<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number __________
CARRIER1 INTERNATIONAL S.A.
(Exact name of registrant as specified in its charter)
LUXEMBOURG 98-0199626
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
ROUTE D'ARLON 3
L-8009 STRASSEN, LUXEMBOURG
---------------------------
(Address, including zip code of principal executive offices)
(011) (41-1) 297-2600
---------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes No X
---- -----
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Common stock, par value $2.00 per share, outstanding at June 30, 1999:
shares 31,019,071
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CARRIER1 INTERNATIONAL S.A.
Table of Contents
<TABLE>
<S> <C>
Part I. Financial Information
Item 1. Unaudited Financial Statements
Consolidated Balance Sheets as of June 30, 1999 and December 31, 1998 ........
Consolidated Statements of Operations for the Three Months Ended June
30, 1999 and June 30, 1998, Six Months Ended June 30, 1999 and
the Period from February 20 1998 (Date of Inception) to June
30, 1998 ...............................................................
Consolidated Statement of Shareholders' Equity as of June 30, 1999 ...........
Consolidated Statements of Cash Flows for the Six Months Ended June
30, 1999 and the Period from February 20, 1998 (Date of
Inception) to June 30, 1998 ............................................
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ...................................................
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Part II. Other Information
Item 1. Legal Proceedings .........................................................
Item 6. Exhibits and Reports on Form 8-K ..........................................
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
CARRIER1 INTERNATIONAL S.A. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 1999 AND DECEMBER 31, 1998
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE INFORMATION)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
JUNE 30, 1999 DEC. 31, 1998*
--------------- ---------------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .......................................... $ 48,105 $ 4,184
Restricted cash .................................................... 2,815 1,518
Restricted investments held in escrow .............................. 91,427 --
Accounts receivables ............................................... 13,506 1,217
Unbilled receivables ............................................... 8,064 1,645
Other receivables .................................................. 8,580 3,014
Prepaid expenses and other current assets .......................... 7,887 3,179
--------- ---------
Total current assets ........................................ 180,384 14,757
PROPERTY AND EQUIPMENT - NET .......................................... 82,909 31,091
INVESTMENT IN JOINT VENTURES .......................................... 4,681 4,675
RESTRICTED INVESTMENTS HELD IN ESCROW ................................. 44,059 --
OTHER ASSETS .......................................................... 13,256 911
--------- ---------
TOTAL ................................................................. $ 325,289 $ 51,434
--------- ---------
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade accounts payable ............................................. $ 25,193 $ 27,602
Accrued interest ................................................... 11,936
Other accrued liabilities .......................................... 21,235 4,643
--------- ---------
Total current liabilities ................................... 58,364 32,245
LONG-TERM DEBT (Net of discount of $2,202) (See Note 5)
Senior notes ....................................................... $ 245,350 --
Other long-term debt ............................................... 8,629 --
---------
Total long-term debt ................................. 253,979 --
COMMITMENTS AND CONTINGENT LIABILITIES
SHAREHOLDERS' EQUITY:
Common stock, $2 par value, 31,019,071 and 30,000,000 shares
respectively authorized, 31,019,071 and 18,885,207, respectively
issued and outstanding at June 30, 1999 and December 31, 1998 .. 62,038 37,770
Additional paid-in capital ......................................... 2,304 --
Accumulated deficit ................................................ (53,297) (19,235)
Accumulated other comprehensive income ............................. 1,901 654
--------- ---------
Total shareholders' equity .................................. 12,946 19,189
--------- ---------
TOTAL ................................................................. $ 325,289 $ 51,434
--------- ---------
--------- ---------
</TABLE>
* Derived from audited consolidated financial statements.
See notes to unaudited consolidated financial statements.
3
<PAGE>
CARRIER1 INTERNATIONAL S.A. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENT OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1999 AND
JUNE 30, 1998, SIX MONTHS ENDED JUNE 30, 1999 AND
THE PERIOD FROM FEBRUARY 20, 1998 (DATE OF INCEPTION) TO JUNE 30, 1998
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE INFORMATION)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PERIOD FROM
THREE MONTHS THREE MONTHS SIX MONTHS FEBRUARY 20,
ENDED JUNE ENDED JUNE 30, ENDED JUNE 1998 TO JUNE 30,
30, 1999 1998 30, 1999 1998
------------ ------------ ---------- ------------
<S> <C> <C> <C> <C>
REVENUES .................................... 20,194 $ -- $ 32,487 $ --
OPERATING EXPENSES:
Cost of services (exclusive of
items shown separately below) ....... 22,346 -- 39,361 --
Selling, general and administrative ...... 3,147 1,280 6,465 1,438
Depreciation and amortization ............ 2,298 -- 3,634 --
-------- -------- -------- --------
Total operating expenses ................. 27,791 1,280 49,460 1,438
-------- -------- -------- --------
LOSS FROM OPERATIONS ........................ (7,597) (1,280) (16,973) (1,438)
OTHER INCOME (EXPENSE):
Interest expense ......................... (8,400) -- (12,605) --
Interest income .......................... 2,099 -- 3,078 --
Currency exchange loss, net .............. (4,721) -- (7,149) --
Other, net ............................... (413) -- (413) --
-------- -------- -------- --------
Total other income (expense) ........... (11,435) -- (17,089) --
-------- -------- -------- --------
LOSS BEFORE INCOME TAX
BENEFIT ..................................... (19,032) (1,280) (34,062) (1,438)
INCOME TAX BENEFIT - Net of
valuation allowance ......................... -- -- -- --
-------- -------- --------
NET LOSS .................................... $(19,032) $ (1,280) $(34,062) $ (1,438)
-------- -------- -------- --------
-------- -------- -------- --------
EARNINGS (LOSS) PER SHARE:
Net loss:
Basic ................................ $ (0.63) $ (1.56) $ (1.23) $ (2.40)
-------- -------- -------- --------
-------- -------- -------- --------
Diluted .............................. $ (0.63) $ (1.56) $ (1.23) $ (2.40)
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
See notes to unaudited consolidated financial statements.
4
<PAGE>
CARRIER1 INTERNATIONAL S.A. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
SIX MONTHS ENDED JUNE 30, 1999
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE INFORMATION)
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN- ACCUMULATED COMPREHENSIVE
STOCK CAPITAL DEFICIT INCOME TOTAL
--------- -------- -------- -------- ---------
<S> <C> <C> <C> <C> <C>
BALANCE--December 31, 1998................... $ 37,770 $(19,235) $ 654 $19,189
Issuance of shares (12,133,864 shares)....... 24,268 24,268
Issuance of warrants......................... $2,304 2,304
Comprehensive income (loss):
Net loss..................................... (34,062) (34,062)
Other comprehensive income, net of
tax:
Currency translation adjustments............. 1,247 1,247
Total comprehensive loss..................... (32,815)
--------- -------- -------- -------- ---------
BALANCE--June 30, 1999........................ $ 62,038 $2,304 $(53,297) $1,901 $12,946
--------- -------- -------- -------- ---------
--------- -------- -------- -------- ---------
</TABLE>
See notes to unaudited consolidated financial statements.
5
<PAGE>
CARRIER1 INTERNATIONAL S.A. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENT OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 1999 AND
PERIOD FROM FEBRUARY 20, 1998 (DATE OF INCEPTION) TO JUNE 30, 1998
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE INFORMATION)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PERIOD FROM
SIX MONTHS FEBRUARY 20,
ENDED JUNE 30, 1998 TO JUNE
1999 30, 1998
------------------ ---------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ..................................................... $ (34,062) $ (1,438)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization ............................ 3,634 --
Changes in operating assets and liabilities
Restricted cash ....................................... (1, 297) --
Receivables ........................................... (24,875) --
Prepaid expenses and other current assets ............. (4,347) (514)
Other assets .......................................... (13,262) --
Trade accounts payable and accrued liabilities ........ 21,799 404
--------- ---------
Net cash used in operating activities ............. (52,410) (1,548)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of restricted investments held in escrow ........... (135,486)
Purchase of property and equipment ........................... (51,460) (917)
Investments in joint ventures ................................ (6) --
--------- ---------
Net cash used in investing activities ............. (186,952) (917)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of short-term debt .................... 3,070
Proceeds from issuance of long-term debt ..................... 253,858 --
Proceeds from issuance of common stock and warrants .......... 26,571 177
--------- ---------
Net cash provided by financing activities ......... 280,429 3,247
EFFECT OF EXCHANGE RATE CHANGES ON CASH
AND CASH EQUIVALENTS ......................................... 2,854 9
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS ....................... 43,921 791
CASH AND CASH EQUIVALENTS
Beginning of period .......................................... 4,184
--------- ---------
End of period ................................................ $ 48,105 $ 791
--------- ---------
--------- ---------
SUPPLEMENTAL DISCLOSURE OF NONCASH
OPERATING AND INVESTING ACTIVITIES:
At June 30, 1999 and December 31, 1998, the Company had purchased
approximately $24,982 and $17,315, respectively, of equipment
on open accounts payable.
</TABLE>
CARRIER1 INTERNATIONAL S.A. AND SUBSIDIARIES
6
<PAGE>
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 1999 AND JUNE 30, 1998 AND SIX MONTHS
ENDED JUNE 30, 1999 AND THE PERIOD FROM FEBRUARY 20, 1998 (DATE OF
INCEPTION) TO JUNE 30, 1998
(In Thousands of U.S. Dollars, Except Share Information)
1. NATURE OF OPERATIONS
Carrier1 International S.A., its subsidiaries in Europe and its subsidiary
in the United States ("Carrier1" or the "Company"), operate in the
telecommunications industry offering long distance voice and Internet Protocol
telecommunication services on a wholesale basis. The Company offers these
services primarily to competitive fixed-line operators, other carriers, wireless
operators, Internet service providers, resellers, and multi-national
corporations. The Company is a societe anonyme organized under the laws of the
Grand Duchy of Luxembourg and has adopted a fiscal year end of December 31.
2. UNAUDITED FINANCIAL INFORMATION
The financial information included herein is unaudited; however, the
information reflects all adjustments (consisting solely of normal recurring
adjustments) that are, in the opinion of management, necessary for a fair
presentation of the Company's financial position and results of operations and
cash flows for the interim periods presented. The results of operations for the
three months ended June 30, 1999 are not necessarily indicative of the results
to be expected for the full year.
3. EARNINGS PER SHARE
The following details the earnings per share calculations for the three
months ended June 30, 1999 and June 30, 1998, for the six months ended June
30, 1999 and for the period from February 20, 1998 (date of inception) to
June 30, 1998 (in thousands of U.S. dollars, except share information):
<TABLE>
<CAPTION>
PERIOD
FROM
THREE MONTHS THREE MONTHS SIX MONTHS FEBRUARY
ENDED ENDED ENDED 20, 1998 TO
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1999 1998 1999 1998
----------- ------------- ----------- ---------
<S> <C> <C> <C> <C>
Loss from operations ............................. $ (7,597) $ (1,280) $ (16,973) $ (1,438)
----------- ------------- ----------- ---------
----------- ------------- ----------- ---------
Net loss ......................................... $ (19,032) $ (1,280) $ (34,062) $ (1,438)
----------- ------------- ----------- ---------
----------- ------------- ----------- ---------
Total number of shares used to compute
basic earnings (loss) per share .................. 30,170,000 819,000 27,618,000 599,000
----------- ------------- ----------- ---------
----------- ------------- ----------- ---------
Loss from operations:
Basic loss per share .......................... $ (0.25) $ (1.56) $ (0.61) $ (2.40)
----------- ------------- ----------- ---------
----------- ------------- ----------- ---------
Diluted loss per shares ....................... $ (0.25) $ (1.56) $ (0.61) $ (2.40)
----------- ------------- ----------- ---------
----------- ------------- ----------- ---------
</TABLE>
7
<PAGE>
<TABLE>
<S> <C> <C> <C> <C>
Net loss:
Basic loss per share.................... $ (0.63) $ (1.56) $(1.23) $(2.40)
----------- ------------- ----------- ---------
Diluted loss per shares................. $ (0.63) $ (1.56) $(1.23) $(2.40)
----------- ------------- ----------- ---------
----------- ------------- ----------- ---------
</TABLE>
Potential dilutive securities have been excluded from the computation
for the three months ended June 30, 1999 and June 30, 1998, for the six
months ended June 30, 1999 and for the period from February 20, 1998 (date of
inception) to June 30, 1998 as their effect is antidilutive. Had the Company
been in a net income position for the three months ended June 30, 1999 and
June 30, 1998, for the and six months ended June 30, 1999 and for the period
from February 20, 1998 (date of inception) to June 30, 1998, diluted earnings
per share would have included an additional 5,687,615, 2,822,000, 5,687,615 and
2,822,000 shares, respectively, related to outstanding warrants, stock
options and stock subscriptions.
4. PROPERTY AND EQUIPMENT
Property and equipment at June 30, 1999, consist of the following:
<TABLE>
<S> <C>
Network equipment..................................................... $ 46,258
Indefeasible right of use investments................................. 21,184
Leasehold improvements................................................ 5,661
Furniture, fixtures and office equipment.............................. 2,422
Construction in progress.............................................. 12,210
------------
87,735
Less: accumulated depreciation and amortization....................... (4,826)
------------
Property and equipment, net........................................ $ 82,909
------------
------------
</TABLE>
5. LONG-TERM DEBT
On February 19, 1999, the Company issued $160 million and [euro]85
million of 13 1/4% senior notes (the "Notes") with detachable warrants with a
scheduled maturity of February 15, 2009. Each Dollar warrant is initially
exercisable to purchase 6.71013 shares of common stock and each Euro warrant
is initially exercisable to purchase 7.53614 shares of common stock. Holders
will be able to exercise the warrants at a per share price equal to the
greater of $2.00 per share and the minimum par value required by Luxembourg
law (currently 50 Luxembourg francs), subject to adjustment.
The Company has the right to redeem any of the Notes beginning on
February 15, 2004. The initial redemption price is 106.625% of their
principal amount, plus accrued interest. The redemption price will decline
each year after 2004 and will be 100% of their principal amount, plus accrued
interest, beginning on February 15, 2007. In addition, before February 15,
2002, the Company may redeem up to 35% of the aggregate amount of either
series of Notes with the proceeds of sales of its capital stock at 113.25% of
their principal amount. The Company may make such redemption only if after
any such redemption, an amount equal to at least 65% of the aggregate
principal amount of such Notes originally issued remains outstanding.
The Notes contain covenants that restrict the Company's ability to
enter into certain transactions including, but not limited to, incurring
additional indebtedness, creating liens, paying dividends, redeeming capital
stock, selling assets, issuing or selling stock of restricted subsidiaries,
or effecting a consolidation or merger.
The Company is obligated to use its best efforts to cause the Notes
to generally be freely transferable under the Securities Act of 1993 no later
than August 19, 1999. If this requirement is not met, then the interest on
the Notes will increase by 0.5% per annum until the Notes are generally
freely transferable. The Company expects this requirement to be met in
September, 1999.
As required by the terms of the Notes, the Company used approximately
$49.2 million of the net proceeds to purchase a portfolio of U.S. government
securities and approximately [euro]26.9 million ($29.8 million) of the net
proceeds to purchase a portfolio of European government securities, and
pledged these portfolios for the benefit of the holders of the respective
series of Notes to secure and fund the first five interest payments.
The details of other long-term debt are as follows:
<TABLE>
<S> <C>
Seller financing............................ $2,929
Network fiber lease......................... 5,317
Other....................................... 383
------
Total....................................... 8,629
======
</TABLE>
Approximately $2.9 million of other long term indebtedness is
attributable to seller financing of fiber optic cable for the Company's
German network. Pursuant to the terms of the financing agreement, the seller
will either provide financing for the entire amount of the purchase with the
contract value to be repaid over three years in equal annual installments
beginning on December 31, 2001 together with interest, or will allow the
Company to make payment in full by December 31, 2000 without interest. The
loan, if provided, will bear interest at the U.S. dollar Libor rate plus 4%
per annum.
Approximately $5.3 million of other long term indebtedness is
attributable to a lease of network fiber the Company entered into on April 1,
1999. The lease requires the Company to make monthly payments of $274
for operating and maintenance costs for 36 months, after which the
Company will obtain a 15 year indefeasible right of use in the fiber
underlying the lease. The Company will be required to pay an annual operating
and maintenance fee of $250 for the term of the indefeasible right of use.
The Company also has available to it, but as of June 30, 1999, had not
drawn any amounts under, a vendor financing facility with Nortel. The Nortel
facility will allow the Company to borrow money to purchase network equipment
from Nortel and, in limited amounts, other suppliers. Under this facility,
the Company may borrow up to $75 million or the actual amount paid or payable
by the Company for network equipment supplied prior to December 31, 1999,
whichever is less. Advances under the facility will bear interest at a
floating rate tied to LIBOR, and interest payments will be payable
periodically from the date of the relevant advance. At the Company option, it
may pledge assets to secure the Nortel facility and receive a lower interest
rate. The Company may not borrow additional funds under the Nortel facility
after December 31, 2000. Advances are to be repaid in sixteen equal quarterly
installments beginning March 31, 2001.
8
<PAGE>
6. COMMITMENTS AND CONTINGENCIES
PURCHASE COMMITMENTS
On April 16, 1999, the Company signed an agreement to swap fiber
wavelength on the basis of a 15 year indefeasible right of use (IRU). Carrier1
is to receive two unprotected wavelengths on diverse routes between Hamburg,
Copenhagen and Malmo and provide two unprotected wavelengths on the routes
between Hamburg and Frankfurt, Hamburg and Berlin, and Berlin and Frankfurt in
exchange. The first wavelength to Scandinavia is scheduled for receipt by
Carrier1 in the third quarter of 1999, the second for early fourth quarter,
1999. Carrier1 will deliver the two wavelengths on the German ring during the
first quarter of 2000. The Company will account for this transaction as a
nonmonetary exchange in accordance with Accounting Principles Board Opinion No.
29, "Accounting for Nonmonetary Transactions."
On April 29, 1999, Carrier1 signed a letter of intent with Nortel for the
purchase of DWDM equipment to light up dark fiber in Germany and on the London
ring. The value of the purchases and the associated services to be performed
within 18 months amounts to $25 million.
On May 7, 1999, Carrier1 signed a contract for the purchase of a 10-year
indefeasible right of use (IRU) for 2.5 Gbit/s of capacity from London to
Amsterdam, Frankfurt, Paris and Brussels in the amount of $15.0 million. The
capacity is scheduled to be delivered in mid-1999. Carrier1 sold in exchange to
the same company a 10-year IRU for 2.5 Gbit/s of capacity from London to
Frankfurt, Amsterdam and Paris in the amount of $12.0 million. Carrier1 will pay
$3.0 million on the date of acceptance; the remaining $12.0 million will be
offset by the delivery of Carrier1's wavelength.
7. SHAREHOLDERS' EQUITY
Carrier1 has granted options pursuant to the 1999 Share Option Plan to
acquire approximately 2,110,968 Shares at an exercise price of $2.00 per Share
plus applicable capital duty (currently 1% of the subscription price payable to
Carrier1 International by the subsidiary granting the applicable option).
Carrier1 intends to grant additional options in the future.
As of May 1, the Company had substantially completed a restructuring of
its management equity arrangements. Pursuant to this restructuring, certain
members of management in effect have exchanged their equity interests and
options that they had held in Carrier One, LLC (the "LLC") (which holds a
majority of the equity of Carrier1 International) to acquire an equivalent
dollar amount of shares and options of Carrier1 International common stock. Each
LLC share with a par value of $1 was exchanged for 1/2 of a Carrier1
International S.A. share with a par value of $2. Each option to purchase one LLC
share at an exercise price of $1 was exchanged for 1/2 of an option bearing the
right to purchase one share of Carrier1 International S.A. with an exercise
price of $2. Management believes that this restructuring of management equity
arrangements does not result in a new measurement date for purposes of APB 25.
8. INCOME TAXES
9
<PAGE>
The Company has tax loss carryforwards of approximately $34,000 at June
30, 1999. The ability of the Company to fully realize deferred tax assets
related to these tax loss carryforwards in future years is contingent upon its
success in generating sufficient levels of taxable income before the statutory
expiration periods for utilizing such net operating losses lapses. Due to its
limited history, the Company was unable to conclude that realization of such
deferred tax assets in the near future was more likely than not. Accordingly, a
valuation allowance was recorded to offset the full amount of such assets.
9. SEGMENT INFORMATION
Summarized financial information concerning the Company's reportable
segments for the six months ended June 30, 1999 is shown in the following table.
The "Other" column includes unallocated shared and corporate related assets.
<TABLE>
<CAPTION>
VOICE SERVICES DATA SERVICES OTHER CONSOLIDATED
-------------- ------------- ----- ------------
<S> <C> <C> <C> <C>
Revenues.............................. $27,748 $ 4,739 $32,487
Fixed cost contribution............... 5,384 4,739 10,123
Identifiable assets................... 18,252 2,962 304,075 325,289
</TABLE>
10. SUBSEQUENT EVENTS
During the third quarter, Carrier1 announced an agreement to swap 12
strands of dark fiber on Carrier1's German ring for 12 strands of dark fiber
covering substantially all of the major cities in France. Like Carrier1's
German fiber infrastructure, this new homogeneous French ring utilizes the
latest generation of high speed, high capacity fiber optic cable. The French
fiber infrastructure will become available in phases throughout the year of
2000. Moreover, each party has executed an agreement whereby they will
provide certain network maintenance services for the other party in their
respective countries. This swap transaction, in which no cash will change
hand, will be accounted for as a "non monetary transaction" in accordance
with U.S. GAAP.
10
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
THE FOLLOWING DISCUSSION AND ANALYSIS OF CARRIER1'S FINANCIAL CONDITION AND
RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED
FINANCIAL STATEMENTS AND THE NOTES THERETO CONTAINED ELSEWHERE IN THIS REPORT.
CERTAIN INFORMATION CONTAINED IN THE DISCUSSION AND ANALYSIS OR SET FORTH
ELSEWHERE IN THIS REPORT, INCLUDING INFORMATION WITH RESPECT TO CARRIER1'S PLANS
AND STRATEGY FOR ITS BUSINESS AND RELATED FINANCING, INCLUDES FORWARD-LOOKING
STATEMENTS THAT INVOLVE RISK AND UNCERTAINTIES. ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM THE RESULTS DESCRIBED IN OR IMPLIED BY THE FORWARD-LOOKING
STATEMENTS CONTAINED HEREIN DUE TO, AMONG OTHER THINGS, POLITICAL, ECONOMIC
OR LEGAL CHANGES IN THE MARKETS IN WHICH CARRIER1 DOES BUSINESS, COMPETITIVE
DEVELOPMENTS, OR RISKS INHERENT IN CARRIER1'S BUSINESS PLAN, SUCH AS ITS
SIGNIFICANT CAPITAL REQUIREMENTS, ITS SIGNIFICANT INDEBTEDNESS AND COVENANT
RESTRICTIONS AND ITS NEEDS TO CONTINUE TO EXPAND AND DEVELOP ITS NETWORK
RAPIDLY AND COST-EFFECTIVELY. THESE FACTORS ARE DETAILED ELSEWHERE IN THIS
REPORT AND IN CARRIER1'S REGISTRATION STATEMENT ON FORM S-4 ON FILE WITH THE
UNITED STATES SECURITIES AND EXCHANGE COMMISSION.
OVERVIEW
Carrier1 is a rapidly expanding European facilities-based provider of
long distance voice and Internet Protocol data telecommunications services.
Carrier1 offers these services on a wholesale basis primarily to competitive
fixed-line operators, other carriers, wireless operators, ISPs, resellers and
multi-national corporations. In March 1998, Carrier1's experienced management
team and Providence Equity Partners formed Carrier1 to capitalize on the
significant voice and data opportunities that are emerging for facilities-based
carriers in Europe's rapidly liberalizing telecommunications markets. By
September 1998, Carrier1 had deployed its initial network and commenced selling
wholesale services. As of March 31, 1999, Carrier1 had executed 79 contracts
with voice customers and 35 contracts with data customers. As of June 30, 1999,
Carrier1 had executed an additional 63 contracts with voice customers and an
additional 11 contracts with data customers.
Carrier1 is developing an extensive city-to-city European network
linking key population centers. Carrier1 intends to continue rapidly expanding
this network in a cost-effective manner to serve the needs of its existing and
potential customers. Carrier1 believes that its network will allow it to provide
and price its services in Europe on a city-to-city basis without regard to
national borders. This provisioning and pricing structure will put Carrier1 at
the forefront of a shift beginning to occur in the European telecommunications
market away from services and pricing that distinguish between international and
national long distance.
To date, Carrier1 has experienced net losses and negative cash flow
from operating activities. From Inception to September 1998, Carrier1's
principal activities included developing its business plans, obtaining
governmental authorizations and licenses, acquiring equipment and facilities,
designing and implementing its voice and data networks, hiring management and
other key personnel, developing, acquiring and integrating information and
operational support systems and operational procedures, negotiating
interconnection agreements and negotiating and executing customer service
agreements. In September 1998, Carrier1 commenced the roll-out of its services.
Carrier1 expects to continue to generate net losses and negative cash flow as it
expands its operations and does not expect to generate positive cash flow from
operating activities through 2000. Whether or when Carrier1 will generate
positive cashflow from operating activities will depend on a number of
financial, competitive, regulatory, technical and other factors. See "Liquidity
and Capital Resources."
Although Carrier1's management is highly experienced in the wholesale
telecommunications business, Carrier1 itself has a limited operating history.
Holders of Carrier1's securities therefore
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have limited operating and financial information about Carrier1 upon which to
base an evaluation of Carrier1's performance and an investment in Carrier1's
securities.
Carrier1's consolidated financial statements are prepared in accordance
with U.S. generally accepted accounting principles. Carrier1 will be reporting
on a calendar quarterly basis in the future.
FACTORS AFFECTING FUTURE OPERATIONS
REVENUES
Carrier1 generates most of its revenues through the sale of wholesale
long distance voice and data services to competitive fixed-line operators, other
carriers, wireless operators, ISPs, resellers and multi-national corporations.
Carrier1 is beginning to expand the scope of its wholesale market by adding
value-added services for customers such as switchless resellers. Carrier1
records revenues from the sale of voice and data services at the time of
customer usage. Carrier1's agreements with its voice customers are typically for
an initial term of twelve months and will be renewed automatically unless
cancelled. They employ usage-based pricing and do not provide for minimum volume
commitments by the customer. Carrier1 generates a steady stream of voice traffic
by providing high-quality service and superior customer support. Carrier1's data
services are charged, depending on service type, either at a flat monthly rate,
regardless of usage, based on the line speed and level of performance made
available to the customer, or on a usage basis, with no minimum volume
commitment by the customer. Initially, the majority of Carrier1's data contracts
were usage-based. Since March 31, 1999, Carrier1 has migrated to offering usage
based data pricing only in combination with data contracts that have a fee-based
component that guarantees minimum revenue, in order to encourage usage of its
network services by its data customers. Carrier1's agreements with its data
customers are generally for a minimum term of twelve months, although Carrier1
may seek minimum terms of two years or more for agreements providing for higher
line speeds. Carrier1 believes that, if the quality of the service is
consistently high, data customers will typically renew their contracts because
it is costly and technically burdensome to switch carriers.
Currently, voice and data services are both priced competitively and
Carrier1 emphasizes quality and customer support, rather than offering the
lowest prices in the market. The rates charged to voice and data customers are
subject to change from time to time. Carrier1 will also vary pricing on its
routes as a traffic management tool. As expected, Carrier1 has experienced
declining revenue per billable minute for voice traffic and declining revenue
per Mb for data traffic, in part as a result of increasing competition. Carrier1
expects to continue to experience declining revenue per unit. Carrier1 believes,
however, that the impact on its results of operations from such price decreases
has been, and, it believes, will continue to be at least partially offset by
decreases in its cost of providing services and increases in its voice and data
traffic volumes.
Carrier1's focus on the wholesale international and national long
distance markets results in its having substantially fewer customers than a
carrier in the mass retail sector. As a result, a shift in the traffic pattern
of any one customer, especially in the near term and on one of Carrier1's high
volume routes, could have a material impact, positive or negative, on Carrier1's
revenues. One customer accounted for approximately 20% of Carrier1's revenues in
June, 1999 and may continue to account for a substantial portion of revenues in
the near term. Furthermore, most wholesale customers of voice services tend to
be price sensitive and, assuming the quality of service is
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equivalent, certain customers may switch suppliers for certain routes on the
basis of small price differentials. In contrast, data customers tend to use
fewer suppliers than voice customers, cannot switch suppliers as easily and,
Carrier1 believes, are more sensitive to service quality than to price.
COST OF SERVICES, EXCLUSIVE OF ITEMS DISCUSSED SEPARATELY BELOW
Cost of services, exclusive of depreciation and amortization, which is
discussed separately below, are classified into three general categories: access
costs, transmission costs and termination costs. Carrier1 has minimal access
costs as its wholesale customers are typically responsible for the cost of
accessing its network. Carrier1 has begun to target switchless resellers and,
for those services, Carrier1 will have access costs payable to the originating
local provider, usually the incumbent telephone operator. These costs will vary
based on calling volume and the distance between the caller and Carrier1's point
of presence.
TRANSMISSION COSTS. Initially, Carrier1's transmission costs for voice and data
traffic consists primarily of leased capacity charges and switch and router
facilities costs. As a result of Carrier1's objective to enter the market early,
its initial European transmission platform consists of leased capacity. Leased
capacity charges are fixed monthly payments based on capacity provided and are
typically higher than a "dark fiber cost level," which is Carrier1's target cost
level and represents the lowest possible per unit cost. Dark fiber cost level is
the per unit cost of high-capacity fiber that has been laid and readied for use.
Dark fiber cost levels can be achieved not only through owned facilities, but
also may be possible through other rights of use such as multiple investment
units, known as "MIUs."
As part of Carrier1's strategy to lower its cost base over time, it
will seek dark fiber cost levels for its entire transmission platform, either
through building, acquiring or swapping capacity. Carrier1 further minimizes its
transmission costs by optimizing the routing of its voice traffic and increasing
volumes on its fixed-cost leased and owned lines, thereby spreading the
allocation of fixed costs over a larger number of voice minutes or larger volume
of data traffic, as applicable. To the extent Carrier1 overestimates anticipated
traffic volume, however, per unit costs will increase. As Carrier1 continues to
develop its owned network and relies less on leased capacity, per unit voice
transmission costs will decrease substantially, offset partially by an increase
in depreciation and amortization expense. Carrier1 also expects to experience
declining transmission costs per billable minute or per Mb, as applicable, as a
result of decreasing cost of leased transmission capacity, increasing
availability of more competitively priced indefeasible rights of use and MIUs
and increasing traffic volumes.
VOICE TERMINATION COSTS. Termination costs represent the costs Carrier1 is
required to pay to other carriers from the point of exit from Carrier1's
network to the final point of destination. Generally, at least one-half of
the total costs associated with a call, from receipt to completion, are
termination-related costs. Voice termination costs per unit are generally
variable based on distance, quality, geographical location of the termination
point and the degree of competition in the country in which the call is being
terminated.
If a call is terminated in a city in which Carrier1 has a point of
presence and an interconnection agreement with the national incumbent telephone
operator, the call will be transferred to the public switched telephone network
for local termination. This is the least costly mode of
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terminating a call. To the extent incumbent telephone operators deny or delay
granting Carrier1 interconnection or grant it interconnection for insufficient
capacity or in undesirable locations, Carrier1 may incur high termination costs,
which could have a material adverse effect on its ability to compete with
carriers that do have interconnection agreements. If a call is to a location in
which Carrier1 does not have a point of presence, or has a point of presence but
does not have an interconnection agreement giving it access to the public
switched telephone network, then the call must be transferred to, and refiled
with, another carrier that has access to the relevant public network for local
termination. Carrier1 pays this carrier a refile fee for terminating its
traffic. Most refilers currently operate out of London or New York, so that the
refiled traffic is rerouted to London or New York and from there is carried to
its termination point. Refile agreements provide for fluctuating rates with rate
change notice periods typically of one or four weeks. To the extent Carrier1 has
to rely heavily on refiling to terminate certain traffic, Carrier1's margins on
such voice traffic will be materially adversely affected. Carrier1 will seek to
reduce its refile costs by utilizing least cost routing. In those countries
where Carrier1 has a point of presence but does not have an interconnection
agreement implemented yet, it has implemented one or more "resale" agreements
whereby a local carrier that has an interconnection agreement with the incumbent
telephone operator "resells" or shares this interconnection right with Carrier1
for a fee. Termination through resale agreements is significantly less expensive
than through refile agreements because the traffic does not need to be rerouted
to another country, as is done with refiling. Termination through resale
agreements is, however, more expensive than through interconnection agreements.
In countries where it has not been directly authorized to provide services,
Carrier1 will negotiate to obtain direct operating agreements with correspondent
telecommunications operators where such agreements will result in lower
termination costs than might be possible through refile arrangements. Carrier1
believes its refile and resale agreements are competitively priced. If
Carrier1's traffic volumes are higher than expected, it may have to divert
excess traffic onto another carrier's network, which would also increase its
termination costs. Carrier1 believes, however, that it has sufficient capacity
and could, if necessary, lease more. In addition, its technologically advanced
traffic monitoring capabilities allow Carrier1 to identify changes in volume and
termination cost patterns as they begin to develop, thereby permitting it to
respond in a cost-efficient manner.
Carrier1 believes that its termination costs per unit should decrease
as it extends its network and increases transmission capacity, adds additional
switches and interconnects with more incumbent telephone operators. Carrier1
also believes that continuing liberalization in Europe will lead to decreases in
termination costs as new telecommunications service providers emerge, offering
alternatives to the incumbent telephone operators for local termination, and as
European Union member states implement and enforce regulations requiring
incumbent telephone operators to establish rates which are set on the basis of
forward-looking, long run economic costs that would be incurred by an efficient
provider using advanced technology. There can be no assurance, however,
regarding the extent or timing of such decreases in termination costs.
DATA TERMINATION COSTS. Termination costs represent costs Carrier1 is
required to pay to other Internet backbone providers from the point of exit
of Carrier1's network. Data termination is effected through peering and
transit arrangements. Peering arrangements provide for the exchange of data
traffic free-of-charge. Carrier1 has entered into peering arrangements with
several ISPs in the United States and Europe, including recent peering
arrangements with several European incumbent telephone operators. There can
be no assurance that Carrier1 will be able to negotiate additional peering
arrangements or that it will be able to terminate traffic on their networks
at favorable prices. Under transit arrangements, Carrier1 is required to pay
a fee to exchange traffic. That fee has a variable and a fixed component. The
variable component is based on monthly traffic
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volumes. The fixed component is based on the minimum Mb amount charged to
Carrier1 by its transit partners. The major United States ISPs require almost
all European ISPs and Internet backbone providers, including Carrier1, to pay a
transit fee to exchange traffic.
Recently, the Internet services industry has experienced increased
merger and consolidation activity among ISPs and Internet backbone providers.
This activity is likely to increase the concentration of market power of
Internet backbone providers, and may adversely affect Carrier1's ability to
obtain peering arrangements.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Carrier1's wholesale strategy allows it to maintain lower selling,
general and administrative expenses than companies providing services to the
mass retail market. Carrier1's selling, general and administrative expenses
consist primarily of personnel costs, information technology costs, office
costs, travel, commissions, billing, professional fees and advertising and
promotion expenses. Carrier1 employs a direct sales force located in the major
markets in which it offers services. To attract and retain a highly qualified
sales force, Carrier1 offers its sales personnel a compensation package
emphasizing performance based commissions and stock options. Carrier1 expects to
incur significant selling and marketing costs in advance of anticipated related
revenue as it continues to expand its operations. Carrier1's selling, general
and administrative expenses are expected to decrease as a percentage of
revenues, however, once it has established its operations in targeted markets
and expanded its customer base.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense includes charges relating to
depreciation of property and equipment, which will consist principally of
equipment (such as switches, multiplexers and routers), investments in
indefeasible rights of use and in multiple investment units, furniture and
equipment. Depreciation and amortization also include the amortization of
interest capitalized during the construction of the 2,300 kilometer fiber
network Carrier1 is building in Germany in conjunction with Viatel, Inc. and
Metromedia Fiber Network, Inc. Carrier1 depreciates its network over periods
ranging from 5 to 15 years and amortizes its intangible assets over a period of
5 years. Carrier1 depreciates its investments in indefeasible rights of use and
in multiple investment units over their estimated useful lives of not more than
15 years. Carrier1 expects depreciation and amortization expense to increase
significantly as Carrier1 expands its owned network, including the development
of the German network.
NETWORK DEVELOPMENT
During the second quarter, Carrier1 continued to expand its network,
installing switches in Amsterdam, Dusseldorf, Berlin and Paris, a router in
Brussels, and a switch and router in Hamburg, increasing its number of switches
and routers to ten each. In addition, Carrier1 entered into two fiber swap
agreements, one for capacity on diverse routes between Hamburg, Copenhagen and
Malmo and the other for an indefeasible right of use of 2.5 Gbit/s of capacity
linking London to Amsterdam, Frankfurt, Paris and Brussels.
Also in the second quarter, Carrier1 concluded negotiating and
initiated the implementation of interconnect agreements with France Telecom,
Telecom Italia, Telia in Sweden
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and Tele Denmark. It also added Cologne, Frankfurt, Leipzig and Hamburg as
additional points of interconnect with Deutsche Telecom. Carrier1 signed and
initiated implementation of a bilateral direct interconnect agreement with PT
Luxembourg. An international direct route into Turkey was successfully
implemented increasing the quality of traffic to Turkey while lowering its cost.
Construction on the German network proceeded on schedule. In addition, Carrier1
secured several new peering arrangements with ISPs, bringing to over 70 its
total number of ISP peering arrangements.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1999
Because Carrier1 commercially introduced its services in September
1998, Carrier1's management believes that comparisons of results for the
six-month period ended June 30, 1999 to the period from Inception to June 30,
1998 and for the three month period ending June 30, 1999 to the three month
period ending June 30, 1998 are not meaningful.
Revenues for the three-month period ended June 30, 1999 were
approximately $20.2 million, primarily relating to voice services, which
contributed $15.8 million or 78.2% to the total revenue generated in the
second quarter of 1999. Voice revenue growth compared to the first quarter of
1999 amounted to 64%. Voice traffic volume of 122 million minutes was billed
to Carrier1's customers. Average revenue per minute was $0.13, which
represented a decrease of approximately 32% compared to the first quarter of
1999 due primarily to changes in traffic mix and, to a lesser extent, price
reductions. The majority of voice traffic in the second quarter of 1999 both
originated and terminated in Europe where prices are generally lower, but
where Carrier1 has implemented interconnection agreements and therefore
generally does not need to terminate traffic via more costly refile or resale
arrangements. Data services revenue of $4.4 million for the same period was
generated by internet services.
Cost of services for the three-month period ended June 30, 1999 was
approximately $22.3 million. These costs consisted of operation of the network,
leases for transmission capacity, and termination expenses including refiling.
Depreciation and amortization for the three-month period ended June 30,
1999 was approximately $2.3 million and consisted primarily of depreciation
costs for network equipment, indefeasible rights of use, and other furniture and
equipment. Selling, general and administrative expenses were approximately $3.1
million for the three-month period ended June 30, 1999 and consisted primarily
of personnel costs, information technology costs, office costs, professional
fees and expenses.
Net interest expense for the three-month period ended June 30, 1999 was
approximately $ 6.3 million. It consisted during this period of approximately
$8.4 million of interest accrued on the notes, less interest income of
approximately $2.1 million. Interest income consists of interest earned from
investing the proceeds of the $60 million dollars invested by funds managed by
Carrier1's equity sponsors to finance the deployment of Carrier1's network and
to fund start-up operations (the "Equity Investment") and the offering (the
"Offering") on February 19, 1999, of $160,000,000 senior dollar units, each such
unit consisting of one 13 1/4 senior dollar note and one warrant to purchase
shares of common stock and [euro]85,000,000 senior euro units, each such unit
consisting of one 13 1/4 senior euro note and one warrant to purchase shares of
common stock. Interest expense increased significantly in this period as
compared to the previous fiscal quarter and as compared to
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the period from Inception to December 31, 1998 as a result of the issuance of
these units and corresponding notes.
The strengthening of the U.S. dollar to the euro in the second
quarter of 1999 resulted in a currency exchange loss of $4.7 million.
Carrier1's management evaluates the relative performance of its
voice and data services operations based on their respective fixed cost
contributions. Fixed cost contribution consists of the revenues generated by
the provision of voice services or data services, as the case may be, less
direct variable costs incurred as a result of providing such services.
Certain direct costs, such as network and transmission costs, are shared by
both the voice and data operations and are not allocated by management to
either service. See Note 9 to the Unaudited Consolidated Financial Statements
presented elsewhere in this report. Fixed cost contribution for voice
services for the three-month period ended June 30, 1999 was $3.0 million,
representing $15.8 million in voice revenue less $12.8 million, or 10.5
cents per minute, in voice termination costs. Fixed cost contribution for
data services for the same period was equivalent to data services revenue, or
$4.4 million, as there were no direct variable costs associated directly with
providing data services.
PERIOD FROM INCEPTION THROUGH DECEMBER 31, 1998
Carrier1 commercially introduced its services in September 1998.
Revenues for the period from Inception to December 31, 1998 were approximately
$2.8 million, primarily relating to voice services, which contributed 98% to the
total revenue achieved in 1998. Voice traffic volume from the start of
operations in September 1998 until the end of 1998 amounted to 10 million
minutes. Data services revenue of $0.1 million for the same period was generated
by internet services.
Cost of services for the period from Inception to December 31, 1998 was
approximately $11.7 million. These costs consisted of operation of the network,
leases for transmission capacity, and termination expenses including refiling.
Depreciation and amortization for the period from Inception to December
31, 1998 was approximately $1.4 million and consisted primarily of depreciation
costs for network equipment, indefeasible rights of use, and other furniture and
equipment. Selling, general and administrative expenses were approximately $9.0
million for the period from Inception to December 31, 1998 and consisted
primarily of start-up expenses, personnel costs, information technology costs,
office costs, professional fees and promotion expenses.
Interest income during the period from Inception to December 31, 1998
consisted of interest earned from investing the proceeds of the issuance of
equity. Interest income totaled approximately $81,000 for the period from
Inception to December 31, 1998. No interest expense was incurred for the period
from Inception to December 31, 1998.
Fixed cost contribution for voice services for the period from
Inception to December 31, 1998 was $0.1 million, representing $2.7 million in
voice revenue less $2.6 million in voice termination costs, reflecting the fact
that during the early stages of its operations, Carrier1 had relatively few
interconnection agreements with incumbent telephone operators so that traffic
had to be terminated at higher cost through refiling. Fixed cost contribution
for data services for the same
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period was equivalent to data services revenue, or $0.1 million, as there were
no direct variable costs associated directly with providing data services.
LIQUIDITY AND CAPITAL RESOURCES
Carrier1 broadly defines liquidity as its ability to generate
sufficient cash flow from operating activities to meet its obligations and
commitments. In addition, liquidity includes the ability to obtain appropriate
debt and equity financing and to convert into cash those assets that are no
longer required to meet existing strategic and financial objectives. Therefore,
liquidity cannot be considered separately from capital resources that consist of
current or potentially available funds for use in achieving long-range business
objectives and meeting debt service commitments.
From Inception through December 31, 1998, Carrier1 financed its
operations through equity contributions. During the six-month period ended June
30, 1999, Carrier1 financed its operations through additional equity
contributions and with the proceeds of the Offering. The further development of
Carrier1's business and deployment of its network will require significant
capital to fund capital expenditures, working capital, cash flow deficits and
any debt service. Carrier1's principal capital expenditure requirements include
the expansion of its network, including construction of the German network, and
the acquisition of switches, multiplexers, routers and transmission equipment.
Additional capital will be required for office space, switch site buildout and
corporate overhead and personnel.
Carrier1 estimates it will incur capital expenditures of approximately
$200.0 million from Inception through 1999. By the end of 1999, Carrier1 plans
to complete construction of the German network and to purchase additional
switches, multiplexers and routers. As of December 31, 1998, Carrier1 had
incurred capital expenditures of approximately $37.2 million since Inception,
including amounts related to the German Network. As of June 30, 1999 Carrier1
had incurred capital expenditures of approximately $55 million since December
31, 1998, including amounts related to the German Network. Carrier1's aggregate
funding requirements include requirements to fund capital expenditures, working
capital, debt service and cash flow deficits. Carrier1 estimates, based on its
current business plan, that its aggregate funding requirements for the
deployment and operation of its network will total approximately $280.0 million
through 1999.
As of December 31, 1998 funds managed by Carrier1's equity sponsors
had invested a total of approximately $37.8 million to fund start-up
operations. As of February 19, 1999, such funds had completed their aggregate
equity investment totaling $60 million in equity contributions to Carrier1.
On February 19, 1999 Carrier1 completed the Offering. Net proceeds from the
Offering were $242 million (based on the February 19, 1999, conversion rate
of [euro]0.90316 per $1.00), after deducting discounts and commissions and
expenses of the Offering. Approximately $49.2 million of the net proceeds and
[euro]26.9 million ($29.8 million) of the net proceeds were used to purchase
a portfolio of government securities for the benefit of the holders of the
respective series of notes.
Carrier1 believes, based on its current business plan, that the net
proceeds from the Offering, the Equity Investment, and the Nortel facility,
together with either (1) proceeds of possible sales of dark fiber on the German
network, (2) proceeds from an accounts receivable facility, if completed, or (3)
proceeds from one or more additional equipment financing facilities, or a
combination of these sources, will be sufficient to fund the expansion of
Carrier1's business as planned, and to fund operations until Carrier1 achieves
positive cash flow from operations. Carrier1 expects to continue
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to generate net losses and negative cash flow as it expands its operations and
does not expect to generate positive cash flow from operating activities through
2000. Whether or when Carrier1 will generate positive cash flow from operating
activities will depend on a number of financial, competitive, regulatory,
technical and other factors. For example, Carrier1's net losses and negative
cash flow from operating activities are likely to continue beyond that time if:
- Carrier1 decides to build extensions to its network because it
cannot otherwise reduce its transmission costs;
- Carrier1 does not establish a customer base that generates
sufficient revenue;
- Carrier1 does not reduce its termination costs by negotiating
competitive interconnection rates and peering arrangements as
it expands its network;
- prices decline faster than Carrier1 has anticipated;
- Carrier1 does not attract and retain qualified personnel; or
- Carrier1 does not obtain necessary governmental approvals and
operator licenses.
Carrier1's ability to achieve these objectives is subject to financial,
competitive, regulatory, technical and other factors, many of which are beyond
Carrier1's control. There can be no assurance that Carrier1 will achieve
profitability or positive cash flow.
The actual amount and timing of Carrier1's future capital requirements
may differ materially from Carrier1's estimates as a result of, among other
things, the demand for Carrier1's services and regulatory, technological and
competitive developments. Sources of additional financing, if available on
acceptable terms or at all, may include commercial bank borrowings, equipment
financing or accounts receivable financing, or the private or public sale of
equity or debt securities.
On February 18, 1999, Carrier1 entered into an agreement to purchase
fiber optic cable for the German network during 1999 for $20.3 million plus
value-added tax. The seller will either provide financing for the entire amount
of the purchase with the contract value to be repaid over three years in equal
annual installments beginning on December 31, 2001 together with interest, or
will allow Carrier1 to make payment in full by December 31, 2000 without
interest. The loan, if provided, will bear interest at the U.S. dollar LIBOR
rate plus 4% per annum. If a loan is not provided, the seller is obligated to
provide certain additional equipment to Carrier1 without charge.
Carrier1 also entered into a financing facility with Nortel Networks
Inc., a major equipment supplier, on June 25, 1999. The Nortel facility allows
Carrier1 to borrow money to purchase network equipment from Nortel and, in
limited amounts, other suppliers. Under this facility, Carrier1 may borrow up to
$75,000,000 or the actual amount paid or payable by Carrier1 for network
equipment supplied prior to December 31, 1999, whichever is less. Advances under
the facility will bear interest at a floating rate tied to LIBOR, and interest
payments will be payable periodically from the date of the relevant advance. At
Carrier1's option, it may pledge assets to secure the Nortel facility and
receive a lower interest rate. Carrier1 may not borrow additional funds under
the Nortel facility after December 31, 2000. Advances are to be repaid in
sixteen equal
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quarterly installments beginning March 31, 2001. As of June 30, 1999, Carrier1
had not drawn any amounts under the Nortel facility.
As of June 30, 1999, Carrier1 had total current assets of $180.4
million, of which $76.9 million was escrowed interest on the notes issued in the
Offering and $58.6 million of which was allocated to the construction cost of
the German network. Net unrestricted cash as of the same date was $48.1 million.
EBITDA, which Carrier1 defines as earnings before interest, taxes,
depreciation amortization, foreign currency exchange gains or losses and
other income (expense), increased from negative $8.0 million in the first
quarter of 1999 to negative $5.3 million in the second quarter of 1999.
EBITDA is used by management and certain investors as an indicator of a
company's historical ability to service debt. Management believes that an
increase in EBITDA is an indicator of Carrier1's improved ability to service
existing debt, to sustain potential future increases in debt and to satisfy
capital requirements. However, EBITDA is not a measure of financial
performance under generally accepted accounting principles and should not be
considered as an alternative to cash flows from operating, investing or
financing activities as a measure of liquidity or an alternative to net
income as indications of Carrier1's operating performance or any other
measure of performance derived under generally accepted accounting
principles. EBITDA as used in this report may not be comparable to other
similarly titled measures of other companies or to Consolidated EBITDA as
calculated under the indentures pursuant to which Carrier1's 13 1/4 notes
were issued.
FOREIGN CURRENCY
Carrier1's reporting currency is the U.S. dollar, and interest and
principal payments on its 13 1/4 notes will be in U.S. dollars and Euro.
However, the majority of Carrier1's revenues and operating costs are derived
from sales and operations outside the United States and are incurred in a
number of different currencies. Accordingly, fluctuations in currency
exchange rates may have a significant effect on Carrier1's results of
operations and balance sheet data. The Euro has eliminated exchange rate
fluctuations among the 11 participating European Union member states.
Adoption of the Euro has therefore reduced the degree of intra-Western
European currency fluctuations to which Carrier1 is subject. Carrier1 will,
however, continue to incur revenues and operating costs in non-Euro
denominated currencies, such as pounds sterling. Although Carrier1 does not
currently engage in exchange rate hedging strategies, it may attempt to limit
foreign exchange exposure by purchasing forward foreign exchange contracts or
engaging in other similar hedging strategies. Carrier1 has outstanding one
contract to purchase Deutschemarks in exchange for dollars from time to time
in amounts anticipated to satisfy its Deutschemark-denominated obligations
under its German network arrangements. Any reversion from the Euro currency
system to a system of individual country floating currencies could subject
Carrier1 to increased currency exchange risk. Carrier1 has selected its
computer and operational systems in an attempt to ensure that its ability to
transact business will not be impaired by complications resulting from the
introduction of the Euro. While Carrier1 believes that its systems have not
been adversely impacted by the Euro conversion, there can be no assurance
that Carrier1 will be able to avoid the accounting, billing and logistical
difficulties that might result from the introduction of the Euro. In
addition, there can be no assurance that Carrier1's third-party suppliers and
customers will be able to successfully implement the necessary protocols.
INFLATION
Carrier1 does not believe that inflation will have a material effect on
its results of operations.
NEW ACCOUNTING PRONOUNCEMENT
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In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes accounting and
reporting standards for derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction, or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction. This standard is effective
for Carrier1's fiscal year ending December 31, 2000. Management has not yet
completed its analysis of this new accounting standard and, therefore, has not
determined whether this standard will have a material effect on Carrier1's
financial statements.
IMPACT OF YEAR 2000
"Year 2000" generally refers to the various problems that may result
from the improper processing of dates and date-sensitive calculations by
computers and other equipment as a result of computer hardware and software
using two digits, rather than four digits, to define the applicable year. If a
computer program or other piece of equipment fails to properly process dates
including and after the Year 2000, date-sensitive calculations may be inaccurate
or a major system failure may occur. Any such miscalculations or system failures
may cause disruptions in operations including, among other things, a temporary
inability to process transactions, send invoices or engage in other routine
business activities. A failure of Carrier1's computer systems could have a
material adverse effect on its operations, including its ability to make
payments on the notes.
STATE OF READINESS
As Carrier1 has developed and implemented its network, operational
support systems, and computer systems, it has conducted an evaluation for Year
2000 compliance. Based on such evaluation, Carrier1 believes that its
information technology ("IT") systems and its non-IT systems, such as its
network transmission equipment and the Nortel and Cisco network operating
systems, are Year 2000 compliant. In addition, Carrier1 has received written
assurances from Cisco, Nortel, and International Computers Limited that the
systems they have provided Carrier1 are Year 2000 compliant. Carrier1,
therefore, does not expect to have to remedy any of its IT or non-IT systems to
be Year 2000 compliant. Carrier1 does not know whether the systems of its
vendors, service or capacity suppliers or customers are or will be Year 2000
compliant. Carrier1 has contacted its principal vendors, service or capacity
suppliers and customers and evaluating these parties' efforts to prepare for the
Year 2000 and the degree of its corresponding exposure if such efforts are
inadequate. Carrier1 expects to complete such evaluation by September, 1999.
RISKS OF YEAR 2000 ISSUES
Any failure of the computer systems of Carrier1's vendors, service or
capacity suppliers or customers as a result of not being Year 2000 compliant
could materially and adversely affect Carrier1's ability to operate its network
and retain customers. As noted above, Carrier1 has
21
<PAGE>
contacted its principal vendors, service or capacity suppliers and customers and
is in the process of evaluating Carrier1's risks associated with their
noncompliance.
CONTINGENCY PLANS AND COSTS TO ADDRESS YEAR 2000 ISSUES
Carrier1 is still in the process of developing plans, including a
contingency plan to assess the likelihood of and address worst-case scenarios,
to deal with potential Year 2000 problems caused by a failure of its vendors,
service or capacity suppliers or customers to be Year 2000 compliant. Soon after
it completes its on-going evaluation of the likelihood of such a failure,
Carrier1 expects to substantially complete such plans.
Carrier1 has not incurred any significant costs associated with Year
2000 compliance and does not anticipate incurring significant costs in the
future. Carrier1 may, however, have to bear costs and expenses in connection
with the failure of its vendors, suppliers or customers to be Year 2000
compliant on a timely basis. Because no material Year 2000 issues have yet been
identified in connection with external sources, Carrier1 cannot reasonably
estimate costs which may be required for remediation or for implementation of
contingency plans.
RECENT DEVELOPMENTS
On August 5, 1999, Carrier1 commenced an offer to exchange, for its
dollar- and Euro-denominated notes issued on February 19, 1999, notes that are
registered under the Securities Act of 1933. The new notes will have materially
identical terms (with minor exceptions relating to restrictions on transfers,
payment of additional interest and administrative terms). This exchange offer is
expected to remain open until September 3, 1999.
In the third quarter of 1999, Carrier1 announced an agreement to
swap 12 strands of dark fiber on Carrier1's German ring for 12 strands of
dark fiber covering substantially all of the major cities in France. Like
Carrier1's German fiber infrastructure, this new homogeneous French ring
utilizes the latest generation of high speed, high capacity fiber optic
cable. The French fiber infrastructure will become available in phases
throughout the year of 2000. Moreover, each party has executed an agreement
whereby they will provide certain network maintenance services for the other
party in their respective countries. This swap transaction, in which no cash
will change hand, will be accounted for as a "non monetary transaction" in
accordance with U.S. GAAP.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Because substantially all of Carrier1's outstanding debt at June 30,
1999 is fixed-rate debt, a change in market interest rates would not have a
material effect on Carrier1's earnings, cash flows or financial condition.
Carrier1 is exposed to market risk from changes in foreign currency exchange
rates. As of June 30, 1999, Carrier1 does not have futures, forwards, swaps,
options, and other derivative financial instruments with similar
characteristics to manage the risk arising from these exposures. Carrier1's
market risk exposure exists from changes in foreign currency exchange rates
associated with its non-derivative financial instruments and with
transactions in currencies other than local currencies in which it operates.
Carrier1 has foreign currency exposures related to purchasing and
selling in currencies other than the local currencies in which it operates.
Carrier1's most significant foreign currency exposures relate to Western
European countries (primarily Germany, Switzerland, and the United Kingdom)
where its principle operations exist. However, the introduction of the euro
has significantly reduced in the degree of intra Western European currency
fluctuations to which Carrier1 is subject as of June 30, 1999. Additionally,
Carrier1 is exposed to cash flow risk related to debt obligations denominated
in foreign currencies.
The table below presents principal cash flows and related average
interest rates for Carrier1's obligations by expected maturity dates as of
June 30, 1999. The information is presented in U.S. dollar equivalents,
Carrier1's reporting currency, using the exchange rate at June 30, 1999. the
actual cash flows are payable in either U.S. dollars (US$) or euro (EURO), as
indicated in the parentheses. Average variable interest rates are based on
Carrier1's borrowing rate as of June 30, 1999. Fair value of the dollar and
euro notes was estimated based on quoted market prices. Fair value for all
other debt obligations was estimated using discounted cash flows analyses,
based on Carrier1's borrowing rate as of June 30, 1999.
<TABLE>
<CAPTION>
(IN THOUSANDS)
EXPECTED MATURITY There Fair
DATE 1999 2000 2001 2002 2003 after Total Value
- ------------------ ---- ---- ---- ---- ---- ------ ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Notes Payable:
Fixed Rate (EURO) $ 87,552 $ 87,552 $ 93,680
Interest Rate 13.25% 13.25%
Fixed Rate (US$) $160,000 $160,000 $161,600
Interest Rate 13.25% 13.25%
Fixed Rate (US$) $1,519 $3,038 $3,038 $760 $8,355 $6,735
Fixed Rate 9.7% 9.7% 9.7% 9.7%
Variable Rate (US$) $976 $976 $977 $2,929 $2,028
Interest Rate 9.7% 9.7% 9.7%
</TABLE>
22
<PAGE>
The cash flows in the table above are presented in accordance with
the maturity dates defined in the debt obligations. However, the dollar and
euro notes provide for early redemption at specified dated in stated
principle amounts, plus accrued interest. Carrier1 has not determined if
these debt obligations will be redeemed at the specified early redemption
dates and amounts. Carrier1 may elect to redeem these debt obligations early
at a future date. Cash flows associated with the early redemption of these
debt obligations are not assumed in the table above. Should Carrier1 elect to
redeem these debt obligations earlier than the required maturities, the cash
flow amounts in the table above could change significantly.
23
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Carrier1 may, from time to time, be a party to litigation that arises
in the normal course of its business operations. Carrier1 is not presently a
party to any such litigation that Carrier1 believes would reasonably be expected
to have a material adverse effect on its business or results of operation.
Item 6. Exhibits and Reports on Form 8-K
Exhibits:
4.1 Loan Agreement, dated June 25, 1999, between Carrier1
International S.A. as Borrower, the Lenders and
Financial Institutions named therein, and Nortel
Networks Inc., as Agent (incorporated by reference to
Exhibit 4.8 to Carrier1's registration statement on
Form S-4 (Registration No. 333-75195)).
27.1 Financial Data Schedule
Reports on Form 8-K
None.
24
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Carrier1 International S.A.
Date August 16, 1999 By: /s/ Joachim W. Bauer
---------------------- --------------------------------------
Name: Joachim W. Bauer
Title: Chief Financial Officer
Date August 16, 1999 /s/ Joachim W. Bauer
---------------------- ----------------------------------------
Name: Joachim W. Bauer
Title: Chief Financial Officer
(Principal Financial Officer and Principal
Accounting Officer)
25
<PAGE>
Exhibit Index
4.1 Loan Agreement, dated June 25, 1999, between Carrier1 International S.A.
as Borrower, the Lenders and Financial Institutions named therein, and
Nortel Networks Inc., as Agent (incorporated by reference to Exhibit 4.8
to Carrier1's registration statement on Form S-4 (Registration No.
333-75195)).
27.1 Financial Data Schedule
26
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 50920
<SECURITIES> 135485
<RECEIVABLES> 21570
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 180384
<PP&E> 82909
<DEPRECIATION> 4826
<TOTAL-ASSETS> 325289
<CURRENT-LIABILITIES> 58364
<BONDS> 253979
0
0
<COMMON> 62038
<OTHER-SE> (49092)
<TOTAL-LIABILITY-AND-EQUITY> 325289
<SALES> 32487
<TOTAL-REVENUES> 32487
<CGS> 0
<TOTAL-COSTS> 49460
<OTHER-EXPENSES> 7562
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 12605
<INCOME-PRETAX> (34062)
<INCOME-TAX> 0
<INCOME-CONTINUING> (34062)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (34062)
<EPS-BASIC> (1.23)
<EPS-DILUTED> (1.23)
</TABLE>
