<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
(Commission file number: )
GLOBAL TELESYSTEMS GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3068423
(State of incorporation) (I.R.S. Employer Identification No.)
1751 Pinnacle Drive, North Tower, 12th Floor
McLean, Virginia 22102
(Address of principal executive office)
(703) 918-4500
(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
registrants were required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes [X] No [ ]
At April 30, 1998, there were outstanding approximately 53,245,706
shares of common stock of the registrant.
<PAGE> 2
TABLE OF CONTENTS
PART I. Financial Information
Item 1A Financial Statements of Global TeleSystems Group, Inc.
Condensed Consolidated Balance Sheets
As of December 31, 1997 and March 31, 1998
Condensed Consolidated Statements of Operations
For the Three Months Ended March 31, 1997 and 1998
Condensed Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 1997 and 1998
Notes to Condensed Consolidated Financial Statements
Item 1B Financial Statements of EDN Sovintel
Condensed Balance Sheets
As of December 31, 1997 and March 31, 1998
Condensed Statements of Operations
For the Three Months Ended March 31, 1997 and 1998
Condensed Statements of Cash Flows
For the Three Months Ended March 31, 1997 and 1998
Notes to Condensed Financial Statements
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations
PART II. Other Information
Item 2 Changes in Securities and Use of Proceeds
Item 5 Other Information
Item 6 Exhibits and Reports on Form 8-K
Signatures
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
Item 1A Financial Statements of Global TeleSystems Group, Inc.
Condensed Consolidated Balance Sheets
As of December 31, 1997 and March 31, 1998
Condensed Consolidated Statements of Operations
For the Three Months Ended March 31, 1997 and 1998
Condensed Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 1997 and 1998
Notes to Condensed Consolidated Financial Statements
3
<PAGE> 4
GLOBAL TELESYSTEMS GROUP, INC.
Condensed, Consolidated Balance Sheets
(unaudited)
<TABLE>
<CAPTION>
December 31, March 31,
1997 1998
- ------------------------------------------------------------------------------------- ------------- -------------
(in thousands, except share data)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 318,766 $ 507,895
Accounts receivable, net 17,079 23,078
Restricted cash 30,486 41,344
Prepaid expenses 14,101 15,492
Other assets 6,707 8,113
------------- -------------
TOTAL CURRENT ASSETS 387,139 595,922
Property and equipment, net 236,897 270,641
Investments in and advances to ventures 76,730 88,083
Goodwill and intangible assets, net 43,284 58,055
Restricted cash 36,411 35,849
------------- -------------
TOTAL ASSETS $ 780,461 $ 1,048,550
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 61,984 $ 62,750
Debt maturing within one year 6,390 8,882
Current portion of capital lease obligations 21,490 19,250
Related party debt maturing within one year 5,708 10,023
Other current liabilities 6,301 20,510
------------- -------------
TOTAL CURRENT LIABILITIES 101,873 121,415
Long-term debt, less current portion 408,330 506,336
Long-term portion of capital lease obligations 117,645 136,988
Related party long-term debt, less current portion 79,796 3,530
Taxes and other non-current liabilities 14,595 12,970
------------- -------------
TOTAL LIABILITIES 722,239 781,239
COMMITMENTS AND CONTINGENCIES
Minority interest 18,766 12,470
Common stock, subject to repurchase (797,100 outstanding at
December 31, 1997) 12,489 --
SHAREHOLDERS' EQUITY
Preferred stock, $0.0001 par value (10,000,000 shares authorized;
none issued and outstanding) -- --
Common stock, $0.10 par value (135,000,000, shares authorized; 37,606,814 and
52,040,140 shares issued and outstanding, net of 195,528 and 195,528 shares
of treasury stock at December 31, 1997 and March 31, 1998, respectively) 3,761 5,204
Additional paid-in capital 274,359 539,911
Accumulated other comprehensive loss (8,269) (10,213)
Accumulated deficit (242,884) (280,061)
------------- -------------
TOTAL SHAREHOLDERS' EQUITY 26,967 254,841
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 780,461 $ 1,048,550
============= =============
</TABLE>
4
<PAGE> 5
GLOBAL TELESYSTEMS GROUP, INC.
Condensed, Consolidated Statements of Operations
(unaudited)
<TABLE>
<CAPTION>
Three Months Three Months
Ended March 31, Ended March 31,
1997 1998
- ------------------------------------------------------------ ---------- ----------
(in thousands, except per share data)
<S> <C> <C>
REVENUES, NET:
Telecommunication and other services $ 7,957 $ 20,792
Equipment sales 430 2,025
---------- ----------
8,387 22,817
---------- ----------
OPERATING COSTS AND EXPENSES:
Cost of revenues:
Telecommunication and other services 5,550 17,467
Equipment sales 874 1,556
Selling, general and administrative 11,488 19,749
Depreciation and amortization 1,246 2,195
Non-income taxes 287 742
---------- ----------
19,445 41,709
Equity in losses (earnings) of ventures 3,420 (3,412)
---------- ----------
LOSS FROM OPERATIONS (14,478) (15,480)
OTHER INCOME (EXPENSE):
Interest income 1,296 7,066
Interest expense (3,668) (16,466)
Foreign currency losses (494) (1,394)
---------- ----------
(2,866) (10,794)
---------- ----------
Net loss before income taxes, minority interest and
extraordinary loss (17,344) (26,274)
Income taxes 365 552
---------- ----------
Net loss before minority interest and extraordinary loss (17,709) (26,826)
Minority interest (24) 2,353
---------- ----------
Net loss before extraordinary loss (17,733) (24,473)
Extraordinary loss - extinguishment of debt -- (12,704)
---------- ----------
NET LOSS $ (17,733) $ (37,177)
========== ==========
Loss per share before extraordinary loss $ (0.51) $ (0.54)
Extraordinary loss per share -- (0.28)
---------- ----------
Net loss per share $ (0.51) $ (0.82)
========== ==========
Weighted average common shares outstanding 34,758 45,549
========== ==========
</TABLE>
5
<PAGE> 6
GLOBAL TELESYSTEMS GROUP, INC.
Condensed, Consolidated Statements of Cash Flows
(unaudited)
<TABLE>
<CAPTION>
Three Months Three Months
Ended March 31, Ended March 31,
1997 1998
- -------------------------------------------------------------------------------- ----------- -----------
(in thousands)
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $ (17,733) $ (37,177)
ADJUSTMENTS TO RECONCILE NET LOSS TO NET CASH USED IN OPERATING ACTIVITIES:
Extraordinary loss -- 12,704
Depreciation and amortization 2,124 7,150
Amortization of discount on note payable 1,157 477
Equity in losses (earnings) of ventures, net of dividends received 3,420 (3,412)
Deferred interest 1,806 1,636
Minority interest 24 (6,561)
Other 255 (237)
Changes in assets and liabilities, excluding effects of
acquisitions and ventures:
Accounts receivable (2,259) (2,162)
Prepaid expenses (803) (1,161)
Accounts payable and accrued expenses (1,848) (774)
Other changes in assets and liabilities 500 2,130
----------- -----------
NET CASH USED IN OPERATING ACTIVITIES (13,357) (27,387)
INVESTING ACTIVITIES
Investments in and advances to ventures, net of repayments (10,420) 2,370
Purchases of property and equipment (1,589) (14,389)
Restricted cash 238 (10,357)
Goodwill and other intangibles 208 (14,634)
----------- -----------
NET CASH USED IN INVESTING ACTIVITIES (11,563) (37,010)
FINANCING ACTIVITIES
Proceeds from debt -- 105,300
Repayments of debt (175) (91,355)
Payment of debt issue costs -- (3,957)
Net proceeds from issuance of common stock -- 235,620
Other financing activities (394) 7,199
----------- -----------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (569) 252,807
Effect of exchange rate changes on cash and
cash equivalents (1,692) 719
----------- -----------
Net (decrease) increase in cash and cash equivalents (27,181) 189,129
Cash and cash equivalents at beginning of period 57,874 318,766
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 30,693 $ 507,895
=========== ===========
</TABLE>
6
<PAGE> 7
GLOBAL TELESYSTEMS GROUP, INC.
Notes to Condensed, Consolidated Financial Statements
(unaudited)
1. Financial Presentation and Disclosures
The financial statements of Global TeleSystems Group, Inc. (the "Company")
included herein are unaudited and have been prepared in accordance with
generally accepted accounting principles for interim financial reporting and
Securities and Exchange Commission regulations. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed
or omitted pursuant to such rules and regulations. Material intercompany
affiliate account transactions have been eliminated; however, other
adjustments may have been required had an audit been performed. In the
opinion of management, the financial statements reflect all adjustments of a
normal and recurring nature necessary to present fairly the Company's
financial position, results of operations and cash flows for the interim
periods. These financial statements should be read in conjunction with the
Company's 1997 audited consolidated financial statements and the notes
related thereto. The results of operations for the three months ended March
31, 1998 may not be indicative of the operating results for the full year.
The Company's operations are carried out through alliances with strategic
local partners in the form of venture arrangements. Wholly-owned
subsidiaries and majority-owned ventures where the Company has unilateral
operating and financial control are consolidated within the Company's
financial results and operations. Those ventures where the Company exercises
significant influence, but does not exercise unilateral operating and
financial control, are accounted for by the equity method. The Company has
certain majority-owned investments that are accounted for by the equity
method as a result of minority shareholder rights, super-majority voting
conditions or other governmentally imposed uncertainties so severe that they
prevent the Company from obtaining unilateral control of the venture. If the
Company has little ability to exercise significant influence over the
ventures, those ventures are accounted for by the cost method. All
significant intercompany accounts and transactions are eliminated upon
consolidation.
The Company recognizes profits and losses in accordance with its underlying
ownership percentage or allocation percentage as specified in the agreements
with its partners; however, the Company recognizes 100% of the losses in
ventures where the Company bears all of the financial risk. When such
ventures become profitable, the Company recognizes 100% of the profits until
such time as the excess losses previously recorded have been recovered.
2. Policies and Procedures
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income," which
establishes standards for reporting and display of comprehensive income and
its components in a full set of general purpose financial statements.
Comprehensive income is defined as the change in equity of a business
enterprise during a period from nonowner sources. Comprehensive loss was
$19.4 million and $39.1 million for the three months ended March 31, 1997
and 1998, respectively, and was comprised of net loss of $17.7 million and
$37.2 million and foreign currency translation adjustments of $1.7 million
and $1.9 million for the three months ended March 31, 1997 and 1998,
respectively.
During 1997, the Company adopted SFAS No. 128, "Earnings Per Share," which
requires the Company to present basic and diluted earnings per share
for all periods presented. The Company's net loss per share calculation
(basic and diluted) is based upon the weighted average common shares issued.
There are no reconciling items in the numerator or denominator of the
Company's net loss per share calculation. Employee stock options, warrants,
and convertible debt instruments have been excluded from the net loss per
share calculation because their effect would be anti-dilutive.
Certain reclassifications have been made to the March 1997 condensed,
consolidated financial statements in order to conform to the 1998
presentation.
7
<PAGE> 8
GLOBAL TELESYSTEMS GROUP, INC.
Notes to Condensed, Consolidated Financial Statements
(unaudited)
3. Shareholders' Equity
In February 1998, the Company completed an initial public offering of 12.8
million shares of common stock at $20.00 per common share (the "Stock
Offering"). The Stock Offering resulted in the Company's common stock being
listed in the United States on the National Association of Securities
Dealers Automated Quotation Market and internationally on the European
Association of Securities Dealers Automated Quotation Market. Net proceeds
from the Stock Offering were approximately $235.6 million.
As a result of the Stock Offering, the Company no longer has a significant
obligation to repurchase or assist the seller in locating a purchaser for
the 797,100 shares of common stock subject to repurchase that were
outstanding at December 31, 1997. Therefore, all amounts outstanding have
been reclassified as additional paid-in capital as of March 31, 1998.
4. Debt Obligations
In February 1998, the Company issued aggregate principal amount $105.0
million of 9.875% senior notes due in 2005 (the "Notes Offering" and
together with the Stock Offering, the "Offerings"). Net proceeds from the
Notes Offering were approximately $100.5 million. Approximately $19.6
million of the net proceeds was placed in escrow for the first four
semiannual interest payments, commencing August 15, 1998.
As a result of the completion of the Stock Offering, the interest rate on
the $144.8 million aggregate principal amount of senior subordinated
convertible bonds issued in July 1997 (the "Bonds") will remain at 8.75%
until maturity and the approximately $5.1 million of the 6.25% additional
interest that was previously accrued through the date of the Stock Offering
has been reflected as an increase to additional paid-in capital. Upon
completion of the Stock Offering, the Bonds became convertible into 7.2
million common shares at a conversion price of $20.00 per share. In March
1998, $6.4 million of the outstanding Bonds was converted into 0.3 million
shares of the Company's common stock.
In 1996, the Company entered into long-term obligations ("Debt Obligations")
totaling $70.0 million with lenders that are affiliated with and are
considered related parties to the Company as a result of their ownership of
the Company's common stock. In February 1998, approximately $85.2 million of
the net proceeds of the Offerings was used to repay the Debt Obligations of
$70.0 million plus accrued interest that were due March 31, 2001. In
addition, the unamortized discount costs and debt issuance costs on the Debt
Obligations were written off at the time of repayment, resulting in the
Company recording an extraordinary loss of $12.7 million.
5. Other Transactions
In March 1998, the Company purchased an additional 10.3% interest in Hermes
Europe Railtel B.V. ("HER") from an existing shareholder of HER for ECU 13.5
million (approximately $14.6 million). As a result of the purchase, the
Company owns approximately 89.4% of HER. The purchase price has been
allocated to the net assets based on the fair value at the date of
acquisition. The excess purchase price over the fair value of the net assets
acquired was $10.2 million, which has been recorded as goodwill and is being
amortized on a straight-line basis over five years.
Pursuant to a purchase agreement that the Company has with a venture's
partner, the Company was obligated to issue 336,630 shares of common stock
to the partner, based on the venture's 1997 earnings performance. These
shares were issued to the partner in April 1998 and the obligation of $13.5
million, based on the share price of the common stock on the date of
issuance, has been reflected in "Other current liabilities" on the balance
sheet as of March 31, 1998.
8
<PAGE> 9
GLOBAL TELESYSTEMS GROUP, INC.
Notes to Condensed, Consolidated Financial Statements
(unaudited)
In February 1998, the Company acquired the remaining 33% interest in Sovam
Teleport from its minority partner and as a result in 1998 Sovam is
accounted for by the consolidation as opposed to the equity method of
accounting. The Company paid a nominal amount for the additional interest.
6. Supplemental Cash Flow Information
The following table summarizes non-cash investing and financing activities
for the Company:
<TABLE>
<CAPTION>
Three Months Ended
March 31, 1998
-------------------
(in thousands)
<S> <C>
Capitalization of leases $ 26,864
Accrual for additional consideration in relation to purchase of a venture 13,549
Reclassification of common stock subject to repurchase 12,489
Conversion of the Bonds into common stock 6,350
Reclassification of accrued interest on the Bonds 5,052
</TABLE>
No significant non-cash activities were incurred for the three months ended
March 31, 1997.
7. Subsequent Events
In April 1998, $16.3 million of the Bonds were converted into 0.8 million
common shares of the Company's common stock.
Subsequent to March 31, 1998, HER entered into contractual commitments to
lease fiber pairs, including facilities and maintenance and utilize the
partial routes for laying fiber optic cable. Based on the contract
provisions, these commitments are currently estimated to aggregate
approximately $22.5 million. The commitments have expected lease terms of
ten to twenty-one years with options for renewal rights of one and one-half
to five additional years.
9
<PAGE> 10
Item 1B Financial Statements of EDN Sovintel
Condensed Balance Sheets
As of December 31, 1997 and March 31, 1998
Condensed Statements of Operations
For the Three Months Ended March 31, 1997 and 1998
Condensed Statements of Cash Flows
For the Three Months Ended March 31, 1997 and 1998
Notes to Condensed Financial Statements
10
<PAGE> 11
EDN SOVINTEL
Condensed Financial Statements
For the First Quarter of 1998
(Unaudited)
11
<PAGE> 12
EDN SOVINTEL
Condensed Balance Sheets
(unaudited)
<TABLE>
<CAPTION>
December 31, March 31,
1997 1998
- --------------------------------------------------------------------------- ---------- ----------
(in thousands)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 5,620 $ 6,956
Accounts receivable, less allowance for doubtful accounts of $643 and
$800 at December 31, 1997 and March 31, 1998 16,223 19,766
Restricted cash 485 474
Due from affiliated companies 1,586 2,267
Inventory 1,697 1,697
Deferred tax asset 186 186
Prepaid expenses and other assets 5,318 7,303
---------- ----------
Total current assets 31,115 38,649
Property and equipment, net of accumulated depreciation of $14,557 and
$16,026 at December 31, 1997 and March 31, 1998 38,709 40,741
Deferred expenses 945 912
========== ==========
TOTAL ASSETS $ 70,769 $ 80,302
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable $ 5,725 $ 6,543
Accrued expenses 3,194 2,969
Due to affiliated companies 10,104 12,478
Note payable to shareholder 39 --
Taxes and other liabilities 2,438 4,698
---------- ----------
TOTAL LIABILITIES 21,500 26,688
Commitments and contingencies
SHAREHOLDERS' EQUITY
Contributed capital 2,000 2,000
Retained earnings 47,269 51,614
---------- ----------
TOTAL SHAREHOLDERS' EQUITY 49,269 53,614
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 70,769 $ 80,302
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
12
<PAGE> 13
EDN SOVINTEL
Condensed Statements of Operations
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------
1997 1998
--------------------------------------------- ---------- ----------
(in thousands)
<S> <C> <C>
REVENUES, NET: 25,162 32,404
COST OF REVENUES: 14,763 21,957
---------- ----------
Gross margin 10,399 10,447
OPERATING EXPENSES:
Selling, general and administrative 2,696 3,027
Depreciation and amortization 160 177
Non-income taxes 999 1,442
---------- ----------
Total operating expenses 3,855 4,646
Income from operations 6,544 5,801
OTHER (EXPENSE) INCOME:
Interest income 55 37
Interest expense (159) --
Foreign currency losses (38) (220)
---------- ----------
(142) (183)
Net income before taxes 6,402 5,618
Income taxes 1,708 1,273
---------- ----------
Net income $ 4,694 $ 4,345
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
13
<PAGE> 14
EDN SOVINTEL
Condensed Statements of Cash Flows
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------
1997 1998
---------------------------------------------------------------- ---------- ----------
(in thousands)
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 4,694 $ 4,345
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 1,113 1,501
Provision for doubtful accounts 152 157
Changes in assets and liabilities:
Accounts receivable (4,616) (3,700)
Inventory 293 --
Prepaid expenses and other assets (600) (1,985)
Accounts payable and accrued expenses 1,686 2,853
---------- ----------
Net cash provided by operating activities 2,722 3,171
INVESTING ACTIVITIES
Purchases of property and equipment (3,541) (3,500)
Restricted cash (31) 11
---------- ----------
Net cash used in investing activities (3,572) (3,489)
FINANCING ACTIVITIES
Borrowing on (repayment of) shareholder note, net 204 (39)
Due to affiliated companies, net (961) 1,693
---------- ----------
Net cash (used in) provided by financing activities (757) 1,654
---------- ----------
Net (decrease) increase in cash and cash equivalents (1,607) 1,336
Cash and cash equivalents at beginning of period 3,606 5,620
---------- ----------
Cash and cash equivalents at end of period $ 1,999 $ 6,956
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
14
<PAGE> 15
EDN SOVINTEL
Notes to Condensed Financial Statements
(unaudited)
1. Financial Presentation and Disclosures
In the opinion of management, the accompanying unaudited condensed financial
statements of EDN Sovintel (the "Company") contain all adjustments
(consisting only of normal recurring accruals) necessary to present fairly
the Company's financial position as of December 31, 1997 and March 31, 1998,
and the results of operations and cash flows for the periods indicated.
The Company was established as a competitive local exchange carrier (CLEC)
in August 1990. Through the design, construction, and operation of a
telecommunications network in Moscow, the Company provides its customers,
principally major hotels, business offices and mobile communications
companies, with an alternative to the local telephone company for worldwide
communications services. Telecommunications services are subject to local
licensing. The Company's license for international, intercity and local
calls was most recently renewed on November 4, 1996 and is valid until May
1, 2000. The Company received a license for leased lines on September 20,
1996 valid for 5 years. The Company began operating in December 1991,
providing services under long-term contracts payable in US dollars.
The Company initially registered as a Soviet-American joint venture. The
venture re-registered as a Russian limited liability partnership in November
1992. The Company is 50% owned by Open Joint Stock Company "Rostelecom," an
intercity and long-distance carrier which is 38% owned by Svyazinvest, and
50% owned by Sovinet, a US general partnership, owned by two wholly-owned
Global TeleSystems Group, Inc. ("GTS") subsidiaries.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. Material accruals have been
recorded; however, other adjustments may have been required had an audit
been performed. It is suggested that these financial statements be read in
conjunction with the Company's 1997 audited financial statements and the
notes related thereto. The results of operations for the three months ended
March 31, 1998 may not be indicative of the operating results for the full
year.
The Company maintains its records and prepares its financial statements in
Russian roubles in accordance with the requirements of Russian accounting
and tax legislation. The accompanying financial statements differ from the
financial statements used for statutory purposes in Russia in that they
reflect certain adjustments, not recorded on the Company's statutory books,
which are appropriate to present the financial position, results of
operations and cash flows in accordance with generally accepted accounting
principles in the United States of America ("US GAAP"). The principal
adjustments are related to certain accrued revenue and expenses, foreign
currency translation, deferred taxation, and depreciation and valuation of
property and equipment. The preparation of financial statements, in
conformity with US GAAP, requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
2. Policies and Procedures
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 130, "Reporting Comprehensive Income," which
establishes standards for reporting and display of comprehensive income and
its components in a full set of general purpose financial statements.
Comprehensive income is defined as the change in equity of a business
enterprise during a period from nonowner sources. For the three months ended
March 31, 1997 and 1998, comprehensive income for the Company is equal to
net income.
15
<PAGE> 16
EDN SOVINTEL
Notes to Condensed Financial Statements
(unaudited)
3. Contingencies
Legislation and regulations regarding taxation, foreign currency
transactions and licensing of foreign currency loans in the Russian
Federation continues to evolve as the central government manages the
transformation from a command to a market-oriented economy. The various
legislation and regulations are not always clearly written and their
interpretation is subject to the opinions of the tax inspectors, Central
Bank officials and the Ministry of Finance. Instances of inconsistent
opinions between local, regional and national tax authorities and between
the Central Bank and Ministry of Finance are not unusual.
The Company believes that it has paid or accrued all taxes that are
applicable. Where practice concerning the provision of taxes is unclear, the
Company has accrued tax liabilities based on management's best estimate. The
Company's policy is to accrue contingencies in the accounting period in
which a loss is deemed probable and the amount is reasonably determinable.
Because of the uncertainties associated with the Russian tax and legal
systems, the ultimate amount of taxes, penalties and interest, if any,
assessed may be in excess of the amount expensed to date and accrued at
December 31, 1997 and March 31, 1998.
The Company's operations and financial position will continue to be affected
by Russian political developments, including the application of existing and
future legislation and tax regulations. The Company does not believe that
these contingencies, as related to its operations, are any more significant
than those of similar enterprises in Russia.
16
<PAGE> 17
Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Certain statements contained in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" including, without limitation,
those concerning (i) projected traffic volume, (ii) future revenues and costs,
(iii) changes in the Company's competitive environment and (iv) the performance
of future equity-method investments, contain forward-looking statements
concerning the Company's operations, economic performance and financial
condition. Because such statements involve risks and uncertainties, actual
results may differ materially from those expressed or implied by such
forward-looking statements.
OVERVIEW
Business. GTS is a provider of a broad range of telecommunications services
to businesses, other telecommunications service providers and consumers in
Russia and the CIS, Central Europe and Asia. In Western Europe, through HER, GTS
is developing and operating the initial segments of a pan-European high capacity
fiber optic network which is designed to interconnect a majority of the largest
Western and Central European cities and to transport international voice, data
and multimedia/image traffic for other carriers throughout Western and Central
Europe. GTS's strategy to develop its businesses generally has been to establish
joint ventures with a strong local partner or partners while maintaining a
significant degree of operational control. The Company's business activities
consist of the ownership and operation of (i) international long distance
businesses, which operate through international gateways that provide
international switching services and transmission capacity, (ii) local access
networks, which provide local telephone service, (iii) cellular networks, which
provide wireless telecommunications services, (iv) a domestic long distance
business, (v) data networks and (vi) carriers' carrier networks, which provide
high volume transmission capacity to other carriers.
The Company began to acquire interests in numerous telecommunications
ventures beginning in 1994 and continued to acquire such interests throughout
1995 and 1996. Ventures with significant financial results in 1994 included
Sovintel (an international long distance and domestic and local access
telecommunications service provider) and GTS-Hungary (a VSAT network
telecommunications service provider); ventures that incurred start-up costs
associated with building out their business infrastructure in 1994 included
Sovam (a data and internet telecommunications service provider) and EuroHivo (a
paging telecommunications service provider). In 1995, TeleRoss (a domestic long
distance telecommunications service provider) and GTS Cellular (a basic cellular
telecommunications service provider) began operations and expanded into numerous
regions within the CIS by the end of 1996. Telecommunications of Moscow ("TCM")
(a local access telecommunications service provider) began operations in 1996.
HER (a carriers' carrier telecommunications service provider) began its network
build-out in 1995, began limited operations at the end of 1996 and expects to
continue to develop its network during 1998 and beyond. The fact that these
ventures are in various stages of development affects the discussion of
comparative results below.
GTS has invested significantly in its ventures through capital contributions
and loans. In addition, the Company has made a significant commitment to its
businesses and ventures through
17
<PAGE> 18
the provision of management assistance and training. GTS has also incurred
significant expenses in identifying, negotiating and pursuing new
telecommunications opportunities. GTS and certain of its ventures are
experiencing continuing losses and negative operating cash flow primarily
because the businesses are in the developmental and start-up phases of
operations. Management recognizes that the Company must generate additional
capital resources in order to continue its operations and meet its new
development initiatives. The ultimate recoverability of the Company's
investments in and advances to ventures is dependent on many factors including,
but not limited to, the ability of the Company to obtain sufficient financing to
continue to meet its capital and operational commitments, the economies of the
countries in which it does business and the ability of the Company to maintain
the necessary telecommunications licenses.
The Company's businesses are developing rapidly. Some of the businesses
operate in countries with emerging economies which have uncertain economic,
political and regulatory environments. The general risks of operating businesses
in the CIS and other developing countries include the possibility for rapid
change in government policies including telecommunications regulations, economic
conditions, the tax regime and foreign currency regulations.
ACCOUNTING METHODOLOGY
Accounting for Business Ventures. Wholly-owned subsidiaries and
majority-owned ventures where the Company has unilateral operating and financial
control are consolidated. Those ventures where the Company exercises significant
influence, but does not exercise unilateral operating and financial control, are
accounted for by the equity method. The Company has certain majority-owned
ventures that are accounted for by the equity method as a result of minority
shareholder rights, super-majority voting conditions or other governmentally
imposed uncertainties so severe that they prevent the Company from obtaining
unilateral control of the venture.
Profit and Loss Accounting. The Company recognizes profits and losses in
accordance with its underlying ownership percentage or allocation percentage as
specified in the agreements with its partners; however, the Company recognizes
100% of the losses in ventures where the Company bears all of the financial risk
(which includes all of the Company's significant ventures except for Sovintel
and, historically, HER). Accordingly, the portion of the losses that would
normally be assigned to the minority interest partner ("Excess Losses") is
recognized by the Company. When such ventures become profitable, the Company
recognizes 100% of the profits until such time as the Excess Losses previously
recognized by the Company have been recovered. As of March 31, 1998, $5.3
million and $8.9 million represent the net unrecovered Excess Losses for the
Company's consolidated and equity method investments, respectively, that is
expected to favorably benefit future period results from operations upon the
Company's existing business ventures becoming profitable. This accounting policy
was adopted prior to 1995; however, 1995 was the first year that the excess loss
amount was deemed material for recognition within the Company's accounting
records. For the period from January 1, 1997, through August 31, 1997, the
Company recognized 100% of HER's losses due to GTS being the financing partner
during this period. As a result of HER's issuance of $265 million aggregate
principal amount of senior notes (of which $56.6 million was placed in escrow
for the first two
18
<PAGE> 19
years' interest payments) in August 1997, the Company no longer considers itself
as the financing partner.
Inter-Affiliate Transactions. Several of the Company's ventures have entered
into business arrangements through which they provide integrated solutions for
their customers by leveraging each others' telecommunications infrastructure.
These arrangements have historically been focused primarily within a region;
however, as GTS has increased its geographic coverage and telecommunication
capabilities, these arrangements have expanded between regions. In accordance
with generally accepted accounting principles, all significant intercompany
accounts and transactions are eliminated upon consolidation.
Turnover Taxes. The Company's ventures within the CIS region incur a 4%
turnover tax that is based on the revenues earned. The Company includes these
taxes as a component of its operating expenses, since these taxes are incidental
to the revenue cycle.
The following table summarizes the accounting methodology for the principal
business ventures through which the Company conducts its business.
<TABLE>
<CAPTION>
COUNTRY/REGION EFFECTIVE GTS ACCOUNTING
Company Name OF OPERATIONS OWNERSHIP METHODOLOGY
- ------------------------------- ---------------- --------------- -------------
<S> <C> <C> <C>
CIS
Sovintel Russia 50% Equity
TCM Russia 50% (1) Equity
TeleRoss Operating Company Russia 100% (2) Consolidated
TeleRoss Ventures Russia 50% (3) Equity
Sovam Russia 100% (4) Consolidated (4)
GTS Cellular CIS 25%-70% (5) Equity
Western Europe
HER Western Europe 89% (6) Consolidated (6)
GTS-Monaco Access Monaco 50% Equity
Central Europe
GTS-Hungary Hungary 99% Consolidated
EuroHivo Hungary 70% (7) Equity
CzechNet Czech Republic 100% Consolidated
CzechCom Czech Republic 100% Consolidated
Asia
V-Tech China 75% Equity
Beijing Tianmu China 47% Equity
CDI India 100% Consolidated
</TABLE>
- ----------
(1) The Company is currently engaged in negotiations to purchase the
remaining minority ownership interest in GTS-Vox Limited. If such purchase
is consummated the Company would have a 95% interest in TCM.
(2) The TeleRoss Operating Company is comprised of a wholly-owned subsidiary
that operates a domestic long distance network and holds the applicable
operating license for TeleRoss and performs the customer invoicing and
collection functions for telecommunications services. TeleRoss Operating
Company is accounted for under the consolidation method of accounting
19
<PAGE> 20
because GTS has unilateral control over the operations and management
decisions. TeleRoss Operating Company's operations are further discussed in
"--Results of Operations--Consolidated Ventures." A significant portion of
TeleRoss Operating Company's costs of revenue consists of settlement fees
paid to the TeleRoss Ventures, with such fees being recorded as revenue by
the TeleRoss Ventures. To date, all of the TeleRoss Ventures' revenue was
derived from such fees. Any decline in the business or operations of the
TeleRoss Ventures would have a material adverse effect on the results of
TeleRoss Operating Company.
(3) TeleRoss Ventures is comprised of fourteen joint ventures that are 50%
beneficially owned by GTS, which originate traffic and provide local
termination of calls through agency arrangements with TeleRoss Operating
Company. GTS does not exercise unilateral control over the TeleRoss
Ventures, and therefore they are appropriately accounted for under the
equity method of accounting. TeleRoss Ventures' operations are further
discussed in "--Results of Operations--Non-Consolidated Ventures."
(4) GTS purchased the remaining 33% interest in Sovam in February 1998 and as a
result Sovam is now accounted for by the consolidation as opposed to the
equity method of accounting.
(5) GTS conducts its cellular operations through (i) Vostok Mobile, a wholly
owned GTS venture that owns between 50% and 70% of a series of twelve
cellular joint ventures in various regions in Russia, (ii) PrimTelefone, a
50% owned venture in Vladivostok, Russia and (iii) Bancomsvyaz, an
approximately 25% beneficially owned venture in Kiev, Ukraine. The Company
is currently engaged in negotiations to restructure the capital and
ownership of Bancomsvyaz.
(6) As of July 16, 1997, HER is accounted for by the consolidation as opposed
to the equity method of accounting. In addition, in March 1998, GTS
acquired an additional 10% interest in HER.
(7) The Company has reached a definitive agreement to sell its ownership
interest in EuroHivo. The closing of this transaction is conditioned upon
the regulatory approval of the share transfer and customary conditions
precedent. The Company does not anticipate that the closing of this
transaction will have a material effect on the Company's results from
operations and financial condition.
RESULTS OF OPERATIONS -- CONSOLIDATED VENTURES
Management's discussion included within "--Results of
Operations--Consolidated Ventures" reflects the following significant operating
ventures: TeleRoss Operating Company, Sovam, GTS-Hungary, the Czech Companies
and HER. Although the Company was not able to follow consolidation method of
accounting for Sovam and HER in the three months ended March 31, 1997, the
Company has included, for comparative purposes, a discussion of their financial
performance for the three months ended March 31, 1997 in our discussion of
"Results of Operations--Consolidated Ventures". See "Results of
Operations--Non-Consolidated Ventures
20
<PAGE> 21
(Equity Investees)" for a discussion of the operating results of Sovintel, TCM,
TeleRoss Ventures, GTS Cellular and GTS-Monaco Access.
Revenue. The Company's consolidated revenue was $22.8 million and $8.4
million for the three months ended March 31, 1998 and 1997, respectively. The
$14.4 million growth in revenue was primarily attributable to the inclusion of
Sovam and HER in the Company's consolidated financial results, with Sovam and
HER contributing $5.9 million and $4.7 million in revenue, respectively. The
remaining revenue growth was attributable to the TeleRoss Operating Company, as
its revenue increased $2.7 million year over year.
The CIS region's consolidated revenue was $13.8 million and $5.2 million for
the three months ended March 31, 1998 and 1997, respectively. TeleRoss Operating
Company generated revenue of $7.1 million and $4.4 million, representing 51.4%
and 84.6% of the region's consolidated revenue for the three months ended March
31, 1998 and 1997, respectively. The growth in the TeleRoss Operating Company
revenue from March 1997 to March 1998 was the result of the increase in traffic
volume generated by the TeleRoss Ventures due the increase in the number of
cities and number of VSAT's installed at customer locations outside of cities in
which they have a presence. Sovam generated revenue of $5.9 million and $3.7
million for the three months ended March 31, 1998 and 1997 (Sovam was an equity
method company in 1997), respectively. The growth in Sovam revenue is primarily
attributable to the expansion of Sovam's network throughout Russia and the CIS
and the wider variety of service offerings.
HER generated $4.7 million of revenue in the three months ended March 31,
1998, compared to $0.2 million in the same period in 1997 (HER was an equity
method company prior to July 1997). The growth in revenue is attributable to the
deployment of the network; i.e. the Brussels-Amsterdam route generated revenue
in 1997 whereas the Brussels-Amsterdam-London-Paris route generated revenue in
1998.
The Central Europe region's consolidated revenue was $3.9 million in the
three months ended March 31, 1998, compared to $2.8 million in the same period
of 1997. The Company's operations in both Hungary and the Czech Republic
experienced year over year revenue growth of 39.3%. This growth is attributable
the expansion of the customer base and product offerings of these businesses.
Gross Margin. GTS's consolidated gross margin was $3.8 million, or 16.7% of
revenue, for the three months ended March 31, 1998 and $2.0 million, or 23.8% of
revenue, for the three months ended March 31, 1997.
Sovam contributed $2.8 million to consolidated gross margin for the three
months ended March 31, 1998. For comparative purposes, Sovam had a gross margin
of $1.3 million for three months ended March 31, 1997 (Sovam was an equity
method company in 1997). Sovam had gross margin as a percentage of revenues of
47.5% and 35.1%, for the three months ended March 31, 1998 and 1997,
respectively. The increase in gross margin, both amount and as a percentage of
revenue, reflects the higher margin service offerings that Sovam is currently
providing and also management's focus to improve its cost structure; i.e. the
negotiation of improved channel costs from suppliers and controlled growth in
both personnel and capital expenditures. The
21
<PAGE> 22
TeleRoss Operating Company contributed gross margin of $1.0 million and $1.5
million for the three months ended March 31, 1998 and 1997, respectively, or
14.1% and 34.1% of TeleRoss Operating Company revenue for the respective
periods. The decrease in margin, both amount and as a percentage of revenue,
reflects the high fixed cost component of its network hub in Moscow. The Central
European region contributed $1.3 million to gross margin in both the three
months ended March 31, 1998 and March 31, 1997, respectively, or 33.3% and 44.8%
of Central European revenue for the respective periods. The decrease in gross
margin as a percentage of revenue primarily reflects the startup activities of
the GTS Net product offering in Hungary. HER had an unfavorable effect on
consolidated gross margins of $(1.4) million for the three months ended March
31, 1998. For comparative purposes, HER had an unfavorable gross margin of
$(1.2) million for three months ended March 31, 1997 (HER was an equity method
company prior to July 1997.)
Operating Expenses. Consolidated operating costs were $22.7 million and
$13.0 million for the three months ended March 31, 1998 and 1997, respectively.
The increase in operating costs is attributable to the inclusion of HER and
Sovam in the Company's consolidated financial results, the growth in
expenditures associated with building business infrastructure for primarily the
TeleRoss Operating Company and costs attributable to increasing the corporate
staff.
Equity in (Losses)/Earnings of Ventures. GTS recognized earnings of $3.4
million for its investments in non-consolidated ventures in the three months
ended March 31, 1998 as compared to recognizing losses of $3.4 million in the
same period a year ago. This improvement was primarily the result of HER no
longer being an equity method investee and TCM's year over year net income
improvement. Included in the March 31, 1998 results were $0.1 million of
additional earnings associated with our recovery of prior period excess losses
recognized. Included in the March 31, 1997 results were $2.7 million of
additional losses as a result of the application of the Company's previously
discussed profit and loss accounting. Sovintel and TCM generated combined
earnings of $4.1 million and $3.9 million for the three months ended March 31,
1998 and 1997, respectively, which offset the losses generated by other ventures
that are in the early stages of operations. See "Results of
Operations--Non-Consolidated Ventures (Equity Investees) for a discussion of the
results of operations of the Company's significant equity investees.
Interest, Net. GTS incurred interest expense of $16.5 million and $3.7
million for the three months ended March 31, 1998 and 1997, respectively. The
significant increase in interest expense was due to the $409.8 million increase
in debt raised in 1997. See "--Liquidity and Capital Resources."
GTS earned interest income of $7.1 million and $1.3 million for the three
months ended March 31, 1998 and 1997, respectively, primarily as a result of
investing the proceeds from the Company's 1997 and 1998 capital raising efforts.
See "--Liquidity and Capital Resources."
Provision for Income Taxes. The Company's consolidated tax provision was
$0.6 million and $0.4 million for the three months ended March 31, 1998 and
1997, respectively. The Company's financial statements do not reflect any
provision for benefits that might be associated with the U.S. and non-U.S. loss
carryforwards. There can be no assurance that such non-U.S. loss carryforwards
will be allowed, in part or in full, by local tax authorities against future
income.
22
<PAGE> 23
Extraordinary Loss. The Company recognized a $12.7 million extraordinary
charge to earnings in the three months ended March 31, 1998, as a result of the
Company's early extinguishment of certain related party debt obligations. The
nature of the charge is comprised of the write-off of $11.6 million of
unamortized debt discount and $1.1 million of unamortized debt issuance costs
that were deferred as financing costs and were being amortized over the original
maturity of the debt.
RESULTS OF OPERATIONS -- NON-CONSOLIDATED VENTURES (EQUITY INVESTEES)
RUSSIA -- CIS
Sovintel. Sovintel's revenue for the three months ended March 31, 1998 and
1997 was $32.4 million and $25.2 million, respectively. The increase in revenue
was primarily the result of telecommunications service revenue, which increased
to $23.8 million for the three months ended March 31, 1998 from $19.1 million
for the three months ended March 31, 1997, due to the Moscow customer base
growth and traffic from other GTS ventures that generated increased volume of
outgoing international and domestic minutes carried by Sovintel. Sovintel
realized a 91% increase in outgoing international and domestic minutes in the
three months ended March 31, 1998, as compared with the same period a year-ago.
Revenue from incoming international minutes decreased slightly to $2.5 million
for the three months ended March 31, 1998, from $2.7 million for the three
months ended March 31, 1997.
Sovintel's non-traffic-related revenue of $8.6 million and $6.1 million for
the three months ended March 31, 1998 and 1997, respectively, was primarily
attributable to port sales and monthly port fees revenue.
Sovintel's gross margin was $10.4 million in both the three months ended
March 31, 1998 and 1997, respectively, or 32.1% and 41.3% of revenue for the
respective periods. The decrease in gross margin as a percentage of revenue was
attributable to a general price decrease in international and domestic revenue
due to competitive pressures and a higher percentage of domestic minutes, which
yield a lower margin.
Operating expenses were $4.6 million and $3.9 million, or 14.2% and 15.5% of
total revenue, for the three months ended March 31, 1998 and 1997, respectively.
The increase in operating expenses was related to increases in turnover taxes
associated with revenues and also increased personnel, advertising and sales
force costs required to support Sovintel's growth.
Income tax expense was $1.3 million and $1.7 million for the three months
ended March 31, 1998 and 1997, respectively. The increase in income tax expense
was attributable to Sovintel's profitable operations.
TCM. TCM's revenue was $9.5 million and $6.3 million for the three months
ended March 31, 1998 and 1997, respectively. TCM had a gross margin of $6.9
million and $4.8 million, or 72.6% and 76.2% of total revenue. The decrease in
gross margin as a percentage of revenue was attributable to higher
infrastructure and settlement costs. TCM had operating expenses of $0.9
23
<PAGE> 24
million and $0.6 million, or 9.5% and 9.5% of total revenue, for the three
months ended March 31, 1998 and 1997, respectively.
TeleRoss Ventures. Revenue for the TeleRoss Ventures for the three months
ended March 31, 1998 and 1997 was $2.4 million and $1.5 million, respectively.
Revenues resulted from settlement fees charged to TeleRoss Operating Company.
The growth in revenue reflects the growth of the customer base.
Gross margin for the three months ended March 31, 1998 and 1997 was $1.7
million and $1.2 million, respectively. Operating expenses of $1.0 million and
$0.6 million were incurred for the three months ended March 31, 1998 and 1997,
respectively.
GTS Cellular. The Company operates three cellular networks through differing
ownership structures: Vostok Mobile, PrimTelefone and Bancomsvyaz.
Revenue for Vostok Mobile was $7.3 million and $5.0 million for the three
months ended March 31, 1998 and 1997, respectively. Vostok Mobile's gross margin
was $3.7 million and $2.8 million, or 50.7% and 56.0% of total revenue, and
operating expenses were $2.6 million and $2.1 million for the three months ended
March 31, 1998 and 1997, respectively.
Revenue for PrimTelefone was $3.7 million and $2.5 million for the three
months ended March 31, 1998 and 1997, respectively. PrimTelefone's gross margin
was $2.1 million and $1.7 million, or 56.8% and 68.0% of total revenue, and
operating expenses were $1.1 million and $0.6 million for the three months ended
March 31, 1998 and 1997, respectively.
Revenue for Bancomsvyaz was $4.2 million and $0.6 million for the three
months ended March 31, 1998 and 1997, respectively. Bancomsvyaz's gross margin
was $2.4 million and $(0.04) million, or 57.1% and (6.7)% of total revenue, and
operating expenses were $1.8 million and $1.0 million for the three months ended
March 31, 1998 and 1997, respectively.
WESTERN EUROPE
GTS-Monaco Access: Total revenue was $4.5 million and $1.9 million and gross
margin was $0.2 million and $0.02 million for the three months ended March 31,
1998 and 1997, respectively.
LIQUIDITY AND CAPITAL RESOURCES
THE COMPANY
The telecommunications business is capital intensive. The Company generally
is the primary source of funding for its ventures, both for working capital and
capital expenditures. Under a typical arrangement, GTS's venture partner
contributes the necessary licenses or permits under which the venture will
conduct its business, office space and other equipment. GTS's contribution is
generally cash and equipment, but may consist of other specific assets as
required by the joint venture agreement.
24
<PAGE> 25
The Company has raised capital through the issuance of equity securities and
through various debt agreements. The issuance of equity securities has raised
$238.7 million, $36.4 million, $107.7 million, $42.1 million and $62.1 million
in 1998, 1997, 1996, 1995 and 1994, respectively, net of placement fees, for a
total of $487.0 million. In addition, the Company and HER received $105.0
million, $409.8 million, $60.0 million and $23.3 million in 1998, 1997, 1996 and
1995, respectively, for a total of $598.1 million under various debt agreements.
Included within the debt proceeds identified above, the Company received $3.5
million, $60.0 million and $10.0 million in 1997, 1996 and 1995, respectively,
from lenders who are affiliated with, and are considered related parties to, the
Company as a result of their (or their affiliates) ownership of the Company's
Common Stock.
The Company had working capital of $474.5 million and $23.0 million as of
March 31, 1998 and 1997, respectively. The Company had an accumulated deficit of
$280.1 million as of March 31, 1998, including net losses of approximately $37.2
million and $17.7 million for the three months ended March 31, 1998 and 1997,
respectively. During 1998, the Company has incurred and expects to continue to
incur substantial expenditures to fund the working capital requirements of its
ventures, to provide capital equipment for certain of its ventures, and to
engage in new development and acquisitions.
GTS will require substantial capital investment to execute its business
plans and to fund expected operating losses. Management expects that GTS and its
ventures will incur over $510.0 million of capital expenditures and investments
in ventures during the next three years, of which approximately $171.0 million
is expected to be incurred in the remaining three quarters of 1998. The Company
obtained funds in 1998 through a variety of financing arrangements, including
(i) the Company raised approximately $255.3 million in gross proceeds from an
initial public stock offering of 12.8 million common shares at $20.00 per share,
and (ii) the Company issued $105.0 million in gross proceeds of 9-7/8% senior
notes due February 15, 2005, of which $19.6 million was placed in escrow to fund
the first two years' interest payments ("9-7/8% Notes"). The initial public
offering constituted a "complying public equity offering" under the Company's
Convertible Bonds. As a result, the conversion price of the Convertible Bonds is
$20 per share. The Company believes that its existing cash balances will be
sufficient to fund its expected capital needs under its current business plan,
excluding any funds expended in connection with the potential implementation of
the Company's business plan with regard to its European Services Strategy. See
"European Services Strategy." The amount and timing of the Company's future
capital requirements, however, may differ materially from management's
estimates and, therefore, GTS may require additional capital to operate its
current business plan and to fund expected operating losses, as well as to
consummate future acquisitions and exploit opportunities to expand and develop
its businesses.
The actual amount and timing of the Company's future capital requirements
may differ materially from management's estimates. In particular, the accuracy
of management's estimates is subject to changes and fluctuations in the
Company's revenues, operating costs and development expenses, which can be
affected by the Company's ability to (i) effectively and efficiently manage the
expansion of the HER network and operations, (ii) obtain infrastructure
contracts, rights-of-way, licenses and other regulatory approvals necessary to
complete and operate the HER network, (iii) negotiate favorable contracts with
suppliers, including large volume discounts on purchases of capital equipment
and (iv) access markets, attract sufficient numbers of customers and provide and
develop services for which customers will subscribe. The Company's revenues and
costs are also dependent upon factors that are not within the Company's control
such as regulatory changes, changes in technology, increased competition and
various
25
<PAGE> 26
factors such as strikes, weather, and performance by third parties in connection
with the Company's operations. Due to the uncertainty of these factors, actual
revenues and costs may vary from expected amounts, possibly to a material
degree, and such variations are likely to affect the Company's future capital
requirements. Historically, GTS has experienced liquidity problems resulting in
part from the Company's need to meet the capital requirements of certain of its
joint ventures in excess of forecast amounts. In addition, certain of the
Company's joint ventures have not met management's financial performance
expectations or have not been able to secure local country financing and thus
have not been able to generate the expected cash inflows. In addition, if the
Company expands its operations at an accelerated rate or consummates
acquisitions, the Company's funding needs will increase, possibly to a
significant degree, and it will expend its capital resources sooner than
currently expected. The Company may also be required to repay its Convertible
Bonds upon maturity in the year 2000 to the extent such bonds are not converted
into Common Stock. As a result of the foregoing, or if the Company's capital
resources otherwise prove to be insufficient, the Company will need to raise
additional capital.
There can be no assurance that the Company will be able to consummate
additional financing on favorable terms. As a result, the Company may be subject
to additional or more restrictive financial covenants, its interest obligations
may increase significantly and its existing shareholders may be adversely
diluted. Failure to generate sufficient funds in the future, whether from
operations or by raising additional debt or equity capital, may require the
Company to delay or abandon some or all of its anticipated expenditures, to sell
assets, or both, either of which could have a material adverse effect on the
operations of the Company.
HER
Construction of the HER fiber optic network is one of the Company's most
significant business activities. The buildout of the network is expected to
require approximately $290.0 million of capital expenditures. Through March 31,
1998, approximately $64.7 million has been spent on network capital expenditure.
In August 1997, HER completed the issuance of $265.0 million in gross proceeds
of 11-1/2% Senior Notes due in August 2007 ("11-1/2% Senior Notes). The 11-1/2%
Senior Notes are general unsecured obligations of HER. The Company believes that
the net proceeds of the 11-1/2% Senior Notes, combined with HER's projected
internally generated funds, should be sufficient to fund HER's expected capital
expenditures. However, the actual amount and timing of HER's future requirements
may differ materially from management's estimates. Any failure to obtain
necessary financing may require HER to delay or abandon its plans for deploying
the remainder of the network and would jeopardize the viability of HER, or may
require the Company to make additional capital contributions to HER at the
expense of the Company's other operations, either of which could have a material
adverse effect on the operations of the Company. There can be no assurance that
GTS or its partners in HER would have sufficient capital to make contributions
to HER, or that they would be willing to do so.
European Services Strategy
In order to capitalize on the increasing liberalization of
telecommunications regulation in Europe, GTS intends to offer, through one or
more subsidiaries, facilities-based telecommunications products and services
primarily to business and other high-usage customers in certain metropolitan
markets throughout Europe (the "European Services Strategy"). GTS presently
provides end user services in Russia, the CIS and Central Europe and carriers'
carrier services in Western Europe and has experience in developing cross-border
networks in Western Europe through HER. Management has developed a business plan
for the Company's European Services Strategy that calls for the Company to
leverage its experience in developing and operating local, national and
international telecommunications networks by building or acquiring networks and
establishing competitive local exchange carrier service capabilities in up to 12
metropolitan markets throughout Europe, as regulatory conditions permit.
Currently the regulatory regimes in Europe vary from country to country and some
countries do not permit competitive local exchange carriers to operate.
The aforementioned discussion of capital requirements does not include
any capital spending that will be required for the implementation of the
Company's European Services Strategy. Due to the preliminary nature of the
Company's business plan for such strategy, the Company cannot estimate with any
degree of certainty the amount and timing of the Company's future capital
requirements for such implementation, which will be dependent on many factors,
including the success of the Company's European services business, the rate at
which the Company expands its networks and develops new networks, the types of
services the Company offers, staffing levels, acquisitions and customer growth,
as well as other factors that are not within the Company's control, including
competitive conditions, regulatory developments and capital costs. Management
believes, however, that if the European Services Strategy is implemented it is
likely that the Company will need to raise additional capital above that being
raised in the offerings of $300.0 million of Common Stock and $400.0 million
aggregate principal amount of senior convertible debentures, which offerings the
Company registered with the Securities and Exchange Commission on May 15, 1998.
Many of GTS's planned service offerings under its European Services
Strategy will compete with the services offered by customers that HER targets
as an independent carrier's carrier. To the extent that GTS's other
subsidiaries offering the new services discussed above contract with HER for
capacity, GTS expects that such arrangements will be entered into on an arms'
length basis. However, GTS's European Services Strategy could affect the
perception of HER as an independent operator and could negatively impact HER's
ability to attract and retain customers which could, in turn, have an adverse
effect on the Company's financial condition and results of operations.
26
<PAGE> 27
LIQUIDITY ANALYSIS
The Company had cash and cash equivalents of $507.9 million and $30.7
million as of March 31, 1998 and 1997, respectively. The Company had restricted
cash of $77.2 million and $1.5 million as of March 31, 1998 and 1997,
respectively. The restricted cash at March 31, 1998 primarily represents amounts
held in escrow to pay the first two years interest payments on the $105.0
million of the 9-7/8% Notes and $265.0 million of the 11-1/2% Senior Notes.
During the three months ended March 31, 1998 and 1997, the Company used
$27.4 million and $13.4 million, respectively, of cash for operating activities.
Cash used for investing activities was $37.0 million and $11.6 million for the
three months ended March 31, 1998 and 1997, respectively. Included in the cash
used for investing activities for the three months ended March 31, 1998 is $10.2
million to acquire an additional 10.3% interest in HER. The use of cash in
operations and for investing activities reflected primarily the development and
buildout of existing telecommunications networks and the funding of fully
operational ventures. There can be no assurance that the Company's operations
will achieve or sustain profitability or positive cash flow in the future. If
the Company cannot achieve and sustain operating profitability or positive cash
flow from operations, it may not be able to meet its debt service obligations or
working capital requirements.
In February 1998, as contemplated by the Company, as contemplated by
approximately $85.2 million of the net proceeds from the initial public
offering and the 9-7/8% Notes were applied by the Company to repay $70.0
million plus accrued interest of debt from lenders who are affiliated with, and
are considered related parties to, the Company as a result of their (or their
affiliates) ownership of the Company's Common Stock.
Substantially all of the Company's operations are in foreign countries and
therefore the Company's consolidated financial results are subject to
fluctuations in currency exchange rates. The Company's consolidated operations
transact their business in the following significant currencies: Russian Ruble,
Hungarian Florint, Belgium Franc and the European Currency Equivalent. For those
operating companies that transact their business in currencies that are not
readily convertible, the Company attempts to minimize its exposure by indexing
its invoices and collections to the applicable dollar/foreign currency exchange
rate to the extent its costs (including interest expense, capital expenditures
and equity) are incurred in U.S. dollars. Although the Company is attempting to
match revenues, costs, borrowing and repayments in terms of their respective
currencies, the Company may experience economic loss and a negative impact on
earnings with respect to holdings solely as a result of foreign currency
exchange rate fluctuations, which include foreign currency devaluations against
the U.S. dollar. Furthermore, certain of the Company's operations have notes
payable and notes receivable which are denominated in a currency other than
their own functional currency or loans linked to the U.S. dollar. The Company
may also experience economic loss and a negative impact on earnings related to
these monetary assets and liabilities.
The Company has developed risk management policies that establish
guidelines for managing foreign exchange risk. The Company is currently
evaluating the materiality of foreign exchange exposures in different countries
and the financial instruments available to mitigate this exposure. The Company's
ability to hedge its exposure is limited since certain of its operations are
located in countries whose currencies are not easily convertible. Financial
hedge instruments for these
27
<PAGE> 28
countries are nonexistent or limited and also pricing of these instruments is
often volatile and not always efficient. The Company is designing reporting
processes to monitor the potential exposure on an ongoing basis and expects to
implement this process before the end of 1998. The Company will use the output
of this process to execute financial hedges to cover foreign exchange exposure
when practical and economically justified.
In April 1998, the Company consummated a transaction to hedge the foreign
exchange exposure resulting from the issuance of the 11-1/2% Senior Notes by
HER.
YEAR 2000 COMPLIANCE
The Company is currently in the process of assessing its year 2000
compliance costs and of converting, where necessary, its computer systems to
year 2000 compliant software. This process includes obtaining confirmations from
the Company's primary vendors that plans are being developed or are already in
place to address processing of transactions in the year 2000. The Company does
not expect that the cost of converting such systems will be material to its
financial condition or results of operations. The Company currently believes it
will be able to achieve year 2000 compliance by the end of 1999, and currently
does not anticipate any material disruption in its operations as the result of
any failure by the Company to be in compliance or that year 2000 compliance
costs will have a material effect on the Company's earnings.
SUPPLEMENTAL INFORMATION - SELECTED HISTORICAL
FINANCIAL DATA - COMBINED EQUITY INVESTMENTS
The following unaudited selected historical financial data - equity
investments for the three months ended March 31, 1997 and March 31, 1998, are
derived from the Company's financial records. It is intended to supplement the
unaudited condensed consolidated financial statements. The financial data set
forth below represents 100% of the results of operations for each of the
entities.
The Company believes that this information provides additional insight on
the Company's unconsolidated equity method investments. Generally accepted
accounting principles prescribe inclusion of revenues and expenses of
consolidated interests (generally interests of more than 50%, absent some other
factors), but not for equity interests (generally interests of 20% to 50%) or
cost interests (generally interests of less than 20%). Equity accounting
ordinarily results in the same net income as consolidation; however, the net
operating results are reflected on one line within the income statement.
28
<PAGE> 29
<TABLE>
<CAPTION>
OWNERSHIP REVENUES COST OF OPERATING NET INCOME/
INTEREST (1) REVENUES EXPENSES (LOSS)
------------ -------- -------- ---------- -----------
<S> <C> <C> <C> <C> <C>
THREE MONTHS ENDED MARCH 31, 1997
Sovintel 50% $ 25,162 $ 14,763 $ 3,855 $ 4,695
TCM 50% 6,326 1,535 600 2,910
TeleRoss 50% 1,529 284 674 515
Sovam 66.7% 3,703 2,388 1,359 (118)
GTS Cellular Companies 50% (2) 8,045 3,665 3,590 (877)
Other 50% (2) 3,261 4,186 4,067 (5,159)
------------- ------------- --------------- ---------------
Total $ 48,026 $ 26,821 $ 14,145 $ 1,966
Adjustments for Inter-Affiliate Transactions (3) (5,933) (4,760) (2,875)
THREE MONTHS ENDED MARCH 31, 1998 (4)
Sovintel 50% $ 32,404 $ 21,957 4,646 $ 4,345
TCM 50% 9,456 2,578 852 3,847
TeleRoss 50% 2,392 717 978 325
GTS Cellular Companies 50% (2) 14,905 6,775 5,192 1,415
Other 50% (2) 4,526 4,360 1,124 (947)
------------- ------------- --------------- ---------------
Total $ 63,683 $ 36,387 $ 12,792 $ 8,985
Adjustments for Inter-Affiliate Transactions (3) (8,890) (8,105) 4,158
</TABLE>
- ---------------------
(1) The ownership interest column indicates the Company's legal ownership
percentage for the respective equity investments. The information is being
provided to assist an investor or analyst in determining the Company's
legal rights associated with the presented financial data.
(2) The Company generally maintains a 50% ownership interest in these equity
investments.
(3) The adjustment amounts represent the effect of inter-affiliate transactions
between the Company's consolidated and equity method ventures. More
detailed information about inter-affiliate transactions is included under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Accounting Methodology."
(4) As a result of the Company's purchase of the minority partner's 33.3%
interest in Sovam during the first quarter of 1998, the Company accounts
for its ownership interest in Sovam under the consolidation method of
accounting. Prior to this date, the Company accounted for Sovam under the
equity method of accounting.
PART II. OTHER INFORMATION
Item 2 Changes in Securities and Use of Proceeds
(d) In February 1998, the Company completed the sale of 12.8 million shares
of Common Stock at a per share price of $20.00 in an initial public offering
("Offering") pursuant to a Registration Statement on Form S-1 (Registration No.
333-36555), which was declared effective on February 5, 1998. The shares of
Common Stock were sold by several U.S. and international
29
<PAGE> 30
underwriters and the Global Coordinator was Merrill Lynch & Co. with UBS
Securities in a Co-Global Coordinator role. Of the $255.3 million in gross
proceeds, including $33.3 million attributable to the sale of shares resulting
from the exercise by the underwriters of an over-allotment option, the Company
paid $16.6 million to the underwriters in connection with underwriting discounts
and $3.1 million was paid by the Company in connection with expenses, including
legal, printing and filing fees, in connection with the offering.
The remaining net proceeds of $235.6 million have been invested by the
Company for future use as additional working capital. Concurrent with the
Offering, the Company issued $105.0 million of senior notes, net proceeds of
$100.5 million, that was principally used to extinguish shareholder debt of
approximately $85.2 million. Accordingly, there were no direct or indirect
payments to directors or officers of the Company or to any person or entity and
none of the proceeds from the Offering have been used for the repayment of
indebtedness.
Item 5 Other Information
As described in "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources - The
Company - European Services Strategy," in May 1998, the Company filed
registration statements with the Securities and Exchange Commission to offer to
sell concurrently $300 million of its common stock (with an overallotment option
of up to $75 million in additional shares) and $400 aggregate principal amount
of its convertible senior debentures (with an overallotment option of up to $60
million in additional debentures). The common stock offering may include a
secondary offering of $200 million of common shares owned by existing
shareholders.
Item 6 Exhibits and Reports on Form 8-K
A. Exhibits
Designation Description
27 Financial Data Schedule
B. Reports on Form 8-K
Date of Report Subject of Report
None
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrants have duly caused this report to be signed on their behalf by the
undersigned thereunto duly authorized.
GLOBAL TELESYSTEMS GROUP, INC.
(Registrant)
By: /s/ William H. Seippel
Name: William H. Seippel
Title: Executive Vice President and
Chief Financial Officer
Date: May 15, 1998 (Principal Financial and
Accounting Officer)
30
<PAGE> 31
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM (A) 3/31/98
UNAUDITED CONDENSED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH (B) FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 507,895
<SECURITIES> 0
<RECEIVABLES> 23,078
<ALLOWANCES> 3,142
<INVENTORY> 0
<CURRENT-ASSETS> 595,922
<PP&E> 293,976
<DEPRECIATION> (23,336)
<TOTAL-ASSETS> 1,048,550
<CURRENT-LIABILITIES> 121,415
<BONDS> 685,009
0
0
<COMMON> 5,204
<OTHER-SE> 249,637
<TOTAL-LIABILITY-AND-EQUITY> 1,048,550
<SALES> 2,025
<TOTAL-REVENUES> 22,817
<CGS> 1,556
<TOTAL-COSTS> 19,023
<OTHER-EXPENSES> 27,492
<LOSS-PROVISION> 515
<INTEREST-EXPENSE> 16,466
<INCOME-PRETAX> (26,274)
<INCOME-TAX> 552
<INCOME-CONTINUING> (24,473)
<DISCONTINUED> 0
<EXTRAORDINARY> (12,704)
<CHANGES> 0
<NET-INCOME> (37,177)
<EPS-PRIMARY> (0.82)
<EPS-DILUTED> (0.82)
</TABLE>
