UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
OR
|_| 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 __________
CARRIER1 INTERNATIONAL S.A.
(Exact name of registrant as specified in its charter)
LUXEMBOURG 98-0199626
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
ROUTE D'ARLON 3
L-8009 STRASSEN, LUXEMBOURG
(Address, including zip code of principal executive offices)
(011) (41-1) 297-2600
(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
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes |X| No |_|
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Common stock, par value $2.00 per share, outstanding at September 30,
1999: shares 31,019,071
CARRIER1 INTERNATIONAL S.A.
Table of Contents
Part I. Financial Information
Item 1. Unaudited Financial Statements
Consolidated Balance Sheets as of September 30, 1999
and December 31, 1998.........................................
Consolidated Statements of Operations for the Three Months Ended
September 30, 1999 and September 30, 1998, Nine Months Ended
September 30, 1999 and the Period from February 20, 1998
(Date of Inception) to September 30, 1998.....................
Consolidated Statement of Shareholders' Equity as of
September 30, 1999 ...........................................
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 1999 and the Period from February 20, 1998
(Date of Inception) to September 30, 1998.....................
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ........................................
Item 3. Quantitative and Qualitative Disclosures about Market Risk........
Part II. Other Information
Item 1. Legal Proceedings.................................................
Item 6. Exhibits and Reports on Form 8-K .................................
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
CARRIER1 INTERNATIONAL S.A. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1999 AND DECEMBER 31, 1998
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE INFORMATION)
SEPTEMBER 30, DECEMBER. 31,
1999 1998*
------------- -------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ............................................... $ 13,931 $ 4,184
Restricted cash ......................................................... 7,217 1,518
Restricted investments held in escrow ................................... 74,750 --
Accounts receivables .................................................... 19,066 1,217
Unbilled receivables .................................................... 14,322 1,645
Other receivables ....................................................... 13,208 3,014
Prepaid expenses and other current assets ............................... 7,453 3,179
--------- ---------
Total current assets .................................................. 149,947 14,757
PROPERTY AND EQUIPMENT - NET .............................................. 142,350 31,091
INVESTMENT IN JOINT VENTURES .............................................. 4,681 4,675
RESTRICTED INVESTMENTS HELD IN ESCROW ..................................... 28,993 --
OTHER ASSETS .............................................................. 15,491 911
--------- ---------
TOTAL ..................................................................... $ 341,462 $ 51,434
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade accounts payable .................................................. $ 33,936 $ 27,602
Accrued interest ........................................................ 4,148
Other accrued liabilities ............................................... 44,224 4,643
--------- ---------
Total current liabilities ............................................. 82,308 32,245
LONG-TERM DEBT (Net of discount of $2,199) (See Note 7)
Senior notes ............................................................ $ 248,259 --
Other long-term debt .................................................... 16,758 --
---------
Total long-term debt .................................................. 265,017 --
COMMITMENTS AND CONTINGENT LIABILITIES
SHAREHOLDERS' EQUITY:
Common stock, $2 par value, 55,000,000 and 30,000,000 shares respectively
authorized, 31,019,071 and 18,885,207, respectively
issued and outstanding at September 30, 1999 and December 31, 1998 .... 62,038 37,770
Additional paid-in capital .............................................. 2,304 --
Accumulated deficit ..................................................... (71,731) (19,235)
Accumulated other comprehensive income .................................. 1,526 654
--------- ---------
Total shareholders' equity ............................................ (5,863) 19,189
--------- ---------
TOTAL ..................................................................... $ 341,462 $ 51,434
========= =========
* Derived from audited consolidated financial statements.
See notes to unaudited consolidated financial statements.
3
CARRIER1 INTERNATIONAL S.A. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENT OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1999 AND
SEPTEMBER 30, 1998, NINE MONTHS ENDED SEPTEMBER 30, 1999 AND
THE PERIOD FROM FEBRUARY 20, 1998 (DATE OF INCEPTION) TO SEPTEMBER 30, 1998
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE INFORMATION)
PERIOD FROM
THREE MONTHS THREE MONTHS NINE MONTHS FEBRUARY 20,
ENDED SEPTEMBER ENDED SEPTEMBER ENDED SEPTEMBER 1998 TO SEPTEMBER
30, 1999 30, 1998 30, 1999 30, 1998
-------- -------- -------- --------
REVENUES ............................ 27,311 $ 51 $ 59,798 $ 51
OPERATING EXPENSES:
Cost of services (exclusive of
items shown separately below) ... 32,543 4,062 71,904 4,062
Selling, general and administrative 4,216 2,671 10,681 4,109
Depreciation and amortization ..... 4,183 246 7,817 246
-------- -------- -------- --------
Total operating expenses .......... 40,942 6,979 90,402 8,417
-------- -------- -------- --------
LOSS FROM OPERATIONS ................ (13,631) (6,928) (30,604) (8,366)
OTHER INCOME (EXPENSE):
Interest expense .................. (8,718) -- (21,323) --
Interest income ................... 2,009 89 5,087 89
Currency exchange gain (loss), net 1,931 871 (5,218) 871
Other, net ........................ (25) -- (438) --
-------- -------- -------- --------
Total other income (expense) .... (4,803) 960 (21,892) 960
-------- -------- -------- --------
LOSS BEFORE INCOME TAX
BENEFIT ............................. (18,434) (5,968) (52,496) (7,406)
INCOME TAX BENEFIT - Net of
valuation allowance ................. -- -- -- --
-------- -------- -------- --------
NET LOSS ............................ $(18,434) $ (5,968) $(52,496) $ (7,406)
======== ======== ======== ========
EARNINGS (LOSS) PER SHARE:
Net loss:
Basic ........................... $ (0.59) $ (0.63) $ (1.83) $ (1.75)
======== ======== ======== ========
Diluted ......................... $ (0.59) $ (0.63) $ (1.83) $ (1.75)
======== ======== ======== ========
See notes to unaudited consolidated financial statements.
4
CARRIER1 INTERNATIONAL S.A. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 1999
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE INFORMATION)
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN- ACCUMULATED COMPREHENSIVE
STOCK CAPITAL DEFICIT INCOME TOTAL
-------- -------- -------- -------- --------
BALANCE--December 31, 1998 ........... $ 37,770 $(19,235) $ 654 $ 19,189
Issuance of shares (12,133,864 shares) 24,268 24,268
Issuance of warrants ................. $ 2,304 2,304
Comprehensive income (loss):
Net loss ........................... (52,496) (52,496)
Other comprehensive income, net of
tax:
Currency translation adjustments . 872 872
Total comprehensive loss ............. (51,624)
-------- -------- -------- -------- --------
BALANCE--September 30, 1999 .......... $ 62,038 $ 2,304 $(71,731) $ 1,526 $ (5,863)
======== ======== ======== ======== ========
See notes to unaudited consolidated financial statements.
5
CARRIER1 INTERNATIONAL S.A. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENT OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 1999 AND
PERIOD FROM FEBRUARY 20, 1998 (DATE OF INCEPTION) TO SEPTEMBER 30, 1998
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE INFORMATION)
PERIOD FROM
NINE MONTHS FEBRUARY 20,
ENDED SEPTEMBER 1998 TO SEPTEMBER
30, 1999 30, 1998
--------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss .......................................... $ (52,496) $ (7,406)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization ................... 7,817 246
Changes in operating assets and liabilities
Restricted cash ............................... (5,699) --
Receivables ................................... (40,781) --
Prepaid expenses and other current assets ..... (3,863) (1,869)
Other assets .................................. (14,687) --
Trade accounts payable and accrued liabilities 38,103 4,201
--------- ---------
Net cash provided by (used in) operating
activities ................................ (71,606) (4,828)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of restricted investments held in escrow (103,743)
Purchase of property and equipment ................ ( 95,506) (13,093)
Investments in joint ventures ..................... (6) --
--------- ---------
Net cash used in investing activities ....... (199,255) (13,093)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt .......... 248,259 --
Proceeds from issuance of common stock and warrants 26,572 21,398
Proceeds from subscription of shares .............. 4,018 --
--------- ---------
Net cash provided by financing activities ... 278,849 21,398
EFFECT OF EXCHANGE RATE CHANGES ON CASH
AND CASH EQUIVALENTS .............................. 1,759 809
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS ........... 9,747 4,286
CASH AND CASH EQUIVALENTS
Beginning of period ............................... 4,184
--------- ---------
End of period ..................................... $ 13,931 $ 4,286
========= =========
SUPPLEMENTAL DISCLOSURE OF NONCASH
OPERATING AND INVESTING ACTIVITIES:
At September 30, 1999 and September 30, 1998, the Company had purchased
approximately $23,429 and $11,828, respectively, of equipment on open
accounts payable. During 1999, the Company acquired property and equipment
of $7,944 by entering into a capital lease. In addition, the Company
acquired $12,230 of equipment by entering into a long-term loan with the
vendor.
See notes to unaudited consolidated financial statements.
6
CARRIER1 INTERNATIONAL S.A. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED SEPTEMBER 30, 1999 AND SEPTEMBER 30, 1998 AND NINE MONTHS
ENDED SEPTEMBER 30, 1999 AND THE PERIOD FROM FEBRUARY 20, 1998 (DATE OF
INCEPTION) TO SEPTEMBER 30, 1998 (IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE
INFORMATION)
1. NATURE OF OPERATIONS
Carrier1 International S.A., its subsidiaries in Europe and its subsidiary
in the United States ("Carrier1" or the "Company"), operate in the
telecommunications industry offering long distance voice and Internet Protocol
telecommunication services on a wholesale basis. The Company offers these
services primarily to competitive fixed-line operators, other carriers, wireless
operators, Internet service providers, resellers, and multi-national
corporations. The Company 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 months ended September 30, 1999 are not necessarily indicative of the
results to be expected for the full year.
3. EARNINGS PER SHARE
The following details the earnings per share calculations for the three
months ended September 30, 1999 and September 30, 1998, for the nine months
ended September 30, 1999 and for the period from February 20, 1998 (date of
inception) to September 30, 1998 (in thousands of U.S. dollars, except share
information):
PERIOD
FROM
THREE MONTHS THREE MONTHS NINE MONTHS FEBRUARY
ENDED ENDED ENDED 20, 1998 TO
September 30, September 30, September 30, September 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
Loss from operations ................. $ (13,631) $ (6,928) $ (30,604) $ (8,366)
=========== =========== =========== ===========
Net loss ............................. $ (18,434) $ (5,968) $ (52,496) $ (7,406)
=========== =========== =========== ===========
Total number of shares used to compute
basic earnings (loss) per share ...... 31,019,000 9,514,000 28,764,000 4,222,000
=========== =========== =========== ===========
Loss from operations:
Basic loss per share ............... $ (0.44) $ (0.73) $ (1.06) $ (1.98)
=========== =========== =========== ===========
Diluted loss per share ............. $ (0.44) $ (0.73) $ (1.06) $ (1.98)
=========== =========== =========== ===========
7
Net loss:
Basic loss per share.................... $ (0.59) $ (0.63) $ (1.83) $ (1.75)
----------- ----------- ----------- -----------
Diluted loss per shares................. $ (0.59) $ (0.63) $ (1.83) $ (1.75)
=========== =========== =========== ===========
Potential dilutive securities have been excluded from the computation for
the three months ended September 30, 1999 and September 30, 1998, for the nine
months ended September 30, 1999 and for the period from February 20, 1998 (date
of inception) to September 30, 1998 as their effect is antidilutive. Had the
Company been in a net income position for the three months ended September 30,
1999 and September 30, 1998, for the nine months ended September 30, 1999 and
for the period from February 20, 1998 (date of inception) to September 30, 1998,
diluted earnings per share would have included an additional 8,204,893,
2,822,000, 8,204,893 and 2,822,000 shares, respectively, related to outstanding
warrants, stock options and stock subscriptions.
4. OTHER RECEIVABLES
Other receivables at September 30, 1999, consist of the following:
VAT receivable $12,995
Withholding Tax 213
-------
Other receivable $13,208
=======
5. PROPERTY AND EQUIPMENT
Property and equipment at September 30, 1999, consist of the following:
Network equipment .......................................... $ 59,127
Indefeasible right of use investments ...................... 37,447
Leasehold improvements ..................................... 7,847
Furniture, fixtures and office equipment ................... 6,464
Construction in progress ................................... 40,661
---------
151,546
Less: accumulated depreciation and amortization ............ (9,196)
---------
Property and equipment, net .............................. $ 142,350
=========
6. OTHER ACCRUED LIABILITIES
Other accrued liabilities at September 30, 1999, consist of the following:
VAT payable $ 5,838
Accrued refile cost 13,967
Accrued network cost 15,874
Employee shares not registered 4,018
Miscel. Accruals 4,527
-------
Other accrued liabilities $44,224
=======
7. LONG-TERM DEBT
On February 19, 1999, the Company issued $160 million and [euro]85 million
of 13 1/4% senior notes (the "Notes") with detachable warrants with a scheduled
maturity of February 15, 2009. Each Dollar warrant is initially exercisable to
purchase 6.71013 shares of common stock and each Euro warrant is initially
exercisable to purchase 7.53614 shares of common stock. Holders will be able to
exercise the warrants at a per share price equal to the greater of $2.00 per
share and the minimum par value required by Luxembourg law (currently 50
Luxembourg francs), subject to adjustment.
The Company has the right to redeem any of the Notes beginning on February
15, 2004. The initial redemption price is 106.625% of their principal amount,
plus accrued interest. The redemption price will decline each year after 2004
and will be 100% of their principal amount, plus accrued interest, beginning on
February 15, 2007. In addition, before February 15, 2002, the Company may redeem
up to 35% of the aggregate amount of either series of Notes with the proceeds of
sales of its capital stock at 113.25% of their principal amount. The Company may
make such redemption only if after any such redemption, an amount equal to at
least 65% of the aggregate principal amount of such Notes originally issued
remains outstanding.
The Notes contain covenants that restrict the Company's ability to enter
into certain transactions including, but not limited to, incurring additional
indebtedness, creating liens, paying dividends, redeeming capital stock, selling
assets, issuing or selling stock of restricted subsidiaries, or effecting a
consolidation or merger.
Carrier1 International completed an exchange offer for the Notes on
September 8, 1999. Because completion did not occur by August 19, 1999,
additional interest is due on the Notes at the rate of 0.5% per annum for the
period from August 19, 1999 to September 8, 1999.
As required by the terms of the Notes, the Company used approximately
$49.2 million of the net proceeds to purchase a portfolio of U.S. government
securities and approximately [euro]26.9 million ($29.8 million) of the net
proceeds to purchase a portfolio of European government securities, and pledged
these portfolios for the benefit of the holders of the respective series of
Notes to secure and fund the first five interest payments.
The details of other long-term debt are as follows:
Seller financing ...................................... $12,719
Network fiber lease ................................... 3,736
Other ................................................. 303
-------
Total ................................................. 16,758
=======
Approximately $12.7 million of other long term indebtedness is
attributable to seller financing of fiber optic cable for the Company's German
network. Pursuant to the terms of the financing agreement, the seller will
either provide financing for the entire amount of the purchase with the contract
value to be repaid over three years in equal annual installments beginning on
December 31, 2001 together with interest, or will allow the Company to make
payment in full by December 31, 2000 without interest. The loan, if provided,
will bear interest at the U.S. dollar Libor rate plus 4% per annum.
Approximately $3.7 million of other long term indebtedness is attributable
to a lease of network fiber the Company entered into on April 1, 1999. The lease
requires the Company to make monthly payments of $274 for operating and
maintenance costs for 36 months, after which the Company will obtain a 15 year
indefeasible right of use in the fiber underlying the lease. The Company will be
required to pay an annual operating and maintenance fee of $250 for the term of
the indefeasible right of use.
The Company also has available to it, but as of September 30, 1999, had
not drawn any amounts under, a vendor financing facility with Nortel. The Nortel
facility will allow the Company to borrow money to purchase network equipment
from Nortel and, in limited amounts, other suppliers. Under this facility, the
Company may borrow up to $75 million or the actual amount paid or payable by the
Company for network equipment supplied prior to December 31, 1999, whichever is
less. Advances under the facility will bear interest at a floating rate tied to
LIBOR, and interest payments will be payable periodically from the date of the
relevant advance. At the Company option, it may pledge assets to secure the
Nortel facility and receive a lower interest rate. The Company may not borrow
additional funds under the Nortel facility after December 31, 2000. Advances are
to be repaid in sixteen equal quarterly installments beginning March 31, 2001.
8
8. COMMITMENTS AND CONTINGENCIES
Purchase Commitments
On April 16, 1999, Carrier1 signed an agreement to swap fiber wavelength
on the basis of a 15 year indefeasible right of use (IRU). Carrier1 is to
receive two unprotected wavelengths on diverse routes between Hamburg,
Copenhagen and Malmo and provide two unprotected wavelengths on the routes
between Hamburg and Frankfurt, Hamburg and Berlin, and Berlin and Frankfurt in
exchange. The first wavelength to Scandinavia is confirmed for receipt by
Carrier1 by mid December 1999, the second for the first quarter of 2000.
Carrier1 will deliver the two wavelengths on the German ring during the first
quarter of 2000. The Company will account for this transaction as a nonmonetary
exchange in accordance with Accounting Principles Board Opinion No. 29,
"Accounting for Nonmonetary Transactions."
On April 29, 1999, Carrier1 signed a letter of intent with Nortel for the
purchase of DWDM equipment to light up dark fiber in Germany and on the London
ring. The value of the purchases and the associated services to be performed
within 18 months amounts to $25 million.
On May 7, 1999, Carrier1 signed a contract for the purchase of a 10-year
indefeasible right of use (IRU) for 2.5 Gbit/s of capacity from London to
Amsterdam, Frankfurt, Paris and Brussels in the amount of $15.0 million. The
capacity was delivered in August 1999. Carrier1 sold in exchange to the same
company a 10-year IRU for 2.5 Gbit/s of capacity from London to Frankfurt,
Amsterdam and Paris in the amount of $12.0 million. Carrier1 paid $3.0 million
on the date of acceptance; the remaining $12.0 million will be offset by the
delivery of Carrier1's wavelength.
On August 17, 1999, Carrier1 signed a contract to swap 12 strands of dark fiber
on Carrier1's German network for 12 strands of dark fiber covering substantially
all of the major cities in France. Like Carrier1's German fiber infrastructure,
this new homogeneous French ring utilizes the latest generation of high speed,
high capacity fiber optic cable. The French fiber infrastructure will become
available in phases throughout the year of 2000. Each party will provide certain
network maintenance services for the other party in their respective countries.
The Company will account for this transaction as a nonmonetary exchange in
accordance with Accounting Principles Board Opinion No. 29, "Accounting for
Nonmonetary Transactions."
On September 3, 1999, Carrier1 signed a swap agreement under which it will
provide internet services for a total amount of $20.7 million in exchange for
bandwidth capacity connecting Malmo, Oslo and Gothenburg. The bandwidth capacity
is scheduled to be provided on May 31, 2000, with an initial wavelength of 2.5
Gbps, increasing to 10 Gbps one year later. Carrier1 has the right to convert
the wavelength any time after May 31, 2000 to an 18 year indefeasible right of
use of one fiber pair.
On September 29, 1999, Carrier1 contracted to build a 44 kilometer, multiple
duct city ring connecting major telecommunications points-of-presence in
Amsterdam. The ring will pass much of Amsterdam's business and financial
district, and is scheduled to be completed in the third quarter of 2000. Parts
of the ring are expected to be usable in the first quarter of 2000. The
construction cost is expected to amount to approximately $4.8 million, based on
the September 30, 1999 exchange rate of hfl 2.07 to $1.00.
On October 19, 1999, Carrier1 signed an agreement to swap one of the ducts of
the Amsterdam city ring for one duct on a city ring connecting Amsterdam south
with the business centers in Amsterdam-Schiphol and Amsterdam-Hoofddorp. The
swap extends the Amsterdam city ring network by an additional 71 kilometers.
9. SHAREHOLDERS' EQUITY
Carrier1 has granted options pursuant to the 1999 Share Option Plan to
acquire approximately 2,295,718 Shares at an exercise price of $2.00 per Share
plus applicable capital duty (currently 1% of the subscription price payable to
Carrier1 International by the subsidiary granting the applicable option).
Carrier1 intends to grant additional options in the future.
9
10. INCOME TAXES
The Company has tax loss carry forwards of approximately $20,000 at
September 30, 1999. 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 lapses. 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.
11. SEGMENT INFORMATION
Summarized financial information concerning the Company's reportable
segments for the nine months ended September 30, 1999 is shown in the following
table. The "Other" column includes unallocated shared and corporate related
assets.
VOICE SERVICES DATA 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
12. SUBSEQUENT EVENTS
During the fourth quarter of 1999, Carrier1 entered into a memorandum of
understanding for a joint venture to build carrier co-location-facilities, or
"IT mega centers," in major markets throughout Europe. Carrier1 has committed
$23.4 million to a $155 million project to develop full-service carrier hotels
providing bandwidth-intensive internet and telecom customers co-location
services. Other partners in the venture are expected to include affiliates of
U.S.-based investment firms, Providence Equity Partners Inc. and Carlyle Group,
as well as European network operator iaxis BV. Carrier1 and iaxis also are
expected to serve as strategic anchor tenants in these facilities, which are
expected to be connected to Carrier1's network. A fund managed by Providence
Equity Partners Inc. indirectly holds a majority of Carrier1's outstanding
common stock.
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
THE FOLLOWING DISCUSSION AND ANALYSIS OF CARRIER1'S FINANCIAL CONDITION AND
RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED
FINANCIAL STATEMENTS AND THE NOTES THERETO CONTAINED ELSEWHERE IN THIS REPORT.
CERTAIN INFORMATION CONTAINED IN THE DISCUSSION AND ANALYSIS OR SET FORTH
ELSEWHERE IN THIS REPORT, INCLUDING INFORMATION WITH RESPECT TO CARRIER1'S PLANS
AND STRATEGY FOR ITS BUSINESS AND RELATED FINANCING, INCLUDES FORWARD-LOOKING
STATEMENTS THAT INVOLVE RISK AND UNCERTAINTIES. ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM THE RESULTS DESCRIBED IN OR IMPLIED BY THE FORWARD-LOOKING
STATEMENTS CONTAINED HEREIN DUE TO, AMONG OTHER THINGS, POLITICAL, ECONOMIC OR
LEGAL CHANGES IN THE MARKETS IN WHICH CARRIER1 DOES BUSINESS, COMPETITIVE
DEVELOPMENTS, OR RISKS INHERENT IN CARRIER1'S BUSINESS PLAN, SUCH AS ITS
SIGNIFICANT CAPITAL REQUIREMENTS, ITS SIGNIFICANT INDEBTEDNESS AND COVENANT
RESTRICTIONS AND ITS NEEDS TO CONTINUE TO EXPAND AND DEVELOP ITS NETWORK RAPIDLY
AND COST-EFFECTIVELY. THESE FACTORS ARE DETAILED ELSEWHERE IN THIS REPORT AND IN
CARRIER1'S REGISTRATION STATEMENT ON FORM S-4 ON FILE WITH THE UNITED STATES
SECURITIES AND EXCHANGE COMMISSION.
OVERVIEW
Carrier1 is a rapidly expanding European facilities-based provider of long
distance voice and Internet Protocol data telecommunications services. Carrier1
offers these services on a wholesale basis primarily to competitive fixed-line
operators, other carriers, wireless operators, ISPs, resellers and
multi-national corporations. In March 1998, Carrier1's experienced management
team and Providence Equity Partners formed Carrier1 to capitalize on the
significant voice and data opportunities that are emerging for facilities-based
carriers in Europe's rapidly liberalizing telecommunications markets. By
September 1998, Carrier1 had deployed its initial network and commenced selling
wholesale services. As of March 31, 1999, Carrier1 had executed 79 contracts
with voice customers and 35 contracts with data customers. As of June 30, 1999,
Carrier1 had executed an additional 63 contracts with voice customers and an
additional 11 contracts with data customers. As of September 30, 1999, Carrier1
had executed additional 70 contracts with voice customers and additional 14
contracts with data customers.
Carrier1 is developing an extensive city-to-city European network linking
key population centers. Carrier1 intends to continue rapidly expanding this
network in a cost-effective manner to serve the needs of its existing and
potential customers. Carrier1 believes that its network will allow it to provide
and price its services in Europe on a city-to-city basis without regard to
national borders. This provisioning and pricing structure will put Carrier1 at
the forefront of a shift occuring in the European telecommunications market away
from services and pricing that distinguish between international and national
long distance.
To date, Carrier1 has experienced net losses and negative cash flow from
operating activities. From Inception to September 1998, Carrier1's principal
activities included developing its business plans, obtaining governmental
authorizations and licenses, acquiring equipment and facilities, designing and
implementing its voice and data 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. In
September 1998, Carrier1 commenced the roll-out of its services. Carrier1
expects to continue to generate net losses and negative cash flow as it expands
its operations and does not expect to generate positive cash flow from operating
activities through 2000. Whether or when Carrier1 will generate positive
cashflow from operating activities will depend on a number of financial,
competitive, regulatory, technical and other factors. See "Liquidity and Capital
Resources."
Although Carrier1's management is highly experienced in the wholesale
telecommunications business, Carrier1 itself has a limited operating history.
Holders of Carrier1's securities therefore
11
have limited operating and financial information about Carrier1 upon which to
base an evaluation of Carrier1's performance and an investment in Carrier1's
securities.
Carrier1's consolidated financial statements are prepared in accordance
with U.S. generally accepted accounting principles. Carrier1 reports on a
calendar quarterly basis.
FACTORS AFFECTING FUTURE OPERATIONS
REVENUES
Carrier1 generates most of its revenues through the sale of wholesale long
distance voice and data services to competitive fixed-line operators, other
carriers, wireless operators, ISPs, resellers and multi-national corporations.
Carrier1 is beginning to expand the scope of its wholesale market by adding
value-added services for customers such as switchless resellers. Carrier1
records revenues from the sale of voice and data services at the time of
customer usage. Carrier1's agreements with its 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. Carrier1 generates a steady stream of voice traffic
by providing high-quality service and superior customer support. Carrier1's data
services are charged, depending on service type, either at a flat monthly rate,
regardless of usage, based on the line speed and level of performance made
available to the customer, or on a usage basis, with no minimum volume
commitment by the customer. Initially, the majority of Carrier1's data contracts
were usage-based. Since March 31, 1999, Carrier1 has migrated to offering usage
based data pricing only in combination with data contracts that have a fee-based
component that guarantees minimum revenue, in order to encourage usage of its
network services by its data customers. Carrier1's agreements with its data
customers are generally for a minimum term of twelve months, although Carrier1
may seek minimum terms of two years or more for agreements providing for higher
line speeds. Carrier1 believes that, if the quality of the service is
consistently high, data customers will typically renew their contracts because
it is costly and technically burdensome to switch carriers.
Currently, voice and data services are both priced competitively and
Carrier1 emphasizes quality and customer support, rather than offering the
lowest prices in the market. The rates charged to voice and data customers are
subject to change from time to time. Carrier1 will also vary pricing on its
routes as a traffic management tool. Although Carrier1's revenue per billable
minute for voice traffic in the third quarter of 1999 increased, in general,
Carrier1 expects to experience declining revenue per billable minute for voice
traffic and declining revenue per Mb for data traffic, in part as a result of
increasing competition. Carrier1 believes, however, that the impact on its
results of operations from price decreases has been in prior quarters, and, it
believes, will continue to be, at least partially offset by decreases in its
cost of providing services and increases in its voice and data traffic volumes.
Carrier1's focus on the wholesale international and national long distance
markets results in its 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 Carrier1's high volume
routes, could have a material impact, positive or negative, on Carrier1's
revenues. One customer accounted for approximately 12% of Carrier1's revenues in
September, 1999, and may continue to account for a significant portion of
revenues in the near term. Furthermore, most wholesale customers of voice
services tend to be price sensitive and, assuming the quality of service is
12
equivalent, certain customers may switch suppliers for certain routes on the
basis of small price differentials. In contrast, data customers tend to use
fewer suppliers than voice customers, cannot switch suppliers as easily and,
Carrier1 believes, are more sensitive to service quality than to price.
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 three general categories: access
costs, transmission costs and termination costs. Carrier1 has minimal access
costs as its wholesale customers are typically responsible for the cost of
accessing its network. Carrier1 has begun to target switchless resellers and,
for those services, Carrier1 will have access costs payable to the originating
local provider, usually the incumbent telephone operator. These costs will vary
based on calling volume and the distance between the caller and Carrier1's point
of presence.
TRANSMISSION COSTS. Carrier1's transmission costs for voice and data traffic
currently consist primarily of leased capacity charges and switch and router
facilities costs. As a result of Carrier1's objective to enter the market early,
its initial European transmission platform consists largely of leased capacity.
Leased capacity charges are fixed monthly payments based on capacity provided
and are typically higher than a "dark fiber cost level," which is Carrier1's
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. Dark fiber cost levels can be achieved not only through owned
facilities, but also may be possible through other rights of use such as
multiple investment units, known as "MIUs."
As part of Carrier1's strategy to lower its cost base over time, it will
seek dark fiber cost levels for its entire transmission platform, either through
building, acquiring or swapping capacity. Carrier1 further minimizes its
transmission costs by optimizing the routing of its voice traffic and increasing
volumes on its fixed-cost leased and owned lines, thereby spreading the
allocation of fixed costs over a larger number of voice minutes or larger volume
of data traffic, as applicable. To the extent Carrier1 overestimates anticipated
traffic volume, however, per unit costs will increase. As Carrier1 continues to
develop its owned network and relies less on leased capacity, per unit voice
transmission costs are expected to decrease substantially, offset partially by
an increase in depreciation and amortization expense. Carrier1 also expects to
experience declining transmission costs per billable minute or per Mb, as
applicable, as a result of decreasing cost of leased transmission capacity,
increasing availability of more competitively priced indefeasible rights of use
and MIUs and increasing traffic volumes.
VOICE TERMINATION COSTS. Termination costs represent the costs Carrier1 is
required to pay to other carriers from the point of exit from Carrier1's network
to the final point of destination. Generally, at least one-half 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 call is terminated in a city in which Carrier1 has 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 the least costly mode of
13
terminating a call. To the extent incumbent telephone operators deny or delay
granting Carrier1 interconnection or grant it interconnection for insufficient
capacity or in undesirable locations, Carrier1 may incur high termination costs,
which could have a material adverse effect on its ability to compete with
carriers that do have interconnection agreements. If a call is to a location in
which Carrier1 does not have a point of presence, or has a point of presence but
does not have an interconnection agreement giving it 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. Carrier1 pays this carrier a refile fee for terminating its
traffic. Most refilers currently operate out of London or New York, so that the
refiled traffic is rerouted to London or New York and from there is carried to
its termination point. Refile agreements provide for fluctuating rates with rate
change notice periods typically of one or four weeks. To the extent Carrier1 has
to rely heavily on refiling to terminate certain traffic, Carrier1's margins on
such voice traffic will be materially adversely affected. Carrier1 will seek to
reduce its refile costs by utilizing least cost routing. In those countries
where Carrier1 has a point of presence but does not have an interconnection
agreement implemented yet, it has implemented one or more "resale" agreements
whereby a local carrier that has an interconnection agreement with the incumbent
telephone operator "resells" or shares this interconnection right with Carrier1
for a fee. Termination through resale agreements is significantly less expensive
than through refile agreements because the traffic does not need to be rerouted
to another country, as is done with refiling. Termination through resale
agreements is, however, more expensive than through interconnection agreements.
In countries where it has not been directly authorized to provide services,
Carrier1 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. Carrier1
believes its refile and resale agreements are competitively priced. If
Carrier1's traffic volumes are higher than expected, it may have to divert
excess traffic onto another carrier's network, which would also increase its
termination costs. Carrier1 believes, however, that it has sufficient capacity
and could, if necessary, lease more. In addition, its technologically advanced
traffic monitoring capabilities allow Carrier1 to identify changes in volume and
termination cost patterns as they begin to develop, thereby permitting it to
respond in a cost-efficient manner.
Carrier1 believes that its termination costs per unit should decrease as
it extends its network and increases transmission capacity, adds additional
switches and interconnects with more incumbent telephone operators. Carrier1
also believes that continuing liberalization in Europe will lead to decreases in
termination costs as new telecommunications service providers emerge, offering
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.
DATA TERMINATION COSTS. Termination costs represent costs Carrier1 is required
to pay to other internet backbone providers from the point of exit of Carrier1's
network. Data termination is effected through peering and transit arrangements.
Peering arrangements provide for the exchange of data traffic free-of-charge.
Carrier1 has entered into peering arrangements with several ISPs in the United
States and Europe, including recent peering arrangements with several European
incumbent telephone operators. There can be no assurance that Carrier1 will be
able to negotiate additional peering arrangements or that it will be able to
terminate traffic on their networks at favourable prices. Under transit
arrangements, Carrier1 is required to pay a fee to exchange traffic. That fee
has a variable and a fixed component. The variable component is based on monthly
traffic
14
volumes. The fixed component is based on the minimum Mb amount charged to
Carrier1 by its transit partners. The major United States ISPs require almost
all European ISPs and internet backbone providers, including Carrier1, to pay a
transit fee to exchange traffic.
Recently, the internet services industry has experienced increased merger
and consolidation activity among ISPs and internet backbone providers. This
activity is likely to increase the concentration of market power of Internet
backbone providers, and may adversely affect Carrier1's ability to obtain
peering arrangements.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Carrier1's wholesale strategy allows it to maintain lower selling, general
and administrative expenses than companies providing services to the mass retail
market. Carrier1's 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. Carrier1 employs a direct sales force located in the major markets in
which it offers services. To attract and retain a highly qualified sales force,
Carrier1 offers its sales personnel a compensation package emphasizing
performance based commissions and stock options. Carrier1 expects to incur
significant selling and marketing costs in advance of anticipated related
revenue as it continues to expand its operations. Carrier1's selling, general
and administrative expenses are expected to decrease as a percentage of
revenues, however, once it has established its operations in targeted markets
and expanded its customer base.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense includes charges relating to
depreciation of property and equipment, which will consist principally of
equipment (such as switches, multiplexers and routers), investments in
indefeasible rights of use and in multiple investment units, furniture and
equipment. Depreciation and amortization also include the amortization of
interest capitalized during the construction of the 2,400 kilometer fiber
network Carrier1 is building in Germany in conjunction with Viatel, Inc. and
Metromedia Fiber Network, Inc. Carrier1 depreciates its network over periods
ranging from 5 to 15 years and amortizes its intangible assets over a period of
5 years. Carrier1 depreciates its investments in indefeasible rights of use and
in multiple investment units over their estimated useful lives of not more than
15 years. Carrier1 expects depreciation and amortization expense to increase
significantly as Carrier1 expands its owned network, including the development
of the German network.
NETWORK DEVELOPMENT
During the third quarter, Carrier1 continued to expand its network,
installing a switch in Brussels and beginning work on switch installations in
Stockholm, Milan, and Manchester. In August, The total number of switches at the
end of the third quarter amounted to eleven. Carrier1 replaced its leased STM-1
transmission ring with its own capacity (an indefeasible right of use)
connecting London with Amsterdam, Frankfurt, Paris and Brussels and moved its
traffic from the leased ring to this new optical network link.
15
Also in the third quarter, Carrier1 finalized the implementation of its
interconnect agreement with TeleDenmark and continued the implementation of its
interconnect agreements with Belgacom, Telia, France Telecom and Telecom Italia.
It also upgraded its direct link into Turkey and signed and started to implement
bilateral agreements with selected African incumbent telephone operators,
lowering its cost to terminate traffic into these regions, while improving the
quality of transmission. Construction on the German network proceeded on
schedule. In addition, Carrier1 secured several new peering arrangements with
ISPs, bringing to over 90 its total number of ISP peering arrangements.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1999
Because Carrier1 commercially introduced its services in September 1998,
Carrier1's management believes that comparisons of results for the nine-month
period ended September 30, 1999 to the period from Inception to September 30,
1998 and for the three month period ending September 30, 1999 to the three month
period ending September 30, 1998 are not meaningful.
Revenues for the three-month period ended September 30, 1999 were
approximately $27.3 million, primarily relating to voice services, which
contributed $25.6million or 93.8% to the total revenue generated in the third
quarter of 1999. Voice revenue growth compared to the second quarter of 1999
amounted to 61%. Voice traffic volume of 183 million minutes was billed to
Carrier1's customers. Average revenue per minute was $0.14, which represented an
increase of approximately 8% compared to the second quarter of 1999 due
primarily to changes in traffic mix offset somewhat by price reductions. The
majority of voice traffic in the third quarter of 1999 both originated and
terminated in Europe where prices are generally lower, but where Carrier1 has
implemented interconnection agreements and therefore generally does not need to
terminate traffic via more costly refile or resale arrangements. Data services
revenue of $1.7 million for the same period was generated by internet and
bandwidth services.
Cost of services for the three-month period ended September 30, 1999 was
approximately $32.5 million. These costs consisted of operation of the network,
leases for transmission capacity, and termination expenses including refiling.
Depreciation and amortization for the three-month period ended September
30, 1999 was approximately $4.2 million and consisted primarily of depreciation
costs for network equipment, indefeasible rights of use, and other furniture and
equipment. Selling, general and administrative expenses were approximately $4.2
million for the three-month period ended September 30, 1999 and consisted
primarily of personnel costs, information technology costs, office costs,
professional fees and expenses.
Net interest expense for the three-month period ended September 30, 1999
was approximately $6.7 million. It consisted during this period of approximately
$8.7 million of interest on the Notes, less interest income of approximately
$2.0 million. Interest income consists of interest earned from investing the
remaining proceeds of the $60 million dollars invested by funds managed by
Carrier1's equity sponsors to finance the deployment of Carrier1's network and
to fund start-up operations (the "Equity Investment") and the offering (the
"Offering") on February 19, 1999, of $160,000,000 senior dollar units, each such
unit consisting of one 13 1/4 senior dollar Note and one warrant to purchase
shares of common stock and [euro]85,000,000 senior euro units, each such unit
consisting of one 13 1/4 senior euro Note and one warrant to purchase shares of
common stock.
16
The strengthening of the euro to the U.S. dollar in the third quarter of
1999 resulted in a currency exchange gain of $1.9 million.
Carrier1's management evaluates the relative performance of its voice and
data services operations based on their respective fixed cost contributions.
Fixed cost contribution consists of the revenues generated by the provision of
voice services or data services, as the case may be, less direct variable costs
incurred as a result of providing such services. 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 either service. See Note 9 to the
Unaudited Consolidated Financial Statements presented elsewhere in this report.
Fixed cost contribution for voice services for the three-month period ended
September 30, 1999 was $4.2 million, representing $25.6 million in voice revenue
less $21.4 million, or 11.7 cents per minute, in voice termination costs. Fixed
cost contribution for data services for the same period was equivalent to data
services revenue, or $1.7 million, as there were no direct variable costs
associated directly with providing data services.
PERIOD FROM INCEPTION THROUGH DECEMBER 31, 1998
Carrier1 commercially introduced its services in September 1998. Revenues
for the period from Inception to December 31, 1998 were approximately $2.8
million, primarily relating to voice services, which contributed 98% to the
total revenue achieved in 1998. Voice traffic volume from the start of
operations in September 1998 until the end of 1998 amounted to 10 million
minutes. Data services revenue of $0.1 million for the same period was generated
by internet services.
Cost of services for the period from Inception to December 31, 1998 was
approximately $11.7 million. These costs consisted of operation of the network,
leases for transmission capacity, and termination expenses including refiling.
Depreciation and amortization for the period from Inception to December
31, 1998 was approximately $1.4 million and consisted primarily of depreciation
costs for network equipment, indefeasible rights of use, and other furniture and
equipment. Selling, general and administrative expenses were approximately $9.0
million for the period from Inception to December 31, 1998 and consisted
primarily of start-up expenses, personnel costs, information technology costs,
office costs, professional fees and promotion expenses.
Interest income during the period from Inception to December 31, 1998
consisted of interest earned from investing the proceeds of the issuance of
equity. Interest income totaled approximately $81,000 for the period from
Inception to December 31, 1998. No interest expense was incurred for the period
from Inception to December 31, 1998.
Fixed cost contribution for voice services for the period from Inception
to December 31, 1998 was $0.1 million, representing $2.7 million in voice
revenue less $2.6 million in voice termination costs, reflecting the fact that
during the early stages of its operations, Carrier1 had relatively few
interconnection agreements with incumbent telephone operators so that traffic
had to be terminated at higher cost through refiling. Fixed cost contribution
for data services for the same
17
period was equivalent to data services revenue, or $0.1 million, as there were
no direct variable costs associated directly with providing data services.
LIQUIDITY AND CAPITAL RESOURCES
Carrier1 broadly defines liquidity as its ability to generate sufficient
cash flow from operating activities to meet its 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 Inception through December 31, 1998, Carrier1 financed its operations
through equity contributions. During the nine-month period ended September 30,
1999, Carrier1 financed its operations through additional equity contributions
and with the proceeds of the Offering. The further development of Carrier1's
business and deployment of its network will require significant capital to fund
capital expenditures, working capital, cash flow deficits and any debt service.
Carrier1's principal capital expenditure requirements include the expansion of
its network, including construction of the German network, and the acquisition
of switches, multiplexers, routers and transmission equipment. Additional
capital will be required for office space, switch site buildout and corporate
overhead and personnel.
Carrier1 estimates it will incur capital expenditures of approximately
$220.0 million from Inception through 1999. By the end of 1999, Carrier1 plans
to complete construction of the German network and to purchase additional
switches, multiplexers and routers. As of December 31, 1998, Carrier1 had
incurred capital expenditures of approximately $37.2 million since Inception,
including amounts related to the German Network. As of September 30, 1999
Carrier1 had incurred capital expenditures of approximately $121 million since
December 31, 1998, including amounts related to the German Network. Carrier1's
aggregate funding requirements include requirements to fund capital
expenditures, working capital, debt service and cash flow deficits. Carrier1
estimates, based on its current business plan, that its aggregate funding
requirements for the deployment and operation of its network will total
approximately $330.0 million through 1999.
As of December 31, 1998 funds managed by Carrier1's equity sponsors had
invested a total of approximately $37.8 million to fund start-up operations. As
of February 19, 1999, such funds had completed their aggregate equity investment
totaling $60 million in equity contributions to Carrier1. On February 19, 1999
Carrier1 completed the Offering. Net proceeds from the Offering were $242
million (based on the February 19, 1999, conversion rate of [euro]0.90316 per
$1.00), after deducting discounts and commissions and expenses of the Offering.
Approximately $49.2 million of the net proceeds and [euro]26.9 million ($29.8
million) of the net proceeds were used to purchase a portfolio of government
securities for the benefit of the holders of the respective series of notes.
Carrier1 believes, based on its current business plan, that the net
proceeds from the Offering, the Equity Investment, and the Nortel facility,
together with either (1) proceeds of possible sales of dark fiber on the German
network, (2) proceeds from an accounts receivable facility or other bank
facility, if completed, or (3) proceeds from one or more additional equipment
financing facilities, or a combination of these sources, will be sufficient to
fund the expansion of Carrier1's business as planned, and to fund operations
until Carrier1 achieves positive cash flow from operations. Carrier1 expects to
continue
18
to generate net losses and negative cash flow as it expands its operations and
does not expect to generate positive cash flow from operating activities through
2000. Whether or when Carrier1 will generate positive cash flow from operating
activities will depend on a number of financial, competitive, regulatory,
technical and other factors. For example, Carrier1's net losses and negative
cash flow from operating activities are likely to continue beyond that time if:
- Carrier1 decides to build extensions to its network because it
cannot otherwise reduce its transmission costs;
- Carrier1 does not establish a customer base that generates
sufficient revenue;
- Carrier1 does not reduce its termination costs by negotiating
competitive interconnection rates and peering arrangements as it
expands its network;
- prices decline faster than Carrier1 has anticipated;
- Carrier1 does not attract and retain qualified personnel; or
- Carrier1 does not obtain necessary governmental approvals and
operator licenses.
Carrier1's ability to achieve these objectives is subject to financial,
competitive, regulatory, technical and other factors, many of which are beyond
Carrier1's control. There can be no assurance that Carrier1 will achieve
profitability or positive cash flow.
The actual amount and timing of Carrier1's future capital requirements may
differ materially from Carrier1's estimates as a result of, among other things,
the demand for Carrier1's services and regulatory, technological and competitive
developments. Sources of additional financing, if available on acceptable terms
or at all, may include commercial bank borrowings, equipment financing or
accounts receivable financing, or the private or public sale of equity or debt
securities.
On February 18, 1999, Carrier1 entered into an agreement to purchase fiber
optic cable for the German network during 1999 for $20.3 million plus
value-added tax. The seller will either provide financing for the entire amount
of the purchase with the contract value to be repaid over three years in equal
annual installments beginning on December 31, 2001 together with interest, or
will allow Carrier1 to make payment in full by December 31, 2000 without
interest. The loan, if provided, will bear interest at the U.S. dollar LIBOR
rate plus 4% per annum. If a loan is not provided, the seller is obligated to
provide certain additional equipment to Carrier1 without charge.
Carrier1 also entered into a financing facility with Nortel Networks Inc.,
a major equipment supplier, on June 25, 1999. The Nortel facility allows
Carrier1 to borrow money to purchase network equipment from Nortel and, in
limited amounts, other suppliers. Under this facility, Carrier1 may borrow up to
$75,000,000 or the actual amount paid or payable by Carrier1 for network
equipment supplied prior to December 31, 1999, whichever is less. Advances under
the facility will bear interest at a floating rate tied to LIBOR, and interest
payments will be payable periodically from the date of the relevant advance. At
Carrier1's option, it may pledge assets to secure the Nortel facility and
receive a lower interest rate. Carrier1 may not borrow additional funds under
the Nortel facility after December 31, 2000. Advances are to be repaid in
sixteen equal
19
quarterly installments beginning March 31, 2001. As of September 30, 1999,
Carrier1 had not drawn any amounts under the Nortel facility.
As of September 30, 1999, Carrier1 had total current assets of $149.9
million, of which $33.2 million was escrowed interest on the Notes issued in the
Offering and $41.6 million of which was allocated to the construction cost of
the German network. Net unrestricted cash as of the same date was $13.9 million.
EBITDA, which Carrier1 defines as earnings before interest, taxes,
depreciation, amortization, foreign currency exchange gains or losses and other
income (expense), decreased from negative $5.3 million in the second quarter of
1999 to negative $9.5 million in the third quarter of 1999. EBITDA is used by
management and certain investors as an indicator of a company's historical
ability to service debt. Management believes that EBITDA is an indicator of
ability to service existing debt, to sustain potential future increases in debt
and to satisfy capital requirements. However, EBITDA is not a measure of
financial performance under generally accepted accounting principles 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 indications of Carrier1's operating performance or any other measure of
performance derived under generally accepted accounting principles. EBITDA as
used in this report may not be comparable to other similarly titled measures of
other companies or to Consolidated EBITDA as calculated under the indentures
pursuant to which the Notes were issued.
FOREIGN CURRENCY
Carrier1's reporting currency is the U.S. dollar, and interest and
principal payments on its Notes will be in U.S. dollars and Euro. However, the
majority of Carrier1's 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 Carrier1's 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 Carrier1 is
subject. Carrier1 will, however, continue to incur revenues and operating costs
in non-Euro denominated currencies, such as pounds sterling. Although Carrier1
does not currently engage in exchange rate hedging strategies, it may attempt to
limit foreign exchange exposure by purchasing forward foreign exchange contracts
or engaging in other similar hedging strategies. Carrier1 has outstanding one
contract to purchase Deutschemarks in exchange for dollars from time to time in
amounts anticipated to satisfy its Deutschemark-denominated obligations under
its German network arrangements. Any reversion from the Euro currency system to
a system of individual country floating currencies could subject Carrier1 to
increased currency exchange risk. Carrier1 has selected its computer and
operational systems in an attempt to ensure that its ability to transact
business will not be impaired by complications resulting from the introduction
of the Euro. While Carrier1 believes that its systems have not been adversely
impacted by the Euro conversion, there can be no assurance that Carrier1 will be
able to avoid the accounting, billing and logistical difficulties that might
result from the introduction of the Euro. In addition, there can be no assurance
that Carrier1's third-party suppliers and customers will be able to successfully
implement the necessary protocols.
INFLATION
Carrier1 does not believe that inflation will have a material effect on
its results of operations.
NEW ACCOUNTING PRONOUNCEMENT
20
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. It requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. If
certain conditions are met, a derivative may be specifically designated as (a) a
hedge of the exposure to changes in the fair value of a recognized asset or
liability or an unrecognized firm commitment, (b) a hedge of the exposure to
variable cash flows of a forecasted transaction, or (c) a hedge of the foreign
currency exposure of a net investment in a foreign operation, an unrecognized
firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction. This standard is effective
for Carrier1's fiscal year ending December 31, 2000. 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 Carrier1's
financial statements.
IMPACT OF YEAR 2000
"Year 2000" generally refers to the various problems that may result from
the improper processing of dates and date-sensitive calculations by computers
and other equipment as a result of computer hardware and software using two
digits, rather than four digits, to define the applicable year. If a computer
program or other piece of equipment fails to properly process dates including
and after the Year 2000, date-sensitive calculations may be inaccurate or a
major system failure may occur. Any such miscalculations or system failures may
cause disruptions in operations including, among other things, a temporary
inability to process transactions, send invoices or engage in other routine
business activities. A failure of Carrier1's computer systems could have a
material adverse effect on its operations, including its ability to make
payments on the notes.
STATE OF READINESS
As Carrier1 has developed and implemented its network, operational support
systems, and computer systems, it has conducted an evaluation for Year 2000
compliance. Based on such evaluation, Carrier1 believes that its critical
information technology ("IT") systems and its non-IT systems, such as its
network transmission equipment and its Nortel and Cisco network operating
systems, are Year 2000 compliant. In addition, Carrier1 has received written
assurances from Cisco, Nortel, and International Computers Limited (a
significant software supplier) that the systems they have provided Carrier1 are
Year 2000 compliant. Carrier1, therefore, does not expect to have to remedy any
of its IT or non-IT systems to be Year 2000 compliant.
Carrier1 has instituted a Year 2000 project team with responsibility for the
Company's efforts to protect Carrier1 and its customers from Year 2000 issues
and the other potential problem dates in that year. The Year 2000 project team
includes members of the network and voice switches, IP network services, IT,
building services, corporate network, customer care and legal departments.
Throughout 1999, this Year 2000 team has worked together with all suppliers of
IT, network equipment, access and building control and power backup systems and
equipment and software in an effort to assure Year 2000 compliance. By September
30, 1999, the Year 2000 team had completed its review of the Company's voice and
data networks, voice management systems, switch and router location sites power
backup, billing systems and critical internal IT systems and believes these
networks and systems are Year 2000 compliant. Non-critical IT systems are
believed to be approximately 99% Year 2000 compliant.
Carrier1 has contacted its principal service or capacity suppliers and
customers, with a view towards evaluating these parties' efforts to prepare for
the Year 2000 and the degree of its corresponding exposure if such efforts are
inadequate. Carrier1 has received responses from 70% of these capacity suppliers
and customers. Carrier1 is in the process of evaluating these responses.
Carrier1 intends to follow up with suppliers and customers who have not yet
responded.
RISKS OF YEAR 2000 ISSUES
Any failure of the computer systems of Carrier1's vendors, service or
capacity suppliers or customers as a result of not being Year 2000 compliant
could materially and adversely affect Carrier1. For example, in the event of a
failure as a result of Year 2000 issues in any systems of third parties with
whom Carrier1 interacts, the Company could experience disruptions in portions of
its network, lose or have trouble accessing or receive inaccurate third party
data, experience internal and external communications difficulties, or have
difficulty obtaining components that are Year 2000 compliant from its vendors.
Any of these occurrences could adversely affect Carrier1's ability to operate
its network and retain customers. In addition, the Company could also experience
a slowdown or reduction of sales if customers are adversely affected by Year
2000 issues. As noted above, Carrier1 has
21
contacted its service or capacity suppliers and customers and is in the process
of evaluating Carrier1's risks associated with their noncompliance. As Carrier1
has not yet received responses from all of its suppliers and customers, there
can be no assurance as to Carrier1's degree of exposure to Year 2000-related
problems.
CONTINGENCY PLANS AND COSTS TO ADDRESS YEAR 2000 ISSUES
Based on Year 2000 compliance information it has received from suppliers
and customers Carrier1 has developed a contingency plan to assess the likelihood
of and address worst-case scenarios, to deal with potential Year 2000 problems
caused by a failure of its vendors, service or capacity suppliers or customers
to be Year 2000 compliant. This contingency plan is currently being reviewed by
management. There can be no assurance this plan will not need to be revised or
replaced as Carrier1 continues to receive and review responses regarding Year
2000 compliance from its suppliers and customers.
Carrier1 has not incurred any significant costs associated with Year 2000
compliance and does not anticipate incurring significant costs in the future.
Carrier1 may, however, have to bear costs and expenses in connection with the
failure of its vendors, suppliers or customers to be Year 2000 compliant on a
timely basis. Because no material Year 2000 issues have yet been identified in
connection with external sources, Carrier1 cannot reasonably estimate costs
which may be required for remediation or for implementation of contingency
plans.
RECENT DEVELOPMENTS
During the fourth quarter, Carrier1 entered into a memorandum of understanding
for a joint venture to build carrier co-location-facilities, or "carrier
hotels," in major markets throughout Europe. Carrier1 has committed $23.4
million to a $155 million project to develop full-service carrier hotels
providing bandwidth-intensive internet and telecom customers co-location
services. Other partners in the venture are expected to include affiliates of
U.S.-based investment firms, Providence Equity Partners Inc. and Carlyle Group,
as well as European network operator iaxis BV. Carrier1 and iaxis also are
expected to serve as strategic anchor tenants in these facilities, which are
expected to be connected to Carrier1's network. A fund managed by Providence
Equity Partners Inc. indirectly holds a majority of Carrier 1's outstanding
common stock.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Because substantially all of Carrier1's outstanding debt at September 30,
1999 is fixed-rate debt, a change in market interest rates would not have a
material effect on Carrier1's earnings, cash flows or financial condition.
Carrier1 is exposed to market risk from changes in foreign currency exchange
rates. As of September 30, 1999, Carrier1 does not have a position in futures,
forwards, swaps, options or other derivative financial instruments with similar
characteristics to manage the risk arising from these exposures. Carrier1's
market risk exposure exists from changes in foreign currency exchange rates
associated with its non-derivative financial instruments and with transactions
in currencies other than local currencies in which it operates.
Carrier1 has foreign currency exposures related to purchasing and selling
in currencies other than the local currencies in which it operates. Carrier1's
most significant foreign currency exposures relate to Western European countries
(primarily Germany, Switzerland, and the United Kingdom) where its principle
operations exist. However, the introduction of the euro has significantly
reduced the degree of intra Western European currency fluctuations to which
Carrier1 is subject as of September 30, 1999 (other than fluctuations in
currencies that were not converted to euros, such as the British pound and the
Swiss franc). Additionally, Carrier1 is exposed to cash flow risk related to
debt obligations denominated in foreign currencies.
The table below presents principal cash flows and related average interest
rates for Carrier1's obligations by expected maturity dates as of September 30,
1999. The information is presented in U.S. dollar equivalents, Carrier1's
reporting currency, using the exchange rate at September 30, 1999. the actual
cash flows are payable in either U.S. dollars (US$) or euro (EURO), as indicated
in the parentheses. Average variable interest rates are based on Carrier1's
borrowing rate as of September 30, 1999. Fair value of the dollar and euro notes
was estimated based on quoted market prices. Fair value for all other debt
obligations was estimated using discounted cash flows analyses, based on
Carrier1's borrowing rate as of September 30, 1999.
(IN THOUSANDS)
EXPECTED MATURITY There Fair
DATE 1999 2000 2001 2002 2003 after Total Value
-------- -------- -------- -------- -------- -------- -------- --------
Notes Payable:
Fixed Rate (EURO) . $ 90,458 $ 90,458 $ 94,171
Interest Rate ..... 13.25% 13.25%
Fixed Rate (US$) .. $160,000 $160,000 $158,738
Interest Rate ..... 13.25% 13.25%
Fixed Rate (US$) .. $ 1,013 $ 3,038 $ 3,038 $ 760 $ 7,849 $ 6,351
Fixed Rate ........ 9.7% 9.7% 9.7% 9.7%
Variable Rate (US$) $ 4,240 $ 4,240 $ 4,239 $ 12,719 $ 8,806
Interest Rate ..... 9.7% 9.7% 9.7%
22
The cash flows in the table above are presented in accordance with the
maturity dates defined in the debt obligations. However, the dollar and euro
notes provide for early redemption at specified dates in stated principal
amounts, plus accrued interest. Carrier1 has not determined if these debt
obligations will be redeemed at the specified early redemption dates and
amounts. Carrier1 may elect to redeem these debt obligations early at a future
date. Cash flows associated with the early redemption of these debt obligations
are not assumed in the table above. Should Carrier1 elect to redeem these debt
obligations earlier than the required maturities, the cash flow amounts in the
table above could change significantly.
23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Carrier1 may, from time to time, be a party to litigation that arises in
the normal course of its business operations. Carrier1 is not presently a party
to any such litigation that Carrier1 believes would reasonably be expected to
have a material adverse effect on its business or results of operation.
Item 6. Exhibits and Reports on Form 8-K
Exhibits:
3.1 Articles of Incorporation of Carrier1 International S.A.
27.1 Financial Data Schedule
Reports on Form 8-K
None
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Carrier1 International S.A.
Date November 15, 1999 By: /s/ Joachim W. Bauer
Name: Joachim W. Bauer
Title: Chief Financial Officer
Date November 15, 1999 /s/ Joachim W. Bauer
------------------------------------------
Name: Joachim W. Bauer
Title: Chief Financial Officer
(Principal Financial Officer and Principal
Accounting Officer)
25
Exhibit Index
3.1 Articles of Incorporation of Carrier1 International S.A.
27.1 Financial Data Schedule
26