<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
FLAG Telecom Holdings Limited
----------------------------------------------------
(Exact name of registrant as specified in its charter)
March 3, 2000
-----------------------------------------------
Date of Report (Date of earliest event reported)
Bermuda 000-29207 N/A
- ------------------------------ ------------ --------------------
(State or other (Commission (I.R.S. Employer
jurisdiction of incorporation) File Number) Identification No.)
Emporium Building, 69 Front Street, Hamilton HM12, Bermuda
----------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(441) 296-0909
--------------------------------------------------
(Registrant's telephone number, including area code)
<PAGE>
Item 5. OTHER EVENTS.
On March 3, 2000, FLAG Telecom Holdings Limited issued a press release
announcing its financial results for the year ended December 31, 1999. A copy of
(1) the press release, (2) FLAG's audited financial statements and (3) a related
Management's Discussion and Analysis of Financial Condition and Results of
Operations for the relevant period are attached to this Form 8-K as Exhibits
99.1, 99.2 and 99.3, respectively, and are incorporated herein by reference.
Item 7. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Not applicable.
(b) Not applicable.
(c) Exhibits.
<TABLE>
<S> <C>
23.1 Consent of Arthur Andersen & Co.
99.1 Press Release of FLAG Telecom Holdings Limited
99.2 Consolidated Financial Statements of FLAG Telecom
Holdings Limited as of and for the period ended
December 31, 1999
99.3 Management's Discussion and Analysis of Financial
Condition and Results of Operations for the year
ended December 31, 1999 compared to the year ended
December 31, 1998
</TABLE>
<PAGE>
SIGNATURE
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 TELECOM HOLDINGS LIMITED
(Registrant)
Dated: March 3, 2000 By: /s/ Edward McCormack
-------------------------
Edward McCormack
Chief Operating Officer and
Chief Financial Officer
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Item No. Description
- -------- -----------
<S> <C>
23.1 Consent of Arthur Andersen & Co.
99.1 Press Release of FLAG Telecom Holdings Limited
99.2 Consolidated Financial Statements of FLAG Telecom Holdings
Limited as of and for the period ended December 31, 1999
99.3 Management's Discussion and Analysis of Financial Condition
and Results of Operations for the year ended December 31, 1999
compared to the year ended December 31, 1998
</TABLE>
ii
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the inclusion in this Current Report on Form 8-K of our report
dated March 3, 2000 on our audit of the Consolidated Annual Statements of
FLAG Telecom Holdings Limited.
Arthur Andersen & Co.
Hamilton, Bermuda
March 3, 2000
<PAGE>
Exhibit 99.1
FLAG TELECOM HOLDINGS LIMITED ANNOUNCES 4Q AND FY99 RESULTS
CUMULATIVE SALES EXCEED $1.5 BILLION; 1999 ADJUSTED EBITDA INCREASES 86% TO
$128 MILLION
Hamilton, Bermuda - March 3, 2000 - FLAG Telecom (Nasdaq: FTHL; LSE: FTL) today
announced its results for the fourth quarter and full year 1999. Highlights of
the year included the following:
o Cumulative sales on the FLAG Telecom network exceed $1.5 billion.
o Adjusted EBITDA increased 86% to $128 million.
o Sales commitments for over 50% of FLAG Atlantic-1 system capacity.
o First site-to-site wholesale services activated.
o Completion of additional landings in Saudi Arabia and Jordan.
o FLAG Atlantic Limited obtained a $600 million bank facility.
Andres Bande, Chairman and CEO, FLAG Telecom, said: "Following the recent IPO of
the company, we have completed the transition into a public company and are now
set to accelerate the development of our network in furtherance of our objective
of being the leading carriers' carrier providing an innovative range of products
and services over our owned global network. Demand for capacity was strong in
1999 as evidenced by repeat purchases from incumbent carriers and new
commitments from emerging carriers and Internet service providers. Generally
sales were at higher bandwidth units than in 1998 reflecting continued growth in
the Internet and broadband applications."
"We are very pleased with our overall performance for 1999", said Ed McCormack,
COO and CFO, FLAG Telecom. "The fourth quarter results were as expected and the
full year results were ahead of our plan. Adjusted EBITDA was up 86% to $128
million for 1999 compared to $69 million in 1998. Gross revenues for 1999 were
$162 million compared to $208 million in 1998. Reported revenue trends reflected
the requirement to defer some revenues to subsequent periods for accounting
purposes as a result of recent changes in revenue recognition policies and the
inclusion of non-cash items in 1998 reported revenues," he added.
<PAGE>
Due to the coming into effect of a new accounting standard for the second half
of 1999, certain sales of capacity may no longer be recognized as current
revenue because they do not satisfy the requirements for sales-type lease
accounting. Instead, revenues from these sales will be deferred and amortized
over the term of the contract. The result was a deferral of $26.0 million of
revenue in 1999. This deferral in revenue recognition had no impact on cash
flow.
As a result of extending our range of products and services, the Company expects
the greater part of future sales will be under contracts the terms of which will
preclude the application of sales-type lease accounting. Accordingly, during the
first quarter of 2000, the Company intends to depreciate the costs of the
network over its remaining useful life and intends to recognize revenues over
the relevant term of the agreements. To the extent that contracts in the future
satisfy the requirements for sales-type lease accounting, we expect to recognize
revenues without deferral.
The interpretation and application of this accounting practice are still
evolving in the industry and a number of matters have been referred to the
accounting standard setting boards. We expect further clarification over the
next few months, however, the Company notes that any changes of accounting
treatment for capacity sales and network costs will not impact cash flows or
Adjusted EBITDA.
FLAG Telecom owns and operates the FLAG (Fiberoptic Link Around the Globe)
Europe-Asia cable system, stretching 28,000 km from the UK to Japan, and
provides an innovative range of products and services to the international
carrier community and Internet Service Providers.
The FLAG Europe-Asia cable, with 16 operational landing points in 13 countries,
directly connects landings in Japan (2) and the UK, via the Atlantic Ocean,
Mediterranean Sea, Red Sea, Indian Ocean, the South China Sea, and the Pacific
Ocean. The cable is the longest private cable system ever built and provides
high-capacity digital services to international carriers, resellers, and ISPs.
The FLAG Europe-Asia cable, along what is considered the most difficult route of
any cable system in the world, took 27 months and required approximately 4,000
permits to install. It spans many of the world's fastest growing economies and
offers direct connectivity to over 75 percent of the world's population.
Privately financed at a cost of $1.6bn, the cable is designed to meet the
growing demand for international communications services, providing carriers
with a world-class broadband
<PAGE>
superhighway. Currently the company has over 90 telecommunications operators as
customers, including most of the world's top carriers.
FLAG Atlantic-1, the company's latest venture now under construction, is
designed to be the world's first terabit/s transoceanic dual cable system
offering fully protected services between Paris, London and New York. The system
will be a triple-ring, dual cable system, connecting the East Coast of the
United States, with nodes in the heart of New York to two landings in Europe -
one in Brittany, France and the other in Cornwall, UK, with city nodes in Paris
and London. Customers will be able to add traffic either at the shore landing
stations or the city nodes. The planned three self-healing rings are designed to
provide secure end to end circuits to most of the major world business centres.
FA-1 will connect to the FLAG Europe-Asia cable system in Cornwall, UK.
The single FLAG network operations centre (FNOC) is located in the central time
zone of the Europe-Asia route, at Fujairah in the United Arab Emirates. The FNOC
manages all maintenance activity, performance monitoring and activates capacity
on demand. With the addition of FLAG Atlantic-1, which will be built and
operated as a 50:50 joint venture with GTS, the network is expected to extend to
over 42,500 route kilometers, enough to encircle the globe.
www.flagtelecom.com
Attachment: 1999 Results
For further information about FLAG Telecom, please contact:
Jane Windsor Larry Bautista
FLAG Telecom FLAG Telecom
Tel: +44 171 317 0811 Tel: +1 212 319 2995
Fax: +44 171 317 0808 Fax:
M: +44 777 55 23 156 M:
[email protected] [email protected]
- ------------------------ -------------------------
Statements contained in this Press Release which are not historical facts may be
forward-looking statements, as the term is defined in the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements are subject to
risks and uncertainties which could cause actual results to differ materially
from those currently anticipated due to a number of factors, which include, but
are not limited to: the Company's ability to achieve revenues from products and
services that are in the early stages of development or operation, the Company's
completion of FLAG Atlantic-1 within budget and on time, the Company's ability
to deploy sophisticated technologies on a global basis, the Company's ability to
upgrade and expand its network and respond to customer demands and industry
changes, regulatory enactments and changes, competition and pricing pressure,
rapid technological change, adverse foreign economic or political events and
other factors that are discussed in the Company's Registration Statement on Form
F-1 filed with the Securities and Exchange Commission.
<PAGE>
1999 ANNUAL CONSOLIDATED RESULTS
The following table shows the significant income statement amounts, in thousands
for (1) FLAG Telecom Holdings Limited for the year ended December 31, 1999,
being a combination of the results of FLAG Limited for the period from January
1, 1999 to February 26, 1999 and the results of FLAG Telecom for the period from
incorporation to December 31, 1999, and (2) FLAG Limited for the year ended
December 31, 1998. The results of FLAG Telecom Holdings Limited have been
adjusted to eliminate minority interests in order to enable a better comparison
with the results for the year ended December 31, 1998. These adjustments will
not be reflected in our future financial statements:
<TABLE>
<CAPTION>
Year ended Year ended
Dec 31, 1999 Dec 31, 1998
<S> <C> <C>
REVENUE:
Capacity Sales 120,157 182,935
Standby Maintenance and 42,285 25,313
-------- --------
Restoration Revenues
TOTAL REVENUE 162,442 208,248
SALES & OTHER OPERATING COSTS:
Cost of Capacity Sold 49,643 101,288
Operations & Maintenance 31,315 37,931
Sales & Marketing 11,733 10,680
General and Administrative 25,771 21,674
Depreciation 11,366 844
-------- --------
129,828 172,417
OPERATING INCOME 32,614 35,831
Income from Affiliates 361
Interest Expense 54,820 61,128
Interest Income 9,013 14,875
-------- --------
LOSS BEFORE INCOME TAXES (12,832) (10,422)
Provision for Taxes 1,720 1,260
-------- --------
NET LOSS (14,552) (11,682)
Net Loss per share attributable
To common shareholders (0.22) (0.17)
Adjusted EBITDA* 128,112 68,720
Adjusted EBITDA margin** 68% 49%
</TABLE>
* Operating income plus cost of capacity sold, depreciation and amortization,
non-cash stock compensation and change in deferred revenue.
** Adjusted EBITDA divided by the sum of total revenue and change in deferred
revenue.
<PAGE>
FOURTH QUARTER REPORTED CONSOLIDATED RESULTS
The following table summarizes the results as reported for the three months
ended December 31, 1999 and 1998 for FLAG Telecom Holdings Limited and FLAG
Limited, respectively, (numbers in $' 000, except per share amounts):
<TABLE>
<CAPTION>
Quarter ended Quarter ended
Dec 31, 1999 Dec 31, 1998
<S> <C> <C>
REVENUE:
Capacity Sales, Net of Discounts $ 5,380 $ 45,916
Standby Maintenance and 9,067 6,737
-------- --------
Restoration Revenues
14,447 52,653
SALES & OTHER OPERATING COSTS:
Cost of Capacity Sold (2,450) 29,412
Operations & Maintenance 8,782 9,174
Sales & Marketing 3,011 2,388
General and Administrative 10,113 3,915
Depreciation 5,913 314
-------- --------
25,369 45,203
OPERATING INCOME (LOSS) (10,922) 7,450
Income from Affiliates 361
Interest Expense 13,798 14,231
Interest Income 2,264 3,154
-------- --------
LOSS BEFORE MINORITY INTEREST AND (22,095) (3,627)
INCOME TAXES
MINORITY INTEREST (5,745) --
-------- --------
LOSS BEFORE INCOME TAXES (16,350) (3,627)
PROVISIONS FOR INCOME TAXES 451 (229)
--------
NET LOSS (16,801) (3,398)
-------- --------
Net loss per share attributed to $ (0.24) $ (0.03)
common shareholders
</TABLE>
<PAGE>
Exhibit 99.2
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of FLAG Telecom Holdings Limited:
We have audited the accompanying consolidated balance sheet of FLAG Telecom
Holdings Limited (a Bermuda company) and subsidiaries (the "Group") as of
December 31, 1999, and the related consolidated statement of operations,
comprehensive income, shareholders' equity and cash flows for the period from
incorporation to December 31, 1999. These financial statements are the
responsibility of FLAG Telecom Holdings Limited's management. Our responsibility
is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of FLAG Telecom
Holdings Limited and subsidiaries as of December 31, 1999, and the consolidated
results of their operations and their cash flows for the period from
incorporation to December 31, 1999, in conformity with accounting principles
generally accepted in the United States.
Arthur Andersen & Co.
Hamilton, Bermuda
March 3, 2000
F-2
<PAGE>
FLAG TELECOM HOLDINGS LIMITED
CONSOLIDATED BALANCE SHEET
AS OF DECEMBER 31, 1999
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1999
----------
<S> <C>
ASSETS:
Current assets:
Cash...................................................... $ 3,191
Accounts receivable, net of allowance for doubtful
accounts of $6,827...................................... 90,065
Due from affiliate........................................ 2,000
Prepaid expenses and other assets......................... 3,460
----------
98,716
Funds held by collateral trustee............................ 134,066
Capacity available for sale................................. 774,366
Capitalized financing costs, net of accumulated amortization
of $2,731................................................. 11,678
Investment in associated companies.......................... 7,162
Fixed assets, net........................................... 299,743
----------
$1,325,731
==========
LIABILITIES:
Current liabilities:
Accrued construction costs................................ $ 52,411
Accrued liabilities....................................... 39,152
Accounts payable.......................................... 7,807
Income taxes payable...................................... 4,531
Deferred revenue and other.................................. 48,501
----------
152,402
8 1/4% Senior Notes, due 2008, net of unamortized discount
of $4,878................................................. 425,270
Long-term debt.............................................. 190,000
Deferred revenue and other.................................. 100,724
Deferred taxes.............................................. 3,973
----------
872,369
MINORITY INTEREST........................................... 154,817
SHAREHOLDERS' EQUITY:
Common shares, $.0006 par value............................. 42
Additional paid-in capital.................................. 313,848
Foreign currency translation adjustment..................... 141
Accumulated deficit......................................... (15,486)
----------
298,545
----------
$1,325,731
==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
FLAG TELECOM HOLDINGS LIMITED
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1999
-----------
<S> <C>
REVENUES:
Capacity sales, net of discounts.......................... $ 94,603
Standby maintenance and restoration revenue............... 37,827
-----------
132,430
SALES AND OTHER OPERATING EXPENSES:
Cost of capacity sold..................................... 41,349
Operations and maintenance (including non-cash
compensation expense of $2,647)......................... 26,201
Sales and marketing (including non-cash compensation
expense of $1,534)...................................... 11,096
General and administrative (including non-cash
compensation expense of $4,619)......................... 22,901
Depreciation and amortization............................. 11,133
-----------
112,680
OPERATING INCOME............................................ 19,750
INCOME FROM AFFILIATE....................................... 361
INTEREST EXPENSE............................................ 45,062
INTEREST INCOME............................................. 7,188
-----------
LOSS BEFORE MINORITY INTEREST AND INCOME TAXES.............. (17,763)
MINORITY INTEREST........................................... (3,826)
-----------
LOSS BEFORE INCOME TAXES.................................... (13,937)
PROVISION FOR INCOME TAXES.................................. 1,549
-----------
NET LOSS.................................................... $ (15,486)
===========
Basic income per common share............................... $ (0.22)
Diluted income per common share............................. $ (0.21)
Weighted average common shares outstanding.................. 69,709,935
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
FLAG TELECOM HOLDINGS LIMITED
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
FOR THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999
(EXPRESSED IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
1999
--------
<S> <C>
NET LOSS.................................................... $(15,486)
Foreign currency translation adjustment..................... 141
--------
COMPREHENSIVE INCOME........................................ $(15,345)
--------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
FLAG TELECOM HOLDINGS LIMITED
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
FOREIGN
COMMON SHARES ADDITIONAL CURRENCY TOTAL
---------------------- PAID-IN STOCK RETAINED TRANSLATION SHAREHOLDERS'
SHARES AMOUNT CAPITAL COMPENSATION EARNINGS ADJUSTMENT EQUITY
---------- --------- ---------- ------------ -------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Opening balance........... -- $ -- $ -- $ -- $ -- $ -- $ --
Issuance of shares in
exchange for shares in
FLAG Limited............ 69,709,935 42 305,048 -- -- -- 305,090
Stock compensation
accrued................. -- -- 18,088 (18,088) -- --
Stock compensation current
year charge............. -- -- -- 8,800 -- -- 8,800
Foreign currency
translation
adjustment.............. -- -- -- -- -- 141 141
Net loss for period....... -- -- -- -- (15,486) -- (15,486)
---------- --------- -------- ------- -------- ---- --------
Balance, December 31,
1999.................... 69,709,935 $ 42 $323,136 $(9,288) $(15,486) $141 $298,545
========== ========= ======== ======= ======== ==== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
FLAG TELECOM HOLDINGS LIMITED
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999
(EXPRESSED IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
1999
--------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss applicable to common shareholders.................. $(15,486)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Minority interest......................................... (3,826)
Amortization of financing costs........................... 1,370
Provision for doubtful accounts........................... (1,803)
Accretion of discount on 8 1/4% senior notes.............. 493
Stock compensation........................................ 8,800
Depreciation and amortization............................. 11,133
Deferred taxes............................................ 625
Add (deduct) net changes in operating assets and
liabilities:
Accounts receivable..................................... 1,078
Due from affiliate...................................... (2,000)
Prepaid expenses and other assets....................... 86
Capacity available for sale............................. 47,463
Accounts payable and accrued liabilities................ 24,972
Income taxes payable.................................... (2,793)
Due to affiliate........................................ (1,175)
Deferred revenue and other.............................. 46,845
--------
Net cash provided by operating activities............. 115,782
CASH FLOWS FROM FINANCING ACTIVITIES:
Financing costs incurred.................................... (970)
Repayment of long-term debt................................. (66,500)
Decrease in funds held by collateral trustee................ 85,068
--------
Net cash provided by financing activities............. $ 17,598
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash paid for construction.................................. (123,558)
Investment in affiliate..................................... (7,162)
--------
Purchase of fixed assets.................................... (1,407)
--------
Net cash used in investing activities................. (132,127)
NET INCREASE IN CASH........................................ 1,254
Effect of foreign currency movements........................ 21
CASH, beginning of period................................... 1,916
--------
CASH, end of year........................................... $ 3,191
========
SUPPLEMENTAL INFORMATION ON NON-CASH INVESTING ACTIVITIES:
Decrease in capacity available for sale..................... $ 59,463
Decrease in accrued construction costs...................... (12,000)
--------
Cost of capacity sold....................................... $ 47,463
--------
SUPPLEMENTAL INFORMATION ON NON-CASH INVESTING ACTIVITIES:
Increase in construction in progress........................ $ 34,039
Decrease in accrued construction costs...................... 89,519
--------
Cash paid for construction in progress...................... $123,558
--------
SUPPLEMENTAL INFORMATION DISCLOSURE OF CASH FLOW
INFORMATION:
Interest expense for period................................. $ 45,062
Amortization of financing costs............................. (1,863)
Decrease (increase) in accrued interest payable............. (4,170)
--------
Interest paid............................................... $ 39,029
--------
Interest capitalized........................................ $ 1,281
--------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-7
<PAGE>
FLAG TELECOM HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)
1. BACKGROUND
FLAG Telecom was incorporated on February 3, 1999 to serve as the holding
company for the FLAG Telecom group of companies. On February 26, 1999 FLAG
Telecom acquired approximately 65.79% of FLAG Limited by exchanging 69,709,935
shares of FLAG Limited common stock for the same number of shares of FLAG
Telecom common stock. The minority shareholder of FLAG Limited exchanged its
remaining holding in FLAG Limited for shares in FLAG Telecom on January 4, 2000
such that on that date FLAG Limited became a wholly owned subsidiary of FLAG
Telecom. This acquisition has been accounted for as a recapitalisation such that
no goodwill arises and assets and liabilities are reflected at carryover basis.
The results of the operations of FLAG Limited have been included in the
consolidated results of FLAG Telecom's operations since the date of acquisition.
FLAG Limited is a facilities-based provider of telecommunications capacity
to licensed international carriers through its ownership of the world's longest
independent, privately-owned digital fiberoptic undersea cable system. The FLAG
Europe-Asia cable system links the telecommunications markets of Western Europe
and Japan through the Middle East, India, Southeast Asia and China, along a
route which adjoins countries with approximately 75% of the world's population.
The FLAG Europe-Asia cable system was constructed to address the growing demand
for high performance, secure and cost-effective digital communications for
voice, data and video along its route. FLAG Limited provides capacity on the
FLAG Europe-Asia cable system at market-based prices to licensed international
carriers. The FLAG Europe-Asia cable system, which was placed in commercial
service on November 22, 1997, cost approximately $1.6 billion to construct, and
consists of over 28,000 kilometers of fiberoptic cable.
FLAG Telecom also has an indirect 50% interest in FLAG Atlantic Limited via
FLAG Atlantic Holdings Limited, a wholly-owned subsidiary. FLAG Atlantic Limited
is a joint venture company set up to build, own and operate a transatlantic
fiber optic cable system connecting the United States, United Kingdom and
France. Global Telesystems Group, Inc. owns the other 50% interest in the
venture. The transatlantic cable system will be designed to carry voice,
high-speed data and video traffic. The FLAG Atlantic system is expected to be
ready for service in the first quarter of 2001.
FLAG Telecom is also developing various wholesale services, which will
provide customers city-to-city and site-to-site managed bandwidth on a short
term lease basis. The first such service on the London to Madrid route went into
service in the fourth quarter.
2. SIGNIFICANT ACCOUNTING POLICIES
These financial statements have been prepared in accordance with accounting
principles generally accepted in the United States ("U.S. GAAP") and are
expressed in U.S. Dollars ("Dollars"). The preparation of financial statements
in conformity with U.S. GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of
F-8
<PAGE>
FLAG TELECOM HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
revenues and expenses during the reporting period. Actual results could differ
from those estimates. The significant accounting policies are summarized as
follows:
a) Basis of Consolidation
The financial statements consolidate the financial statements of FLAG
Telecom and its subsidiary companies after eliminating intercompany transactions
and balances. Investments in which FLAG Telecom has an investment of 20%-50% or
investments in which FLAG Telecom can assert significant influence, but does not
control, are accounted for under the equity method. The excess of the
contributions over the Group's proportionate share of the net assets acquired
are amortized on a straight line basis over the expected economic life and is
recorded as a component of "income from affiliates".
b) Revenue Recognition
Capacity contracts are accounted for as leases. For contracts that satisfy
sales type lease accounting, revenues are recognized upon the date the risks and
rewards of ownership are transferred to the purchaser, which is the date the
capacity is made available for activation and the customer becomes responsible
for maintenance charges. As a result of the issue of Interpretation 43 "Real
Estate Sales, an interpretation of FASB Statement No. 66", capacity contracts
entered into after June 30, 1999 must satisfy the additional requirements for
sales of real estate to qualify for sales type lease accounting.
Capacity contracts that do not qualify for sales type lease accounting are
accounted for as operating leases and revenue is recognized over the term of the
lease. Until June 30, 1999 revenues from operating lease transactions were
considered incidental and recorded as a reduction of the capacity available for
sale.
Payments received from customers before the relevant criteria for revenue
recognition are satisfied are included in deferred revenue.
Because substantially all receivables under agreements qualifying as
sales-type leases are receivable within 75 days of the date the risks and
rewards of ownership are transferred to the customer, the accounts receivable
balance in the accompanying balance sheets, representing the gross future
minimum lease payments due, approximates the present value of future minimum
lease payments. Amounts billed to customers for maintenance and repair services
are invoiced separately from capacity lease payments. There are no guaranteed or
unguaranteed residual values accruing to the benefit of the Group.
In exchange for construction costs incurred, FLAG Limited had granted
credits to suppliers toward future capacity. In addition, certain customers have
committed to purchase capacity at a future date under signed capacity credit
agreements. Such amounts received or receivable under these agreements and the
capacity credits granted to suppliers are recorded as deferred revenue until the
date the credits are utilized, at which time the deferred revenue is recognized
as earned. Amounts receivable under these capacity agreements are reflected
within accounts receivable in the accompanying balance sheets. Deferred revenue
also includes amounts invoiced for standby maintenance which are applicable to
future periods.
F-9
<PAGE>
FLAG TELECOM HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Standby maintenance and restoration charges are invoiced separately from
capacity sales. Revenues relating to standby maintenance and restoration are
recognized over the period the service is provided.
c) Cost of Sales
The cost relating to capacity sold under sales type lease contracts is
recognized as cost of sales upon recognition of revenues. The amount charged to
cost of sales is based on the ratio of capacity sales recognized as revenues in
the period to total expected revenues over the entire life of the cable system
multiplied by the total construction costs. This calculation of cost of sales
matches costs with the relative sales value of each sale to total expected
revenues.
Management's estimate of total expected revenues over the life of the cable
system may change due to a number of factors affecting estimated future revenues
including changes in management's estimate of the units of capacity to be sold
and changes in the expected sales value per unit of capacity to be sold.
Additionally, the cost per unit will decrease in the event the capacity of the
cable system is upgraded in the future to increase the units of capacity
available for sale. Changes in management's estimate of total expected revenues
over the life of the cable system will result in adjustments to the calculations
of cost of sales. These adjustments will be recorded on a prospective basis over
future periods commencing with the period management revises its estimate.
Costs of the network relating to capacity contracts accounted for as
operating leases are treated as fixed assets and depreciated over the remaining
economic life of the network.
d) Commissions
Commissions for purchase commitments are recognized as an expense upon
recognition of the related revenues.
e) Capacity Available for Sale and Construction in Progress
Capacity available for sale is recorded at the lower of cost or fair value
less cost to sell and is charged to cost of sales as capacity is sold. Until
contracts are entered into that preclude sales type lease accounting for a
particular segment, the cost of such segment will remain in capacity available
for sale. Construction in progress is transferred to capacity available for sale
at the date it is completed and placed into commercial operation if the capacity
contracts on the particular segment will satisfy sales type lease accounting
rules. Construction in progress relating to other segments is transferred to
fixed assets and depreciated over its remaining economic life. Construction in
progress is stated at cost. Capitalized costs include costs incurred under the
construction contract, engineering and consulting fees, legal fees related to
obtaining landing right licenses, costs related to program management, costs for
the route surveys, and other costs necessary for developing the cable system.
f) Capitalized Financing Costs
Costs incurred by FLAG Limited to obtain financing for the FLAG Europe-Asia
cable system have been capitalized and are being amortized over the term of the
related borrowings. Capitalized costs relating to existing financings are
written off when a refinancing occurs.
F-10
<PAGE>
FLAG TELECOM HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
g) Fixed Assets
Fixed assets are stated at cost, net of accumulated depreciation.
Depreciation is provided on a straight-line basis over the estimated useful
lives of the assets as follows:
<TABLE>
<S> <C>
Computer equipment..................................... 33 1/3% per annum
Fixtures and fittings.................................. 20% per annum
Leashold improvement................................... remaining lease term
Motor vehicles......................................... 20% per annum
Network assets......................................... 6 2/3% per annum
</TABLE>
h) Interest Rate Derivatives
The Group uses derivative financial instruments for the purpose of reducing
its exposure to adverse fluctuations in interest rates. The Group does not
utilize derivative financial instruments for trading or other speculative
purposes. The counterparties to these instruments are major financial
institutions with high credit quality. The Group is exposed to credit loss in
the event of nonperformance by these counterparties.
At the end of March 1998, FLAG Limited entered into two interest rate swap
agreements to manage its exposure to interest rate fluctuations on the $370,000
bank credit facility undertaken on January 30, 1998 (the "New Credit Facility").
Under the swap agreements, FLAG Limited pays a fixed rate of 5.60% 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 by an
additional one year and six months, respectively, at the option of the
counterparty.
The 8 1/4% Senior Notes arising on the refinancing undertaken on
January 30, 1998 (the "Senior Notes") accrue interest at the rate of 8 1/4% per
annum paid semi-annually on January 30 and July 30 of each year, commencing on
July 30, 1998 (see Note 4. "Long-term Debt"). Interest is expensed as it
accrues. The Senior Notes are redeemable at FLAG Limited's option, in whole or
in part, at any time on or after January 30, 2003, at specified option prices.
In the event of any equity offering before January 31, 2001, FLAG Limited may
use all or a portion of the net proceeds therefrom to redeem up to 33 1/3% of
the original principal amount of the Senior Notes at a redemption price of
108.25% plus accrued and unpaid interest. If FLAG Limited has excess cash flow,
as defined, for any fiscal year commencing in 2001, FLAG Limited is required,
subject to certain exceptions and limitations, to make an offer to purchase the
Senior Notes at specified prices. Upon a change in control, the noteholders may
require FLAG Limited to purchase all or any portion of the outstanding notes at
a price equal to 101% of the principal amount plus accrued but unpaid interest.
For interest rate derivatives to qualify for hedge accounting, the debt
instrument being hedged must expose the Group to interest rate risk and, at the
inception of the derivative instrument and throughout the period the derivative
is held, there must be a high correlation of changes in the market value of the
derivative and interest expense of the hedged item. Under hedge accounting, net
interest
F-11
<PAGE>
FLAG TELECOM HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
payments due to or from the counterparties are recorded as an increase or
reduction in interest expense.
If an interest rate derivative instrument were to terminate or be replaced
by another instrument and no longer qualify as a hedge instrument, then it would
be marked to market and carried on the balance sheet at fair value.
i) Translation of Foreign Currencies
Transactions in foreign currencies are translated into United States Dollars
at the rate of exchange prevailing at the date of each transaction. Monetary
assets and liabilities denominated in foreign currencies at year end are
translated into Dollars at the rate of exchange at that date. Foreign exchange
gains or losses are reflected in the accompanying statements of operations.
The statements of operations of overseas subsidiary undertakings are
translated into United States Dollars at average exchange rates and the year-end
net investments in these companies are translated at year-end exchange rates.
Exchange differences arising from retranslation at year-end exchange rates of
the opening net investments and results for the year are charged or credited
directly to the cumulative translation adjustment in shareholders' equity.
j) Long Term Incentive Plan
As permitted by Statement of Financial Accounting Standards No. 123,
"Accounting for Stock Based Compensation" (SFAS 123), the Company has chosen to
account for employee stock options under Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" (APB 25), and, accordingly,
recognizes compensation expense for stock option grants to the extent that the
estimated fair value of the stock exceeds the exercise price of the option at
the measurement date. The compensation expense is charged against operations
ratably over the vesting period of the options.
k) Income Taxes
Deferred taxes are determined based on the difference between the tax basis
of an asset or liability and its reported amount in the financial statements. A
deferred tax liability or asset is recorded using the enacted tax rates expected
to apply to taxable income in the period in which the deferred tax liability or
asset is expected to be settled or realized. Future tax benefits attributable to
these differences, if any, are recognizable to the extent that realization of
such benefits is more likely than not.
l) Net Income per Common Share
Basic net income per common share is based on dividing net income applicable
to common shareholders by the weighted average number of common shares
outstanding in the period. Diluted net income per common share is computed by
dividing net income by the weighted average number of common shares and common
share equivalents outstanding during the period.
F-12
<PAGE>
FLAG TELECOM HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
m) Impairment of Long-Lived Assets
The Group periodically reviews events and changes in circumstances to
determine whether the recoverability of the carrying value of long-lived assets
should be reassessed. Should events or circumstances indicate that the carrying
value may not be recoverable based on undiscounted future cash flows, an
impairment loss measured by the difference between the discounted cash flows and
the carrying value of long-lived assets would be recognized by the Group.
n) Pending Accounting Standards
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standard No. 133, "Accounting for Derivative Instruments and Hedging
Activities" (SFAS 133). Following the amendment made by SFAS No. 137, SFAS 133
is effective for periods beginning after June 15, 2000. Management is currently
assessing the impact of the adoption of SFAS 133 on the Company's financial
position and results of operations, which may be material.
o) Reverse Stock Split
The accompanying consolidated financial statements have been retroactively
restated to give effect to the reverse stock split of 6:1 carried out by the
Company on February 11, 2000.
3. FIXED ASSETS
Fixed assets consist of the following:
<TABLE>
<CAPTION>
1999
--------
<S> <C>
Fixtures and fittings....................................... $ 1,504
Leasehold improvements...................................... 2,667
Computer equipment.......................................... 3,031
Motor vehicles.............................................. 286
Network assets.............................................. 304,508
--------
311,996
Less--Accumulated depreciation.............................. (12,253)
--------
Net book value.............................................. $299,743
========
</TABLE>
As a result of the application of FIN 43, sales on certain parts of the FLAG
system will not be able to satisfy the requirements for sales type lease
accounting. Accordingly the costs of these parts of the system have been
reclassified with effect from July 1, 1999 from capacity available for sale to
fixed assets and are being depreciated over their remaining useful economic life
of 15 years.
F-13
<PAGE>
FLAG TELECOM HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)
4. LONG-TERM DEBT
The Group's long-term debt comprises the following:
<TABLE>
<CAPTION>
1999
--------
<S> <C>
Bank credit facility........................................ $190,000
8 1/4% Senior Notes, due 2008, net of unamortized discount
of $4,730................................................. $425,270
</TABLE>
On January 30, 1998, FLAG Limited completed a refinancing which consisted of
$370,000 of bank credit facilities under the New Credit Facility and $430,000 of
the Senior Notes. Proceeds received under the Senior Notes were $424,088, net of
a $5,912 discount. The Senior Notes are not secured by any asset of the Group.
Accordingly, they are effectively subordinated to any secured obligation arising
from the New Credit Facility.
The bank credit facilities include a seven-year $320,000 term loan facility
and a $50,000 revolving credit facility. Total Group borrowings under the credit
facility at December 31, 1999 are $190,000. Under the term loan and revolving
credit facilities, borrowings bear interest at LIBOR plus 190 to 212.5 basis
points and are secured by a pledge of substantially all of FLAG Limited's assets
and revenues, other than FLAG Limited's physical assets.
The New Credit Facility and the indenture under which the Senior Notes were
issued impose certain operating and financial restrictions on FLAG Limited. Such
restrictions will affect, and in many respects significantly limit or prohibit,
among other things, the ability of FLAG Limited to incur additional
indebtedness, repay indebtedness (including the Senior Notes) prior to stated
maturities, sell assets, make investments, engage in transactions with
shareholders and affiliates, issue capital stock, create liens or engage in
mergers or acquisitions. These restrictions could also limit the ability of FLAG
Limited to effect future financings, make needed capital expenditures, withstand
a future downturn in FLAG Limited's business or the economy in general, or
otherwise conduct necessary corporate activities.
The collateral trustee maintains certain accounts in accordance with the
terms of FLAG Limited's credit facility. The collateral trustee has a security
interest in these accounts.
As at December 31, 1999, contractual maturities of the Group's indebtedness
over the next five years were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------
<S> <C>
2000........................................................ --
2001........................................................ --
2002........................................................ --
2003........................................................ 58,080
2004........................................................ 105,600
</TABLE>
F-14
<PAGE>
FLAG TELECOM HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)
4. LONG-TERM DEBT (CONTINUED)
The above bank credit facility was amended on February 16, 2000 and the
contractual maturities of the new facility over the next five years are as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------
<S> <C>
2000........................................................ --
2001........................................................ 5,625
2002........................................................ 22,500
2003........................................................ 28,125
2004........................................................ 35,625
</TABLE>
5. SHAREHOLDER'S EQUITY
The authorized common share capital of FLAG Telecom consists of 189,833,333
shares with a par value of $.0006 per share. The following number of shares were
issued and outstanding at December 31, 1999.
<TABLE>
<CAPTION>
1999
-----------
<S> <C>
Shares outstanding.......................................... 69,709,935
Share capital............................................... $ 42
</TABLE>
On February 26, 1999, FLAG Limited's shareholders other than Bell Atlantic
Network Systems exchanged all their common shares in FLAG Limited for common
shares in FLAG Telecom. Bell Atlantic Network Systems, however, exchanged only a
limited portion of its common shares in FLAG Limited for 3,666,155 common shares
in FLAG Telecom. At the same time, Bell Atlantic Network Systems and FLAG
Telecom entered into an Exchange Agreement and Plan of Reorganization providing
that Bell Atlantic Network Systems' remaining common shares in FLAG Limited
would be exchanged for common shares in FLAG Telecom in the event that, prior to
February 26, 2002, Bell Atlantic receives certain regulatory approvals from the
Federal Communications Commission allowing Bell Atlantic to offer long distance
service. Such regulatory approvals were obtained and Bell Atlantic exchanged its
remaining common shares in FLAG Limited for 36,256,121 common shares in FLAG
Telecom on January 4, 2000.
By ownership of their common shares, the shareholders are entitled to one
vote per share at each meeting of the shareholders and, at any general meeting
or special meeting of all shareholders. Common shareholders are entitled to
receive dividends or distributions declared or paid, pro rata in proportion to
the total number of common shares held.
6. STOCK OPTIONS
In March, 1998, the Group adopted a Long-Term Incentive Plan under which
options may be granted on up to 4,206,305 shares of common stock to eligible
members of staff. During 1999, the maximum number of options that could be
granted under the plan was increased to 6,763,791. Generally, options granted
under this plan vest and are exercisable over periods up to four years from
F-15
<PAGE>
FLAG TELECOM HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)
6. STOCK OPTIONS (CONTINUED)
the date of their grant, subject to meeting certain qualifying criteria. All
options vest no later than eight years and expire ten years after the date of
grant.
The following summarizes stock option activity under this plan:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
--------- ----------------
<S> <C> <C>
Balance December 31, 1997.......................... -- $ --
Granted............................................ 2,357,706 6.42
Forfeited.......................................... -- --
--------- ------
Balance December 31, 1998.......................... 2,357,706 6.42
Granted............................................ 1,758,344 6.80
Forfeited.......................................... (21,651) 6.42
--------- ------
Balance December 31, 1999.......................... 4,094,399 $ 6.58
========= ======
</TABLE>
At December 31, 1998 and December 31, 1999 no options had vested.
The weighted average fair value of options granted during 1998 and 1999 was
$3.64 and $13.15 per share respectively. The fair value of each option grant is
estimated on the date of grant using the Black-Scholes option pricing model with
the following assumptions used for grants in 1998 and 1999: risk-free interest
rates ranging from 5.1% to 5.8%; expected lives of 5.0 years; expected dividend
yield of zero percent; and expected volatility of 59%.
During the period ended December 31, 1999 the Company recorded additional
shareholders capital of $18,088 relating to awards under the Long Term Incentive
Plan. During the period the Company recorded an expense of $8,800. Expected
future charges in respect of these stock options are as follows:
<TABLE>
<S> <C>
2000........................................................ 7,231
2001........................................................ 2,007
2002........................................................ 50
</TABLE>
F-16
<PAGE>
FLAG TELECOM HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)
6. STOCK OPTIONS (CONTINUED)
Had compensation cost for these grants been determined consistent with
Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based
Compensation," the Group's net income and net income per share would have been
reduced to the following amounts:
<TABLE>
<CAPTION>
NET LOSS 1999
- -------- --------
<S> <C>
As reported............................................... $(15,486)
Pro forma................................................. $(26,967)
Basic income per share
As reported............................................... $ (0.22)
Pro forma................................................. $ (0.39)
Diluted income per share
As reported............................................... $ (0.21)
Pro forma................................................. $ (0.37)
</TABLE>
The weighted average remaining contractual life of all options is 8.9 years.
The effects of applying SFAS 123 for disclosing compensation cost may not be
representative of the effects on reported income for future years.
7. BASIC AND DILUTED INCOME PER COMMON SHARE
<TABLE>
<CAPTION>
1999
-----------
<S> <C>
Net loss.................................................... $ (15,486)
Number of shares............................................ 69,709,935
Basic income per share...................................... $ (0.22)
Diluted income per share.................................... $ (0.21)
</TABLE>
8. FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and fair values of the
Group's financial instruments as of December 31, 1999:
<TABLE>
<CAPTION>
1999
NOTIONAL CARRYING FAIR
AMOUNT AMOUNT VALUE
-------- -------- --------
<S> <C> <C> <C>
Funds held by Collateral Trustee................. -- 134,066 134,066
8 1/4% Senior Notes.............................. 430,000 425,270 395,600
Long-term debt................................... -- 190,000 190,000
Interest rate swaps.............................. 160,000 -- 370
</TABLE>
The notional amounts of interest rate derivatives do not represent amounts
exchanged by the parties and, thus, are not a measure of the Group's exposure
through its use of derivatives. The amounts exchanged are determined by
reference to the notional amounts and the other terms of the derivatives.
F-17
<PAGE>
FLAG TELECOM HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)
8. FINANCIAL INSTRUMENTS (CONTINUED)
The Company is exposed to credit-related losses in the event of
nonperformance by counterparties to financial instruments but does not expect
any counterparties to fail to meet their obligations. The Company deals only
with highly rated counterparties.
<TABLE>
<S> <C>
Funds held by Collateral Trustee................ The carrying amount is a reasonable estimate of
fair value as the balance includes amounts held in
banks and time deposits with a short-term maturity.
8 1/4% Senior Notes............................. The carrying amount of the 8 1/4% Senior Notes is
the net proceeds of the Senior Notes issue. The
fair value is based on the market price of the
Senior Notes at December 31, 1999.
Long-term debt.................................. The carrying amount of the long term debt is the
proceeds drawn on the New Credit Facility. The debt
is subject to variable interest rates, and
therefore, in management's opinion, the carrying
amount approximates the fair value of the long term
debt.
Interest rate swaps............................. The interest rate swaps agreements are "zero cost"
meaning that the cost of acquiring the agreement is
embedded in the interest rate spread. As such, the
agreement does not have a carrying value. The fair
value is estimated using an option pricing model
and values the changes in interest rates since
inception, and the potential for future changes
over the remaining term.
</TABLE>
9. TAXES
At the present time, no income, profit, capital or capital gains taxes are
levied in Bermuda. In the event that such taxes are levied, FLAG Telecom and all
its subsidiaries registered in Bermuda have received an undertaking from the
Bermuda Government exempting them from all such taxes until March 28, 2016.
The provision for income taxes reflected in the accompanying statement of
operations consists of taxes incurred on income derived from capacity sales and
standby maintenance revenues from customers in certain jurisdictions along the
FLAG Europe-Asia cable system where FLAG Limited is deemed to have a taxable
presence or the Group is otherwise subject to tax.
F-18
<PAGE>
FLAG TELECOM HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)
9. TAXES (CONTINUED)
Income tax expense, which consists entirely of taxes payable to foreign
governments, is comprised of the following:
<TABLE>
<CAPTION>
1999
--------
<S> <C>
Current..................................................... 1,080
Deferred.................................................... 469
------
$1,549
</TABLE>
Deferred taxes arise principally because, for tax purposes, in certain
jurisdictions, revenues from capacity sales are deferred and recognized as
taxable income over the estimated life of the FLAG Europe-Asia cable system. The
provision for deferred tax comprises the following:
<TABLE>
<CAPTION>
1999
--------
<S> <C>
Capacity sales revenues deferred for tax purposes........... $17,066
Deferred commissions for tax purposes....................... (1,851)
Future depreciation for tax purposes........................ (8,648)
Tax losses carried forward.................................. (2,220)
Other....................................................... (374)
-------
$ 3,973
</TABLE>
Since Bermuda does not impose an income tax, the difference between reported
tax expense in the accompanying statements of operations and tax as computed at
statutory rates, is attributable to the provisions for foreign taxes shown
above.
10. RELATED PARTY TRANSACTIONS
In May 1998, FLAG Limited entered into an Employee Services Agreement with
Bell Atlantic Global Systems ("BAGS") pursuant to which BAGS seconds certain
employees to FLAG Limited. The total cost incurred for this service during the
period from incorporation to December 31, 1999 was $298. These costs have been
expensed in the accompanying statements of operations.
11. COMMITMENTS AND CONTINGENCIES
As of December 31, 1999, FLAG Limited was committed under supply contracts
for the cable system for final payments totalling $52,411 representing funds
withheld pending the completion of certain outstanding items under the supply
contracts. Provision has been made in full in the Group's financial statements
to cover the anticipated final payments.
During 1997 FLAG Limited entered into an operations contract for the FLAG
Network Operations Center (the "FNOC") with one of the landing parties on the
FLAG, Europe-Asia cable system. The terms of the contract require the landing
party to provide a permanent facility in which to locate the FNOC along with
qualified personnel and additional support as required to assist in the
operations of the FNOC. In exchange for the services provided under the
contract, FLAG Limited is committed to compensate the landing party an annual
fixed charge for rent of the premises where the
F-19
<PAGE>
FLAG TELECOM HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE PERIOD FROM INCORPORATION TO DECEMBER 31, 1999
(EXPRESSED IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
FNOC is located equal to $200 for the first year of the contract increasing in
5% increments for the following three years. Costs incurred by the landing party
to provide qualified personnel and additional support are to be reimbursed by
FLAG Limited on a cost plus basis.
FLAG Limited has entered into lease agreements for the rental of office
space. Estimated future minimum rental payments under the leases are as follows:
<TABLE>
<S> <C>
2000........................................................ $1,301
2001........................................................ 717
2002........................................................ 556
2003........................................................ 541
2004........................................................ 541
Thereafter.................................................. 2,291
</TABLE>
FLAG Limited is also committed to make quarterly payments under standby
maintenance agreements for the period commencing October 8, 1997 and continuing
through December 31, 2007. Estimated future payments under the standby
maintenance agreements are as follows:
<TABLE>
<S> <C>
2000........................................................ $24,540
2001........................................................ 24,790
2002........................................................ 25,286
2003........................................................ 25,792
2004........................................................ 26,307
Thereafter.................................................. 82,121
</TABLE>
The estimated future payments under the standby maintenance agreements are
based on a number of assumptions, including, among other things, the proportion
of the total cable system capacity sold at any point in time and the number of
other cable systems serviced under the agreement.
The Group is subject to legal proceedings and claims in the ordinary course
of business. Based on consultations with legal counsel, management does not
believe that any of these proceedings or claims will have a material effect on
the Group's financial position or results of operations.
F-20
<PAGE>
Exhibit 99.3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
YOU SHOULD READ THIS DISCUSSION IN CONJUNCTION WITH OUR CONSOLIDATED
FINANCIAL STATEMENTS AND NOTES THERETO. THIS DISCUSSION CONTAINS
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THOSE DISCUSSED IN THE FORWARD-LOOKING
STATEMENTS AS A RESULT OF VARIOUS FACTORS, INCLUDING THOSE SET FORTH IN
"RISK FACTORS" AND ELSEWHERE IN OUR REGISTRATION STATEMENT ON FORM F-1
(FILE NO. 333-94899) PREVIOUSLY FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION.
FLAG TELECOM GROUP OF COMPANIES
FLAG Telecom was formed in February 1999 to be the parent company for the
FLAG Telecom group of companies. The principal companies which comprise the
FLAG Telecom group of companies are FLAG Limited, FLAG Atlantic Limited and
FLAG Wholesale Services Limited. Pursuant to a restructuring on February 26,
1999, FLAG Limited became our 66% owned subsidiary and the other companies
then comprising the FLAG Telecom group of companies became our wholly owned
subsidiaries, other than FLAG Atlantic Limited in which we have a 50%
ownership interest. On January 4, 2000, we acquired the remaining 34%
ownership interest in FLAG Limited and FLAG Limited became our wholly owned
subsidiary. The financial information presented herein comprises the
consolidated results of FLAG Limited for the accounting periods to February
26, 1999 and the FLAG Telecom consolidated results for the period from
incorporation to December 31, 1999. On February 16, 2000 FLAG Telecom
completed an initial public offering of common shares.
REVENUE RECOGNITION
Our primary business to date has been to sell capacity on the FLAG
Europe-Asia cable system. The primary method by which we have sold capacity has
been through agreements providing for an outright sale of, or the sale of a
right of use of, the capacity for the lifetime of this system. Each agreement
provides that, in return for payment of the purchase price, the customer
receives beneficial ownership of the relevant capacity. In addition, the
customer becomes responsible for paying the agreed maintenance charges.
We have recognized revenues from capacity sales on the FLAG Europe-Asia
cable system upon the date the risks and rewards of ownership of the relevant
capacity are transferred to the customer, which is the date the capacity is made
available for activation and the customer becomes responsible for maintenance
charges. The Financial Accounting Standards Board issued a recent pronouncement
(FASB Interpretation No. 43), as a result of which sales of fiber-optic cable
capacity after June 30, 1999 are to be accounted for in the same manner as sales
of real estate with property improvements or integral equipment. The application
of this pronouncement will result in a deferral of revenue recognition for US
GAAP purposes for certain capacity sale contracts that do not satisfy the
necessary requirements of FASB Interpretation No. 43. This accounting treatment
will not affect our cash flows from customers, who will continue to be liable
for payments in accordance with the signed agreements.
As a result of extending our range of products and services, we expect the
greater part of our future sales to be under agreements which will require us to
recognize revenues over the relevant term of these agreements. To the extent
that we enter into contracts in the future that satisfy the requirements for
sales type lease accounting, we will recognize revenues without deferral.
We recognize revenues from providing maintenance and restoration services in
the period in which we provide these services.
We have previously considered revenues from operating lease transactions
to be incidental. We have therefore recorded these revenues as reductions of
the capacity available for sale. However, as noted above, the magnitude of
these transactions has increased such that we will now recognize revenues
from lease transactions over the term of the leases.
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Payments due from purchasers of capacity are generally payable within
30 days; however, we have receivables outstanding greater than 30 days. We have
established an allowance for doubtful accounts based on historical industry
experience with potential uncollectible receivables and our expectations as to
payments. As of December 31, 1999, we had an allowance of $6.8 million which
principally relates to potential uncollectible amounts due from two carriers.
All revenues from capacity sales agreements and billings of standby
maintenance and restoration services are payable in U.S. dollars. All contracts
for the provision by third parties of restoration are invoiced to us in U.S.
dollars. Some vendor contracts for the provision to the FLAG Europe-Asia cable
system of operations and maintenance services are payable in Japanese Yen,
British Pounds, French Francs and Singapore Dollars in addition to U.S. dollars.
Whenever deemed appropriate, we have hedged, and may continue to hedge, our
exposure to foreign currency movements.
ACCOUNTING FOR THE CAPITAL COSTS OF THE FLAG TELECOM NETWORK
We capitalized direct and indirect expenditures incurred in connection with
the construction of the FLAG Telecom network. When a system was ready for
commercial service we transferred such expenditures to capacity available for
sale and charged a proportion of these expenditures to cost of sales as we
recognized revenues from sales of capacity. In the case of the FLAG Europe-Asia
cable system, the amount charged as cost of sales was a function of the
allocated costs of construction for each segment and management's estimate of
revenues from future capacity sales. As a result of the application of FASB
Interpretation No. 43, sales on certain segments of the FLAG Europe-Asia cable
system will not be able to satisfy the requirements for sales type lease
accounting. The costs of these segments have been reclassified at July 1, 1999
from capacity available for sale to fixed assets and are being depreciated over
their remaining useful life.
As a result of extending our range of products and services, we expect the
greater part of our future revenue to be under agreements that will be accounted
for as operating leases or service contracts and will require us to recognize
revenues over the relevant term of the agreements. We have therefore
reclassified the remaining cost of the FLAG Europe-Asia cable from capacity
available for sale to fixed assets in the first quarter of 2000. This cost will
be depreciated over the remaining estimated economic life of the system. The
construction costs of the FLAG Atlantic-1 cable system will be amortized over
its economic life from the date it is ready for commercial service or will be
written off as cost of sales against revenues from any transactions whose terms
satisfy the requirements of sales-type lease accounting. Capital costs
associated with development of the other elements of the FLAG Telecom network
will be amortized over their respective economic lives.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1999 COMPARED WITH THE YEAR ENDED DECEMBER 31, 1998
ADJUSTED CONSOLIDATED RESULTS
The table below shows the significant income statement amounts, in
thousands, for the year ended December 31, 1999, being a combination of the
results of FLAG Limited for the period from January 1, 1999 to February 26, 1999
and the results of FLAG Telecom for the period from incorporation to
December 31, 1999. These results have been adjusted to eliminate minority
interests in
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order to enable a better comparison with the results for the year ended
December 31, 1998. These adjustments will not be reflected in our current and
future financial statements.
<TABLE>
<CAPTION>
ADJUSTED
YEAR ENDED
DECEMBER 31,
1999
-------------
<S> <C>
Revenue:
Capacity sales.............................................. $120,157
Standby maintenance and restoration revenues................ 42,285
--------
$162,442
Sales and other operating costs:
Cost of capacity sold....................................... $ 49,643
Operations and maintenance (including non-cash compensation
expense of $2,647)........................................ 31,315
Sales and marketing (including non-cash compensation expense
of $1,534)................................................ 11,733
General and administrative (including non-cash compensation
expense of $4,620)........................................ 25,771
Depreciation and amortization............................... 11,366
Interest expense............................................ 54,820
Interest income............................................. 9,013
Income from affiliates...................................... 361
--------
Loss before income taxes.................................... $(12,832)
Provision for taxes......................................... 1,720
EBITDA...................................................... 102,423
Adjusted EBITDA............................................. 128,112
</TABLE>
REVENUES
We recognized total revenue during the year ended December 31, 1999 of
$162.4 million compared to $208.2 million in total revenue for the year ended
December 31, 1998.
We recognized revenue from the sale of capacity of $120.2 million for the
year ended December 31, 1999 compared to $182.9 million during the year ended
December 31, 1998. The reduction in revenue is partly attributable to our
deferring the recognition of some revenues to subsequent periods as the result
of our adoption of FASB Interpretation No. 43 with effect from July 1, 1999 and
partly as a result of accounting revenues in 1998 including certain non-cash
items. As of December 31, 1999, we had entered into sales transactions with over
90 international telecommunication carriers and internet service providers
compared to 80 as of December 31, 1998.
We recognized revenue from standby maintenance and restoration services of
$42.3 million for the year ended December 31, 1999 compared to $25.3 million for
the year ended December 31, 1998. The increase of $17.0 million for the year
ended December 31, 1999 is primarily a result of the increase in cumulative
capacity sales on the FLAG Europe-Asia cable system combined with an increase in
revenue from restoration services. Restoration services refer to receipts from
third party cable systems in respect of traffic routed on the FLAG Europe-Asia
cable system during periods when these cable systems are temporarily out of
service.
OPERATING EXPENSES
For the year ended December 31, 1999, we recorded $49.6 million in respect
of the cost of capacity sold compared to $101.3 million recorded in the year
ended December 31, 1998. The decrease in the cost of capacity sold in the year
ended December 31, 1999 is primarily a result of lower revenue recognized from
capacity sales combined with sales of capacity on segments having a lower cost
of sales
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percentage, computed as described above for that segment, compared to the cost
of sales for the segments on which capacity was sold during the year ended
December 31, 1998.
During the year ended December 31, 1999, we incurred $31.3 million in
operations and maintenance costs compared to $37.9 million for the year ended
December 31, 1998. Operations and maintenance costs relate primarily to the
provision of standby maintenance under maintenance zone agreements as well as
salaries and overhead expenses directly associated with operations and
maintenance activities. The decrease in operations and maintenance costs is
largely a result of the termination of the program management services agreement
with Bell Atlantic Network Systems in May 1998 combined with lower costs of some
maintenance zone agreements.
During the year ended December 31, 1999, we incurred $11.7 million in sales
and marketing costs compared to $10.7 million incurred during the year ended
December 31, 1998. Sales and marketing costs are comprised of all sales and
marketing activities that are directly undertaken by us.
During the year ended December 31, 1999, we incurred $25.8 million of
general and administrative expenses compared to $21.7 million during the year
ended December 31, 1998. The increase in general and administrative costs in the
year ended December 31, 1999, is largely due to non-cash compensation expense in
the amount of $4.6 million.
Costs for the year ended December 31, 1999 noted above include charges for
non-cash compensation expense in respect of awards under our long term incentive
plan. These charges are required under US accounting standards and are purely
accounting charges having no effect on cash flows.
Depreciation expense for the year ended December 31, 1999 was $11.4 million
compared to $0.8 million for the year ended December 31, 1998. The increase of
$10.6 million is primarily a result of us adopting FASB Interpretation No. 43
which is effective from July 1, 1999, pursuant to which the cost of part of the
FLAG Europe-Asia cable system which does not satisfy the requirements of sales
type lease accounting is being depreciated over its remaining economic life.
Prior to July 1, 1999, the cost of the FLAG Europe-Asia cable system was wholly
accounted for as capacity available for sale for which no depreciation was
recorded but which was expensed as cost of capacity sold as revenues were
recognized.
INTEREST EXPENSE AND INTEREST INCOME
Interest expense on borrowings decreased from $61.1 million for the year
ended December 31, 1998 to $54.8 million for the year ended December 31, 1999.
The decrease in interest expense of $6.3 million is attributable to a reduction
in long term debt facility from $271.5 million as at December 31, 1998 to
$190.0 million as at December 31, 1999 combined with a $1.8 million reduction in
amortized financing costs.
During the year ended December 31, 1999 we capitalized $1.3 million of
interest costs as a component of construction in progress.
We earned interest income of $9.0 million during the year ended
December 31, 1999 compared to $14.9 million earned during the year ended
December 31, 1998. Interest was earned on cash balances and short term
investments held by the collateral trustee for FLAG Limited's credit facility or
in escrow arising from ongoing business operations.
PROVISION FOR TAXES
The provision for taxes was $1.7 million for the year ended December 31,
1999 compared to $1.3 million for the year ended December 31, 1998. The tax
provisions for these periods consist of taxes on income derived from capacity
sales and standby maintenance revenue from customers in certain jurisdictions
along the FLAG Europe-Asia cable system route where we are deemed to have a
taxable presence or are otherwise subject to tax. At the present time, no
income, profit, capital or capital gains taxes are levied in Bermuda. In the
event that such taxes are levied, we have received an undertaking from the
Bermuda Government exempting us from all such taxes until March 28, 2016.
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EXTRAORDINARY ITEM
In connection with a refinancing that took place on January 30, 1998, we
recorded an extraordinary loss of $59.8 million in the statement operations for
the year ended December 31, 1998. The loss on refinancing represents the
write-off of unamortized deferred financing costs related to FLAG Limited's
prior credit facility. No refinancing occurred in the year ended December 31,
1999.
In addition, in connection with the refinancing in January 1998, FLAG
Limited redeemed its outstanding preferred stock at a redemption price of 105%
of the liquidation preference. We reflected the $8.5 million excess of the
redemption value over the carrying value of the preferred stock on the date of
the redemption as a decrease in additional paid-in capital in the year ended
December 31, 1998. There were no costs of this nature recorded in the year
ended December 31, 1999.
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