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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 SEPTEMBER 30, 1999
(COMMISSION FILE NUMBER: 0-23717)
GLOBAL TELESYSTEMS GROUP, INC.
(Exact name of registrant as specified in its charter)
---------------------
<TABLE>
<S> <C>
DELAWARE 94-3068423
(State of incorporation) (I.R.S. Employer Identification No.)
</TABLE>
4121 WILSON BOULEVARD
8TH FLOOR
ARLINGTON, VIRGINIA 22203
(Address of principal executive office)
(703) 236-3100
(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 October 22, 1999, there were 180,098,665 outstanding shares of common
stock of the registrant.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1 Financial Statements of Global TeleSystems Group, Inc
(unaudited) Condensed Consolidated Balance Sheets as of
September 30, 1999 and December 31, 1998.................. 3
Condensed Consolidated Statements of Operations for the
Three and Nine months Ended September 30, 1999 and 1998... 4
Condensed Consolidated Statements of Cash Flows for the Nine
months Ended September 30, 1999 and 1998.................. 5
Notes to Condensed Consolidated Financial Statements........ 6
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 12
Item 3 Quantitative and Qualitative Disclosures About Market
Risk...................................................... 21
PART II. OTHER INFORMATION
Item 5 Other Information........................................... 21
Item 6 Exhibits and Reports on Form 8-K............................ 24
Signatures............................................................. 26
</TABLE>
2
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PART I. FINANCIAL INFORMATION
ITEM 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
GLOBAL TELESYSTEMS GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
-------------- -------------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents................................. $ 979,933 $ 998,510
Restricted cash........................................... 41,576 82,025
Accounts receivable, net.................................. 289,421 174,430
Prepaid expenses and other assets......................... 142,011 38,392
---------- ----------
TOTAL CURRENT ASSETS............................... 1,452,941 1,293,357
Property and equipment, net................................. 905,683 643,044
Goodwill and intangible assets, net......................... 1,055,427 543,524
Investments in and advances to ventures..................... 68,627 50,751
Restricted cash and other non-current assets................ 48,170 83,926
---------- ----------
TOTAL ASSETS....................................... $3,530,848 $2,614,602
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses..................... $ 399,653 $ 279,509
Current portion of debt and capital lease obligations..... 184,298 66,961
Unearned revenue and other current liabilities............ 80,058 64,589
---------- ----------
TOTAL CURRENT LIABILITIES.......................... 664,009 411,059
Long-term debt and capital lease obligations................ 1,972,037 1,725,353
Unearned revenue............................................ 101,060 34,093
Taxes and other non-current liabilities..................... 10,613 40,784
---------- ----------
TOTAL LIABILITIES.................................. 2,747,719 2,211,289
COMMITMENTS AND CONTINGENCIES
Minority interest........................................... 101,981 37,329
Common stock, subject to repurchase (576,882 shares
outstanding at December 31, 1998)......................... -- 16,081
Redeemable preferred stock, $0.0001 par value (10,000,000
shares authorized; 100,000 shares issued and outstanding
at September 30, 1999).................................... 502,316 --
SHAREHOLDERS' EQUITY
Common stock, $0.10 par value (270,000,000 shares
authorized; 174,345,621 and 161,466,744 shares issued and
outstanding at September 30, 1999 and December 31, 1998,
respectively)............................................. 17,435 16,147
Additional paid-in capital.................................. 1,107,982 876,983
Notes receivable, common stock.............................. (10,265) --
Accumulated other comprehensive income/(loss)............... (15,215) 488
Accumulated deficit......................................... (921,105) (543,715)
---------- ----------
TOTAL SHAREHOLDERS' EQUITY......................... 178,832 349,903
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY......... $3,530,848 $2,614,602
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
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GLOBAL TELESYSTEMS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
1999 1998 1999 1998
--------- -------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenues........................................ $ 227,921 $118,335 $ 599,137 $ 230,547
Operating expenses:
Access and network services................... 140,226 72,948 356,088 151,153
Selling, general and administrative........... 95,907 57,467 265,249 126,529
Depreciation and amortization................. 59,133 24,811 146,782 50,831
Merger and restructuring costs................ 19,829 -- 83,543 --
--------- -------- --------- ---------
Total operating expenses........................ 315,095 155,226 851,662 328,513
Loss from operations............................ (87,174) (36,891) (252,525) (97,966)
Other income (expense):
Interest, net................................. (31,637) (14,199) (97,577) (43,132)
Foreign currency gains/(losses)............... 12,597 (8,460) (1,565) (13,413)
Other (expenses)/income....................... (4,016) (3,376) (15,091) 7,888
--------- -------- --------- ---------
(23,056) (26,035) (114,233) (48,657)
--------- -------- --------- ---------
Loss before income taxes and extraordinary
loss.......................................... (110,230) (62,926) (366,758) (146,623)
Income taxes.................................... 2,655 770 10,632 2,154
--------- -------- --------- ---------
Net loss before extraordinary loss.............. (112,885) (63,696) (377,390) (148,777)
Extraordinary loss -- debt refinancing.......... -- -- -- (12,704)
--------- -------- --------- ---------
Net Loss........................................ $(112,885) $(63,696) $(377,390) $(161,481)
--------- -------- --------- ---------
Preferred dividend.............................. (9,063) -- (16,615) --
--------- -------- --------- ---------
Net loss applicable to common shareholders...... $(121,948) $(63,696) $(394,005) $(161,481)
========= ======== ========= =========
Loss per common share:
Net loss per share, before extraordinary
loss....................................... $ (0.70) $ (0.42) $ (2.35) $ (1.08)
Extraordinary loss per share.................. -- -- -- (0.09)
--------- -------- --------- ---------
Net loss per share.............................. $ (0.70) $ (0.42) $ (2.35) $ (1.17)
========= ======== ========= =========
Weighted average common shares outstanding...... 173,610 152,142 167,756 138,348
========= ======== ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
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GLOBAL TELESYSTEMS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------
1999 1998
--------- ----------
(IN THOUSANDS)
<S> <C> <C>
OPERATING ACTIVITIES
Net loss.................................................... $(377,390) $ (161,481)
ADJUSTMENTS TO RECONCILE NET LOSS TO NET CASH USED IN
OPERATING ACTIVITIES:
Depreciation and amortization............................. 146,137 59,453
Other operating activities................................ 43,506 34,375
Changes in assets and liabilities:
Accounts receivable.................................... (123,607) (76,153)
Accounts payable and accrued expenses.................. 50,913 100,943
Unearned revenue....................................... 97,682 --
Other changes in assets and liabilities................ (40,550) 23,846
--------- ----------
NET CASH USED IN OPERATING ACTIVITIES............. (203,309) (19,017)
--------- ----------
INVESTING ACTIVITIES
Acquisitions, goodwill and other intangibles.............. (332,263) (212,936)
Purchases of property and equipment....................... (221,468) (184,379)
Investments in and advances to ventures, net of
repayments............................................. (31,692) 15,055
Restricted cash and other investing activities............ 30,864 25,893
--------- ----------
NET CASH USED IN INVESTING ACTIVITIES............. (554,559) (356,367)
--------- ----------
FINANCING ACTIVITIES
Net proceeds from issuance of equity securities........... 507,342 362,729
Proceeds from debt, net of debt issue costs............... 292,287 791,602
Repayments of debt........................................ (68,083) (104,028)
Other financing activities................................ -- 9,473
--------- ----------
NET CASH PROVIDED BY FINANCING ACTIVITIES......... 731,546 1,059,776
--------- ----------
Effect of exchange rate changes on cash and cash
equivalents............................................... 7,745 1,687
--------- ----------
Net (decrease) increase in cash and cash equivalents........ (18,577) 686,079
Cash and cash equivalents at beginning of period............ 998,510 538,593
--------- ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $ 979,933 $1,224,672
========= ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE> 6
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
Global TeleSystems Group, Inc. ("GTS" or "the Company"), is a provider of a
broad range of telecommunications services to businesses, other
telecommunications service providers and consumers through its operation of
voice and data networks, international gateways, local access and cellular
networks and the provision of various value-added services in Western Europe,
Central Europe and the Commonwealth of Independent States ("CIS"), primarily
Russia. Except as indicated, all disclosures in the financial statements and
those notes pertaining to the Company's common stock reflect the two-for-one
common stock split discussed below in this note.
The financial statements of GTS included herein are unaudited and have been
prepared in accordance with generally accepted accounting principles for interim
financial reporting and in accordance with 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 account transactions have been eliminated. In
the opinion of management, the financial statements reflect all adjustments of a
normal and recurring nature necessary to present fairly the Company's financial
position, results of operations and cash flows for the interim periods. These
financial statements should be read in conjunction with the Company's 1998
audited consolidated financial statements and the notes related thereto. The
results of operations for the three and nine months ended September 30, 1999 may
not be indicative of the operating results for the full year.
Effective March 4, 1999, the Company completed its business combination
with Esprit Telecom Group plc ("Esprit") which was accounted for as a pooling of
interests. Accordingly, these financial statements have been restated and are
presented as if the companies have been combined since inception.
On June 16, 1999 the GTS's stockholders approved an increase in the
Company's authorized common stock from 135 million to 270 million shares. In
June 1999, the Company's Board of Directors approved a two-for-one split of its
common stock. The stock split was effected by the distribution of a stock
dividend on July 21, 1999 to holders of the Company's common stock at the close
of business on July 1, 1999.
2. EARNINGS PER SHARE
Basic earnings per share is computed on the basis of the weighted average
number of common shares outstanding. Diluted earnings per share is computed on
the basis of the weighted average number of common shares outstanding plus the
effect of outstanding preferred shares using the "if-converted" method and
outstanding stock options using the "treasury stock" method.
6
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of basic and diluted earnings per share were as follows:
Earnings Per Share
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
1999 1998 1999 1998
--------- -------- --------- ---------
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
<S> <C> <C> <C> <C>
Net loss(A)............................. $(112,885) $(63,696) $(377,390) $(161,481)
Preferred stock dividends............... (9,063) -- (16,615) --
--------- -------- --------- ---------
Net loss available for common
shareholders(B)....................... $(121,948) $(63,696) $(394,005) $(161,481)
========= ======== ========= =========
Weighted average outstanding of:
Common stock shares..................... 173,583 152,142 167,745 138,348
Restricted shares, vested............... 27 -- 11 --
--------- -------- --------- ---------
Total Weighted Average Shares
outstanding(C)........................ 173,610 152,142 167,756 138,348
Dilutive effect of:
Preferred stock......................... 14,492 -- 14,492 --
Warrants................................ 8,773 8,889 8,773 8,889
Restricted shares, unvested............. 218 -- 218 --
Common shares issuable upon debt
conversion............................ 27,542 28,903 27,542 28,903
Employee stock options.................. 21,781 12,580 21,781 12,580
--------- -------- --------- ---------
Common stock and common stock
equivalents(D)........................ 246,416 202,514 240,562 188,720
========= ======== ========= =========
Interest on convertible preferred stock,
net of taxes(E)....................... $ 8,975 -- $ 26,827 --
--------- -------- --------- ---------
Earnings per share:
Basic (B/C)........................... $ (0.70) $ (0.42) $ (2.35) $ (1.17)
========= ======== ========= =========
Diluted ((A+E)/D)..................... $ (0.42) $ (0.31) $ (1.46) $ (0.86)
========= ======== ========= =========
</TABLE>
The information in the table above represents all items that would normally
effect dilutive earnings per share. However, all of the items identified above
that are included in the dilutive calculation should not be considered, as they
are anti-dilutive. The above table is presented for informational purposes only
and is not representative of the GTS diluted earnings per share, which would be
equal to basic earnings per share for all periods presented.
7
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. COMPREHENSIVE INCOME (LOSS)
The following table reflects the calculation of comprehensive income (loss)
for GTS for the three and nine months ended September 30, 1999 and 1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
1999 1998 1999 1998
--------- -------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Net loss................................ $(112,885) $(63,696) $(377,390) $(161,481)
Other comprehensive income (loss)
Preferred Dividends................... (9,063) -- (16,615) --
Foreign currency translation
adjustments........................ (10,256) 5,445 (15,703) 2,382
--------- -------- --------- ---------
Comprehensive loss...................... $(132,204) $(58,251) $(409,708) $(159,099)
========= ======== ========= =========
</TABLE>
4. INVESTMENTS IN FLAG ATLANTIC LIMITED
GTS indirectly owns fifty percent of FLAG Atlantic Limited, a Bermuda
corporation ("FLAG Atlantic"), which was formed to develop, construct, operate
and arrange the financing for a 15,000 kilometer, 12 fiber, submarine fiber
optic cable system which will connect the United States and Europe, and the
landed portions of the system, which will connect London, Paris and New York.
FLAG Telecom is the indirect owner of the other 50% of FLAG Atlantic. The
project will have an initial available capacity of 160 gigabits per second that
may be upgraded with wave division multiplexing technology to a total system
capacity of 2.4 terabits per second. The Company anticipates that the first leg
and second leg of the system will be available for commercial operation on or
about the first quarter of 2001 and second quarter of 2001, respectively. Total
project costs are estimated at $1.1 billion.
GTS has made an equity investment commitment of $100 million and a dark
fiber capacity purchase commitment of $200 million which are fully supported by
a bank letter of credit. The bank facility is non-recourse to GTS and FLAG;
however, in addition to other collateral and assignment of certain contracts,
GTS and FLAG Telecom have pledged the stock they own in FLAG Atlantic to the
lenders in the bank credit facility.
5. BUSINESS COMBINATIONS AND OTHER TRANSACTIONS
On March 4, 1999, GTS acquired substantially all of the outstanding
ordinary shares and American Depositary Shares of Esprit Telecom Group plc
("Esprit"). Upon completion of the transaction, the number of shares issued for
the outstanding ordinary shares and American Depository Shares of Esprit was
32,055,024. The Company accounted for this combination as a pooling of
interests. Accordingly, the Company restated the accompanying financial
statements and financial data to represent the combined financial results of the
previously separate entities for all periods presented.
Esprit had a fiscal year-end of September 30. The Esprit statements of
operations for the years ended September 30, 1997 and 1996 were combined with
GTS's statements of operations for the calendar year ended December 31, 1997.
The three months of operations of Esprit from October 1, 1997 to December 31,
1997 are not included in any of the statements of operations presented.
Accordingly, an adjustment was made in the consolidated statements of
shareholders' equity for 1997 to include the net income and other transactions
of Esprit for the three months ended December 31, 1997. On September 24, 1999,
Esprit filed an 8-K declaring a fiscal year-end change from September 30 to
December 31.
On April 26, 1999, GTS acquired a majority stake in Omnicom, a French
company, and assumed operational control. On April 27, 1999, GTS initiated an
offer for the remaining shares of Omnicom and as of
8
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
May 12, 1999, GTS had acquired 98.9 percent of the fully diluted capital and
voting rights of Omnicom. Total consideration for the Omnicom shares consisted
of approximately $320 million in cash and 3,700,994 shares of the Company's
common stock. The excess of the purchase price over the fair value of assets
acquired has been preliminarily calculated at approximately $440.2 million.
On May 25, 1999, the Company purchased the remaining 25% minority interest
in Ebone A/S ("Ebone") from the Ebone Holding Association ("EHA") for a purchase
price of Euro 35 million. The purchase price was comprised of cash of Euro 15
million and the issuance to EHA of capacity rights on the Hermes Railtel network
valued at Euro 20 million (the "Rights"). The excess of the purchase price over
the fair value of the assets acquired has been preliminary calculated at
approximately $9.2 million.
In June 1999, GTS increased its ownership of Hermes Europe Railtel B.V.
("Hermes Railtel") to 95.4% percent by acquiring the remaining shares held by
NMBS/SNCB (the Belgian Railway). The Company issued 2,150,380 shares of its
common stock in exchange for its interest in Hermes Railtel. The excess of the
purchase price paid over the incremental fair value of assets acquired has been
preliminarily calculated at approximately $70.9 million.
On September 30, 1999, Golden Telecom, Inc. ("Golden Telecom"), a wholly
owned subsidiary of Global TeleSystems Group, Inc. completed its initial public
offering of Golden Telecom's common stock. Golden Telecom was formed to hold
GTS's interest in the businesses it owns and operates in Russia and the CIS.
Golden Telecom, through subsidiaries, is a facilities-based provider of
integrated telecommunications services in Moscow, Kiev, St. Petersburg and other
major population centers throughout Russia, Ukraine and other countries of the
CIS. Through the initial public offering, Golden Telecom raised over $50 million
from public investors, approximately $30 million from strategic investors and
$50 million from GTS. Following the initial public offering, GTS maintains a 66%
ownership in Golden Telecom.
6. RELATED PARTY TRANSACTIONS
The Company has entered into a subscription agreement (the "Subscription
Agreement") dated as of April 6, 1999 with H. Brian Thompson, its Chairman and
Chief Executive Officer, in connection with Mr. Thompson's employment agreement
with the Company. The Subscription Agreement provides that Mr. Thompson purchase
$20 million of the Company's common stock valued at $27.17 per share, or a total
of 736,056 shares. The Subscription Agreement provides further that Mr. Thompson
pay for 368,028 of these shares in cash and for 368,028 of these shares using
the proceeds of a loan from the Company. These arrangements were consummated in
June 1999. In connection with the loan, Mr. Thompson has delivered a secured
promissory note to the Company which bears interest at the Federal Mid-Term Rate
and which has a maturity of six years.
7. DEBT AND OTHER OBLIGATIONS
In January 1999, our subsidiary Hermes Railtel issued, through a private
placement, aggregate principal amount $200 million of senior notes due January
15, 2009 (the "Dollar Notes") and Euro 85 million (approximately $100 million)
of senior notes due January 15, 2006 (the "Euro Notes" and together with the
Dollar Notes, the "New Senior Notes"). The New Senior Notes are general
unsecured obligations of Hermes Railtel, with interest payable semiannually at a
rate of 10.375%. Net proceeds from the issuance of the New Senior Notes were
approximately $289.3 million. Hermes Railtel filed an S-4 registration statement
with the Securities and Exchange Commission to exchange registered senior notes,
with the same terms and conditions as the New Senior Notes, for the New Senior
Notes, which became effective in February 1999. The exchange of registered notes
for the New Senior Notes was completed on March 24, 1999.
In April 1999, the Company issued, for gross proceeds of $500 million in a
private placement, ten million Depositary Shares, each representing 1/100th of a
share of a new series of 7.25% cumulative convertible
9
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
preferred stock. Net proceeds of this offering were $485 million, excluding
certain transaction costs. Holders of the Depositary Shares will be entitled to
a quarterly cash payment of $0.90625 per Depositary Share (or 7 1/4% per year
per depositary share) payable on March 15, June 15, September 15 and December 15
of each year commencing on June 15, 1999. Each Depositary Share will have a
liquidation preference of $50 per share and will be convertible into GTS common
stock at $34.50 per GTS common share. The Company filed an S-3 registration
statement with the Securities and Exchange Commission to register the Depositary
Shares, the preferred shares and the common shares into which the Depositary
Shares are convertible. The Securities and Exchange Commission declared that
registration statement effective on June 7, 1999.
8. CAPITAL LEASE OBLIGATIONS
The Company entered into contractual commitments to lease fiber pairs,
including facilities and maintenance. Based on the contract provisions, these
commitments are currently estimated to aggregate approximately $314.3 million.
The commitments have expected lease terms of ten to eighteen years.
9. SUPPLEMENTAL CASH FLOW INFORMATION
The following table summarizes significant non-cash investing and financing
activities for the Company:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, 1999
------------------
(IN THOUSANDS)
<S> <C>
Capitalization of leases.................................... $108,027
Acquisition of minority interests in Hermes................. 69,536
Acquisition of Omnicom...................................... 106,872
Acquisition of minority interests in Ebone.................. 21,423
Acquisition of capacity..................................... 31,244
</TABLE>
10. SEGMENT INFORMATION
The Company adopted the Financial Accounting Standards Board's Statement of
Financial Accounting Standards No. 131, or SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information" as of December 31, 1998. SFAS
No. 131 establishes annual and interim reporting standards for an enterprise's
operating segment and related disclosures about its products, services,
geographic areas and major customers.
10
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company's chief operating decision-maker utilizes revenue information
in assessing performance and making overall operating decisions and resource
allocations. Information about the Company's segments is as follows:
<TABLE>
<CAPTION>
CORPORATE
CARRIER BUSINESS CENTRAL OFFICE &
SERVICES SERVICES EUROPE CIS OTHER TOTAL
---------- ---------- ------- -------- --------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Nine months Ended
September 30, 1999
Total revenue........... $ 205,526 $ 299,604 $19,357 $ 72,466 $ 2,184 $ 599,137
Total assets............ 1,202,010 1,197,954 46,431 225,949 858,504 3,530,848
Nine months Ended
September 30, 1998
Total revenue........... $ 42,933 $ 113,248 $12,552 $ 60,672 $ 1,142 $ 230,547
Total assets............ 697,733 652,979 38,859 232,691 845,392 2,467,654
</TABLE>
11. SUBSEQUENT EVENTS
Purchase of Minority Interest in Hermes Railtel
On October 15, 1999, the Company entered into an exchange agreement with
all of the minority interest holders of Hermes Railtel's common shares and
grantees of Hermes Railtel stock options that provides for the acquisition by
the Company of their equity interest in Hermes Railtel. Specifically, the
agreement provides that the Company will acquire the respective minority
interest holders' common shares in Hermes Railtel that have been held by them
for a period greater than six months based on the current fair market value of
Hermes Railtel on the date of the exchange, as determined by a
globally-recognized investment banking firm that is mutually acceptable to the
parties of the agreement. The agreement also provides that the Company would
issue its common shares to Hermes Railtel's minority interest holders based on
the fair market value of the Company's common shares on the date of the
exchange.
Pursuant to this agreement and effective October 15, 1999, the Company
exchanged 5,985,930 of its common shares for 6,565 of Hermes Railtel's common
shares. This transaction will result in excess purchase price paid over the fair
value of the assets acquired of approximately $133.0 million, which will be
recorded in the fourth quarter of 1999.
Further, minority interest holders of Hermes Railtel have additional
beneficial ownership rights in Hermes Railtel's common shares, and common share
options, totaling 3,601 common shares. As stated previously, the Company intends
to acquire these Hermes Railtel common shares in the future; however, future
acquisitions will be based on future market values of Hermes Railtel and the
Company.
Hermes Railtel High-Yield Debt Financing
Hermes Railtel is currently engaged in an offering to issue approximately
Euro 300 million of general unsecured senior notes pursuant to Rule 144A and
Regulation S of the Securities Act of 1933. Hermes Railtel will use the net
proceeds from this offering, its existing cash balances and its projected
internally generated cash flows to meet its strategic capital expenditure plans
through December 31, 2000.
HERMES RAILTEL -- NAME CHANGE
A notarial deed amending the Company's articles of association to change
Hermes Railtel's name to Global TeleSystems Europe B.V. was executed on October
22, 1999. The change in Hermes Railtel's legal
11
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
name will become effective upon the issuance by the Dutch Ministry of Justice of
a declaration of non-objection, which is expected on or about November 18, 1999.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis relates to the financial condition
and results of operations of the Company for the three and nine months ended
September 30, 1999 and 1998. This information should be read in conjunction with
the Company's Condensed, Consolidated Financial Statements and the notes related
thereto appearing elsewhere in the document.
Special Note Regarding Forward Looking Statements
Certain statements contained in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" including, without limitation,
those concerning (i) projected traffic volume, (ii) future revenues and costs,
(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.
In addition, any statements that express, or involve discussions as to,
expectations, beliefs, plans, objectives, assumptions or future events or
performance (often, but not always, through the use of words or phrases such as
"will likely result," "are expected to," "will continue," "is anticipated,"
"estimated," "intends," "plans," "projection" and "outlook") are not historical
facts and may be forward-looking and, accordingly, such statements involve
estimates, assumptions and uncertainties which could cause actual results to
differ materially from those expressed in the forward-looking statements.
Accordingly, any such statements are qualified in their entirety by reference
to, and are accompanied by, the factors discussed throughout this report. Among
the key factors that have a direct bearing on the Company's results of
operations are the potential risk of delay in implementing the Company's
business plan; the political, economic and legal aspects of the markets in which
the Company operates; competition and the Company's need for additional
substantial financing. These and other factors are discussed herein under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and elsewhere in this Report.
The factors described in this report could cause actual results or outcomes
to differ materially from those expressed in any forward-looking statements of
the Company made by or on behalf of the Company, and investors, therefore,
should not place undue reliance on any such forward-looking statements. Further,
any forward-looking statement speaks only as of the date on which such statement
is made, and the Company undertakes no obligation to update any forward-looking
statement or statements to reflect events or circumstances after the date on
which such statement is made or to reflect the occurrence of unanticipated
events. New factors may emerge from time to time, and it is not possible for
management to predict all of such factors. Further, management cannot assess the
impact of each such factor on the Company's business or the extent to which any
factor, or combination of factors, may cause actual results to differ materially
from those contained in any forward-looking statements.
Overview
We are a leading independent provider of telecommunications services to
businesses, other high usage customers and telecommunications carriers in
Western and Central Europe. We also provide telecommunications services in
Russia and the Commonwealth of Independent States (CIS).
From our inception until 1998, we focused on (1) providing
telecommunications services in emerging markets, particularly in Russia and (2)
establishing and developing Hermes Europe Railtel B.V. ("Hermes Railtel"), a
venture designed to provide a high speed transmission network across national
borders in Western
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Europe. We intended to capitalize on the rapidly growing demand for
telecommunications services in countries emerging from totalitarian rule and
state-controlled economies. In addition, in Western Europe, growing
liberalization of regulations governing the provision of telecommunications
services has resulted in a proliferation of new competitors to the incumbent
public telecommunications operators. At the same time, with the trend toward the
increasing globalization of business, there has been substantial growth in
demand for high-quality voice and data telecommunications. We perceived a need
for a fast, efficient and lower cost cross-border network that would carry the
traffic of established public telecommunications operators and other carriers.
Since we began operating our Hermes Railtel network in late 1996, the demand for
its services has validated our decision to build and develop such a network. In
1998, we changed our strategy in response to the economic crisis in emerging
markets and the advent on January 1, 1998 of the deregulation of the provision
of telecommunications services in Western Europe.
Our strategy to develop our businesses is to:
- Continue the buildout of the Hermes Railtel network by extending its
coverage and enhancing its capacity and by putting in place a
cost-efficient transatlantic link through our participation in FLAG
Atlantic Limited;
- Develop City Enterprise Network infrastructure to facilitate our
customers' access to our Hermes Railtel network;
- Capitalize on growth in data/IP traffic by expanding our IP-based
capabilities and product offerings, including the implementation of data
and web-hosting centers in London, Amsterdam, Frankfurt, Paris and other
European cities;
- Reinforce and extend market penetration of Hermes Railtel's network by
enhancing the scope, capacity, reliability and efficiency of our
infrastructure, and by providing our own local access; and
- Maximize traffic over our own network.
As part of our business strategy, we expect to continue to expand through
additional significant acquisitions and by entering into additional joint
ventures and other cooperative business relationships. We believe that
additional attractive acquisition opportunities currently exist in Western and
Central Europe and in the United States and are continually evaluating these
opportunities. Certain of these transactions, if consummated, may be material to
our operations and financial condition.
Results of Operations
The following discussion of our results of operations and liquidity and
capital resource requirements reflect the restatement of our financial results
for 1999 and prior periods as a result of the business combination with Esprit
Telecom, which we accounted for as a pooling of interests.
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table sets forth our statement of operations as a percentage
of revenues:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
1999 1998 1999 1998
------ ------ ------ ------
<S> <C> <C> <C> <C>
Revenues...................................... 100.0% 100.0% 100.0% 100.0%
Access and network services................... 61.5 61.6 59.4 65.6
Selling, general and administrative........... 42.1 48.6 44.3 54.9
Depreciation and amortization................. 25.9 21.0 24.5 22.0
Merger and restructuring costs................ 8.7 -- 13.9 --
----- ----- ----- -----
Loss from operations.......................... (38.2) (31.2) (42.1) (42.5)
Interest, net................................. (13.9) (12.0) (16.3) (18.7)
Other non-operating expenses.................. 3.8 (10.0) (2.8) (2.4)
----- ----- ----- -----
Net loss before income taxes, minority
interest and extraordinary loss............. (48.3) (53.2) (61.2) (63.6)
Income taxes.................................. 1.2 0.7 1.8 0.9
----- ----- ----- -----
Net loss before extraordinary loss............ (49.5) (53.9) (63.0) (64.5)
----- ----- ----- -----
Extraordinary loss -- debt refinancing........ -- -- -- (5.5)
----- ----- ----- -----
Net loss...................................... (49.5)% (53.9)% (63.0)% (70.0)%
===== ===== ===== =====
Preferred dividend............................ (4.0) -- (2.8) --
===== ===== ===== =====
Net loss applicable to common shareholders.... (53.5)% (53.9)% (65.8)% (70.0)%
===== ===== ===== =====
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 1998
Revenue. Our consolidated revenue increased to $227.9 million for the three
months ended September 30, 1999 as compared to $118.3 million for the three
months ended September 30, 1998. Significant components of revenue for the three
months ended September 30, 1999 were Carrier Services ($81.6 million), Business
Services ($113.7 million), Central Europe ($7.0 million) and CIS ($25.1
million). Revenue for the three months ended September 30, 1998 was primarily
comprised of Carrier Services ($27 million), Business Services ($54.5 million),
Central Europe ($4.3 million) and CIS ($32 million). The growth in revenue was
primarily attributable to the increase in our customer base and resulting
traffic in all of our operations.
Access and Network Services. Our access and network services costs for the
three months ended September 30, 1999 increased to $140.2 million or 61.5% of
revenues as compared to $72.9 million or 61.6% of revenues for the three months
ended September 30, 1998. The slight decrease in access and network services
costs as a percentage of revenues in the third quarter of 1999 is attributable
to the growth in our customer revenue offset by increased settlement and
interconnect costs paid to third parties and direct network operating and
maintenance costs.
Selling, General and Administrative. Selling, general and administrative
expenses for the three months ended September 30, 1999 increased to $95.9
million or 42.1% of revenues as compared to $57.5 million or 48.6% of revenues
for the three months ended September 30, 1998. The decrease in selling, general
and administrative expenses as a percentage of revenue is attributable to the
growth in our revenue base and our efforts to integrate our business operations
and eliminate redundant costs. The increase in selling, general and
administrative expenses in 1999 is attributable to increases in the number of
personnel associated with business growth, as well as administrative and
marketing costs required for our increased customer base.
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Depreciation and Amortization. Depreciation and amortization increased to
$59.1 million for the three months ended September 30, 1999 as compared to $24.8
million for the three months ended September 30, 1998. The substantial increase
in depreciation and amortization costs is attributable to the depreciation
related to the expansion of our network infrastructure that we have undertaken
over the past several years. Additionally, we have experienced an increase in
amortization expense associated with the goodwill and intangibles that have
arisen from our acquisition activities.
Merger and Restructuring Costs. In September 1999, during the process of
completing the initial public offering of Golden Telecom common shares, we
determined that the allocation of sufficient resources to support certain of our
cellular ventures, which are not material to our financial condition or results
of operations, was not consistent with our current strategic plans. Accordingly,
we decided to abandon certain cellular ventures and decided to cease to provide
any further financial assistance to these ventures, other than the assumption of
certain debt obligations. We are seeking to sell our ownership interests in
these assets in furtherance of our plan of abandonment. As a result of this plan
of abandonment, we recognized an $18.5 million charge to earnings, $10.6 million
of which is non-cash and $7.9 million of which represents a cash outlay. In
addition, the Company also recognized a $1.3 million charge to earnings in the
third quarter of 1999, which is associated with cancellation fees that are
attributable to certain transmission capacity that will not be required in
future periods.
Interest, net. Interest increased to approximately ($31.6) million for the
three months ended September 30, 1999 from ($14.2) million in the three months
ended September 30, 1998. This significant increase in interest is attributable
to the substantial increase in our outstanding debt obligations since the third
quarter of 1998 partially offset by an increase in interest earned on our short
term investments of the cash proceeds generated from our previous sales of debt
and equity securities.
Other non-operating income (expenses). Other non-operating income increased
to $8.6 million for the three months ended September 30, 1999 as compared to
$(11.8) million for the three months ended September 30, 1998. This increase is
primarily due to the impact of foreign currency fluctuations on our unhedged
debt obligations.
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1998
Revenue. Our consolidated revenue increased to $599.1 million for the nine
months ended September 30, 1999 as compared to $230.5 million for the nine
months ended September 30, 1998. Significant components of revenue for the nine
months ended September 30, 1999 were Carrier Services ($205.5 million), Business
Services ($299.6 million), Central Europe ($19.4 million) and CIS ($72.5
million). Revenue for the nine months ended September 30, 1998 was primarily
comprised of Carrier Services ($42.9 million), Business Services ($113.2
million), Central Europe ($12.6 million) and CIS ($60.7 million). The growth in
revenue was primarily attributable to the increase in our customer base and
resulting traffic in all of our operations. An additional contributor to the
revenue growth in 1999 for the CIS business segment was that we followed the
consolidation method of accounting for certain business ventures, whereas in the
first half of 1998, these business ventures were accounted for following the
equity method of accounting.
Access and Network Services. Our access and network costs in 1999 increased
to $356.1 million or 59.4% of revenues for the nine months ended September 30,
1999, as compared to $151.2 million or 65.6% of revenues for the nine months
ended September 30, 1998. The decrease in access and network services costs as a
percentage of revenues in 1999 is attributable to the growth in our customer
revenue offset by increased settlement and interconnect costs paid to third
parties and direct network operating and maintenance costs.
Selling, General and Administrative. Selling, general and administrative
expenses for the nine months ended September 30, 1999 increased to $265.2
million or 44.3% of revenues as compared to $126.5 million or 54.9% of revenues
for the nine months ended September 30, 1998. The decrease in selling, general
and
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
administrative expenses as a percentage of revenue is attributable to the growth
in our revenue base and our efforts to integrate our business operations and
eliminate redundant costs. The increase in selling, general and administrative
expenses in 1999 is attributable to increases in the number of staff associated
with business growth, as well as administrative and marketing costs required for
our increased customer base.
Depreciation and Amortization. Depreciation and amortization increased to
$146.8 million for the nine months ended September 30, 1999 as compared to $50.8
million for the nine months ended September 30, 1998. The substantial increase
in depreciation and amortization costs is attributable to the depreciation
related to the expansion of our network infrastructure that we have undertaken
over the past several years. Additionally, we have experienced an increase in
amortization expense associated with goodwill and intangibles that has arisen
from our acquisition activities.
Merger and Restructuring Costs. In connection with our business combination
with Esprit Telecom and our abandonment and restructuring of certain Russian
assets, we recognized an $83.5 million charge to earnings, or 13.9% of revenue
for the nine months ended September 30, 1999. The Esprit Telecom business
combination costs of $63.7 million are comprised of transaction costs related to
the acquisition, debt restructuring, the write-off of excess network equipment,
the accrual for fiber lease cancellation costs. As previously discussed, the
write-off of $19.8 million in merger and restructuring costs is principally
related to our September 1999 decision to abandon certain cellular ventures in
Russia.
Interest, net. Interest increased to approximately ($97.6) million in the
nine months ended September 30, 1999 from ($43.1) million in the nine months
ended September 30, 1998. This significant increase in interest is attributable
to the substantial increase in our outstanding debt obligations since the third
quarter of 1998 partially offset by an increase in interest earned on our short
term investments of the cash proceeds generated from previous sales of debt and
equity securities.
Other non-operating income (expenses). Other non-operating expenses
increased to ($16.7) million for the nine months ended September 30, 1999 as
compared to ($5.5) million for the nine months ended September 30, 1998. This
increase is primarily due to the impact of foreign currency fluctuations on our
unhedged debt obligations.
LIQUIDITY AND CAPITAL RESOURCES
CORPORATE
The telecommunications industry is capital intensive. In order for us to
successfully compete, we will require substantial capital to continue to develop
our telecommunications networks and meet the funding requirements of our
operations, including losses from operations, as well as to provide capital for
our acquisition and business development initiatives. We currently expect that
we will incur, in the fourth quarter of 1999 through December 31, 2000, between
$900 million and $1.0 billion in capital expenditures, including capital lease
obligations, to implement our current strategic capital expenditure plan,
including the transatlantic capacity participation discussed below.
We are participating in the construction and operation of the FLAG
Atlantic-1 transoceanic cable through our 50% interest in the FLAG Atlantic
Limited joint venture. We have agreed pursuant to the terms of the joint venture
to (1) invest $100 million for our interest in the venture and (2) purchase
capacity on the fiber cable for $200 million.
In January 1999, Hermes Railtel issued $200 million aggregate principal
amount of 10.375% senior notes due 2009 and Euro 85 million (approximately $100
million) aggregate principal amount of 10.375% senior notes due 2006. These new
senior notes have substantially the same terms as the notes Hermes Railtel
issued in 1997. Our 98.7%-held Hermes Railtel subsidiary is currently engaged in
an offering in which it expects to
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
issue approximately Euro 300 million of general unsecured senior notes (the
"Notes"). In addition, Hermes Railtel is currently evaluating entering into a
new credit facility (the "New Credit Facility") with one or more institutional
lenders in an aggregate amount of up to approximately $750.0 million in the
first quarter of 2000. Borrowings under the New Credit Facility would be
structurally senior to previous senior notes of Hermes Railtel.
We believe that the net proceeds from the issuance of the Notes, combined
with our existing cash balances and projected internally generated funds, should
be sufficient to fund our currently identified capital expenditures, at least
through December 31, 2000, including capital expenditures and payments on the
long-term fiber lease arrangements on our Hermes Railtel network. However, it is
possible that we will seek additional financing in the future. Additionally, as
our business strategy evolves, we continuously evaluate the optimal capital
structure to ensure that it meets our overall corporate strategy.
The actual amount and timing of our future capital requirements may differ
materially from our estimates. In particular, the accuracy of our estimates is
subject to changes and fluctuations in our revenues, operating costs and
development expenses, which can be affected by our ability to (1) effectively
and efficiently manage the expansion of the Hermes Railtel network and
operations and the build-out of our City Enterprise Network infrastructure in
our targeted metropolitan markets, (2) effectively and efficiently manage the
build-out of the FLAG Atlantic-1 transatlantic cable through our participation
in the FLAG Atlantic joint venture, (3) obtain infrastructure contracts,
rights-of-way, licenses, interconnection agreements and other regulatory
approvals necessary to complete and operate the Hermes Railtel network,
construct our City Enterprise Network infrastructure and implement data and
Web-hosting centers in London, Amsterdam, Frankfurt, Paris and other European
cities, (4) negotiate favorable contracts with suppliers, including large volume
discounts on purchases of capital equipment and (5) access markets, attract
sufficient numbers of customers and provide and develop services for which
customers will subscribe. Our revenues and costs are also dependent upon factors
that are not within our control such as political, economic and regulatory
changes, changes in technology, increased competition and various factors such
as strikes, weather, and performance by third parties in connection with our
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 our future capital requirements. In addition, if
we expand our operations at an accelerated rate or consummate acquisitions, our
funding needs will increase, possibly to a significant degree, and we will
expend our capital resources sooner than currently expected. As a result of the
foregoing, or if our capital resources otherwise prove to be insufficient, we
will need to raise additional capital to execute our current business plan and
to fund expected operating losses, as well as to consummate future acquisitions
and exploit opportunities to expand and develop our businesses.
LIQUIDITY ANALYSIS
We had cash and cash equivalents of $979.9 million and $998.5 million as of
September 30, 1999 and December 31, 1998, respectively. We had restricted cash
of $73.8 million and $143.4 million as of September 30, 1999 and December 31,
1998, respectively, that primarily represent amounts held in escrow for debt
interest payments.
We used cash of $203.3 million and $19.0 million for our operating
activities for the nine months ended September 30, 1999 and 1998, respectively.
The significant increase in cash spending for our operations in the nine months
ended September 30, 1999 as compared to 1998 is attributable to the growth of
our business operations which has resulted in higher operating cash costs
including significant merger and restructuring costs. We also used cash of
$554.6 million and $356.4 million for our investing activities in the nine
months ended September 30, 1999 and 1998, respectively. We cannot assure you
that our operations will achieve or sustain profitability or positive cash flow
in the future. If we cannot achieve and sustain operating profitability
17
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
or positive cash flow from operations, we may not be able to meet our debt
service obligations or working capital requirements.
Substantially all of our operations are outside the United States and
therefore our consolidated financial results are subject to fluctuations in
currency exchange rates. Our operations transact their business in the following
significant currencies: Deutschmark, French Franc, British Pound Sterling,
Belgian Franc, Dutch Guilder, the Russian Ruble, and, effective January 1, 1999,
the Euro. For those operating companies that transact their business in
currencies that are not readily convertible, we attempt to minimize our exposure
by indexing our invoices and collections to the applicable dollar/foreign
currency exchange rate to the extent our costs (including interest expense,
capital expenditures and equity) are incurred in US Dollars. Although we are
attempting to match revenues, costs, borrowing and repayments in terms of their
respective currencies, we have experienced, and may continue to experience,
losses and a resulting negative impact on earnings with respect to holdings
solely as a result of foreign currency exchange rate fluctuations, which include
foreign currency devaluation's against the US Dollar. Furthermore, certain of
our operations have notes payable and notes receivable which are denominated in
a currency other than their own functional currency or loans linked to the US
Dollar. We may also experience economic loss and a negative impact on earnings
related to these monetary assets and liabilities.
We have developed risk management policies that establish guidelines for
managing foreign exchange risk. We are currently evaluating the materiality of
foreign exchange exposures in different countries and the financial instruments
available to mitigate this exposure. Our ability to hedge our exposure is
limited since certain of our operations are located in countries whose
currencies are not easily convertible. Financial hedge instruments for these
countries are nonexistent or limited and also pricing of these instruments is
often volatile and not always efficient. We designed and implemented reporting
processes to monitor the potential exposure on an ongoing basis beginning in
1998. We will use the output of this process to execute financial hedges to
cover foreign exchange exposure when practical and economically justified.
In April 1998, we consummated a foreign exchange swap transaction to
mitigate the foreign exchange exposure resulting from the issuance of $265
million senior notes issued by Hermes Railtel.
YEAR 2000 COMPLIANCE
The "Year 2000" issue is the result of computer programs using two digits
rather than four to define the applicable year. Because of this programming
convention, software, hardware or firmware may recognize a date using "00" as
the year 1900 rather than the year 2000. Use of non-year 2000 compliant programs
could result in system failures, miscalculations or errors causing disruptions
of operations or other business problems, including, among others, a temporary
inability to process transactions and invoices or engage in similar normal
business activities.
Issues Posed by the Year 2000 Issue. We are exposed to the Year 2000 issue
in a number of ways. Among other things, the Year 2000 issue might affect our:
(1) computer hardware and software; (2) telecommunications equipment and other
systems with embedded logic (among other things, this includes our fire
detection, access control systems, heating, ventilation and air conditioning,
and uninterruptible power supply); (3) operating partners and organizations upon
which we are dependent; (4) local access connections, upon which we are
dependent; and (5) supply chain.
Our Year 2000 Compliance Program. We have initiated a Year 2000 compliance
program to address the aforementioned risks which the Year 2000 issue poses and
to avoid any material loss or impact to us or our customers due to these risks.
The object of this Year 2000 compliance program is to ensure that neither the
performance nor functionality of our operations are affected by dates, prior to,
during and after 2000. The scope of the Year 2000 compliance program includes
all of the business functions, locations and resources which are essential to
us. The resources which are within the scope of the Year 2000 compliance program
are,
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
among other things, our computer systems, software, vendor supplied software,
telecommunications equipment, third party telecommunications partners and other
network service suppliers, environmental and building control systems, internal
communication systems and other interfaces with third party services. As
explained below, our efforts to assess our systems as well as non-system areas
related to Year 2000 compliance involve (1) a wide-ranging assessment of the
Year 2000 problems that may affect us, (2) the development of remedies to
address the problems discovered in the assessment phase and (3) testing of the
remedies.
Assessment Phase. The assessment phase includes internal and third party
review of potential risks associated with the availability, integrity and
reliability of operational systems necessary to conduct business. During the
assessment phase we have identified substantially all of our major hardware and
software platforms, applications, telecommunications equipment and other non-IT
resources that support the business functions. The assessment phase of the Year
2000 compliance program further identified the internal and external technical
interfaces, third party business relationships and internally developed systems
which might be materially impacted by Year 2000 issues. Our observations from
the assessment phase during the third and fourth quarters of 1998 is that most
of our telecommunications equipment and software has been purchased within the
past three years and the majority is already compliant or can be made compliant
with minor upgrades. We completed the assessment phase of our Year 2000
readiness in the fourth quarter of 1998.
Assessment of Third Party Compliance. As noted above, we have also
undertaken our Year 2000 compliance program to assess and monitor the progress
of third party vendors in resolving Year 2000 issues. We have obtained
confirmations, wherever possible, from our primary telecommunication vendors,
business partners and hardware and software vendors as to what plans, if any,
are being developed or are already in place to address their ability to process
transactions related to the Year 2000 transition. The British Standards
Institute (BSI) defines these transition dates. We have received statements of
intended compliance as of mid-1999 from the majority of vendors contacted.
Remediation, Prevention and Testing Phases. Based on those resources
identified in the assessment phase, we developed a detailed plan in the fourth
quarter of 1998, which directed the remediation and testing phases. As of
September 30, 1999 we were still in the testing phase of our critical and
non-critical components. We currently anticipate all critical components will be
Y2K compliant by December 31, 1999.
Business Continuity, Contingency Planning and Y2K Crisis Command Center. We
believe that we have identified and remediated the high risk and high impact
items in support of business continuity. We believe that we are prepared through
our contingency plans to respond to Y2K transition problems for our
subsidiaries, whether external or internal. This process will be directed by our
Y2K Command Center which is being established in Brussels, Belgium to execute
planned responses to identified Y2K transition problem scenarios.
Our Worst Case Scenario. Our worst case scenario would be the failure of
our telecommunications equipment, power providers and/or interfaces with other
telecommunication vendors and either or both of the following:
- a loss of interconnect capacity from one or more major suppliers of
transmission capacity; and
- our inability to record, track or invoice billable minutes which could
ultimately cause us to temporarily stop carrying traffic.
These cases would create business interruption at some of our operations
and would adversely affect our revenues. However, we have operations that are
geographically diversified; therefore, it is not anticipated that the worst case
scenario would affect all operations at the same time. Additionally, if power
failures occur, we currently have diesel generators at certain of our major
sites. Based on our assessment during the third and fourth quarters of 1998, we
do not foresee a material loss due to these conditions. However, we cannot
assure
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
you that Year 2000 non-compliance by our systems or the systems of vendors,
customers, partners or others will not result in a material adverse effect.
Contingency Plans. We have developed a contingency plan to address our
worst case scenario; however, certain of the initiatives are subject to
execution risk. This risk would include the ability to have access to diesel
fuel or large generators should power failures occur, the ability to quickly
replace telecommunications equipment and the ability to contract with
alternative telecommunication and maintenance providers at reasonable terms.
Moreover, we are further limited in resources in certain geographical regions
due to the market volatility and weak economies in which we have business
operations.
Costs Related to the Year 2000 Issue. We expect that we will incur
approximately $5.0 million in expenses to complete the assessment, detailed
planning, remediation, prevention and testing phases, including costs to be
incurred at our Y2K Crisis Command Center, exclusive of replacement costs for
telecommunications equipment and software, of which approximately $1.1 million
had been incurred during 1998. It is estimated that $1.0 million of the total
expenditure will be required to complete the remediation and testing phase,
excluding the replacement of telecommunications equipment and software. We have
currently identified that certain telecommunications equipment and software will
need to be replaced and we anticipate that we will incur approximately $2.0
million to replace the identified telecommunications equipment and software.
Further, we are currently unable to quantify the total costs that we may incur
for the replacement of all telecommunications equipment and software due to the
stage of our Year 2000 readiness review. These costs will be funded from
operating cash flows and expensed as incurred. In addition, the preceding cost
estimate does not include amounts associated with the accelerated acquisition of
replacement systems as none are included in the initial assessment during the
third and fourth quarters of 1998. We do not expect that the costs of addressing
our Year 2000 readiness will have a material effect on our financial condition
or results of operations. However, we cannot assure you that Year 2000
non-compliance by our systems or the systems of vendors, customers, partners or
others will not result in a material adverse effect for us.
Crisis Command Center. We expect to operate a twenty-four hour Crisis
Command Center in Brussels, Belgium beginning December 30 to assist in the
detection of problems and to facilitate internal and external communication. It
is anticipated that the Crisis Command Center will remain open until at least
January 7, 2000.
Risks Related to the Year 2000 Issue. Although our efforts to be Year 2000
compliant are intended to minimize the adverse effects of the Year 2000 issue on
our business and operations, the actual effects of the issue will not be known
until 2000. Difficulties in implementing the remediation or prevention phases or
failure by us to fully implement the planning or remediation phases or the
failure of our major vendors, third party network service providers, and other
material service providers and customers to adequately address their respective
Year 2000 issues in a timely manner would have a material adverse effect on our
business, results of operations, and financial condition.
IMPACT OF THE EURO
On January 1, 1999, eleven of the fifteen member countries of the European
Union, including Belgium, The Netherlands, Ireland, France, Germany, Italy and
Spain established fixed conversion rate between their existing sovereign
currencies and a new currency called the "Euro." These countries adopted the
Euro as their common legal currency on that date. The Euro trades on currency
exchanges and is available for non-cash transactions. Hereafter and until
January 1, 2002, the existing sovereign currencies will remain legal tender in
these countries. On January 1, 2002, the Euro is scheduled to replace the
sovereign legal currencies of these countries.
We have significant operations within the European Union including many of
the countries that have adopted the Euro. We are currently evaluating the impact
the Euro will have on our continuing business
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
operations and no assurances can be given that the Euro will not have material
adverse affect on our business, financial condition and results of operations.
However, we do not expect the Euro to have a material effect on our competitive
position as a result of price transparency within the European Union as we have
always operated as a pan-European business with transparent pricing in ECU for
the majority of our customers. Moreover, we are evaluating our ability to update
our information systems to accommodate the adoption of the Euro but we do not
expect to incur material costs in either the evaluating or the updating of such
systems. In addition, we cannot accurately predict the impact the Euro will have
on currency exchange rates or on our currency exchange risk.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk from changes in interest rates on long-term
obligations and as a global company, we also face exposure to adverse movements
in foreign currency exchange rates. A portion of the our debt obligations are
denominated in currencies which expose us to risks associated with changes in
foreign exchange rates. We have developed risk management policies that
establish guidelines for managing foreign exchange risk and periodically
evaluates the materiality of foreign exchange exposures and the financial
instruments available to mitigate this exposure.
Our subsidiary, Hermes Railtel, entered into a foreign currency swap
agreement in 1998 in order to mitigate its exposure on US dollar denominated
debt. We also attempt to mitigate this and other exposures from debt obligations
denominated in exposed currencies by maintaining assets in the exposed currency
wherever possible. We find it impractical to hedge all foreign currency exposure
and, as a result, will continue to experience foreign currency gains and losses.
The introduction of the Euro as a common currency for members of the European
Union occurred on January 1, 1999. We have not determined what impact, if any,
the Euro will have on our foreign exchange exposure.
The following are the significant changes since December 31, 1998:
- In January 1999, Hermes Railtel, a subsidiary of the Company, issued $200
million 10.375% senior notes due January 15, 2009 which exposes Hermes
Railtel to interest and foreign exchange rates, and the issuance of Euro
85 million 10.375% senior notes due January 15, 2006 which exposes Hermes
Railtel to changes in interest rates.
- In April 1999, we issued $500 million of depositary shares representing a
new series of 7 1/4% cumulative convertible preferred stock in a private
offering. We have filed a registration statement covering these
securities with the Securities and Exchange Commission under the
Securities Act of 1933. The issuance of these equity securities exposes
us to changes in interest rates.
PART II. OTHER INFORMATION
ITEM 5. OTHER INFORMATION
In June 1999, the Company restructured its operations and management in
order to support its objective of becoming a unified international
telecommunications services provider with a clear shared vision, a single brand
identity, and a focus on the highest levels of customer products and services,
network quality and operational efficiency. Accordingly, the Company reorganized
its activities along the following divisions, instead of the six lines of
business that had been in place previously:
- three divisions which comprise the sales and marketing functions of the
Company, namely, GTS Business Services, GTS Carrier Services and GTS
Central Europe. Each of these divisions focuses on a distinct market
segment that it serves with an array of products that meet the specific
needs of that customer group. GTS Business Services focuses on retail
business customers and telecommunications
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
service providers and resellers and also provides international traffic
termination service to other telecommunications carriers, including
incumbent telecommunications providers, alternative carriers and regional
telephone companies. GTS Carrier Services focuses on the carrier
community, including incumbent telecommunications providers, alternative
carriers, Internet service providers, value-added networks, resellers and
multimedia providers. The product portfolio of this division includes the
synchronous digital hierarchy-, dense wavelength division multiplex-, and
Internet Protocol- based transport and transit services operated by the
Company. GTS Central Europe focuses on retail and business customers and
telecommunications service providers and resellers in that region.
- GTS Product Services, which develops the products and services that will
be marketed to the Company's customers. This unit works closely with the
three sales and marketing divisions to understand and anticipate the
needs of the customer segments and with GTS Network Services to define
infrastructure requirements.
- GTS Network Services which is responsible for implementing the
operational infrastructure, platforms and systems from all of the
Company's operations in Western Europe, including the pan-European fiber
optic network, Internet protocol infrastructure, Internet backbone
network, all switching systems (international, national and central
office), and current and planned international networks, including the
Flag Atlantic transatlantic fiber optic cable project.
CITY ENTERPRISE NETWORKS
In the course of implementing its restructuring, the Company determined to
combine the functions of the former GTS Local Access Services line of business
into the business divisions described above because these functions were
duplicative of the functions performed by those divisions. In addition, the
Company recently determined to accelerate its local access strategy by building
intracity fiber networks called City Enterprise Networks in major European
cities.
In order to originate and/or terminate the Company's transmission services
closer to our customers, the Company intends to build City Enterprise Networks
in fourteen major European cities by year-end 2001. Each City Enterprise Network
will, subject to regulatory constraints and market conditions, consist of up to
144 fiber pairs that the Company will buy, lease, or lay in underground ducts.
We also expect to install dense wavelength division multiplexing equipment to
enhance the efficiency of the City Enterprise Networks.
Each City Enterprise Network will typically connect, within a city, the
major telecommunications transmission centers, including, points of presence of
the Company's network in such city, telehouses, Internet protocol exchange
points and, where economically feasible, points of presence of our existing
customers in such city. In some instances, if warranted by customer demand, the
Company will provide end-to-end connectivity by leasing from local access
carriers on behalf of such customers, capacity on the "last mile" connecting the
relevant City Enterprise Network to such customers' premises. In addition,
depending on the circumstances, we may connect some retail customers to the
applicable City Enterprise Networks.
Relying on the Company's own local infrastructure in key cities through the
City Enterprise Networks will allow the Company to reduce operating expenses (by
avoiding or reducing our payments to local access providers) and to enhance the
robustness of the Company's network (through end-to-end network management and
compatibility of the City Enterprise Networks with our existing network). Such
fully integrated network of intracity and intercity connectivity will, the
Company believes, appeal to our customers in need of managed bandwidth services.
The Company will also connect the planned data and Webhosting centers described
below to the relevant City Enterprise Networks. By offering co-location and data
and Webhosting capabilities as a bundled product with our broadband network
capabilities, the Company intends to attract Web-centric and media-centric
companies to its network without procuring expensive services from local access
providers.
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In September 1999, through its subsidiaries, the Company began commercial
operation of a City Enterprise Network in Berlin and completed the operational
testing of a City Enterprise Network in Paris. The Company has accelerated its
rollout plans and expects to have City Enterprise Networks operational in twelve
additional key cities in Europe by year-end 2001. The following are cities in
which the Company plans to build City Enterprise Networks: Geneva, Amsterdam,
Frankfurt, Madrid, London and Milan. The Company is also evaluating construction
of City Enterprise Networks in the following additional cities: Stockholm,
Munich, Brussels, Barcelona, Zurich, Stuttgart, Vienna and Dusseldorf.
The intracity network rings in Western Europe will eventually connect
customers at data transmission rates of up to 2.5 gigabits per second.
DATA/WEB HOSTING CENTERS
Moreover, in order to strengthen the Internet protocol transit services
that the Company presently offers, the Company plans to locate data- and
Web-hosting centers near key public Internet exchange points. This will
establish the necessary facilities to undertake data- and Web-hosting services
and facilitate electronic commerce solutions.
The Company expects to open a data- and Web-hosting center in London by the
end of 1999 and additional data- and Web-hosting centers in Frankfurt, Paris and
Amsterdam by mid-2000. These four initial sites will each be in excess of 25,000
square feet. The Company intends to construct nine additional data- and
Web-hosting centers during the next two years. These facilities will be
specifically designed to offer high-speed access to the Company's network and
provide co-location, dedicated and shared data- and Web-hosting services. Each
data- and Web-hosting center will be equipped with environmental controls,
back-up generators, round-the-clock security and continuous monitoring.
Additional benefits of the data- and Web-hosting centers include:
- providing Internet service providers with telehousing and managed
services for their Internet protocol routers and servers;
- providing a NT or UNIX based server, allowing Internet service providers
and Web-centric companies to take full advantage of our expertise in
traffic and server management; and
- providing a shared server and management, offering an entry solution to
emerging Internet service providers and Web-centric companies at a
reasonable cost.
The data- and Web-hosting centers will offer seamless and scalable Internet
distribution for emerging Internet service providers and Web-centric companies,
offering direct connection to the Company's network at bandwidths of initially
2.5 gigabits per second, with upgrades up to 10 gigabits per second. This will
provide cross-selling opportunities to improve customer retention and enable the
Company to address new target segments.
OPERATIONS IN THE CIS
In October 1999, Golden Telecom, Inc. ("Golden"), the subsidiary that owns
the Company's operations in Russia, Ukraine and other countries of the CIS,
completed an initial public offering of its common stock. The Company continues
to own approximately 66% of Golden's outstanding common stock. Golden realized
net proceeds of approximately $128.4 million from the offering and other
contemporaneous placements of its stock.
23
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
MEMORANDUM OF UNDERSTANDING WITH GLOBENET
In November 1999, GTS and GlobeNet Communications Group Limited, through
its wholly owned subsidiary, Atlantica Network (Bermuda) Ltd., entered into a
memorandum of understanding to be one of the first providers of seamless
undersea connections between Europe and South America.
The agreement will enable GTS to sell managed bandwidth services from a
variety of European cities to Latin America and GlobeNet to sell similar
services between Latin America and Europe. The service will be offered on GTS's
FLAG Atlantic-1 ("FA-1") and trans-European networks and GlobeNet's Atlantica-1
subsea cable system. Both systems will feature a self-healing ring design.
Through GTS's purchased FA-1 fiber pair, which will provide seamless
connectivity of 400 Gigabits per second ("Gbps") of fully protected capacity (or
800 Gbps unprotected), GTS will connect its trans-European network and New York.
With 2.4 terabits per second ("Tbps") of transmission capacity, FA-1's northern
subsea route is expected to be complete and operational in March 2001; the
remaining route is expected to be operational in June 2001.
Atlantica-1's first leg -- from New York through Bermuda to Fortaleza,
Brazilis scheduled to be available in September 2000, with the full northern
ring of the system, including Fortaleza to Venezuela to Florida and back to New
York, slated to be operational by year-end 2000. An additional link from
Fortaleza to Rio de Janeiro is scheduled to be ready for service by February
2001. Atlantica-1 has a design capacity of 1.28 Tbps.
The proposed interconnection and joint sales/marketing arrangement will
result in high-quality seamless connections between Europe and South America.
The arrangement will allow both GTS and GlobeNet to offer their customers
undersea cable capacity -- along with end-to-end extensions to major inland
metropolitan centers -- through a single point of contact. GTS and GlobeNet will
offer capacity purchasers flexible, open network architecture and co-location at
the cable stations and hosting sites in select cities. The arrangement will
facilitate ease of operation and interconnectivity with a variety of other
domestic and international networks.
LISTING ON NEW YORK STOCK EXCHANGE
On October 26, 1999, the Company delisted its common stock from trading on
the Nasdaq National Market and listed its common stock for trading on the New
York Stock Exchange under the symbol "GTS."
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
27 -- Financial Data Schedule
</TABLE>
24
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
B. Reports on Form 8-K
<TABLE>
<CAPTION>
DATE OF REPORT SUBJECT OF REPORT
- -------------- -----------------
<S> <C>
June 16, 1999 On June 16, 1999, the Company's stockholders approved an
increase in the Company's authorized common stock from 135
million to 270 million shares.
In June 1999, the Company's Board of Directors approved a
two-for-one split of its common stock. The stock split was
effected by the distribution of a stock dividend on July 21,
1999 to holders of the Company's common stock at the close
of business on July 1, 1999.
July 14, 1999 Golden Telecom, Inc., a wholly-owned subsidiary of GTS,
filed a registration statement with the Securities and
Exchange Commission to sell shares of its common stock in an
initial public offering.
</TABLE>
25
<PAGE> 26
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/ ROBERT A. SCHRIESHEIM
----------------------------------
Name: Robert A. Schriesheim
Title: Executive Vice President
and Chief Financial
Officer (Principal
Financial and Accounting
Officer)
Date: November 09, 1999
26
<PAGE> 27
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
27 -- Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM 9/30/99
UNAUDITED CONSOLIDATED FINANCIAL STATEMENT AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 979,933
<SECURITIES> 0
<RECEIVABLES> 309,564
<ALLOWANCES> (20,143)
<INVENTORY> 0
<CURRENT-ASSETS> 1,452,941
<PP&E> 1,083,889
<DEPRECIATION> (178,206)
<TOTAL-ASSETS> 3,530,848
<CURRENT-LIABILITIES> 664,009
<BONDS> 2,156,335
0
0
<COMMON> 17,435
<OTHER-SE> 161,397
<TOTAL-LIABILITY-AND-EQUITY> 3,530,848
<SALES> 4,217
<TOTAL-REVENUES> 599,137
<CGS> 3,523
<TOTAL-COSTS> 356,088
<OTHER-EXPENSES> 495,574
<LOSS-PROVISION> 11,409
<INTEREST-EXPENSE> 148,157
<INCOME-PRETAX> (366,758)
<INCOME-TAX> 10,632
<INCOME-CONTINUING> (377,390)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (377,390)
<EPS-BASIC> (2.25)
<EPS-DILUTED> (2.25)
</TABLE>
