UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 2000
|_| Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ______ to ______.
Commission file number 001-15693
- -------------------------------------------------------------------------------
CARRIER 1 INTERNATIONAL S.A. (EXACT NAME OF REGISTRANT AS
SPECIFIED IN ITS CHARTER)
LUXEMBOURG 98-0199626
(STATE OR OTHER JURISDICTION OF INCORPORATION OR (I.R.S. EMPLOYER
ORGANIZATION) IDENTIFICATION NO.)
- -------------------------------------------------------------------------------
ROUTE D'ARLON 3
L-8009 STRASSEN, LUXEMBOURG (011) (41-1) 297-2600
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE
OFFICES)
- -------------------------------------------------------------------------------
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
At November 1, 2000 there were 41,721,178 shares of Common Stock of
the registrant outstanding.
In this report, "Carrier 1 International" refers to Carrier 1
International S.A., a societe anonyme organized under the laws of the Grand
Duchy of Luxembourg, and "Carrier1," "we," "our" and "us" refers to Carrier 1
International and its subsidiaries and their predecessors, except where the
context otherwise requires. In our filings with the United States Securities
Commission in "EDGAR" format, the symbol for the euro may be represented by
"(u)", "e", "[euro]", or similar symbol.
Certain statements contained herein which express "belief,"
"anticipation" "expectation," or "intention" or any other projection, including
statements concerning the design, configuration, feature and performance of our
network and related services, the development and expansion of our business,
the markets in which our services are or will be offered, capital expenditures
and regulatory reform, insofar as they may apply prospectively and are not
historical facts, are "forward-looking" statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Because such statements include risks and uncertainties,
actual results may differ materially from those expressed or implied by such
forward-looking statements. Factors that could cause actual results to differ
materially from those expressed or implied by such forward-looking statements
include, but are not limited to, the factors set forth in "Item 2. Management's
Discussion and Analysis of Financial Condition and Results of Operations."
2
CARRIER 1 INTERNATIONAL S.A.
FORM 10Q
INDEX
Part I - FINANCIAL INFORMATION...........................................................................4
Item 1. Financial Statements........................................................................4
Consolidated Balance Sheets September 30, 2000 (Unaudited) and
December 31, 1999..........................................................................4
Unaudited Consolidated Statements of Operations Three Months
Ended September 30, 2000 and September 30, 1999 and Nine
Months Ended September 30, 2000 and September 30, 1999.....................................5
Unaudited Consolidated Statement of Shareholders' Equity
(Deficit) Nine Months Ended September 30, 2000.............................................6
Unaudited Consolidated Statements of Cash Flows Nine Months
Ended September 30, 2000 and September 30, 1999............................................7
Notes To Unaudited Consolidated Financial Statements.......................................8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.....................................................................12
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................29
Part II - OTHER INFORMATION.............................................................................30
Item 1. Legal Proceedings.........................................................................30
Item 2. Changes in Securities and Use of Proceeds.................................................30
Item 5. Other Information.........................................................................31
Item 6. Exhibits and Reports on Form 8-K..........................................................31
Signatures.....................................................................................32
Exhibit Index..................................................................................33
3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CARRIER 1 INTERNATIONAL S.A. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2000 AND DECEMBER 31, 1999
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE INFORMATION)
SEPTEMBER 30, 2000 DECEMBER 31,
(UNAUDITED) 1999*
(SEE NOTE 3)
------------- ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents........................................... $ 453,355 $ 28,504
Restricted cash..................................................... 21,354 5,512
Restricted investments held in escrow............................... 29,375 61,863
Accounts receivable, net of allowance for doubtful accounts of $1,613
and $840 at September 30, 2000 and December 31, 1999, respectively 53,298 26,795
Unbilled receivables................................................ 26,459 18,226
Value-added tax refunds receivable.................................. 21,671 20,499
Prepaid expenses and other current assets .......................... 17,337 9,873
------------- ------------
Total current assets....................................... 622,849 171,272
PROPERTY AND EQUIPMENT - NET (SEE NOTE 5)................................ 286,861 213,743
INVESTMENT IN JOINT VENTURES ............................................ 32,431 4,691
RESTRICTED INVESTMENTS HELD IN ESCROW.................................... 28,314
OTHER ASSETS ............................................................ 13,073 19,635
------------- ------------
TOTAL.................................................................... $ 955,214 $ 437,655
============= ============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Trade accounts payable.............................................. $ 40,506 $ 46,338
Accrued network costs .............................................. 15,517 22,154
Accrued refile costs................................................ 38,458 18,234
Accrued interest.................................................... 3,892 12,984
Other accrued liabilities........................................... 14,658 17,020
Short-term deferred revenue ........................................ 9,860 -
Short-term debt..................................................... 3,318 12,658
------------- ------------
Total current liabilities.................................. 126,209 129,388
------------- ------------
DEFERRED REVENUE ........................................................ 73,925 5,020
LONG-TERM DEBT (See Note 6):
Senior notes........................................................ 233,210 243,415
Other long-term debt................................................ 1,489 94,341
------------- ------------
Total long-term debt ...................................... 234,699 337,756
COMMITMENTS AND CONTINGENT LIABILITIES
SHAREHOLDERS' EQUITY (DEFICIT):
Common stock, $2 par value, 100,000,000 and 55,000,000 shares
respectively, authorized, 41,721,178 and 33,010,700, respectively
issued and outstanding at September 30, 2000 and December 31, 1999 83,442 66,021
Additional paid-in capital.......................................... 666,757 2,524
Accumulated deficit................................................. (197,464) (107,734)
Accumulated other comprehensive income (loss)....................... (31,697) 4,688
Common stock held in treasury....................................... (657) (8)
------------- ------------
Total shareholders' equity (deficit)....................... 520,381 (34,509)
------------- ------------
TOTAL.................................................................... $ 955,214 $ 437,655
============= ============
See notes to unaudited consolidated financial statements.
* Derived from audited consolidated financial statements.
4
CARRIER 1 INTERNATIONAL S.A. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999 AND NINE MONTHS ENDED
SEPTEMBER 30, 2000 AND 1999
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE INFORMATION)
THREE THREE NINE
MONTHS MONTHS NINE MONTHS MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER SEPTEMBER SEPTEMBER SEPTEMBER
30, 2000 30, 1999 30, 2000 30, 1999
--------- --------- ---------- ---------
REVENUES ............................... $77,280 $27,311 $186,078 $59,798
OPERATING EXPENSES:
Cost of services (exclusive
of items shown separately
below) ................... 75,500 32,543 188,503 71,904
Selling, general and
administrative ................ 8,699 4,216 25,502 10,681
Depreciation and amortization ..... 9,201 4,183 22,580 7,817
--------- --------- ---------- ---------
Total operating expenses .......... 93,400 40,942 236,585 90,402
--------- --------- ---------- ---------
LOSS FROM OPERATIONS ................... (16,120) (13,631) (50,507) (30,604)
OTHER INCOME (EXPENSE):
Interest expense .................. (8,057) (8,718) (27,682) (21,323)
Interest income ................... 5,494 2,009 14,584 5,087
Currency exchange gain (loss), net (10,298) 1,931 (26,123) (5,218)
Other, net ........................ 4 (25) (2) (438)
--------- --------- ---------- ---------
Total other income (expense) ...... (12,857) (4,803) (39,223) (21,892)
--------- --------- ---------- ---------
LOSS BEFORE INCOME TAX BENEFIT ......... (28,977) (18,434) (89,730) (52,496)
INCOME TAX BENEFIT - Net of valuation
allowance (See note 7) .............
--------- --------- ---------- ---------
NET LOSS ............................... $(28,977) $(18,434) $(89,730) $(52,496)
========= ========= ========== =========
LOSS PER SHARE:
Net loss:
Basic ......................... $(0.70) $(0.59) $(2.25) $(1.83)
========= ========= ========== =========
Diluted ....................... $(0.70) $(0.59) $(2.25) $(1.83)
========= ========= ========== =========
See notes to unaudited consolidated financial statements.
5
CARRIER 1 INTERNATIONAL S.A. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)
NINE MONTHS ENDED SEPTEMBER 30, 2000
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE INFORMATION)
ACCUMULATED COMMON
ADDITIONAL OTHER STOCK
COMMON PAID-IN ACCUMULATED COMPREHENSIVE HELD IN
STOCK CAPITAL DEFICIT INCOME (LOSS) TREASURY TOTAL
------ ---------- ----------- ------------- -------- -----
BALANCE-December 31, 1999.... $66,021 $ 2,524 $(107,734) $ 4,688 $ (8) $(34,509)
Issuance of Shares
(8,710,478 shares)......... 17,421 664,233 681,654
Repurchase of shares......... (649) (649)
Comprehensive income (loss):
Net loss................... (89,730) (89,730)
Other comprehensive income (loss),
net of tax:
Currency translation
adjustments.............. (36,385) (36,385)
--------
Total comprehensive loss (126,115)
------- -------- --------- -------- ----- --------
BALANCE-September 30, 2000... $83,442 $666,757 $(197,464) $(31,697) $(657) $520,381
======= ======== ========= ======== ===== ========
See notes to unaudited consolidated financial statements.
6
CARRIER 1 INTERNATIONAL S.A. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE INFORMATION)
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2000 SEPTEMBER 30, 1999
------------------- --------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss................................................. $(89,730) $(52,496)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activities:
Depreciation and amortization.......................... 22,580 7,817
Amortization and write-off of capitalized financing
costs................................................ 5,049
Changes in operating assets and liabilities:
Restricted cash...................................... (2,005) (5,699)
Receivables.......................................... (43,865) (40,781)
Prepaid expenses and other current assets............ (8,674) (3,863)
Other assets......................................... 312 (14,687)
Accounts payable and accrued liabilities............. 48,324 38,103
Deferred revenue..................................... 78,765
--------------- ----------------
Net cash provided by (used in) operating
activities.................................... 10,756 (71,606)
--------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of restricted investments held in escrow....... (103,743)
Purchase of property and equipment....................... (153,691) (95,506)
Investments in joint ventures............................ (28,585) (6)
Receipts from maturity of restricted investments......... 58,227
--------------- ----------------
Net cash used in investing activities........... (124,049) (199,255)
--------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of short-term debt................ 47,664
Proceeds from issuance of long-term debt................. 248,259
Proceeds from issuance of common stock and warrants...... 681,654 26,572
Proceeds from superscription of shares................... 4,018
Payment on debt.......................................... (152,808)
Purchase of treasury stock............................... (649)
Cash pledged for letter of credit........................ (19,318)
Receipts from cash pledged for letter of credit.......... 5,480
--------------- ----------------
Net cash provided by financing activities....... 562,023 278,849
--------------- ----------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS.. (23,879) 1,759
--------------- ----------------
NET INCREASE IN CASH AND CASH EQUIVALENTS..................... 424,851 9,747
CASH AND CASH EQUIVALENTS:
Beginning of period...................................... 28,504 4,184
--------------- ----------------
End of period............................................ $453,355 $ 13,931
=============== ================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest........................................ $ 35,800 $ 16,480
=============== ================
7
SUPPLEMENTAL DISCLOSURE OF NONCASH OPERATING AND INVESTING ACTIVITIES:
o At September 30, 2000 and September 30, 1999, equipment purchases of
approximately $9,887 and $23,429, respectively, are included in
accounts payable and accrued network costs.
See notes to unaudited consolidated financial statements.
CARRIER 1 INTERNATIONAL S.A. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE INFORMATION)
1. NATURE OF OPERATIONS
Carrier 1 International S.A., its subsidiaries in Europe and its
subsidiary in the United States ("Carrier1" or the "Company"), operate in the
telecommunications industry offering end-to-end voice, Internet and bandwidth
and related telecommunication services to large users of communication
services. Carrier1 offers these services primarily to other telecommunications
companies. Carrier1 is a societe anonyme organized under the laws of the Grand
Duchy of Luxembourg and has adopted a fiscal year end of December 31.
2. UNAUDITED FINANCIAL INFORMATION
The financial information included herein is unaudited; however, the
information reflects all adjustments (consisting solely of normal recurring
adjustments) that are, in the opinion of management, necessary for a fair
presentation of the Company's financial position and results of operations
and cash flows for the interim periods presented. The results of operations
for the three and nine months ended September 30, 2000 and 1999 are not
necessarily indicative of the results to be expected for the full year.
8
3. CHANGE IN FUNCTIONAL CURRENCY
During the third quarter of 2000, Carrier1 determined that the
functional currency of the Luxembourg holding company, Carrier1 International
S.A., had clearly changed from the U.S. dollar to the Euro due to significant
changes in economic facts and circumstances underlying the Company's business.
The functional currencies of Carrier1's subsidiaries have not changed and, in
all instances, are the respective local currency.
Carrier1 applied this change prospectively as of the beginning of the
quarter. As a result of this change, transactions entered into by the holding
company that are denominated in currencies other than the Euro are now
translated into Euros in accordance with Statement of Financial Accounting
Standards No. 52, FOREIGN CURRENCY TRANSLATION.
The net effect of this change in functional currency for the three
months ended September 30, 2000 was to reduce the currency exchange loss (net)
and the net loss reported in the statement of operations by approximately $17.8
million and to increase the negative currency translation adjustment component
of other comprehensive income (loss) reported in the statement of shareholders'
equity by approximately $17.8 million.
9
4. EARNINGS PER SHARE
The following details the earnings per share calculations for the
three months ended September 30, 2000 and 1999 and for the nine months ended
September 30, 2000 and 1999 (in thousands of U.S. dollars, except share
information):
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER SEPTEMBER SEPTEMBER SEPTEMBER
30, 2000 30, 1999 30, 2000 30, 1999
-------------- -------------- -------------- --------------
Loss from operations................................ $ (16,120) $ (13,631) $ (50,507) $ (30,604)
============= ============ =========== ===========
Net loss............................................ $ (28,977) $ (18,434) $ (89,730) $ (52,496)
============= ============ =========== ===========
Total number of shares used to compute
basic and diluted earnings (loss) per share...... 41,648,000 31,019,000 39,923,000 28,764,000
============= ============ =========== ===========
Loss from operations:
Basic and diluted loss per share............... $ (0.39) $ (0.44) $ (1.27) $ (1.06)
============= ============ =========== ===========
Net loss:
Basic and diluted loss per share............... $ (0.70) $ (0.59) $ (2.25) $ (1.83)
============= ============ =========== ===========
Potential dilutive securities have been excluded from the
computation for the three and nine months ended September 30, 2000 and 1999
as their effect is antidilutive. Had the Company been in a net income
position for the three and nine months ended September 30, 2000 and 1999,
diluted earnings per share would have included an additional 5,230,000 and
8,205,000 shares, respectively, related to outstanding warrants, stock
options and stock subscriptions.
10
5. PROPERTY AND EQUIPMENT
Property and equipment at September 30, 2000, consist of the
following:
[caad 234]E
Network equipment.................................................... $112,506
Indefeasible right of use investments................................ 165,128
Leasehold improvements............................................... 16,809
Furniture, fixtures and office equipment............................. 13,850
Construction in progress............................................. 12,812
--------
321,105
Less: accumulated depreciation and amortization (34,244)
--------
Property and equipment, net.......................................... $286,861
========
6. DEBT
Other long-term debt of $1.5 million represents amounts due under a
network fiber lease.
7. INCOME TAXES
The Company has tax loss carry forwards of approximately $55.5 million
at September 30, 2000. The ability of the Company to fully realize deferred tax
assets related to these tax loss carryforwards in future years is contingent
upon its success in generating sufficient levels of taxable income before the
statutory expiration periods for utilizing such net operating losses lapse. Due
to its limited history, the Company was unable to conclude that realization of
such deferred tax assets in the near future was more likely than not.
Accordingly, a valuation allowance was recorded to offset the full amount of
such assets.
8. INITIAL PUBLIC OFFERING
On March 1, 2000, Carrier1 completed its initial public offering of
8,625,000 shares of common stock (including the underwriters' overallotment
of 1,125,000 shares) at a price of (U)87 per share (approximately $87.42 per
share). Carrier1 received proceeds of approximately $682 million, net of
underwriting discounts and commissions, listing fees, and offering-related
expenses. Carrier1's shares are quoted and traded in the Federal Republic of
Germany on the Neuer Markt segment of the Frankfurt Stock Exchange. In the
United States of America, Carrier1's shares are traded in the form of
American Depositary Shares ("ADSs"). Each ADS represents the right to receive
0.2 shares of common stock. The ADS's are quoted and traded in the U.S. on
the NASDAQ National Market.
11
9. SEGMENT INFORMATION
Summarized financial information concerning the Company's reportable
segments for the nine months ended September 30, 2000 and 1999 is shown in the
following table. The "Other" column includes unallocated shared and corporate
related assets.
Nine Months Ended September 30, 2000:
VOICE INTERNET AND
SERVICES BANDWIDTH SERVICES OTHER CONSOLIDATED
-------- ------------------ ------- ------------
Revenues......................... $158,051 $28,027 $186,078
Fixed cost contribution.......... 13,769 22,608 36,377
Identifiable assets.............. 26,976 8,235 920,003 955,214
Nine Months Ended September 30, 1999:
VOICE INTERNET AND
SERVICES BANDWIDTH SERVICES OTHER CONSOLIDATED
-------- ------------------ ------- ------------
Revenues......................... $53,342 $6,456 $59,798
Fixed cost contribution.......... 9,540 6,456 15,996
Identifiable assets.............. 30,856 3,761 306,845 341,462
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of our financial condition and
results of operations for the three and nine months ended September 30, 2000
should be read in conjunction with our consolidated financial statements and
related notes. Certain information contained in the discussion and analysis or
set forth elsewhere in this report, including information with respect to our
plans and strategy for our business and related financing, includes
forward-looking statements that involve risk and uncertainties, as detailed in
our most recent Form 10-K as of December 31, 1999.
OVERVIEW
We are a rapidly expanding European facilities-based provider of
end-to-end voice, Internet and bandwidth and related telecommunications
services to large users of communication services. We offer these services
primarily to other telecommunications service providers. In March 1998, our
experienced management team and Providence Equity Partners formed Carrier1 to
capitalize on the significant opportunities emerging for facilities-based
carriers in Europe's rapidly liberalizing telecommunications markets. By
September 1998, we had deployed our initial network and commenced selling
services. By September 30, 2000, we had 409 contracts with voice customers and
192 contracts with Internet and bandwidth customers.
12
We are developing an extensive city-to-city European fiber optic
network accessing and linking key population centers. In select European
cities, we are also developing intra-city networks and data centers for housing
and managing equipment. We expect these intra-city networks to give us faster,
lower cost access to customers, with better quality control. We also expect to
bundle and cross-sell our intra-city network and data center capabilities with
our other services. We intend to continue rapidly expanding our network in a
cost-effective manner by building, buying or swapping network assets.
To date, we have experienced net losses and, with the exception of
the three months ended June 30, 2000 and the three months ended September 30,
2000, negative cash flow from operating activities. Positive cash flow from
operations during the three months ended June 30, 2000 and the three months
ended September 30, 2000 is mainly attributable to bandwidth IRU sales in
those periods. From our inception to September 1998, our principal activities
included developing our business plans, obtaining governmental authorizations
and licenses, acquiring equipment and facilities, designing and implementing
our voice and Internet networks, hiring management and other key personnel,
developing, acquiring and integrating information and operational support
systems and operational procedures, negotiating interconnection agreements
and negotiating and executing customer service agreements. We expect to
continue to generate net losses and negative cash flow through at least 2002
as we expand our operations. Whether or when we will generate positive cash
flow will depend on a number of financial, competitive, regulatory, technical
and other factors. See "--Liquidity and Capital Resources."
Although our management is highly experienced in the wholesale
telecommunications business, our company itself has a limited operating
history. Prospective investors therefore have limited operating and financial
information about our company upon which to base an evaluation of our
performance and an investment in our securities.
Our consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America ("US
GAAP"). We have adopted a fiscal year end of December 31.
FACTORS AFFECTING FUTURE OPERATIONS
REVENUES
We expect to generate most of our revenues through the sale of
voice, Internet and bandwidth services and related telecommunication
services, including broadband solutions, co-location/hosting services, and
infrastructure services to other telecommunications service providers. We
record revenues from the sale of voice and Internet services at the time of
customer usage. Revenue from bandwidth IRU sales is recognized in accordance
with the Financial Accounting Standards Board (the "FASB") interpretation of
accounting rules generally on a monthly basis over the contract life,
13
typically 15 to 20 years. For contracts that satisfy sales-type lease
accounting, revenues are recognized at the time of sale. Our agreements with
our voice customers are typically for an initial term of twelve months and will
be renewed automatically unless cancelled. They employ usage-based pricing and
do not provide for minimum volume commitments by the customer. We generate a
steady stream of voice traffic by providing high-quality service and superior
customer support. Our Internet (both transport and access services) and
bandwidth services are generally charged at a flat monthly rate, regardless of
usage, based on the line speed and level of performance or, in the case of
Internet access services, the number of ports, made available to the customer.
We also offer usage-based Internet pricing for our Internet transport services,
"Internet Exchange Connect", "Euro Transit" and "Global Transit", only in
combination with Internet contracts that have a fee-based component that
guarantees minimum revenue, in order to encourage usage of our network services
by our Internet customers. Our agreements with our Internet customers are
generally for a minimum term of twelve months. Currently, our bandwidth
services are typically also for an initial term of twelve months, although we
expect to be able to offer more flexible pricing alternatives to bandwidth
customers in the future. We believe that, if the quality of the service is
consistently high, Internet customers will typically increase the amount of
capacity they purchase from us. We believe that they will also generally renew
their contracts because it is costly and technically burdensome to switch
carriers.
Our services are priced competitively and we emphasize quality and
customer support. The rates charged to voice, Internet and bandwidth customers
are subject to change from time to time. As a result of a more favorable
traffic and services mix, our revenue per billable minute for voice traffic in
the third quarter of 2000 increased compared with the third quarter 1999 and
remained stable in the third quarter of 2000 compared with the second quarter
2000. We generally expect to experience, and have planned for, declining
revenue per billable minute for voice traffic and declining revenue per Mb for
Internet traffic and bandwidth, in part as a result of increasing competition.
As a result of the construction of European fiber optic networks by
our competitors, the price of bandwidth capacity is declining rapidly, which
has lowered the price at which we are able to sell our Internet and bandwidth
products, including dark fiber. We also expect technological advances that
greatly increase the capacity of fiber optic cable to exacerbate downward price
pressure. We anticipate, however, that the incremental costs of lighting dark
fiber with transmission equipment will remain significant and will therefore
serve as an economic restraint to increases in available managed bandwidth
capacity at low marginal costs. Furthermore, we believe that price decreases
will promote demand for high volumes and opportunities for volume related
revenue increases. The impact on our results of operations from price decreases
has been in prior quarters, and we believe it will continue to be, at least
partially offset by decreases in our cost of providing services, largely due to
our increased use of our own fiber and our consequent decreased termination
costs, and increases in our voice and Internet traffic volumes. In addition, we
believe that our ability to bundle and cross-sell network services allows us to
compete effectively and to protect our business, in part, against the impact of
these price decreases.
14
Our focus on providing services to large users of communication
services, including other operators, results in us having substantially fewer
customers than a carrier in the mass retail sector. As a result, a shift in
the traffic pattern of any one customer, especially in the near term and on
one of our high volume routes, could have a material impact, positive or
negative, on our revenues. Furthermore, many wholesale customers of voice
services tend to be price sensitive and may switch suppliers for certain
routes on the basis of small price differentials. In contrast, Internet and
bandwidth customers tend to use fewer suppliers than voice customers, cannot
switch suppliers as easily and, we believe, are more sensitive to service
quality and stability than to price. We believe that customers for data
center services are more sensitive to the value-added services that we plan
to provide than to price. In addition, we believe that they are unlikely to
move between facilities due to their initial investments in tenant
improvements and the high costs and risks of network outage associated with
moving to another facility.
As of September 30, 2000, we have entered into contracts to provide
bandwidth and capacity on our network and co-location/hosting services with a
total value to us of approximately $271 million over contract life (excluding
swaps and a potentially significant scalable contract). Although we have
begun to deliver capacity under some of the contracts, most of these are
operating leases, and we will generally recognize revenue on a monthly basis
over the contract life, typically 15 to 20 years.
COST OF SERVICES, EXCLUSIVE OF ITEMS DISCUSSED
SEPARATELY BELOW
Cost of services, exclusive of depreciation and amortization, which is
discussed separately below, are classified into the following general
categories: access costs, transmission costs, voice and Internet termination
costs and other costs of services.
ACCESS COSTS. We have minimal access costs as our customers are typically
responsible for the cost of accessing our network. We have begun to provide
access services to switchless resellers and ISPs. Switchless resellers and ISPs
generally do not have any telecommunications infrastructure. Therefore, for
services to switchless resellers and ISPs we will have access costs payable to
the originating local provider, usually the incumbent telephone operator. These
costs are reflected in our pricing and will vary based on calling volume and
the distance between the caller and our point of presence.
TRANSMISSION COSTS. Our transmission costs currently consist of leased
capacity, operation, administration and maintenance cost of owned fiber as well
as switch and router facilities costs. Leased capacity charges are fixed
monthly payments based on capacity provided and are typically higher than a
"dark fiber cost level," which is our target cost level and represents the
lowest possible per unit cost. Dark fiber cost level is the per unit cost of
high-capacity fiber that has been laid and readied for use but which has not
been "lit" with transmission electronics. Dark fiber cost levels can be
achieved not only through owned facilities, but also may be possible through
other rights of use
15
such as multiple investment units, known as "MIUs," or indefeasible rights of
use, known as "IRUs."
As part of our strategy to lower our cost base over time, we will seek
dark fiber cost levels for our entire transmission platform, through building,
acquiring or swapping capacity. For example, our German network is operational
and in commercial service. The Paris, Amsterdam and Rotterdam intra-city
networks are expected to be operational at the end of 2000. We have acquired
intra-city capacity in London to lower our access costs, and we have made
capital-efficient arrangements to swap capacity on the German network for
capacity on other networks. We will provide and sell dark fibre on our German
network and our city rings and broadband capacity on our pan-European network.
We further minimize our transmission costs by optimizing the routing of our
voice traffic and increasing volumes on our fixed-cost leased and owned lines,
thereby spreading the allocation of fixed costs over a larger number of voice
minutes or larger volume of Internet traffic, as applicable. To the extent we
overestimate anticipated traffic volume, however, per unit costs will increase.
As we continue to develop our owned network and rely less on leased capacity,
per unit voice transmission costs are expected to decrease substantially,
offset partially by an increase in depreciation and amortization expense. We
also expect to experience declining transmission costs per billable minute or
per Mb, as applicable, as a result of increasing use of our owned network as
opposed to leased network assets, decreasing cost of leased transmission
capacity, increasing availability of more competitively priced IRUs and MIUs
and increasing traffic volumes.
VOICE TERMINATION COSTS. Termination costs represent the costs we are required
to pay to other carriers from the point of exit from our network to the final
point of destination. Generally, most of the total costs associated with a
call, from receipt to completion, are termination-related costs. Voice
termination costs per unit are generally variable based on distance, quality,
geographical location of the termination point and the degree of competition in
the country in which the call is being terminated.
If a non-mobile call is terminated in a city in which we have a point
of presence and an interconnection agreement with the national incumbent
telephone operator, the call will be transferred to the public switched
telephone network for local termination. This is usually the least costly mode
of terminating a call. If a call is to a location in which we do not have a
point of presence, or have a point of presence but do not have an
interconnection agreement giving us access to the public switched telephone
network, then the call must be transferred to, and refiled with, another
carrier that has access to the relevant public network for local termination.
We pay this carrier a refile fee for terminating our traffic. Most refilers
currently operate out of New York and various European cities such as London,
Frankfurt and Vienna, so that the refiled traffic is rerouted to such cities
and from there is carried to its termination point. Refile agreements provide
for fluctuating rates with rate change notice periods typically of one to four
weeks. We seek to reduce our refile costs by utilizing least cost routing. For
example, where we do not yet have interconnection agreements, we implement
"resale" agreements whereby a local carrier that has an interconnection
agreement with the incumbent telephone operator "resells" or shares this
interconnection right with us for a fee. Termination through resale agreements
is more expensive than through interconnection
16
agreements but significantly less expensive than through refile agreements
because the traffic does not need to be rerouted to another country.
In countries where we have not been directly authorized to provide
services, we will negotiate to obtain direct operating agreements with
correspondent telecommunications operators where such agreements will result in
lower termination costs than might be possible through refile arrangements. We
believe our refile and resale agreements are competitively priced. If our
traffic volumes are higher than expected, we may have to divert excess traffic
onto another carrier's network, which would also increase our termination
costs. We believe, however, that we have sufficient capacity and could, if
necessary, obtain more. In addition, our technologically advanced daily traffic
monitoring capabilities allow us to identify changes in volume and termination
cost patterns as they begin to develop, thereby permitting us to respond in a
cost-efficient manner.
We believe that our termination costs per unit should decrease as we
extend our network and increase transmission capacity. We also believe that
continuing liberalization in Europe will lead to decreases in termination costs
as new telecommunications service providers offer alternatives to the incumbent
telephone operators for local termination, and as European Union member states
implement and enforce regulations requiring incumbent telephone operators to
establish rates which are set on the basis of forward-looking, long run
economic costs that would be incurred by an efficient provider using advanced
technology. There can be no assurance, however, regarding the extent or timing
of such decreases in termination costs.
TERMINATION OF MOBILE TRAFFIC. A substantial portion of our revenue from our
voice products is based on mobile traffic. We have arrangements in place for
termination of mobile traffic. However, direct operating agreements with mobile
operators tend to be expensive and refiling of mobile traffic generally does
not meet our quality targets. Although we currently have a number of direct
agreements with mobile operators and quality refilers in place, we cannot
guarantee that we can maintain these agreements or enter into similar
agreements of adequate price levels, or at all, to support the expansion of our
mobile traffic.
INTERNET TERMINATION COSTS. Termination costs represent costs we are required to
pay to other Internet backbone providers from the point of exit of our network.
Internet termination is effected through peering and transit arrangements.
Peering arrangements provide for the exchange of Internet traffic
free-of-charge. We have entered into peering arrangements with ISPs in the
United States and Europe, including recent peering arrangements with several
European incumbent telephone operators. There can be no assurance that we will
be able to negotiate additional peering arrangements. Under transit
arrangements, we are required to pay a fee to exchange traffic. That fee is
largely fixed and is based on the minimum Mb amount charged to us by our transit
partners.
Recently, the Internet services industry has experienced merger and
consolidation activity. This activity is likely to increase the concentration
of market power of Internet
17
backbone providers, and may adversely affect our ability to obtain peering and
cost-effective transit arrangements.
OTHER COSTS OF SERVICES. Other costs of planned services include the expenses
associated with providing value-added Internet services and data center
capabilities. These expenses will consist primarily of certain engineering
costs, personnel costs and lease expenses within our data center facilities.
HEADCOUNT. The number of our employees grew to 267 at September 30, 2000, up
from 121 at September 30, 1999. We believe that the number of our employees
will continue to increase in the fourth quarter of 2000 at the same rate as
during the third quarter of 2000. We expect a similar growth rate quarter to
quarter during 2001 unless more employees are required for major new contracts.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Our strategy of selling mainly to large users of communication
services allows us to maintain lower selling, general and administrative
expenses than companies providing services to the mass retail market. Our
selling, general and administrative expenses consist primarily of personnel
costs, information technology costs, office costs, travel, commissions,
billing, professional fees and advertising and promotion expenses. We employ a
direct sales force located in the major markets in which we offer services. To
attract and retain a highly qualified sales force, we offer our sales personnel
a compensation package emphasizing performance-based commissions and equity
options. We expect to incur significant selling and marketing costs in advance
of anticipated related revenue as we continue to expand our operations and
service offerings. Our selling, general and administrative expenses are
expected to remain stable as a percentage of revenues, however, once we have
established our operations in targeted markets and expanded our customer base.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense includes charges relating to
depreciation of property and equipment, which consist principally of equipment
(such as switches, multiplexers and routers), investments in indefeasible
rights of use and in multiple investment units, furniture and equipment. We
depreciate our network over periods ranging from 5 to 15 years and amortize our
intangible assets over a period of 5 years. We depreciate our investments in
indefeasible rights of use and in multiple investment units over their
estimated useful lives of not more than 20 years. We expect depreciation and
amortization expense to increase significantly as we further expand our owned
network, including the German network.
18
FINANCIAL POSITION
Current assets at September 30, 2000 were approximately $622.8
million, representing an increase of approximately 264% over current assets
at December 31, 1999 of approximately $171.3 million. The increase is
primarily related to the receipt of the net proceeds of our initial public
offering (the "IPO") of common stock in February 2000. In addition, total
accounts and unbilled receivables increased from approximately $45.0 million
at December 31, 1999 to approximately $79.8 million at September 30, 2000 as
a result of increased revenues.
Investment in joint ventures increased approximately 589% from
approximately $4.7 million at December 31, 1999 to approximately $32.4 million
at September 30, 2000 as a result of our investment in the Digiplex joint
venture.
Restricted investments held in escrow (both current and long-term)
decreased from December 31, 1999 to September 30, 2000 as a result of our
funding of scheduled interest payments on our senior notes and additions to our
German network.
Deferred revenue (both current and long-term) increased approximately
1,576% from approximately $5.0 million at December 31, 1999 to approximately
$83.8 million at September 30, 2000 as a result of new bandwidth and
infrastructure sales agreements.
Total long-term debt was approximately $234.7 million at September
30, 2000, representing a decrease of approximately 31% from long-term debt at
December 31, 1999 of approximately $337.8 million. The decrease is mainly
related to the repayment of our credit facilities with Nortel Networks of
approximately $77.2 million and Siemens of approximately $26.1 million.
Shareholders' equity (deficit) rose from a deficit of approximately
$34.5 million at December 31, 1999 to an equity balance of approximately
$520.4 million at September 30, 2000 mainly due to our IPO offset by the net
loss incurred in the nine-month period ended September 30, 2000.
THREE MONTHS ENDED SEPTEMBER 30, 2000 AS COMPARED TO
THREE MONTHS ENDED SEPTEMBER 30, 1999:
Revenues for the three months ended September 30, 2000 were
approximately $77.3 million, representing an increase of approximately 183%
over revenues for the three months ended September 30, 1999 of approximately
$27.3 million. Revenues primarily related to voice services, which contributed
approximately $62.4 million or 81% of total revenue in the third quarter of
2000. Voice revenue grew 144% over the three months ended September 30, 1999.
Voice traffic volume during the three months ended September 30, 2000 was
approximately 437 million minutes compared with approximately 183 million
minutes during the three months ended September 30, 1999. Average revenue per
minute was approximately 14.3 cents, which represented an increase of
approximately 2% compared to the third quarter of 1999, which primarily
reflects changes in traffic mix. The majority of voice traffic in the third
quarter of 2000 both
19
originated and terminated in Europe where prices are generally lower,
but where we have implemented interconnection agreements and therefore
generally do not need to terminate traffic via more costly refile or resale
arrangements. Internet and bandwidth services revenue was approximately $14.9
million during the three months ended September 30, 2000, representing an
increase of 776% over the three months ended September 30, 1999, primarily due
to increases in our customer base. During the third quarter of 2000, we
recognized revenue of approximately $4.2 from one bandwidth IRU contract that
qualified as a sales-type lease.
Cost of services (exclusive of items shown separately) for the three
months ended September 30, 2000 were approximately $75.5 million compared with
approximately $32.5 million for the three months ended September 30, 1999. Such
costs increased primarily as a result of costs directly associated with our
increased voice traffic. These costs consisted primarily of operation of the
network, leases for transmission capacity, operation, administration and
maintenance cost of owned fiber as well as termination expenses including
refiling.
Expressed as a percentage of revenues, cost of services (exclusive of
items shown separately) was 98% during the three months ended September 30,
2000 compared with 119% for the three months ended September 30, 1999. This
decrease is primarily the result of higher volumes carried on our owned
network.
Depreciation and amortization for the three months ended September 30,
2000 was approximately $9.2 million compared with approximately $4.2 million
for the three months ended September 30, 1999. These costs increased over the
three months ended September 30, 1999 due to higher investments for network
equipment, indefeasible rights of use, other furniture and equipment and
completion of the German ring.
Selling, general and administrative expenses were approximately $8.7
million during the three months ended September 30, 2000 compared with
approximately $4.2 million for the three months ended September 30, 1999. Such
costs consisted primarily of personnel costs, information technology costs,
office costs, professional fees and expenses. These costs increased over the
three months ended September 30, 1999 primarily as a result of increased
headcount, information technology costs, promotional costs, office costs and
provisions for bad debts.
Net interest income for the three months ended September 30, 2000
was approximately $2.6 million. Interest income of approximately $5.5 million
consisted of interest earned on deposits of escrowed proceeds of our senior
notes and unused net proceeds of our IPO. Interest expense of approximately
$8.1 million mainly consisted of interest accrued on the senior notes and
other borrowings, less capitalized interest of approximately $0.2 million.
The strengthening of the U.S. dollar to the Euro in the third quarter
of 2000 resulted in a currency exchange loss of $10.3 million, compared with
currency exchange gain of $1.9 million during the quarter ended September
30, 1999.
20
Our management evaluates the relative performance of our voice and
Internet and bandwidth ("data") operations based on their respective fixed cost
contributions. Fixed cost contribution is defined as segment revenues less
direct variable costs incurred by the segment. Certain direct costs, such as
network and transmission costs, are shared by both the voice and data
operations and are not allocated by management to the segment.
Fixed cost contribution for voice services for the three months
ended September 30, 2000 was $4.3 million, representing $62.4 million in voice
revenue less $58.1 million, or approximately 13 cents per minute, in voice
termination costs. Fixed cost contribution for data services for the same
period was $11.7 million representing $14.9 million in data revenue less $3.2
million in data direct cost.
NINE MONTHS ENDED SEPTEMBER 30, 2000 AS COMPARED TO NINE
MONTHS ENDED SEPTEMBER 30, 1999:
Revenues for the nine months ended September 30, 2000 were
approximately $186.1 million, representing an increase of approximately 211%
over revenues for the nine months ended September 30, 1999 of approximately
$59.8 million. Revenues primarily related to voice services, which contributed
approximately $158.1 million or 85% of total revenue for the nine months ended
September of 2000. Voice revenue grew 196% over the nine months ended September
30, 1999. Voice traffic volume during the nine months ended September 30, 2000
was approximately 1,090 million minutes compared with approximately 366 million
minutes during the nine months ended September 30, 1999. Average revenue per
minute was approximately 14.5 cents, which represented a decrease of
approximately 1% compared to the nine months ended September 30, 1999, due
primarily to changes in traffic mix. The majority of voice traffic for the nine
months ended September 2000 both originated and terminated in Europe where
prices are generally lower, but where we have implemented interconnection
agreements and therefore generally do not need to terminate traffic via more
costly refile or resale arrangements. Internet and bandwidth services revenue
was approximately $28.0 million during the nine months ended September 30,
2000, representing an increase of 334% over the nine months ended September 30,
1999, primarily due to increases in our customer base.
Cost of services (exclusive of items shown separately) for the nine
months ended September 30, 2000 were approximately $188.5 million compared with
approximately $71.9 million for the nine months ended September 30, 1999. Such
costs increased primarily as a result of costs directly associated with our
increased voice traffic. These costs consisted primarily of operation of the
network, leases for transmission capacity, operation, administration and
maintenance cost of owned fiber as well as termination expenses including
refiling.
Expressed as a percentage of revenues, cost of services (exclusive of
items shown separately) was approximately 101% during the nine months ended
September 30, 2000 compared with approximately 120% for the nine months ended
September 30, 1999. This decrease is primarily the result of higher volumes
carried on our owned network.
21
Depreciation and amortization for the nine months ended September 30,
2000 was approximately $22.6 million compared with approximately $7.8 million
for the nine months ended September 30, 1999. These costs increased compared to
the nine months ended September 30, 1999 due to higher investments for network
equipment, indefeasible rights of use, and other furniture and equipment.
Selling, general and administrative expenses were approximately $25.5
million during the nine months ended September 30, 2000 compared with
approximately $10.7 million for the nine months ended September 30, 1999. Such
costs consisted primarily of personnel costs, information technology costs,
office costs, professional fees and expenses. These costs increased over the
nine months ended September 30, 1999 primarily as a result of increased
headcount, information technology costs, promotional costs, office costs and
provisions for bad debts.
Net interest expense for the nine-months ended September 30, 2000 was
approximately $13.1 million. Interest income of approximately $14.6 million
consisted of interest earned on deposits of escrowed proceeds of our senior
notes and unused net proceeds of our IPO. Interest expense of approximately
$27.7 million mainly consisted of interest accrued on the senior notes and
other borrowings, less capitalized interest of approximately $4.3 million.
The over-all weakening of the Euro to the U.S. dollar in the nine
months ended September 2000 resulted in a currency exchange loss of $26.1
million compared with a loss of $5.2 million during the nine months ended
September 30, 1999.
Fixed cost contribution for voice services for the nine months ended
September 30, 2000 was approximately $13.8 million, representing $158.1 million
in voice revenue less $144.3 million, or approximately 13.7 cents per minute,
in voice termination costs. Fixed cost contribution for data services for the
same period was $22.6 million representing $28.0 million in data revenue less
$5.4 million in data direct cost.
LIQUIDITY AND CAPITAL RESOURCES
We broadly define liquidity as our ability to generate sufficient cash
flow from operating activities to meet our obligations and commitments. In
addition, liquidity includes the ability to obtain appropriate debt and equity
financing and to convert into cash those assets that are no longer required to
meet existing strategic and financial objectives. Therefore, liquidity cannot
be considered separately from capital resources that consist of current or
potentially available funds for use in achieving long-range business objectives
and meeting debt service commitments.
From our inception through December 31, 1998, we financed our
operations through equity contributions. During the year ended December 31,
1999, we financed our operations through additional equity contributions and
with the proceeds of the issuance of our 13 1/4% senior notes and related
warrants, vendor financing and an interim credit
22
facility. The further development of our business and deployment of our network
will require significant capital to fund capital expenditures, working capital,
cash flow deficits and debt service. Our principal capital expenditure
requirements include the acquisition of fiber and duct infrastructure and
transmission equipment and the construction of data center facilities.
Additional funding will also be required for office space, switch site
build-out and corporate overhead and personnel.
We estimate that we will incur capital expenditures of approximately
$370 million from January 2000 through the end of 2001 ($213 million for 2000
and $157 million for 2001), including approximately $31 million for our
investment in the Digiplex joint venture. We expect capital expenditures in
2000 and 2001 will be principally for investments in fiber and duct
infrastructure, transmission equipment, and the construction of data center
facilities. Our German network is operational and in commercial service. We
plan to purchase additional multiplexers and routers for our network. We plan
to complete the Amsterdam, Rotterdam and Paris intra-city network by the end of
2000.
On March 1, 2000, we completed our initial public offering of
8,625,000 shares of common stock (including the underwriters' overallotment of
1,125,000 shares) at a price of (EURO)87 per share (approximately $87.42 per
share). We received proceeds of approximately $682 million, net of underwriting
discounts and commissions, listing fees, and offering-related expenses.
In addition to the net proceeds of our initial public offering,
other potential sources of capital, if available on acceptable terms or at
all, may include possible additional private or public financings, such as an
offering of debt or equity in the capital markets, an accounts receivable or
bank facility, equipment or project financings. We believe, based on our
current business plan, that these sources, or a combination of them, will be
sufficient to fund the expansion of our business as planned, and to fund
operations and additional expansions until we achieve positive cash flow from
operations. We expect to continue to generate net losses and negative cash
flow through at least 2002 as we expand our operations. Whether or when we
will generate positive cash flow from operating activities will depend on a
number of financial, competitive, regulatory, technical and other factors.
For example, our net losses and negative cash flow from operating activities
are likely to continue beyond that time if:
o we decide to build extensions to our network because we
cannot otherwise reduce our transmission costs,
o we do not establish a customer base that generates sufficient
revenue,
o we do not reduce our termination or access costs by
negotiating competitive interconnection rates and peering
arrangements as we expand our network,
o prices decline faster than we have anticipated,
23
o we do not attract and retain qualified personnel,
o we do not obtain necessary governmental approvals and
operator licenses or
o we are unable to obtain any additional financing as may be
required.
Our ability to achieve these objectives is subject to financial,
competitive, regulatory, technical and other factors, many of which are beyond
our control. There can be no assurance that we will achieve profitability or
continued positive cash flow.
The actual amount and timing of our future capital requirements may
differ materially from our estimates as a result of, among other things, the
demand for our services and regulatory, technological and competitive
developments. There can be no assurance that sources of additional financing
will be available on acceptable terms or at all.
As of September 30, 2000, we had total current assets of $622.8
million, of which $29.4 million was escrowed for interest payments on the
senior notes. Net unrestricted cash as of the same date was $453.4 million.
In the first quarter of 2000, we allocated approximately $19.3 million in
additional funds for the construction cost of the German network and provided
a letter of credit to secure payment of that amount. The balance of that
letter of credit was $13.8 million as of September 30, 2000. An additional
amount for cost of construction of the German network is currently in
dispute, and the construction company and development company are in the
process of negotiating a settlement. Although we expect the disputed amount
will not be payable in full, our total share of that amount, if ultimately
paid in full, would be approximately $12.0 million.
After September 30, 2000, we have made alternative arrangements for
network assets that we had arranged to acquire from an affiliate of Iaxis
Ltd. In the third quarter, Iaxis Ltd. went into administration, which
provides temporary protection from creditors, and which necessitated these
alternative arrangements. We estimate the maximum total cost of such
alternative arrangements would be less than $1 million. The network assets
provided by the Iaxis affiliate currently have a book value of approximately
$10 million, which amount is being amortized over a period between 10 to 12
years. Should the Iaxis affiliate fail to continue to provide the network
assets we would have to write down the amortized book value of these assets.
EBITDA, which we define as earnings before interest, taxes,
depreciation, amortization, foreign currency exchange gains or losses and other
income (expense), decreased from negative $12.3 million in the fourth quarter
of 1999 to negative $10.1 million in the second quarter of 2000 and decreased
to negative $6.9 million in the third quarter of 2000. EBITDA is used by
management and certain investors as an indicator of a company's ability to
service debt and to satisfy capital requirements. However, EBITDA is not a
measure of financial performance under US GAAP and should not be considered as
an alternative to cash flows from operating, investing or financing activities
as a measure of liquidity or an alternative to net income as an indication of
our operating performance or any other measure of performance derived under US
GAAP.
24
EBITDA as used in this report may not be comparable to other similarly titled
measures of other companies or to similarly titled measures as calculated under
our debt agreements.
FOREIGN CURRENCY
Our reporting currency is the U.S. dollar, and interest and principal
payments on the 13 1/4% senior notes are in U.S. dollars and euros and a
significant portion of our costs and investments are denominated in euros.
However, the majority of our revenues and operating costs are derived from
sales and operations outside the United States and are incurred in a number of
different currencies. Accordingly, fluctuations in currency exchange rates may
have a significant effect on our results of operations and balance sheet data.
The euro has eliminated exchange rate fluctuations among the 11 participating
European Union member states. Adoption of the euro has therefore reduced the
degree of intra-Western European currency fluctuations to which we are subject.
We will, however, continue to incur revenues and operating costs in non-Euro
denominated currencies, such as pounds sterling. Although we do not currently
engage in exchange rate hedging strategies, we may attempt to limit foreign
exchange exposure by purchasing forward foreign exchange contracts or engaging
in other similar hedging strategies. Any reversion from the euro currency
system to a system of individual country floating currencies could subject us
to increased currency exchange risk.
INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS
Certain of the statements contained in this report (other than the
financial statements and other statements of historical fact) are
forward-looking statements, including, without limitation:
(i) the statements in "--Overview" concerning (a) our expectations of
improved access to customers and better quality control associated with the
building of intra-city networks, (b) our expectations with regard to our
ability to bundle and cross-sell our intra-city network and data center
capabilities with our other services and (c) our expectation that we will
continue to generate net losses and negative cash flow through at least 2002;
(ii) the statements in "--Revenues" concerning (a) the generation of
most of our revenues through the sale of wholesale long distance voice and
Internet and bandwidth services to other telecommunications service providers,
(b) our belief that, if the quality of the service is consistently high,
Internet transport customers will typically increase the amount of capacity
they purchase from us and will also generally renew their contracts, (c) our
expectation of declining revenue per billable minute for voice traffic and
declining revenue per Mb for Internet traffic and bandwidth, (d) our
expectation that technological advances will exacerbate downward price
pressure, (e) our anticipation that the incremental costs of lighting dark
fiber will serve as an economic restraint to increases in available managed
bandwidth capacity at low marginal costs, (f) our belief that price decreases
will promote demand for high volumes, (g) our belief that the impact on our
results of operations from price decreases will continue to be at least
partially offset by decreases in our cost of providing services and increases
in our traffic volumes,
25
(h) our belief that our ability to bundle and cross-sell network services
allows us to compete effectively and to protect our business, in part, against
the impact of these price decreases and (i) our belief that customers for data
center services are more sensitive to the differential services that we plan to
provide than to price and that they are unlikely to move between facilities;
(iii) the statements in "--Transmission Costs" concerning (a) the
times at which our Paris, Rotterdam and Amsterdam intra-city networks will be
operational, (b) our expectation that per unit voice transmission costs will
decrease, partially offset by increases in depreciation and amortization
expenses and (c) our expectation that we will experience declining transmission
costs as a result of increasing use of our owned network, decreasing cost of
leased transmission capacity, increasing availability of more competitively
priced IRUs and MIUs and increasing traffic volumes;
(iv) the statements in "--Voice Termination Costs" concerning (a) our
belief that we can obtain more transmission capacity, if necessary, (b) our
belief that our termination costs per unit should decrease as we extend our
network, increase capacity and interconnect with more incumbent telephone
operators and (c) our belief that continuing liberalization in Europe will lead
to decreases in termination costs;
(v) the statement in "--Internet Termination Costs" that the increase
in merger and consolidation activity in the Internet services industry is
likely to increase the concentration of market power of Internet backbone
providers;
(vi) the statements in "--Selling, General and Administrative
Expenses" concerning our expectation that selling, general and administrative
expenses will remain stable as a percentage of revenues once our operations are
more established and our customer base expands;
(vii) the statement in "--Depreciation and Amortization" regarding our
expectation that depreciation and amortization expense will increase as we
further expand our owned network;
(viii) the statement in "--Headcount" regarding the rate of growth in
our number of employees in the fourth quarter 2000 and for the year 2001; and
(ix) other statements as to management's or the Company's expectations
and beliefs presented in this "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Forward-looking statements are made based upon management's current
expectations and beliefs concerning future developments and their potential
effects upon us. There can be no assurance that future developments will be in
accordance with management's expectations or that the effect of future
developments on us will be those anticipated by management. The important
factors described elsewhere in this report (including, without limitation,
those discussed in "--Financial Condition, Liquidity and Capital Resources"),
our most recent report on Form 10-K for the year ended
26
December 31, 1999, our most recent report on Form 10-Q for the three months
ended September 30, 2000, or in other Securities and Exchange Commission
filings, could affect (and in some cases have affected) our actual results and
could cause such results to differ materially from estimates or expectations
reflected in such forward-looking statements.
These factors include the following:
o Our limited operating history makes it difficult for others to
evaluate our performance.
o We expect to experience net losses and negative cash flow.
o If we are unable to improve and adapt our operations and systems as we
grow, we could lose customers and revenues.
o Our operating results may fluctuate significantly.
o Our ability to generate cash to service our substantial capital needs
depends on many factors, some of which are beyond our control.
o Our substantial indebtedness and our ability to incur more
indebtedness could prevent us from fulfilling our obligations under
our existing debt obligations.
o Our debt agreements impose operating and financial restrictions, which
may prevent us from capitalizing on business opportunities.
o If we are unable to extend our network in the manner we have planned,
our operating revenues or gross margins could be adversely affected.
o European use of the Internet, electronic commerce and the demand for
bandwidth intensive applications may not increase as substantially as
we expect, which would limit demand for our services and limit our
ability to increase our revenues.
o We have no control over third parties on whom we rely for the supply,
operation or maintenance of portions of our network, and if they or
their facilities do not perform or function adequately, our network
may be impaired.
o We depend on our highly trained executive officers and employees. Any
difficulty in retaining our current employees or in hiring new
employees would adversely affect our ability to operate our business.
o A failure to enter into or maintain adequate interconnection and
peering arrangements could cause us to incur higher termination and
access costs than competitors who have such arrangements.
27
o If we lost one or more of our government licenses or became subject to
more onerous government regulations, we could be adversely affected.
o The adoption or modification of laws or regulations relating to the
Internet could adversely affect our business.
o The telecommunications industry is highly competitive and we may be
unable to compete successfully.
o Our competitors may have more experience, superior operational
economies or greater resources, placing us at a cost and price
disadvantage.
o We may not be able to obtain sufficient cost-effective transmission
capacity, which could delay our ability to penetrate certain markets
or carry a higher volume of traffic in markets in which we already
operate.
o If estimates we have made are not correct, we may have too much or too
little capacity.
o We may have difficulty enhancing our sophisticated billing, customer
and information systems. Any such difficulties could delay or disrupt
our ability to service or bill our customers.
o Rapid change in our industry could require us to expend substantial
costs to implement new technologies. We could lose customers if our
competitors implement new technologies before we do.
o Customers that are price sensitive may divert their traffic to another
carrier based on small price changes, resulting in fluctuations or
loss in our revenue.
o We rely on a small number of significant customers, and the loss of
any single customer could therefore have a material adverse effect on
our revenues.
o We will engage in joint ventures, which are accompanied by inherent
risks.
o The costs and difficulties of acquiring and integrating businesses or
engaging in other strategic transactions could impede our future
growth and adversely affect our competitiveness.
o We are controlled by parties whose interests may not be aligned with
other holders of our securities.
o The international scope of our operations may adversely affect our
business.
o Conversion to the euro may result in increased costs and possible
accounting, billing and logistical difficulties in operating our
business.
28
o We may be adversely affected by year 2000 issues.
o Enforcing judgments against us may require compliance with non-U.S.
law.
o Volatility in the price of our common shares could result in a lower
trading price than your purchase price.
o The possible volatility of our stock price could adversely affect our
shareholders.
o Future sales of substantial numbers of shares could adversely affect
the market price of the shares.
While we periodically reassess material trends and uncertainties
affecting our results of operations and financial condition in connection with
our preparation of management's discussion and analysis of results of
operations and financial condition contained in our quarterly and annual
reports, we do not intend to review or revise any particular forward-looking
statement referenced in this report in light of future events.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes accounting and
reporting standards for derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities. The
adoption of this standard is effective for the first quarter of our fiscal year
ending December 31, 2001. Management has not yet completed its analysis of this
new accounting standard and, therefore, has not determined whether this
standard will have a material effect on our financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion summarizes the financial instruments and
derivative instruments held by us at September 30, 2000 that are sensitive to
changes in interest rates and foreign exchange rates. In the normal course of
business, we also face risks that are either nonfinancial or nonquantifiable.
Such risks principally include country risk, credit risk, and legal risk, and
are not reviewed in this discussion.
INTEREST RATE RISK MANAGEMENT. Within the past year, the sensitivity
of our cash flows, earnings, and financial condition to changes in market
interest rates declined significantly, upon our repayment (from the proceeds
of our initial public offering) of the [EURO]40 million, the $75 million and
the $26 million that were outstanding under floating rate facilities.
Because most of our outstanding debt at September 30, 2000 is
fixed-rate debt, a change in market interest rates is not likely to have a
material effect on our earnings, cash
29
flows or financial condition. As of September 30, 2000, we did not have a
position in futures, forwards, swaps, options or other similar financial
instruments to manage the risk arising from these interest rate exposures.
FOREIGN EXCHANGE RISK MANAGEMENT. We have foreign exchange currency
exposures related to purchasing services and equipment and selling our
services in currencies other than the US dollar, our reporting currency.
Because the majority of our revenues and operating costs are derived from sales
and operations outside the United States and are incurred in a number of
different currencies, changes in foreign currency exchange rates may have a
significant effect on our results of operations and balance sheet data. The
most significant of our foreign currency exposures relate to our purchasing and
selling activities in the Western European countries such as Germany,
Switzerland and the United Kingdom, where our principal operations exist.
In addition, the $160 million of our 13 1/4% senior notes payable
denominated in USD exposes us to foreign exchange rate risk.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We may, from time to time, be a party to litigation that arises in
the normal course of our business operations. Since our inception we have not
been, and we are not presently, a party to any litigation or arbitration that
we believe had or would reasonably be expected to have a material adverse
effect on our business or results of operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
RECENT SALES OF UNREGISTERED SECURITIES
During the quarterly period ended September 30, 2000, we issued 2,000
shares in connection with the exercise by an employee of vested
options.
30
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION
- ------------ -----------
3.1 Articles of Incorporation of Carrier1 International S.A.
(filed as exhibit 3.1 to the Company's registration statement
on form S-1 (number 333-44058))
27.1 Financial Data Schedule
(b) Reports on Form 8-K
We did not file any reports on Form 8-K during the fiscal quarter
ended September 30, 2000.
31
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934, AS AMENDED, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO
BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
SIGNATURE CAPACITY IN WHICH SIGNED DATE
/s/ Stig Johansson
- ---------------------------- Director, Chief Executive Officer and President November 13,
Stig Johansson (Principal Executive Officer) 2000
/s/ Joachim W. Bauer
- ---------------------------- Chief Financial Officer (Principal Financial November 13,
Joachim W. Bauer Officer and Principal Accounting Officer) 2000
32
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
---------- -----------
3.1 Articles of Incorporation of Carrier 1 International S.A.
27.1 Financial Data Schedule
33