UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 6-K
REPORT OF FOREIGN PRIVATE ISSUER PURSUANT TO
RULE 13a-16 OR 15d-16 UNDER THE SECURITIES
EXCHANGE ACT OF 1934
For the nine months ended September 30, 1998
FLAG Limited
(Exact name of Registrant as specified in its charter)
Richmond House
12 Par-la-Ville Road
Hamilton, HM08 Bermuda
(Address of principal executive office)
Indicate by check mark whether the Registrant files or will file annual reports
under cover of Form 20-F or Form 40-F
Form 20-F |X| Form 40-F |_|
Indicate by check mark whether the Registrant by furnishing the information
contained in this Form is also thereby furnishing the information to the
Commission pursuant to Rule 12g-2(b) under the Securities Exchange Act of 1934
Yes |_| No |X|
<PAGE>
This report (the "Quarterly Report") sets forth certain information regarding
the financial condition and results of operations of FLAG Limited, a Bermuda
company (the "Company"), for the fiscal quarter ended September 30, 1998. The
Quarterly Report contains a review of the Company's unaudited financial
information and analysis for the third quarter, as well as certain other
information.
The following unaudited financial statements, in the opinion of the Company's
management, reflect all necessary adjustments (which include only normal
recurring adjustments) necessary for a fair presentation of the financial
position, the results of operations and cash flows for the periods presented.
Certain capitalized terms contained herein have the meaning given to them in the
Company's prospectus, dated as of June 30, 1998.
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FORM 6-K Page 1
<PAGE>
FLAG LIMITED
FORM 6-K
INDEX TO UNAUDITED FINANCIAL STATEMENTS
Page
----
PART I FINANCIAL INFORMATION..............................................3
ITEM 1: FINANCIAL STATEMENTS...............................................3
1.A Consolidated Balance Sheets..................................3
1.B Consolidated Statements of Operations........................4
1.C Consolidated Statements of Cash Flows........................5
1.D Notes to Consolidated Financial Statements...................7
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.........................................11
PART II OTHER INFORMATION.................................................16
ITEM 1: LEGAL PROCEEDINGS.................................................16
ITEM 2: CHANGES IN SECURITIES.............................................16
ITEM 3: DEFAULTS UPON SENIOR SECURITIES...................................16
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...............16
ITEM 5: OTHER INFORMATION.................................................16
ITEM 6: EXHIBITS AND REPORTS FILED ON FORM 6-K............................16
SIGNATURES ..................................................................17
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FORM 6-K Page 2
<PAGE>
PART I
ITEM 1.A
FLAG LIMITED
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 1998 AND DECEMBER 31, 1997
(Expressed in thousands of Dollars except per share amounts)
1998 1997
(unaudited) (audited)
ASSETS:
Current Assets:
Cash $ 788 $ 2,490
Accounts receivable, net of allowance of
doubtful accounts of $10,499 (1997 - $9,054) 25,308 91,102
Due from affiliates and other receivables 179 690
Prepaid expenses and other assets 1,705 2,395
----------- -----------
27,980 96,677
Accounts receivable 23,578 42,023
Funds held by collateral trustee 240,939 425,905
Construction in progress 7,547 389
Capacity available for sale 1,136,087 1,208,948
Capitalized financing costs, net of accumulated
amortization of $1,047 (1997 - 52,669) 12,363 61,848
Fixed assets, net 3,829 1,147
----------- -----------
$ 1,452,323 $ 1,836,937
=========== ===========
LIABILITIES:
Current Liabilities:
Accounts payable $ 2,033 $ 5,262
Accrued construction costs 145,066 317,058
Accrued liabilities 24,074 21,394
Income taxes payable 5,054 4,391
Due to affiliate 6,135 5,892
Deferred revenue 19,161 16,558
----------- -----------
201,523 370,555
8 1/4% senior notes, due 2008, net of unamortized
discount of $5,469 424,531 --
Long-term debt 276,400 615,087
Deferred revenue and other 81,631 176,221
Deferred taxes 5,340 4,600
----------- -----------
989,425 1,166,463
=========== ===========
COMMITMENTS AND CONTINGENCIES
PREFERRED SHARES:
Series A, $100 liquidation value (1997 - net
of unamortized discount of $1,905) -- 129,445
SHAREHOLDERS' EQUITY:
Class A common shares, $.0001 par value 13 13
Class B common shares, $.0001 par value 57 57
Additional paid-in capital 504,381 514,389
Retained earnings (accumulated deficit) (41,553) 26,570
----------- -----------
462,898 541,029
----------- -----------
$ 1,452,323 $ 1,836,937
=========== ===========
The accompanying notes are an integral part of these financial statements.
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FORM 6-K Page 3
<PAGE>
PART I
ITEM 1.B
FLAG LIMITED
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(Expressed in thousands of Dollars except per share amounts)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
REVENUES:
Capacity sales, net of discounts $ 88,602 $ -- $ 137,019 $ --
Standby maintenance revenue 6,482 -- 16,956 --
Restoration revenue 1,620 -- 1,620 --
----------- ----------- ----------- -----------
96,704 -- 155,595 --
SALES AND OTHER OPERATING COSTS:
Cost of capacity sold 47,170 -- 71,876 --
Operations and maintenance 9,583 -- 28,757 --
Sales and marketing 6,718 -- 8,292 --
General and administrative 5,812 4,470 18,289 11,264
----------- ----------- ----------- -----------
69,283 4,470 127,214 11,264
OPERATING INCOME (LOSS) 27,421 (4,470) 28,381 (11,264)
INTEREST EXPENSE 14,676 -- 46,897 --
INTEREST INCOME 3,248 1,184 11,721 3,416
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES 15,993 (3,286) (6,795) (7,848)
PROVISION FOR INCOME TAXES 678 -- 1,489 --
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE EXTRAORDINARY ITEM 15,315 (3,286) (8,284) (7,848)
EXTRAORDINARY ITEM -- -- 59,839 --
----------- ----------- ----------- -----------
NET INCOME (LOSS) 15,315 (3,286) (68,123) (7,848)
CUMULATIVE PAY-IN-KIND PREFERRED DIVIDENDS -- 4,141 1,508 12,051
REDEMPTION PREMIUM AND WRITE-OFF OF
DISCOUNT ON PREFERRED SHARES -- -- 8,500 --
----------- ----------- ----------- -----------
NET INCOME (LOSS) APPLICABLE TO COMMON
SHAREHOLDERS $ 15,315 $ (7,427) $ (78,131) $ (19,899)
=========== =========== =========== ===========
Basic and diluted income (loss) per common share - Class A $ 0.01 $ (0.01) $ (0.07) $ (0.02)
Basic and diluted income (loss) per common share - Class B $ 0.02 $ (0.01) $ (0.12) $ (0.05)
Weighted average common shares outstanding - Class A 132,000,000 132,000,000 132,000,000 132,000,000
Weighted average common shares outstanding - Class B 565,858,741 463,171,078 565,858,741 343,785,693
</TABLE>
The accompanying notes are an integral part of these financial statements.
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FORM 6-K Page 4
<PAGE>
PART I
ITEM 1.C
FLAG LIMITED
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(Expressed in thousands of Dollars except per share amounts)
(UNAUDITED)
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss applicable to common shareholders $ (78,131) $ (19,899)
Adjustments to reconcile net loss to net cash used in operating activities:
Pay-in-kind preferred dividends 1,508 12,051
Redemption premium and write-off of discount on preferred shares 8,500 --
Amortization of financing costs 2,976 --
Extraordinary item-loss on refinancing 59,839 --
Provision for doubtful accounts 1,445 --
Accretion of discount on 8 1/4% senior notes 443 --
Depreciation 530 186
Deferred taxes 740 --
Add (deduct) net changes in assets and liabilities:
Accounts receivable, net 82,794 --
Due from affiliates and other receivables 511 42
Prepaid expenses and other assets 690 (4,887)
Capacity available for sale 72,861 --
Accounts payable and accrued liabilities (549) (1,278)
Income taxes payable 663 --
Due to affiliate 243 (110)
Deferred revenue and other (91,987) 2,360
--------- ---------
Net cash provided by (used in) operating activities 63,076 (11,535)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Financing costs incurred (13,330) (12,017)
Net proceeds from issuance of 8 1/4% senior notes 424,088 --
Proceeds from long-term debt 320,000 302,544
Repayment of long-term debt (658,687) --
Capital contributions - common shares -- 260,000
Redemption of preferred shares (139,453) --
Decrease in funds held by collateral trustee or in escrow 184,966 (49,455)
--------- ---------
Net cash provided by financing activities 117,584 501,072
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash paid for construction in progress (179,150) (488,512)
Purchase of fixed assets, net (3,212) (592)
--------- ---------
Net cash used in investing activities (182,362) (489,104)
--------- ---------
NET INCREASE (DECREASE) IN CASH (1,702) 433
CASH, beginning of period 2,490 310
--------- ---------
CASH, end of period $ 788 $ 743
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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FORM 6-K Page 5
<PAGE>
FLAG LIMITED
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(Expressed in thousands of Dollars except per share amounts)
(UNAUDITED)
1998 1997
SUPPLEMENTAL INFORMATION ON NON-CASH INVESTING
ACTIVITIES:
Costs incurred for construction in progress $ 7,158 $ 786,786
Increase in accounts receivable -- 3,364
Increase in deferred revenue -- (82,000)
Decrease (increase) in accrued construction costs 171,992 (201,381)
Amortization of capitalized financing costs -- (18,257)
--------- ---------
Cash paid for construction in progress $ 179,150 $ 488,512
========= =========
SUPPLEMENTAL INFORMATION DISCLOSURE OF CASH FLOW
INFORMATION:
Interest paid $ 43,379 $ 22,469
The accompanying notes are an integral part of these financial statements.
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FORM 6-K Page 6
<PAGE>
PART I
ITEM 1.D
FLAG LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 1998 AND 1997
(Expressed in thousands of Dollars except per share amounts)
(UNAUDITED)
1. GENERAL
The interim consolidated financial statements presented herein have been
prepared on the basis of U.S. generally accepted accounting principles and
include the accounts of the Company and its wholly-owned subsidiaries. All
significant intercompany transactions have been eliminated in
consolidation. In the opinion of management, the unaudited consolidated
financial statements reflect all adjustments (consisting of normal
recurring accruals) necessary for a fair presentation of the results of
operations for the three and nine month periods ended September 30, 1998
and 1997, the balance sheet as of September 30, 1998 and the cash flows
for the nine month periods ended September 30, 1998 and 1997. These
interim consolidated financial statements should be read in conjunction
with the audited consolidated financial statements for the year ended
December 31, 1997. The results of operations for any interim period are
not necessarily indicative of results for the full year.
2. NET INCOME (LOSS) PER COMMON SHARE
The Company has adopted Statement of Accounting Standard No. 128,
"Earnings per Share," which requires dual presentation of basic and
diluted earnings per share. Basic net income (loss) per Class A common
share and basic net income (loss) per Class B common share are based on
dividing net income (loss) applicable to Class A and Class B shareholders
by the weighted average number of common shares and common share
equivalents outstanding during the period. None of the employee stock
options granted to date were considered common share equivalents for the
first three quarters of 1998 since the options were determined to be
anti-dilutive (see Note 3).
3. EVENTS SUBSEQUENT
On January 30, 1998, the Company completed a refinancing which resulted in
the repayment of all $615,087 of outstanding borrowings under the Amended
and Restated Participation Agreement (the "Agreement") and the redemption
of the Series A Preferred Shares (the "Preferred Shares"). The refinancing
consisted of $370,000 of bank credit facilities and $430,000 of 8 1/4%
senior unsecured notes maturing January 30, 2008 (the "Senior Notes"). The
Company has registered the Senior Notes with the Securities Exchange
Commission (the "SEC"). Proceeds received under the Senior Notes were
$424,100, net of a $5,900 underwriters' discount.
The bank credit facilities include a seven-year $320,000 term loan
facility and a $50,000 revolving credit facility (collectively, the "New
Credit Facility"). On January 30, 1998, the Company borrowed $320,000
under the term loan facility. Under the New Credit Facility, borrowings
bear interest at LIBOR plus 190 to 212.5 basis points and are secured by a
pledge
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FORM 6-K Page 7
<PAGE>
of substantially all of the Company's assets and revenues, other than the
Company's physical assets.
At the end of March 1998, the Company entered into two interest rate swap
agreements to manage the Company's exposure to interest rate fluctuations
on the New Credit Facility. Under the swap agreements, the Company pays a
fixed rate of 5.6% on a notional amount of $60,000 and a fixed rate of
5.79% on a notional amount of $100,000 and the counterparty pays the
floating rate based on LIBOR. The swap agreements terminate in January and
July 2000, respectively, unless extended an additional one year and six
months, respectively, at the option of the counterparty.
Interest on the Senior Notes will accrue at the rate of 8 1/4% per annum,
payable semi-annually on January 30 and July 30 of each year, commencing
on July 30, 1998. The Senior Notes are redeemable at the Company's option,
in whole or in part, at any time on or after January 30, 2003, at
specified option prices and in the event of any equity offering before
January 31, 2001, the Company may use all or a portion of the net proceeds
therefrom to redeem up to 331/3% of the original principal amount of the
Senior Notes at a redemption price of 108.25% plus accrued and unpaid
interest. If the Company has excess cash flow, as defined, for any fiscal
year commencing in 2001, the Company is required, subject to certain
exceptions and limitations, to make an offer to purchase the Senior Notes
at 100% of the principal amount thereof plus accrued and unpaid interest,
if any, to the date of purchase. Upon a change in control, the noteholders
may require the Company to purchase all or any portion of the outstanding
Senior Notes at a price equal to 101% of the principal amount plus accrued
but unpaid interest.
In the first quarter of 1998, the Company recognized a loss on refinancing
of $59,839 which has been reflected as an extraordinary item in the
accompanying statement of operations. The loss on refinancing primarily
represents the write-off of the remaining unamortized deferred financing
costs on the outstanding borrowings under the Agreement. In addition, the
Company paid a premium of $6,600 to redeem the Preferred Shares, which,
together with the write-off of the remaining $1,900 of discount and
issuance costs related to the Preferred Shares, was charged to additional
paid-in capital in the quarter ended March 31, 1998.
In connection with the refinancing, certain shareholders were released of
their obligations under the Contingent Sponsor Support Agreements.
On February 2, 1998, FLAG Telecom Limited, a United Kingdom company, was
incorporated as a wholly-owned subsidiary of the Company to provide
management services. On May 27, 1998 and May 22, 1998, respectively, FLAG
Telecom USA Ltd., a Delaware corporation and FLAG Telecom Asia Limited, a
Hong Kong company, were incorporated as wholly-owned subsidiaries of the
Company to provide marketing services.
On March 22, 1998, the Company adopted a Long-Term Incentive Plan under
which the Company may grant up to 25,237,831 shares of common stock to
eligible employees. Under the plan, options to purchase 6,430,239 Class B
common shares were granted to the CEO pursuant to his employment agreement
of December, 1997. In July and August of 1998, the Company granted
employees options to purchase 7,716,000 of the Company's Class B common
shares. The options granted vest over a period of one to two years and are
exercisable in three to four years. All of the options were granted at an
exercise price of $1.07 per share which is management's estimate of the
fair value of the Class B common shares on the date of the grant. Since
the Company accounts for employee options in accordance with APB No. 25,
the Company has not recognized compensation expense with respect to the
options granted since
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FORM 6-K Page 8
<PAGE>
the exercise price did not exceed the estimated fair value of the shares
on the date of the grant (the measurement date).
During the nine months ended September 30, 1998, the Company repaid
$43,600 of its outstanding borrowings under the term loan facility from
available cash flow.
Effective May 21, 1998, under a Marketing Transition Agreement, the
Company and Bell Atlantic Network Systems (Bermuda) Limited ("BANS"), a
subsidiary of Bell Atlantic and the Company's exclusive sales agent around
the world, agreed to terminate the Marketing Services Agreement. Under the
Marketing Transition Agreement, the Company agreed to pay certain of BANS'
costs of closing its operations and certain commissions in connection with
their pre-termination and post-termination activities. The Company will
pay BANS (i) commissions accrued under the Marketing Services Agreement
but remaining unpaid and (ii) up to $3,000 of commissions resulting from
certain sales. Also under the Marketing Transition Agreement, the Company
has agreed to pay BANS or its affiliate a 50% commission where BANS or its
affiliate secures the sale of four whole DS-3s (which equates to 84 whole
MIUs) on the FLAG System. The Company will accrue a liability for the
commissions in the period it becomes probable that BANS or its affiliate
will obtain the sales and that the amount of the commissions can be
reasonably estimated.
Effective May 14, 1998, the Company entered into a Termination and Release
Agreement providing for the termination of the Program Management Services
Agreement since services to be performed under this agreement were
substantially completed.
In May 1998, the Company entered into an Employee Services Agreement with
Bell Atlantic Global Systems Company ("BAGSC"), an affiliate of a common
shareholder of the Company, pursuant to which BAGSC seconds certain
employees to the Company. Under such Employee Services Agreement, the
Company reimburses BAGSC for the actual cost of the employees'
compensation and benefits.
4. CONTINGENCIES
The Company is involved in litigation from time to time in the ordinary
course of business. In management's opinion, the litigation in which the
Company is currently involved, individually and in the aggregate, is not
material to the Company's financial condition, results of operations or
cash flows.
5. COMPREHENSIVE INCOME (LOSS)
The Company adopted Statement of Accounting Standard No. 130 ("SFAS"),
"Reporting Comprehensive Income" as of January 1, 1998. SFAS 130 requires
reporting and disclosure of comprehensive income (loss), as defined. As
the Company has no items of comprehensive income other than net income,
the Company is not required to report comprehensive income for any period
presented.
6. PENDING ACCOUNTING STANDARDS
AICPA Statement of Position 98-5 ("SOP 98-5"), "Reporting on the Costs of
Start-Up Activities," was issued in April 1998 and is effective for fiscal
years beginning after December 15, 1998. SOP 98-5 requires that costs of
start-up activities and organization costs be expensed as incurred. The
Company does not have any deferred organizational or start-up costs. Net
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FORM 6-K Page 9
<PAGE>
income after adoption of SOP 98-5 would be the same as reported for each
of the periods presented.
The Financial Accounting Standards Board has also recently issued
Statement of Financial Accounting Standard No. 133, "Accounting for
Derivative Instruments and Hedging Activities," ("SFAS 133") which is
effective for periods beginning after June 15, 1999. Management does not
expect the impact of the adoption of SFAS 133 on the Company's financial
position or results of operations to be material.
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FORM 6-K Page 10
<PAGE>
PART I
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Quarter Ended September 30, 1998 Compared with the Quarter Ended September 30,
1997
Results of Operations
Revenues
During the quarter ended September 30, 1998, the Company recognized revenues of
$88.6 million. This was comprised of $15.0 million of sales entered into during
the quarter and recorded as revenue and $63.6 million recognized as revenue from
amounts previously deferred which was comprised primarily of two significant
transactions. As of September 30, 1998, the Company had entered into sales
transactions with 75 international telecommunications carriers. Customers are
also billed annual fees for standby maintenance. In the quarter ended September
30, 1998, the Company recognized standby maintenance revenues of $6.5 million.
The Company also recognized restoration revenues of $1.6 million in the quarter
ended September 30, 1998. These revenues were generated from providing
restoration services to alternate cable systems on a non-reciprocal basis.
No revenues were recognized in respect of sales, standby maintenance or
restoration during the quarter ended September 30, 1997, as the FLAG System had
not yet been placed into service.
Operating Expenses
For the quarter ended September 30, 1998, the Company recorded $47.2 million in
respect of the cost of capacity sold. The corresponding capacity sales revenues
of $88.6 million resulted in a gross profit on capacity sales of 46.8% compared
to a gross profit of 41.6% realized in the period from Provisional System
Acceptance ("PSA"), which occurred on October 8, 1997 to December 31, 1997 and a
gross profit of 55.0% and 41.0% realized in the first and second quarters of
1998, respectively. The variations in margin result from the fact that certain
segments of the system have a higher gross margin than others based on the
allocated cost of constructing each segment. There were no sales or cost of
capacity sold recognized in the quarter ended September 30, 1997.
During the quarter ended September 30, 1998 the Company recognized $9.6 million
in operations and maintenance costs relating primarily to the provision of
standby maintenance under Maintenance Zone Agreements. No operations and
maintenance costs were incurred by the Company in respect of the quarter ended
September 30, 1997 because prior to PSA, maintenance of the partially
constructed system was the responsibility of the Contractors.
During the quarter ended September 30, 1998, $6.7 million in sales and marketing
costs were recognized, comprising primarily of sales commissions due under an
agreement with the Company's suppliers plus costs associated with sales and
marketing activities that are now directly undertaken by the Company. During the
quarter there was a significant reduction in
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<PAGE>
sales commissions due to BANS as a result of the Company and BANS agreeing to
terminate the Marketing Services Agreement in May 1998. No sales commissions
were recognized by the Company in respect of the quarter ended September 30,
1997.
General and administrative expenses increased from $4.5 million in the quarter
ended September 30, 1997 to $5.8 million in the quarter ended September 30,
1998. Most of the increase is due to a $.7 million increase in salaries, wages
and benefits reflecting the Company's staffing up for operations, a $.9 million
increase in recruiting and other professional services costs, approximately $.5
million of costs associated with restructuring the Company, offset by a $.6
million reduction in insurance and other costs.
Interest Expense and Interest Income
During the quarter ended September 30, 1998 the Company incurred $14.7 million
in interest expense on borrowings. Prior to PSA, the Company capitalized
interest costs as a component of construction in progress and, accordingly, no
interest charges were expensed during the quarter ended September 30, 1997.
Interest income of $3.3 million was earned during the quarter ended September
30, 1998 on cash balances and short term investments held by the Collateral
Trustee or in escrow arising from ongoing business operations and the various
reserve accounts established pursuant to the New Credit Facility. Prior to PSA,
the Company's income consisted entirely of interest earned on cash balances
received from equity contributions. During the quarter ended September 30, 1997,
such interest earned on cash balances amounted to $1.2 million.
Provision for Taxes
The tax expense of $.7 million recorded in the statement of operations for the
quarter ended September 30, 1998 consists primarily of taxes on income derived
from capacity sales and standby maintenance revenue from customers in certain
jurisdictions along the FLAG Route where the Company is deemed to have a taxable
presence or is otherwise subject to tax. There was no taxable income earned by
the Company during the quarter ended September 30, 1997.
Net Income (Loss) and Net Income (Loss) Applicable to Common Shareholders
For the quarter ended September 30, 1998 the Company recorded net income of
$15.3 million compared to a net loss of $3.3 million for the quarter ended
September 30, 1997. The third quarter net income is a result of an increase in
operating revenue of $96.7 million offset by an increase in sales and other
operating costs of $64.8 million and net interest expense and taxes of $13.3
million.
Net income applicable to common shareholders for the quarter ended September 30,
1998 was $15.3 million compared to a net loss for the quarter ended September
30, 1997 of $7.4 million. This variance is a result of the $15.3 million in net
income recorded in the third quarter ended September 30, 1998 compared to a net
loss of $3.3 million for the quarter ended September 30, 1997 and $4.1 million
reduction in PIK dividends as a result of the redemption of the Preferred Stock
during the first quarter of 1998.
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FORM 6-K Page 12
<PAGE>
Nine Months Ended September 30, 1998 Compared with the Nine Months Ended
September 30, 1997
Results of Operations
Revenues
During the nine months ended September 30, 1998, the Company recognized revenues
of $137 million. This was comprised of $30.3 million of sales entered into
during the period and recorded as revenue and $106.7 million recognized as
revenue from amounts previously deferred. As of September 30, 1998, the Company
had entered into sales transactions with 75 international telecommunications
carriers. In the nine months ended September 30, 1998, the Company recognized
standby maintenance revenues of $17.0 million. The Company also recognized
restoration revenues of $1.6 million in the nine months ended September 30,
1998. These revenues were generated from providing restoration services to
alternate cable systems on a non-reciprocal basis.
No revenues were recognized in respect of capacity sales, standby maintenance or
restoration during the nine months ended September 30, 1997 as the FLAG System
had not yet been placed into service.
Operating Expenses
For the nine months ended September 30, 1998, the Company recorded $71.9 million
in respect of the cost of capacity sold. The corresponding capacity sales
revenues of $137.0 million resulted in a gross profit on capacity sales of 47.5%
compared to a gross profit of 41.6 % realized in the period from PSA to December
31, 1997. The improved margin results from the fact that the cost of capacity
sales recorded in 1997 included the recognition of $28.9 million in price
protection credits and higher discounts associated with the 1997 net sales of
$336.0 million. There were no sales or cost of capacity sold recognized in the
nine months ended September 30, 1997.
During the nine months ended September 30, 1998 the Company recognized $28.7
million in operations and maintenance costs relating primarily to the provision
of standby maintenance under Maintenance Zone Agreements. No operations and
maintenance costs were incurred by the Company in respect of the nine months
ended September 30, 1997 because prior to PSA, maintenance of the partially
constructed system was the responsibility of the Contractors.
After PSA, the Company has recognized sales commissions as an expense in the
period in which the revenues are recognized. During the nine months ended
September 30, 1998, $8.3 million in sales and marketing costs were recognized,
comprised of $6.7 million of commissions due under an agreement with the
Company's suppliers, sales commissions due to BANS and costs associated with
sales and marketing activities that are now directly undertaken by the Company
as a result of an agreement between the Company and BANS to terminate the
Marketing Services Agreement in May 1998. Sales and marketing activities are now
directly undertaken by the Company. No sales commissions were recognized by the
Company in respect of the nine months ended September 30, 1997.
General and administrative expenses increased from $11.3 million in the nine
months ended September 30, 1997 to $18.3 million in the nine months ended
September 30, 1998. Most of
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FORM 6-K Page 13
<PAGE>
the increase is due to a $1.4 million provision for doubtful accounts, a $2.8
million increase in salaries, wages and benefits reflecting the Company's
staffing up for operations, combined with absorbing the sales and marketing
activities performed by BANS prior to June 1998, a $3.0 million increase in
recruiting and other professional services costs and approximately $1.6 million
of costs associated with restructuring the Company, offset by a $1.9 million
reduction in insurance and other costs.
Interest Expense and Interest Income
During the nine months ended September 30, 1998 the Company incurred $46.9
million in interest expense on borrowings. Prior to PSA, the Company capitalized
interest costs as a component of construction in progress and, accordingly, no
interest charges were expensed during the nine months ended September 30, 1997.
Interest income of $11.7 million was earned during the nine months ended
September 30, 1998 on cash balances and short term investments held by the
Collateral Trustee or in escrow arising from ongoing business operations and the
various reserve accounts established pursuant to the New Credit Facility. Prior
to PSA, the Company's income consisted entirely of interest earned on cash
balances received from equity contributions. During the nine months ended
September 30, 1997, such interest earned on cash balances amounted to $3.4
million.
Provision for Taxes
The tax expense of $1.5 million recorded in the statement of operations for the
nine months ended September 30, 1998 consists of taxes on income derived from
capacity sales and standby maintenance revenue from customers in certain
jurisdictions along the FLAG Route where the Company is deemed to have a taxable
presence or is otherwise subject to tax. There was no taxable income earned by
the Company during the nine months ended September 30, 1997.
Net Loss and Net Loss Applicable to Common Shareholders
Net loss increased to $68.1 million for the nine months ended September 30, 1998
compared to a net loss of $7.9 million for the nine months ended September 30,
1997. The increase is due to an increase in sales and other operating costs of
$116.0 million, net interest expense and taxes of $40.1 million and the
extraordinary loss on refinancing of $59.8 million offset by an increase in
operating income of $155.6 million arising from the recognition of capacity
sales and standby maintenance revenues.
Net loss applicable to common shareholders increased to a loss of $78.1 million
for the nine months ended September 30, 1998 from a loss of $19.9 million for
the nine months ended September 30, 1997. This increase reflects the $60.3
million increase in net loss and the redemption premium and write-off of
discount on preferred shares of $8.5 million offset by a $10.5 million reduction
in PIK dividends as a result of the redemption of the Preferred Stock during the
first nine months of 1998.
Liquidity and Capital Resources
The Company has financed its operations to date through a combination of equity
contributions, shareholder advances and bank debt.
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FORM 6-K Page 14
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Cash contributions from Class B shareholders totaling $260.0 million were made
during the nine months ended September 30, 1997. No cash contribution by
shareholders were made during the nine month period ended September 30, 1998.
For the nine month period ended September 30, 1997 the Company made draw downs
on the Old Credit Facility of $302.5 million. During the nine month period ended
September 30, 1998, the Company completed the Refinancing and repaid $615.1
million related to the Old Credit Facility, received proceeds of $320.0 million
(of which $43.6 million has been repaid) from the New Credit Facility and
proceeds of $424.1 million from the issuance of the Senior Notes. As part of the
Refinancing the Company redeemed the Preferred Stock through the payment of
$139.5 million.
As of September 30, 1998 and December 31, 1997, the Company had working capital
deficits of $173.5 million and $273.9 million, respectively. The working capital
deficits at September 30, 1998 and December 31, 1997 are primarily a result of
the current accounts payable to the Contractors which are classified as current
liabilities but for which the associated funds -- held by the Collateral Trustee
or in escrow are classified as a non-current asset and are hence excluded from
the measure of working capital.
Total cash provided by operating activities during the period ended September
30, 1998 was $63.1 million and cash used in investing activities was $182.4
million. Total cash used in operating activities and investing activities during
the period ended September 30, 1997 was $11.5 million and $489.1 million,
respectively. As of September 30, 1998, cash on deposit with the Collateral
Trustee had decreased to $240.9 million from $425.9 million at December 31,
1997, primarily as a result of payments to the Contractors.
The Year 2000
The Year 2000 problem arises from the fact that due to early limitations
on memory and disk storage many computer programs indicate the year by only two
digits, rather than four. This limitation can cause programs (both system and
application) that perform arithmetic operations, comparisons, or sorting of data
fields to yield incorrect results when working outside the year range of
1900-1999. The Company began its investigation into Year 2000 compliance in 1997
and completed its analysis during 1997. The analysis covered all network
operations support systems used to support the operations of its network, and
all administrative support systems. While the Company believes it is year 2000
compliant, a failure of the Company's or of its significant vendors' computer
systems could have a material adverse effect on the Company's business and
financial position and results of operations.
SAFE HARBOR STATEMENT UNDER
THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
With the exception of historical information, certain of the matters discussed
in this report are forward-looking statements that involve risks and
uncertainties, including, without limitation, the risks and uncertainties
described in registration statements, reports and other documents filed by the
Company from time to time with the Securities and Exchange Commission pursuant
to the Securities Act of 1933, as amended, and the Securities Exchange Act of
1934, as amended. Such risks and uncertainties could cause the Company's actual
results for 1998 and beyond to differ materially from those expressed in any
forward-looking statements made by, or on behalf of, the Company.
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FORM 6-K Page 15
<PAGE>
PART II
ITEM 1: LEGAL PROCEEDINGS
The Company is involved in litigation from time to time in the ordinary
course of business. In management's opinion, the litigation in which the Company
is currently involved, individually and in the aggregate, is not material to the
Company's financial condition, results of operations or cash flows.
ITEM 2: CHANGES IN SECURITIES
Not Applicable.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
ITEM 5: OTHER INFORMATION
Not Applicable.
ITEM 6: EXHIBITS AND REPORTS FILED ON FORM 6-K
Not Applicable.
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FORM 6-K Page 16
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FLAG LIMITED
By: /s/ Edward McCormack
--------------------------
Name: Edward McCormack
Title: Chief Financial Officer
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FORM 6-K Page 17
