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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
(COMMISSION FILE NUMBER: )
HERMES EUROPE RAILTEL B.V.
(Exact name of registrant as specified in its charter)
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<TABLE>
<CAPTION>
<S> <C>
NETHERLANDS NONE
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
</TABLE>
TERHULPSESTEENWEG 6A
1560 HOEILAART
BELGIUM
(Address of principal executive office)
(322) 658-5200
(Registrant's telephone number)
---------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] [ ]
At July 31, 1999, there were outstanding approximately 199,683 shares of
common stock of the registrant.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C> <C>
PART I. FINANCIAL INFORMATION 3
Item 1. Financial Statements........................................ 3
Condensed Consolidated Balance Sheets as of June 30, 1999
and December 31, 1998..................................... 4
Condensed Consolidated Statements of Operations for the
three and six months ended June 30, 1999 and 1998......... 5
Condensed Consolidated Statements of Cash Flows for the
three and six months ended June 30, 1999 and 1998......... 6
Notes to Condensed Consolidated Financial Statements........ 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 10
Item 3. Quantitative and Qualitative Disclosure About Market Risk... 14
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds................... 15
Item 4. Submission of Matters to a Vote of Security Holders......... 15
Item 6. Exhibits and Reports on Form 8-K............................ 15
Signatures................................................................ 16
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets as of June 30, 1999 and December 31,
1998
Condensed Consolidated Statements of Operations for the three and six
months ended June 30, 1999 and 1998
Condensed Consolidated Statements of Cash Flows for the three and six
months ended June 30, 1999 and 1998
Notes to Condensed Consolidated Financial Statements
3
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HERMES EUROPE RAILTEL B.V.
CONDENSED, CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
---------- ------------
(IN THOUSANDS, EXCEPT
SHARE DATA)
<S> <C> <C>
Current assets
Cash and cash equivalents................................. $ 341,818 $130,081
Restricted cash........................................... 15,060 30,062
Accounts receivable, net.................................. 72,993 48,034
Due from affiliated companies............................. 7,749 2,164
Other assets.............................................. 44,982 29,810
---------- --------
Total current assets.............................. 482,602 240,151
Property and equipment, net................................. 470,738 438,984
Goodwill and intangible assets, net......................... 43,737 32,467
Other non-current assets.................................... 18,131 14,456
---------- --------
TOTAL ASSETS...................................... $1,015,208 $726,058
========== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued expenses..................... $ 77,816 $ 84,047
Due to affiliated companies............................... 4,502 15,976
Deferred income........................................... 61,010 32,255
Current portion of capital lease obligations.............. 28,689 37,135
---------- --------
Total current liabilities......................... 172,017 169,413
Long-term debt, less current portion...................... 553,171 265,353
Long term portion of capital lease obligations............ 174,290 190,378
Deferred income........................................... 97,588 34,000
Other non-current liabilities............................. 1,259 29,259
---------- --------
TOTAL LIABILITIES................................. 998,325 688,403
Commitments and contingencies
Minority interest........................................... -- 27,759
SHAREHOLDERS' EQUITY
Common stock, 1000 guilders par value (297,000 shares
authorized; 199,683 and 196,716 shares issued and
outstanding at June 30, 1999 and December 31, 1998,
respectively).......................................... 101,518 100,110
Additional paid-in capital................................ 8,331 8,437
Accumulated other comprehensive loss...................... (3,748) (1,300)
Accumulated deficit....................................... (89,218) (97,351)
---------- --------
TOTAL SHAREHOLDERS' EQUITY........................ 16,883 9,896
---------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $1,015,208 $726,058
========== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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HERMES EUROPE RAILTEL B.V.
CONDENSED, CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
1999 1998 1999 1998
-------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenues....................................... $ 67,142 $ 11,230 $122,869 $ 15,936
-------- -------- -------- --------
Operating costs and expenses:
Telecommunications services.................. 19,458 6,180 38,764 9,032
Selling, general and administrative.......... 10,267 5,671 21,404 10,092
Depreciation and amortization................ 14,042 4,807 23,914 8,240
-------- -------- -------- --------
43,767 16,658 84,082 27,364
-------- -------- -------- --------
Income (loss) from operations.................. 23,375 (5,428) 38,787 (11,428)
Other income/(expense):
Interest income.............................. 4,190 2,620 8,000 5,912
Interest expense............................. (16,741) (8,093) (33,986) (15,521)
Foreign currency gains (losses).............. 1,039 (1,542) (530) (2,666)
-------- -------- -------- --------
(11,512) (7,015) (26,516) (12,275)
-------- -------- -------- --------
Net income (loss) before income taxes and
minority interest............................ 11,863 (12,443) 12,271 (23,703)
Income taxes................................... 2,525 -- 3,670 --
-------- -------- -------- --------
Net income (loss) before minority interest..... 9,338 (12,443) 8,601 (23,703)
Minority interest.............................. (338) (40) (468) (40)
-------- -------- -------- --------
Net income (loss).............................. $ 9,000 $(12,483) $ 8,133 $(23,743)
======== ======== ======== ========
Net income (loss) per share:
Basic........................................ $ 45.61 $ (65.54) $ 41.28 $(124.66)
======== ======== ======== ========
Diluted...................................... $ 45.02 $ (65.54) $ 40.69 $(124.66)
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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HERMES EUROPE RAILTEL B.V.
CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)................................. $ 9,000 $(12,483) $ 8,133 $(23,743)
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Depreciation and amortization................... 14,915 5,135 26,037 8,861
Change in value of foreign currency
instruments.................................. (10,067) 3,224 (32,836) 3,224
Minority interest............................... 338 40 468 40
Non-cash compensation........................... 163 262 214 528
Changes in assets and liabilities:
Accounts receivable.......................... (45,778) (9,872) (64,609) (11,830)
Deposits..................................... 1,090 234 (2,379) (187)
Accounts payable and accrued expenses........ 20,936 15,912 (509) 1,998
Other changes in assets and liabilities...... 37,808 4,066 65,663 8,100
-------- -------- -------- --------
Net cash provided by (used) in operating
activities............................ 28,405 6,518 182 (13,009)
INVESTING ACTIVITIES
Purchases of property and equipment............. (45,712) (18,381) (63,139) (30,844)
Acquisition, net of cash acquired............... (15,667) 13,352 (15,667) 13,352
Other investing activities...................... (446) -- (446) --
Restricted cash................................. (187) (543) 15,673 13,612
-------- -------- -------- --------
Net cash used in investing activities... (62,012) (5,572) (63,579) (3,880)
FINANCING ACTIVITIES
Proceeds from debt.............................. -- -- 302,450 --
Repayments of debt.............................. (3,287) (7,102) (16,476) (10,721)
Payment of debt issue costs..................... (191) -- (10,164) (825)
Net Proceeds from issuance of common stock...... 1,249 -- 1,249 --
Due to affiliated companies, net................ (4,293) (380) (17,782) (499)
-------- -------- -------- --------
Net cash (used in) provided by financing
activities............................ (6,522) (7,482) 259,277 (12,045)
Effect of exchange rate changes on cash and cash
equivalents..................................... 8,089 (923) 15,857 (59)
-------- -------- -------- --------
Net (decrease) increase in cash and cash
equivalents..................................... (32,040) (7,459) 211,737 (28,993)
Cash and cash equivalents at beginning of
period.......................................... 373,858 182,793 130,081 204,327
-------- -------- -------- --------
Cash and cash equivalents at end of period........ $341,818 $175,344 $341,818 $175,334
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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HERMES EUROPE RAILTEL B.V.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS
1. FINANCIAL PRESENTATION
The financial statements of Hermes Europe Railtel B.V. (the "Company")
included herein are unaudited and have been prepared in accordance with
generally accepted accounting principles for interim financial reporting and
Securities and Exchange Commission regulations. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. Material intercompany affiliate account
transactions have been eliminated; however, other adjustments may have been
required had an audit been performed. In the opinion of management, the
financial statements reflect all adjustments of a normal and recurring nature
necessary to present fairly the Company's financial position, results of
operations and cash flows for the interim periods. These financial statements
should be read in conjunction with the Company's 1998 audited consolidated
financial statements and the notes related thereto. The results of operations
for the three and six months ended June 30, 1999 may not be indicative of the
operating results for the full year.
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 June 30, 1999
operated in Belgium, the Netherlands, the United Kingdom, France, Germany,
Switzerland, Italy, Denmark, Sweden and Spain. As of June 30, 1999 the Company's
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, Stockholm,
Hamburg, Madrid, Barcelona, Valencia, Basle and Gothenburg. The Company intends
to continue to build the Network using an accessible and cost-efficient
infrastructure of rights-of-way and fiber of railways, motorways, pipeline
companies, waterways and power companies.
The Company was formed on July 6, 1993 and as of June 30, 1999 was 95.4%
owned by GTS Carrier Services, Inc., a wholly owned subsidiary of Global
TeleSystems Group, Inc. ("GTS"), a leading independent provider of
telecommunications services to businesses, other high usage customers and
telecommunications carriers in Europe, Russia and the Commonwealth of
Independent States.
2. POLICIES AND PROCEDURES
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
130, "Reporting Comprehensive Income", comprehensive income was $8.4 million and
$5.7 million for the three and six months ended June 30, 1999, respectively, and
was comprised of net income of $9.0 million and $8.1 million and foreign
currency translation losses of $0.6 million and $2.4 million for the three and
six months ended June 30, 1999, respectively. Comprehensive loss was $11.6
million and $24.3 million for the three and six months ended June 30, 1998,
respectively, and was comprised of net losses of $12.5 million and $23.7 million
and foreign currency translation income of $0.9 million and foreign currency
translation loss of $0.6 million for the three and six months ended June 30,
1998, respectively.
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HERMES EUROPE RAILTEL B.V.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 of the Company's net income (loss) per share calculation. The
following is a reconciliation of the denominator of the Company's net income
(loss) per share calculation:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -----------------
1999 1998 1999 1998
-------- -------- ------- -------
<S> <C> <C> <C> <C>
Weighted Average Shares Outstanding.................... 197,335 190,468 197,026 190,468
Common Stock Equivalents............................... 2,591 -- 2,868 --
------- ------- ------- -------
Diluted Shares Outstanding............................. 199,926 190,468 199,894 190,468
======= ======= ======= =======
</TABLE>
As of January 1, 1999, the Company adopted the Euro as its functional
currency.
Certain reclassifications have been made to the June 1998 condensed,
consolidated financial statements in order to conform to the 1999 presentation.
3. ACQUISITION OF MINORITY INTEREST IN SUBSIDIARY
On May 25, 1999, the Company purchased the remaining 25% minority interest
in Ebone A/S ("Ebone") from the Ebone Holding Association ("EHA") for a purchase
price of Euro 35 million. The purchase price was comprised of cash of Euro 15
million and the issuance to EHA of capacity rights on the Network valued at Euro
20 million (the "Rights"). Rights may be applied by members of EHA, in lieu of
cash, to the payment of future invoices related to services provided by the
Company or Ebone on contracts for services entered into through May 31, 2003.
EHA must assign these Rights among its members by October 1, 1999 and once
assigned, the Rights are non-transferable. Prior to December 31, 1999, EHA may
elect to change the composition of the consideration by converting the cash to
Rights at a rate of Rights valued at four Euros for three Euros in cash
consideration. To the extent EHA elects this alternative, the cash converted
will be paid back to the Company.
The excess of the purchase price over the fair value of the assets acquired
of $9.2 million was allocated to goodwill and is being amortized over five
years.
4. DEBT OBLIGATIONS
In January, 1999 the Company issued, through a private placement, aggregate
principal amount $200 million of senior notes due January 15, 2009 (the "Dollar
Notes") and Euro 85 million (approximately $100 million) of senior notes due
January 15, 2006 (the "Euro Notes" and together with the Dollar Notes, the "New
Senior Notes"). The New Senior Notes are general unsecured obligations of the
Company, with interest payable semiannually at a rate of 10.375%. The Company
may redeem the Dollar Notes in whole or in part, any time on or after January
15, 2004 at specific redemption prices. The Company may redeem the Euro Notes,
in whole or in part, any time on or after January 15, 2003 at specific
redemption prices. The Company may also redeem the Dollar Notes and the Euro
Notes at a price equal to 110.375% of the principal amounts prior to January 15,
2002 with net cash proceeds of a public equity offering with gross proceeds of
at least $75 million or in certain other circumstances specified in the
indentures for the Dollar Notes and the Euro Notes provided, however that at
least two-thirds of the principal amount of the Dollar Notes and the Euro Notes
originally issued remain outstanding after each such redemption. Net proceeds
from the issuance of the New Senior Notes was approximately $289.3 million. The
Company filed an S-4 registration statement with the Securities and Exchange
Commission to exchange registered senior notes, with the same terms and
conditions as the New Senior Notes, for the New Senior Notes, which registration
statement became effective in February 1999. The exchange of registered notes
for the New Senior Notes was completed on March 24, 1999.
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HERMES EUROPE RAILTEL B.V.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. CAPITAL LEASE OBLIGATIONS
During the six months ended June 30, 1999, in order to expand the Network,
the Company entered into contractual commitments to lease fiber 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 $42.1 million. The commitments have
expected lease terms of ten to eighteen years.
6. EQUITY TRANSACTIONS
During June 1999, certain employees were issued 2,967 shares of the
Company's common stock as a result of the exercise of their vested stock
options. In addition, in June 1999, GTS Carrier Services, Inc. increased its
ownership of the Company to 95.4% percent by acquiring the remaining shares held
by SNCB/ NMBS in exchange for 2,150,380 (post-split) shares of GTS common stock.
In connection with this purchase, GTS Carrier Services, Inc. paid approximately
$4.8 million to a company which is affiliated with a board member for
negotiating with SNCB/NMBS on behalf of GTS Carrier Services, Inc. The excess of
the purchase price over the fair value of the assets acquired of approximately
$90.3 million was allocated to goodwill that will be amortized over 10 years by
GTS Carrier Services, Inc.
7. RELATED PARTY TRANSACTIONS
Included in revenues for the three and six months ended June 30, 1999,
respectively, is $2.3 million and $2.5 million of intercompany revenue from GTS
affiliates. There was no intercompany revenue for the comparable periods in
1998.
8. RESTATEMENT OF NET LOSS PER SHARE
The following Net Loss Per Share data is being presented to reflect the
effect of restating the Company's Net Loss Per Share amounts that were disclosed
in the financial statements of the Company's previous filings. This restatement
is necessary to correct an error in our previously reported amounts.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------
1998 1997 1996
--------- --------- ------------
<S> <C> <C> <C>
Net Loss Per Share.................................... $ (234.48) $ (330.04) $(199,612.50)
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
THREE MONTHS ENDED ENDED ENDED
MARCH 31, SEPTEMBER 30, SEPTEMBER 30,
--------------------- ------------- -------------
1999 1998 1998 1998
-------- -------- ------------- -------------
<S> <C> <C> <C> <C>
Net Loss Per Share...................... $ (4.41) $ (59.12) $ (59.99) $(184.65)
</TABLE>
9
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis relates to our financial condition
and results of operations as of June 30, 1999 and 1998 and for the three and six
months ended June 30, 1999 and 1998 and of certain factors that management
believes are likely to affect our prospective financial condition. The following
discussion should be read in conjunction with our Condensed, Consolidated
Financial Statements and the notes related thereto.
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
Certain statements contained in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" including, without limitation,
those concerning (i) projected 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. London, Paris, Antwerp and
Rotterdam came into operation during 1997 and Frankfurt, Strasbourg, Zurich,
Geneva, Stuttgart, Dusseldorf, Munich, Milan, Berlin, Copenhagen and Stockholm
during 1998. In the first quarter of 1999, Hamburg and Madrid came into
operation. During the second quarter of 1999, Barcelona, Valencia, Basle and
Gothenburg came into operation. We also currently lease capacity on
transatlantic cables linking the network to North America. In addition, GTS and
we are exploring the possibility of including local access assets and operations
as part of our 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. We purchased the
remaining 25% interest on May 25, 1999. The results of Ebone have been included
in the accompanying consolidated financial statements from the date of
acquisition.
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RESULTS OF OPERATIONS
Revenue. Our consolidated revenues for the three and six months ended June
30, 1999 were $67.1 million and $122.9 million, respectively, as compared to
$11.2 million and $15.9 million for the comparable periods in 1998. The growth
in revenue is attributable to the continued deployment of our network.
Telecommunications Services. Our telecommunications services costs for the
three and six months ended June 30, 1999 were $19.5 million and $38.8 million,
respectively, as compared to $6.2 million and $9.0 million for the comparable
periods in 1998. The increase in telecommunications services costs for the three
and six months ended June 30, 1999 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 Expenses. Selling, general and
administrative expenses for the three and six months ended June 30, 1999 were
$10.3 million and $21.4 million, respectively, as compared to $5.7 million and
$10.1 million for the same periods in 1998. The increase in selling, general and
administrative expenses is reflective of the growth of our business operations
and support personnel. At June 30, 1999 we had 323 employees as compared to 166
employees at June 30, 1998.
Depreciation and Amortization. Depreciation and amortization expense for
the three and six months ended June 30, 1999 was $14.0 million and $23.9
million, respectively, as compared to $4.8 million and $8.2 million for the
comparable periods in 1998. The increase in depreciation and amortization
expense is attributable to an increase in depreciation of network assets due to
the continued deployment of our network.
Interest. Interest expense for the three and six months ended June 30, 1999
was $16.7 million and $34.0 million, respectively, as compared to $8.1 million
and $15.5 million for the comparable periods in 1998. The increase was primarily
attributable to the interest and related costs associated with the issuance in
January 1999 of $200 million aggregate principal amount of 10.375% senior notes
due 2009 and Euro 85 million aggregate principal amount of 10.375% senior notes
due 2006.
Interest income for the three and six months ended June 30, 1999 was $4.2
million and $8.0 million, respectively, as compared to $2.6 million and $5.9
million in the comparable periods in 1998. The increase is due to the interest
earned through our short-term investments that have grown, due to the proceeds
of our financing activities.
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 $265 million aggregate
principal amount of 11.5% senior notes in 1997 and cash equity contributions of
$103.2 million in 1997. In addition, 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. The senior notes issued in 1999 are general
unsecured obligation and have substantially the same general terms and
conditions as the senior notes issued in 1997. Net proceeds from the issuance of
these senior notes were approximately $289.3 million.
Development of our fiber optic network is capital intensive. We have spent
approximately $234 million in cash on network capital expenditures through June
30, 1999 and expect to incur an additional $556 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 June
30, 1999, $315 million has been capitalized in connection with long-term fiber
lease arrangements and an additional $109 million is expected to be capitalized
through 2000 in order to complete the build-out of the network.
On January 13, 1999, GTS, through its subsidiary GTS Transatlantic Holdings
Ltd., entered into an agreement with FLAG Telecom to form a 50/50 joint venture,
to be known as FLAG Atlantic Limited, that will build and operate a transoceanic
fiber optic link, known as FLAG Atlantic-1 between Europe and the United States.
The joint venture will also provide backhaul links from the European landing
points of the transoceanic link to Paris and London. By interconnecting to FLAG
Atlantic-1, the Company will be able to
11
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provide their carrier and Internet service provider customers with high-capacity
cable access from major European cities to New York City. The high-capacity
fiber optic link will be based on synchronous digital hierarchy and use dense
wave division multiplexing technology. GTS is currently in the process of
assigning its 50% interest in the FLAG Atlantic Limited joint venture to the
Company. Once assigned, the terms of the joint venture require that we (1)
invest $100 million for our interest in the venture and (2) purchase capacity on
the cable for $150 million. Although these expenditures are payable over a
number of years, we may be required to cover these payments by posting a fully
cash collateralized letter of credit during the second half of 1999.
We believe that the net proceeds from the issuance of the 1997 and 1999
senior notes, combined with projected internally generated funds, should be
sufficient to fund expected capital expenditures, including payments on the
long-term fiber lease arrangements, as well as all Flag Atlantic Limited
requirements. However, the actual amount and timing of our future requirements
may differ materially from our estimates. In addition, GTS and we are exploring
the possibility of including local access assets and operations as part of our
network. 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 $310.6 million and $154.6 million as
of June 30, 1999 and 1998, respectively. We had cash and cash equivalents of
$341.8 million and $175.3 million at June 30, 1999 and 1998 respectively. We had
$15.1 million and $44.2 million of restricted cash at June 30, 1999 and 1998,
respectively. The restricted cash at June 30, 1999 and 1998 primarily represents
our obligation to place into escrow the first four scheduled semi-annual
interest payments on the 1997 senior notes.
During the three months ended June 30, 1999, we provided $28.4 million cash
for operating activities compared with providing $6.5 million for the comparable
period in 1998. During the six months ended June 30, 1999, we provided $0.2
million cash for operating activities compared with using $13.0 million for the
comparable period in 1998. Investing activities used cash of $62.0 million and
$63.6 million for the three and six months ended June 30, 1999 as compared to
using cash of $5.6 million and $3.9 million for the comparable periods in 1998.
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 expect to implement this
process by the end of the third quarter of 1999. We have limited our foreign
currency exposure by entering into a foreign currency swap agreement. We find it
impractical to hedge all foreign currency exposure and as a result, will
continue to experience foreign currency gains and losses.
YEAR 2000 COMPLIANCE
The "Year 2000" issue is the result of computer programs using two digits
rather than four to define the applicable year. Because of this programming
convention, software, hardware or firmware may recognize a date using "00" as
the year 1900 rather than the year 2000. Use of non-Year 2000 compliant programs
could result in system failures, miscalculations or errors causing disruptions
of operations or other business problems, including, among others, a temporary
inability to process transactions and invoices or engage in similar normal
business activities.
Issues Posed by the Year 2000 Issue. We are exposed to the Year 2000 issue
in a number of ways. Among other things, the Year 2000 issue might affect our:
(i) computer hardware and software; (ii) telecommunications equipment and other
systems with embedded logic (among other things, this includes our fire
detection, access control systems, heating, ventilation and air conditioning,
and uninterruptible power supply; (iii) operating partners and organizations
upon which we are dependent; (iv) local access connections, upon which we are
dependent; and (v) supply chain.
Year 2000 Compliance Program. We have initiated a Year 2000 compliance
program to address the aforementioned risks which the Year 2000 issue poses and
to avoid any material loss or impact to us or our customers due to these risks.
The object of the Year 2000 compliance program is to ensure that neither the
12
<PAGE> 13
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 and began the upgrade, remediation, prevention and testing
phases in early 1999. All important upgrades were performed on our systems by
the end of the second quarter. The remaining actions include some upgrades on
non-critical systems and the installation of the latest Year 2000 patches on
certain systems. These are expected to be completed by the end of the third
quarter of 1999. Testing will continue through the third and fourth quarters of
1999.
Assessment of Third Party Compliance. As noted above, we have also
undertaken our Year 2000 compliance program to assess and monitor the progress
of third party vendors in resolving Year 2000 issues. To ensure the compliance
of vendors of hardware and software applications used by us, we are obtaining
confirmations from its primary telecommunications vendors, business partners and
hardware and software vendors as to what plans, if any, are being developed or
are already in place to address their ability to process transactions in the
Year 2000. We have received responses from approximately 84% of our vendors,
including all critical ones. We have not received any responses that indicate
material problems that would require our follow-up.
Worst Case Scenario for the Company. Our worst case scenario would be the
failing of our 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 our assessment during the third and fourth
quarters of 1998, we do not foresee a material loss due to these conditions.
However, there can be no assurance that Year 2000 non-compliance by our systems
or the systems of vendors, customers, partners or others will not result in a
material adverse effect.
Contingency Plans. We 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 $0.4 million
has been incurred through June 30, 1999. These costs will be funded from
operating cash flows and expensed as incurred. In addition, the preceding cost
estimate does not include amounts associated with the accelerated acquisition of
replacement systems as none are included in the initial assessment during
13
<PAGE> 14
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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to market risk from changes in interest rates on long-term
obligations and as a global company, we also face exposure to adverse movements
in foreign currency exchange rates. A portion of the our debt obligations are
denominated in currencies which expose us to risks associated with changes in
foreign exchange rates. We have developed risk management policies that
establish guidelines for managing foreign exchange risk and periodically
evaluates the materiality of foreign exchange exposures and the financial
instruments available to mitigate this exposure.
We entered into a foreign currency swap agreement in 1998 in order to
mitigate its exposure on US dollar denominated debt. We also attempt to mitigate
this and other exposures from debt obligations denominated in exposed currencies
by maintaining assets in the exposed currency wherever possible. We find it
impractical to hedge all foreign currency exposure and as a result will continue
to experience foreign currency gains and losses. The introduction of the Euro as
a common currency for members of the European Union occurred on January 1, 1999.
We have not determined what impact, if any, the Euro will have on its foreign
exchange exposure.
The only significant change since December 31, 1998 is the issuance in
January 1999 of $200 million 10.375% senior notes due January 15, 2009 which
exposes us to changes in interest and foreign exchange rates, and the issuance
of Euro 85 million 10.375% senior notes due January 15, 2006 which exposes us to
changes in interest rates.
14
<PAGE> 15
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) In June 1999, we issued stock that was not registered under the
Securities Act of 1993, as amended, pursuant to the exercise by certain
employees of options to purchase 2,967 shares of common stock.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF THE SECURITY HOLDERS
On May 7, 1999, our shareholders had an extraordinary general meeting and
unanimously approved the following:
- The appointment of Mr. Robert J. Amman and Mr. Jan Loeber as members of
the Supervisory Board
- The resignation of Mr. Bruno d'Avanzo and Mr. Mikel Williams as members
of the Supervisory Board
- The appointment of Mr. Jim H. Reynolds as Managing Director of the
Company to replace Mr. Loeber (Mr. Loeber became Executive Vice
President -- Strategic Planning of GTS)
- The authorization to execute the issuance of 2,967 shares of our common
stock pursuant to the exercise by certain employees of stock options
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
27 -- Financial Data Schedule
</TABLE>
B. Reports on Form 8-K
<TABLE>
<CAPTION>
DATE OF REPORT SUBJECT OF REPORT
-------------- -----------------
<C> <S>
None
</TABLE>
15
<PAGE> 16
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrants have duly caused this report to be signed on their behalf by the
undersigned thereunto duly authorized.
HERMES EUROPE RAILTEL B.V.
(Registrant)
By: /s/ FRANCOIS NOTE
----------------------------------
Name: Francois Note
Title: Corporate Financial
Director --
Chief Financial Officer
(Principal Financial and
Accounting Officer)
Date: August 13, 1999
16
<PAGE> 17
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
Ex. 27 -- Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM (A)
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH (B) FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 341,818
<SECURITIES> 0
<RECEIVABLES> 72,993
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 482,602
<PP&E> 516,967
<DEPRECIATION> 46,229
<TOTAL-ASSETS> 1,015,208
<CURRENT-LIABILITIES> 172,017
<BONDS> 756,150
0
0
<COMMON> 101,518
<OTHER-SE> (84,635)
<TOTAL-LIABILITY-AND-EQUITY> 1,015,208
<SALES> 0
<TOTAL-REVENUES> 122,869
<CGS> 0
<TOTAL-COSTS> 38,764
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 33,986
<INCOME-PRETAX> 12,271
<INCOME-TAX> 3,670
<INCOME-CONTINUING> 8,133
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,133
<EPS-BASIC> 41.28
<EPS-DILUTED> 40.69
</TABLE>
