the participant may
decide to receive the cash surrender value of the policy, to continue paying
premiums or cease paying premiums but in either case maintaining the policy
which is paid out according to its terms.
<TABLE>
<CAPTION>
PENSION PLAN TABLE
YEARS OF SERVICE
--------------------------------------------------------------
REMUNERATION 15 20 25 30 35
- ------------ ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
$125,000......................... $ 370,313 $ 493,750 $ 617,188 $ 740,625 $ 863,200
$150,000......................... 467,870 623,829 779,786 935,744 1,090,610
$175,000......................... 565,508 754,011 942,513 1,131,056 1,318,200
$200,000......................... 663,100 884,140 1,105,170 1,326,210 1,545,700
$225,000......................... 760,703 1,014,271 1,267,838 1,521,405 1,773,200
$250,000......................... 858,300 1,144,400 1,430,500 1,716,600 2,000,000
$300,000......................... 1,053,490 1,404,660 1,755,820 2,106,990 2,455,700
$400,000......................... 1,443,880 1,925,181 2,406,476 2,887,771 3,365,700
$450,000......................... 1,639,080 2,185,440 2,731,800 3,278,160 3,820,700
$500,000......................... 1,834,270 2,445,700 3,057,120 3,668,550 4,275,700
</TABLE>
The above pension benefits are based on the following formula:
(260% S1 + 910% S2) X N/35
<TABLE>
<S> <C> <C>
S = annual salary
S1 = S up to the "ceiling"
S2 = S above the "ceiling"
N = years of service up to a maximum of 35
</TABLE>
For purposes of this calculation the "ceiling" is U.S. $42,200.
EMPLOYMENT AGREEMENTS
All the named executive officers have employment agreements with either
Hermes Railtel (the "Company Employment Agreements") or an affiliate of Global
TeleSystems Group (the "GTS Employment Agreements"). We reimburse Global
TeleSystems Group for payments made to named executive officers under contracts
with Global TeleSystems Group. The Employment Agreements generally are each for
a term of two to three years and include an automatic renewal provision unless
either party provides notice of termination on or prior to 90 days thereof.
55
<PAGE> 58
Mr. Shearing has an employment agreement. Mr. Shearing's employment
agreement was entered into by the parties of November 1, 1995 for an
undetermined period of time. Mr. Shearing's initial annual salary was
BF2,800,000, which is net of all tax and social security contributions. Mr.
Shearing's gross salary for fiscal year 1998 was BF5,083,553. He may also
receive a yearly performance-based bonus of up to 20% of his base salary at our
discretion. Mr. Shearing participates in our pension plan and is provided with a
company car.
See "Certain Relationships and Related Transactions" for a description of
the GTS Employment Agreements.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the beneficial
ownership of Hermes Railtel Ordinary Shares, as of March 15, 1999, by each
beneficial owner of 5% or more of the Ordinary Shares and by our directors and
officers. For the purpose of this table, a person or group of persons is deemed
to have "beneficial ownership" of any shares which such person or group has the
right to acquire within 60 days after such date, but such shares are not deemed
to be outstanding for the purpose of computing the percentage ownership of any
other person.
<TABLE>
<CAPTION>
NUMBER OF PERCENTAGE
SHARES BENEFICIALLY
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED OWNED
- ------------------------ ------------------ ------------
<S> <C> <C>
GTS Carrier Services, Inc................................... 176,858 89.9%
SNCB/NMBS................................................... 13,610 6.90%
Jan Loeber(1)............................................... 4,812 2.40%
Gerard Caccappolo(1)........................................ 1,714 *
Peter Magnus(1)............................................. 688 *
John Green(1)............................................... 572 *
Bruce Rudy(1)............................................... 476 *
John Shearing(1)............................................ 317 *
Jan De Wispelaere(1)........................................ 317 *
Steven Andrews(1)........................................... 317 *
-------
All Directors and Executive Officers as a Group (8
persons).................................................. 9,213 4.68%
-------
Total of above.................................... 199,681
=======
</TABLE>
- ---------------
* Less than 1%.
(1) The shares are beneficially owned by these persons and are held in trust by
Stichting Administratiekantoor Hermes Foundation, which in turn has issued
depositary receipts to such persons representing beneficial ownership in the
shares. In addition, Hermes Railtel has established a stock option plan
pursuant to which key officers and employees were granted options to
purchase Ordinary Shares of Hermes Railtel. We expect that the number of
Ordinary Shares subject to the proposed plan will be approximately 13% of
the total Ordinary Shares of Hermes Railtel issued and outstanding. See
"Management -- Executive Compensation."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
PURCHASE OF SHARES BY GTS CARRIER SERVICES
In connection with the purchase of AB Swed Carrier's interest in Hermes
Railtel in December 1998, GTS Carrier Services paid approximately $5.3 million
to a company that is affiliated with a member of the Supervisory Board of Hermes
Railtel for negotiating with AB Swed Carrier and SNCB/NMBS on behalf of GTS
Carrier Services to purchase their respective ownership interest in HER. See
"Security Ownership of Principal Shareholders and Management."
56
<PAGE> 59
SHAREHOLDERS AGREEMENT
Under the Shareholders Agreement, SNCB/NMBS, so long as it holds at least
6.8% of the shares of HER, is entitled to make a binding nomination for the
appointment of one member of the Board of Supervisory Directors.
SHAREHOLDER LEASES AND LOANS
The Company currently leases dark fiber and facilities from SNCB/NMBS.
SNCB/NMBS is a direct shareholder of HER.
GTS EMPLOYMENT AGREEMENTS
Messrs. Loeber, Caccappolo and Rudy and Andrews are parties to Global
TeleSystems Group employment agreements. Each employment agreement provides the
relevant named executive officer with a salary, bonus and a standard company
welfare benefits package as well as the use of an automobile, cost of living
allowance, tax equalization and certain other fringe benefits. In addition, the
employment agreements include severance benefit provisions. Finally, the
employment agreements include noncompete and nonsolicitation clauses that cover
the term of employment and twelve months thereafter. Under the employment
agreements, each party employee was entitled to participate in the GTS-Hermes
Plan. The options outstanding under the GTS-Hermes Plan were cancelled and
replaced by options under the Hermes Railtel Stock Option Plan. In addition, Mr.
Loeber received a restricted stock award of 30,000 shares of Global TeleSystems
Group common stock.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
a) The following documents are filed as part of this report:
1 Consolidated Financial Statements
The following consolidated financial statements of Hermes Railtel are
included in Part II, Item 8 of this report:
- Report of Ernst & Young Reviseurs d'Entreprises S.C.C., Independent
Auditors
- Consolidated Balance Sheets as of December 31, 1998 and 1997
- Consolidated Statements of Operations for each of the Three Years
Ended December 31, 1998
- Consolidated Statements of Cash Flows for each of the Three Years
Ended December 31, 1998
- Consolidated Statements of Changes in Stockholders' Equity (Deficit)
for each of the Three Years Ended December 31, 1998
- Notes to Consolidated Financial Statements
2 Consolidated Financial Statement Schedules
We have furnished Schedule II Valuation and Qualifying Accounts.
All other schedules are omitted because they are not applicable or not
required, or because the required information is either incorporated herein by
reference or included in the financial statements or notes thereto included in
this report.
b) Reports on Form 8-K
<TABLE>
<CAPTION>
DATE OF REPORT SUBJECT OF REPORT
-------------- -----------------
<S> <C>
None
</TABLE>
57
<PAGE> 60
c) Exhibits
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
3.1* -- Deed of Incorporation and Articles of Association, as
amended to date
4.1* -- Form of Outstanding Note (contained in Indenture filed as
Exhibit 4.3)
4.2* -- Form of Exchange Note (contained in Indenture filed as
Exhibit 4.3)
4.3* -- Indenture, dated August 19, 1997, among the Company,
Global TeleSystems Group, Inc. and The Bank of New York,
as Trustee
4.4* -- Registration Rights Agreement, dated August 19, 1997,
between the Company and Donaldson, Lufkin & Jenrette
Securities Corporation, UBS Securities LLC and Lehman
Brothers Inc.
4.5* -- Escrow Agreement, dated August 19, 1997, among the
Company and The Bank of New York, as Trustee and as
Escrow Agent
4.6*** -- Form of Outstanding Dollar Note for the Registrant's
10 3/8% Senior Notes due 2009 (contained in Dollar
Indenture filed as Exhibit 4.10)
4.7*** -- Form of Outstanding Euro Note for the Registrant's
10 3/8% Senior Notes due 2006 (contained in Euro
Indenture filed as Exhibit 4.11)
4.8*** -- Form of Dollar Exchange Note for the Registrant's 10 3/8%
Senior Notes due 2009 (contained in Dollar Indenture
filed as Exhibit 4.10)
4.9*** -- Form of Euro Exchange Note for the Registrant's 10 3/8%
Senior Notes due 2006 (contained in Euro Indenture filed
as Exhibit 4.11)
4.10*** -- Dollar Indenture, dated as of January 4, 1999, between
Hermes Railtel and The Bank of New York of New York, as
Trustee
4.11*** -- Euro Indenture dated as of January 4, 1999, between
Hermes Railtel and The Bank of New York, as Trustee
4.12*** -- Dollar Registration Rights Agreement, dated as of January
4, 1999, between Hermes Railtel and Initial Purchasers
4.13*** -- Euro Registration Rights Agreement, dated as of January
4, 1999, between Hermes Railtel and Initial Purchasers
10.1* -- Shareholders Agreement among the Company, GTS-Hermes
Inc., HIT Rail B.V., SNCB/NMBS and AB Swed Carrier
10.2* -- Employment Agreement, dated as of January 3, 1995,
between SFMT, Inc. and Jan Loeber
10.3* -- Employment Agreement, dated as of January 3, 1995,
between SFMT, Inc. and Gerard Caccappolo
10.4* -- Employment Agreement, dated as of January 1, 1996,
between GTS Group, Inc. and Bruce Rudy
10.5* -- Employment Agreement between the Company and Peter Magnus
10.6* -- Employment Agreement, dated as of September 26, 1995,
between the Company and J.A. Shearing
10.7* -- License, dated December 18, 1996, granted by the
Secretary of State for Trade and Industry relating to the
United Kingdom
10.8* -- Registration, dated July 26, 1996, granted by IBPT
relating to Belgium
10.9* -- Authorization Letter, dated August 1, 1996, granted by
Hoofdirectie Telecommunicate & Post relating to the
Netherlands
10.10* -- License, dated May 28, 1997, granted by BMPT relating to
Germany
10.11*+ -- Agreement, dated April 1, 1997, between Eastern Group
Telecoms Limited and the Company
10.12*+ -- Agreement, dated January 16, 1997, between SNCB/NMBS and
the Company
10.13*+ -- Agreement, dated February 3, 1997, between SANEF and the
Company
10.14** -- License, dated October 22, 1997 granted by the Secretary
of State of Industry relating to France
</TABLE>
58
<PAGE> 61
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
10.15** -- Authorization Letter, dated March 16, 1998, granted by
the Deputy Director of Federal Communication Office
relating to Switzerland.
10.16**+ -- Fiber Agreement, dated September 24, 1997
10.17**+ -- Fiber Agreement, dated October 8, 1997
10.18**+ -- Fiber Agreement, dated December 15, 1997
10.19***+ -- Agreement, dated November 24, 1997 between COLT and
Hermes Railtel
10.20***+ -- Authorization Letter, dated March 16, 1998, granted by
the Deputy Director of Federal Communication Office
relating to Switzerland
10.21***+ -- Agreement dated April 3, 1998 between AT&T Unisource and
Hermes Railtel
10.22***+ -- Agreement dated November 3, 1998 between Cable & Wireless
and Hermes Railtel
21.1**** -- List of Subsidiaries
27.1**** -- Financial Data Schedule for the Year Ended December 31,
1998
</TABLE>
- ---------------
* Incorporated by reference to the correspondingly numbered Exhibit to
Amendment No. 4 to the Company's Registration Statement on Form S-4
(Commission File No. 333-37719).
** Incorporated by reference to the correspondingly numbered Exhibit to the
Company's annual report on Form 10-K for the year ended December 31, 1997.
*** Incorporated by reference to the Exhibits to Amendment No. 1 to the
Company's Registration Statement on Form S-4 (Commission File No.
333-70723) as follows: Exhibit 4.6 was Exhibit 4.1 to the Form S-4
Registration Statement; Exhibit 4.7 was Exhibit 4.2 to the Form S-4
Registration Statement; Exhibit 4.8 was Exhibit 4.3 to the Form S-4
Registration Statement; Exhibit 4.9 was Exhibit 4.4 to the S-4 Registration
Statement; Exhibit 4.10 was Exhibit 4.5 to the Form S-4 Registration
Statement; Exhibit 4.11 was Exhibit 4.6 to the Form S-4 Registration
Statement; Exhibit 4.12 was Exhibit 4.7 to the Form S-4 Registration
Statement; Exhibit 4.13 was Exhibit 4.8 to the Form S-4 Registration
Statement; Exhibit 10.19 was Exhibit 10.15 to the Form S-4 Registration
Statement; Exhibit 10.20 was Exhibit 10.16 to the Form S-4 Registration
Statement; Exhibit 10.21 was Exhibit 10.17 to the Form S-4 Registration
Statement; and Exhibit 10.22 was Exhibit 10.18 to the Form S-4 Registration
Statement.
**** Filed herewith.
+ Confidential material has been redacted and filed separately with the
Securities and Exchange Commission.
59
<PAGE> 62
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities
Exchange Act 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in Hoeilaart, Belgium,
on this 31st day of March, 1999.
HERMES EUROPE RAILTEL B.V.
By: /s/ JAN LOEBER
----------------------------------
Jan Loeber
Managing Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the 31st day of March, 1999.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S>
/s/ JAN LOEBER Managing Director (Principal Executive
- ----------------------------------------------------- Officer) and Member of Board of Managing
(Jan Loeber) Directors
/s/ FRANCOIS NOTE Corporate Financial Director -- Chief
- ----------------------------------------------------- Financial Officer (Principal Financial and
(Francois Note) Accounting Officer)
Member of Board of Supervisory Directors
- -----------------------------------------------------
(Gerald W. Thames)
/s/ BERNARD J. MCFADDEN Member of Board of Supervisory Directors
- -----------------------------------------------------
(Bernard J. McFadden)
/s/ BO C.O. HAMNELL Member of Board of Supervisory Directors
- -----------------------------------------------------
(Bo C.O. Hamnell)
/s/ LARS STIG M. LARSSON Member of Board of Supervisory Directors
- -----------------------------------------------------
(Lars Stig M. Larsson)
/s/ JOSEPH SURMONT Member of Board of Supervisory Directors
- -----------------------------------------------------
(Joseph Surmont)
/s/ BRUNO D'AVANZO Member of Board of Supervisory Directors
- -----------------------------------------------------
(Bruno d'Avanzo)
/s/ MIKEL H. WILLIAMS Member of Board of Supervisory Directors
- -----------------------------------------------------
(Mikel H. Williams)
/s/ WILLIAM H. SEIPPEL Member of Board of Managing Directors
- -----------------------------------------------------
(William H. Seippel)
/s/ GRIER RACLIN Member of Board of Managing Directors
- -----------------------------------------------------
(Grier Raclin)
</TABLE>
60
<PAGE> 63
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
COL. A COL. B COL. C COL. D COL. E
- -------------------------------------------- ---------- ----------------------- ---------- ----------
ADDITIONS
-----------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS OF PERIOD
- -------------------------------------------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts at
12/31/98.................................. -0- 887 887
</TABLE>
61
<PAGE> 64
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
3.1* -- Deed of Incorporation and Articles of Association, as
amended to date
4.1* -- Form of Outstanding Note (contained in Indenture filed as
Exhibit 4.3)
4.2* -- Form of Exchange Note (contained in Indenture filed as
Exhibit 4.3)
4.3* -- Indenture, dated August 19, 1997, among the Company,
Global TeleSystems Group, Inc. and The Bank of New York,
as Trustee
4.4* -- Registration Rights Agreement, dated August 19, 1997,
between the Company and Donaldson, Lufkin & Jenrette
Securities Corporation, UBS Securities LLC and Lehman
Brothers Inc.
4.5* -- Escrow Agreement, dated August 19, 1997, among the
Company and The Bank of New York, as Trustee and as
Escrow Agent
4.6*** -- Form of Outstanding Dollar Note for the Registrant's
10 3/8% Senior Notes due 2009 (contained in Dollar
Indenture filed as Exhibit 4.10)
4.7*** -- Form of Outstanding Euro Note for the Registrant's
10 3/8% Senior Notes due 2006 (contained in Euro
Indenture filed as Exhibit 4.11)
4.8*** -- Form of Dollar Exchange Note for the Registrant's 10 3/8%
Senior Notes due 2009 (contained in Dollar Indenture
filed as Exhibit 4.10)
4.9*** -- Form of Euro Exchange Note for the Registrant's 10 3/8%
Senior Notes due 2006 (contained in Euro Indenture filed
as Exhibit 4.11)
4.10*** -- Dollar Indenture, dated as of January 4, 1999, between
Hermes Railtel and The Bank of New York of New York, as
Trustee
4.11*** -- Euro Indenture dated as of January 4, 1999, between
Hermes Railtel and The Bank of New York, as Trustee
4.12*** -- Dollar Registration Rights Agreement, dated as of January
4, 1999, between Hermes Railtel and Initial Purchasers
4.13*** -- Euro Registration Rights Agreement, dated as of January
4, 1999, between Hermes Railtel and Initial Purchasers
10.1* -- Shareholders Agreement among the Company, GTS-Hermes
Inc., HIT Rail B.V., SNCB/NMBS and AB Swed Carrier
10.2* -- Employment Agreement, dated as of January 3, 1995,
between SFMT, Inc. and Jan Loeber
10.3* -- Employment Agreement, dated as of January 3, 1995,
between SFMT, Inc. and Gerard Caccappolo
10.4* -- Employment Agreement, dated as of January 1, 1996,
between GTS Group, Inc. and Bruce Rudy
10.5* -- Employment Agreement between the Company and Peter Magnus
10.6* -- Employment Agreement, dated as of September 26, 1995,
between the Company and J.A. Shearing
10.7* -- License, dated December 18, 1996, granted by the
Secretary of State for Trade and Industry relating to the
United Kingdom
10.8* -- Registration, dated July 26, 1996, granted by IBPT
relating to Belgium
10.9* -- Authorization Letter, dated August 1, 1996, granted by
Hoofdirectie Telecommunicate & Post relating to the
Netherlands
10.10* -- License, dated May 28, 1997, granted by BMPT relating to
Germany
10.11*+ -- Agreement, dated April 1, 1997, between Eastern Group
Telecoms Limited and the Company
10.12*+ -- Agreement, dated January 16, 1997, between SNCB/NMBS and
the Company
10.13*+ -- Agreement, dated February 3, 1997, between SANEF and the
Company
10.14** -- License, dated October 22, 1997 granted by the Secretary
of State of Industry relating to France
</TABLE>
<PAGE> 65
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
10.15** -- Authorization Letter, dated March 16, 1998, granted by
the Deputy Director of Federal Communication Office
relating to Switzerland.
10.16**+ -- Fiber Agreement, dated September 24, 1997
10.17**+ -- Fiber Agreement, dated October 8, 1997
10.18**+ -- Fiber Agreement, dated December 15, 1997
10.19***+ -- Agreement, dated November 24, 1997 between COLT and
Hermes Railtel
10.20***+ -- Authorization Letter, dated March 16, 1998, granted by
the Deputy Director of Federal Communication Office
relating to Switzerland
10.21***+ -- Agreement dated April 3, 1998 between AT&T Unisource and
Hermes Railtel
10.22***+ -- Agreement dated November 3, 1998 between Cable & Wireless
and Hermes Railtel
21.1**** -- List of Subsidiaries
27.1**** -- Financial Data Schedule for the Year Ended December 31,
1998
</TABLE>
- ---------------
* Incorporated by reference to the correspondingly numbered Exhibit to
Amendment No. 4 to the Company's Registration Statement on Form S-4
(Commission File No. 333-37719).
** Incorporated by reference to the correspondingly numbered Exhibit to the
Company's annual report on Form 10-K for the year ended December 31, 1997.
*** Incorporated by reference to the Exhibits to Amendment No. 1 to the
Company's Registration Statement on Form S-4 (Commission File No.
333-70723) as follows: Exhibit 4.6 was Exhibit 4.1 to the Form S-4
Registration Statement; Exhibit 4.7 was Exhibit 4.2 to the Form S-4
Registration Statement; Exhibit 4.8 was Exhibit 4.3 to the Form S-4
Registration Statement; Exhibit 4.9 was Exhibit 4.4 to the S-4 Registration
Statement; Exhibit 4.10 was Exhibit 4.5 to the Form S-4 Registration
Statement; Exhibit 4.11 was Exhibit 4.6 to the Form S-4 Registration
Statement; Exhibit 4.12 was Exhibit 4.7 to the Form S-4 Registration
Statement; Exhibit 4.13 was Exhibit 4.8 to the Form S-4 Registration
Statement; Exhibit 10.19 was Exhibit 10.15 to the Form S-4 Registration
Statement; Exhibit 10.20 was Exhibit 10.16 to the Form S-4 Registration
Statement; Exhibit 10.21 was Exhibit 10.17 to the Form S-4 Registration
Statement; and Exhibit 10.22 was Exhibit 10.18 to the Form S-4 Registration
Statement.
**** Filed herewith.
+ Confidential material has been redacted and filed separately with the
Securities and Exchange Commission.
<PAGE> 1
EXHIBIT 21.1
<TABLE>
<CAPTION>
NAME PLACE OF INCORPORATION
- ---- ----------------------
<S> <C>
Hermes Europe Railtel B.V. Holland
Hermes Europe Railtel Holdings B.V. Holland
HER Network Services B.V.B.A Belgium
Hermes Europe Railtel (US) Inc. Delaware
Hermes Europe Railtel (Spain) S.L. Spain
Hermes Europe Railtel (Switzerland) GmbH Switzerland
Hermes Europe Railtel (Ireland) Ltd. Ireland
Hermes Europe Railtel (Network) Ltd. Ireland
Hermes Europe Railtel (Germany) GmbH Germany
Hermes Europe Railtel (France) Sarl France
Hermes Europe Railtel (Italy) s.r.l. Italy
Hermes Europe Railtel (Denmark) ApS Denmark
HER (Sweden) AB Sweden
Hermes Europe Railtel (UK) Limited United Kingdom
Ebone A/S Denmark
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 130,081
<SECURITIES> 0
<RECEIVABLES> 48,034
<ALLOWANCES> 887
<INVENTORY> 0
<CURRENT-ASSETS> 240,151
<PP&E> 467,531
<DEPRECIATION> 28,547
<TOTAL-ASSETS> 726,058
<CURRENT-LIABILITIES> 169,413
<BONDS> 492,866
0
0
<COMMON> 100,110
<OTHER-SE> (90,214)
<TOTAL-LIABILITY-AND-EQUITY> 726,058
<SALES> 0
<TOTAL-REVENUES> 85,251
<CGS> 0
<TOTAL-COSTS> 41,848
<OTHER-EXPENSES> 52,947
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 30,852
<INCOME-PRETAX> (41,707)
<INCOME-TAX> 2,343
<INCOME-CONTINUING> (44,971)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (44,971)
<EPS-PRIMARY> (0.23)
<EPS-DILUTED> (0.23)
</TABLE>
