<PAGE> 1
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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 JUNE 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>
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 July 23, 1999, there were 170,238,692 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)............................................... 3
Condensed Consolidated Balance Sheets as of June 30, 1999
and December 31, 1998..................................... 3
Condensed Consolidated Statements of Operations for the
Three and Six Months Ended June 30, 1999 and 1998......... 4
Condensed Consolidated Statements of Cash Flows for the
Three and Six Months Ended June 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 2. Changes in Securities and Use of Proceeds................... 22
Item 4. Submission of Matters to a Vote of Security Holders......... 22
Item 5. Other Information........................................... 22
Item 6. Exhibits and Reports on Form 8-K............................ 23
Signatures................................................................ 24
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
GLOBAL TELESYSTEMS GROUP, INC.
CONDENSED, CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
---------- ------------
(IN THOUSANDS, EXCEPT
SHARE DATA)
<S> <C> <C>
Current assets
Cash and cash equivalents................................. $1,146,028 $ 998,510
Accounts receivable, net.................................. 268,935 174,430
Restricted cash........................................... 61,555 82,025
Prepaid expenses.......................................... 34,608 21,640
Other assets.............................................. 18,133 16,752
---------- ----------
Total current assets.............................. 1,529,259 1,293,357
Property and equipment, net................................. 791,290 643,044
Investments in and advances to ventures..................... 55,125 50,751
Goodwill and intangible assets, net......................... 1,055,050 543,524
Restricted cash and other non-current assets................ 53,527 83,926
---------- ----------
TOTAL ASSETS...................................... $3,484,251 $2,614,602
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued expenses..................... $ 325,763 $ 279,509
Related party short-term debt............................. 2,600 --
Debt maturing within one year............................. 161,143 23,859
Current portion of capital lease obligations.............. 44,843 43,102
Unearned revenue.......................................... 61,176 36,059
Other current liabilities................................. 21,883 28,530
---------- ----------
Total current liabilities......................... 617,408 411,059
Long-term debt, less current portion...................... 1,684,938 1,504,614
Long-term portion of capital lease obligations............ 261,106 218,139
Related party long-term debt, less current portion........ -- 2,600
Unearned revenue, less current portion.................... 96,571 34,093
Taxes and other non-current liabilities................... 10,097 40,784
---------- ----------
TOTAL LIABILITIES................................. 2,670,120 2,211,289
Commitments and Contingencies
Minority interest........................................... 9,353 37,329
Common stock, subject to repurchase (253,718 shares and
576,882 shares outstanding at June 30, 1999 and
December 31, 1998, respectively)....................... 10,276 16,081
Redeemable preferred stock, $0.0001 par value (10,000,000
shares authorized; 100,000 shares issued and
outstanding at June 30, 1999).......................... 502,316 --
SHAREHOLDERS' EQUITY
Common stock, $0.10 par value (270,000,000 shares
authorized; 171,652,852, and 161,466,744 shares issued
and outstanding at June 30, 1999 and December 31, 1998,
respectively).......................................... 17,165 16,147
Additional paid-in capital................................ 1,098,200 876,983
Notes receivable, common stock............................ (10,000) --
Accumulated other comprehensive income/(loss)............. (4,959) 488
Accumulated deficit....................................... (808,220) (543,715)
---------- ----------
TOTAL SHAREHOLDERS' EQUITY........................ 292,186 349,903
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $3,484,251 $2,614,602
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 4
GLOBAL TELESYSTEMS GROUP, INC.
CONDENSED, CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
1999 1998 1999 1998
--------- -------- --------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenues........................................ $ 200,335 $ 65,964 $ 371,216 $112,212
Operating expenses:
Telecommunications services................... 113,323 45,026 215,862 78,205
Selling, general and administrative........... 90,747 38,820 169,342 69,062
Esprit Telecom business combination costs..... -- -- 63,714 --
Depreciation and amortization................. 48,391 16,507 87,649 26,020
Equity in losses/(earnings) of ventures....... 4,908 (4,215) 9,033 (7,627)
--------- -------- --------- --------
Total operating expenses.............. 257,369 96,138 545,600 165,660
Loss from operations............................ (57,034) (30,174) (174,384) (53,448)
Other income (expense):
Interest, net................................. (33,392) (15,486) (65,940) (28,933)
Foreign currency losses....................... (6,035) (2,762) (14,162) (4,953)
--------- -------- --------- --------
(39,427) (18,248) (80,102) (33,886)
--------- -------- --------- --------
Loss before income taxes and minority
interest...................................... (96,461) (48,422) (254,486) (87,334)
Income taxes.................................... 4,213 829 7,977 1,384
--------- -------- --------- --------
Net loss before minority interest and
extraordinary
loss.......................................... (100,674) (49,251) (262,463) (88,718)
Minority interest............................... (1,623) 1,284 (2,042) 3,637
--------- -------- --------- --------
Net loss before extraordinary loss.............. (102,297) (47,967) (264,505) (85,081)
Extraordinary loss -- debt refinancing.......... -- -- -- (12,704)
--------- -------- --------- --------
Net Loss........................................ $(102,297) $(47,967) $(264,505) $(97,785)
========= ======== ========= ========
Preferred dividend.............................. (7,552) -- (7,552) --
--------- -------- --------- --------
Net loss applicable to common shareholders...... $(109,849) $(47,967) $(272,057) $(97,785)
========= ======== ========= ========
Loss per common share:
Net loss per share, before extraordinary
loss....................................... $ (0.66) $ (0.34) $ (1.65) $ (0.65)
Extraordinary loss per share.................. -- -- -- (0.09)
--------- -------- --------- --------
Net loss per share.............................. $ (0.66) $ (0.34) $ (1.65) $ (0.74)
========= ======== ========= ========
Weighted average common shares outstanding...... 167,553 139,745 164,828 131,265
========= ======== ========= ========
</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>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------- ---------------------
1999 1998 1999 1998
---------- -------- ---------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss...................................... $ (102,297) $(47,967) $ (264,505) $(97,785)
Adjustments to reconcile net loss to net cash
used in operating activities:
Extraordinary loss......................... -- -- -- 12,704
Depreciation and amortization.............. 47,379 16,914 85,406 26,120
Amortization of discount on note payable... -- -- -- 477
Equity in losses of ventures, net of
dividends received....................... 4,908 (4,215) 9,033 (7,627)
Fair value adjustment for foreign currency
instrument............................... 10,067 -- 32,836 --
Pooling transaction costs.................. (10,585) -- 25,114 --
Minority interest.......................... 2,574 (1,284) 2,980 (3,637)
Non-cash compensation...................... 98 -- 887 178
Other...................................... 3,448 (1,406) 5,486 (225)
Changes in assets and liabilities:
Accounts receivable...................... (54,207) (27,277) (97,166) (35,702)
Accounts payable and accrued expenses.... (15,318) 23,551 (8,338) 34,253
Unearned revenue......................... 41,095 -- 65,241 --
Other changes in assets and
liabilities........................... (24,643) 14,171 (55,958) 8,169
---------- -------- ---------- --------
Net cash used in operating
activities.......................... (97,481) (27,513) (198,984) (63,075)
---------- -------- ---------- --------
INVESTING ACTIVITIES
Restricted cash............................... (10,000) 14,457 13,976 17,209
Investments in and advances to ventures, net
of repayments.............................. 2,234 4,565 (14,944) 6,935
Purchases of property and equipment........... (11,947) (49,386) (33,089) (84,229)
Acquisitions, net of cash acquired............ (346,084) (157,307) (346,084) (158,360)
---------- -------- ---------- --------
Net cash used in investing
activities.......................... (365,797) (187,671) (380,141) (218,445)
---------- -------- ---------- --------
FINANCING ACTIVITIES
Proceeds from debt, net of debt issue costs... 4,469 223,550 296,954 324,893
Repayments of debt............................ (38,884) (6,660) (62,571) (98,015)
Net proceeds from issuance of securities...... 501,348 1,995 504,577 237,972
Other......................................... -- 2,272 -- 9,471
---------- -------- ---------- --------
Net cash provided by financing
activities.......................... 466,933 221,157 738,960 474,321
---------- -------- ---------- --------
Effect of exchange rate changes on cash and cash
equivalents................................... 17,379 (3,755) (12,317) (8,141)
---------- -------- ---------- --------
Net increase in cash and cash equivalents....... 21,034 2,218 147,518 184,660
Cash and cash equivalents at beginning of
period........................................ 1,124,994 722,660 998,510 540,218
---------- -------- ---------- --------
Cash and cash equivalents at end of period...... $1,146,028 $724,878 $1,146,028 $724,878
========== ======== ========== ========
</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 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 1998 audited consolidated financial statements and the notes
related thereto. The results of operations for the three and six months ended
June 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. POLICIES AND PROCEDURES
The Company's net loss per share calculation (basic and diluted) is based
upon the weighted average common shares outstanding. There are no reconciling
items in the numerator or denominator of the Company's net loss per share
calculation. Employee stock options and convertible preferred stock have been
excluded from the net loss per share calculation because their effects would be
anti-dilutive.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which was amended in June 1999. The Company
expects to adopt the new statement effective January 1, 2001. The statement will
require the Company to recognize all derivatives on the balance sheet at fair
value. The Company does not anticipate that the adoption of the statement will
have a significant effect on its results of operations or financial position.
3. INVESTMENTS IN FLAG ATLANTIC LIMITED
On January 13, 1999, GTS, through a subsidiary, entered into an agreement
with FLAG Telecom to form a 50/50 joint venture, to be known as FLAG Atlantic
Limited, that will build and operate a transoceanic fiber optic link, known as
FLAG Atlantic-1 between Europe and the United States. We are currently in the
process of assigning our investment in the joint venture to Hermes Railtel,
which we believe will result in a more efficient structure. The joint venture
will also provide backhaul links from the European landing points of the
transoceanic link to Paris and London. By interconnecting to FLAG Atlantic-1, we
will be able to provide
6
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
carrier and Internet service provider customers with high-capacity cable access
from major European cities to New York City. FLAG Atlantic Limited is expected
to offer service by the end of the year 2000. The project is subject to
financing, the execution of related agreements and other conditions. The Company
has committed to a $100 million equity contribution and an additional purchase
commitment for $150 million worth of capacity.
4. BUSINESS COMBINATIONS
On March 4, 1999, GTS acquired substantially all of the outstanding
ordinary shares and American Depository Shares of Esprit Telecom Group plc
("Esprit"). 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. In addition, as
reflected in the Company's consolidated statements of cash flows, the "Cash and
cash equivalents at the beginning of the year" for 1998 of $540.2 million and
"Cash and cash equivalents at the end of year," of $358.4 million for the year
ended December 31, 1997, as presented in the Company's report for the year ended
December 31, 1998 on Form 10-K filed with the Securities and Exchange Commission
on March 23, 1998, do not agree. The $181.8 million difference reflects the cash
flow activity of Esprit for the three month period ended December 31, 1997. The
Company's consolidated balance sheet as of December 31, 1997 represents the
audited historical Esprit balance sheet as of September 30, 1997 combined with
GTS's historical balance sheet as of December 31, 1997.
On April 26, 1999, GTS acquired a majority stake in Omnicom, a French
company, and assumed operational control. On April 27, 1999, GTS initiated a
10-day tender offer for the remaining shares of Omnicom and as of 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 and was allocated to
goodwill which is being amortized over its 15 year life.
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 of $9.2 million was allocated to goodwill
and is being amortized over five years.
In June 1999, GTS increased its ownership of Hermes Railtel to 95.4%
percent by acquiring the remaining shares held by NMBS/SNCB (the Belgian
Railway). We issued 2,150,380 shares of our common stock in exchange for their
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 $90.3 million and is being amortized over it's ten-year life.
7
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. 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 $54.34375 per share, or a
total of 368,028 shares (the share numbers and purchase price per share
discussed in this note do not reflect the two-for-one stock split covered in
Note 1). The Subscription Agreement provides further that Mr. Thompson pay for
184,014 of these shares in cash and for 184,014 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. The shares were sold to Mr. Thompson
pursuant to the private placement exemption from registration under the
Securities Act of 1933, however, on July 20, 1999 the company filed a Form S-3
registration statement in order to register these securities.
6. 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 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.
As of June 30, 1999, certain of GTS's subsidiaries have outstanding
balances on their lines of credit, which are 100 percent collateralized by cash
that GTS has specifically set aside as restricted for these lines. The Company
has, for financial statement presentation purposes, reclassified its' restricted
cash, related to these lines of credit, in order to offset the outstanding
balances on these credit lines.
7. CAPITAL LEASE OBLIGATIONS
During the six months ended June 30, 1999, the Company entered into
contractual commitments to lease fiber pairs, including facilities and
maintenance and utilizing the partial routes for laying fiber optic cable. Based
on the contract provisions, these commitments are currently estimated to
aggregate approximately $42.1 million. The commitments have expected lease terms
of ten to eighteen years.
8
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GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. SUPPLEMENTAL CASH FLOW INFORMATION
The following table summarizes non-cash investing and financing activities
for the Company:
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
1999 1999
------------- -----------
(IN THOUSANDS)
<S> <C> <C>
Capitalization of leases................................... $ 48,221 $ 96,348
Acquisition of Hermes...................................... 84,590 84,590
Acquisition of Omnicom..................................... 106,872 106,872
Acquisition of minority interest in Ebone.................. 21,423 21,423
Acquisition of capacity.................................... 31,244 31,244
</TABLE>
9. COMPREHENSIVE INCOME (LOSS)
The following table reflects the calculation of comprehensive income (loss)
for GTS for the three and six months ended June 30, 1999 and 1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------- ----------------------
1999 1998 1999 1998
--------- -------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Net loss............................ $(102,297) $(47,967) $(264,505) $ (97,785)
Other comprehensive income (loss)...
Preferred Dividends............... (7,552) -- (7,552) --
Foreign currency translation
adjustments.................... 1,626 (1,163) (5,447) (3,063)
--------- -------- --------- ---------
Comprehensive loss................ $(108,223) $(49,130) $(277,504) $(100,848)
========= ======== ========= =========
</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.
When we adopted SFAS No. 131, we disclosed in our annual audited financial
statements for the fiscal year ended December 31, 1998 that we operate in five
segments within the telecommunications industry. Further we disclosed that the
telecommunications industry consists of a wide range of telecommunications
services to international business customers, including long distance voice and
data services and electronic messaging services.
During the second quarter of 1999, the Company's management shifted its
operational focus to reflect our current organizational structure, in that, we
currently operate in four reportable segments: Western Europe, Central Europe,
CIS and Corporate Office & Other. The Company's reportable segments represent
business units that primarily offer similar products and services; however, the
business units are managed separately due to geographic dispersion of their
operations and the unique regulatory environments in which they operate.
9
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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
WESTERN CENTRAL OFFICE &
EUROPE CIS EUROPE OTHER TOTAL
---------- -------- ------- --------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Three Months Ended June 30, 1999
Total revenue............... $ 171,758 $ 23,154 $ 6,689 $ (1,266) $ 200,335
Total assets................ 2,319,999 197,025 45,485 921,742 3,484,251
Three Months Ended June 30, 1998
Total revenue............... $ 46,546 $ 14,587 $ 4,301 $ 530 $ 65,964
Total assets................ 1,225,729 130,319 25,430 391,918 1,773,396
Six Months Ended June 30, 1999
Total revenue............... $ 311,960 $ 47,340 $12,588 $ (672) $ 371,216
Total assets................ 2,319,999 197,025 45,485 921,742 3,484,251
Six Months Ended June 30, 1998
Total revenue............... $ 74,683 $ 28,344 $ 8,205 $ 980 $ 112,212
Total assets................ 1,225,729 130,319 25,430 391,918 1,773,396
</TABLE>
11. SUBSEQUENT EVENTS
On July 14, 1999, Golden Telecom, Inc. ("Golden Telecom"), a wholly owned
subsidiary of Global TeleSystems Group, Inc. filed a registration statement for
the 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. As of the date of this filing, the registration statement has not
yet been declared effective. 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. Specifically, these businesses,
including Sovintel, Sovam Teleport, TeleCommunications of Moscow and TeleRoss,
provide customers with CLEC, broadband data and Internet services, including
Russia On-Line, the first Russian-language Internet service. The Company will
contribute its interests in such businesses to Golden Telecom prior to
consummation of the initial public offering. GTS expects that it will continue
to hold a majority interest in Golden Telecom following consummation of the
initial public offering.
There is currently a high level of political and economic instability and
uncertainty in the Russian Federation. As a result of the financial crisis in
August 1998, financial markets were subject to significant downward adjustments.
The national currency was severely devalued during the crisis and continued to
deteriorate through the end of the year. The Russian banking system suffered
significant liquidity problems, and several large Russian banking institutions
stopped operations and/or experienced significant losses.
In the telecommunications industry, the impact of the financial crisis has
been more severe in the regions of Russia outside of Moscow and in the cellular
business generally. The average monthly service revenue per subscriber and
minutes of use in the Company's cellular businesses, which are all
regionally-based, have declined significantly both since August 1998 for all of
the Company's cellular businesses and continued during 1999 for certain of its
cellular businesses. Accordingly, management has begun evaluating and assessing
these conditions as they exist in the regional cellular businesses to determine
the nature and scope of any actions it may consequently take. This may include
curtailing or abandoning certain businesses or other actions. As part of the
reorganization and transfer of ownership rights of CIS entities to Golden
Telecom, management will complete a full evaluation of all such properties.
However, this evaluation and assessment is not completed or near completion and,
accordingly, no decisions have been taken by management. When
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<PAGE> 11
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
completed, the Company and Golden Telecom may incur additional liabilities or
adjust the carrying value of certain assets or both and such amounts may be
material to the respective financial statements.
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<PAGE> 12
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 six months ended June
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
"Business," "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 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-
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<PAGE> 13
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. We also sought to
build on the success of our Hermes Railtel network by developing a plan to
provide telecommunications services, including local access services, directly
to businesses and other customers.
Our strategy to develop our businesses is to:
- Continue the buildout of the Hermes Railtel network by extending its
coverage and by putting in place a cost-efficient transatlantic link
through our participation in FLAG Atlantic Limited;
- Develop local access infrastructure to facilitate our customers' access
to our network and to exploit what we believe to be an expanding market;
- Capitalize on growth in data/IP traffic by expanding our IP-based
capabilities and product offerings;
- 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
- Increase high usage retail customer base and route 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. As part of our business
strategy, we expect to make significant acquisitions in the future. 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. Such acquisitions may not be
successfully integrated or result in projected benefits. We may not be able to
raise the additional capital necessary to fund such acquisitions and may have to
divert resources from other areas.
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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<PAGE> 14
The following table sets forth our statement of operations as a percentage
of revenues:
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
-------------- --------------
1999 1998 1999 1998
----- ----- ----- -----
<S> <C> <C> <C> <C>
Revenues........................................... 100.0% 100.0% 100.0% 100.0%
Telecommunications services........................ 56.6 68.2 58.2 69.7
Selling, general and administrative................ 45.3 58.9 45.6 61.5
Esprit Telecom business combination costs.......... -- -- 17.2 --
Depreciation and amortization...................... 24.2 25.0 23.6 23.2
Equity in losses of ventures....................... 2.4 (6.4) 2.4 (6.8)
----- ----- ----- -----
Loss from operations............................... (28.5) (45.7) (47.0) (47.6)
Interest, net...................................... (16.7) (23.5) (17.8) (25.8)
Foreign currency losses............................ (3.0) (4.2) (3.8) (4.4)
----- ----- ----- -----
Net loss before income taxes, minority interest and
extraordinary loss............................... (48.2) (73.4) (68.6) (77.8)
Income taxes....................................... 2.1 1.2 2.1 1.2
Net loss before minority interest and extraordinary
loss............................................. (50.3) (74.6) (70.7) (79.0)
Minority interest.................................. (0.8) 1.9 (0.6) 3.2
----- ----- ----- -----
Net loss before extraordinary loss................. (51.1) (72.7) (71.3) (75.8)
Extraordinary loss -- debt refinancing............. -- -- -- (11.3)
----- ----- ----- -----
Net loss........................................... (51.1)% (72.7)% (71.3)% (87.1)%
===== ===== ===== =====
Preferred dividend................................. (3.8) -- (2.0) --
===== ===== ===== =====
Net loss applicable to common shareholders......... (54.9)% (72.7)% (73.3)% (87.1)%
===== ===== ===== =====
</TABLE>
THREE MONTHS ENDED JUNE 30, 1999 COMPARED TO THE THREE MONTHS ENDED JUNE 30,
1998
Revenue. Our consolidated revenue increased to $200.3 million for the three
months ended June 30, 1999 as compared to $66.0 million for the three months
ended June 30, 1998. Significant components of revenue for the three months
ended June 30, 1999 were Western Europe ($171.8 million), Central Europe ($6.7
million) and CIS ($23.2 million). Revenue for the three months ended June 30,
1998 was primarily comprised of Western Europe ($46.5 million), CIS ($14.6
million) and Central Europe ($4.3 million). The growth in revenue was primarily
attributable to the increase in our customer base and resulting traffic in all
of our operations. Our reported revenues in our Western Europe business segment
would have been 10-12% higher in the second quarter of 1999 had the Euro and
other European currencies not weakened against the US Dollar during this period.
An additional contributor to the revenue growth in the second quarter of 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.
Telecommunications Services. Our costs associated with providing
telecommunications services for the three months ended June 30, 1999 increased
to $113.3 million or 56.6% of revenues as compared to $45.0 million or 68.2% of
revenues for the three months ended June 30, 1998. The decrease in
telecommunication services as a percentage of revenues in the second 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. Although telecommunications services costs as a
percentage of revenue have decreased, we are incurring substantial costs related
to the implementation of our business strategy.
Selling, General and Administrative. Selling, general and administrative
expenses for the three months ended June 30, 1999 increased to $90.7 million or
45.3% of revenues as compared to $38.8 million or 58.9% of revenues for the
three months ended June 30, 1998. 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
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<PAGE> 15
administrative and marketing costs required for our increased customer base. We
expect to establish sales offices in additional European cities, which involves
incurring substantial start-up costs. Accordingly, our consolidated results of
operations will fluctuate depending on the timing of our expansion strategy.
Further, during a period of rapid expansion, as we are currently experiencing in
both our base business and our CLEC initiative, selling, general and
administrative expenses will be relatively higher than during more stable
periods of growth.
Depreciation and Amortization. Depreciation and amortization increased to
$48.4 million for the three months ended June 30, 1999 as compared to $16.5
million for the three months ended June 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 that has arisen from our
acquisition activities.
Losses in Ventures. We recognized losses in our investments in
non-consolidated ventures of $4.9 million for the three months ended June 30,
1999 as compared to income of $4.2 million for the three months ended June 30,
1998. Included in these losses/income was our ownership share of losses of $2.8
million and earnings of $4.1 million for the three months ended June 30, 1999
and 1998, respectively.
Interest, net. Interest increased to approximately ($33.4) million for the
three months ended June 30, 1999 from ($15.5) million in the three months ended
June 30, 1998. This significant increase in interest is attributable to the
substantial increase in our outstanding debt obligations since the second
quarter of 1998 offset by an increase in interest earned on the short term
investments of equity and debt proceeds.
Foreign Currency Loss. We recognized foreign currency losses of $6.0
million in the three months ended June 30, 1999 as compared to $2.8 million in
the three months ended June 30, 1998. Our foreign currency losses are primarily
attributable to the Company's US dollar denominated debt obligations at certain
subsidiaries in Western Europe.
SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 1998
Revenue. Our consolidated revenue increased to $371.2 million for the six
months ended June 30, 1999 as compared to $112.2 million for the six months
ended June 30, 1998. Significant components of revenue for the six months ended
June 30, 1999 were Western Europe ($312.0 million), Central Europe ($12.6
million) and CIS ($47.3 million). Revenue for the six months ended June 30, 1998
was primarily comprised of Western Europe ($74.7 million), CIS ($28.3 million)
and Central Europe ($8.2 million). The growth in revenue was primarily
attributable to the increase in our customer base and resulting traffic in all
of our operations. Our reported revenues in our Western Europe business segment
would have been 8-10% higher in the six months ended June 30, 1999 had the Euro
and other European currencies not weakened against the US Dollar during this
period. An additional contributor to the revenue growth in the first half of
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.
Telecommunications Services. Our costs associated with providing
telecommunications services in 1999 increased to $215.9 million or 58.2% of
revenues for the six months ended June 30, 1999, as compared to $78.2 million or
69.7% of revenues for the six months ended June 30, 1998. The decrease in
telecommunication services 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. Although telecommunications services costs as a percentage of
revenue have decreased, we are incurring substantial costs related to the
implementation of our business strategy.
Selling, General and Administrative. Selling, general and administrative
expenses for the six months ended June 30, 1999 increased to $169.3 million or
45.6% of revenues as compared to $69.1 million or 61.5% of revenues for the six
months ended June 30, 1998. 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
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<PAGE> 16
administrative and marketing costs required for our increased customer base. We
expect to establish sales offices in additional European cities, which involves
incurring substantial start-up costs. Accordingly, our consolidated results of
operations will fluctuate depending on the timing of our expansion strategy.
Further, during a period of rapid expansion, as we are currently experiencing in
both our base business and our CLEC initiative, selling, general and
administrative expenses will be relatively higher than during more stable
periods of growth.
Esprit Telecom Combination Costs. In connection with our business
combination with Esprit Telecom, we recognized a $63.7 million, or 17.2% of
revenue for the six months ended June 30, 1999 charge to earnings for
transaction and integration costs. This charge is comprised of transaction costs
related to the acquisition, including investment banking, advisory, debt
restructuring, legal, accounting, printing and employee-related expenses and the
accrual for fiber lease cancellation costs, write-off of excess equipment and
costs associated with re-deploying switches.
Depreciation and Amortization. Depreciation and amortization increased to
$87.6 million for the six months ended June 30, 1999 as compared to $26.0
million for the six months ended June 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 that has arisen from our
acquisition activities.
Losses in Ventures. We recognized losses in our investments in
non-consolidated ventures of $9.0 million for the six months ended June 30, 1999
as compared to income of $7.6 million of the six months ended June 30, 1998.
Included in these losses/income was our ownership share of losses of $4.7
million for the six months ended June 30, 1999. For the six months ended June
30, 1998, excess losses recognized were minimal.
Interest, net. Interest increased to approximately ($65.9) million in the
six months ended June 30, 1999 from ($28.9) million in the six months ended June
30, 1998. This significant increase in interest is attributable to the
substantial increase in our outstanding debt obligations since the second
quarter of 1998 offset by an increase in interest earned on the short term
investments of equity and debt proceeds.
Foreign Currency Loss. We recognized foreign currency losses of $14.2
million in the six months ended June 30, 1999 as compared to $5.0 million in the
six months ended June 30, 1998. Our foreign currency losses are primarily
attributable to the Company's US dollar denominated debt obligations at certain
subsidiaries in Western Europe.
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 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 expect that we will spend over $1.3 billion
in cash over the next three years to meet our capital expenditures and operating
funding requirements to implement our business plan.
Historically, we have raised capital through a combination of public and
private offerings of equity and debt securities. We have received cash proceeds
of $504.6 million, $370.1 million, $89.8 million and $141.7 million during the
first six months of 1999 and for the years ended December 31, 1998, 1997 and
1996, respectively, net of placement costs, associated with the issuance of our
common and preferred stock in connection with these offerings, including
issuance of warrants and the exercise of stock options. In addition, the Company
received $289.3 million, $812.0 million, $714.8 million and $60.0 million in
gross proceeds during the first six months of 1999 and for the years ended
December 31, 1998, 1997 and 1996, respectively, for a total of approximately
$1.9 billion under various debt securities that were issued by Hermes Railtel,
Esprit Telecom and ourselves.
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<PAGE> 17
We believe that our existing cash balances and cash flow received from
certain operating ventures will be sufficient to fund our currently anticipated
capital needs over at least the next 12 months. However, with acquisitions as a
strategic initiative of our business strategy, 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 buildout of our local access infrastructure in our targeted
metropolitan markets, (2) effectively and efficiently manage the build-out of
the FLAG Atlantic-1 transatlantic cable, either directly or 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 local access infrastructure and offer telecommunications
services to end-users, (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.
We cannot assure you that we will be able to consummate additional
financing on favorable terms. As a result, we may be subject to additional or
more restrictive financial covenants, our interest obligations may increase
significantly and our 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 us to delay or abandon some or
all of our anticipated expenditures, to sell assets, or both, either of which
could have a material adverse effect on our operations.
WESTERN EUROPE REGION -- SIGNIFICANT DEVELOPMENT ACTIVITIES
Development of Hermes Railtel's fiber optic network has been capital
intensive. We have spent approximately $234 million in cash on network capital
expenditures through June 30, 1999 and we expect to incur an additional $556
million through 2000 in order to complete the build-out of the network and
enhance its capacity through the implementation of dense wave division
multiplexing technology. In addition, as of June 30, 1999, $315 million has been
capitalized in connection with long-term fiber lease arrangements and an
additional $109 million is expected to be capitalized through 2000 in order to
complete the build-out of the network.
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 are currently in the process of assigning our
investment in the joint venture to Hermes Railtel, which we believe will result
in a more efficient structure. The terms of the joint venture require that we
(1) invest $100 million for our interest in the venture and (2) purchase
capacity on the cable for $150 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. We believe that the net proceeds from the Hermes Railtel debt
securities, combined with projected
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<PAGE> 18
internally generated funds, should be sufficient to fund expected capital
expenditures as well as payments on the long-term fiber lease arrangements as
well as all FLAG Atlantic Limited requirements. However, the actual amount and
timing of our future requirements may differ materially from our estimates. In
addition, we are currently exploring the possibility of including local access
assets and operations as part of our network. Any failure to obtain necessary
financing may require us to delay or abandon our plans for deploying the
remainder of the network.
We plan to provide local access services through competitive local exchange
carrier ("CLEC") operations in up to 12 major European cities by the end of
2001. We plan to develop our infrastructure by constructing, purchasing or
leasing fiber optic networks, developing microwave transmission networks or
through acquisition or partnership. We project that approximately $250 million
will be required through the end of 2000 to implement these networks. We expect
to be able to fund these expenditures through a combination of cash on hand and
equity and debt financings.
We cannot estimate with any degree of certainty the amount and timing of
these future capital requirements or other cash requirements for the
implementation of our CLEC business initiative. These expenditures will be
dependent on many factors, including the rate at which we deploy our CLEC
networks, the types of services we offer, staffing levels, acquisitions and
customer growth, as well as other factors that are not within our control,
including competitive conditions, regulatory developments and capital costs. We
expect that we will have significant operating and net losses and will record
significant net cash outflow, before financing, in coming years in connection
with our CLEC business initiative. We cannot assure you that we will be able to
fund the $250 million in projected expenditures or any additional expenditures
or that our CLEC business operations will achieve or sustain profitability or
positive cash flow in the future.
LIQUIDITY ANALYSIS
We had cash and cash equivalents of $1,146.0 million and $998.5 million as
of June 30, 1999 and December 31, 1998, respectively. We had restricted cash of
$96.1 million and $143.4 million as of June 30, 1999 and December 31, 1998,
respectively, that primarily represent amounts held in escrow for debt interest
payments.
In the three and six months ended June 30, 1999 we used cash of $97.5
million and $199.0 million respectively, for our operating activities compared
to $27.5 million and $63.1 million, respectively, used in the comparable periods
of 1998. The significant increase in cash spending for our operations in the
quarter ended June 30, 1999 as compared to 1998 is attributable to the growth of
our business operations which has resulted in higher operating cash costs and
accounts receivable carrying balances. We also used cash of $365.8 million and
$380.1 million for our investing activities in the three and six months ended
June 30, 1999 and $187.7 million and $218.4 million for the three and six months
ended June 30, 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 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 devaluations 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
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<PAGE> 19
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, 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
19
<PAGE> 20
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. All critical
components were in testing by June 30, 1999. We expect that all critical
components will be Y2K compliant by September 30, 1999. Finally, we expect that
all non-critical components will be tested by December 1, 1999.
Business Continuity, Contingency Planning and Y2K Crisis Command Center. 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 London 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. For example, the Moscow power
authorities have publicly stated that they do not intend to address Year 2000
issues until problems arise. 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 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 are considering 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 between
$10.0 million to $11.5 million in expenses to complete the assessment, detailed
planning, remediation, prevention and testing phases, exclusive of replacement
costs for telecommunications equipment and software, of which approximately $4.9
million had been incurred during 1998. It is estimated that between $5.0 million
to $6.0 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.
20
<PAGE> 21
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 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 its 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.
21
<PAGE> 22
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
c) 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
$54.34375 per share, or a total of 368,028 shares (the share numbers and
purchase price per share discussed in this paragraph do not reflect the
two-for-one stock split effective on July 21, 1999). The Subscription
Agreement provides further that Mr. Thompson pay for 184,014 of these shares
in cash and for 184,014 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. The shares were sold to Mr. Thompson pursuant to private placement
exemption from registration under the Securities Act of 1933, however, on
July 20, 1999 the Company filed a Form S-3 registration statement in order to
register these securities.
d) In April 1999, we issued for cash, pursuant to exemptions from registration
under the Securities Act of 1933 (the "Securities Act"), 10 million
depositary shares, each representing 1/100 of a new series of 7.25%
cumulative convertible preferred stock. The underwriters for the sale were
Merrill Lynch & Co.; Donaldson, Lufkin & Jenrette; Bear, Stearns & Co., Inc.;
BT Alex. Brown; Lehman Brothers. Gross proceeds for the sale of the
depositary shares were $500 million. The underwriters' discount was $15
million. We received net proceeds, before other expenses associated with the
sale, of $485 million. We sold the depositary shares pursuant to Rule 144A
under the Securities Act. 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 16, 1999, the Company held its annual meeting of shareholders. In
connection with the meeting, the Company solicited proxies pursuant to
Regulation 14 under the Securities Exchange Act of 1934 from holders of record
of its common stock as of May 7, 1999. Each of the Company's four nominees for
election to its Board of Directors was elected to a term ending at the Company's
annual meeting of shareholders to be held in 2002. Three additional proposals
were submitted to shareholders for approval and were approved. The votes cast on
each such proposal were as follows:
(1) Approval of the increase in the Company's authorized common stock
from 135 million to 270 million shares- FOR 60,750,785 shares; AGAINST
348,045 shares; ABSTAIN 5,583 shares
(2) Approval of the Company's executive compensation plan- FOR
60,878,691 shares; AGAINST 104,041 shares; ABSTAIN 121,681 shares
(3) Ratification of selection of Ernst & Young, LLP as the Company's
independent auditors for 1999- FOR 61,096,036 shares; AGAINST 2,925 shares;
ABSTAIN 5,452 shares
The share tabulations referenced above do not reflect the two-for-one stock
split effective July 21, 1999.
ITEM 5. OTHER INFORMATION
See Note 11 to the Company's unaudited Condensed, Consolidated Financial
Statements included in this report.
22
<PAGE> 23
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
27 -- Financial Data Schedule
</TABLE>
B. Reports on Form 8-K
<TABLE>
<CAPTION>
DATE OF REPORT SUBJECT OF REPORT
-------------- -----------------
<C> <S>
April 14, 1999 Agreement to acquire 52% of the outstanding shares of
Omnicom, a French corporation.
The April 19, 1999 offering of 10 million depository shares,
each representing 1/100 of a share of 7.25% cumulative
convertible preferred stock.
</TABLE>
23
<PAGE> 24
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
(Principal
Financial and Accounting
Officer)
Date: August 13, 1999
24
<PAGE> 25
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
Ex. 27 -- Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 1,146,028
<SECURITIES> 0
<RECEIVABLES> 283,863
<ALLOWANCES> (14,928)
<INVENTORY> 0
<CURRENT-ASSETS> 1,529,259
<PP&E> 933,798
<DEPRECIATION> (142,508)
<TOTAL-ASSETS> 3,484,251
<CURRENT-LIABILITIES> 617,408
<BONDS> 2,154,630
17,165
0
<COMMON> 0
<OTHER-SE> 275,021
<TOTAL-LIABILITY-AND-EQUITY> 3,484,251
<SALES> 1,944
<TOTAL-REVENUES> 371,216
<CGS> 3,147
<TOTAL-COSTS> 215,862
<OTHER-EXPENSES> 329,738
<LOSS-PROVISION> 6,887
<INTEREST-EXPENSE> 96,968
<INCOME-PRETAX> (254,486)
<INCOME-TAX> 7,977
<INCOME-CONTINUING> (262,463)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (264,505)
<EPS-BASIC> (1.60)
<EPS-DILUTED> (1.60)
</TABLE>
