ITEM 1. BUSINESS
Introduction
Global Crossing Limited, or “GCL,” was formed as an exempt company with limited liability under the laws of Bermuda in 2003. GCL is the successor to Global Crossing Ltd., a company formed under the laws of Bermuda in 1997 which, together with a number of its subsidiaries (collectively, the “GC Debtors”), emerged from reorganization proceedings on December 9, 2003. Except as otherwise noted herein, references in this annual report on Form 10-K to “Global Crossing,” “the Company,” “we,” “our” and “us” mean GCL and its subsidiaries.
We are a global communications service provider, serving many of the world’s largest corporations and many other telecommunications carriers, providing a full range of IP and managed data and voice products and services. Our network delivers services to more than 690 cities in more than 60 countries and six continents around the world. We operate as an integrated global services provider with operations in North America, Europe, Latin America and a portion of the Asia/Pacific region, providing services that support a migration path to a fully converged Internet Protocol (“IP”) environment.
Our principal executive offices are located at Wessex House, 45 Reid Street, Hamilton, HM 12 Bermuda. Our principal administrative offices are located at 200 Park Avenue, Suite 300, Florham Park, New Jersey 07932. Our Internet address is www.globalcrossing.com, where you can find copies of this annual report on Form 10-K and our quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as well as our proxy statements for our meetings of shareholders, all of which we will make available free of charge as soon as reasonably practicable after such reports are electronically filed with or furnished to the Securities and Exchange Commission (the “SEC”).
As of February 15, 2009, we employed approximately 5,219 people, of whom approximately 98% are full-time employees and the balance are part-time or temporary employees. We consider our employee relations to be good. None of our employees are currently covered by collective bargaining agreements, other than approximately 39 employees in the United Kingdom (“U.K.”). In addition, Brazilian law requires us to negotiate certain labor terms and conditions, including salaries and wages, with industry-specific unions, and to obtain approval of our approximately 464 employees in that country.
We report financial results based on the following three operating segments: (i) Global Crossing (UK) Telecommunications Limited (“GCUK”) and its subsidiaries (collectively, the “GCUK Segment”), which provide services primarily to customers in the U.K.; (ii) GC Impsat Holdings I Plc (“GC Impsat”), and its subsidiaries (collectively, the “GC Impsat Segment”), which provide services primarily to customers in Latin America; and (iii) GCL and its other subsidiaries (collectively, the “Rest of World Segment” or “ROW Segment”), which represent all our operations outside of the GCUK Segment and the GC Impsat Segment and operate primarily in North America, with smaller operations in Europe, Latin America and Asia. Prior to the Impsat acquisition, our operating segments were based on product and customer groupings rather than geographic region. Specifically, our operating segments before the Impsat acquisition were “enterprise, carrier data and indirect channels” (which we sometimes refer to as “invest and grow” sales channels in our press releases pertaining to financial results), “carrier voice” and “consumer voice.” These groupings are now considered sales channels within our geographic operating segments, although we are no longer marketing voice services directly to consumers, and consumer voice revenues constituted less than 0.2% of consolidated revenues in 2008. See below in this Item 1, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Note 24, “Segment Reporting,” to our consolidated financial statements included in this annual report on Form 10-K for further information regarding our operating segments.
Following our reorganization in 2003, we strategically restructured the focus of our business operations. During 2004 and 2005, we completed the following dispositions:
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On August 13, 2004, we sold our subsea cable installation and maintenance business, Global Marine Systems Limited, to Bridgehouse Marine Limited (“Bridgehouse”) for $1 million. During the third quarter of 2005, we completed the transfer of our forty-nine percent shareholding in a related joint venture primarily engaged in the subsea cable installation and maintenance business in China to Bridgehouse for $14 million.
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On May 3, 2005, we sold our trader voice business, which provided services primarily to the financial markets industry, to WestCom Corporation for $25 million.
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On December 31, 2005, we completed the sale of our Small Business Group business, which provided services to approximately 30,000 small to medium-sized businesses in the United States, to Matrix Telecom for approximately $38 million.
On October 11, 2006, we announced the acquisition by one of our ROW Segment subsidiaries of 91% of the outstanding ordinary share capital of Fibernet Group Plc (“Fibernet”), a provider of specialist telecommunications services in the U.K. On December 12, 2006, such subsidiary acquired all remaining outstanding Fibernet shares. Total consideration for the transaction including direct costs was approximately 52 million pounds sterling (approximately $97 million). On December 28, 2006 Global Crossing Finance (UK) Plc (“Finance”), a wholly owned finance subsidiary of GCUK, issued 52 million pounds sterling aggregate principal amount of notes pursuant to its indenture dated as of December 23, 2004, priced at 109.25 percent of par value for gross proceeds of 56.8 million pounds sterling (approximately $111 million). Substantially all of these proceeds were used by GCUK to purchase the shares of Fibernet from the ROW Segment. Fibernet is now a subsidiary within the GCUK Segment and a guarantor of GCUK’s $200 million and 157 million pounds sterling aggregate original principal amount of senior secured notes due 2014 (the “GCUK Notes”).
On October 25, 2006, GCL and our subsidiary, GC Crystal Acquisition, Inc. (“GC Crystal”) entered into an Agreement and Plan of Merger, as amended (the “Merger Agreement”), with Impsat Fiber Networks, Inc. (together with its subsidiaries, “Impsat”), a leading provider of private telecommunications, Internet and information technology services to corporate and government clients in Latin America. On February 14, 2007, GC Impsat , a wholly-owned indirect subsidiary of GCL, issued $225 million of 9.875% senior notes due 2017 (the “GC Impsat Notes”) in connection with the acquisition of Impsat, including the refinancing of debt. On May 9, 2007, we announced the completion of the acquisition of Impsat for cash representing a total equity value of approximately $95 million.
Although we operate GC Impsat as a separate segment, since the acquisition we have been engaged in integration activities to realize cost savings and to take advantage of cross-selling opportunities. We are in the process of consolidating our “legacy” operating entities in the Latin American region (i.e., those that pre-dated the Impsat acquisition), which are included in our ROW Segment, with the Impsat entities comprising the GC Impsat Segment. During 2007 and 2008, we transferred our legacy Venezuelan, Brazilian and Chilean operations from the ROW Segment to the GC Impsat Segment. We anticipate transferring our Argentine operations from the ROW Segment to the GC Impsat Segment during 2009 in a continuing effort to streamline our operations.
Business Strategy
The enterprise customer sector continues to represent a significant market opportunity for us, particularly in the financial services, high-tech, healthcare, pharmaceuticals, transportation and distribution, and research and education sectors, as does the government sector. We also target the communications carrier and alternative provider sectors, which include international and domestic network service providers, cable providers, internet service providers, wireless carriers, and content distribution service companies. Our primary method of
distribution is through a worldwide direct sales force. To complement direct distribution, we have developed alliances with major systems integrators to effectively address the requirements of customers who prefer turnkey or outsourced solutions provided by these industry participants. We also use incumbent and other telecommunications providers as an alternative channel of distribution. To facilitate this method of distribution, we have enabled our advanced IP solutions to inter-operate with incumbent and other telecommunications service providers. This interfacing allows these providers to augment their own capabilities and address a wider range of their enterprise customers’ geographic and product-related requirements, while allowing us to benefit from their considerable distribution capabilities. We now have over 50 incumbent and alternative carriers around the world participating in this distribution arrangement called the Global Partners Program.
We expect continued growth in the demand for global bandwidth and IP-enabled solutions due to several significant trends. End-user traffic is expected to continue to grow due to continued adoption of broadband access to the Internet by businesses and consumers and significant mass adoption of high bandwidth and data-intensive consumer and business applications that have large file content such as video. We expect the demand for high performance data communications to continue to be driven by the introduction of more powerful computers and software applications, facilitating higher download rates, and increased usage of e-mail, voice over Internet Protocol (“VoIP”) services, streaming video, wireless local area networks, videoconferencing and other innovations. In addition, we expect global enterprises to continue to outsource their networking needs as companies require networks that interact internally, as well as with partners, customers and vendors, driving the demand for IP-based virtual private networks (“VPNs” or “IP VPNs”) and managed services. We also expect mobile traffic growth to remain strong due to increased adoption of mobile communications, increased usage per mobile connection and increased usage of mobile data applications. We expect a continuation of the industry shift of business applications to IP-based platforms as well as a move towards convergence of telecom and IT in the form of business outsourcing, business continuity and hosting services.
The competitive landscape in the telecommunications industry continues to change, and we believe we are well positioned to take advantage of these changes. With industry consolidation, we expect to experience greater demand from customers seeking network diversity, redundancy and a supplier that can meet their requirements worldwide. We believe that our existing customer base, transport, IP-enabled solutions and hosting capabilities, and extensive network of suppliers globally, coupled with our systems, processes and strong customer service, position us as a viable provider of global services. In addition, our corporate development activities, including the acquisitions of Fibernet and Impsat, have accelerated the growth of our enterprise and carrier data businesses. We continue to analyze potential corporate development opportunities that would increase our scale and efficiency and/or expand our product sets and network reach.
For 2009, we have defined the following operational imperatives which we believe will help enhance revenue growth and profitability.
Continue to Aggressively Manage Costs and Improve Margins. We intend to continue our ongoing cost structure improvement initiatives, including managing our direct operating costs and third party access costs. These initiatives include network optimization, infrastructure improvements, customer migrations, use of alternative termination providers and other traditional means such as revenue assurance and dispute resolution. We also intend to leverage relationships with third party access providers for our wholesale voice services to help reduce our costs across our product offerings. Finally, in an effort to control costs in the current economic environment, we are implementing measures to reduce expenditures on discretionary items and to temporarily reduce payroll costs through salary freezes, mandatory unpaid leaves of absence, reductions in defined benefit plan matching contributions, and other means to maximize our financial flexibility.
Focus on our Employees and Customers and Selectively Augment our Sales Force. We will continue our efforts to maintain a motivated, enthusiastic and talented work force in order to achieve our strategies and support our growing customer base. We have adopted a continuous improvement management approach to enhance the customer experience and are investing in processes, systems, personnel and tools to better enable our
customers to configure and manage our services, including the development of a new customer portal that provides customers with real-time visibility of our network and grant them certain self-service ability. We also intend to selectively strengthen our sales and support staff, both in our indirect and direct channels serving governments, multinational and regional enterprises and carriers.
Capitalize on Industry Trends to Capture New Demand. We believe that our growing customer base, transport and hosting capabilities, and extensive network of suppliers globally, coupled with our systems, processes and strong customer service, position us as a leading provider of global services. We believe that our comprehensive network and value-add service offerings position us well to meet the growing demand for complete solutions for outsourcing, hosting as well as for bandwidth and IP connectivity. We also intend to leverage our innovation and focus on IP services to capture the customer demand created by the convergence of legacy protocols to fixed, mobile and unified communications, which increasingly rely on IP networks such as ours.
Leverage our Global Network and Enhance our Service Offerings. We intend to continue our efforts to offer substantially all of our service offerings throughout our entire network. For example, we are introducing the hosting and Ethernet capabilities that we acquired in the Impsat and Fibernet acquisitions in new markets where we have operations but do not yet provide these services. We intend to increase our selling efforts on managed solutions and collaboration services, as we believe that the current economic environment should support these product trends. We also intend to continue to add capacity to and maintain our network, bringing new cities on-net and adding new service offerings to our product portfolio such as hosted IP telephony and hosted contact center.
Enhance our Business Through Opportunistic Expansion. We intend to continue to pursue the extension of our network in order to offer our growing suite of value-add service offerings to additional markets. The expansion of our network may occur through ongoing capital expenditures and other organic initiatives, additional service arrangements with other carriers and targeted acquisitions, which in the past have accelerated the growth of our enterprise and carrier data businesses. Given our desire to conserve cash in the current economic environment, we will demand higher returns in shorter time frames from any capital investment we make. We also intend to continue to analyze potential acquisition opportunities that would increase our scale and efficiency and/or expand our product sets and network reach.
Overview of Our Business
We are a global communications service provider, serving many of the world’s largest corporations and many other telecommunications carriers, providing a full range of IP and managed data and voice products and services. Our network delivers services to more than 690 cities in more than 60 countries and six continents around the world. Our flexible service options allow customers to focus on their own high priority business initiatives, leaving all or any part of their day-to-day communications management to Global Crossing.
The services we provide include data services, voice services and collaboration services. These services are built around a streamlined global service delivery model intended to provide outstanding customer service, including prompt and accurate provisioning and billing. Our uCommand® Web-based network management tool allows customers to securely monitor their voice and data services, create utilization reports, reroute traffic, order new services, create and track trouble tickets and perform online bill payment.
We group our services (including those obtained through the Impsat and Fibernet acquisitions) into solution sets that address key business requirements of our customers. Individual services may be associated with more than one solution set as appropriate to reflect the interconnected nature of the services we offer. There are eight such solutions sets:
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Global Crossing IP Solutions, which combine voice, data, video and multimedia onto a single IP-based platform.
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Global Crossing Voice Solutions, which represent traditional local and long-distance voice services with a transition path to VoIP.
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Global Crossing Data Transport Solutions, which transport customer data using various network designs and capacities.
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Global Crossing Collaboration Solutions, which provide audio, web, and video-based conferencing services.
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Global Crossing On Demand Solutions, which allow customers to procure IT infrastructure and flexible voice services as they need them.
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Global Crossing Continuity Solutions, which help identify mission-critical applications and develop backup solutions.
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Global Crossing Security Solutions, which help assess network security vulnerabilities and implement appropriate solutions.
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Global Crossing Consulting Solutions, which provide consulting services to support customers in the planning, implementation and operation of information and communication technology requirements.
Service Offerings
The following is a brief description of the key service offerings generally available in all of our operating segments, except as otherwise noted below.
Data Services
We offer a broad range of telecommunications services that provide data and network interconnectivity, capacity services and access services to enterprise and carrier customers. In the aggregate, data services accounted for approximately 59%, 55% and 40% of consolidated revenues in 2008, 2007 and 2006, respectively. Our global data services feature end-to-end service level agreements that guarantee service availability along our network as well as through local access circuits. The service level agreements support key areas such as end-to-end network availability, guaranteed time of installation and mean time to restore.
Our global data services include the following:
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IP Services: We offer a full portfolio of IP services to enterprises and carriers, including converged IP services which use a single access connection to manage and deliver voice, video, data and multimedia over a VPN. Our feature-rich IP VPN Service features multiple access options and service level agreements for latency, packet delivery, jitter and availability. IP VPN customers can also take advantage of our Application Performance Management services, offered through a strategic relationship with Fluke Networks® , which give customers visibility into the applications running on their networks, providing a single point of contact, customer care, billing and accountability. Our GCUK Segment provides a specialized UK Government IP VPN, which combines a managed connectivity platform, equipment, circuits and services to support the interconnection among U.K. Government Ethernet Local Area Networks (“LAN”). Our remote access services allow enterprises in each of our segments to extend the reach of their wide area networks for multiple users via remote access through global dial, WiFi and broadband Internet access while providing end point security policy management. Our IP services also include Dedicated Internet Access, which provides always-on, direct high-speed connectivity to the Internet at a wide range of speeds with connectivity to all worldwide domains and peering locations in Europe, the U.S., Latin America, and Asia. In addition, we recently introduced Content Delivery Network services, implementing a multi-vendor reselling approach to bring our customers a fast, efficient way to move content among their employees, customers and vendors.
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Transport Services: International Private Line Service and Wavelength Services provide secure point-to-point digital connectivity. These services are available between any two points of presence on our network, enabling customers to build private networks that carry business-critical applications at a wide range of speeds, including 2.5 gigabits per second (“Gbps”) and 10 Gbps. Ethernet IP Service is a premises-to-premises service that provides a simple, cost-effective alternative to long haul private line service, with pricing that is not distance sensitive. The GCUK Segment offers enhanced Ethernet services, including multi-point to multi-point Ethernet connectivity up to 10Gbps. Our Metropolitan Access Network Service brings our worldwide network capabilities to the customer’s premises in 55 major metropolitan markets across North America, Europe and South America.
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Collocation Services: Allow for the placement of customer equipment within certain Global Crossing points of presence (“PoPs”) in order to interconnect with our IP network or fiber-optic backbone. Collocation delivers improved provisioning speed, stability and security for critical network requirements.
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Managed Solutions: Our managed solutions include pre-sales engineering and customer premises equipment design, equipment procurement, provisioning and installation, and network monitoring and management. Managed Security Services include Firewall, Intrusion Detection, Intrusion Prevention and Network Security Scanning and Analysis, providing customers with the expertise and vigilance required to maintain the security of networks connected to the public Internet.
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Frame Relay & ATM Service: Frame Relay provides a reliable data transport network for connecting customer locations requiring partial mesh and hub-and-spoke network applications. Asynchronous Transfer Mode (“ATM”) service connects customer locations while providing multiple classes of service, supporting multiple data applications with diverse requirements for network transport, prioritization and performance.
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Global Crossing Carrier Rings: Specific metro networks in London and Frankfurt, connecting many of the most popular telehotel facilities and private operator premises, provide voice interconnections on a secure private Synchronous Digital Hierarchy (“SDH”) network. Global Crossing IP Carrier Ring is an extension of the London Carrier Ring, providing a high volume gateway between TDM traffic and IP traffic.
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Data Center Services: GC Impsat operates 15 data center facilities in Latin America that offer hosting services by integrating our broadband services with advanced value added solutions. These facilities offer a complete set of data center services, ranging from housing and hosting to more complex managed solutions, including disaster recovery, applications management, business continuity, and security services in order to manage mission critical applications. In 2008, Global Crossing opened a new data center in London. Work continues on a new data center in Amsterdam which we expect to open early 2009. These new data centers are equipped to offer hosting and communications services consistent with those offered in other regions.
Collaboration Services
We offer a full range of collaboration services, including the audio, video and Web conferencing services described below. Collaboration services accounted for approximately 6%, 6% and 7% of consolidated revenues in 2008, 2007 and 2006, respectively.
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Videoconferencing Services: Provides video over IP and integrated services digital network (“ISDN”) platforms, using multipoint bridging to connect multiple sites. Our iVideoconferencingSM offering sends ISDN calls onto our IP network, minimizing dependence on international ISDN lines for superior quality, reliability and cost savings. Enhanced options available with our videoconferencing services include scheduling, recording and hybrid meetings that combine our audio and video services.
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Audio Conferencing: Ready-Access®, our on-demand/reservationless audio conferencing service, provides toll free access in key business markets worldwide. Event Call provides highly reliable,
operator assisted, full-service conference calls. Participants can access this service by dialing in on either a toll or a toll-free number, or by being dialed out to by an operator. This service is suitable for as few as three or up to thousands of participants. Enhanced service options include PostView® conference playback, taping/transcription service, translation services and on-line participant lists.
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Web Conferencing: Ready-Access Web Meeting is fully integrated with Ready-Access® audio conferencing for on-demand collaboration, allowing customers to manage their calls on-line, change account options, share presentations with participants and record entire meetings, including visuals. eMeeting is a full-featured Web conferencing application that allows customers to collaborate and share documents, presentations, applications, data and feedback with polling and instant messaging features. Global Crossing Live Meeting uses technology licensed from Microsoft® to allow multiple attendees to participate in meetings using only their computer, a phone, and an Internet connection. We have integrated Ready-Access® as an audio conferencing component into Live Meeting.
Voice Services
Our global voice services include switched and dedicated outbound services, local services and inbound voice services for domestic and international long-distance traffic, toll-free enhanced routing services, and commercial managed voice services, all offered via traditional TDM or VoIP interconnections. During 2008, 2007 and 2006 we carried more than 27, 27 and 37 billion minutes of voice traffic over our global voice network. Voice services accounted for approximately 34%, 39% and 53% of our consolidated revenues in 2008, 2007 and 2006, respectively.
Our dedicated voice services feature end-to-end service level agreements that apply globally and guarantee service availability along our network as well as through local access circuits. The service level agreements support three key areas: end-to-end network availability, guaranteed time of installation and mean time to restore.
We offer a complete suite of VoIP services, replicating the full functionality of our traditional TDM portfolio. Our VoIP solutions are offered in a managed or non-managed environment, to meet the calling needs of our customers.
Our global voice services include the following:
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VoIP Services: We offer a complete VoIP services portfolio of inbound, outbound, and on-net calling solutions. Global Crossing is licensed to provide outbound calling services to the public switched telephone network (“PSTN”) in 30 countries, and can secure and provision direct dial inbound numbers in 21 countries. VoIP toll free service from those originating locations that adhere to the North American dialing plan is also available for call termination in the U.S. Key features include VoIP Ready Access®, which provides IP access to our reservation-less audio conferencing service; VoIP Community Peering, which provides true IP-to-IP call flows for VoIP Outbound calls terminating in Global Crossing VoIP Local Services™ local numbers; and VoIP Integrity Service, which enables customers to monitor and manage their VoIP applications through our suite of Application Performance Management tools.
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Traditional Voice Services: Our traditional voice services provide the ability to place in-country, long distance, and international calls via traditional TDM based connections. Switched access services are available in the U.S. and indirect access services are available in the U.K. We can support toll free applications in Europe and North America, and local service in 46 major metropolitan markets throughout the United States via our competitive local exchange carrier (“CLEC”) footprint.
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Hosted IP Telephony: Provides customers with IP telephony services that use software-enabled switching managed from the core of Global Crossing’s network. Hosted IP Telephony is the first product under our Unified Communications suite and provides a platform on which future products will deliver integrated unified communications, presence and collaboration services.
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Railnet (GCUK only): Railnet is a fully managed voice service provided to the U.K. Rail Industry over our core network and offers enhanced telephony, voicemail and reporting. Users are offered a range of handsets, headsets, and classes of service.
Sales and Principal Customers
We focus our sales and marketing efforts on target sectors within the enterprise and carrier markets that require significant telecommunications services. We have sales and sales support personnel in 24 countries. Our ROW, GCUK and GC Impsat segments target the following sectors: global multinational corporations, financial services, high-tech, healthcare/pharmaceuticals, transportation and distribution, research and education and systems integrators. Our ROW Segment also targets resellers, fixed and mobile telecom carriers, cable service providers, and ISPs.
Our ROW, GCUK and GC Impsat segments currently employ approximately 528, 136 and 298, respectively, sales and sales support employees worldwide for the following sales channels, each of which targets customers in North America, Europe, Latin America and the Asia/Pacific region:
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Global Enterprise Direct Sales Channel: Through the enterprise sales channel, we target mid-sized businesses, large multinational enterprises, higher educational institutions and governmental entities.
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Global Enterprise Indirect Sales Channel: Through the indirect enterprise sales channel, we target systems integrators and application service providers, using dedicated sales and support personnel in our Global Partner Program that recruit, train and provide on-going support for indirect partners who offer our products and services directly to their end user enterprise and government customers. At this time, we have more than 50 carriers in our Global Partner Program offering our Fast Track Services™ with whom we are offering solutions to the enterprise market.
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Carrier Data Sales Channel: Through the carrier data sales channel, we focus on local, national and global cable and wireless telecommunications carriers and on facilities and non-facilities based resellers.
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Carrier Voice Sales Channel: Through the carrier voice sales channel, we target carrier customers predominantly in the United States for the provision of domestic and international long distance voice services. However, we do not intend to actively market these services.
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Collaboration Sales Channel: This channel is used to offer audio, video and Web-based conferencing services to enterprises and both governmental and non-governmental organizations.
Although our ROW, GCUK and GC Impsat segments enjoy a large customer base, various agencies of the U.K. Government together represented approximately 47%, 47% and 53% of the GCUK Segment’s revenues in 2008, 2007 and 2006, respectively. See Item 1A, -Risk Factors, “Many of our most important government customers have the right to terminate their contracts with us if a change of control occurs or to reduce the services they purchase from us.”
Our Network
Our network consists of a series of assets and rights that allow us to operate service platforms enabling the delivery of various protocol-based data and voice services in major business centers throughout the world. We monitor and provide surveillance utilizing a suite of operational support systems to provision and maintain this network worldwide.
At the base of our network are subsea and terrestrial fiber-optic cables that connect and cross North America, South America, Europe and a portion of the Asia/Pacific region, which we either own or hold under long-term indefeasible rights of use (“IRUs”) from other carriers. These fiber-optic assets and related network transmission, switching and routing equipment (the “GC Fiber Network”) provide seamless, broadband connectivity to 30 countries through a combination of subsea cables, national and international networks and metropolitan networks.
In addition to the GC Fiber Network, we lease rights (such as wavelengths) on other carriers’ fiber-optic cables on a non-IRU basis. In certain cases, we own and operate the network transmission, switching and routing equipment that provides us with the ability to monitor and manage traffic over these leased facilities. We refer to the portions of our leased network over which we have this degree of control, together with the GC Fiber Network, as the “Core Network.”
The Core Network has approximately 800 PoPs in approximately 400 cities in 45 countries worldwide (“Regional PoPs”). These Regional PoPs house dense wave division multiplexing (“DWDM”) equipment that combines multiple colored wavelengths (or channels) on a single fiber and transports them as multiple signals across the network. In addition to the DWDM equipment, the Regional PoPs generally house add/drop multiplexer equipment that combines lower speed private line, data, Ethernet and voice traffic.
The North American network portion of the GC Fiber Network comprises approximately 18,000 route miles of fiber in the U.S. and Canada, most of which consists of IRUs in fibers purchased from other carriers. It has approximately 170 Regional PoPs, 20 integrated service platform sites, three subsea cable landing stations and five primary international voice gateway sites. The North American network carries voice, data and private line services over our IP, synchronous optical network (“SONET”), and ATM backbones, all traversing 2.5 and 10 Gbps DWDM systems. IP, SONET and ATM are methods of sending audio, video and computer data at the same time over one high-speed digital/optical line.
The European network portion of the GC Fiber Network (excluding the U.K.) consists of more than 14,000 route miles of fiber in the western region of the continent, most of which are contained in cable that we own. This network has approximately 70 Regional PoPs, six cable landing stations, and two international voice and three international data gateway sites. The European network carries voice, data and private line services over our IP, SDH (which is a transmission format similar to SONET) and ATM backbones, all traversing 2.5 and 10 Gbps DWDM transmission systems.
The GCUK portion of the GC Fiber Network comprises approximately 9,750 route miles of fiber and comes within 1.5 miles of more than two-thirds of Britain’s business infrastructure. This network has approximately 390 Regional PoPs and carries voice, data and private line services over IP and ATM/Frame Relay backbones, all traversing DWDM and SDH transmission systems. The U.K. network also encompasses nine major metro markets and 55 smaller towns and cities providing seamless services to the rest of the Global Crossing network. Less than 25% of the GCUK portion of the GC Fiber Network is held under leases which come up for renewal prior to 2011.
The subsea portion of the GC Fiber Network consists of six fiber-optic cable systems owned by us: Atlantic Crossing-1 (“AC-1”), Atlantic Crossing-2 (“AC-2”), Mid-Atlantic Crossing (“MAC”), South American Crossing (“SAC”), Pan American Crossing (“PAC”) and an approximately 340 route mile system connecting the U.K. and Ireland. SAC is a 12,000 route mile sub-sea system that includes a 1,500 mile terrestrial route connecting Argentina and Chile. SAC connects major markets throughout Latin America and is one of only two sub-sea systems currently in operation that circumnavigates the majority of South America. At approximately 4,600 route miles, MAC provides a strategic gateway between the Eastern Seaboard of the U.S. and our Latin America assets, a route that is experiencing acute demand growth and increasing capacity scarcity. PAC is integrated with a 2,300 mile terrestrial ring route (including associated backhaul) within Mexico, and we completed the extension of our PAC system to Costa Rica in 2008. In the aggregate, these systems span approximately 39,000 route miles and have approximately 30 landing points on three continents: North America, South America and Europe. These are all two or four fiber strand pair cables equipped with 10 Gbps DWDM transmission systems. AC-2 consists of two fiber strand pairs in a cable containing four fiber strand pairs that was co-built with Level 3 Communications, Inc. These systems include 14 Regional PoPs in the Latin America and Caribbean regions.
The GC Impsat Segment’s portion of the GC Fiber Network comprises a multiple strand 5,200 mile long-haul fiber network that connects more than 250 cities. The GC Impsat Segment also operates a metro network that covers more than 575 miles in 14 metro markets. The deployed facilities include 15 metropolitan area
networks in the largest cities of the region, long haul networks across Argentina, Brazil, Chile and Colombia, and leased submarine capacity to link South America to the United States. Together, the GC Impsat Segment’s long-haul and metro networks connect more than 450 customer locations. The GC Impsat Segment’s network carries voice, data and private line services over IP, SDH and ATM backbones, all traversing 2.5 and 10 Gbps DWDM transmission systems.
Our network assets in the Asia/Pacific region and those connecting the U.S. to this region include both IRUs and leased circuits on multiple subsea systems. We operate Regional PoPs in Hong Kong, Tokyo, Singapore and Sydney. Each of these PoPs supports Internet access, IP VPN, ATM and Frame Relay services, with Hong Kong also supporting VoIP services. Our Core Network includes IRUs and leases of trans-Pacific capacity on the PC-1 fiber-optic cable system, which is owned by Pacific Crossing Limited, a former subsidiary of the Company (“PCL”).
Our IP network consists of a service layer running on the Core Network and utilizes a single Autonomous System Number (“ASN”). We have 98 distinct IP hubs, 29 of which contain a VoIP presence and 28 of which have public or private peering interconnects. The single ASN implies a greater degree of integration than that which exists in a multiple ASN system. Having a global ASN allows us to deploy certain technologies, such as Multi-Protocol Label Switching (“MPLS”), more quickly and on a global basis. It also provides our international customers with a more global appearance in the global Internet routing table.
Our IP network utilizes a MPLS Juniper core with a mixture of Cisco, Juniper and Foundry devices at the edge of the network. The network is considered a Tier 1 backbone and is quality-of-service enabled, which allows different types of data to be assigned different priorities, such that, for example, voice can always have priority over IP VPN and Internet traffic. The network carries approximately 1,454 Gbps of total IP traffic, of which approximately 21 Gbps is IP VPN and 34 Gbps is voice traffic, averaging approximately one billion minutes of VoIP per month, or more than one-third of the total voice minutes. Our VoIP platform is fully compatible with our TDM network.
We operate our Core Network from four primary network operations centers. The Global Network Operations Center in London manages our subsea cable systems and our European and U.K. networks. The North America Network Operations Center, located in Southfield, Michigan, manages the global voice network and the North American transport network. The Global Data Services Network Operating Center, located in Phoenix, Arizona, manages the global IP and Frame Relay/ATM networks. The GC Impsat Segment’s network operations center located in Buenos Aires manages all of that segment’s networks. In addition, we have a small network operating center in Newark, New Jersey that provides redundant IP and ATM network management capability.
Together with those locations connected directly by the Core Network, through network to network interface agreements with other service providers, we deliver services to more than 690 cities in more than 60 countries and six continents around the world.
Network Security Agreement
On September 23, 2003, the U.S. Government granted approval under Section 721 of the Defense Production Act of the investment in GCL by Singapore Technologies Telemedia Pte Ltd (“ST Telemedia”) pursuant to the GC Debtors’ plan of reorganization. In order to obtain this approval, we entered into an agreement (the “Network Security Agreement”) with certain agencies of the U.S. Government to address the U.S. Government’s national security and law enforcement concerns. The Network Security Agreement is intended to ensure that our operations do not impair the U.S. Government’s ability (1) to carry out lawfully authorized electronic surveillance of communications that originate and/or terminate in the U.S.; (2) to prevent and detect foreign-based espionage and electronic surveillance of U.S. communications; and (3) to satisfy U.S. critical infrastructure protection requirements. Failure to comply with our obligations under the Network Security Agreement could result in the revocation of our telecommunications licenses by the Federal Communications Commission (“FCC”).
While our operations were generally consistent with the requirements of the Network Security Agreement prior to its execution, we have undertaken a number of operational improvements in order to ensure full implementation of, and compliance with, the Network Security Agreement. These improvements relate to information storage and management, traffic routing and management, physical, logical and network security arrangements, and personnel screening and training.
The Network Security Agreement affects our corporate governance as well. The GCL Board of Directors maintains a Security Committee comprised solely of directors who are U.S. citizens and who already possess or are eligible to possess a U.S. security clearance. These “Security Directors” must satisfy the independent director requirements of the New York Stock Exchange, regardless of whether any of GCL’s securities are listed on such exchange. At least half of the members of the GCL board nominated by ST Telemedia must be Security Directors. See Item 10, “Directors and Executive Officers of the Registrant,” below. A Security Director must be present at every meeting of the board of directors of GCL and of any of our U.S. subsidiaries unless such meeting in no way addresses or affects our obligations under the Network Security Agreement.
In connection with the acquisition of Impsat, the Network Security Agreement was amended on February 1, 2007 to clarify that the U.S. operations of Impsat are subject to the terms of the agreement. Such amendment also expanded the scope of the Network Security Agreement to include data hosting, a service that Impsat’s U.S. operations had been engaged in to a limited extent prior to the acquisition.
Our compliance with the Network Security Agreement is subject to annual audits by a neutral third-party auditor. We have completed four technical audits and did not report any areas of material non-compliance with the Network Security Agreement.
Competition
The telecommunications industry is intensely competitive and has undergone significant changes in recent years. Beginning in the late 1990s, a number of new competitors entered the market and commenced network construction activities, resulting in a significant expansion of worldwide network capacity. In 2001, it became clear that, at least in the short-term, actual demand was failing to keep pace with available supply, resulting in intense price pressure and, in many cases, an unsustainably low ratio of revenues to fixed costs. Market valuations of debt and equity securities of telecommunications companies, particularly new providers, decreased precipitously as the financial condition of many carriers deteriorated. During the ensuing five years, a number of these companies, including us, completed reorganizations, under bankruptcy and insolvency laws, with significant improvements to their financial condition or as newly formed entities that have acquired the assets of others at substantial discounts relative to their original cost.
At the same time, the regulatory environment has changed and continues to change rapidly. Although the Telecommunications Act of 1996 (the “1996 Act”) and actions by the FCC and state regulatory authorities have had the general effect of promoting competition in the provision of communications services in the U.S., these effects, together with new technologies, such as VoIP, and the importance of data services, have blurred the distinctions among traditional communications markets and have reduced barriers to entry in various lines of business. Efforts to liberalize markets around the world have produced similar results. In Europe, the new regulatory framework adopted by the European Commission attempts to treat all communications markets the same regardless of the technology used to serve the market. This “technologically neutral” approach to regulation has opened the market to new, non-traditional competitors. In Asia and Latin America, national regulatory authorities are considering policies that would exempt VoIP services from many of the traditional forms of regulation.
Many of our existing and potential competitors have significant competitive advantages, including greater market presence, name recognition and financial, technological and personnel resources, superior engineering and marketing capabilities, more ubiquitous network reach, and significantly larger installed customer bases.
Many of these advantages have increased through consolidations by large industry participants, despite certain regulatory changes or conditions implemented in response to such consolidation in order to mitigate the impact on non-dominant carriers such as ourselves.
On the other hand, as the competitive landscape continues to change with industry consolidation, we expect to experience greater demand from customers seeking network diversity, redundancy and a supplier that can meet their requirements worldwide. Our existing customer base, transport and hosting capabilities, and extensive network of suppliers globally, coupled with our systems, processes and strong customer service, position us as a viable provider of global services.
The following summarizes the competition we face in all of our operating segments by type of competitor.
Incumbent Carriers
In each market that we serve, we face, and expect to continue to face, significant competition from the incumbent carriers, which currently dominate the local telecommunications markets. In the U.S., these are primarily Verizon, Qwest Communications and AT&T Inc. We face competition both outside and, in some cases, inside the U.S. from foreign incumbents, including companies such as British Telecom (“BT”), France Telecom, Telecom Italia, Telefónica, Telstra, Telmex and Deutsche Telekom.
We compete with the incumbent carriers on the basis of product offerings, price, quality, customer service, capacity and reliability of network facilities, technology, route diversity and ease of ordering. Because our fiber-optic systems were installed relatively recently, compared with some of the networks of the incumbent carriers, our network’s architecture and technology may provide us with cost, capacity, and service quality advantages over some existing incumbent carrier networks. However, the incumbent carriers may have long-standing relationships with their customers and provide those customers with various transmission and switching services that we, in many cases, do not currently offer. In their own primary markets, the incumbents have the additional advantages of network concentration, control over local exchange assets, significant existing customer bases and, in the case of many foreign incumbents in their home markets, regulatory protection from competition.
Other Voice Service Competitors
In the U.S., the local incumbents dominate the market for local voice services and are among the strongest competitors in the long distance voice services market. In addition, we face, and expect to continue to face, competition for local and long distance voice telecommunications services from dozens of other companies that compete in the long distance marketplace in the U.S. Outside the U.S., the local incumbents dominate the markets for local and long distance voice services.
Other Data Service Competitors
In addition to the incumbents, we face, and expect to continue to face, competition for Internet access and other data services from telecommunications companies such as Cable and Wireless plc, Colt Telecom Group plc, Orange Business Services (formerly Equant N.V., which is now a unit of France Telecom), Infonet (a unit of BT), XO Communications and Level 3 and from online service providers, DSL service providers, ISPs and Web hosting providers.
Other Conferencing Competitors
In addition to competitors that provide voice and data services generally, our conferencing business competes with non-carriers that specialize in providing audio, video and Web conferencing services, such as InterCall, Inc. (a division of West Corporation) and Premiere Conferencing.
Regulatory Overview
The construction and operation of our facilities and our provision of telecommunications services subject us to regulation in many countries throughout the world. Such regulation requires us to obtain a variety of permits, licenses, and authorizations in the ordinary course of business. In addition to telecommunications licenses and authorizations, we may be required to obtain environmental, construction, zoning and other permits, licenses, and authorizations, as well as rights of way (or their equivalents) necessary for our fiber-optic cable lines to pass through property owned by others. The construction and operation of our facilities and our provision of telecommunications services may subject us to regulation at the national, state, provincial, and local levels. While we believe that we have received all required authorizations to offer our services in the countries in which we operate, the conditions governing our service offerings remain subject to future legislation or regulation that could materially affect our business and operations.
Below is a summary of the regulatory environment in the principal countries in which we operate, grouped by region. Our GCUK Segment and GC Impsat Segment are subject to the regulatory regimes in the U.K. and Latin America, respectively. The ROW Segment is subject to regulation primarily in North America, mainland Europe and Asia. In addition, the ROW Segment is subject to regulation in the U.K. and Latin America to the extent of its limited operations in those jurisdictions.
North American Regulation
Regulation in the U.S.
In the U.S., our facilities and services are subject to regulation at both the federal and state level. The Communications Act of 1934, as amended, is the primary legislation governing our provision of interstate and international services. State communications and/or public utility statutes govern our intrastate operations.
U.S. Federal Regulation
The FCC exercises jurisdiction over our interstate and international services and, to some extent, the construction and operation of our facilities. We have authority from the FCC for the installation, acquisition and operation of our U.S. network and for the provision of international facilities-based services.
Regulation of the Cost of Access
The FCC and the states regulate the rates that incumbent local exchange carriers (“ILECs”) and CLECs (together with ILECs, are referred to herein as “LECs”) charge us for access to local exchanges, which is our single largest expense. Such regulations also apply to us in those states where we operate as a CLEC. Access charges that LECs impose upon us consist of both usage-sensitive switched access charges and flat-rated transport and special access charges. With respect to their access services, the FCC regulates ILECs as dominant carriers. We also may enter into carrier-to-carrier contracts with other, principally long-distance, carriers to transport and terminate our traffic. These latter arrangements are typically not subject to tariff regulation.
ILEC Switched Access Charges
The LECs assess usage-sensitive switched access charges for the use of their switched facilities to originate and terminate switched traffic. In 2000, the FCC established a regime to govern the provision of switched access services by the ILECs over a five-year period (the “CALLS Plan”). Under the CALLS Plan, usage-sensitive rates were decreased over time in favor of increases in end-user charges and a transitional preferred interexchange carrier charge. The LECs’ preferred interexchange carrier charges have decreased over time and most of the largest ILECs have ceased assessing this charge, although smaller ILECs and some CLECs continue to assess it. The CALLS Plan expired in 2005 and the FCC is considering proposals to govern access charges prospectively (see “-Intercarrier Compensation Reform”, below).
ILEC Special Access Charges
The FCC currently regulates ILEC flat-rate transport and special access charges under the terms of its Special Access Pricing Flexibility Order, adopted in 1999. Under the Special Access Pricing Flexibility Order, ILECs are afforded two different levels of pricing flexibility depending upon the extent of deployment of alternative facilities within particular Metropolitan Statistical Areas (“MSAs”). The ILECs have been granted Type I (or the more limited form of pricing flexibility) in most MSAs in the country and have been granted Type II pricing flexibility in a lesser number of MSAs.
Prior to the 2006 FCC-approved merger of AT&T and BellSouth, AT&T petitioned the U.S. Court of Appeals for the District of Columbia Circuit to compel the FCC to consider a proposal to tighten its regulation of ILEC special access services. Although the Court declined to grant the petition, in January 2005 the FCC released a Notice of Proposed Rulemaking to consider how it should regulate ILEC special access services prospectively and whether it should tighten its regulation of special access services. This proceeding is still ongoing and we cannot predict its outcome.
CLEC Access Charges
Unlike the ILECs, the FCC regulates the CLECs as non-dominant carriers. The FCC permits a CLEC to file tariffs for its interstate access services so long as the CLEC’s rates do not exceed the rates of the ILEC that provides service in the territory that the CLEC services. However, a CLEC may charge the full benchmark rate even where it only provides a portion of the access service involved, i.e., in the case of jointly-provided access services. The FCC also permits CLECs to aggregate the traffic of other carriers, e.g., toll-free calls originating from wireless subscribers, although, in this circumstance, the CLEC is only permitted to charge for those portions of the access service it actually provides.
Wireless Access Charges
The FCC has adopted a mandatory detariffing regime for access services that wireless carriers wish to provide. Wireless carriers may not file tariffs for their putative access services and must, instead, enter into voluntary contracts in order to assess access charges upon potential access customers.
Regulation of VoIP Traffic
The FCC has addressed the subject of the jurisdictional nature of access charges and certain duties applicable to VoIP traffic in response to a number of petitions for declaratory ruling (or comparable petitions). The FCC has also issued a Notice of Proposed Rulemaking seeking comment on how it should regulate VoIP traffic prospectively.
In February 2004, the FCC concluded that Pulver.com’s “Free World Dialup” service, which does not make use of the PSTN, is an unregulated information service.
In April 2004, the FCC concluded that AT&T’s “phone-to-phone IP” service, which makes use of the PSTN and inserts an IP segment into the call path but as to which there is no net protocol conversion, is not an information service but is rather a telecommunications service, to which access charges are applicable, without regard to whether one or more service providers are involved.
In November 2004, the FCC granted a petition filed by Vonage Holdings and declared that VoIP traffic that qualifies as an “enhanced” or “information” service (as specifically described in the Vonage petition) was jurisdictionally interstate and that state regulation of such traffic is preempted by federal law (the “Vonage Order”). The exact scope of the FCC’s decision is unclear, although at a minimum, it appears to cover traffic on which a net protocol conversion occurs, measured on an end-to-end basis. The Vonage Order was upheld on appeal.
In June 2005, the FCC concluded that VoIP service providers must support enhanced 911 emergency services or cease marketing VoIP services in areas where they cannot be supported. In September 2005, the FCC also concluded that VoIP service providers must comply with the Communications Assistance for Law Enforcement Act (“CALEA”) and configure their network and services to support law enforcement activity in the area of wiretaps and call records. The FCC ruling applies to all VoIP services that can both receive calls from and terminate calls to the public switched telephone network. The U.S. Court of Appeals for the District of Columbia Circuit upheld the FCC’s actions in both cases. We will incur costs to be compliant with the rulings, but the exact nature and scope of the costs will remain unclear until the FCC issues further guidance regarding standards and compliance. In June 2006, the FCC issued an order holding that interconnected VoIP providers and for an interim two quarter period, their underlying carriers, must contribute to the federal universal service fund (the “FUSF”). The FCC has also recently held that its customer proprietary network information (“CPNI”) rules apply to VoIP carriers. In addition, the FCC has now extended to VoIP providers obligations to provide local number portability, make their services accessible to persons with disabilities, and report certain data relating to broadband.
Local Reciprocal Compensation
Local telephone companies that originate traffic that is terminated on the networks of other local carriers typically compensate the other local carriers for terminating that traffic. The FCC has established the general framework governing the level of such compensation, although the specific rates are established by the states. These rates vary from “bill-and-keep” to rates that approximate those for switched access. As is the case with access charges, the local reciprocal compensation rates are being examined in the FCC’s Intercarrier Compensation proceeding (see “-Intercarrier Compensation Reform” below).
Intrastate Access Charges
Intrastate access charges that LECs assess upon us (or that our CLECs are permitted to charge) are regulated by the states. Although certain LECs have elected to have intrastate access rates mirror interstate access rates, intrastate access rates are typically higher (often, significantly so) than interstate access rates. Intrastate access charges are also being examined in the FCC’s Intercarrier Compensation proceeding. Intrastate access charges are typically significantly higher than interstate access charges or local reciprocal charges. We have been (and are) involved in a number of disputes with LECs regarding the jurisdictional nature of access traffic.
Intercarrier Compensation Reform
As described above, the current regime governing intercarrier compensation consists of a patchwork of different and inconsistent regulation depending upon such factors as the provider, jurisdiction and nature of traffic. To address this inconsistent pattern of regulation, in 2001 the FCC issued a Notice of Proposed Rulemaking to consider how to unify the regulation of intercarrier compensation. The FCC received numerous comments on the subject. On March 3, 2005 and again on July 25, 2006, the FCC requested further comment, including both comprehensive proposals and other measures to reform the current intercarrier compensation schemes. On May 5, 2008, during oral argument concerning a mandamus petition filed by Core Communications, Inc. against the FCC, the FCC advised the U.S. Court of Appeals for the D.C. Circuit of the FCC Chairman’s intent to attempt to achieve broad-based intercarrier compensation reform within the next six months. On November 5, 2008, the FCC issued a narrow decision addressing only the issue on remand concerning compensation for traffic destined for Internet service providers. FCC efforts to address the broader issues of intercarrier compensation reform, however, did not succeed and it is not clear when or if the FCC will take the broader issue up again.
Universal Service
Both the FCC and approximately 23 states administer “universal service” funds to provide for affordable local telephone service in rural and high-cost areas and to fund other social programs, such as Internet access to schools and libraries. In 2008, we expensed approximately $39 million related to payments to such funds. There are numerous regulatory and legislative efforts to reform universal service funding requirements and we cannot predict the outcome of these efforts.
The Universal Service Administrative Company concluded its audit of Global Crossing Bandwidth, Inc.’s USF payment for calendar year 2004 and concluded that our subsidiary owes an additional $5.6 million. We have appealed the audit findings to the FCC and cannot predict the outcome of this appeal.
On April 9, 2008, the FCC issued a Notice of Apparent Liability (“NAL”) proposing a forfeiture of approximately $10.5 million based on certain of our subsidiaries’ apparent failures to make timely and complete contributions to the federal Universal Service Fund and Telecommunications Relay Service Fund. Since that time, we have been engaged in discussions with FCC staff regarding a potential consent decree that would result in cancellation of the NAL, adoption of a voluntary compliance plan, and payment of a voluntary contribution to the United States Treasury. See Item 3, “Legal Proceedings-Universal Service Notice of Apparent Liability” for more information regarding this matter.
Local Competition
The 1996 Act substantially revised the Communications Act of 1934, as amended, in large part to address the subject of local competition. The 1996 Act delegated to the FCC and to the states significant discretion to implement the local competition provisions of the statute and imposed interconnection obligations on LECs, including that they provide unbundled network elements. The regime governing the framework for local competition has changed since the 1996 Act was enacted. The FCC’s February 2003 Triennial Review Order, which revised the unbundling rules, was vacated and remanded in part by the U.S. Court of Appeals for the District of Columbia Circuit in March 2004. In response, in December 2004 the FCC adopted its Triennial Review Remand Order which significantly restricts the types of facilities that ILECs must unbundle and provide to their local competitors and the circumstances under which those facilities must be unbundled and provided. The prices of the local facilities that we obtain from ILECs will increase as resale or commercial arrangements are substituted for the unbundled network element-platform services that ILECs no longer need to make available to competitors and as special access is substituted for the local loop and transport elements that are no longer subject to mandatory unbundling. On June 16, 2006, the U.S. Court of Appeals for the District of Columbia Circuit upheld the Triennial Review Remand Order. We cannot predict the outcome of any subsequent FCC proceedings.
U.S. State Regulation
State regulatory commissions retain jurisdiction over our facilities and services to the extent they are used to provide intrastate communications. We are subject to direct state regulation in most, if not all, states in which we operate. Many states require certification before a company can provide intrastate communications services. We are certified in all states where we have operations and certification is required.
Most states require us to file tariffs or price lists setting forth the terms, conditions and prices for services that are classified as intrastate. In some states, our tariff can list a range of prices for particular services. In other states, prices can be set on an individual customer basis. Several states where we do business, however, do not require us to file tariffs. We are not subject to price cap or to rate of return regulation in any state in which we currently provide service.
U.S. Local Government Regulation
In certain locations, we must obtain local franchises, licenses or other operating rights and street opening and construction permits to install, expand and operate our fiber-optic systems in the public right-of-way. In some of the areas where we provide network services, our subsidiaries pay license or franchise fees based on a percentage of gross revenues or on a per linear foot basis.
Regulation in Canada
Long distance telecommunications services in Canada are regulated by the Canadian Radio-Television and Telecommunications Commission (the “CRTC”). Resellers now have interconnection rights and may provide international services to the U.S. by reselling the services provided by the regional telephone companies and by the former monopoly international carrier, Teleglobe Canada. Under current law, the provision of Canadian domestic and international transmission facilities based services remains restricted to carriers majority owned by Canadians, although non-Canadian carriers such as ourselves may own international subsea cables landing in Canada.
Competition is permitted in other segments of the Canadian telecommunications market, including the local telecommunications services market, although transmission facilities based CLECs are also subject to the above-described majority Canadian ownership requirements. CLECs may interconnect their networks with those of the ILECs and have access to certain ILEC services on an unbundled basis and, in certain cases, subject to mandatory pricing. In addition, transmission facilities based carriers (but not resellers) are entitled to collocate equipment in ILEC central offices pursuant to terms and conditions of tariffs and intercarrier agreements. The CRTC recently adopted a new policy to deregulate wholesale services over the next five years. It is unclear at this time what, if any, impact this will have on our operations.
Regulation in Mexico
The Mexican telecommunications industry is primarily regulated by the Ministry of Communications and Transportation (“SCT”) and the Federal Telecommunications Commission (“Cofetel”), an agency within the SCT. Several laws and regulations govern the provision of telecommunications services in Mexico, including the Law of General Means of Communication, the Federal Telecommunications Law (and its 2006 amendment), and the Telecommunications Regulations.
Market liberalization began in Mexico with the 1990 privatization of the incumbent telecommunications operator, now known as Teléfonos de México, SAB de CV (“Telmex”). The Mexican market for fixed line domestic and international long distance services opened to competition beginning in 1996, although Telmex remains the leading provider of fixed local and long distance telephone services in Mexico. On January 23, 2008, the Federal Competition Commission initiated an investigation to examine the existence of market power in four segments of the telecommunications market dominated by Telmex.
Under the Federal Telecommunications Law and the Telecommunications Regulations, a provider of public telecommunications services must operate under a concession granted by the SCT, and the provision of certain other services likewise requires the issuance of a permit or other approval by the SCT. Our operating entity in Mexico has obtained concessions, permits and authorizations from the Mexican authorities to support its services.
European Regulation
In connection with the construction and operation of our European network, we obtained telecommunications licenses in all countries where authorization was required for us to construct and operate facilities or provide network services, including voice telephony.
Our activities in Europe are subject to regulation by the European Union (“EU”) and national regulatory authorities. The level of regulation and the regulatory obligations and rights that attach to us as an authorized
operator in each country vary. In all Member States of the EU, we, as a competitive entrant, are currently considered to lack significant market power in the provision of bandwidth and call origination services, and consequently we are generally subjected to less intrusive regulation than providers that are deemed to possess such power, who are generally incumbents in the countries concerned.
In April 2002, the then 15 EU Member States agreed to introduce a harmonized set of telecommunications regulations by July 25, 2003, in accordance with a framework as set out in Directive 2002/21/EC and a package of related Directives.
Under the Framework Directive (2002/21/EC), the EU has adopted a revised policy for dealing with the definition and regulation of significant market power. Regulatory remedies are being introduced in due course following a series of national reviews of telecommunications markets defined in accordance with Article 7 of the Framework Directive and Recommendations 2007/879/EC and C(2008)5925. Where a national regulator identifies market dominance that is considered susceptible to ex ante remedies then it is required to impose conditions on the dominant party/ies in order to ensure fair competition. At this time, a number of markets have been reviewed by regulators and ex ante conditions imposed which, in general, facilitate market entry and/or reduce the cost of access to incumbents’ networks. However, a number of jurisdictions have yet to complete their reviews, hence it is not possible to accurately predict what the various remedies may ultimately entail, and their consequential impact on our business.
Also included in the package of Directives are measures under the Authorisation Directive (2002/20/EC) (the “Authorisation Directive”) to remove the necessity for telecommunications network operators and service providers to obtain individual licenses and/or authorizations, save for use of scarce resources such as numbering addresses and radio spectrum. In those countries where the national telecommunications laws have been amended in accordance with the obligations under the Authorisation Directive, our licenses have been revoked in favor of a series of statutory rights to own, build and operate networks and to provide services, including voice.
The size of the EU increased on May 1, 2004 with the accession of ten additional countries and on January 1, 2007 with the accession of a further two countries. In principle, the EU Regulatory Framework and the package of related Directives apply in such countries with effect from their accession date. Accession negotiations between the EU and several additional candidate countries are presently understood to be underway, signaling a possible further enlargement of the EU at some time in the future.
At the present time, not all of the current 27 EU Member States have adopted or correctly adopted all the changes to their national laws to implement the EU’s telecommunications-related Directives. On January 31, 2008, the European Commission published a memorandum indicating that, in total, since the EU telecoms rules entered into force, the Commission has opened proceedings under Article 226 of the EC Treaty for some 95 cases of failure to correctly implement the rules. Since that date, six further cases have been opened by the Commission. These infringement proceedings concern all 27 Member States. Many of the proceedings opened have now been closed while a number of cases are pending before the European Court of Justice.
In June 2006, the Commission published new guidelines concerning the way in which Articles 81 and 82 of the EU Treaty (dealing with the anti-trust concept of abuse of dominance) should be interpreted by regulators.
On November 13, 2007, the European Commission published proposals for a revision to the current regulatory framework applying to the sector. The proposals consist of the following:
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a draft directive amending the Universal Service Directive and the Directive on Privacy in the electronic communications sector (the “citizens rights” directive);
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a draft directive amending the Framework Directive, the Access Directive, and the Authorization Directive (the “better regulation” directive); and
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a draft regulation establishing a European Electronic Communications Market Authority.
These proposals are at an advanced stage, and are being considered by the European Parliament and Council of Ministers. The Commission’s proposals have been subject to change since their publication and various stakeholders, including us, have made representations during the process, both at the EU and national levels. These new regulatory measures will not become effective until such time as may be ultimately agreed by the EU.
In the United Kingdom, The Office of Communications (“OFCOM”) has indicated that its policy focus is intended to support the growth of greater competition, innovation and investment certainty. A Strategic Review of the telecoms sector was completed in September 2005 and as a result of this initiative, the incumbent BT has established a separate “access services division” named “Openreach,” which controls and operates the physical network assets making up BT’s local access and backhaul networks. BT has undertaken to supply a range of wholesale products to all communications providers (including its own downstream operations) on the same timescales, terms and conditions (including price) and by the same systems and processes and, although this process has not yet been fully completed, some significant progress has been made towards this end. BT’s compliance with its obligations arising from the 2005 Strategic Review are regularly measured by both OFCOM and BT’s internal Equivalence of Access Board (“EAB”). On December 19 2008, OFCOM published the most recent in a series of 18 detailed revisions to the specific undertakings that were entered into by BT in 2005 to give effect to BT’s functional separation and we have engaged with OFCOM throughout this process
OFCOM has also recognized the need to create a new regulated interconnection model as the U.K telecommunications market undergoes a move away from the traditional switched-circuit fixed line networks towards next-generation networks and services based on IP. Work on the development of these new models is ongoing and OFCOM has indicated in its draft Annual Plan for 2009/10 that it intends to develop its policy in this area during the coming year. The effect on us of such an action cannot be accurately predicted.
Asian Regulation
The status of liberalization of the telecommunications regulatory regimes of the Asian countries in which we operate or intend to operate varies. Some countries allow full competition in the telecommunications sector, while others limit competition for most services. Similarly, some countries in Asia maintain foreign ownership restrictions which limit the amount of foreign direct investment and require foreign companies to seek local joint venture partners.
Most of the countries in the region have committed to liberalizing their telecommunications regimes and opening their telecommunications markets to foreign investment as part of the World Trade Organization Agreement on Basic Telecommunications Services, which came into force in February 1998. Additionally, the adoption of the Free Trade Agreement between the U.S. and Singapore in January 2003 established a new standard of liberalization based on bilateral negotiations with the U.S. We cannot predict what effect, if any, this agreement will have on other countries in the region or whether the U.S. will pursue similar agreements with those countries. We also cannot be certain whether this liberalizing trend will continue or accurately predict the pace and scope of liberalization. It is possible that one or more of the countries in which we operate or intend to operate will slow or halt the liberalization of its telecommunications markets. The effect on us of such an action cannot be accurately predicted.
The telecommunications regulatory regimes of many Asian countries are in the process of development. Many issues, such as regulation of incumbent providers, interconnection, unbundling of local loops, resale of telecommunications services, offering of voice services and pricing have not been addressed fully or at all. We cannot accurately predict whether or how these issues will be resolved and their impact on our operations in Asia.
Latin American Regulation
Our MAC, PAC and SAC fiber-optic cable systems connect to Latin America. In connection with the construction of these systems, we have obtained cable landing licenses and/or telecommunications licenses in Argentina, Brazil, Chile, Mexico, Panama, Peru, Uruguay, Venezuela and the U.S. We expect to obtain
additional telecommunications authorizations in Latin America in the ordinary course of business, should they be required as a consequence of further network growth and expansion of the regional service portfolio.
The status of liberalization of the telecommunications markets of Latin America varies. All of the countries in which we currently operate are members of the World Trade Organization and most have committed to liberalizing their telecommunications markets and lifting foreign ownership restrictions. Some countries now permit competition for all telecommunications facilities and services, while others allow competition for some facilities and services, but restrict competition for other services. Some countries in which we operate currently impose limits on foreign ownership of telecommunications carriers.
The telecommunications regulatory regimes of many Latin American countries are in the process of development. Many issues, such as regulation of incumbent providers, interconnection, unbundling of local loops, resale of telecommunications services, and pricing have not been addressed fully or at all. We cannot accurately predict whether or how these issues will be resolved and their impact on our operations in Latin America.
Below is a summary of certain of the regulations currently applicable to our Latin American operations, by country. The regulations apply equally to all of Global Crossing’s operating entities within the region. We are in the process of consolidating our “legacy” operating entities in the Latin American region (i.e., those that pre-dated the Impsat acquisition), which are included in our ROW Segment, with the Impsat entities comprising the GC Impsat Segment.
Argentina
The Argentine telecommunications sector is subject to comprehensive regulation by the Comisión Nacional de Comunicaciones (“National Communications Commission”) and the Secretaría de Comunicaciones (“Secretary of Communications”). The Argentine telecommunications market was opened to competition on November 9, 2000.
Following market liberalization, the government has issued a series of regulations to effectuate the transition to competition in telecommunications, including Decree No. 764/00, which establishes rules for the granting of licenses for telecommunications services, interconnection, and the management and control of the radioelectric spectrum. The Decree also established new rules and regulations to promote access to telecommunications services for customers located in high-cost access or maintenance areas or with physical limitations or special social needs. These rules and regulations, effective January 1, 2001, establish that the provision of these services be financed by all telecommunications providers (including us) through a Universal Service Fund, backed by the payment of 1% of each provider’s total revenues for telecommunications services.
During the last 5 years, telecommunications companies in Argentina have been subject to increased taxes and fees from both provincial and municipal authorities. While we have challenged the constitutionality of some of these claims, there is no certainty that we will prevail on such challenges. Furthermore, the cost of defending against these claims could be high.
Colombia
The telecommunications industry in Colombia is subject to regulation by the Colombian Ministry of Communications. Since 1991, the Ministry of Communications has pursued a policy of liberalization and has encouraged joint ventures between public and private telecommunications companies to provide new and improved telecommunications services.
Brazil
Telecommunications services in Brazil are regulated by the Ministry of Communications, pursuant to Law No. 9,472 of July 16, 1997 (the “General Telecommunications Law”). This law authorized the creation of the Agencia Nacional de Telecomunicações (the “National Telecommunications Agency,” known as “ANATEL”), an independent agency subordinated to the Ministry of Communications that regulates and supervises all aspects of telecommunications services, including the granting of licenses under the General Telecommunications Law. ANATEL enforces the legislative determinations of the Ministry of Communications. ANATEL has generally pursued a policy of market liberalization and supported a competitive telecommunications environment.
Ecuador
The telecommunications industry in Ecuador is regulated by the Consejo Nacional de Telecomunicaciones (the “National Telecommunications Council”) and the Secretaria Nacional de Telecomunicaciones (the “National Telecommunications Secretary,” known as “SENATEL”) and is under the control and supervision of the Superintendencia de Telecomunicaciones (“Superintendant of Telecommunications”).
Peru
The telecommunications industry in Peru is regulated by the Supervisory Authority for Private Investment in Telecommunications (“OSIPTEL”) and the Ministry of Transportation and Communications (“MTC”). OSIPTEL is an independent regulatory body attached to the Office of the President of the Council of Ministers.
Under Peruvian law, the provision of public telecommunications services requires a concession. The functions related to the issuance of concessions and market access registration and the assignment of the radio spectrum for public telecommunications services are managed by the MTC’s General Directorate of Telecommunications. Since market liberalization became effective in August 1998, there has been no limitation on the issue of concessions, except for services subject to natural limitations on grounds of scarce resources, as in the case of the radio spectrum.
Venezuela
The Venezuelan telecommunications industry is regulated by the Comisión Nacional de Telecomunicaciones (“CONATEL”), which is ascribed to and under the purview of the Ministry of Infrastructure. Venezuela opened its telecommunications market to competition on November 28, 2000. In 2007, the Venezuelan government nationalized the incumbent telecommunications operator, Compañia Anónima Nacional Teléfonos de Venezuela (“CANTV”). To date, the government has not indicated its intent to expand nationalization within the telecommunications sector.
The legacy Global Crossing operating entity in Venezuela has been amalgamated with IMPSAT Venezuela, the operating entity within the GC Impsat Segment. As required by the Venezuelan Telecommunications Law of 2000, IMPSAT Venezuela has timely filed for the administrative title transformation of all of its concessions and licenses. The administrative title transformation is in process and remains pending due to delays attributable to CONATEL. Such delays affect most market operators and has thus far had no impact on IMPSAT Venezuela’s operations. Although three licenses held by IMPSAT Venezuela have expired, CONATEL has authorized it to continue operations while the licenses are transformed.
Chile
The telecommunications industry in Chile is regulated by the Undersecretariate of Telecommunications, an institution subordinated to the Ministry of Transportation and Telecommunications.
In 1978, a new National Policy on Telecommunications was issued which, in its most relevant aspects, called for the development of telecommunications services to be conducted by private institutions through concessions, authorizations, permits and licenses granted by the government. The policy, nonetheless, endorsed a series of regulations aimed at establishing increased technical control over such investments and conferring certain discretionary powers on the government. The policy was formalized through the General Law on Telecommunications approved in 1982, in which free, non-discriminatory access was granted to private firms in the development of the nation’s telecommunications services. This law established responsibilities with respect to telecommunication services, compulsory interconnection between public service licensees and tools for setting telecommunication service tariffs where existing market conditions were deemed insufficient to guarantee a free tariff system.
Chile amended its General Law on Telecommunications in 1985 to provide that concessions and permits may be granted without limit with respect to the quantity and type of service and geographic location. The law guarantees interconnections among telecommunications service concessionaires. Chile defines value added services as supplementary services. It is not necessary to have a telecommunications service license to offer supplementary services, although those who provide additional services must comply with the technical standards established by the Department of Telecommunications and obtain an authorization.
Panama
The telecommunications industry in Panama is regulated by Ente Regulador de los Servicios Públicos, an independent regulatory body. General Law 26 and General Law 31 established the regulatory framework for telecommunications regulation. Liberalization of the market has been on-going, and the incumbent’s official monopoly ended in 2004.
ITEM 1A.
ITEM 1A. RISK FACTORS
Cautionary Factors That May Affect Future Results
(Cautionary Statements Under Section 21E of the Securities Exchange Act of 1934)
Forward-Looking Statements
This annual report on Form 10-K contains certain “forward-looking statements,” as such term is defined in Section 21E of the Exchange Act. These statements set forth anticipated results based on management’s plans and assumptions. From time to time, we also provide forward-looking statements in other materials we release to the public as well as oral forward-looking statements. Such statements give our current expectations or forecasts of future events; they do not relate strictly to historical or current facts. We have attempted to identify such statements by using words such as “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe,” “will,” “could” and similar expressions in connection with any discussion of future events or future operating or financial performance or strategies. Such forward-looking statements include, but are not limited to, statements regarding:
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our services, including the development and deployment of data products and services based on IP and other technologies and strategies to expand our targeted customer base and broaden our sales channels and the opening and expansion of our data center and collocation services;
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the operation of our network, including with respect to the development of IP-based services and data center and collocation services;
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our liquidity and financial resources, including anticipated capital expenditures, funding of capital expenditures, anticipated levels of indebtedness, and the ability to raise capital through financing activities, including capital leases and similar financings;
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trends related to and management’s expectations regarding results of operations, required capital expenditures, integration of acquired businesses, revenues from existing and new lines of business and sales channels, Adjusted Cash EBITDA (as defined in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”), order volumes and cash flows, including but not limited to those statements set forth in Item 7; and
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sales efforts, expenses, interest rates, foreign exchange rates, and the outcome of contingencies, such as legal proceedings.
We cannot guarantee that any forward-looking statement will be realized. Achievement of future results is subject to risks, uncertainties and potentially inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from past results and those anticipated, estimated or projected. Investors should bear this in mind as they consider forward-looking statements.
We undertake no obligation to update forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our quarterly reports on Form 10-Q and current reports on Form 8-K. Also note that we provide the following cautionary discussion of risks and uncertainties related to our businesses. These are factors that we believe, individually or in the aggregate, could cause our actual results to differ materially from expected and historical results. We note these factors for investors as permitted by Section 21E of the Exchange Act. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties.
Our forward-looking statements are subject to a variety of factors that could cause actual results to differ significantly from current beliefs and expectations. In addition to the risk factors identified under the captions below, the operation and results of our business are subject to risks and uncertainties identified elsewhere in this
annual report on Form 10-K as well as general risks and uncertainties such as those relating to general economic conditions and demand for telecommunications services.
Risks Related to Liquidity and Financial Resources
We face a number of risks related to current global economic conditions and the severe tightening in the global credit markets.
Recently, the global economy and capital and credit markets have been experiencing exceptional turmoil and upheaval. Many major economies entered significant recessions in 2008 which continue into 2009. Ongoing concerns about the systemic impact of potential long-term and wide-spread recession, volatile energy costs, geopolitical issues, the availability, cost and terms credit, consumer and business confidence, substantially increased unemployment and the crisis in the global housing and mortgage markets have contributed to increased market volatility and diminished expectations for both established and emerging economies, including those in which we operate. In the second half of 2008, added concerns fueled by government interventions in financial systems led to increased market uncertainty and instability in both U.S. and international capital and credit markets. These conditions have contributed to economic uncertainty of unprecedented levels. The availability, cost and terms of credit have also been and may continue to be adversely affected by illiquid markets and wider credit spreads. Concern about the stability of the markets generally and the strength of counterparties specifically has led many lenders and institutional investors to reduce, and in many cases cease to provide, credit to businesses and consumers. These factors have led to a substantial and continuing decrease in spending by businesses and consumers, and a corresponding decrease in global infrastructure spending. Continued turbulence in the U.S. and international markets and economies and prolonged declines in business and consumer spending may adversely affect our liquidity and financial condition, and the liquidity and financial condition of our customers, including our ability to refinance maturing debt instruments and to access the capital markets and obtain capital lease financing to meet liquidity needs. This financial crisis may have an impact on our business and financial condition in the following ways as well as others that we currently cannot predict.
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Potential risk in refinancing outstanding debts: Although none of our major debt instruments matures until 2011, if the current lack of credit in the global capital markets were to continue, our ability to refinance our existing indebtedness when due could be severely constrained. Any such refinancing could require significantly more expensive interest rates and covenants that restrict our operations to a significantly greater extent.
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Negative impacts from increased financial pressures on customers and resellers: Uncertainty about current and future global economic conditions and credit markets may cause consumers, business and governments to defer purchases in response to tighter credit, decreased availability of cash and credit and declining business and consumer confidence, and may affect the solvency of our customers and resellers. Accordingly, future demand for our products and services could differ from our current expectations. Similarly, our customers may experience liquidity issues of their own that adversely affect our ability to collect amounts due from them in a timely fashion, or at all. In addition, if the global economy and credit markets continue to deteriorate and our future sales decline, our financial condition and results of operations would be adversely impacted.
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Negative impacts from increased financial pressures on our ability to maintain and further enhance our network: We plan to arrange financing with vendors and third parties for a significant portion of the capital expenditures that we plan for 2009 for the maintenance and upgrade of capacity and services our telecommunication systems. The lack of credit in the global capital markets may constrain our ability to obtain such financing on commercially reasonable terms or at all. To the extent we are not able to obtain appropriate financing, we may not be able to implement certain of our growth investments budgeted for 2009 and thereby not realize additional higher-margin revenues to support our business.
We incurred substantial operating losses in 2008 and will continue to experience negative cash flows in the short term.
For each period since inception, we have incurred substantial operating losses. Although we expect our operating results to improve over time, there is no assurance that our business will generate sufficient cash flow from operations, that currently anticipated cost savings and operating improvements will be realized on schedule or that future borrowings will be available to us in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. In the short term we expect cash provided by operating activities to exceed purchases of property and equipment. This expectation is based in part on arranging financing for such property and equipment from vendors and others in amounts comparable to those arranged in 2008. Our ability to arrange such financings is subject to negotiating acceptable terms from equipment vendors and financing parties. This could prove more difficult given current adverse conditions in the credit markets. If we are unable to arrange such financings, we may not be able to make all necessary capital and other expenditures to run and grow our business, including the expenditures that will be necessary to implement our operational imperatives. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.”
Our ability to generate positive cash flow over the long term is predicated on significant revenue growth in our target enterprise, carrier data and indirect sales channel, including economies of scale expected from such growth, and the success of ongoing cost reduction initiatives. We can provide no assurances that we will be successful in these regards. If our cash flows do not improve, we would need to arrange financing facilities in order to continue as a going concern. We may be unable to arrange financing facilities on acceptable terms or at all. Current adverse conditions in global capital and credit markets could make it more difficult for us to obtain financing on commercially acceptable terms or at all.
We may not be able to achieve anticipated economies of scale.
We expect that economies of scale will allow us to grow revenues while incurring incremental costs that are proportionately lower than those applicable to our existing business. If the increased costs required to support our revenue growth turn out to be greater than anticipated, we may be unable to improve our profitability and/or cash flows even if revenue growth goals are achieved. The current downturn in the world economy could temper our growth, although the value we offer prospective customers could attract business in a cost-saving environment.
Improvements in our cost structure in the short term become more difficult as the amount of potential savings decreases due to the success of past savings initiatives. Cost savings initiatives put a strain on our existing employees and make it more challenging to foster an engaged and enthusiastic workforce. Customer service, which is a critical component of our value proposition, could suffer if employee engagement were to deteriorate.
The sale of IRUs and similar prepayments for services are an important source of cash flows for us.
The sale of IRUs and similar prepayments for services are an important source of cash flows for us, representing tens of million of dollars of cash in most quarters. If customers’ buying patterns were to change such that those traditionally buying IRUs were to switch to monthly payment plans, our liquidity would be adversely affected. The current downturn in the world economy and tightening of global credit markets could cause customers to change their buying patterns away from prepaid services and IRUs in order to conserve cash. In addition, the large dollar amounts and long sales cycles typically associated with IRU sales increase the volatility of our quarter-to-quarter cash flow results.
Access vendors could force us to accelerate payments to them, which would adversely impact our working capital and liquidity.
Cost of access represents our single largest expense and gives rise to material current liabilities. In the past, certain telecommunications carriers from which we purchase access services demanded that we pay for access
services on a timelier basis, which resulted in increased demands on our liquidity. If such demands were to continue to a greater degree than anticipated, or if access vendors were to insist on significant deposits to secure our access payment obligations, we could be prevented from meeting our cash flow projections and our long-term liquidity requirements. The current downturn in the world economy and tightening of global credit markets could cause access vendors to insist upon timelier payment or the provision of security deposits.
The covenants in our debt instruments limit our financial and operational flexibility.
GCL and numerous of its subsidiaries have material indebtedness outstanding under the following debt instruments (collectively, the “Principal Debt Instruments”):
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GCL’s Credit and Guaranty Agreement dated as of May 9, 2007 under which Goldman Sachs Credit Partners L.P. acts as administrative and collateral agent for a group of lenders who made five-year term loans aggregating $350 million in May and June of 2007 (the “Term Loan Agreement”);
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GCL’s $144 million aggregate original principal amount of 5.0% convertible senior notes due 2011 (the “5% Convertible Notes”);
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GCUK’s $200 million and 157 million pounds sterling aggregate principal amount (approximately $512 million combined) of senior secured notes due 2014 (the “GCUK Notes”); and
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The $225 million aggregate original principal amount of GC Impsat Notes due 2017.
The Principal Debt Instruments generally contain covenants and events of default that are customary for high-yield debt and senior secured credit facilities, including limitations on:
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incurring or guaranteeing additional indebtedness;
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dividend and other payments to holders of equity and subordinated debt;
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investments or other restricted payments;
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asset sales, consolidations, and mergers;
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creating or assuming liens; and
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transactions with affiliates.
These covenants impose significant restrictions on the ability of entities in any one of our operating segments from making intercompany funds transfers to entities in any other segment.
In addition, the Term Loan Agreement includes financial maintenance covenants requiring our ROW Segment to maintain a minimum combined cash balance at all times and requiring us to maintain a maximum ratio of consolidated debt to a designated measure of consolidated earnings. The Term Loan Agreement also includes a covenant requiring us to prepay the term loan in full at 102% of the principal amount (101% if after June 1, 2009) in the event of a “Change of Control” (as defined in the Term Loan Agreement). Additionally, the certificate of designations governing our 2% Cumulative Preferred Shares (the “GCL Preferred Stock”) requires the holder’s approval for certain major corporate actions of GCL and/or its subsidiaries. See Item 5, “Market for Registrant’s Common Stock and Related Stockholder Matters-Description of Global Crossing Equity Securities.”
Most of our assets have been pledged to secure the indebtedness under certain of our Principal Debt Instruments, as well as certain lease facilities secured by the assets being leased (the “Capital Lease Facilities”). A failure to comply with the covenants contained in our Principal Debt Instruments or the Capital Lease Facilities could result in an event of default, which, if not cured or waived, could result in an acceleration of all such debts, which would have a material adverse effect on our business, results of operations and financial condition. For example, certain of our capital lease agreements contain non-financial covenants which require
specific tracking and reporting procedures for the physical location of the leased assets. The failure to meet these covenants allows the lessor to accelerate payments under the lease. We have in the past failed to meet these covenants. At December 31, 2008, these non-financial covenants have not been completely satisfied for certain debt and lease agreements representing $2 million of indebtedness. Such indebtedness was classified as current liabilities at December 31, 2008.
If the indebtedness under any of our Principal Debt Instruments or Capital Lease Facilities were to be accelerated, we would have to raise funds from alternative sources, which may not be available on favorable terms, on a timely basis or at all. Moreover, a default by any of our subsidiaries under any capital lease obligation or debt obligation totaling more than $2.5 million, as well as the bankruptcy or insolvency of any of our subsidiaries, could trigger cross-default provisions under certain of our debt instruments.
For a further discussion of these issues and our indebtedness, please see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Indebtedness.”
Our international corporate structure limits the availability of our consolidated cash resources for intercompany funding purposes and reduces our financial restructuring flexibility.
As a holding company, all of our revenues are generated by our subsidiaries and substantially all of our assets are owned by our subsidiaries. As a result, we are dependent upon dividends and inter-company transfers of funds from our subsidiaries to meet our debt service and other payment obligations. Our subsidiaries are incorporated and operate in various jurisdictions throughout the world. Some of our subsidiaries have cash on hand that exceeds their immediate requirements but that cannot be distributed or loaned to us or our other subsidiaries to fund our or their operations due to contractual restrictions (such as those described in the immediately preceding risk factor) or legal constraints related to the lack of retained earnings, the solvency of such entities or other local law restrictions (e.g., restrictions related to foreign exchange controls or transfer approvals). These restrictions, which apply to most of our subsidiaries given their history of operating losses, could cause us or certain of our subsidiaries to become and remain illiquid while other subsidiaries have sufficient liquidity to meet their liquidity needs. Also see “-We are exposed to significant currency exchange rate risks and our net loss may suffer due to currency translations,” below, for a discussion of important exchange rate and expatriation risks involving our Venezuelan and other subsidiaries.
We cannot predict our future tax liabilities. If we become subject to increased levels of taxation or if tax contingencies are resolved adversely, our results of operations could be adversely affected.
Due to the international nature of our operations, we are subject to multiple sets of complex and varying tax laws and rules. We cannot predict the amount of future tax liabilities to which we may become subject. Any increase in the amount of taxation incurred as a result of our operations or due to legislative or regulatory changes could result in a material adverse effect on our business, results of operations and financial condition. While we believe that our current tax provisions are reasonable and appropriate, we cannot be assured that these items will be settled for the amounts accrued or that additional exposures will not be identified in the future. We have material tax-related contingent liabilities that are difficult to predict or quantify. See “Legal Proceedings” in Item 3 and Note 22, “Commitments, Contingencies and Other” to our consolidated financial statements included in this annual report on Form 10-K.
Risks Related to Our Operations
Our revenue and operating results may vary significantly from quarter to quarter due to a number of factors, many of which are outside of our control.
Our revenue and operating results may vary significantly from quarter to quarter due to a number of factors, many of which are outside of our control. The primary factors, among other things, that may affect our results of operations include the following:
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changes in pricing policies or the pricing policies of our competitors;
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general economic conditions as well as those specific to our industry;
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demand for our higher margin services;
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costs of acquisitions, including the integration of such acquisitions; and
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changes in regulations and regulatory rulings.
A delay in generating revenue or the timing of recognizing revenue and expenses could cause significant variations in our operating results from quarter to quarter. It is possible that in some future quarters our results may be below analysts and investors expectations.
Our rights to the use of the fiber that make up our network may be affected by the financial health of our fiber providers.
The majority of our North American network and some of the other transmission facilities comprising our global network are held by us through long-term leases or IRU agreements with various companies that provide us access to fiber owned by them. A bankruptcy or financial collapse of one of these fiber providers could result in a loss of our rights under such leases and agreements with the provider, which in turn could have a negative impact on the integrity of our network and ultimately on our results of operations. To our knowledge, the rights of the holder of such rights in strands of fiber in the event of bankruptcy have not been specifically addressed by the judiciary at the state or federal level in the U.S. or in most of the foreign jurisdictions in which we operate and, therefore, our rights with respect to dark fiber agreements under such circumstances are unclear.
We may not be able to continue to connect our network to incumbent carriers’ networks or maintain Internet peering arrangements on favorable terms.
We must be party to interconnection agreements with incumbent carriers and certain independent carriers in order to connect our customers to the PSTN. If we are unable to renegotiate or maintain interconnection agreements in all of our markets on favorable terms, it could adversely affect our ability to provide services in the affected markets. In Europe, although certain rights to interconnect with other networks are subject to legal and regulatory protection, new IP-based networking technologies are becoming more generally adopted within the industry and new commercial and charging models are being developed for interworking between these networks. The extent to which such new models may affect our business is currently uncertain.
Peering agreements with Internet service providers allow us to access the Internet and exchange transit for free with these providers. Depending on the relative size of the carriers involved, these exchanges may be made without settlement charge. Recently, many Internet service providers that previously offered peering have reduced or eliminated peering relationships or are establishing new, more restrictive criteria for peering and an increasing number of these service providers are seeking to impose charges for transit. Increases in costs associated with Internet and exchange transit could have a material adverse effect on our margins for our products that require Internet access. We may not be able to renegotiate or maintain peering arrangements on favorable terms, which would impair our growth and performance.
The Network Security Agreement imposes significant requirements on us. A violation of the agreement could have severe consequences.
The Network Security Agreement imposes significant requirements on us related to information storage and management; traffic routing and management; physical, logical, and network security arrangements; personnel screening and training; corporate governance practices; and other matters. While we expect to comply fully with our obligations under the Network Security Agreement, it is impossible to eliminate completely the risk of a violation of the agreement. The consequences of a violation of the Network Security Agreement could be severe, potentially including the revocation of our FCC licenses in the U.S., which would result in the cessation of our U.S. operations and would have a material adverse effect on our business, results of operations and financial condition.
It is expensive and difficult to switch new customers to our network, and lack of cooperation of incumbent carriers can slow the new customer connection process.
It is expensive and difficult for us to switch a new customer to our network because:
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we usually charge the potential customer certain one-time installation fees, and, although the fees may be less than the cost to install a new customer, they may act as a deterrent to becoming our customer; and
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we require cooperation from the incumbent carrier in instances where there is no direct connection between the customer and our network, which can complicate and add to the time that it takes to provision a new customer’s service.
Many of our principal competitors, the domestic and international incumbent carriers, are already established providers of local telephone services to all or virtually all telephone subscribers within their respective service areas. Their physical connections from their premises to those of their customers are expensive and difficult to duplicate. To complete the new customer provisioning process, we rely on the incumbent carrier to process certain information. The incumbent carriers have a financial interest in retaining their customers, which could reduce their willingness to cooperate with our new customer provisioning requests, thereby adversely impacting our ability to compete and grow revenues. Further consolidation of incumbent carriers with other telecommunications service providers may make these problems more acute.
The operation, administration, maintenance and repair of our systems require significant expenses and are subject to risks that could lead to disruptions in our services and the failure of our systems to operate as intended for their full design life.
Each of our systems is subject to the risks inherent in large-scale, complex fiber-optic telecommunications systems. The operation, administration, maintenance and repair of our systems require the coordination and integration of sophisticated and highly specialized hardware and software technologies and equipment located throughout the world and require significant operating and capital expenses. Our systems may not continue to function as expected in a cost-effective manner. For example, as our network elements become obsolete or reach their design life capacity, our operating expenses could significantly increase depending on the nature and extent of repairs or replacements. The failure of the hardware or software to function as required could render a cable system unable to perform at design specifications.
Interruptions in service or performance problems, for whatever reason, could undermine confidence in our services and cause us to lose customers or make it more difficult to attract new ones. In particular, a failure of our operations support systems could adversely affect our ability to process orders and provision sales, and to bill for services efficiently and accurately, all of which could cause us to suffer customer dissatisfaction, loss of business, loss of revenue or the inability to add customers on a timely basis, any of which would adversely affect our revenues. In addition, because many of our services are critical to our customers’ businesses, a significant
interruption in service could result in lost profits or other loss to customers. Although we attempt to disclaim liability for these losses in our service agreements, a court might not enforce a limitation on liability under certain conditions, which could expose us to financial loss. In addition, we often provide customers with guaranteed service level commitments. If we are unable to meet these guaranteed service level commitments for whatever reason, we may be obligated to provide our customers with credits, generally in the form of free service for a short period of time, which could negatively affect our operating results.
Recent capital expenditure levels may not be sustainable.
While capital expenditures have remained relatively stable at levels significantly below those prevailing prior to our bankruptcy reorganization, such levels may not be sustainable in the future, particularly as our business continues to grow. Our ability to fund future capital expenditures may be limited by our ability to generate sufficient cash flow, including raising any necessary financings, which could prove to be difficult if the adverse conditions in the credit markets continue.
Intellectual property and proprietary rights of others could prevent us from using necessary technology.
While we do not believe that there exists any technology patented by others, or other intellectual property owned by others, that is necessary for us to provide our services and that is not now subject to a license allowing us to use it, from time to time we receive claims from third parties in this regard and there can be no assurances as to our ability to defend against those claims successfully. If such intellectual property is owned by others and not licensed by us, we would have to negotiate a license for the use of that intellectual property. We may not be able to negotiate such a license at a price that is acceptable or at all. This could force us to cease offering products and services incorporating such intellectual property, thereby adversely affecting operating results.
We have substantial international operations and face political, legal, tax, regulatory and other risks from our operations in foreign jurisdictions.
We derive a substantial portion of our revenue from international operations and have substantial physical assets in several jurisdictions along our routes, including countries in Latin America, Asia and Europe. In addition, we lease capacity and obtain services from carriers in those and other regions. As a result our business is subject to particular risks from operating in some of these areas, including:
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uncertain and rapidly changing political, regulatory and economic conditions, including the possibility of civil unrest, vandalism affecting cable assets, terrorism, armed conflict or the seizure or nationalizing of private property;
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unexpected changes in regulatory environments and trade barriers;
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interruptions to essential energy inputs;
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exchange and/or transfer restrictions;
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direct and indirect price controls;
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cancellation of contract rights;
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delays or denial of governmental approvals;
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exposure to new or different accounting, legal, tax and regulatory standards;
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burdensome tax, customs, duties or regulatory assessments based on new or differing interpretations of law or regulations; and
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difficulties in staffing and managing operations consistently through our several operating areas.
These risks have increased significantly as a result of our acquisition of the Latin American operations of Impsat. In addition, managing operations in multiple jurisdictions may place further strain on our ability to manage growth.
We are subject to the Foreign Corrupt Practices Act (the “FCPA”), and our failure to comply with the laws and regulations thereunder could result in penalties which could harm our reputation and have a material adverse effect on our business, results of operations and financial condition.
We are subject to the FCPA, which generally prohibits companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or keeping business and/or other benefits. Although we have policies and procedures designed to ensure that the Company, its employees and agents comply with the FCPA, there is no assurance that such policies or procedures will work effectively all of the time or protect us against liability under the FCPA for actions taken by our agents, employees and intermediaries with respect to our business or any businesses that we acquire. We operate in a number of jurisdictions that pose a high risk of potential FCPA violations. In May 2007, we acquired Impsat, which was also subject to the FCPA prior to the acquisition. As described in “Additional Information Regarding Impsat” in Item 9A, the facts developed in our review of certain payments made by Impsat employees to government officials and foreign government proceedings concerning Impsat personnel show that: first, although Impsat had policies in place prior to the May 9, 2007 acquisition relating to FCPA compliance and contracting with third-party agents, those policies were not implemented; second, Impsat’s documentation relating to third-party agents and certain government contracts was not sufficient; third, the corporate environment at Impsat did not reflect a sufficient focus by senior management on promotion of, and compliance by the company with, these policies. As previously disclosed, we conducted a review of certain agents, government contracts, and potential unauthorized payments in Latin American countries. That review is now substantially complete. We also brought these matters to the attention of government authorities in the U.S., including the Securities and Exchange Commission, which has commenced a preliminary inquiry into the matter. We are cooperating with that inquiry which may result in legal action. At this point we are unable to predict the duration, scope or result of that inquiry. Failure to comply with the FCPA, other anti-corruption laws and other laws governing the conduct of business with government entities (including local laws) could lead to criminal and civil penalties and other remedial measures (including further changes or enhancements to our procedures, policies, and controls and potential personnel changes and/or disciplinary actions), any of which could have an adverse impact on our business, financial condition, results of operations and liquidity. Any investigation of any potential violations of the FCPA or other anti-corruption laws by U.S. or foreign authorities also could have an adverse impact on our business, financial condition and results of operations.
We are exposed to significant currency exchange rate risks and our net loss may suffer due to currency translations.
Certain of our current and prospective customers derive their revenue in currencies other than U.S. dollars but are invoiced by us in U.S. dollars. The obligations of customers with revenue in foreign currencies may be subject to unpredictable and indeterminate increases in the event that such currencies depreciate in value relative to the U.S. dollar. Furthermore, such customers may become subject to exchange control regulations restricting the conversion of their revenue currencies into U.S. dollars. In either event, the affected customers may not be able to pay us in U.S. dollars. In addition, where we issue invoices for our services in currencies other than U.S. dollars, our operating results may suffer due to currency translations in the event that such currencies depreciate relative to the U.S. dollar and we cannot or do not elect to enter into currency hedging arrangements in respect of those payment obligations. Declines in the value of foreign currencies relative to the U.S. dollar could adversely affect our ability to market our services to customers whose revenues are denominated in those currencies.
Commencing in September 2008, the U.S. Dollar has appreciated considerably against certain foreign currencies in which we conduct a significant portion of our business, including the British Pound Sterling, the Euro and the Brazilian Real. This appreciation adversely impacts consolidated revenue. Since we tend to incur
costs in the same currency in which we realize revenue, the impact on operating income and operating cash flow is largely mitigated. However, if the U.S. Dollar trades at the levels in effect at the end of the fiscal year or continues to appreciate, future revenues, operating income and operating cash flows will be materially affected. In addition, the appreciation of the U.S. Dollar relative to foreign currencies reduces the U.S. Dollar value of cash balances held in those currencies.
Certain Latin American economies have experienced shortages in foreign currency reserves and have adopted restrictions on the ability to expatriate local earnings and convert local currencies into U.S. dollars. Any such shortages or restrictions may limit or impede our ability to transfer or to convert such currencies into U.S. dollars and to expatriate such funds for the purpose of making timely payments of interest and principal on our indebtedness. These restrictions have a significantly greater impact on us and on our ability to service our debt as a result of the Impsat acquisition. In addition, currency devaluations in one country may have adverse effects in another country. For example, in 2001 and 2002, Argentina imposed exchange controls and transfer restrictions substantially limiting the ability of companies to make payments abroad. While these restrictions have been substantially eased, Argentina may tighten exchange controls or transfer restrictions in the future to prevent capital flight, counter a significant depreciation of the peso or address other unforeseen circumstances.
In Venezuela, the official bolivares-U.S. dollar exchange rate established by the Venezuelan Central Bank and the Venezuelan Ministry of Finance attributes to the bolivar a value that is significantly greater than the value prevailing on the parallel market. The official rate is the rate used for recording the assets, liabilities and transactions for our Venezuelan subsidiary. Moreover, the conversion of bolivares into foreign currencies is limited by the current exchange control regime. Accordingly, the acquisition of foreign currency by Venezuelan companies to honor foreign debt, pay dividends or otherwise expatriate capital is subject to registration and subject to a process of application and approval by the Comisión de Administración de Divisas and to the availability of foreign currency within the guidelines set forth by the National Executive Power for the allocation of foreign currency. Such approvals have become less forthcoming over time, resulting in a significant buildup of excess cash in our Venezuelan subsidiaries and a significant increase in our exchange rate and exchange control risks.
Many of our most important government customers have the right to terminate their contracts with us if a change of control occurs or to reduce the services they purchase from us.
Various agencies of the U.K. Government together represented approximately 47% of the GCUK Segment’s revenues in 2008. Many of GCUK’s government contracts contain broad change of control provisions that permit the customer to terminate the contract if GCUK undergoes a change of control. A termination in many instances gives rise to other rights of the government customer, including, in some cases, the right to purchase some of GCUK’s assets used in servicing those contracts. Some change of control provisions may be triggered when any lender (other than a bank lender in the normal course of business) or a noteholder or group of noteholders would have the right to control GCUK or the majority of GCUK’s assets upon any event, including upon bankruptcy. If GCUK’s noteholders have the right to control GCUK or the majority of GCUK’s assets upon such event, it could be deemed to be a change of control of GCUK. Similarly, if ST Telemedia’s ownership interest in Global Crossing falls below certain levels, it could be deemed to be an indirect change of control of GCUK. In addition, most of GCUK’s government contracts do not include significant minimum usage guarantees. Thus, the applicable customers could simply choose not to use GCUK’s services and move to another telecommunications provider. If any of GCUK’s significant government contracts were terminated as a result of a change of control or otherwise, or if the applicable customers were to significantly reduce the services that they purchase under these contracts, we could experience a material and adverse effect on our business, operations and financial condition.
Risks Related to Competition and Our Industry
The prices that we charge for our services have been decreasing, and we expect that such decreases will continue over time.
We expect overall price erosion in our industry to continue at varying rates based on our service portfolio and reflective of marketplace demand and competition relative to existing capabilities and availability. Accordingly, our historical revenues are not indicative of future revenues based on comparable traffic volumes. If the prices for our services decrease for whatever reason and we are unable to increase profitable sales volumes through additional services or otherwise or correspondingly reduce operational costs, our operating results would be adversely affected. Similarly, future price decreases could be greater than we are anticipating.
Technological advances and regulatory changes are eroding traditional barriers between formerly distinct telecommunications markets, which could increase the competition we face and put downward pressure on prices.
New technologies, such as VoIP, and regulatory changes are blurring the distinctions between traditional and emerging telecommunications markets. As a result, a competitor in any of our business areas could potentially compete in our other business areas.
We face competition in each of our markets from the incumbent carrier in that market and from more recent market entrants. In addition, we could face competition from other companies, such as other competitive carriers, cable television companies, microwave carriers, wireless telephone system operators and private networks built by large end-users or municipalities. The introduction of new technologies may reduce the cost of services similar to those that we plan to provide and create significant new competitors with superior cost structures. If we are not able to compete effectively with any of these industry participants, or if this competition places excessive downward pressure on prices, our operating results would be adversely affected.
In the U.K., OFCOM is encouraging new operators to build their own infrastructures to compete with BT. At the same time, BT is constructing a new, IP based network which it refers to as a “21st Century” network. At present, it is not clear how operators will connect with this network. There are currently no proposals as to how and at what level BT will charge for access to the network. Regulation has historically provided for the expansion of competition in the marketplace and the subsequent lowering of tariffs charged across the industry. However, there is no way to know with certainty what regulatory actions OFCOM and other governmental and regulatory agencies may take in the future. Individually and collectively, these matters could have negative effects on our U.K. business, which could materially and adversely affect our consolidated business, operations and financial condition.
Many of our competitors have superior resources, which could place us at a cost and price disadvantage.
Many of our existing and potential competitors have significant competitive advantages, including greater market presence, name recognition and financial, technological and personnel resources, superior engineering and marketing capabilities, more ubiquitous network reach, and significantly larger installed customer bases. As a result, many of our competitors can raise capital at a lower cost than we can, and they may be able to adapt more swiftly to new or emerging technologies and changes in customer requirements, take advantage of acquisition and other opportunities (including regulatory changes) more readily, and devote greater resources to the development, marketing and sale of products and services than we can. Also, our competitors’ greater brand name recognition may require us to price our services at lower levels in order to win business. Our competitors’ financial advantages may give them the ability to reduce their prices for an extended period of time if they so choose. Many of these advantages are expected to increase with the trend toward consolidation by large industry participants.
Our selection of technology could prove to be incorrect, ineffective or unacceptably costly, which would limit our ability to compete effectively.
The telecommunications industry is subject to rapid and significant changes in technology, evolving industry standards, changing customer needs, emerging competition and frequent new product and service introductions. The future success of our business will depend, in part, on our ability to adapt to these factors in a timely and cost-effective manner. If we do not replace or upgrade technology and equipment that becomes obsolete, or if the technology choices we make prove to be incorrect, ineffective or unacceptably costly, we will be unable to compete effectively because we will not be able to meet the expectations of our customers, which would cause our results to suffer.
Our operations are subject to regulation in each of the countries in which we operate and require us to obtain and maintain a number of governmental licenses and permits. If we fail to comply with those regulatory requirements or obtain and maintain those licenses and permits, including payment of related fees, if any, we may not be able to conduct our business. Moreover, those regulatory requirements could change in a manner that significantly increases our costs or otherwise adversely affects our operations.
In the ordinary course of constructing our networks and providing our services we are required to obtain and maintain a variety of telecommunications and other licenses and authorizations in the countries in which we operate, as well as rights-of-way from utilities, railroads, incumbent carriers and other persons. We also must comply with a variety of regulatory obligations. Our failure to obtain or maintain necessary licenses, authorizations and rights-of-way, or to comply with the obligations imposed upon license holders including the payment of fees, in one or more countries, may result in sanctions or additional costs, including the revocation of authority to provide services in one or more countries.
Our operations around the world are subject to regulation at the regional level (e.g., European Union), the national level (e.g., the FCC) and, in many cases, at the state, provincial, and local levels. The regulation of telecommunications networks and services around the world varies widely. In some countries, the range of services that we are legally permitted to provide may be limited. In other countries, existing telecommunications legislation is in the process of development, is unclear or inconsistent, or is applied in an unequal or discriminatory fashion, or inadequate judicial, regulatory or other forums are available to address these inadequacies or disputes. Our inability or failure to comply with the telecommunications laws and regulations of one or more of the countries in which we operate could result in the temporary or permanent suspension of operations in one or more countries. We also may be prohibited from entering certain countries at all or from providing all of our services in one or more countries. In addition, many of the countries in which we operate are conducting regulatory or other proceedings that will affect the implementation of their telecommunications legislation. We cannot be certain of the outcome of these proceedings. These proceedings may affect the manner in which we are permitted to provide our services in these countries as well as the level of fees and taxes payable to the government, and may have a material adverse effect on our business, results of operations and financial condition.
Terrorist attacks and other acts of violence or war may adversely affect the financial markets and our business and operations.
Significant terrorist attacks against the U.S., the U.K. or other countries in which we operate are possible. It is possible that our physical facilities or network control systems could be the target of such attacks or that such attacks could impact other telecommunications companies or infrastructure or the Internet in a manner that disrupts our operations. Terrorist attacks (or threats of attack) also could lead to volatility or illiquidity in world financial markets and could otherwise adversely affect the economy. These events could adversely affect our business and our ability to obtain financing on favorable terms. In addition, it is becoming increasingly difficult and expensive to obtain adequate insurance for losses due to terrorist attacks. Uninsured losses as a result of such attacks could have a material adverse effect on our business, results of operations and financial condition.
Risks Related to Our Common Stock
We have a very substantial overhang of common stock and a majority shareholder that owns a substantial portion of common stock and securities convertible into our common stock. Future sales of our common stock could cause substantial dilution and future acquisitions by our majority shareholder will decrease the liquidity of our common stock, each of which may negatively affect the market price of our shares and impact our ability to raise capital.
As of February 17, 2009, there were 56,722,420 shares of our common stock outstanding, 18,000,000 shares of common stock reserved for issuance upon the conversion of our outstanding convertible preferred stock and 6,255,440 shares of common stock reserved for issuance upon conversion of our 5% Convertible Notes. We also have a significant number of shares of common stock reserved for issuance upon the exercise of outstanding stock options and vesting of unvested restricted stock units (see Item 5, “Market for Registrant’s Common Stock and Related Stockholder Matters-Equity Compensation Plan Information”).
As of February 17, 2009, STT Crossing, a wholly-owned subsidiary of ST Telemedia, beneficially owned over 63% of our capital stock. Although the shares beneficially owned by STT Crossing are not freely transferable under the Securities Act, ST Telemedia has the contractual right to require us to register sales of such restricted stock at any time.
We cannot predict the effect, if any, that future sales of shares of our common stock into the market, the availability of shares of common stock for future sale, or any acquisition of common shares by ST Telemedia and its affiliates will have on the market price of our common stock. Sales of substantial amounts of common stock (including shares issued upon the exercise of stock options or conversion of any convertible securities), the purchase of a substantial amount of common shares by our affiliates, or the perception that such sales or acquisitions could occur, may materially and adversely affect prevailing market prices for our common stock and impact our ability to raise capital.
A large number of freely tradable shares of our common stock will be paid to employees in 2009 in connection with incentive compensation arrangements, and sales of such shares could significantly affect the market value of our common stock, particularly in the short term.
We expect to pay an aggregate of approximately 5.16 million freely tradable shares of our common stock to our employees in 2009 in connection with incentive compensation arrangements, a portion of which will be withheld to cover tax withholding obligations. Of these shares, 4.73 million shares are being paid in connection with our 2008 bonus program, of which 1.38 million shares are expected to be paid on March 18, 2009, 161,000 shares are expected to be paid on March 30, 2009, and 3.19 million shares are expected to be paid on April 8, 2009, in each case a portion of which will be withheld to cover tax withholding obligations (approximately 3.1 million shares will be paid after tax withholding obligations). The remainder of the shares are being paid to employees as restricted stock units previously granted to them vest in 2009. The average daily trading volume of our shares from January 2, 2009 to February 17, 2009 was approximately 158,000 shares. Sales of a significant portion of the incentive compensation shares would be difficult for the market to absorb and could significantly depress our stock price, especially in the short term. Although we have elected to fund the tax withholding for payments relating to our 2008 bonus program by withholding shares and paying the tax with Company cash, we may not do so for share payments relating to the vesting of remaining restricted stock units in 2009. As a result, approximately one-third of the shares being paid in connection with such vesting events may be sold in the open market promptly upon payout in order to satisfy tax withholding obligations. This could create downward pressure on our stock price in the short term at the time of such sales.
Federal law generally prohibits more than 25% of our capital stock to be owned by foreign persons.
Ownership of our common stock is governed in part by the Communications Act of 1934, as amended. Other than ownership by ST Telemedia and its affiliates, which cannot exceed 66.25% without prior FCC approval, foreign ownership of our capital stock (i.e., total equity interests held by non-U.S. persons) generally
cannot exceed 25% without prior FCC approval. Although we monitor foreign ownership in our capital stock, we cannot necessarily detect or control it and could be subject to governmental penalties if trading in our capital stock resulted in foreign ownership in excess of 25% without prior FCC approval.
ST Telemedia is our majority stockholder.
A subsidiary of ST Telemedia owns over 63% of GCL’s outstanding capital stock. As a result, ST Telemedia has the power to elect the majority of GCL’s directors. Under applicable law, GCL’s articles of association and bye-laws and the certificate of designations for GCL’s preferred stock, certain actions cannot be taken without the approval of holders of a majority of our voting stock including, without limitation, mergers, certain acquisitions and dispositions, issuances of additional equity securities (with certain enumerated exceptions), incurrences of indebtedness above specified amounts, the making of capital expenditures in excess of specified amounts, and amendments to our articles of association and bye-laws. GCL’s bye-laws include significant additional corporate governance rights of ST Telemedia. These rights effectively dilute the rights of other shareholders.
A sale by ST Telemedia of a significant portion of its shareholdings in us could trigger contractual provisions tied to a change in control of our company. For example, a change in control could result in the termination of significant contracts with U.K. government customers, the requirement that we offer to purchase the GCUK Notes at a price equal to 101% of their outstanding principal amount plus accrued and unpaid interest and the 5% Convertible Notes at a price equal to 100% of the principal amount of the notes plus accrued and unpaid interest, and the acceleration of the vesting of stock options and other incentive compensation awards granted to our directors and employees.
Economic and political conditions in Latin America pose numerous risks to our operations.
As a result of the completion of our acquisition of Impsat, our business operations are significantly more dependent on the Latin American region. As events in the Latin American region have demonstrated, negative economic or political developments in one country in the region can lead to or exacerbate economic or political instability elsewhere in the region. Furthermore, events in recent years in other developing markets have placed pressures on the stability of the currencies of a number of countries in Latin America, including Argentina, Brazil, Colombia and Venezuela. Latin American countries have historically experienced uneven periods of economic growth, as well as recession, periods of high inflation and economic instability. Certain countries have experienced severe economic crises, which may still have future effects. As a result, governments may not have the financial resources necessary to implement reforms and foster growth. While certain areas in the Latin American region have experienced economic growth, this recovery remains fragile. Pressures on local currencies are likely to have an adverse effect on our customers. Volatility in regional currencies and capital markets could also have an adverse effect on our ability and that of our customers to gain access to international capital markets for necessary financing, refinancing and expatriation of earnings.
In addition, any changes to the political and economic conditions in certain Latin American countries could materially and adversely impact our future business, operations, financial condition and results of operations. For example, in January 2007, the Venezuelan National Assembly issued an Enabling Law allowing the President of Venezuela to carry out the nationalization of certain businesses in the electricity and energy sectors, as well as Venezuela’s largest telecommunications company, Compañía Anónima Nacional Teléfonos de Venezuela (“CANTV”). CANTV was nationalized in the same year. A statement from the Venezuelan minister of telecommunications and director of the Comisión Nacional de Telecomunicaciones, the country’s telecommunications regulatory authority, has indicated that the nationalization of CANTV does not imply the nationalization of the telecommunications sector as a whole. However, there can be no assurance that such nationalization plans will not also extend to other businesses in the telecommunications sector, including our business. The government has also announced plans to modify the telecommunications law, and we cannot predict the impact of such amendments to our business. In addition, a referendum held on February 15, 2009 approved an amendment to the nation’s constitution, removing presidential term limits.
Inflation and certain government measures to curb inflation in some Latin American countries may have adverse effects on their economies, our business and our operations.
Some Latin American countries have historically experienced high rates of inflation. Inflation and some measures implemented to curb inflation have had significant negative effects on the economies of these countries. Governmental actions taken in an effort to curb inflation, coupled with speculation about possible future actions, have contributed to economic uncertainty at times in most Latin American countries. These countries may experience high levels of inflation in the future that could lead to further government intervention in the economy, including the introduction of government policies that could adversely affect our results of operations. In addition, if any of these countries experience high rates of inflation, we may not be able to adjust the price of our services sufficiently to offset the effects of inflation on our cost structures. A high inflation environment would also have negative effects on the level of economic activity and employment and adversely affect our business and results of operations.
Other Risks
We are exposed to significant contingent liabilities, including those related to Impsat, that could result in material losses that we have not reserved against.
Included in “Legal Proceedings” in Item 3 and Note 22, “Commitments, Contingencies and Other” to our consolidated financial statements included in this annual report on Form 10-K, are descriptions of certain important contingent liabilities. If one or more of these contingent liabilities were to be resolved in a manner adverse to us, we could suffer losses that are material to our business, results of operations and financial condition. We have not established reserves for many of these contingent liabilities. Moreover, as described in “Legal Proceedings” and in Note 22 to the consolidated financial statements, certain of these contingent liabilities could have a material adverse effect on our business, results of operations and financial condition in addition to the effect of any potential monetary judgment or sanction against us.
Assets and entities that we have acquired from Impsat may be subject to unknown or contingent liabilities for which we may have no recourse, or only limited recourse. In general, the representations and warranties provided by Impsat under its purchase agreement do not survive the closing of the transaction. As a result, we will not be able to recover any amounts with respect to losses due to breaches by Impsat of its representations and warranties. The total amount of costs and expenses that may be incurred with respect to liabilities associated with the acquisition may exceed our expectations, plus we may experience other unanticipated adverse effects, all of which may adversely affect our revenues, expenses, operating results and financial condition.
Our real estate restructuring reserve represents a material liability, the calculation of which involves significant estimation.
As of December 31, 2008, our real estate restructuring reserve aggregated $107 million of continuing building lease obligations and broker commissions, offset by anticipated receipts of $43 million from existing subleases and $50 million from subleases projected to be entered into in the future. Although we believe these estimates to be reasonable, actual sublease receipts could turn out to be materially different than we have estimated.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
We lease our principal executive offices in Hamilton, Bermuda. Our operating segments also lease significant corporate office space in the following cities and lease smaller sales, administrative, and support offices within their respective geographic regions:
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GCUK Segment: London, Basingstoke and Crewe, England
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GC Impsat Segment: Bogota, Colombia; Buenos Aires, Argentina; Caracas, Venezuela; Lima, Peru; Miami, Florida; Quito, Ecuador; Santiago, Chile; and Sao Paulo, Brazil
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Rest of World Segment: Billings, Montana; Dublin, Ireland; Florham Park, New Jersey; Hong Kong, China; Miami, Florida; Milan, Italy; Montreal, Canada; Naarden, The Netherlands; New York, New York; Paris, France; Phoenix, Arizona; Rochester, New York; Southfield, Michigan; Tokyo, Japan; and Westminster, Colorado
We own or lease numerous cable landing stations and telehouses throughout the world related to undersea and terrestrial cable systems. Furthermore, we own or lease properties to house and operate our fiber-optic backbone and distribution network facilities, our point-to-point distribution capacity, our switching equipment and connecting lines between other carriers’ equipment and facilities and the equipment and facilities of customers in each of our principal operating segments. For additional information on our technical sites, see above in Item 1, “Business-Overview of Our Business-Our Network”.
Our existing properties are in good condition and are suitable for the conduct of our business.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we are party to various legal proceedings in the ordinary course of business or otherwise. In accordance with SFAS No. 5, “Accounting for Contingencies,” we make a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. In accordance with FASB Interpretation No. 14, “Reasonable Estimation of the Amount of a Loss (an interpretation of FASB Statement No. 5),” where it is probable that a liability has been incurred and there is a range in the expected loss and no amount in the range is more likely than any other amount, we accrue the low end of the range. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. Although we believe we have adequate provisions for the following matters, litigation is inherently unpredictable and it is possible that cash flows or results of operations could be materially and adversely affected in any particular period by the unfavorable resolution or disposition of one or more of these contingencies. The following is a description of our current material legal proceedings.
AT&T Corp. (SBC Communications) Claim
On November 17, 2004, AT&T’s LEC affiliates commenced an action against us and other defendants in the U.S. District Court for the Eastern District of Missouri. The complaint alleges that we, through certain unnamed intermediaries, which are characterized as “least cost routers,” terminated long distance traffic to avoid the payment of interstate and intrastate access charges.
The complaint alleges five causes of action: (1) breach of federal tariffs; (2) breach of state tariffs; (3) unjust enrichment (in the alternative to the tariff claims); (4) fraud; and (5) civil conspiracy. Although the complaint does not contain a specific claim for damages, plaintiffs allege that they have been damaged in the amount of approximately $20 million for the time period of February 2002 through August 2004. The complaint also seeks an injunction against the use of “least cost routers” and the avoidance of access charges. We filed a motion to dismiss the complaint on January 18, 2005, which motion was mooted by the filing of a first amended complaint on February 4, 2005. The first amended complaint added as defendants five competitive local exchange carriers
and certain of their affiliates (none of which is affiliated with us) and re-alleged the same five causes of action. We filed a motion to dismiss the first amended complaint on March 4, 2005. On August 23, 2005, the Court referred a comparable case to the FCC and the FCC has sought comments on the issues referred by the Court. We filed comments in the two declaratory judgment proceedings occasioned by the Court’s referral. On February 7, 2006, the Court entered an order: (a) dismissing AT&T’s claims against Global Crossing to the extent that such claims arose prior to December 9, 2003 by virtue of the injunction contained in the joint plan of reorganization of the GC Debtors which became effective on that date; and (b) staying the remainder of the action pending the outcome of the referral to the FCC described above. On February 22, 2006, AT&T moved the Court to reconsider its decision of February 7, 2006 to the extent that it dismissed claims that arose prior to December 9, 2003. We filed our response to the motion on March 6, 2006, requesting that the Court deny the motion. On May 31, 2006, the Court entered an order denying plaintiffs’ motion for reconsideration without prejudice. On April 15, 2008, plaintiffs moved to vacate the stay entered by the Court on the grounds of inaction by the FCC. The Court denied the motion to vacate and plaintiffs have requested reconsideration. That request is presently pending before the Court.
Claim by the U.S. Department of Commerce
A claim was filed in our bankruptcy proceedings by the U.S. Department of Commerce (the “Commerce Department”) on October 30, 2002 asserting that an undersea cable owned by PCL, our former subsidiary, violates the terms of a Special Use permit issued by the National Oceanic and Atmospheric Administration (“NOAA”). We believe responsibility for the asserted claim rests entirely with our former subsidiary. On November 7, 2003, we and the Global Crossing Creditors’ Committee filed an objection to this claim with the Bankruptcy Court. Subsequently, the Commerce Department agreed to limit the size of the pre-petition portion of its claim to $14 million. An identical claim that had been filed in the bankruptcy proceedings of PCL was settled in principle in September 2005 and was subsequently approved by the court as part of the PCL plan of reorganization confirmed in an order dated November 10, 2005. We initiated preliminary discussions with the Commerce Department and its Justice Department attorneys as to the impact that settlement has on the claim against us. The Commerce Department continues to consider its position on the matter.
Qwest Rights-of-Way Litigation
In May 2001, a purported class action was commenced against three of our subsidiaries in the U.S. District Court for the Southern District of Illinois. The complaint alleges that we had no right to install a fiber-optic cable in rights-of-way granted by the plaintiffs to certain railroads. Pursuant to an agreement with Qwest Communications Corporation, we have an indefeasible right to use certain fiber-optic cables in a fiber-optic communications system constructed by Qwest within the rights-of-way. The complaint alleges that the railroads had only limited rights-of-way granted to them that did not include permission to install fiber-optic cable for use by Qwest or any other entities. The action has been brought on behalf of a national class of landowners whose property underlies or is adjacent to a railroad right-of-way within which the fiber-optic cables have been installed. The action seeks actual damages in an unstated amount and alleges that the wrongs done by us involve fraud, malice, intentional wrongdoing, willful or wanton conduct and/or reckless disregard for the rights of the plaintiff landowners. As a result, plaintiffs also request an award of punitive damages. We made a demand of Qwest to defend and indemnify us in the lawsuit. In response, Qwest has appointed defense counsel to protect our interests.
Our North American network includes capacity purchased from Qwest on IRU basis. Although the amount of the claim is unstated, an adverse outcome could have an adverse impact on our ability to utilize large portions of our North American network. This litigation was stayed against us pending the effective date of the GC Debtors’ plan of reorganization, and the plaintiffs’ pre-petition claims against us were discharged at that time in accordance with the plan of reorganization. By agreement between the parties, the plan of reorganization preserved plaintiffs’ rights to pursue any post-confirmation claims of trespass or ejectment. If the plaintiffs were to prevail, we could lose our ability to operate large portions of our North American network, although we
believe that it would be entitled to indemnification from Qwest for any losses under the terms of the IRU agreement under which we originally purchased this capacity. As part of a global resolution of all bankruptcy claims asserted against us by Qwest, Qwest agreed to reaffirm its obligations of defense and indemnity to us for the assertions made in this claim. In September 2002, Qwest and certain of the other telecommunication carrier defendants filed a proposed settlement agreement in the U.S. District Court for the Northern District of Illinois. On July 25, 2003, the court granted preliminary approval of the settlement and entered an order enjoining competing class action claims, except those in Louisiana. The settlement and the court’s injunction were opposed by a number of parties who intervened and an appeal was taken to the U.S. Court of Appeals for the Seventh Circuit (“Court of Appeals”). In a decision dated October 19, 2004, the Court of Appeals reversed the approval of the settlement and lifted the injunction. The case has been remanded to the District Court for further proceedings.
Foreign Income Tax Audit
A tax authority in South America issued a preliminary notice of findings based on an income tax audit for calendar years 2001 and 2002. The examiner’s initial findings took the position that we incorrectly documented our importations and incorrectly deducted our foreign exchange losses against our foreign exchange gains on loan balances. An official assessment of $26 million, including potential interest and penalties, was issued in 2005. Due to accrued interest and foreign exchange effects the total exposure has increased to $50 million. We challenged the assessment and commenced litigation in September 2006 to resolve our dispute with the tax authority.
Claim by Pacific Crossing Limited
This claim arises out of the management of the PC-1 trans-Pacific fiber-optic cable, which was constructed, owned and operated by PCL. PCL asserts that we and Asia Global Crossing, another former subsidiary of ours, breached our fiduciary duties to PCL, improperly diverted revenue derived from sales of capacity on PC-1, and failed to account for the way revenue was allocated among the corporate entities involved with the ownership and operation of PC-1. The claim also asserts that revenues derived from operation and maintenance fees were also improperly diverted and that PCL’s expenses increased unjustifiably through agreements executed by us and Asia Global Crossing Limited on behalf of PCL. To the extent that PCL asserted the foregoing claims were prepetition claims, PCL has settled and released such claims against us.
During the pendency of our Chapter 11 proceedings, on January 14, 2003, PCL filed an administrative expense claim in the GC Debtors’ bankruptcy court for approximately $8 million in post-petition services plus unliquidated amounts arising from our alleged breaches of fiduciary duty and misallocation of PCL’s revenues. We objected to the claim and asserted that the losses claimed were the result of operational decisions made by PCL management and its corporate parent, Asia Global Crossing. On February 4, 2005, PCL filed an amended claim in the amount of approximately $79 million claiming we failed to pay revenue for services and maintenance charges relating to PC-1 capacity and failed to pay PCL for use of the related cable stations and seeking to recover a portion of the monies received by us under a settlement agreement entered into with Microsoft Corporation and an arbitration award against Softbank. We filed an objection to the amended claim seeking to dismiss, expunge and/or reclassify the claim and PCL responded by filing a motion for partial summary judgment claiming approximately $22 million for the capacity, operations and maintenance charges and collocation charges and up to approximately $78 million for the Microsoft and Softbank proceeds. PCL’s claim for collocation charges (which comprised approximately $2 million of the total claim) was settled.
Subsequently (and pursuant to a new scheduling order agreed to by the parties), the parties agreed to hold our motion to dismiss in abatement and PCL agreed not to proceed with its partial summary judgment motion and to file a new summary judgment motion. On June 5, 2006 PCL filed a new motion for partial summary judgment claiming not less than $2 million for revenues for short term leases on PC-1, not less than $6 million in respect of operation and maintenance fees paid to us by our customers for capacity on PC-1 and an unspecified amount to be determined at trial in respect of the Microsoft/ Softbank Claim. We filed a response to that motion
on June 26, 2006, together with a cross motion for partial summary judgment on certain of PCL’s administrative claims. On August 28, 2006, PCL replied to our response to PCL’s new motion for partial summary judgment and responded to our cross motion for partial summary judgment. On November 20, 2006, we filed our reply to PCL’s response to our cross motion for partial summary judgment.
The parties have agreed to a non-binding mediation of their competing administrative claims (including our claim filed against PCL in its separate bankruptcy case). The parties have completed one day of mediation and have exchanged certain documents in connection with the mediation, but have not yet concluded the mediation. The current court proceedings have been stayed until completion of mediation.
Impsat Employee Severance Disputes
A number of former directors and executive officers of Impsat have asserted claims (including accrued interest and attorney fees) in excess of $30 million for separation pay, severance, commissions, pension benefits, unpaid vacation pay, breach of employment contracts and unpaid performance bonuses as a result of their separation from Impsat shortly after the acquisition of Impsat by us.
We have been in negotiations with the claimants over the amount of their claims and other issues arising out of their departure. In October 2007, a former director and officer commenced litigation seeking to recover damages from us for alleged separation benefits and compensation. We responded seeking dismissal of the claim based on lack of jurisdiction but such defense was rejected by the court and the case has moved to the evidentiary stage. In November 2007, a former officer served us a complaint claiming damages. This case is now in the evidentiary stage. In July 2008, a former officer commenced formal judicial proceedings on his claim and we responded seeking dismissal of the claim based on lack of jurisdiction. Such defense was rejected by the court and the case will now continue. We have timely replied in each case and will be vigorously defending against these claims.
Buenos Aires Antenna Tax Liability
The Government of the City of Buenos Aires (“GCBA”) established a tax applicable to private companies owning antennas with supporting structures, whether in service or not, in the amount set forth in the annual tariff law for the use of the public and private air space (the “Antenna Fees”).
Since September 2003, the GCBA has periodically notified Impsat of the Antenna Fees which aggregates approximately $62 million, including interest, and requested payment. Impsat has administratively disputed each of these notifications and in the administrative proceeding questioned the legality and constitutionality of the tax on various grounds, including that: (1) air rights belong to the owner of the underlying private property and GCBA’s charge for use of privately owned air rights is confiscatory and incompatible with the constitutional right of property; (2) Argentine federal telecommunications law exempts the use and occupation of public air space for the purposes of providing public telecommunications service from any charge; (3) the tax that GCBA is trying to impose is excessive and confiscatory; and (4) the GCBA has significantly overstated the number and height of the antennas owned by Impsat that are subject to the tax. Impsat continues to dispute the Antenna Fees and, to date, no summary collection action has been commenced by GCBA on the unpaid Antenna Fees.
In July 2008, Impsat filed an action in the Argentine Federal Courts in Buenos Aires seeking a declaration that the Antenna Fees are unconstitutional and illegal. The request is still pending. In December 2008, the GCBA amended its regulations and those amendments resulted in a significant reduction in the Antenna Fees. We are working to determine the impact those changes will have on our exposure.
Brazilian Tax Claims
In October 2004, the Brazilian tax authorities issued two tax infraction notices against Impsat for the collection of the Import Duty and the Tax on Manufactured Products, plus fines and interests. The notice
informed Impsat Brazil that the taxes were levied because a specific document (Declaração de Necessidade-”Statement of Necessity”) was not provided by Impsat Brazil at the time of importation, in breach of MERCOSUR rules. Oppositions were filed on behalf of Impsat Brazil arguing that the Argentine exporter (Corning Cable Systems Argentina S.A.) complied with the MERCOSUR rules and a favorable first instance decision was granted. However, due to the amount involved, the case was remitted to the official compulsory review by the Federal Taxpayers Council. The administrative final decision is still pending.
In addition, in December 2004, the tax authorities of the State of São Paulo, in Brazil, issued an infraction notice against Impsat Brazil for collection of Tax on Distribution of Goods and Services (“ICMS”) supposedly due on the lease of movable properties by comparing such activity to communications services, on which the ICMS state tax is actually levied. A defense was filed on behalf of Impsat Brazil, arguing that the lease of assets could not be treated as a communication service subject to ICMS. The defense was rejected in the first administrative level, and an appeal to State Administrative Court was then filed, which is pending judgment. Impsat believes there are good grounds to have the tax assessment cancelled. However, if the tax assessment is not cancelled at the administrative level for any reason, judicial measures may be adopted to remove such tax assessment.
Paraguayan Government Contract Claim
The National Telecommunications Commission of Paraguay (“CONATEL”) has commenced administrative investigations against a joint venture between GC Impsat’s Argentine subsidiary and Electro Import S.A. (“JV 1”) and another joint venture between GC Impsat’s Argentine subsidiary and Loma Plata S.A. (“JV 2”), for breach of contract and breach of licensee’s obligations by each of such joint ventures.
In December 2000, after a public bidding process, JV 1 was awarded a contract, with funding, and a universal service license for the design, supply, installation, launch, operation and maintenance of a telecommunications system for public telephones and/or phone booths in certain specified locations in Paraguay. In 2005, CONATEL initiated an administrative investigation due to an alleged breach of contract by JV 1, as well as a criminal investigation pursuant to which two officers of Impsat’s Argentine subsidiary were preliminarily indicted. As a result of such investigation, CONATEL resolved to: (i) determine JV 1’s liability as to the breach of its contract and its legal obligations as licensee of the Universal Service; (ii) revoke the license granted; (iii) terminate the contract due to JV 1’s default; (iv) impose a fine; (v) foreclose on the insurance policy; and (vi) seize the equipment already installed by JV 1.
JV 1 moved for injunctive protection and the reconsideration and annulment of the above referred resolution, based on force majeure and violation of due process defenses. CONATEL filed a motion to dismiss such action, based on the lack of standing to sue, as well as on failure to state a claim upon which relief may be granted. A final judgment regarding CONATEL’s motions must be obtained, prior to moving forward with the following stages on this administrative claim (answer to the claim, evidentiary stage, etc.).
In September 2007, an agreement was reached with the prosecution to conditionally suspend the criminal proceedings against our employees, and to have the charges ultimately dismissed. The agreement was approved by the Court on November 28, 2007. In a decision dated February 3, 2009, the conditional suspension of criminal charges was finalized by the Court and all criminal charges against our individual employees have now been dismissed.
In 2001, after a public bidding process, JV 2 was awarded a contract, with funding, for the installation and deployment of public telephones and/or telephone booths in certain specified locations in Paraguay. JV 2 was required to install and start operating all the required equipment within twelve months of the execution of the contract. In January 2003, JV 2 requested an extension of the twelve month term from CONATEL as a result of force majeure which prevented it from completing the installation of the committed number of remote terminals within the agreed time period. CONATEL denied the request and decided to terminate the contract based on JV 2’s default.
JV 2 then filed a claim before the Administrative Court requesting the annulment of the termination and seeking a stay of the challenged administrative acts. After the legal term to respond to JV 2’s request had lapsed, JV 2 filed a motion to continue the proceedings in CONATEL’s absence. The Administrative Court denied the motion and accepted CONATEL’s late presentation, opening the proceeding’s evidentiary period. JV2 filed an appeal before the Supreme Court, which was rejected on August 31, 2007. JV2 filed a reinstatement and clarification motion against the Supreme Court’s resolution on September 5, 2007. The Supreme Court dismissed the reinstatement motion and remitted the proceedings back to the Administrative Court on February 4, 2008. The parties were instructed to file evidence in connection with deadlines set forth for the evidentiary period. On May 2, 2008, we timely filed our evidence before the Court.
Customer Bankruptcy Claim
During 2007 we commenced default and disconnect procedures against a customer for breach of a sales contract based on the nature of the customer’s traffic, which renders the contract highly unprofitable to us. After the process was begun, the customer filed for bankruptcy protection, thereby barring us from taking further disconnection actions against the customer. We commenced an adversary proceeding in the bankruptcy court, asserting a claim for damages for the customer’s alleged breaches of the contract and for a declaration that, as a result of these breaches, the customer may not assume the contract in its reorganization proceedings.
The customer has filed several counterclaims against us alleging various breaches of contract for attempting improperly to terminate service, for improperly blocking international traffic, for violations of the Communications Act of 1934, as amended, and related tort-based claims. We notified the customer that we would be raising our rates and we subsequently filed a motion with the court seeking additional adequate assurance, or an order allowing us to terminate the customer’s service, based upon the rate change. The customer amended its counter claims to assert claims for breach of contract based upon the rate increase.
After the filing of motions and responses, the Court issued an opinion on these matters on July 3, 2008. The Court held that the agreement did not permit us to increase the rates in the manner we did and that we: (a) breached the sales contract in so doing; and (b) are therefore not entitled to additional adequate assurance. The Court did, however, permit us to amend our complaint to plead a rescission claim, which we filed on July 14, 2008. We also filed notices of appeal of these rulings with the United States District Court of the Southern District of New York, but those appeals were ultimately dismissed for untimeliness, without prejudice to later appeals on the merits. In the meantime, the case is continuing in the bankruptcy court with respect to the remaining liability issues and damages in the adversary proceeding. While the customer has alleged damages in amounts that would be very material to us, we believe that we have valid defenses to limit the amount of these damages. The parties exchanged expert reports in 2008 and the matter is presently scheduled for trial in 2009. We have also moved to dismiss the customer’s bankruptcy case for failure to comply with the “small business” provisions of the Bankruptcy Code. That motion is scheduled to be heard by the bankruptcy court on March 5, 2009. Customer has filed an opposition to the motion.
Universal Service Notice of Apparent Liability
On April 9, 2008, the FCC released a Notice of Apparent Liability for Forfeiture finding that subsidiaries of Global Crossing North America, Inc. apparently violated the Communications Act of 1934, as amended, and the FCC’s rules, by willfully and repeatedly failing to contribute fully and timely to the federal Universal Service Fund and the Telecommunications Relay Service Fund. The FCC alleges that, since emergence from bankruptcy, we have had a history of making our contributions to the funds late or, in certain months, making only partial contributions or not making any contributions. The FCC has proposed to assess a forfeiture of approximately $11 million. We believe that it has several defenses to the proposed forfeiture. We and the FCC are attempting to negotiate a resolution and the due date for our response has been held in abeyance.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A Special General Meeting of Shareholders of our company was held on December 10, 2008. The proposal submitted for shareholder approval at the Special General Meeting was approved. The results of the voting were as follows:
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Market Information
The table below sets forth, on a per share basis for the periods indicated the intra-day high and low sales prices for GCL’s common shares as reported by the Nasdaq Global Market for each quarter of 2007 and 2008.
There were 119 shareholders of record of GCL’s common stock on February 17, 2009.
Dividends
GCL has not declared or paid dividends on its common stock, and we do not expect it to do so for the foreseeable future. The payment of future dividends, if any, will be at the discretion of GCL’s board of directors and will depend upon, among other things, our liquidity, operations, capital requirements and surplus, general financial condition, contractual restrictions (including the preferential cumulative dividend rights of the holders of GCL’s preferred shares), restrictions under Bermuda law, and such other factors as our board of directors may deem relevant. In addition, covenants in our financing agreements significantly restrict GCL’s ability to pay cash dividends on its capital stock and also restrict the ability of GCL’s subsidiaries to transfer funds to GCL in the form of cash dividends, loans or advances. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Indebtedness,” for a discussion of such restrictions.
Description of Global Crossing Equity Securities
GCL is authorized to issue 110,000,000 common shares and 45,000,000 preferred shares. Pursuant to the GC Debtors’ plan of reorganization, on December 9, 2003, GCL issued 15,400,000 common shares to our pre-petition creditors and 6,600,000 common shares and 18,000,000 preferred shares to a subsidiary of ST Telemedia. 18,000,000 common shares were reserved for the conversion of ST Telemedia’s preferred shares. On May 30, 2006, GCL issued an additional 12 million shares and $144 million aggregate principal amount of 5% Convertible Notes in a public offering. The 5% Convertible Notes are convertible into 43.5161 common shares per $1,000 principal of notes (subject to adjustment) at any time at the election of the holders of such notes. Through February 17, 2009, approximately 6.1 million additional common shares have been issued under the 2003 Global Crossing Limited Stock Incentive Plan (the “2003 Stock Incentive Plan”), which is filed as an exhibit to this annual report on Form 10-K. As of February 17, 2009, stock options and restricted stock units covering approximately 8.6 million common shares remained outstanding under the 2003 Stock Incentive Plan (including restricted stock units covering the 4.7 million shares being paid in connection with our 2008 bonus program), and approximately an additional 4.3 million common shares are reserved for future awards to be granted under the plan. In addition, on August 27, 2007, STT Crossing Ltd effectively converted the $250 million of senior secured mandatory convertible notes then held by it into approximately 16.58 million shares of common stock. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Indebtedness.” Such issuance of common shares to STT Crossing was effected through a private placement under Section 4(2) of the Securities Act.
The following is a brief description of GCL’s common and preferred shares.
Global Crossing Common Stock
Each common share of GCL (“GCL Common Stock”) has a par value of $.01 and entitles the holder thereof to one vote on all matters to be approved by stockholders. The amended and restated bye-laws of GCL contain certain special protections for minority shareholders, including certain obligations of ST Telemedia and other third parties to offer to purchase shares of GCL Common Stock under certain circumstances. Further, ST Telemedia has the right to designate up to eight directors to our Board based upon their current percentage ownership. The amended and restated bye-laws of GCL are filed as an exhibit to this annual report on Form 10-K.
Global Crossing Preferred Stock
The 18,000,000 shares of GCL Preferred Stock issued to a subsidiary of ST Telemedia on December 9, 2003 pursuant to the GC Debtors’ plan of reorganization accumulate dividends at the rate of 2% per annum. Those dividends will be payable in cash after GCL and its subsidiaries achieve specified financial targets. The GCL Preferred Stock has a par value of $0.10 per share and a liquidation preference of $10 per share (for an aggregate liquidation preference of $180 million). The GCL Preferred Stock ranks senior to all other capital stock of GCL, provided that any distribution to shareholders following a disposition of all or any portion of the assets of GCL will be shared pro rata by the holders of GCL Common Stock and GCL Preferred Stock on an as-converted basis. Each share of GCL Preferred Stock is convertible into one share of GCL Common Stock at the option of the holder.
The GCL Preferred Stock votes on an as-converted basis with the GCL Common Stock, but has class voting rights with respect to any amendments to the terms of the GCL Preferred Stock. As long as ST Telemedia beneficially owns a certain minimum percentage of the outstanding GCL Common Stock (calculated after giving effect to the conversion of the GCL Preferred Stock), the certificate of designations for the GCL Preferred Stock requires its approval for certain major corporate actions of GCL and/or its subsidiaries. Those corporate actions include (i) the appointment or replacement of the chief executive officer, (ii) material acquisitions or dispositions, (iii) mergers, consolidations or reorganizations, (iv) issuance of additional equity securities (other than enumerated exceptions), (v) incurrence of indebtedness above specified amounts, (vi) capital expenditures in excess of specified amounts, (vii) the commencement of bankruptcy or other insolvency proceedings, and (viii) certain affiliate transactions. The certificate of designations for the GCL Preferred Stock is filed as an exhibit to this annual report on Form 10-K.
Equity Compensation Plan Information
Table of Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth the indicated information regarding our equity compensation plans and arrangements as of December 31, 2008.
The weighted-average exercise price does not take into account the shares issuable upon vesting of 1,219,141 outstanding restricted stock unit awards and 1,170,100 performance share awards, which have no exercise price.
Purchases of Equity Securities
The following table sets forth the indicated information for all purchases made by or on behalf of us of our common stock during 2008. All such purchases were made to comply with tax withholding requirements related to the vesting or exercise of stock-based awards granted to participants under the 2003 Global Crossing Limited Stock Incentive Plan.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The table below presents our selected consolidated financial data as of and for the five years ended December 31, 2008. The historical financial data as of December 31, 2008 and 2007 and for the years ended December 31, 2008, 2007 and 2006 have been derived from the historical consolidated financial statements presented elsewhere in this annual report on Form 10-K and should be read in conjunction with such consolidated financial statements and accompanying notes.
Upon emergence from bankruptcy on December 9, 2003, we adopted fresh start accounting. As a result, the historical financial data for the years ended December 31, 2008, 2007, 2006, 2005 and 2004 reflect settlements of various third-party disputes and revised estimated liabilities for certain contingencies related to periods prior to our emergence from Chapter 11 proceedings. We accounted for these contingencies in accordance with AICPA Practice Bulletin 11-”Accounting for Pre-confirmation Contingencies in Fresh Start Reporting” and recorded net gains on the settlements and/or changes in estimated liabilities.
In reading the above selected historical financial data, please note the following:
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On May 9, 2007, we acquired Impsat for cash of $9.32 per share of Impsat common stock, representing a total equity value of approximately $95 million. The total purchase price including direct costs of acquisition was approximately $104 million. Impsat is a leading Latin American provider of IP, hosting and value-added data solutions. As a result of the acquisition, we are able to provide greater breadth of services and coverage in the Latin American region and enhance our competitive position as a global service provider. The results of Impsat’s operations have been included in our results commencing May 9, 2007. Due to the purchase, we recorded a $27 million non-cash, non-taxable gain from the deemed settlement of pre-existing arrangements.
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During 2007, we raised significant capital through the issuance of debt. On February 14, 2007, GC Impsat, a wholly owned subsidiary, issued $225 million in aggregate principal amount of 9.875% senior notes due February 15, 2017. On May 9, 2007, we entered into the Term Loan Agreement with Goldman Sachs Credit Partners L. P. and Credit Suisse Securities (USA) LLC pursuant to which we borrowed $250 million on that date and on June 1, 2007 amended the Term Loan Agreement to provide for the borrowing of an additional $100 million on that date. Also, in conjunction with the recapitalization pursuant to which we entered into the Term Loan Agreement, on August 27, 2007, STT Crossing Ltd. converted $250 million original principal amount of mandatorily convertible notes due December 2008 (the “Mandatorily Convertible Notes”) into approximately 16.58 million shares of common stock. We recorded a $30 million inducement fee related to the early conversion of STT Crossing Ltd. debt to equity in other income (expense), net.
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During 2007, we released a contingent liability and interest accrued on that liability as a result of a tax court dismissing the claim and recorded a $27 million net gain on settlement of pre-conformation contingencies and an $8 million reduction in interest expense.
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In October 2006, we acquired Fibernet. The total purchase price including direct costs of the acquisition was approximately 52 million pounds sterling (approximately $97 million). Fibernet is a provider of specialist telecommunications services to large enterprises and other telecommunications and internet service companies primarily located in the United Kingdom and Germany. Fibernet’s results of operations have been included in our results since October 11, 2006, the date we took control of their operations.
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During 2006, we raised significant capital (both debt and equity). On May 30, 2006, we made concurrent public offerings of 12,000,000 shares of common stock and $144 million aggregate principal amount of 5% Convertible Senior Notes due 2011 for total gross proceeds of $384 million. On December 28, 2006, we issued an additional 52 million pounds sterling aggregate principal amount of 11.75% pound sterling Senior Secured Notes due 2014. The additional notes were issued at a premium of approximately 5 million pounds sterling which resulted in us receiving gross proceeds, before underwriting fees, of approximately $111 million. The notes are additional notes issued under the original GCUK Senior Secured Notes bond indenture dated December 23, 2004.
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The consolidated statement of operations data for 2004 and 2005 reflect the results of Global Marine and SB Submarine Systems Company Ltd. (“SBSS”) as discontinued operations. In 2004 Global Marine
was sold for consideration of $1 million, resulting in no gain on the sale. In 2005 we completed the transfer of our interest in SBSS for consideration of $14 million, resulting in a gain of $8 million on the sale.
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Restructuring plans resulting in employee terminations, closing of real estate facilities, and cancellation of contracts have resulted in significant restructuring charges (credits). Excluding those related to acquired businesses which are included as liabilities assumed in our purchase price, we have recorded restructuring charges (credits) of $3 million, $(30) million, $(4) million, $18 million and $15 million in the results from operations above in 2008, 2007, 2006, 2005 and 2004, respectively. These charges (credits) are included in selling, general and administrative expenses. See further discussion under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read together with our consolidated financial statements and related notes appearing in this annual report on Form 10-K.
Some of the statements contained in the following discussion of our financial condition and results of operations refer to future expectations and business strategies or include other “forward-looking” information. Those statements are subject to known and unknown risks, uncertainties and other factors that could cause the actual results to differ materially from those contemplated by the statements. The forward-looking information is based on various factors and was derived from numerous assumptions. See Item 1A, “Risk Factors,” for risk factors that should be considered when evaluating forward-looking information detailed below. These factors could cause our actual results to differ materially from the forward-looking statements.
Executive Summary
Overview
We are a global communications service provider, serving many of the world’s largest corporations and many other telecommunications carriers, providing a full range of IP and managed data and voice products and services. Our network delivers services to more than 690 cities in more than 60 countries and six continents around the world. We operate as an integrated global services provider with operations in North America, Europe, Latin America and a portion of the Asia/Pacific region, providing services that support a migration path to a fully converged IP environment. The vast majority of our revenue is generated from monthly services.
As a result of the May 9, 2007 acquisition of Impsat (see Note 4, “Acquisitions,” to the accompanying consolidated financial statements) and the establishment of a business unit management structure, we now report our financial results based on three separate operating segments: (i) the GCUK Segment which provide services to customers primarily based in the U.K.; (ii) the GC Impsat Segment which provide services to customers in Latin America; and (iii) the Rest of World Segment or ROW Segment which represents all our operations outside of the GCUK Segment and the GC Impsat Segment and operates primarily in North America, with smaller operations in Europe, Latin America, and Asia and includes our subsea fiber network. Prior to the Impsat acquisition, our operating segments were based on product and customer groupings rather than geographic region. Specifically, our operating segments before the Impsat acquisition were “enterprise, carrier data and indirect channels” (also referred to as “invest and grow” in our press releases pertaining to financial results), “carrier voice” and “consumer voice.” These groupings are now considered sales channels within our geographic operating segments. See below in this Item 7 and Note 23, “Segment Reporting,” to our consolidated financial statements included in this annual report on Form 10-K for further information regarding our operating segments.
Industry, Strategy and Certain Key Risks
As described more fully in Item 1, “Business-Business Strategy,” our strategy calls for a continued focus on and investment in our target enterprise, carrier data and indirect sales channel, thereby capitalizing on anticipated continued growth in the demand for global bandwidth and IP services. We believe we are well positioned to take advantage of ongoing changes in the telecommunications industry, including globalization and industry consolidation, which we expect to result in increased demand from customers seeking network diversity and redundancy from a supplier who can meet their requirements worldwide.
For 2009, we have set a number of operational objectives which we believe will help enhance revenue growth (on a constant currency basis) and/or profitability. We are implementing actions to improve our cost structure including unpaid leave where permitted by local regulations and suspension of matching contributions under our defined contribution retirement savings plan in the United States. We will continue to focus strongly on customer loyalty, by driving enhancements to ensure superior customer service. We also will continue to
focus on motivating our employees, since they are critical to our differentiation and ability to meet our other objectives. In addition, we intend to invest in products and services by augmenting capacity and selectively bringing new products to market, such as hosted IP telephony and Ethernet services, while enhancing our flagship VPN and VoIP offerings.
Successful execution of these objectives is subject to numerous risks and uncertainties, including the risks described in Item 1A, “Risk Factors,” above. In particular:
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It becomes more difficult to continue to improve our cost structure in the short term as the opportunities for further savings decreases due to the success of past savings initiatives.
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Cost savings initiatives put a strain on our existing employees and make it more challenging to foster an engaged and enthusiastic workforce. Customer service, which is a critical component of our value proposition, could suffer if employee engagement were to deteriorate.
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Our ability to generate positive cash flow over the long term is predicated on significant revenue growth in our target enterprise, carrier data and indirect sales channel, together with associated economies of scale. Although we have experienced consistent growth in this sales channel since we first announced the shift in our business focus in late 2004, there can be no assurance that such growth will continue. The current slowdown in economic conditions in the US. and elsewhere could temper our growth, although the value we offer prospective customers could attract business in a cost-saving environment.
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Although we have significant cash on hand, if the operating and capital expenses required to support our growth turn out to be greater than anticipated or if anticipated growth is not achieved, we may be unable to improve our cash flows. If our cash flows do not improve, we would need to arrange additional financing which may not be available on acceptable terms or at all, particularly given current conditions in the credit markets. See “-Liquidity and Capital Resources,” below.
2008 Highlights
During 2008, revenues from our enterprise, carrier data and indirect sales channel, which is the primary focus of our business strategy, increased $370 million or 21% to $2,164 million from $1,794 million in 2007. This increase was primarily the result of the inclusion of Impsat in our results since May 9, 2007 (which increased $199 million to $459 million from $260 million, a 77% increase from the prior year) and higher revenues at our ROW and GCUK Segments (which together increased $171 million to $1,705 million from $1,534 million, a 11% increase from the prior year), driven by growth in the existing customer base and the acquisition of new customers in specific enterprise and carrier target markets. In addition, currency movements in 2008 compared with 2007 adversely impacted consolidated revenue by $15 million, with an adverse currency impact on our GCUK Segment being partially offset by positive currency impacts on our GC Impsat and ROW Segments.
During 2008, we posted a net operating loss of $53 million, generated $203 million of cash provided by operating activities and had a net decrease in cash and cash equivalents of $37 million. Our cash flows included the following significant items: (i) a decrease in restricted cash and cash equivalents of $31 million primarily resulting from releasing the $22 million debt service reserve account for the GC Impsat Notes, which decrease benefited unrestricted cash balances; (ii) a decrease of $19 million resulting from the effect of exchange rate changes on our cash and cash equivalents due to the appreciation of the U.S. Dollar against certain foreign currencies in which we held significant cash balances; and (iii) the receipt of $146 million of cash from the sale of IRUs and prepayment of services, which significantly exceeded our expectations.
2009 Outlook
On a constant currency basis, we expect revenue to grow in the mid-to-high single digit percentage range in 2009. We expect this growth to come from our enterprise, carrier data and indirect sales channel as a result of acquiring new customers and increased sales to existing customers. We expect our carrier voice sales channel
revenue to decline in the mid-to-high single digit percentage range. The resulting shift in revenues from our low margin carrier voice sales channel to our much higher margin enterprise, carrier data and indirect sales channel, as well as the impact of ongoing access costs savings initiatives, are expected to result in an improved overall gross margin percentage.
Real estate, network and operations and selling, general and administrative expenses are expected to decrease during 2009 relative to 2008 as the U.S. Dollar value of expenditures in foreign currencies decreases as a result of the depreciation in the values of those currencies relative to the U.S. Dollar that occurred in the later part of 2008 and early 2009. On a constant currency basis, we expect these expenses to remain relatively flat or to decrease modestly in 2009 as a result of the actions noted above to improve our cost structure.
In the short-term, we expect cash provided by operating activities to exceed purchases of property and equipment. This expectation is based in part on raising financing for such property and equipment from vendors and others comparable to those arranged in 2008. Our ability to arrange such financings is subject to negotiating acceptable terms from equipment vendors and financing parties. This could prove more difficult given current adverse conditions in the credit markets.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon the accompanying consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, (“U.S. GAAP”). The preparation of financial statements in conformity with U.S. GAAP requires management to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and the related disclosures at the date of the financial statements and during the reporting period. Although these estimates are based on our knowledge of current events, our actual amounts and results could differ from those estimates. The estimates made are based on historical factors, current circumstances, and the experience and judgment of our management, who continually evaluate the judgments, estimates and assumptions and may employ outside experts to assist in the evaluations.
Certain of our accounting policies are deemed “critical,” as they are both most important to the financial statement presentation and require management’s most difficult, subjective or complex judgments as a result of the need to make estimates about the effect of matters that are inherently uncertain. For a full description of our significant accounting policies, see Note 2, “Basis of Presentation and Significant Accounting Policies,” to the accompanying consolidated financial statements.
Receivable Reserves
Sales Credit Reserves
During each reporting period we must make estimates for potential future sales credits to be issued in respect of current revenues, related to billing errors, service interruptions and customer disputes which are recorded as a reduction in revenue. We analyze historical credit activity and changes in customer demands related to current billing and service interruptions when evaluating our credit reserve requirements. We reserve known billing errors and service interruptions as incurred. We review customer disputes and reserve against those we believe to be valid claims. We also estimate a general sales credit reserve related to unknown billing errors and disputes based on such historical credit activity. The determination of the general sales credit and customer dispute credit reserve requirements involves significant estimation and assumption.
Allowance for Doubtful Accounts
During each reporting period we must make estimates for potential losses resulting from the inability of our customers to make required payments. We analyze our reserve requirements using several factors, including the length of time the receivables are past due, changes in the customer’s creditworthiness, the customer’s payment
history, the length of the customer’s relationship with us, the current economic climate, and current industry trends. A specific reserve requirement review is performed on customer accounts with larger balances. A general reserve requirement is performed on accounts not subject to specific review utilizing the factors previously mentioned. We have historically experienced significant changes month to month in reserve level requirements. Due to the current economic climate, the competitive environment in the telecommunications sector and the volatility of the financial strength of particular customer segments including resellers and CLECs, the collectability of receivables and creditworthiness of customers may become more difficult and unpredictable. Changes in the financial viability of significant customers and worsening of economic conditions may require changes to our estimate of the recoverability of the receivables. In some cases receivables previously written off are recovered through litigation, negotiations, settlements and judgments and are recognized as a reduction in bad debt expense in the period realized. Appropriate adjustments are recorded to the period in which these changes become known. The determination of both the specific and general allowance for doubtful accounts reserve requirements involves significant estimation and assumption.
Cost of Access Expense and Accruals
Our cost of access primarily comprises charges for leased lines for dedicated facilities and usage-based voice charges paid to local exchange carriers and interexchange carriers to originate and/or terminate switched voice traffic. Our policy is to record access expense as services are provided by vendors.
The recognition of cost of access expense during any reported period involves the use of significant management estimates and requires reliance on non-financial systems given that bills from access vendors are generally received significantly in arrears of service being provided. Switched voice traffic costs are accrued based on the minutes recorded by our switches, multiplied by the estimated rates for those minutes for that month. Leased line access costs are estimated based on the number of circuits and the average circuit cost, according to our leased line inventory system, adjusted for contracted rate changes. Upon final receipt of invoices, the estimated costs are adjusted to reflect actual expenses incurred.
Disputes
We perform monthly bill verification procedures to identify errors in vendors’ billing processes. The bill verification procedures include the examination of bills, comparing billed rates with rates used by the cost of access expense estimation systems during the cost of access monthly close process, evaluating the trends of invoiced amounts by vendors, and reviewing the types of charges being assessed. If we believe that we have been billed inaccurately, we will dispute the charge with the vendor and begin resolution procedures. We record a charge to the cost of access expense and a corresponding increase to the access accrual based on the last eighteen months of historical loss rates for the particular type of dispute. If we ultimately reach an agreement with an access vendor to settle a disputed amount which is different than the corresponding accrual, we recognize the difference in the period in which the settlement is finalized as an adjustment to cost of access expense.
Impairment of Goodwill and Other Long-Lived Assets
We assess the possible impairment of long-lived assets composed of property and equipment, goodwill, other intangibles and other assets held for a period longer than one year whenever events or changes in circumstances indicate that the carrying amount of the asset(s) may be impaired. Goodwill and intangibles with indefinite lives are reviewed at least annually (beginning on the first anniversary of the acquisition date) for impairment whether or not events have occurred that may indicate impairment. Recoverability of assets to be held and used is measured by comparing the carrying amount of an asset to the undiscounted net future cash flows expected to be generated by the asset. If these projected future cash flows are less than the carrying amount, impairment would be recognized, resulting in a write-down of the assets with a corresponding charge to earnings. The impairment loss is measured by the amount by which the carrying amounts of the assets exceed their fair value. Calculating the future net cash flows expected to be generated by assets to determine if
impairment exists and to calculate the impairment involves significant assumptions, estimation and judgment. The estimation and judgment involves, but is not limited to, industry trends including pricing, estimating long term revenues, revenue growth, operating expenses, capital expenditures, and expected periods the assets will be utilized.
We performed annual impairment reviews of the goodwill acquired as part of the Fibernet and Impsat acquisitions in accordance with Statement of Financial Accounting Standards (“SFAS”) No 142, “Goodwill and Other Intangible Assets.” The impairment reviews compared the fair value of the reporting units, using a discounted cash flow analysis, to their carrying values, including allocated goodwill. The results of the reviews indicate that no impairment exists as the fair value of all reporting units exceeded their carrying values, including allocated goodwill.
As a result of continued operating losses and negative cash flows during 2008, management performed a recoverability test of our long-lived assets as of December 31, 2008. The results of the test indicate that no impairment of our long-lived assets existed as of December 31, 2008.
Taxes
At each period end, we must make certain estimates and assumptions to compute the provision for income taxes including allocations of certain transactions to different tax jurisdictions, amounts of permanent and temporary differences, the likelihood of deferred tax assets being recovered and the outcome of contingent tax risks. These estimates and assumptions are revised as new events occur, more experience is acquired and additional information is obtained. The impact of these revisions is recorded in income tax expense or benefit in the period in which they become known.
Our current and deferred income taxes, and associated valuation allowances, are impacted by events and transactions arising in the normal course of business as well as in connection with special and non-recurring items. Assessment of the appropriate amount and classification of income taxes is dependent on several factors, including estimates of the timing and realization of deferred income tax on income and deductions. Actual realization of deferred tax assets and liabilities may materially differ from these estimates as a result of changes in tax laws as well as unanticipated future transactions impacting related income tax balances.
The assessment of a valuation allowance on deferred tax assets is based on the weight of available evidence that some portion or all of the deferred tax asset will not be realized. Deferred tax liabilities are first applied to the deferred tax assets reducing the need for a valuation allowance. Future utilization of the remaining net deferred tax asset would require the ability to forecast future earnings. Based on past performance resulting in net loss positions, sufficient evidence exists to require a valuation allowance on all of our net deferred tax assets.
See “Recently Issued Accounting Pronouncements” in this item for the impact to accounting for income taxes as a result of the adoption of new accounting pronouncements.
Restructuring
We have engaged in restructuring activities, which require us to make significant judgments and estimates in determining restructuring charges, including, but not limited to, future severance costs and other employee separation costs, sublease income or disposal costs, length of time on market for abandoned rented facilities, and contractual termination costs. Such estimates are inherently judgmental and changes in such estimates, especially as they relate to contractual lease commitments and related anticipated third-party sub-lease payments, could have a material effect on the restructuring liabilities and consolidated results of operations. The undiscounted “2003 and Prior Restructuring Plans” reserve, which represents estimated future cash flows, is composed of continuing building lease obligations and broker commissions for the restructured sites (aggregating $107 million as of December 31, 2008), offset by anticipated receipts from existing and future third-party subleases. As of
December 31, 2008, anticipated third party receipts were $93 million, representing $43 million from subleases already entered into and $50 million from subleases projected to be entered into in the future. A significant amount of judgment is involved in determining the amount and timing of these projected subleases. We continue to review our anticipated costs and third party sublease payments on a quarterly basis and record adjustments for changes in these estimates in the period such changes become known. For further information related to our restructuring activities, see “Restructuring Activities” in this Item and Note 3, “Restructuring,” to the accompanying consolidated financial statements.
Stock-Based Compensation
We follow SFAS No. 123R, “Share Based Payment” (“SFAS 123R”) to account for stock-based compensation. SFAS 123R requires all share-based awards granted to employees to be recognized as compensation expense over the service period (generally the vesting period) in the consolidated financial statements based on their fair values. Under the fair value provisions of SFAS No. 123R, the fair value of each stock-based compensation award is estimated at the date of grant. We estimate the fair value of stock-based compensation awards using current market price for restricted stock units and using the Black-Scholes option pricing model for stock options. We recognize stock compensation expense based on the number of awards expected to vest. Certain stock-based awards have graded vesting (i.e. portions of the award vest at different dates during the vesting period). The fair value of the awards is determined using a single expected life for the entire award (the average expected life for the awards that vest on different dates). We recognize the related compensation cost of such awards on a straight-line basis; provided that the amount amortized at any given date may be no less than the portion of the award vested as of such date.
For a description of our stock-based compensation programs, see Note 18, “Stock-Based Compensation”, to the accompanying consolidated financial statements included in this annual report on Form 10-K.
Assessment of Loss Contingencies
We have legal, tax and other contingencies that could result in significant losses upon the ultimate resolution of such contingencies. We have provided for losses in situations where we have concluded that it is probable that a loss has been or will be incurred and the amount of the loss is reasonably estimable. A significant amount of judgment is involved in determining whether a loss is probable and reasonably estimable due to the uncertainty involved in predicting the likelihood of future events and estimating the financial impact of such events. Accordingly, it is possible that upon the further development or resolution of a contingent matter, a significant charge could be recorded in a future period related to an existing contingent matter. For additional information, see Note 21, “Commitments, Contingencies and Other,” to the accompanying consolidated financial statements.
Results of Operations for the Year Ended December 31, 2008 compared to the Year Ended December 31, 2007
Consolidated Results
NM-Zero balances and comparisons from positive to negative numbers are not meaningful.
Discussion of significant variances:
Revenue
Our consolidated revenues are separated into sales channels based on our target markets and sales structure: (i) enterprise, carrier data and indirect sales channel and (ii) carrier voice.
The enterprise, carrier data and indirect sales channel consists of: (i) the provision of voice, data and collaboration services to all customers other than carriers and consumers; (ii) the provision of data products, including IP, transport and capacity services, to carrier customers; and (iii) the provision of voice, data and managed services to or through business relationships with other carriers, sales agents and system integrators. The carrier voice sales channel consists of the provision of predominantly United States domestic and international long distance voice services to carrier customers.
During 2008, we transferred our legacy Brazilian and Chilean operations from the ROW Segment to the GC Impsat Segment. As these transfers were between entities under common control, we have retroactively restated the GC Impsat Segment results to include the results of the Brazilian and Chilean operations and removed the results of the Brazilian and Chilean operations from the ROW Segment for all applicable periods presented. We anticipate transferring our Argentine operations from the ROW Segment to the GC Impsat Segment during 2009 in a continuing effort to streamline our operations.
Our consolidated revenue increased in 2008 compared with 2007 as a result of higher revenue at all of our segments. Our consolidated revenue increased in 2008 compared with 2007 primarily as a result of higher revenue at our GCUK and ROW Segments, and the inclusion of Impsat in our results since May 9, 2007. Revenue growth reflected strong demand across all of our segments for broadband lease, enterprise voice services and IP VPN and other data products. In addition, ROW Segment revenue growth reflected strong demand for our collaboration services. These increases were partially offset by decreased carrier voice revenue primarily as a result of decreases in our average pricing for our U.S. domestic long distance voice services at our ROW Segment. Our average pricing related to U.S. domestic long distance voice services declined in 2008
compared with 2007, while our sales volumes for these services increased. We expect our carrier voice sales channel revenue to decline in the mid-to-high single digit percentage range in 2009 as we continue to manage the business for margin. In addition, currency movements in 2008 compared with 2007 adversely impacted consolidated revenue by $15 million, with an adverse currency impact on our GCUK Segment being partially offset by positive currency impacts on our GC Impsat and ROW Segments.
Our sales order levels, which are a key indicator of continuing strength in customer demand for our services, remained at healthy levels during 2008. Average monthly estimated gross values for sales orders were similar in 2008 compared to 2007. Average monthly estimated gross values, on a constant currency basis, for the fourth quarter of 2008 decreased approximately 10% from the average value for the entire year with most of the decrease attributable to North American enterprise sales. This metric is used by management as a leading business indicator offering insight into near term revenue trends. The gross values of these monthly recurring orders are estimated based on new business acquired, and they exclude the effects of attrition, the replacement of existing services with new services, and credits.
See “Segment Results” in this Item 7 for further discussion of results by segment.
Cost of Revenue. Cost of revenue primarily includes the following: (i) cost of access, including usage-based voice charges paid to local exchange carriers and interexchange carriers to originate and/or terminate switched voice traffic and charges for leased lines for dedicated facilities and local loop (“last mile”) charges from both domestic and international carriers; (ii) real estate, network and operations charges which include (a) employee-related costs such as salaries and benefits, incentive compensation and stock-related expenses for employees directly attributable to the operation of our network, (b) real estate expenses for all non-restructured technical sites, and (c) other non-employee related costs incurred to operate our network, such as license and permit fees and professional fees; (iii) third party maintenance costs incurred in connection with maintaining the network; and (iv) cost of equipment sales, which includes the software, hardware and equipment sold to our customers.
Cost of Access
Cost of access increased in 2008 compared with 2007 primarily driven by increases in revenue in the enterprise, carrier data and indirect sales channel business of our GCUK and ROW Segments, as well as the inclusion of Impsat in our results since May 9, 2007. Included in our cost of access for 2008 and 2007 was $105 million and $66 million, respectively related to Impsat (net of intersegment cost of access). The increase in cost of access was moderated by: (i) our cost reduction initiatives to optimize access network costs and effectively lower unit prices and (ii) lower carrier voice sales revenue in our ROW Segment. In addition, currency movements in 2008 compared with 2007 favorably impacted our consolidated cost of access expense by $2 million in 2008 compared with 2007, with a favorable impact on our GCUK Segment being partially offset by unfavorable impacts on our GC Impsat and ROW Segments.
Real Estate, Network and Operations. Real estate, network and operations increased in 2008 compared with 2007 primarily due to an increase of $18 million resulting from including Impsat in our results since May 9, 2007 and a $17 million increase in real estate costs primarily driven by higher facilities rent, facilities maintenance and utilities expense. The higher facilities rent resulted primarily from our decision in 2007 to convert idle real estate facilities previously included in the restructuring reserve into productive operating assets in connection with the establishment of our European collocation business. The increase in real estate, network and operations in 2008 compared with 2007 was partially offset by decreases in salaries and benefits of $9 million, primarily as a result of headcount reductions at our GCUK and ROW Segments under the May 10, 2007 restructuring plan.
Third Party Maintenance. Third party maintenance increased in 2008 compared with 2007 primarily due to the inclusion of Impsat in our results since May 9, 2007, partially offset by lower GCUK Segment third party maintenance resulting from renegotiation of certain contracts.
Cost of Equipment Sales. Cost of equipment sales increased in 2008 compared with 2007 primarily due to including Impsat in our results since May 9, 2007 and higher managed services sales at our GCUK Segment. This increase was partially offset by decreased equipment sales volume at our ROW Segment and a $5 million beneficial effect of foreign currency movements at our GCUK Segment.
Selling, General and Administrative Expenses (“SG&A”). SG&A consist of: (i) employee-related costs such as salaries and benefits, incentive compensation and stock-related expenses for employees not directly attributable to the operation of our network; (ii) real estate expenses for all non-restructured administrative sites; (iii) bad debt expense; (iv) non-income taxes, including property taxes on owned real estate and trust fund related taxes such as gross receipts taxes, franchise taxes and capital taxes; (v) restructuring costs; and (vi) regulatory costs, insurance, telecommunications costs, professional fees and license and maintenance fees for internal software and hardware.
The increase in SG&A in 2008 compared with 2007 was primarily due to an increase of $57 million resulting from including Impsat in our results since May 9, 2007, and higher facilities restructuring expenses of $43 million, primarily driven by a release of restructuring reserves during 2007 due to the settlement and termination of existing real estate lease agreements for technical facilities and the decision in 2007 to convert idle real estate facilities previously included in the restructuring reserve to productive operating assets in connection with the establishment of our European collocation business. This increase in SG&A was partially offset by lower severance-related restructuring charges of $10 million, primarily driven by restructuring charges recorded in 2007 due to the May 10, 2007 restructuring plan.
Depreciation and Amortization. Depreciation and amortization consists of depreciation of property and equipment, including leased assets, amortization of cost of access installation costs and amortization of identifiable intangibles. Depreciation and amortization increased in 2008 compared with 2007 primarily due to: (i) amortization of acquired intangible assets related to the Impsat acquisition; (ii) an increased asset base as a result of fixed asset additions, including assets recorded under capital leases; and (iii) the inclusion of Impsat’s results in our results since May 9, 2007.
Interest income. The decrease in interest income in 2008 compared with 2007 was the result of lower average cash balances and lower interest rates.
Interest Expense. Interest expense includes interest related to indebtedness for money borrowed, capital lease obligations, certain tax liabilities, amortization of deferred finance costs and interest on late payments to vendors. The decrease in interest expense in 2008 compared with 2007 was primarily a result of: (i) decreased interest resulting from STT Crossing Ltd.’s effective conversion of its $250 million original principal amount of Mandatorily Convertible Notes into approximately 16.58 million shares of common stock on August 27, 2007 and (ii) lower interest related to our pound sterling denominated GCUK Notes due to beneficial foreign currency movements. The decrease in interest expense for 2008 compared with 2007 as described above was mostly offset by including for a full period interest on the $350 million term loan incurred by us during the second quarter of 2007 and the GC Impsat Notes issued by GC Impsat on February 14, 2007, as well as increased interest related to capital leases and other miscellaneous debt.
Other Expense, Net. Other expense, net consists of foreign currency impacts on transactions, gains and losses on the sale of assets including property and equipment, marketable securities and other assets and other non-operating items. Other expense, net increased in 2008 compared with 2007 primarily as a result of: (i) recording net foreign exchange losses in 2008 compared with net foreign exchange gains in 2007 and (ii) recording in the prior year period a $27 million non-cash, non-taxable gain from deemed settlement of pre-existing arrangements with Impsat on the date of acquisition. This increase in other expense, net was partially offset by: (i) expensing in the prior year period a $30 million inducement fee related to the early conversion of STT debt to equity; (ii) expensing in the prior year period $10 million of deferred financing fees related to both: (a) a Bank of America working capital facility, which was retired during the second quarter of 2007 and (b) a bridge loan commitment which was terminated upon issuance of the GC Impsat Notes; and (iii) recording in 2008 a $4 million gain on the sale of land.
Net Gain on Pre-confirmation Contingencies. During 2008 and 2007, we settled various third-party disputes and revised our estimated liability for certain contingencies related to periods prior to our emergence from chapter 11 proceedings. We have accounted for these in accordance with AICPA Practice Bulletin 11-Accounting for Pre-confirmation Contingencies in Fresh Start Reporting and recorded a net gain on the settlements and changes in estimated liabilities. The most significant gains are related to changes in estimated liabilities for income and non-income tax contingencies and settlements with certain tax authorities. Included in the 2008 net gain on pre-confirmation contingencies is a gain of $4 million related to the release of an accrual for a contingent liability to a government authority in South America. Included in the 2007 net gain on pre-confirmation contingencies was a gain of $27 million related to the release of a contingent liability for a claim made by a tax authority in South America.
Provision for Income Taxes. The decrease in the provision for income taxes in 2008 compared with 2007 was a result of beneficial foreign exchange effects in certain jurisdictions during 2008, and a $9 million valuation allowance recorded against our U.K. deferred tax assets during 2007. This decrease was partially offset by including Impsat in our results for the full year in 2008, and increased taxable income in various jurisdictions due to growth in revenue. During 2008 and 2007, we realized $5 million and $4 million, respectively, of tax benefits resulting from the use of deferred tax assets acquired as part of the Impsat acquisition. These deferred tax assets had been subject to a full valuation allowance. As such, the reversal of the valuation allowance has been recorded as a reduction of goodwill, in accordance with SFAS 109 (see Note 15, “Income Tax” to the accompanying consolidated financial statements).
Provision for income taxes related to fresh start accounting for deferred tax benefits realized after our emergence from bankruptcy does not result in cash taxes. This non-cash tax provision was $30 million and $41 million for the years ended December 31, 2008 and 2007, respectively.
See “Recently Issued Accounting Pronouncements” in this item for the impact to accounting for income taxes as a result of the adoption of new accounting pronouncements.
Results of Operations for the Year Ended December 31, 2007 compared to the Year Ended December 31, 2006
Consolidated Results
Discussion of significant variances:
Revenue.
Our consolidated revenues increased in 2007 compared with 2006 primarily as a result of the inclusion of Fibernet and Impsat in our results since October 11, 2006 and May 9, 2007, respectively; strong growth in the ROW Segment and the favorable impact on our GCUK Segment due to currency movements. Revenue growth in the ROW Segment resulted from strong demand for broadband lease, IP VPN data products, enterprise voice and managed services, partially offset by decreased carrier voice revenues as a result of decreases in sales volumes due to our strategy to reduce our emphasis on this market.
Sales order values remained strong throughout 2007 with average monthly estimated gross values increasing approximately 15% compared with 2006.
See “Segment Results” in this Item 7 for further discussion of results by segment.
Cost of Revenue.
Cost of access
Cost of access increased in 2007 compared with 2006 primarily driven by increases in access charges in our GCUK, GC Impsat and ROW Segments’ enterprise, carrier data and indirect sales channel. The increase in cost of access is due primarily to inclusion of Fibernet and Impsat in our results since October 11, 2006 and May 9, 2007, respectively, and the cost to support the ROW Segment enterprise, carrier data and indirect sales channel revenue growth. Included in our consolidated cost of access were $20 million and $6 million related to Fibernet for 2007 and 2006, respectively, and $66 million and $5 million related to Impsat (net of intersegment cost of access) for 2007 and 2006, respectively. This increase was partially offset by: (i) our cost reduction initiatives to optimize the access network and effectively lower unit prices and (ii) lower carrier voice sales volume in our ROW Segment.
Real Estate, Network and Operations. Real estate, network and operations increased in 2007 compared with 2006 primarily due to: (i) a $20 million increase in salaries and benefits as a result of increased average headcount and salary increases; (ii) a $16 million increase in stock and cash compensation primarily as a result of the retention and motivation awards granted to employees in 2007 and accruing the 2007 annual bonus program at a higher rate than 2006; (iii) an increase of $6 million resulting from including Fibernet in our results since October 11, 2006; and (iv) an increase of $31 million resulting from including Impsat in our results since May 9, 2007.
Third Party Maintenance. Third party maintenance increased in 2007 compared with 2006 primarily due to the inclusion of Fibernet and Impsat in our results since October 11, 2006 and May 9, 2007, respectively.
Cost of Equipment Sales. Cost of equipment sales increased in 2007 compared with 2006 primarily due to increased equipment, conferencing and managed services sales.
Selling, General and Administrative Expenses. The increase in SG&A in 2007 compared with 2006 was primarily due to: (i) a $13 million increase in salaries and benefits primarily as a result of salary increases and increased sales commissions due to increased revenues; (ii) a $14 million increase in stock and cash compensation primarily as a result of the retention and motivation awards granted to employees in 2007 and accruing the 2007 annual bonus program at a higher rate than 2006; (iii) an increase of $5 million resulting from including Fibernet in our results since October 11, 2006; (iv) an increase of $69 million resulting from including Impsat in our results since May 9, 2007; and (v) an increase in employee related restructuring charges of $11 million primarily due to the May 10, 2007 restructuring plan. This increase was partially offset primarily by a decrease in real estate related restructuring charges of $36 million predominantly due to accrual reversals resulting from the settlement and termination of existing real estate lease agreements for technical facilities during 2007 and the decision in 2007 to convert idle real estate facilities previously included in the restructuring reserve to productive operating assets in connection with the establishment of our European collocation business.
Depreciation and Amortization. Depreciation and amortization increased in 2007 compared with 2006 primarily due to: (i) an increased asset base as a result of fixed asset additions, including assets recorded under capital leases; (ii) amortization of acquired intangible assets related to the Fibernet and Impsat acquisitions; (iii) inclusion of Fibernet’s results in our results since October 11, 2006 and (iv) inclusion of Impsat’s results in our results since May 9, 2007.
Interest Expense. The increase in interest expense for 2007 compared with 2006 is primarily a result of incurring additional indebtedness and capital lease obligations, including the $144 million aggregate principal amount of 5% convertible senior notes due 2011 (the “5% Convertible Notes”) which were issued by GCL on May 30, 2006, the 11.75% senior secured notes issued by GCUK on December 28, 2006, the GC Impsat Notes issued by GC Impsat on February 14, 2007, the $350 million Term Loan Agreement incurred by GCL during the second quarter of 2007 and amortization of deferred financing costs related to these debt obligations. The increase in interest expense for 2007 compared to the prior year was slightly offset by decreased interest on the Mandatorily Convertible Notes due to STT Crossing Ltd.’s conversion of such notes into approximately 16.58 million shares of common stock on August 27, 2007.
Other Income, Net. Other income, net increased in 2007 compared to 2006 primarily as a result of recording in 2007 a $27 million non-cash, non-taxable gain from the deemed settlement of pre-existing arrangements with Impsat on the date of its acquisition as well as from recording in 2007 foreign exchange gains compared to foreign exchange losses in 2006. Higher other income, net was also driven by recording a loss in 2006 on a foreign exchange forward contract of $5 million. The year-over-year increase in other income, net was mostly offset by recording in 2007 a $30 million inducement fee related to the early conversion of STT convertible debt to equity as well as the expensing in 2007 of $10 million deferred financing fees related to: (i) a Bank of America working capital facility and (ii) a bridge loan commitment which was terminated upon issuance of the GC Impsat Notes. Other income, net in 2006 also reflected a $16 million non-cash, non-taxable gain from the deemed settlement of pre-existing arrangements with Fibernet on the date of acquisition.
Net Gain on Pre-confirmation Contingencies. During 2007 and 2006, we settled various third-party disputes and revised our estimated liability for certain contingencies related to periods prior to our emergence from chapter 11 proceedings. We have accounted for these in accordance with AICPA Practice Bulletin 11-Accounting for Pre-confirmation Contingencies in Fresh Start Reporting and recorded a net gain on the settlements and changes in estimated liabilities. The most significant gains are related to changes in estimated liabilities for income and non-income tax contingencies and settlements with certain tax authorities. Included in the 2007 net gain on pre-confirmation contingencies is a gain of $27 million related to the release of a contingent liability for a claim made by a tax authority in South America. In February 2008, we received a ruling from the tax court dismissing the claim.
Provision for Income Taxes. Provision for income taxes decreased primarily as a result of recording a lower increase in the valuation allowance recorded against our U.K. deferred tax assets of $9 million in 2007 (resulting
in a full valuation allowance) compared to $21 million in 2006. Each year’s decrease resulted from reducing our estimated realization of these U.K. deferred tax assets. The 2007 decrease was partially offset by including Impsat in our results in 2007. During 2007, we realized $4 million of tax benefits resulting from the use of deferred tax assets acquired as part of the Impsat acquisition. These deferred tax assets had been subject to a full valuation allowance. As such, the reversal of the valuation allowance has been recorded as a reduction of goodwill, in accordance with SFAS 109 (see Note 15, “Income Tax” to the accompanying consolidated financial statements).
Provision for income taxes related to fresh start accounting for deferred tax benefits realized after the emergence from bankruptcy does not result in cash taxes. This non-cash tax provision was $41 million and $45 million for the years ended December 31, 2007 and 2006, respectively.
Segment Results
As a result of the Impsat acquisition (see Notes 4, “Acquisitions” and 23, “Segment Reporting” to our accompanying consolidated financial statements), our chief operating decision makers (“CODMs”) assess performance and allocate resources based on three separate operating segments which we operate and manage as strategic business units: (i) the GCUK Segment; (ii) the GC Impsat Segment; and (iii) the ROW Segment.
The GCUK Segment is a provider of managed network communications services providing a wide range of telecommunications services, including data, IP and voice services to government and other public sector organizations, major corporations and other communications companies in the UK. The GC Impsat Segment is a provider of telecommunication services including IP, voice, data center and information technology services to corporate and government clients in Latin America. The ROW Segment represents all our operations outside the GCUK and GC Impsat Segments and operates primarily in North America, with smaller operations in Europe, Latin America and Asia, serving many of the world’s largest corporations and many other telecommunications carriers with a full range of managed telecommunication services, including data, IP and voice products. The services provided by all our segments support a migration path to a fully converged IP environment.
The CODMs have measured and evaluated our reportable segments based on Adjusted Cash EBITDA. Adjusted Cash EBITDA, as defined by us, is earnings before non-cash stock compensation, depreciation and amortization, interest income, interest expense, other income (expense), net, net gain on pre-confirmation contingencies, provision for income taxes and preferred stock dividends. We believe that Adjusted Cash EBITDA has been an important part of our internal reporting and a key measure used by us to evaluate our profitability and operating performance and to make resource allocation decisions. We believe such measure is especially important in a capital-intensive industry such as telecommunications.
However, there may be important differences between our Adjusted Cash EBITDA measure and similar performance measures used by other companies. Additionally, this financial measure does not include certain significant items such as non-cash stock compensation, depreciation and amortization, interest income, interest expense, other income (expense) net, net gain on pre-confirmation contingencies, provision for income taxes and preferred stock dividends. Adjusted Cash EBITDA should not be considered a substitute for net income, operating income, operating cash flows or other measures of financial performance.
In 2009, our CODMs will begin to assess performance and allocate resources based on operating income before depreciation and amortization (“OIBDA”). OIBDA differs from Adjusted Cash EBITDA in that OIBDA includes non-cash stock compensation. As we expect to reduce our reliance on non-cash stock compensation over time, in particular for the annual incentive plan, we believe this change is appropriate and allows cash or stock to be used to fund our bonus programs without impacting the measure.
During 2008, we transferred our legacy Brazilian and Chilean operations from the ROW Segment to the GC Impsat Segment. As these transfers were between entities under common control, we have retroactively restated the GC Impsat Segment results to include the results of the Brazilian and Chilean operations and removed the
results of the Brazilian and Chilean operations from the ROW Segment for all applicable periods presented. We anticipate transferring our Argentine operations from the ROW Segment to the GC Impsat Segment during 2009 in a continuing effort to streamline our operations.
GCUK Segment
Revenue
2008 Compared to 2007
Revenue for our GCUK Segment increased in 2008 compared with 2007 primarily as a result of strong demand for broadband lease, enterprise voice services and IP VPN data products. In addition, included in 2008 was approximately $3 million of revenue related to incremental billings as a result of a contract review of acquired Fibernet Group Plc customers. These increases were partially offset by currency movements in 2008 compared with 2007 which adversely affected GCUK Segment revenue by $36 million.
Despite current economic conditions, GCUK continues to see strong demand in its IP services and as a result continues to win new business. Many government agencies and enterprises continue to refresh their more traditional technologies and take advantage of converged IP services. However, the telecommunications market in the UK remains highly competitive. One of GCUK’s principal customer relationships in the period to December 31, 2008 was with Camelot, the current holder of the license to operate the UK National Lottery. Camelot had deployed a landline-based ISDN network in relation to the operation of the UK National Lottery. This network was provided by us. On August 31, 2007, Camelot entered into an enabling agreement with the National Lottery Commission which officially appointed Camelot as operator of the National Lottery for a 10 year period from February 2009. On October 9, 2007, Camelot announced its intention to replace its existing landline-based ISDN network with a broadband satellite communications network to be supplied by another service provider. Camelot has substantially completed the migration of the network. In the fourth quarter of 2008 revenue from our relationship with Camelot decreased $4 million to $9 million compared with $13 million in the third quarter of 2008, including $2 million of unfavorable foreign exchange movements. We expect revenues to decline in the first quarter of 2009 by substantially all of the $9 million recorded in the fourth quarter of 2008. Further although our relationship with Camelot continues we do not expect to earn significant revenue from this relationship in the future. Our revenue from sales to Camelot was approximately $48 million and $52 million for 2008 and 2007, respectively.
In the short term, we expect a marginal decline in our GCUK Segment revenues as a result of the Camelot network migration. We anticipate that new orders already sold during 2008, and the strong demand that we continue to see, will offset that impact in the second half of 2009 and start to deliver medium term growth in GCUK Segment revenues, operating results and cash flows.
2007 Compared to 2006
Revenues for our GCUK Segment increased in 2007 compared with 2006 primarily as a result of the inclusion of Fibernet in our results since October 11, 2006, strong demand for broadband lease, IP VPN data
products and enterprise voice services and positive foreign exchange fluctuations. The net effect of Fibernet on our consolidated results was $99 million and $22 million to the GCUK Segment revenue for 2007 and 2006, respectively.
Adjusted Cash EBITDA
2008 Compared to 2007
Adjusted Cash EBITDA in the GCUK Segment decreased in 2008 compared with 2007 primarily as a result of: (i) higher access charges resulting from additional usage volume; (ii) higher cost of equipment sales driven by higher managed services sales; and (iii) higher costs from our real estate, network and operations and SG&A expenses. In addition, adverse foreign currency movements decreased Adjusted Cash EBITDA by $10 million in 2008 compared with 2007. The higher real estate, network and operations costs and SG&A expenses resulted primarily from higher facilities-based expenses and real estate restructuring charges, respectively. The higher facilities-based expenses were driven by increases in facilities rent and facilities maintenance. This decrease in Adjusted Cash EBITDA was moderated by strong demand for our higher margin broadband lease, enterprise voice services and IP VPN data products in our enterprise, carrier data and indirect channels business and by lower third party maintenance resulting from the renegotiation of certain contracts.
2007 Compared to
Adjusted Cash EBITDA in the GCUK Segment increased in 2007 compared with 2006 primarily as a result of the increase in revenue mainly driven by the inclusion of Fibernet and positive foreign exchange fluctuations described above, partially offset by higher access charges resulting from additional usage volume, and higher costs for our real estate, network and operations and SG&A expenses. The higher real estate, network and operations costs and SG&A expenses resulted primarily from higher employee-related costs and higher facilities-based expenses. The increase in employee-related costs resulted from increased headcount driven by the Fibernet acquisition and higher commissions paid to sales employees. In addition, included in the comparison are higher employee severance charges of $2 million related to our May 10, 2007 restructuring plan. The higher facilities based expenses were driven by higher facilities rent and facilities maintenance.
GC Impsat Segment
Revenue
2008 Compared to 2007
Revenue for our GC Impsat Segment increased in 2008 compared to 2007 primarily due to the prior year including the results of Impsat only since May 9, 2007, the date of acquisition. The increase in GC Impsat Segment revenue also reflected strong demand for broadband lease, managed services and IP VPN data products. In addition, GC Impsat Segment revenue increased by $10 million due to beneficial currency movements in 2008 compared with 2007.
2007 Compared to
Reported results for our GC Impsat Segment for periods prior to our acquisition of Impsat on May 9, 2007 consist of: (i) the results of a holding company which had no revenue-generating activities that issued the GC Impsat Notes in anticipation of the acquisition of Impsat; and (ii) the results of our legacy Brazilian and Chilean operations which were transferred from the ROW Segment to the GC Impsat Segment during 2008. As these transfers were between entities under common control, we have retroactively restated the GC Impsat Segment results to include the results of the Brazilian and Chilean operations for all applicable periods presented.
Adjusted Cash EBITDA
2008 Compared to 2007
Adjusted Cash EBITDA for our GC Impsat Segment increased in 2008 compared to 2007 primarily due to the prior year including the results of the GC Impsat Segment only since May 9, 2007, the date of acquisition. In addition, beneficial foreign currency movements increased Adjusted Cash EBITDA by $3 million in 2008 compared with 2007.
2007 Compared to 2006
Adjusted Cash EBITDA for our GC Impsat Segment increased in 2007 compared to 2006 due to the inclusion of Impsat in this segment’s results only since May 9, 2007. Adjusted Cash EBITDA for 2006 consists of the results of our legacy Brazilian and Chilean operations which were transferred from our ROW Segment to our GC Impsat Segment.
ROW Segment
Revenue
2008 Compared to 2007
Revenue for our ROW Segment increased in 2008 compared with 2007 primarily as a result of strong demand for our higher margin broadband lease, enterprise voice services, conferencing and IP VPN data products in our enterprise, carrier data and indirect sales channel. In addition, ROW Segment revenue was positively impacted by $11 million due to beneficial currency movements in 2008 compared with 2007. These increases were partially offset by a decrease in managed services primarily due to lower equipment sales, and by decreased carrier voice revenue as a result of decreases in our average pricing for our U.S. domestic long distance voice services. Our average pricing related to U.S. domestic long distance voice services declined in 2008 compared with 2007, while our sales volumes for our U.S. domestic long distance voice services increased in 2008 compared with 2007. We expect our carrier voice sales channel revenue to decline in the mid-to-high single digit percentage range in 2009 as we continue to manage the business for margin.
2007 Compared to 2006
Revenues for our ROW Segment increased in 2007 compared with 2006 resulting from strong demand for higher margin enterprise voice and broadband lease and IP VPN data products. This increase in enterprise, carrier data, and indirect sales channels revenue was partially offset by decreased lower margin carrier voice revenues as a result of decreases in sales volumes due to our strategy to reduce our emphasis on this market. Our sales volume related to U.S. domestic long distance voice services declined by approximately 27% in 2007 compared with 2006, while our average pricing for our U.S. domestic long distance voice services was flat in 2007 compared with 2006.
Adjusted Cash EBITDA
2008 Compared to 2007
Adjusted Cash EBITDA in our ROW Segment improved in 2008 compared with 2007 primarily as a result of the increase in revenue in our enterprise, carrier data and indirect sales channel business and the gross margin percentage improvement resulting from the associated shift in revenues from our low margin carrier voice sales channel to our much higher margin enterprise, carrier data and indirect sales channel. Adjusted Cash EBITDA improvement in 2008 also reflected lower employee-related expenses and lower cost of equipment sales. The lower employee-related expenses were a result of the 2007 severance-related restructuring charge arising from the May 10, 2007 restructuring plan, which was not repeated in 2008, and the resulting lower headcount driving reduced salaries and benefits in the comparable 2008 period. The lower cost of equipment was driven by decreased equipment sales volumes. These improvements in Adjusted Cash EBITDA were partially offset by higher access costs, higher facilities rent, facilities maintenance, utilities expense and higher facilities restructuring expenses. In addition, adverse foreign currency movements decreased Adjusted Cash EBITDA by $1 million in 2008 compared with 2007. The higher access costs were driven by higher enterprise, carrier data and indirect sales channel business revenue. The higher facilities restructuring expenses in 2008 were driven by the release of restructuring reserves during 2007 due to the settlement and termination of existing real estate lease agreements for technical facilities. The higher facilities rent resulted primarily from our decision in 2007 to convert idle real estate facilities previously included in the restructuring reserve to productive operating assets in connection with the establishment of our European collocation business.
2007 Compared to 2006
Adjusted Cash EBITDA in this segment improved in 2007 compared with 2006 as a result of the increases in revenue from growth in our enterprise, carrier data and indirect sales channel, lower access costs driven by lower carrier voice sales volume, and lower facilities-based expenses driven by a decrease in restructuring charges, primarily due to accrual reversals of $10 million and $31 million, respectively. The accrual reversals were the result of the settlement of existing real estate lease agreements for technical facilities during 2007 and the decision in 2007 to convert idle real estate facilities previously included in the restructuring reserve to productive operating assets in connection with the establishment of our European collocation business. This increase was partially offset by higher employee severance charges of $8 million related to our May 10, 2007 restructuring plan, increased salaries driven by increased headcount and other non-restructuring severance and higher commissions paid to sales employees.
Liquidity and Capital Resources
Financial Condition and State of Liquidity
Our ability to make payments on and to refinance our indebtedness and to fund planned capital expenditures will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors (such as satisfactory resolution of contingent liabilities) that are beyond our control.
Based on our current level of operations and anticipated cost management and operating improvements, we believe our expected cash flow from operations, available cash and other sources of available financing will be adequate to meet our future liquidity needs for at least the next twelve months.
There can be no assurance, however, that our business will generate sufficient cash flow from operations, that currently anticipated cost savings and operating improvements will be realized on schedule or that future borrowings will be available to us in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. We may need to refinance all or a portion of our indebtedness on or before maturity. We cannot provide assurances that we will be able to refinance any of our indebtedness on commercially reasonable terms or at all. Furthermore, we cannot provide any assurances that the ongoing crisis in global capital markets and adverse general economic conditions will not have a material impact on our future operations and cash flows.
We monitor our capital structure on an ongoing basis and from time to time we consider financing and refinancing options to improve our capital structure and to enhance our financial flexibility. Our ability to enter into new financing arrangements is subject to restrictions in our outstanding debt instruments (as described below under “Indebtedness”) and to the rights of ST Telemedia under our outstanding preferred shares. At any given time we may pursue a variety of financing opportunities, and our decision to proceed with any financing will depend, among other things, on prevailing market conditions and available terms.
At December 31, 2008, our available liquidity consisted of $360 million of unrestricted cash and cash equivalents. In addition, at December 31, 2008, we also held $18 million in restricted cash and cash equivalents. Our restricted cash and cash equivalents comprise cash collateral for letters of credit issued in favor of certain of our vendors and deposits securing real estate obligations.
During 2008, we posted a net operating loss of $53 million, generated $203 million of cash provided by operating activities and had a net decrease in cash and cash equivalents of $37 million. Our 2008 cash flows included the following significant items: (i) a decrease in restricted cash and cash equivalents of $31 million primarily due to the release of the $22 million debt service account for the GC Impsat Notes in 2008, which decrease benefited unrestricted cash balances; (ii) a decrease of $19 million resulting from the effect of exchange rate changes on our cash and cash equivalents due to the appreciation of the U.S. Dollar against certain foreign currencies in which we held significant cash balances; and (iii) the receipt of $146 million of cash from the sale of IRUs and prepayment of services, which significantly exceeded our expectations.
In the long term, we expect our operating results and cash flows to continue to improve as a result of the continued growth of our higher margin enterprise, carrier data and indirect sales channel business, including the economies of scale expected to result from such growth, and from ongoing cost reduction initiatives to optimize the access network and effectively lower unit prices. Thus, in the long term we expect to generate positive cash flow from operating activities in an amount sufficient to fund all investing and financing requirements, subject to the possible need to refinance our existing major debt instruments as described below. However, our ability to improve cash flows is subject to the risks and uncertainties described above under Item 1A, “Risk Factors-Cautionary Factors That May Affect Future Results.”
In the short-term, we expect cash provided by operating activities to exceed purchases of property and equipment. This expectation is based in part on raising financing for such property and equipment from vendors and others comparable to those arranged in 2008. Our ability to arrange such financings is subject to negotiating acceptable terms from equipment vendors and financing parties. This could prove more difficult given current adverse conditions in the credit markets.
Our short-term liquidity and more specifically our quarterly liquidity expectations are subject to considerable variability as a result of the timing of interest payments as well as the factors noted below. Therefore, even though certain of our interim periods may have negative cash flows we expect cash provided by operating activities to exceed purchases of property and equipment for the full year 2009. In 2008, our cash provided by operating activities exceeded purchases of property and equipment in the second half of the year, but did not do so in the first half of the year.
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Intra-quarter and working capital variability significantly impacts our cash flows such that our intra-quarter cash balances tend to drop to levels significantly lower than that prevailing at the end of a given quarter.
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We rely on the sale of IRUs and prepaid services, which often involve large dollar amounts and are difficult to predict, although our forecasted cash flows for 2009 contemplate significantly lower sales of IRUs and prepaid services as compared to the $146 million in 2008.
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The continuing adverse conditions in global credit markets and general economic conditions could cause customer buying patterns with us to change as a result of their cash conservation efforts, which could
have an adverse impact on our cash flows. These adverse conditions could also adversely impact our working capital to the extent suppliers seek more timely payment from us or customers pay us on a less timely basis.
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We have exposure to significant currency exchange rate risks. Commencing in 2008, the U.S. Dollar has appreciated considerably against certain foreign currencies in which we conduct a significant portion of our business, including the British Pound Sterling, the Euro and Brazilian Real. Since we tend to incur costs in the same currency in which we earn revenue, the impact on operating cash flows was largely mitigated. However, if the U.S. Dollar continues to appreciate, future revenues, operating income and operating cash flows will be materially affected to an extent we have not contemplated. In addition, the appreciation of the U.S. Dollar relative to foreign currencies reduces the U.S. Dollar value of cash balances held in those currencies. For 2008, our unrestricted cash and cash equivalent balances were reduced by $19 million due to the impact of exchange rates on unrestricted cash and cash equivalents held in currencies other than the U.S. Dollar.
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Our liquidity may also be adversely affected if we are found liable in respect of contingent legal, tax and other liabilities, and the amount and timing of the resolution of these contingencies remain uncertain.
The vast majority of our long-term debt matures after 2010. However, we do have approximately $78 million related to various other debt agreements that are due and payable in 2009. With regard to our major debt instruments, (i) the $144 million original principal amount of our 5% Convertible Notes matures in 2011 (subject to earlier conversion into GCL common stock at the conversion price of approximately $22.98 per share); (ii) $332 million of our Term Loan Agreement is due at final maturity in 2012; (iii) the $414 million original principal amount of the GCUK Notes matures in 2014; and (iv) the $225 million original principal amount of the GC Impsat Notes matures in 2017. We also have approximately $10 million of bonds issued by GC Impsat’s Colombian subsidiary which mature in December 2010. If cash on hand at the time any of these debt instruments mature is insufficient to satisfy these and our other debt repayment obligations, we would need to access the capital markets to meet our liquidity requirements. Such access would depend on market conditions and our credit profile at the time. The ongoing crisis in global capital markets could make it more difficult for us to obtain debt financing.
As a holding company, all of our revenue is generated by our subsidiaries and substantially all of our assets are owned by our subsidiaries. As a result, we are dependent upon intercompany transfers of funds from our subsidiaries to meet our debt service and other payment obligations. Our subsidiaries are incorporated and operate in various jurisdictions throughout the world and are subject to legal and contractual restrictions affecting their ability to make intercompany funds transfers. Such legal restrictions include prohibitions on paying dividends in excess of retained earnings (or similar concepts under applicable law), which prohibition applies to most of our subsidiaries given their history of operating losses, as well as foreign exchange controls on the expatriation of funds that are particularly prevalent in Latin America. Contractual restrictions on intercompany funds transfers include limitations in our major debt instruments on the ability of our subsidiaries to make dividend and other payments on equity securities, as well as limitations on our subsidiaries’ ability to make intercompany loans or to upstream funds in any other manner. These contractual restrictions arise under our major debt instruments, each of which is generally limited in application to one of our segments (e.g., the restrictions in the Term Loan Agreement apply to the ROW Segment, the restrictions in the GCUK Notes indenture apply to the GCUK Segment, and the restrictions in the GC Impsat Notes indenture apply to the GC Impsat Segment). Thus, these contractual restrictions generally do not restrict intercompany funds transfers within a given segment, but rather significantly restrict intercompany funds transfers from one segment to another. Each such debt instrument includes exceptions which allow a limited amount of intercompany loans to entities in other segments, subject to certain restrictions.
At December 31, 2008, unrestricted cash and cash equivalents were $52 million, $92 million, and $216 million at our GCUK, GC Impsat and ROW Segments, respectively. Although operational constraints require us to maintain significant minimum cash balances in each of our segments, we believe that our GCUK
and GC Impsat Segments’ existing unrestricted cash balances are sufficient for their operating and investing activities for the foreseeable future. During the fourth quarter of 2008, the GC Impsat Segment made net loans to Global Crossing Holdings Limited, a wholly owned subsidiary in the ROW Segment, of approximately $40 million. These intercompany loans are guaranteed by GCL, accrue a market-related interest rate, and are denominated in United States dollars and mature on December 15, 2012. We believe that these and possible future inter-segment funds transfers in amounts permitted by our debt instruments will be sufficient to enable each segment to reach the point of sustained recurring positive cash flow from operating and investing activities. Most of our assets other than the assets of our GC Impsat Segment have been pledged to secure our indebtedness, and the GC Impsat Notes indenture contains an “equal and ratable” provision which generally requires GC Impsat to provide the holders of the GC Impsat Notes with an equal and ratable lien if GC Impsat pledges its assets to secure other indebtedness. A failure to comply with the covenants contained in any of our loan instruments could result in an event of default, which, if not cured or waived, could result in an acceleration of all such debts, which would adversely affect our rights under certain commercial agreements and have a material adverse effect on our business, results of operations, financial condition and liquidity. If the indebtedness under any of our loan instruments were to be accelerated, there can be no assurance that our assets would be sufficient to repay such indebtedness in full. In such event, we would have to raise funds from alternative sources, which may not be available on favorable terms, on a timely basis or at all. Moreover, a default by any of our subsidiaries under a capital lease obligation or debt obligation totaling more than $2.5 million, as well as the bankruptcy or insolvency of any of our subsidiaries, could trigger cross-default provisions under certain debt instruments.
Indebtedness
At December 31, 2008, we had $1.32 billion of indebtedness outstanding (including short term debt, the current portion of long term debt and capital lease obligations), consisting of $427 million of GCUK Notes, $144 million of 5% Convertible Notes, $225 million of GC Impsat Notes, $344 million under the Term Loan Agreement, $145 million of capital lease obligations and $35 million of other debt.
Below are summaries of our principal debt instruments outstanding at December 31, 2008. We are in compliance with all covenants under our material debt agreements and expect to continue to be in compliance. At December 31, 2008, we were not in compliance with certain non-financial covenants for debt and capital lease agreements representing $2 million of indebtedness which is classified in current liabilities in the accompanying consolidated balance sheet. The failure to meet these covenants allows the counterparty to accelerate payments under these agreements but does not trigger any cross defaults in other debt agreements.
GCUK Senior Secured Notes
On December 23, 2004 GCUK Finance, issued $200 million in aggregate principal amount of 10.75% U.S. dollar denominated senior secured notes due 2014 and 105 million pounds sterling aggregate principal amount of 11.75% pounds sterling denominated senior secured notes due 2014. The U.S. dollar and sterling denominated notes were issued at a discount of approximately $3 million and 2 million pounds sterling, respectively, which resulted in our receiving gross proceeds, before underwriting fees, of approximately $398 million. The GCUK Notes mature on the tenth anniversary of their issuance. Interest is payable in cash semi-annually on June 15 and December 15.
On December 28, 2006, GCUK Finance issued an additional 52 million pounds sterling aggregate principal amount of pound sterling denominated GCUK Notes. The additional notes were issued at a premium of approximately 5 million pounds sterling, which resulted in our receiving gross proceeds, before underwriting fees, of approximately $111 million.
The GCUK Notes are senior obligations of GCUK Finance and rank equal in right of payment with all of its future debt. GCUK has guaranteed the GCUK Notes as a senior obligation ranking equal in right of payment with
all of its existing and future senior debt. The GCUK Notes are secured by certain assets of GCUK and GCUK Finance, including the capital stock of GCUK Finance, but certain material assets of GCUK do not serve as collateral for the GCUK Notes.
GCUK Finance may redeem the GCUK Notes in whole or in part, at any time on or after December 15, 2009 at redemption prices decreasing from 105.375% (for the U.S. dollar denominated notes) or 105.875% (for the pounds sterling denominated notes) in 2009 to 100% of the principal amount in 2012 and thereafter. At any time before December 15, 2009, GCUK Finance may redeem either series of notes, in whole or in part, by paying a “make-whole” premium calculated in accordance with the GCUK Notes indenture. GCUK Finance may also redeem either series of notes, in whole but not in part, upon certain changes in tax laws and regulations.
The GCUK Notes were issued under an indenture which includes covenants and events of default that are customary for high-yield senior note issuances. The indenture governing the GCUK Notes limits GCUK’s ability to, among other things: (i) incur or guarantee additional indebtedness; (ii) pay dividends or make other distributions to repurchase or redeem its stock; (iii) make investments or other restricted payments; (iv) create liens; (v) enter into certain transactions with affiliates; (vi) enter into agreements that restrict the ability of its material subsidiaries to pay dividends; and (vii) consolidate, merge or sell all or substantially all of its assets.
As required by the indenture governing the GCUK Notes, within 120 days after the end of each twelve month period ending December 31, GCUK must offer (the “Annual Repurchase Offer”) to purchase a portion of the GCUK Notes at a purchase price equal to 100% of their principal amount, plus accrued and unpaid interest, if any, to the purchase date, with 50% of “Designated GCUK Cash Flow” from that period. “Designated GCUK Cash Flow” means GCUK’s consolidated net income plus non-cash charges minus capital expenditures, calculated in accordance with the terms of the indenture governing the GCUK Notes. With respect to the 2007 Annual Repurchase Offer, we made an offer for and purchased approximately $2 million principal amount of the GCUK Notes.
In respect to the 2008 Annual Repurchase Offer, we anticipate making an offer of approximately $11 million, including accrued but unpaid interest. Any such offer is required to be made within 120 days of such date, and the related purchases must be completed within 150 days after year-end.
A loan or dividend payment by GCUK to the Company and its affiliates is a restricted payment under the indenture governing the GCUK Notes. Under the indenture, such a payment (i) may be made only if GCUK is not then in default under the indenture and would be permitted at that time to incur additional indebtedness under the applicable debt incurrence test; (ii) may generally be made only within ten business days of consummation of each Annual Repurchase Offer; and (iii) would generally be limited to 50% of Designated GCUK Cash Flow plus the portion, if any, of the applicable Annual Repurchase Offer that the holders of the notes decline to accept. In addition, so long as GCUK is not then in default under the indenture, GCUK may make up to 10 million pounds sterling (approximately $14 million) in the aggregate in restricted payments in excess of 50% of Designated GCUK Cash Flow for a given period; provided that any such excess payments shall reduce the amount of restricted payments permitted to be paid out of future Designated GCUK Excess Cash Flow. Prior to the conversion of the Mandatorily Convertible Notes (see Term Loan Agreement and Other Financing Activities below), loans from GCUK made to us or our other subsidiaries were subordinated to the payment of obligations under the Mandatorily Convertible Notes. Any future loans from GCUK made to us or our other subsidiaries must be subordinated to the payment of obligations under the $350 million Term Loan Agreement. The terms of any inter-company loan by GCUK to us or our other subsidiaries are required by the GCUK Notes indenture to be at arm’s length and must be agreed to by the board of directors of GCUK, including its independent members. In the exercise of their fiduciary duties, GCUK’s directors will require GCUK to maintain a minimum cash balance in an amount they deem prudent.
5% Convertible Notes
On May 30, 2006, we completed a public offering of $144 million aggregate principal amount of 5% convertible senior notes due 2011 for total gross proceeds of $144 million. The 5% Convertible Notes rank equal
in right of payment with any other senior indebtedness of Global Crossing Limited, except to the extent of the value of any collateral securing such indebtedness. The notes were priced at par value, mature on May 15, 2011, and accrue interest at 5% per annum, payable semi-annually on May 15 and November 15 of each year. The 5% Convertible Notes may be converted at any time prior to maturity at the option of the holder into shares of our common stock at a conversion price of approximately $22.98 per share. At any time prior to maturity, we may unilaterally and irrevocably elect to settle our conversion obligation in cash and, if applicable, shares of our common stock, calculated as set forth in the indenture governing the 5% Convertible Notes. During the twelve months ended May 20, 2009 and May 20, 2010, we may redeem some or all of the 5% Convertible Notes for cash at a redemption price equal to 102% and 101%, respectively, of the principal amount being redeemed, plus accrued and unpaid interest. We may be required to repurchase, for cash, all or a portion of the notes upon the occurrence of a fundamental change (i.e., a change in control or a delisting of our common stock) at a purchase price equal to 100% of their principal amount, plus accrued and unpaid interest, or, in certain cases, to convert the notes at an increased conversion rate based on the price paid per share of our common stock in a transaction constituting a fundamental change.
Concurrent with the closing of the 5% Convertible Notes offering the Company purchased a portfolio of U.S. treasury securities with total face value of $21 million for $20 million, and pledged these securities to collateralize the first six interest payments due on the 5% Convertible Notes. At December 31, 2008, $4 million of these securities are included in prepaid costs and other current assets.
GC Impsat Notes
On February 14, 2007, GC Impsat, a wholly owned subsidiary of GCL, issued $225 million in aggregate principal amount of GC Impsat’s 9.875% senior notes due February 15, 2017. Interest is payable in cash semi-annually in arrears every February 15 and August 15 commencing August 15, 2007. The proceeds of the offering were used to finance a portion of the purchase price (including the repayment of indebtedness) of our acquisition of Impsat, which was consummated on May, 9, 2007 (see Note 4 to our consolidated financial statements included in this annual report on Form 10-K). Pursuant to a pledge and security agreement, entered into on the date of the acquisition, GC Impsat maintained a debt service reserve account in the name of the collateral agent for the benefit of the note holders equal to two interest payments ($22 million) on the GC Impsat Notes until certain cash flow metrics were met. During 2008, those cash flow metrics have been met and the $22 million debt service reserve funds for the GC Impsat Notes were released to unrestricted cash and cash equivalents.
The GC Impsat Notes are the senior unsecured obligations of GC Impsat and rank equal in right of payment with all of its other senior unsecured debt. Upon consummation of the acquisition, the restricted subsidiaries of GC Impsat (including Impsat and most of its subsidiaries) guaranteed the GC Impsat Notes on a senior unsecured basis, ranking equal in right of payment with all of their other senior unsecured debt.
The indenture for the GC Impsat Notes limits GC Impsat’s and its restricted subsidiaries’ ability to, among other things: (1) incur or guarantee additional indebtedness; (2) pay dividends or make other distributions; (3) make certain investments or other restricted payments; (4) enter into arrangements that restrict dividends or other payments to GC Impsat from its restricted subsidiaries; (5) create liens; (6) sell assets, including capital stock of subsidiaries; (7) engage in transactions with affiliates; and (8) merge or consolidate with other companies or sell substantially all of its assets. All of these limitations are subject to a number of important qualifications and exceptions set forth in the indenture.
In addition to refinancing approximately $216 million of debt assumed in the acquisition of Impsat with the proceeds from the issuance of the GC Impsat Notes and other cash, at December 31, 2008 the primary debt of the GC Impsat Segment that remains outstanding is approximately $10 million of bonds issued by Impsat’s subsidiary in Colombia. These bonds bear interest at the Colombian consumer price index plus 8%. The Colombia Bonds are repayable in December 2010. During the year ended December 31, 2008, approximately $10 million of the original principal was repaid.
Term Loan Agreement
On May 9, 2007, we entered into a senior secured term loan agreement with Goldman Sachs Credit Partners L.P. and Credit Suisse Securities (USA) LLC pursuant to which we borrowed $250 million on that date. The Term Loan Agreement was amended on June 1, 2007 to, among other things, provide for the borrowing of an additional $100 million on that date. These term loans (i) mature on May 9, 2012, with amortization of 0.25% of principal repayable on a quarterly basis and the remaining principal due at maturity, (ii) bear interest at LIBOR plus 6.25% per annum payable quarterly, (iii) have repayment premiums of 103% in the first year, 102% in the second year and 101% in the third year, and (iv) are guaranteed by all of our subsidiaries and secured by substantially all the assets of us and our subsidiaries, in each case other than those subsidiaries forming part of our Latin American operations or our GCUK Segment. The Term Loan Agreement limits our and the guarantor subsidiaries’ ability, among other things, to: (1) incur or guarantee additional indebtedness; (2) pay dividends or make other distributions; (3) make certain investments or other restricted payments; (4) enter into arrangements that restrict dividends or other payments to us from our restricted subsidiaries; (5) create liens; (6) sell assets, including capital stock of subsidiaries; (7) engage in transactions with affiliates; and (8) merge or consolidate with other companies or sell substantially all of our assets. All of these limitations are subject to a number of important qualifications and exceptions set forth in the Term Loan Agreement. In addition, the Term Loan Agreement includes financial maintenance covenants requiring our ROW Segment to maintain a minimum consolidated cash balance at all times and requiring us to maintain, as of the end of each fiscal quarter starting with June 30, 2008, a maximum ratio of consolidated debt to a designated measure of consolidated earnings.
A portion of the proceeds of the Term Loan Agreement was immediately used to repay in full our $55 million working capital facility with Bank of America, N.A (and other lenders), to cash collateralize $29 million of letters of credit previously issued under the facility (or replacement thereof), and to fund a portion of the Impsat acquisition. The remaining net proceeds of the Term Loan Agreements are being used for working capital and general corporate purposes, which may include the acquisition of assets or businesses that are complementary to our existing business.
In satisfaction of an obligation under the Term Loan Agreement, in July 2007 we entered into an agreement to mitigate the risk arising from the floating rate debt by hedging the term loans against interest risk volatility. As of December 31, 2008, the hedge consists of interest rate caps for the ensuing two years having notional amounts between $340 million and $344 million.
Other Financing Activities
During 2008 we entered into debt agreements to finance various equipment purchases and software licenses. The total debt obligation resulting from these agreements is $5 million. These agreements have terms that range from 23 to 49 months and annual interest rates that generally range from 3.2% to 11%, with a weighted average effective interest rate of 8.1%. In addition, we also entered into various capital leasing arrangements that amounted to $43 million. These agreements have terms that range from 18 to 55 months and implicit interest rates that range generally from 3.4% to 16.7% with a weighted average effective interest rate of 6.9%.
During 2008, the Company entered into debt agreements and received approximately $10 million of cash proceeds. These agreements have terms that range from 12 to 60 months, $7 million of which have variable interest rates based on a spread over LIBOR and $3 million of which have variable interest rates based on a spread over the Brazilian Inter-bank Lending Rate.
Cash Management Impacts
Condensed Consolidated Statements of Cash Flows
Cash Flows from Operating Activities
Cash flows provided by operating activities increased in 2008 compared with 2007 primarily due to cash collections on increased revenues in our higher margin enterprise, carrier data and indirect channels business and continued management efforts regarding working capital. This was offset by a $28 million decrease in cash receipts from the sale of IRUs of $146 million in 2008 compared with $174 million during 2007 and higher interest payments in 2008.
Cash Flows from Investing Activities
Cash flows used in investing activities decreased in 2008 compared with 2007 primarily as a result of: (i) $78 million decrease in the change in restricted cash and cash equivalents primarily as a result of establishing the $22 million debt service account for the GC Impsat Notes in 2007 and releasing it in 2008 and the release of cash restricted under various credit agreements; (ii) $76 million payment for the acquisition of Impsat in 2007; and (iii) $22 million decrease in capital purchases.
Cash Flows from Financing Activities
Cash flows provided by financing activities decreased in 2008 compared with 2007 primarily as a result of $376 million less net cash inflow from financings, including capital lease obligations, after repayment of debt obligations (the 2007 period included $216 million of acquired Impsat debt repayment). This was offset by a $24 million decrease in finance costs incurred.
Contractual Cash Commitments
The following table summarizes our contractual cash commitments at December 31, 2008:
(1)
Includes both principal and interest on debt obligations.
(2)
The principal repayment of the GCUK Notes of approximately $425 million includes $11 million and $414 million in the “Less than 1 year” and “More than 5 years” section of the table, respectively. The $11 million
represents the portion of the Designated GCUK Cash Flow we expect to offer holders of the GCUK Notes within 120 days of December 31, 2008. As the Designated GCUK Cash Flow will vary from period to period and we have not predicted early purchases of the GCUK Notes beyond 2008. The pound sterling interest and principal due for the GCUK Notes have been exchanged for all periods at the December 31, 2008 year end rate of 1.4435 U.S. dollars to one pound sterling.
(3)
Amount relates to our current expected funding requirements in 2008 related to our defined benefit pension plans. Funding amounts will vary yearly based on actuarial assumptions, company funding policy and statutory funding requirements and therefore we have not included amounts beyond 2009.
(4)
Amounts represent contractual commitments with third parties to purchase network access services ($353 million), maintenance services for portions of our network and information technology ($339 million), other purchase order commitments ($221 million), rental payments for restructured properties ($86 million), and deferred reorganization costs related to our bankruptcy proceedings ($13 million).
Credit Risk
We are subject to concentrations of credit risk in our trade receivables. Although our receivables are geographically dispersed and include customers both large and small and in numerous industries, our receivables from our carrier sales channels are generated from sales of services to other carriers in the telecommunications industry. As of December 31, 2008 and 2007, our receivables related to our carrier sales channels represented approximately 46% and 43%, respectively, of our consolidated receivables. Also as of December 31, 2008 and 2007, our receivables due from various agencies of the U.K. Government together represented approximately 6% and 14%, respectively, of our consolidated receivables.
Currency Risk
Certain of our current and prospective customers derive their revenue in currencies other than U.S. dollars but are invoiced by us in U.S. dollars. The obligations of customers with revenue in foreign currencies may be subject to unpredictable and indeterminate increases in the event that such currencies depreciate in value relative to the U.S. dollar. Furthermore, such customers may become subject to exchange control regulations restricting the conversion of their revenue currencies into U.S. dollars. In either event, the affected customers may not be able to pay us in U.S. dollars. In addition, where we issue invoices for our services in currencies other than U.S. dollars, our operating results may suffer due to currency translations in the event that such currencies depreciate relative to the U.S. dollar and we cannot or do not elect to enter into currency hedging arrangements in respect of those payment obligations. Declines in the value of foreign currencies relative to the U.S. dollar could adversely affect our ability to market our services to customers whose revenue is denominated in those currencies.
Certain Latin American economies have experienced shortages in foreign currency reserves and have adopted restrictions on the ability to expatriate local earnings and convert local currencies into U.S. dollars. Any such shortages or restrictions may limit or impede our ability to transfer or to convert such currencies into U.S. dollars and to expatriate such funds for the purpose of making timely payments of interest and principal on our indebtedness. These restrictions have a significantly greater impact on us and on our ability to service our debt as a result of the Impsat acquisition. In addition, currency devaluations in one country may have adverse effects in another country. For example, in 2001 and 2002, Argentina imposed exchange controls and transfer restrictions substantially limiting the ability of companies to make payments abroad. While these restrictions have been substantially eased, Argentina may tighten exchange controls or transfer restrictions in the future to prevent capital flight, counter a significant depreciation of the peso or address other unforeseen circumstances.
In Venezuela, the official bolivares-U.S. dollar exchange rate established by the Venezuelan Central Bank and the Venezuelan Ministry of Finance attributes to the bolivar a value that is significantly greater than the value prevailing on the parallel market. The official rate is the rate used for recording the assets, liabilities and transactions for our Venezuelan subsidiary. Moreover, the conversion of bolivares into foreign currencies is limited by the current exchange control regime. Accordingly, the acquisition of foreign currency by Venezuelan
companies to honor foreign debt, pay dividends or otherwise expatriate capital is subject to registration and subject to a process of application and approval by the Comisión de Administración de Divisas and to the availability of foreign currency within the guidelines set forth by the National Executive Power for the allocation of foreign currency. Such approvals have become less forthcoming over time, resulting in a significant buildup of excess cash in our Venezuelan subsidiaries and a significant increase in our exchange rate and exchange control risks. As of December 31, 2008 and 2007, approximately $33 million and $25 million, respectively (valued at the fixed exchange rate) of our cash and cash equivalents were held in Venezuelan bolivars.
In 2008, we participated in a debt auction held by the Venezuelan government to purchase $10 million par value of U.S. dollar-denominated bonds in connection with our currency exchange risk mitigation efforts. The purchase price of the bonds was $11 million. We received approval to purchase the bonds and sold these bonds immediately upon receipt at a price of $8 million, which resulted in an approximate 27% discount. The difference was recorded as a loss on the sale of investments and included in other income (expense), net in our consolidated statement of operations.
Commencing in September 2008, the U.S. Dollar has appreciated considerably against certain foreign currencies in which we conduct a significant portion of our business, including the British Pound Sterling, the Euro and the Brazilian Real. This appreciation adversely impacted 2008 consolidated revenue. Since we tend to incur costs in the same currency in which we realize revenue, the impact on operating income and operating cash flows was largely mitigated. However, if the U.S. Dollar trades at the levels in effect at the end of 2008 or continues to appreciate, future revenues, operating income and operating cash flows will be materially affected to an extent we have not contemplated. In addition, the appreciation of the U.S. Dollar relative to foreign currencies reduces the U.S. Dollar value of cash balances held in those currencies.
Off-Balance Sheet Arrangements
As of December 31, 2008 we did not have any off-balance sheet arrangements outstanding.
Recently Issued Accounting Pronouncements
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS No. 141R”). SFAS No. 141R will change how business acquisitions are accounted for and will impact financial statements both in periods before the acquisition date and in subsequent periods. SFAS No. 141R applies to all transactions or other events in which an entity (the acquirer) obtains control of one or more businesses (the acquiree), including those sometimes referred to as “true mergers” or “mergers of equals” and combinations achieved without the transfer of consideration, for example, by contract alone or through the lapse of minority veto rights. SFAS No. 141R is generally to be applied prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Early adoption is prohibited.
SFAS No. 141R amends AICPA Statement of Position 90-7, “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code” (“SOP No. 90-7”). Prior to adoption, reversal of pre-emergence valuation allowances are recorded as a reduction of intangibles to zero and thereafter as additional paid-in-capital. Upon adoption, the reversal of pre-emergence valuation allowances will be recorded as a reduction of tax expense. During the years ended December 31, 2008, 2007 and 2006 we recorded a provision for income taxes and additional paid-in-capital of $30 million, $41 million and $45 million as a result of accounting in accordance with SOP No. 90-7. SFAS No, 141R also amends SFAS 109, “Accounting for Income Taxes”. Prior to adoption, the reversal of valuation allowances recorded in purchase accounting would first reduce goodwill to zero, and then reduce the other acquired non-current intangible assets to zero, and then be reflected in income tax expense. Upon adoption, the reversals of pre-acquisition valuation allowances that do not qualify as a measurement period adjustment are reflected in income tax expense. During the years ended December 31, 2008 and 2007, we recorded $5 million and $4 million, respectively, of valuation allowance reversals for deferred tax assets acquired as part of the Impsat acquisition as a reduction in goodwill.
In May 2008, the FASB issued FSP No. APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“FSP APB No. 14-1”). FSP APB No. 14-1 clarifies that convertible debt instruments that may be settled in cash upon either mandatory or optional conversion (including partial cash settlement) are not addressed by paragraph 12 of APB Opinion No. 14, “Accounting for Convertible Debt and Debt issued with Stock Purchase Warrants”. Additionally, FSP APB No. 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB No. 14-1 must be applied on a retrospective basis and is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Based on our preliminary analysis, upon adoption of FSP APB No. 14-1, we expect to reclassify between $35 million and $40 million of our convertible debt to equity and the amortization of the debt discount will increase annual non-cash interest expense between $7 million and $8 million.
For additional information on recently issued accounting pronouncements, see Note 2, “Basis of Presentation and Significant Accounting Policies” and Note 15, “Income Tax”, to the accompanying consolidated financial statements for a full description of recently issued accounting pronouncements including the date of adoption and effects on results of operations and financial condition, where applicable.
Restructuring Activities
2007 Restructuring Plans
During 2007, we implemented initiatives to generate operational savings which included organizational realignment and functional consolidation resulting in the involuntary separation of employees. As a result of these initiatives, during 2007 we incurred a net charge of $10 million for one-time severance and related benefits which was included in selling, general and administrative expenses in the consolidated statement of operations. On a segment basis, $2 million and $8 million were recorded to the GCUK and ROW Segments, respectively. As of December 31, 2008, all severance amounts have been paid under the plan. As of December 31, 2008 and December 31, 2007, the remaining liability related to these initiatives was $0 million and $1 million, respectively, all related to the ROW Segment.
We adopted a restructuring plan as a result of the Impsat acquisition (see Note 4, “Acquisitions,” to the accompanying consolidated financial statements) under which redundant Impsat employees were terminated. As a result, we incurred cash restructuring costs of approximately $8 million for severance and related benefits. The liabilities associated with this restructuring plan have been accounted for as part of the purchase price of Impsat. As of December 31, 2008 and December 31, 2007, the remaining liability of the restructuring reserve was $8 million and $7 million, respectively, all related to the GC Impsat Segment.
2006 Restructuring Plan
During 2006, we adopted a restructuring plan as a result of the Fibernet acquisition (see Note 4, “Acquisitions,” to the accompanying consolidated financial statements) under which redundant Fibernet employees were terminated and certain Fibernet facility lease agreements will be terminated or restructured. As a result of these efforts we incurred cash restructuring costs of approximately $3 million for severance and related benefits in connection with anticipated workforce reductions and $4 million for real estate consolidation. The liabilities associated with the restructuring plan have been accounted for as part of the purchase price of Fibernet. All amounts incurred for employee separations have been paid and it is anticipated that payment in respect of the restructuring activities for real estate consolidation will continue through 2017. As of December 31, 2008 and December 31, 2007, the remaining liability related to these initiatives was $1 million and $3 million all related to the GCUK Segment.
During 2007, adjustments to the facilities closure liability resulted in an increase of $3 million to accrued restructuring costs, and a corresponding $3 million increase to goodwill, as compared to our preliminary allocation of the acquisition costs of Fibernet.
2003 and Prior Restructuring Plans
Prior to our emergence from bankruptcy on December 9, 2003, we announced and implemented certain restructuring activities to reduce our operating expenses and cash flow requirements. The restructuring activities were taken as a result of the slowdown of the economy and telecommunications industry as well as our efforts to restructure while under Chapter 11 bankruptcy protection. As a result of these activities, we eliminated approximately 5,200 positions and vacated approximately 250 facilities. All amounts incurred for employee separations were paid as of December 31, 2004 and it is anticipated that the remainder of the restructuring liability, all of which relates to facility closings, will be paid through 2025.
The undiscounted facilities closing reserve, which represents estimated future cash flows, is composed of continuing building lease obligations and broker commissions for the restructured sites (aggregating $107 million as of December 31, 2008), offset by anticipated receipts from existing and future third-party subleases. As of December 31, 2008, anticipated third party sublease receipts were $93 million, representing $43 million from subleases already entered into and $50 million from subleases projected to be entered into in the future.
The table below reflects the activity associated with the restructuring reserve relating to the restructuring plans initiated during and prior to 2003 for the years ended December 31, 2008 and 2007:
Included in the $76 million of deductions in 2007 is approximately $10 million related to the settlement and termination of existing real estate lease agreements for technical facilities, $33 million related to the decision to change the use of restructured facilities from idle assets to productive assets, including $31 million related to the development of our European collocation business, with the remainder related to third-party lease payments net of third-party subleases receipts. Upon the changes in use, the restructuring reserve for the facilities was released.
Inflation
We do not believe that our business is impacted by inflation to a significantly different extent than the general economy.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of business we are exposed to market risk arising from changes in interest rates and foreign currency exchange rates that could impact our cash flows and earnings. We selectively use financial instruments to manage these risks.
Interest Rate Risk
The table below provides information about our interest rate sensitive financial instruments and constitutes a “forward looking statement.” For future indebtedness, to the extent we are subject to interest rate risk, our policy is to manage interest rates through use of a combination of fixed and floating rate debt. Interest rate swaps or other derivatives may be used to adjust interest rate exposures when appropriate based upon market conditions. Our objective in managing exposure to changes in interest rates is to reduce volatility on earnings and cash flow associated with such changes.
(1)
The interest rate is LIBOR +6.25% which was 8.08% as of December 31, 2008.
(2)
The interest rate is the Colombian consumer price index +8% which was 15.43% as of December 31, 2008.
(3)
The interest rate is the Brazilian interbank lending rate +8.73% which was 23.29% as of December 31, 2008.
(4)
The interest rate is LIBOR +1.5% to 3.2% which was 4.6% to 7% as of December 31, 2008.
The term loans under the Term Loan Agreement (i) mature on May 9, 2012, with amortization of 0.25% of principal repayable on a quarterly basis and the remaining principal due at maturity, and (ii) bear interest at LIBOR plus 6.25% per annum payable quarterly.
In satisfaction of the obligation under the Term Loan Agreement, we entered into an agreement in July 2007 to mitigate the risk arising from the floating rate debt by hedging the term loans against interest risk volatility. As of December 31, 2008, the hedge consists of interest rate caps.
The table below discloses the key terms of the hedge:
Foreign Currency Risk
The table below provides information about our financial instruments subject to currency risk and constitutes a “forward looking statement.”
(1)
The interest rate is the Colombian consumer price index +8% which was 15.43% as of December 31, 2008.
(2)
The interest rate is the Brazilian interbank lending rate +8.73% which was 23.29% as of December 31, 2008.
In order to better manage our foreign currency risk, we entered into a five-year cross- currency interest rate swap transaction which expires in 2009 with an affiliate of Goldman Sachs & Co. to minimize exposure of any dollar/sterling currency fluctuations related to interest payments on the $200 million U.S. dollar-denominated GCUK Notes. The swap transaction converts the U.S. dollars to pounds sterling at a rate of GBP1 to $1.945. The notional value of the cross-currency swap is equal to the U.S. dollar denominated GCUK Notes principal. At December 31, 2008 and 2007, the fair value of the cross-currency swap was an asset of ($4) million and a liability $4 million, respectively.
See “-Liquidity and Capital Resources,” for information on our indebtedness.
We have not entered into, and do not intend to enter into, financial instruments for speculation or trading purposes. Additional information regarding financial instruments is contained in Note 12, “Debt” and Note 20, “Financial Instruments,” to the accompanying consolidated financial statements included in this annual report on Form 10-K.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See the index included on page of this annual report on Form 10-K, “Index to Consolidated Financial Statements and Schedule.”
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures (as defined in Rule 13(a) -15(e) under the Exchange Act) are controls and other procedures that are designed to ensure that information required to be disclosed by a public company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a public company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Disclosure controls and procedures include many aspects of internal control over financial reporting (as defined later in this Item 9A).
In connection with the preparation of this annual report on Form 10-K, management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures, pursuant to Rule 13a-15 under the Exchange Act. Based upon management’s evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of December 31, 2008.
Management’s Report on Internal Control over Financial Reporting
Management of GCL is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. Internal control over financial reporting refers to a process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, including those policies and procedures that:
•
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
•
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and
•
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting cannot provide absolute assurance of the prevention or detection of misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Criteria”). Management reviewed the results of its assessment with the Audit Committee of our Board of Directors. Based on its evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2008.
Additional Information Regarding Impsat
As previously disclosed, and as discussed more fully in Item 3, “Legal Proceedings,” in October 2006, two Impsat employees were indicted by the Paraguayan Prosecutor’s Office in connection with an investigation relating to the contracting and bidding process at CONATEL, a public entity in Paraguay, which contracted with joint-venture entities in 2000 and 2001 in which Impsat was a participant. In conjunction with an agreement with the Prosecutor, the indictments against the Impsat employees have been conditionally dismissed in November 2007 for a one year term. The conditional suspension period has now lapsed and the final dismissal of the charges is expected soon.
Since the May 9, 2007 acquisition, we have been engaged in the process of integrating the Impsat business into our consolidated operations. As part of this process, management is conducting a review of the controls and procedures intended to ensure compliance with applicable laws in the United States and certain foreign countries in which Impsat operates, including the U.S. Foreign Corrupt Practices Act (“FCPA”). As part of this effort, we became aware of certain issues with respect to Impsat’s use of third-party agents, including the existence of two other government investigations (described below) related to Impsat, that were not known to us at the time of the May 9, 2007 acquisition.
•
In February 2003, as part of an investigation into contract procurement procedures at the Argentine Border Patrol (Gendarmería Nacional), an Argentine government agency with which Impsat had a longstanding contractual relationship, the Argentine Anti-Corruption Office (Oficina Anticorrupción) filed a complaint that resulted in the criminal indictment of four Impsat employees. The charges against all defendants were dismissed for lack of sufficient evidence in August 2007, and the dismissal became final and unappealable in September 2007.
•
The Colombian National Attorney General (Procuraduría General de la Nación (“NAG”)) published a decision in November 2007 (the “NAG Decision”) finding (as part of broader allegations unrelated to Impsat) that funds originated with Impsat had been used by a contractor retained by Impsat to bribe an official within Colombia’s homeland security agency (Departamento Administrativo de Seguridad (“DAS”)). Impsat retained the contractor in question in 2003 and paid him approximately $44,000 in 2004; we have not been able to determine whether any of these funds went to DAS officials. The NAG Decision included a referral of the report and its findings to the criminal prosecutor, and the referral included specific reference to Impsat. One DAS official has been criminally convicted in connection with a related investigation, and criminal proceedings are pending against two other individuals (including a former senior official at DAS).
After learning of these investigations, we conducted an internal review of certain agent relationships and government contracts and potential unauthorized payments in Latin American countries, and engaged outside counsel and accounting advisors to assist in the review. The review is now substantially complete. Additionally, in connection with a post-acquisition deployment of Global Crossing’s ethics policy that included employee certifications of compliance, we were informed by two Impsat employees that, in 2005 and 2006, Impsat made payments of approximately $19,000 to a government official to allow performance of construction work notwithstanding the fact that required permits were not obtained. Additional investigative work confirmed those payments and revealed certain additional, similar payments totaling $4,000, which began in 2004.
The facts developed in our review show that: first, although Impsat had policies in place prior to our May 9, 2007 acquisition relating to FCPA compliance and contracting with third-party agents, those policies were not implemented; second, Impsat’s documentation relating to third-party agents and certain government contracts was not sufficient; and third, the corporate environment at Impsat did not reflect a sufficient focus by senior management on the promotion of, and compliance by the Company with, these policies.
Since the May 9, 2007 acquisition of Impsat, to enhance Global Crossing’s internal controls relating to the FCPA and other laws applicable to our business in Latin America and as part of a remediation plan adopted in connection with our internal review described above, management has implemented the following changes:
•
We have revised the Company’s Ethics Policy and adopted a new Anti-Corruption Policy consolidating in one place our existing policies relating to the FCPA and similar laws, and emphasizing the Company’s commitment to anti-corruption compliance; and we extended both policies to all former Impsat employees who are employees of the Company and have provided additional training in respect of these policies to all Company employees;
•
We have appointed a Corporate Ethics Officer who is responsible for implementation of, and the establishment of procedures for compliance with, our Ethics Policy, our Anti-Corruption Policy and our remedial measures; the Corporate Ethics Officer is a member of senior management reporting to the CEO, and will regularly update the Audit Committee of the Board of Directors on his activities;
•
We have established an Ethics Oversight Team, comprised of members of senior management, to advise and support the Corporate Ethics Officer;
•
We have requested all employees, including all former Impsat employees who now work for the Company to review and certify compliance with the Company’s ethics and anti-corruption policies;
•
We hired an experienced director of external reporting and technical accounting within Impsat;
•
We have established and staffed and are training a legal department and an internal audit department within Impsat separate from its other operational support groups;
•
We have adopted and are implementing new policies and procedures for our Latin American operations covering the retention of third-party agents in connection with government contracts, which are intended to enhance FCPA compliance substantially and to ensure that any employees involved in any of the Company’s relationships with these third-party agents, as well as the agents themselves, understand and agree to abide by the Company’s commitment to FCPA compliance; and
•
We have taken remedial action concerning certain employees, and continue to monitor the effectiveness and implementation of our remediation plan and related policies, procedures and controls, and will take additional action in this regard as warranted.
Changes in Internal Control over Financial Reporting
On May 9, 2007, we acquired Impsat. During 2008, we incorporated Impsat’s internal controls into our control structure and migrated overlapping processes and systems to legacy Global Crossing processes and systems. We consider this integration of Impsat a material change in our internal control over financial reporting.
Except as noted above and under “Additional Information Regarding Impsat,” there were no other material changes in our internal control over financial reporting during the fourth quarter of 2008 and year ended December 31, 2008.
Our independent registered public accounting firm, Ernst & Young LLP, has audited and issued a report expressing its opinion on the effectiveness of our internal control over financial reporting. Ernst & Young LLP’s report appears below in this Item 9A.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of
Global Crossing Limited
We have audited Global Crossing Limited’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Global Crossing Limited’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Global Crossing Limited maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Global Crossing Limited and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of operations, shareholders’ equity (deficit), cash flows, and comprehensive loss for each of the three years in the period ended December 31, 2008 of Global Crossing Limited, and our report dated March 2, 2009 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG
Iselin, New Jersey
March 2, 2009
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by this Item 10 will be contained in our definitive proxy statement for use in connection with our annual general meeting of shareholders expected to be held in June 2009. Such information is incorporated into this annual report on Form 10-K by reference.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
The information called for by this Item 11 will be contained in our definitive proxy statement for use in connection with our annual general meeting of shareholders expected to be held in June 2009. Such information is incorporated into this annual report on Form 10-K by reference.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by Item 201(d) of Regulation S-K regarding securities authorized for issuance under equity compensation plans is contained in Item 5 above under the caption “Equity Compensation Plan Information.” The other information called for by this Item 12 will be contained in our definitive proxy statement for use in connection with our annual general meeting of shareholders expected to be held in June 2009. Such information is incorporated into this annual report on Form 10-K by reference.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information called for by this Item 13 will be contained in our definitive proxy statement for use in connection with our annual general meeting of shareholders expected to be held in June 2009. Such information is incorporated into this annual report on Form 10-K by reference.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information called for by this Item 14 will be contained in our definitive proxy statement for use in connection with our annual general meeting of shareholders expected to be held in June 2009. Such information is incorporated into this annual report on Form 10-K by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) List of documents filed as part of this report:
1. Financial Statements-Included in Part II of this Form 10-K:
Report of Independent Registered Public Accounting Firm: Ernst & Young LLP.
Consolidated Balance Sheets as of December 31, 2008 and December 31, 2007.
Consolidated Statements of Operations for the years ended December 31, 2008, 2007 and 2006.
Consolidated Statements of Shareholders’ Equity (Deficit) for the years ended December 31, 2008, 2007 and 2006.
Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006.
Consolidated Statements of Comprehensive Loss for the years ended December 31, 2008, 2007 and 2006.
Notes to Consolidated Financial Statements
2. Financial Statement Schedules-Included in Part II of this Form 10-K:
Schedule II-Valuation and Qualifying Accounts
3. Exhibit Index:
* Denotes management contract or compensatory plan, contract or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf on March 3, 2009 by the undersigned, thereunto duly authorized.
GLOBAL CROSSING LIMITED
By:
/s/ JOHN J. LEGERE
John J. Legere
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 3, 2009 by the following persons on behalf of the registrant in the capacities indicated.
S-1
S-2
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of
Global Crossing Limited
We have audited the accompanying consolidated balance sheets of Global Crossing Limited and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of operations, shareholders’ equity (deficit), cash flows, and comprehensive loss for each of the three years in the period ended December 31, 2008. Our audits also included the financial statement schedule listed in the index at Item 15. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Global Crossing Limited and subsidiaries at December 31, 2008 and 2007, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, represents in all material respects the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, in 2007 the Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109.”
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Global Crossing Limited’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 2, 2009 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Iselin, New Jersey
March 2, 2009
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in millions, except share and per share information)
The accompanying notes are an integral part of these consolidated financial statements.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except share and per share information)
The accompanying notes are an integral part of these consolidated financial statements.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)
(in millions, except share information)
The accompanying notes are an integral part of these consolidated financial statements.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
The accompanying notes are an integral part of these consolidated financial statements.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in millions)
The accompanying notes are an integral part of these consolidated financial statements.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
1. BACKGROUND AND ORGANIZATION
Global Crossing Limited or “GCL” was formed as an exempt company with limited liability under the laws of Bermuda in 2003. GCL is the successor to Global Crossing Ltd., a company organized under the laws of Bermuda in 1997 (“Old GCL”), which, together with a number of its subsidiaries (collectively, the “GC Debtors”) emerged from reorganization proceedings on December 9, 2003 (the “Effective Date”) as a result of the consummation of the transactions contemplated by the Joint Plan of Reorganization of the GC Debtors, as amended (the “Plan of Reorganization”), pursuant to chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”).
Global Crossing Limited (“GCL”) and its subsidiaries (collectively, the “Company”) are a global communications service provider, serving many of the world’s largest corporations and many other telecommunications carriers, providing a full range of Internet Protocol (“IP”) and managed data and voice products and services. The Company’s network delivers services to more than 690 cities in more than 60 countries and six continents around the world. The Company operates as an integrated global services provider with operations in North America, Europe, Latin America and a portion of Asia/Pacific region, providing services that support a migration path to a fully converged IP environment. The vast majority of the Company’s revenue is generated from monthly services. As a result of the May 9, 2007 acquisition of Impsat Fiber Networks, Inc. and its subsidiaries (collectively, “Impsat”) (see Note 4) and the establishment of a business unit management structure, the Company now reports financial results based on three separate operating segments: (i) Global Crossing (UK) Telecommunications Ltd (“GCUK”) and its subsidiaries (collectively, the “GCUK Segment”); (ii) GC Impsat Holdings I Plc (“GC Impsat”) and its subsidiaries (collectively, the “GC Impsat Segment”); and (iii) GCL and its other subsidiaries (collectively, the “Rest of World Segment” or “ROW Segment”) (see Note 23).
2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
A summary of the basis of presentation and the significant accounting policies followed in the preparation of these consolidated financial statements is as follows:
Basis of Presentation and Use of Estimates
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). These consolidated financial statements include the accounts of GCL and its subsidiaries over which it exercises control. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the Company’s results as of and for the years ended December 31, 2008, 2007 and 2006.
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements, the disclosure of contingent assets and liabilities in the consolidated financial statements and the accompanying notes, and the reported amounts of revenue and expenses and cash flows during the periods presented. Actual amounts and results could differ from those estimates. The estimates the Company makes are based on historical factors, current circumstances and the experience and judgment of the Company’s management. The Company evaluates its assumptions and estimates on an ongoing basis and may employ outside experts to assist in the Company’s evaluations.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
Principles of Consolidation
The consolidated financial statements include the accounts of GCL and its wholly-owned subsidiaries. Under U.S. GAAP, consolidation is generally required for investments of more than 50% of the outstanding voting stock of an investee, except when control is not held by the majority owner. All significant intercompany accounts and transactions have been eliminated in consolidation.
Reclassifications
Certain amounts in prior period consolidated financial statements and accompanying footnotes have been reclassified to conform to the current year presentation, such as the movement of certain subsidiaries from the ROW Segment to the GC Impsat Segment.
Revenue Recognition
Services
Revenue derived from telecommunication and maintenance services, including sales of capacity under operating-type leases, are recognized as services are provided. Non-refundable payments received from customers on billings made before the relevant criteria for revenue recognition are satisfied are included in deferred revenue in the accompanying consolidated balance sheets.
Operating Leases
The Company offers customers flexible bandwidth products to multiple destinations for stipulated periods of time and many of the Company’s contracts for subsea circuits are entered into as part of a service offering. Consequently, the Company defers revenue related to those circuits and amortizes the revenue over the appropriate term of the contract. Accordingly, the Company treats non-refundable cash received prior to the completion of the earnings process as deferred revenue in the accompanying consolidated balance sheets.
Telecom Installation Revenue and Costs
In accordance with SEC Staff Accounting Bulletin 101, “Revenue Recognition in Financial Statements” (“SAB No. 101”), as amended by SEC Staff Accounting Bulletin 104, “Revenue Recognition” (“SAB No. 104”), the Company generally amortizes revenue related to installation services on a straight-line basis over the average contracted customer relationship (generally 24 months). In situations where the contracted period is significantly longer than the average, the actual contract term is used.
The Company capitalizes installation costs incurred for new facilities and connections from the Global Crossing network to networks of other carriers in order to provision customer orders. The costs are capitalized to deferred installation costs (current portion and long-term portions-see Note 7) and amortized using the straight-line method into depreciation and amortization over the average contracted relationship (generally 24 months). In situations where the contracted period is significantly longer, the actual contract term is used.
Gross vs. Net Revenue Recognition
The Company follows the guidance of Emerging Issues Task Force (“EITF”) No. 99-19 “Recording Revenue Gross as a Principal versus Net as an Agent” (“EITF No. 99-19”), in its presentation of revenue and
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
costs of revenue. This guidance requires the Company to assess whether it acts as a principal in the transaction or as an agent acting on behalf of others. Where the Company is the principal in the transaction and has the risks and rewards of ownership, the transactions are recorded gross in the consolidated statements of operations. If the Company does not act as a principal in the transaction, the transactions are recorded on a net basis in the consolidated statement of operations.
In June 2006, the EITF ratified the consensus on EITF Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement” (“EITF No. 06-3”). EITF No. 06-3 requires that companies disclose their accounting policy regarding the gross or net presentation of certain taxes. Taxes within the scope of EITF No. 06-3 are any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer and may include, but are not limited to, sales, use, value-added and some excise taxes. In addition, if such taxes are significant, and are presented on a gross basis, the amounts of those taxes should be disclosed. EITF No. 06-3 was effective as of the quarterly reporting period ending March 31, 2007. There was no impact on our financial position and results of operations. The Company’s policy is generally to record taxes within the scope of EITF No. 06-3 on a net basis.
Arrangements with Multiple Elements
The Company follows the guidance of EITF No. 00-21, “Revenue Arrangements with Multiple Deliverables” (“EITF No. 00-21”) in its presentation of revenue and costs of revenue. Pursuant to EITF No. 00-21, revenues from contracts with multiple-element arrangements are recognized as the revenue for each unit of accounting is earned based on the relative fair value of each unit of accounting as determined by internal or third-party analyses of market based prices. A delivered element is considered a separate unit of accounting if it has value to the customer on a standalone basis, there is objective and reliable evidence of the fair value of undelivered elements in the arrangement, and delivery or performance of undelivered elements is considered probable and substantially under our control. Revenue is generally recognized when services are performed provided that all other revenue recognition criteria are met.
Operating Expenses
Cost of Access
The Company’s cost of access primarily comprises charges for leased lines for dedicated facilities and usage-based voice charges paid to local exchange carriers and interexchange carriers to originate and/or terminate switched voice traffic. The Company’s policy is to record access expense as services are provided by vendors.
The recognition of cost of access expense during any reported period involves the use of significant management estimates and requires reliance on non-financial systems given that bills from access vendors are generally received significantly in arrears of service being provided. Switched voice traffic costs are accrued based on the minutes recorded by the Company’s switches, multiplied by the estimated rates for those minutes for that month. Leased line access costs are estimated based on the number of circuits and the average circuit cost, according to the Company’s leased line inventory system, adjusted for contracted rate changes. Upon final receipt of invoices, the estimated costs are adjusted to reflect actual expenses incurred.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
Disputes
The Company performs monthly bill verification procedures to identify errors in vendors’ billing processes. The bill verification procedures include the examination of bills, comparing billed rates with rates used by the cost of access expense estimation systems during the cost of access monthly close process, evaluating the trend of invoiced amounts by vendors, and reviewing the types of charges being assessed. If the Company believes that it has been billed inaccurately, it will dispute the charge with the vendor and begin resolution procedures. The Company records a charge to the cost of access expense and a corresponding increase to the access accrual based on the last eighteen months of historical loss rates for the particular type of dispute. If the Company ultimately reaches an agreement with an access vendor to settle a disputed amount which is different than the corresponding accrual, the Company recognizes the difference in the period in which the settlement is reached as an adjustment to cost of access expense.
Operating Leases
The Company maintains commitments for office and equipment space, automobiles, equipment rentals, network capacity contracts and other leases, under various non-cancelable operating leases. The lease agreements, which expire at various dates into the future, are subject, in many cases, to renewal options and provide for the payment of taxes, utilities and maintenance. Certain lease agreements contain escalation clauses over the term of the lease related to scheduled rent increases resulting from the pass through of increases in operating costs, property taxes and the effect on costs from changes in consumer price indices. In accordance with SFAS No. 13, “Accounting for Leases” (“SFAS No. 13”) the Company recognizes rent expense on a straight-line basis and records a liability representing the rent expensed but not invoiced in other deferred liabilities. Any leasehold improvements related to operating leases are amortized over the lesser of their economic lives or the remaining lease term. Rent-free periods and other incentives granted under certain leases are charged to rent expense on a straight-line basis over the related terms of such leases.
See Note 21 for the Company’s estimated future minimum lease payments and rental expense on operating leases.
Cash and Cash Equivalents, Restricted Cash and Cash Equivalents (Current and Long-Term)
The Company considers cash in banks and short-term highly liquid investments with an original maturity of three months or less to be cash and cash equivalents. Cash and cash equivalents and restricted cash and cash equivalents are stated at cost, which approximates fair value. Restricted cash balances are comprised of various rental guarantees, performance bonds, collateralized letters of credit and debt service account (see Note 12).
Allowance for Doubtful Accounts and Sales Credits
The Company provides allowances for doubtful accounts and sales credits. Allowances for doubtful accounts are charged to selling, general, and administrative expenses, while allowances for sales credits are charged to revenue. The adequacy of the reserves is evaluated monthly by the Company utilizing several factors including the length of time the receivables are past due, changes in the customer’s credit worthiness, the customer’s payment history, the length of the customer’s relationship with the Company, the current economic climate, and current industry trends. A specific reserve requirement review is performed on customer accounts with larger aged balances. A general reserve requirement is performed on accounts not already included under the specific reserve requirement utilizing past loss experience and the factors previously mentioned. Service level
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
requirements are assessed to determine sales credit requirements where necessary. Changes in the financial viability of significant customers and worsening of economic conditions may require changes to its estimate of the recoverability of the receivables. Such changes in estimates are recorded in the period in which these changes become known.
Property and Equipment, net
Property and equipment, net, which includes amounts under capitalized leases, were stated at their estimated fair values as of the Effective Date as determined by the Company’s reorganization value. The Company determined the fair value of its property and equipment as of the Effective Date by using a replacement cost approach and, in the limited circumstances described below, a market approach. Under the replacement cost approach, fair value was determined by examining an asset’s replacement cost and adjusting for loss in value due to physical depreciation and economic and functional obsolescence. The replacement cost estimates were based on vendor pricing, inclusive of discounts, available to the Company at the Effective Date for technology available at the time, and were not based on prices that may have been available through equipment purchases from financially distressed communications companies. For assets where actual vendor pricing information as of the Effective Date was not available to the Company, the market approach was used. Under the market approach, fair value was determined by comparing recent sales of similar assets and adjusting for factors such as physical differences, age, and economic and functional obsolescence. The estimates were based on market comparables obtained from various sources, including discussions with equipment brokers and dealers.
Purchases of property and equipment, net, including amounts under capital leases, subsequent to the Effective Date are stated at cost, net of depreciation and amortization. Major enhancements are capitalized, while expenditures for repairs and maintenance are expensed when incurred. Costs incurred prior to the capital project’s completion are reflected as construction in progress, which is included in property and equipment and is depreciated starting on the date the project is complete. Direct internal costs of constructing or installing property and equipment are capitalized.
Depreciation is provided on a straight-line basis over the estimated useful lives of the assets, with the exception of leasehold improvements and assets acquired through capital leases, which are depreciated over the lesser of the estimated useful lives or the term of the lease.
Estimated useful lives of the Company’s property and equipment are as follows as of December 31, 2008:
Buildings
10-40 years
Leasehold improvements
Lesser of 20 years
or remaining lease term
Furniture, fixtures and equipment
3-7 years
Transmission equipment
3-25 years
When property or equipment is retired or otherwise disposed of, the cost and accumulated depreciation is relieved from the accounts, and resulting gains or losses are reflected in other income (expense), net.
In accordance with SFAS No. 144, the Company periodically evaluates the recoverability of its long-lived assets and evaluates such assets for impairment whenever events or circumstances indicate that the carrying amount of such assets (or group of assets) may not be recoverable. Impairment is determined to exist if the
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
estimated future undiscounted cash flows are less than the carrying value of such asset. The amount of any impairment then recognized would be calculated as the difference between the fair value and the carrying value of the asset. As a result of continued operating losses and negative cash flows during 2008, management performed a recoverability test of the Company’s long-lived assets as of December 31, 2008. The results of the test indicate that no impairment of the Company’s long-lived assets exists.
Internally Developed Software
The Company capitalizes the cost of internal-use software which has a useful life in excess of one year in accordance with Statement of Position No. 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” Subsequent additions, modifications or upgrades to internal-use software are capitalized only to the extent that they allow the software to perform a task it previously did not perform. Capitalized costs are included in property and equipment in the consolidated balance sheet. Software maintenance and training costs are expensed in the period in which they are incurred. Capitalized computer software costs are amortized using the straight-line method over a 3 year period (see Note 8).
Intangibles
Intangibles consist primarily of customer contracts, customer relationships and internally developed software and goodwill primarily attributable to the assembled work force related to the 2006 and 2007 acquisitions of Fibernet Group Plc (“Fibernet”) and Impsat, respectively. The fair values attributable to the identified intangibles as of the acquisition dates were based on a number of significant assumptions as determined by the Company. Identifiable intangible assets with finite lives will be amortized using the straight-line method over their applicable estimated useful lives (see Note 9). Goodwill and intangibles with indefinite lives are not amortized in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”) but are reviewed for impairment at least annually (beginning with the first anniversary of the acquisition date). The Company performed annual impairment reviews for the Fibernet and Impsat acquisitions during the year ended December 31, 2008. The results of the reviews indicate that no impairment exists.
Deferred Financing Costs
Costs incurred to obtain financing through the issuance of debt and other financing agreements (see Note 12) have been reflected as an asset included in “other assets” in the accompanying December 31, 2008 and 2007 consolidated balance sheets. Debt financing costs are amortized to interest expense over the lesser of the term or the expected payment date of the debt obligation using the effective interest rate method.
Restructuring
The Company initiated restructuring programs commencing in August 2001, October 2004, October 2006 and May 2007, which have continued through December 31, 2008. The components of the restructuring liability represent direct costs of exiting lease commitments for certain real estate facility locations and employee termination costs, along with certain other costs associated with approved restructuring plans (see Note 3 for further information on the Company’s restructuring plans). The restructuring programs initiated commencing in August 2001 were recorded in accordance with EITF No. 94-3 “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)” (“EITF No. 94-3”) through January 1, 2003, when the Company adopted the provisions of SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS No. 146”), which requires that costs,
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
including severance costs, associated with exit or disposal activities be recorded at their fair value when a liability has been incurred. Under EITF No. 94-3, certain exit costs, including severance costs, were accrued upon management’s commitment to an exit plan, which is generally before the exit activity has occurred. The Company has applied the provisions of SFAS No. 146 to all restructuring programs initiated after December 31, 2002, except for those programs related to business acquisitions (see Note 4). Restructuring programs related to business acquisitions are recorded in accordance with EITF No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination,” which requires costs associated with exit or disposal activities of the acquired company to be recognized as an acquired liability included in the allocation of acquisition cost. Adjustments for changes in assumptions are recorded in the period such changes become known. Changes in assumptions, especially as they relate to contractual lease commitments and related anticipated third-party sub-lease payments, could have a material effect on the restructuring liabilities.
Derivative Instruments
The Company follows SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), as amended, which requires that all derivatives be measured at fair value and recognized as either assets or liabilities in the Company’s consolidated balance sheets. Changes in fair value of derivative instruments that do not qualify as hedges and/or any ineffective portion of hedges are recognized as a gain or loss in the Company’s consolidated statement of operations in the current period. Changes in the fair values of the derivative instruments used effectively as fair value hedges are recognized in income (loss), along with the change in the value of the hedged item. Changes in the fair value of the effective portions of cash flow hedges are reported in other comprehensive income (loss) and recognized in income (loss) when the hedged item is recognized in income (loss).
For the years ended December 31, 2008, 2007 and 2006, hedge ineffectiveness was not material to our results of operations.
Fair Value of Financial Instruments
The Company does not enter into financial instruments for trading or speculative purposes. The carrying amounts of financial instruments classified as current assets and liabilities, other than marketable securities, approximate their fair value due to their short maturities. The fair value of marketable securities, short-term investments, debt, including short-term and long-term portions and derivative instruments are based on market quotes, current interest rates, or management estimates, as appropriate (see Notes 5 and 20).
Asset Retirement Obligations
The Company follows SFAS No. 143 “Accounting for Asset Retirement Obligations” (“SFAS No. 143”). SFAS No. 143 recognizes the fair value of a liability for an asset retirement obligation in the period in which it is incurred when a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset, characterized as leasehold improvements, and depreciated over the lesser of 20 years or the remaining lease term.
Income Taxes
The provision for income taxes, income taxes payable and deferred income taxes are determined using the liability method. Deferred tax assets and liabilities are determined based on differences between the financial
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
reporting and tax basis of assets and liabilities and are measured by applying enacted tax rates and laws to taxable years in which such differences are expected to reverse. A valuation allowance is provided when the Company determines that it is more likely than not that a portion of the deferred tax asset balance will not be realized.
The Company adopted the provisions of the Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes: an interpretation of FASB Statement No. 109” (“FIN 48”), on January 1, 2007. This interpretation states that an “enterprise shall initially recognize the financial statement effects of a tax position where it is more likely than not, based on the technical merits, that the position will be sustained upon examination.” “More likely than not” is defined as a likelihood of greater than 50% based on the facts, circumstances and information available at the reporting date. The cumulative effect of applying FIN 48 is to be reported as an adjustment to the beginning balance of accumulated deficit. There was no impact to the Company’s January 1, 2007 balance of accumulated deficit upon adoption (see Note 15).
The Company’s reorganization has resulted in a significantly modified capital structure as a result of applying fresh-start accounting in accordance with AICPA Statement of Position 90-7, “Financial Reporting by Entities in Reorganization under the Bankruptcy Code”, (“SOP 90-7”) on the Effective Date. Fresh-start accounting has important consequences on the accounting for the realization of valuation allowances, related to net deferred tax assets that existed on the Effective Date but which arose in pre-emergence periods. Specifically, fresh start accounting requires the reversal of such allowances to be recorded as a reduction of intangible assets established on the Effective Date until exhausted, and thereafter as additional paid in capital (see Note 15). This treatment does not result in any change in liabilities to taxing authorities or in cash flows.
At each period end, it is necessary for the Company to make certain estimates and assumptions to compute the provision for income taxes including allocations of certain transactions to different tax jurisdictions, amounts of permanent and temporary differences, the likelihood of deferred tax assets being recovered and the outcome of contingent tax risks. These estimates and assumptions are revised as new events occur, more experience is acquired and additional information is obtained. The impact of these revisions is recorded in income tax expense or benefit in the period in which they become known.
Foreign Currency Translation and Transactions
For transactions that are in a currency other than the entity’s functional currency, translation adjustments are recorded in the accompanying consolidated statements of operations. For those subsidiaries not using the U.S. dollar as their functional currency, assets and liabilities are translated at exchange rates in effect at the balance sheet date and income and expense transactions are translated at average exchange rates during the period. Resulting translation adjustments are recorded directly to a separate component of shareholders’ deficit and are reflected in the accompanying consolidated statements of comprehensive loss.
The Company’s foreign exchange transaction gains (losses) included in “other income (expense), net” in the consolidated statements of operations for the years ended December 31, 2008, 2007 and 2006 were $(30), $28, and $(6), respectively.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
Loss Per Common Share
Basic loss per common share (“EPS”) is computed as loss applicable to common shareholders divided by the weighted-average number of common shares outstanding for the period. Loss applicable to common shareholders includes preferred stock dividends for the years ended December 31, 2008, 2007 and 2006 respectively (see Note 17).
Stock-Based Compensation
The Company follows SFAS No. 123R, “Share Based Payment,” (“SFAS No. 123R”) to account for stock-based compensation. SFAS No. 123R requires all share-based awards granted to employees to be recognized as compensation expense over the service period (generally the vesting period) in the consolidated financial statements based on their fair values.
Certain stock-based awards have graded vesting (i.e. portions of the award vest at different dates during the vesting period). The fair value of the awards is determined using a single expected life for the entire award (the average expected life for the awards that vest on different dates). The Company recognizes the related compensation cost of such awards on a straight-line basis; provided that the amount amortized at any given date may be no less than the portion of the award vested as of such date.
See Note 18 for a description of stock-based compensation plans.
Concentration of Credit Risk
The Company has some concentration of credit risk among its customer base. The Company’s trade receivables, which are unsecured, are geographically dispersed and include customers both large and small and in numerous industries. Trade receivables from the carrier sales channels are generated from sales of services to other carriers in the telecommunications industry. At December 31, 2008 and 2007, the Company’s trade receivables related to the carrier sales channel represented approximately 46% and 43%, respectively, of the Company’s consolidated receivables. Also as of December 31, 2008 and 2007, the Company’s receivables due from various agencies of the U.K. Government together represented approximately 6% and 14%, respectively, of consolidated receivables. The Company performs ongoing credit evaluations of its larger customers’ financial condition. The Company maintains a reserve for potential credit losses, based on the credit risk applicable to particular customers, historical trends and other relevant information. As of December 31, 2008 and 2007, no one customer accounted for more than 3% or 5%, respectively, of consolidated accounts receivable, net.
Currency Risk
Certain of the Company’s current and prospective customers derive their revenue in currencies other than U.S. dollars but are invoiced by the Company in U.S. dollars. The obligations of customers with revenue in foreign currencies may be subject to unpredictable and indeterminate increases in the event that such currencies depreciate in value relative to the U.S. dollar. Furthermore, such customers may become subject to exchange control regulations restricting the conversion of their revenue currencies into U.S. dollars. In either event, the affected customers may not be able to pay the Company in U.S. dollars. In addition, where the Company issues invoices for its services in currencies other than U.S. dollars, the Company’s operating results may suffer due to currency translations in the event that such currencies depreciate relative to the U.S. dollar and the Company
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
cannot or does not elect to enter into currency hedging arrangements in respect of those payment obligations. Declines in the value of foreign currencies relative to the U.S. dollar could adversely affect the Company’s ability to market its services to customers whose revenue is denominated in those currencies.
Certain Latin American economies have experienced shortages in foreign currency reserves and have adopted restrictions on the ability to expatriate local earnings and convert local currencies into U.S. dollars. Any such shortages or restrictions may limit or impede the Company’s ability to transfer or to convert such currencies into U.S. dollars and to expatriate such funds for the purpose of making timely payments of interest and principal on the Company’s indebtedness. These restrictions have a significantly greater impact on the Company and the Company’s ability to service its debt as a result of the Impsat acquisition. In addition, currency devaluations in one country may have adverse effects in another country. For example, in 2001 and 2002, Argentina imposed exchange controls and transfer restrictions substantially limiting the ability of companies to make payments abroad. While these restrictions have been substantially eased, Argentina may tighten exchange controls or transfer restrictions in the future to prevent capital flight, counter a significant depreciation of the peso or address other unforeseen circumstances.
In Venezuela, the official bolivares-U.S. dollar exchange rate established by the Venezuelan Central Bank and the Venezuelan Ministry of Finance attributes to the bolivar a value that is significantly greater than the value prevailing on the parallel market. The official rate is the rate used for recording the assets, liabilities and transactions for our Venezuelan subsidiary. Moreover, the conversion of bolivares into foreign currencies is limited by the current exchange control regime. Accordingly, the acquisition of foreign currency by Venezuelan companies to honor foreign debt, pay dividends or otherwise expatriate capital is subject to registration and subject to a process of application and approval by the Comisión de Administración de Divisas and to the availability of foreign currency within the guidelines set forth by the National Executive Power for the allocation of foreign currency. Such approvals have become less forthcoming over time, resulting in a significant buildup of excess cash in the Company’s Venezuelan subsidiaries and a significant increase in the Company’s exchange rate and exchange control risks. As of December 31, 2008 and 2007, approximately $33 and $25, respectively of the Company’s cash and cash equivalents were held in Venezuelan bolivars.
Pension Benefits
The Company follows SFAS No.158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”) to account for its defined benefit pension plans. The Company is required to recognize in its statement of financial condition the funded status of its defined benefit postretirement plans, measured as the difference between the fair value of the plan assets and the benefit obligation. SFAS No. 158 also requires an entity to recognize changes in the funded status within accumulated other comprehensive income, net of tax to the extent such changes are not recognized in earnings as components of periodic net benefit cost (see Note 19).
Comprehensive Loss
Comprehensive loss includes net loss and other non-owner related income (charges) in equity not included in net loss, such as unrealized gains and losses on marketable securities classified as available for sale, foreign currency translation adjustments related to foreign subsidiaries, changes in the unrealized gains and losses on cash flow hedges and the impact of recognizing changes of the funded status of pension plans as a result of adopting SFAS No. 158.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
Advertising Costs
The Company expenses the cost of advertising as incurred. Advertising expense was $5, $3, and $3 for the years ended December 31, 2008, 2007 and 2006, respectively, and is included in selling, general and administrative expenses as reported in the consolidated statements of operations.
Recently Issued Accounting Pronouncements
In September 2006, the FASB issued SFAS No.157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 clarifies that fair value is the amount that would be exchanged to sell an asset or transfer a liability in an orderly transaction between market participants and requires that a fair value measurement technique include an adjustment for risks inherent in a particular valuation technique and/or the risks inherent in the inputs to the model if market participants would also include such an adjustment. SFAS No. 157 also expands disclosures about fair value measurements. In February 2008, the FASB issued FASB Staff Position No. 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13” (“FSP No. 157-1”), which removed certain leasing transactions accounted for under SFAS No. 13 from the scope of SFAS No. 157, and FASB Staff Position No. 157-2, “Effective Date of FASB Statement No. 157” (“FSP No. 157-2”), which delayed the effective date of SFAS No. 157 for certain nonfinancial assets and nonfinancial liabilities to January 1, 2009, amending SFAS No. 157 (“SFAS No. 157, as amended”). In October 2008, the FASB issued FASB Staff Position No. 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active” (“FSP No. 157-3”), which amended SFAS No. 157 to include an additional example illustrating the key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. The Company adopted the effective provisions of SFAS No. 157, as amended, as of January 1, 2008 which did not have any impact on the Company’s consolidated position or results of operations (see Note 5). The Company’s evaluation of the impact of this standard is ongoing, and the Company has not yet determined the impact of the deferred portion of this standard on our financial position or results of operations.
The FASB issued SFAS No.159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”), in February 2007. SFAS No. 159 allows entities to voluntarily choose, at specified election dates, to measure many financial assets and financial liabilities (as well as certain non-financial instruments that are similar to financial instruments) at fair value (the “fair value option”). The election is made on an instrument-by-instrument basis and is irrevocable. If the fair value option is elected for an instrument, SFAS No. 159 specifies that all subsequent changes in fair value for that instrument shall be reported in earnings. The provisions of SFAS No. 159 are effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. While SFAS No. 159 became effective for the Company as of January 1, 2008, the Company did not elect the fair value option for any of our financial assets or liabilities. As such, the adoption of SFAS No. 159 did not have an impact on the Company’s financial position or results of operations.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS No. 141R”). SFAS No. 141R will change how business acquisitions are accounted for and will impact financial statements both in periods before the acquisition date and in subsequent periods. SFAS No. 141R applies to all transactions or other events in which an entity (the acquirer) obtains control of one or more businesses (the acquiree), including those sometimes referred to as “true mergers” or “mergers of equals” and combinations achieved without the transfer of consideration, for example, by contract alone or through the lapse of minority veto rights. SFAS No. 141R is generally to be applied prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Early adoption is prohibited.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
SFAS No. 141R amends AICPA Statement of Position 90-7, “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code” (“SOP No. 90-7”). Prior to adoption, reversal of pre-emergence valuation allowances are recorded as a reduction of intangibles to zero and thereafter as additional paid-in-capital. Upon adoption, the reversal of pre-emergence valuation allowances will be recorded as a reduction of tax expense. During the years ended December 31, 2008, 2007 and 2006 the Company recorded a provision for income taxes and additional paid-in-capital of $30, $41 and $45 as a result of accounting in accordance with SOP No. 90-7. SFAS No. 141R also amends SFAS 109, “Accounting for Income Taxes”. Prior to adoption, the reversal of valuation allowances recorded in purchase accounting would first reduce goodwill to zero, and then reduce the other acquired non-current intangible assets to zero, and then be reflected in income tax expense. Upon adoption, the reversals of pre-acquisition valuation allowances that do not qualify as a measurement period adjustment are reflected in income tax expense. During the years ended December 31, 2008 and 2007, the Company recorded $5 and $4, respectively, of valuation allowance reversals for deferred tax assets acquired as part of the Impsat acquisition as a reduction in goodwill.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of Accounting Research Bulletin No. 51” (“SFAS No. 160”). SFAS No. 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS No. 160 applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary. The provisions of SFAS No. 160 are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Early adoption is prohibited. This Statement shall be applied prospectively as of the beginning of the fiscal year in which SFAS No. 160 is initially applied, except for the presentation and disclosure requirements which shall be applied retrospectively for all periods presented. The Company does not currently own any noncontrolling interests.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133” (“SFAS No. 161”). SFAS No. 161 requires enhanced disclosure related to derivatives and hedging activities. Under SFAS No. 161, entities must describe: (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedge items are accounted for under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. The requirements of SFAS No. 161 are effective for both interim and annual reporting periods beginning after November 15, 2008, with early application encouraged. The Company is currently evaluating the impact that SFAS No. 161 will have on its financial statements.
In April 2008, the FASB issued FASB Staff Position (“FSP”) No. FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP No. 142-3”). This FSP was issued to improve consistency between the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”), and the period of expected cash flows used to measure the fair value of the intangible asset under SFAS No. 141R. FSP No. 142-3 will require that the determination of the useful life of intangible assets acquired after the effective date of this FSP shall include assumptions regarding renewal or extension, regardless of whether such arrangements have explicit renewal or extension provisions, based on an entity’s historical experience in renewing or extending such arrangements. In addition, FSP No. 142-3 requires expanded disclosures regarding intangible assets existing as of each reporting period. FSP No. 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. Early adoption is prohibited. Except for disclosure requirements, FSP No. 142-3 can only be applied prospectively to intangible assets acquired after the effective date.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
In May 2008, the FASB issued FSP No. APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“FSP APB No. 14-1”). FSP APB No. 14-1 clarifies that convertible debt instruments that may be settled in cash upon either mandatory or optional conversion (including partial cash settlement) are not addressed by paragraph 12 of APB Opinion No. 14, “Accounting for Convertible Debt and Debt issued with Stock Purchase Warrants”. Additionally, FSP APB No. 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB No. 14-1 must be applied on a retrospective basis and is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Based on preliminary analysis, upon adoption of FSP APB No. 14-1, the Company expects to reclassify between $35 and $40 of its convertible debt to equity and that amortization of the debt discount will increase annual non-cash interest expense between $7 and $8.
3. RESTRUCTURING
2007 Restructuring Plans
During 2007, the Company implemented initiatives to generate operational savings which included organizational realignment and functional consolidation resulting in the involuntary separation of employees. As a result of these initiatives, during 2007 the Company incurred a net charge of $10 for one-time severance and related benefits which was included in selling, general and administrative expenses in the consolidated statement of operations. On a segment basis, $2 and $8 were recorded to the GCUK and ROW Segments, respectively. As of December 31, 2008, all severance amounts have been paid under the plan. As of December 31, 2008 and December 31, 2007, the remaining liability related to these initiatives was $0 and $1, respectively, all related to the ROW Segment.
During 2007, the Company adopted a restructuring plan as a result of the Impsat acquisition (see Note 4) under which redundant Impsat employees were terminated. As a result, the Company incurred cash restructuring costs of approximately $8 for severance and related benefits. The liabilities associated with this restructuring plan have been accounted for as part of the purchase price of Impsat. As of December 31, 2008 and December 31, 2007, the remaining liability of the restructuring reserve was $8 and $7, respectively, all related to the GC Impsat Segment.
2006 Restructuring Plan
The Company adopted a restructuring plan as a result of the Fibernet acquisition (see Note 4) under which redundant Fibernet employees were terminated and certain Fibernet facility lease agreements will be terminated or restructured. As a result of these efforts the Company incurred cash restructuring costs of approximately $3 for severance and related benefits in connection with anticipated workforce reductions and $4 for real estate consolidation. The liabilities associated with the restructuring plan have been accounted for as part of the purchase price of Fibernet. All amounts incurred for employee separations have been paid and it is anticipated that payment in respect of the restructuring activities for real estate consolidation will continue through 2017. As of December 31, 2008 and December 31, 2007, the remaining liability related to these initiatives was $1 and $3 all related to the GCUK Segment.
During 2007, an adjustment to the facilities closure liability resulted in an increase of $3 to accrued restructuring costs, and a corresponding $3 increase to goodwill, as compared to our preliminary allocation of the acquisition costs of Fibernet.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
2003 and Prior Restructuring Plans
Prior to the Company’s emergence from bankruptcy on December 9, 2003, the Company adopted certain restructuring plans as a result of the slowdown of the economy and telecommunications industry, as well as its efforts to restructure while under Chapter 11 bankruptcy protection. As a result of these activities, the Company eliminated approximately 5,200 positions and vacated over 250 facilities. All amounts incurred for employee separations were paid as of December 31, 2004 and it is anticipated that the remainder of the restructuring liability, all of which relates to facility closings, will be paid through 2025.
The undiscounted facilities closing reserve, which represents estimated future cash flows, is composed of continuing building lease obligations and broker commissions for the restructured sites (aggregating $107 as of December 31, 2008), offset by anticipated receipts from existing and future third-party subleases. As of December 31, 2008, anticipated third party sublease receipts were $93, representing $43 from subleases already entered into and $50 from subleases projected to be entered into in the future.
The table below reflects the activity associated with the restructuring reserve relating to the restructuring plans initiated during and prior to 2003 for the years ended December 31, 2008 and 2007:
Included in the $76 of deductions in 2007 is approximately $10 related to the settlement and termination of existing real estate lease agreements for technical facilities, $33 related to the decision to change the use of restructured facilities from idle assets to productive assets, including $31 as a result of the development of a collocation hosting business, with the remainder primarily related to third-party lease payments net of third-party sublease receipts. Upon the change in use, the restructuring reserve for the facilities was released. As of December 31, 2008 and 2007, the remaining restructuring liability was $18 and $26, respectively, all related to the GCUK and ROW segments.
4. ACQUISITIONS
Impsat Acquisition
On May 9, 2007, the Company acquired Impsat for cash of $9.32 per share of Impsat common stock, representing a total equity value of approximately $95. The total purchase price including direct costs of acquisition was approximately $104. Impsat is a leading Latin American provider of IP, hosting and value-added data solutions. As a result of the acquisition, the Company is able to provide greater breadth of services and
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
coverage in the Latin American region and enhance its competitive position as a global service provider. The results of Impsat’s operations are included in the consolidated financial statements commencing May 9, 2007.
In connection with the Impsat acquisition, the Company recorded a $27 non-cash, non-taxable gain from the deemed settlement of existing telecom services agreements with Impsat. Under these agreements, the Company earned revenues or incurred expenses that, based on current market rates at the acquisition date, were favorable to the Company. EITF No. 04-1, “Accounting for Pre-Existing Relationships between the Parties to a Business Combination” (“EITF No. 04-1”) stipulates that business relationships between an acquirer and acquiree pre-existing a business combination must be analyzed as a separate element of accounting. The gain or loss on the effective termination of these pre-existing business relationships should be recorded at the date of acquisition as an adjustment to goodwill. The gain recorded as goodwill, represents the net present value of the favorable portion of the fees over the remaining life of the agreements. This gain is included in other income, net in the consolidated statement of operations for the year ended December 31, 2007.
As a result of refinements to the preliminary purchase price allocation, there were additional changes to goodwill that were made during 2007. The primary adjustments were to reallocate $4 of goodwill to intangible assets and the reduction in our estimates of acquisition liabilities.
Fibernet Acquisition
In October 2006, the Company acquired Fibernet. The total purchase price including direct costs of the acquisition was approximately 52 pounds sterling (approximately $97). Fibernet is a provider of specialist telecommunications services to large enterprises and other telecommunications and internet service companies primarily located in the United Kingdom and Germany. The Company purchased Fibernet to expand its presence as a provider of telecommunications services in those markets. The acquisition was accounted for using the purchase method of accounting and, accordingly, the results of Fibernet’s operations have been included in the consolidated financial statements as of October 11, 2006.
In connection with the Fibernet acquisition, the Company recorded a non-cash, non-taxable gain from the deemed settlement termination of existing Indefeasible Right of Use (“IRU”) and telecom services agreements with Fibernet. Under these agreements, the Company earned revenues that, based on current market rates at the acquisition date, were favorable to the Company. In accordance with EITF No. 04-1, the Company recognized a $16 gain ($13 recorded as goodwill and $3 as a reduction in pre-acquisition deferred revenue), representing the net present value of the favorable portion of the fees over the remaining life of the agreements. This gain is included in other income, net in the consolidated statement of operations for the year ended December 31, 2006.
In the Company’s consolidated financial statements as of December 31, 2006, the cost related to the accrued restructuring liability for facility closures was based on preliminary information and was subject to adjustment as new information was obtained. During 2007, adjustments to the facilities closure liability resulted in an increase of $3 to accrued restructuring costs, and a corresponding $3 increase to goodwill, compared to our preliminary allocation of the acquisition costs of the Fibernet acquisition.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
Pro Forma Financial Information
The following unaudited pro forma consolidated results of operations have been prepared as if the acquisition of Impsat and Fibernet had occurred at January 1, 2006:
Included in the pro forma consolidated results of operations for the year ended December 31, 2007 are the following significant non-recurring items: (i) a charge of $30 representing the accelerated issuance of common stock to STT Crossing Ltd. on account of foregone interest through the original scheduled maturity date of the Mandatorily Convertible Notes as an inducement to convert the Mandatorily Convertible Notes, which is included in other income, net in the accompanying consolidated statements of operations (see Note 12); (ii) expenses of approximately $8 related to the write off of deferred financing fees for a bridge loan facility which was terminated upon issuance of the GC Impsat Notes; these expenses are included in other income, net in the accompanying consolidated statements of operations; (iii) a $27 non-cash , non-taxable gain from the deemed settlement of pre-existing arrangements with Impsat in accordance with EITF No. 04-1 which is included in other income, net in the accompanying consolidated statements of operations (see discussion above); (iv) a $31 gain due to the decision to change the use of restructured facilities at our ROW Segment from idle to productive assets as a result of the development of a collocation hosting business, which is included in selling, general and administrative expenses in the accompanying consolidated statement of operations (see Note 3); and (v) a $35 gain due to the reversal of contingent liability accruals for a tax claim against the Company which was dismissed by the tax court, which is recorded as $27 in net pre-confirmation contingencies and $8 in interest expense in the accompanying consolidated statement of operations.
Included in the pro forma consolidated results of operations for the year ended December 31, 2006 is a non-recurring loss on a foreign exchange forward contract of $5. Also, included the pro forma consolidated results of operations for the year ended December 31, 2006 is a $16 non-cash, non-taxable gain from the deemed settlement of pre-existing arrangements with Fibernet recorded in accordance with EITF No. 04-1 which is included in other income, net in the accompanying consolidated statements of operations (see discussion above).
The unaudited pro forma financial information is not intended to represent or be indicative of the Company’s consolidated result of operations that would have been reported had the Impsat and Fibernet acquisitions been completed as of the beginning of the periods presented, nor should it be taken as indicative of the Company’s future consolidated results of operations.
5. FAIR VALUE MEASUREMENTS
The Company has only adopted the effective provisions of SFAS No. 157 and has deferred adoption of SFAS No. 157, as amended, applicable to non-financial assets and non-financial liabilities in accordance with FSP No. 157-2. The Company measures its derivative instruments, which include interest rate swaps and caps classified as cash flow hedges, at fair value on a recurring basis under a Level 2 input as defined by SFAS
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
No. 157. The Company relies on mid-market pricing valuations prepared by its brokers to record derivative instruments at fair value. There was no impact, or change in the basis for which the fair value of these items is determined as a result of the adoption of SFAS No. 157.
The following table provides a summary of the fair values of significant financial assets and financial liabilities under SFAS No. 157:
6. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following:
The fair value of accounts receivable balances approximates their carrying value because of their short-term nature. The Company has some concentrations of credit risk from other telecommunications providers within its carrier sales channels (see Note 2).
7. PREPAID COSTS AND OTHER CURRENT ASSETS
Prepaid assets and other current assets consist of the following:
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
8. PROPERTY AND EQUIPMENT
Property and equipment, including assets held under capital leases, consist of the following:
Assets recorded under capital lease agreements included in property and equipment consisted of $203 and $159 of cost less accumulated depreciation of $80 and $51 at December 31, 2008 and 2007, respectively.
Labor related to internally developed software in the amount of $23 and $15 was capitalized at December 31, 2008 and December 31, 2007, respectively. The accumulated depreciation related to this internal labor was $5 and $2 at December 31, 2008 and 2007, respectively.
Depreciation and amortization expense related to property and equipment including cost of access installation costs (see Note 2) for the years ended December 31, 2008, 2007 and 2006 was approximately $321, $259 and $163, respectively.
9. INTANGIBLES
Goodwill
Changes in the carrying amount of goodwill are as follows:
At December 31, 2006, the $2 of goodwill resulted from the Company’s acquisition of Fibernet on October 11, 2006. The increase in goodwill at December 31, 2007 compared to December 31, 2006 in the GCUK Segment resulted primarily from an adjustment to the facilities closure liability compared to our preliminary allocation of the acquisition costs of the Fibernet acquisition (See Note 4).
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
Goodwill acquired in the GC Impsat Segment resulted from the Company’s acquisition of Impsat on May 9, 2007 while the reduction of goodwill for the year ended December 31, 2007 resulted from the reversal of valuation allowances for deferred tax assets acquired as part of the Impsat acquisition which has been recorded as a provision for income taxes and a reduction in goodwill (see Note 15).
The reduction of goodwill for the year ended December 31, 2008 resulted from foreign exchange translation adjustments and the reversal of valuation allowances for deferred tax assets acquired as part of the Impsat acquisition which has been recorded as a provision for income taxes and a reduction in goodwill (see Note 15). This reduction was partially offset by purchase price adjustments to our preliminary allocation of the acquisition costs of the Impsat acquisition (see Note 4).
Other Intangible Assets
Intangible asset amortization expense was $5, $5 and $1 for the years ended December 31, 2008, 2007 and 2006, respectively.
The following table projects the expected future amortization of the above intangible assets for the next five years:
10. INVESTMENTS
In 2008, the Company participated in a debt auction held by the Venezuelan government to purchase $10 par value of U.S. dollar-denominated bonds in connection with the Company’s currency exchange risk mitigation efforts. The purchase price of the bonds was $11. The Company received approval to purchase the bonds and sold these bonds immediately upon receipt at a price of $8, which resulted in an approximate 27% discount. The difference was recorded as a loss on the sale of investments and included in other income (expense), net in our consolidated statements of operations.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
11. OTHER CURRENT LIABILITIES
Other current liabilities consist of the following:
12. DEBT
Outstanding debt obligations consist of the following:
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
Future maturities of debt are as follows as of December 31, 2008:
GCUK Senior Secured Notes
On December 23, 2004, Global Crossing (UK) Finance PLC (“GCUK Finance”), a special purpose financing subsidiary of the Company’s Global Crossing (UK) Telecommunications Limited subsidiary (together with its subsidiaries, “GCUK”) issued $200 in aggregate principal amount of 10.75% U.S. dollar denominated senior secured notes and 105 pounds sterling aggregate principal amount of 11.75% pounds sterling denominated senior secured notes (collectively, the “GCUK Notes”). The dollar and sterling denominated notes were issued at a discount of approximately $3 and 2 pounds sterling, respectively. The GCUK Notes mature on the tenth anniversary of their issuance. Interest is payable in cash semi-annually on June 15 and December 15.
On December 28, 2006, GCUK Finance issued an additional 52 pounds sterling aggregate principal amount of pound sterling denominated GCUK Notes. The additional notes were issued at a premium of approximately 5 pounds sterling, which resulted in the Company receiving gross proceeds, before underwriting fees, of approximately $111.
The GCUK Notes are senior obligations of GCUK Finance and rank equal in right of payment with all of its future debt. GCUK has guaranteed the GCUK Notes as a senior obligation ranking equal in right of payment with all of its existing and future senior debt. The GCUK Notes are secured by certain assets of GCUK and GCUK Finance, including the capital stock of GCUK Finance, but certain material assets of GCUK do not serve as collateral for the GCUK Notes.
GCUK Finance may redeem the GCUK Notes in whole or in part, at any time on or after December 15, 2009 at redemption prices decreasing from 105.375% (for the dollar denominated notes) or 105.875% (for the pounds sterling denominated notes) in 2009 to 100% of the principal amount in 2012 and thereafter. At any time before December 15, 2009, GCUK Finance may redeem either series of notes, in whole or in part, by paying a “make-whole” premium, calculated in accordance with the GCUK Notes indenture. GCUK Finance may also redeem either series of notes, in whole but not in part, upon certain changes in tax laws and regulations.
The GCUK Notes were issued under an indenture which includes covenants and events of default that are customary for high-yield senior note issuances. The indenture governing the GCUK Notes limits GCUK’s ability to, among other things: (i) incur or guarantee additional indebtedness, (ii) pay dividends or make other distributions to repurchase or redeem its stock; (iii) make investments or other restricted payments, (iv) create liens; (v) enter into certain transactions with affiliates (vi) enter into agreements that restrict the ability of its material subsidiaries to pay dividends; and (vii) consolidate, merge or sell all or substantially all of its assets.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
Within 120 days after the end of the period beginning on December 23, 2004 and ending December 31, 2005 and for each twelve month period thereafter ending December 31, GCUK must offer (the “Annual Repurchase Offer”) to purchase a portion of the GCUK Notes at a purchase price equal to 100% of their principal amount, plus accrued and unpaid interest, if any, to the purchase date, with 50% of “Designated GCUK Cash Flow” from that period. “Designated GCUK Cash Flow” means GCUK’s consolidated net income plus non-cash charges minus capital expenditures, calculated in accordance with the terms of the indenture governing the GCUK Notes. With respect to the 2007 Annual Repurchase Offer, the Company made an offer for and purchased approximately $2 principal amount of the GCUK Notes. In respect to the 2008 Annual Repurchase Offer, GCUK anticipates making an offer of approximately $11, including accrued but unpaid interest. Any such offer is required to be made within 120 days of such date, and the related purchases must be completed within 150 days after year-end.
A loan or dividend payment by GCUK to the Company and its affiliates is a restricted payment under the indenture governing the GCUK Notes. Under the indenture such a payment (i) may be made only if GCUK is not then in default under the indenture and would be permitted at that time to incur additional indebtedness under the applicable debt incurrence test; (ii) may generally be made only within ten business days of consummation of each Annual Repurchase Offer; and (iii) would generally be limited to 50% of GCUK’s Designated GCUK Cash Flow plus the portion, if any, of the applicable Annual Repurchase Offer that the holders of the notes decline to accept. In addition, so long as GCUK is not then in default under the indenture, GCUK may make up to 10 pounds sterling (approximately $14) in the aggregate in restricted payments in excess of 50% of Designated GCUK Cash Flow for a given period; provided that any such excess payments shall reduce the amount of restricted payments permitted to be paid out of future Designated GCUK Excess Cash Flow. Prior to the conversion of the Mandatorily Convertible Notes (see Term Loan Agreement below), loans from GCUK made to the Company or the Company’s other subsidiaries were subordinated to the payment of obligations under the Mandatorily Convertible Notes. Any future loans from GCUK made to the GCL or other subsidiaries must be subordinated to the payment of obligations under the Term Loan Agreement. The terms of any inter-company loan by GCUK to the Company or the Company’s other subsidiaries are required by the GCUK Notes indenture to be at arm’s length and must be agreed to by the board of directors of GCUK, including its independent members. In the exercise of their fiduciary duties, GCUK’s directors will require GCUK to maintain a minimum cash balance in an amount they deem prudent.
In order to better manage the Company’s foreign currency risk, the Company entered into a five-year cross- currency interest rate swap transaction with an affiliate of Goldman Sachs & Co. to minimize exposure of any dollar/sterling currency fluctuations related to interest payments on the $200 dollar denominated GCUK Notes. The swap transaction converts the U.S. dollar currency rate on interest payments to a specified pound sterling amount. In addition, the hedge counterparty has been granted a security interest in the collateral securing the GCUK Notes ranking equally with the security interest holders of the GCUK Notes. The hedging arrangements are subject to early termination upon events of default under the indenture governing the GCUK Notes.
For accounting purposes, the cross-currency interest rate swap is classified as a cash flow hedge in accordance with SFAS No. 133. The Company measures the effectiveness of this derivative instrument on a cumulative basis, comparing changes in the cross-currency interest rate swaps cash flows since inception with changes in the hedged item’s cash flows (the interest payment on the $200 U.S. dollar-denominated GCUK Notes) (see Note 20).
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
5% Convertible Notes
On May 30, 2006, the Company completed a public offering of $144 aggregate principal amount of 5% convertible senior notes due 2011 (the “5% Convertible Notes”) for total gross proceeds of $144. The 5% Convertible Notes rank equal in right of payment with any other senior indebtedness of Global Crossing Limited, except to the extent of the value of any collateral securing such indebtedness. The notes were priced at par value, mature on May 15, 2011, and accrue interest at 5% per annum, payable semi-annually on May 15 and November 15 of each year. The 5% Convertible Notes may be converted at any time prior to maturity at the option of the holder into shares of the Company’s common stock at a conversion price of approximately $22.98 per share. At any time prior to maturity, the Company may unilaterally and irrevocably elect to settle the Company’s conversion obligation in cash and, if applicable, shares of the Company’s common stock, calculated as set forth in the indenture governing the 5% Convertible Notes. During the twelve months ended May 20, 2009 and May 20, 2010, the Company may redeem some or all of the 5% Convertible Notes for cash at a redemption price equal to 102% and 101%, respectively, of the principal amount being redeemed, plus accrued and unpaid interest. The Company may be required to repurchase, for cash, all or a portion of the notes upon the occurrence of a fundamental change (i.e., a change in control or a delisting of the Company’s common stock) at a purchase price equal to 100% of their principal amount, plus accrued and unpaid interest, or, in certain cases, to convert the notes at an increased conversion rate based on the price paid per share of the Company’s common stock in a transaction constituting a fundamental change.
Concurrent with the closing of the 5% Convertible Notes offering the Company purchased a portfolio of U.S. treasury securities with total face value of $21 for $20, and pledged these securities to collateralize the first six interest payments due on the 5% Convertible Notes. At December 31, 2008, $4 of these securities are included in prepaid costs and other current assets. At December 31, 2007, $7 and $3 of these securities were included in the prepaid costs and other current assets and other assets, respectively. (See Note 7).
GC Impsat Notes
On February 14, 2007, GC Impsat, a wholly owned subsidiary of the Company, issued $225 in aggregate principal amount of 9.875% senior notes due February 15, 2017 (the “GC Impsat Notes”). Interest on these notes is payable in cash semi-annually in arrears every February 15 and August 15, commencing August 15, 2007. The proceeds of this offering were used to finance a portion of the purchase price (including the repayment of indebtedness and payment of fees) of the Company’s acquisition of Impsat, which was consummated on May 9, 2007 (see Note 4). Pursuant to a pledge and security agreement, entered into on the date of the acquisition, GC Impsat maintained a debt service reserve account in the name of the collateral agent for the benefit of the note holders equal to two interest payments ($22) on the GC Impsat Notes until certain cash flow metrics were met. At December 31, 2007, the amounts included in the debt service reserve account were included in long-term restricted cash and cash equivalents. During 2008, those cash flow metrics have been met and the $22 debt service reserve funds for the GC Impsat Notes were released to unrestricted cash and cash equivalents.
The GC Impsat Notes are senior unsecured obligations of GC Impsat and rank equal in right of payment with all of its other senior unsecured debt. Upon consummation of the acquisition, the restricted subsidiaries of GC Impsat (including Impsat Fiber Networks Inc. and substantially all of its subsidiaries, other than its Colombian subsidiary) guaranteed the GC Impsat Notes on a senior unsecured basis, ranking equal in right of payment with all of their other senior unsecured debt.
The indenture for the GC Impsat Notes limits GC Impsat’s and its restricted subsidiaries’ ability to, among other things: (1) incur or guarantee additional indebtedness; (2) pay dividends or make other distributions;
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
(3) make certain investments or other restricted payments; (4) enter into arrangements that restrict dividends or other payments to GC Impsat from its restricted subsidiaries; (5) create liens; (6) sell assets, including capital stock of subsidiaries; (7) engage in transactions with affiliates; and (8) merge or consolidate with other companies or sell substantially all of its assets. All of these limitations are subject to a number of important qualifications and exceptions set forth in the indenture.
In addition to refinancing approximately $216 of debt assumed in the acquisition of Impsat with use of the proceeds from the issuance of the GC Impsat Notes and other cash, at December 31, 2008 the primary debt of the Impsat segment that remains outstanding in addition to the GC Impsat Notes is approximately $10 of bonds issued by Impsat’s subsidiary in Colombia. These bonds bear interest at the Colombian consumer price index plus 8% and are repayable on December 2010. During the year ended December 31, 2008, approximately $10 of the original principal was repaid.
Term Loan Agreement and Conversion of the Mandatorily Convertible Notes
On May 9, 2007, the Company entered into a senior secured term loan agreement (the “Term Loan Agreement”) with Goldman Sachs Credit Partners L.P. and Credit Suisse Securities (USA) LLC pursuant to which it borrowed $250 on that date. The Term Loan Agreement was amended on June 1, 2007 to, among other things, provide for the borrowing of an additional $100 on that date. These term loans (i) mature on May 9, 2012, with amortization of 0.25% of principal repayable on a quarterly basis and the remaining principal due at maturity, (ii) bear interest at LIBOR plus 6.25% per annum payable quarterly, (iii) have repayment premiums of 103% in the first year, 102% in the second year and 101% in the third year, and (iv) are guaranteed by all of the Company’s subsidiaries and secured by substantially all the assets of the Company and its subsidiaries, in each case other than those subsidiaries forming part of its Latin American operations or its GCUK Segment. The Term Loan Agreement limits the Company’s and the guarantor subsidiaries’ ability, among other things, to: (1) incur or guarantee additional indebtedness; (2) pay dividends or make other distributions; (3) make certain investments or other restricted payments; (4) enter into arrangements that restrict dividends or other payments to the Company from its restricted subsidiaries; (5) create liens; (6) sell assets, including capital stock of subsidiaries; (7) engage in transactions with affiliates; and (8) merge or consolidate with other companies or sell substantially all of its assets. In addition, the Term Loan Agreement includes financial maintenance covenants requiring our ROW Segment to maintain a minimum consolidated cash balance at all times and requiring us to maintain, as of the end of each fiscal quarter starting with June 30, 2008, a maximum ratio of consolidated debt to a designated measure of consolidated earnings. All of these limitations are subject to a number of important qualifications and exceptions set forth in the Term Loan Agreement.
On September 12, 2007, the Company satisfied its initial obligations regarding the implementation of a collateral package securing its obligations under the Term Loan Agreement. In accordance with the terms of such agreement, the Company has an ongoing obligation to ensure that the facility is guaranteed by all its subsidiaries and secured by substantially all the assets of the Company and its subsidiaries, in each case other than those subsidiaries forming part of its Latin American operations or its GCUK Segment and excluding guarantees and assets as to which the Administrative Agent for the facility reasonably determines that the cost of obtaining such guarantee or security interest is excessive in relation to the benefit afforded to the facility’s lenders.
A portion of the proceeds of the Term Loan Agreement was used to repay in full the Company’s $55 working capital facility with Bank of America, N.A. (and other lenders), to cash collateralize $29 of letters of credit issued under the facility (or replacement thereof) and to fund a portion of the Impsat acquisition. The
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
working capital facility has been terminated and no further extensions of credit will be made thereunder. Approximately $2 of unamortized deferred financing fees related to the working capital facility were expensed in other income, net in the consolidated statement of operations during 2007. The remaining net proceeds of the Term Loan Agreement are being used for working capital and general corporate purposes, which may include the acquisition of assets or businesses that are complimentary to the Company’s existing business.
In satisfaction of an obligation under the Term Loan Agreement, the Company entered into an agreement in July 2007 to mitigate the risk arising from the floating rate debt by hedging the term loans against interest rate risk volatility. As of December 31, 2008, the hedge consists of interest rate caps for the ensuing two years having notional amounts between $340 and $344. For accounting purposes, the interest rate caps are classified as cash flow hedges in accordance with SFAS No. 133 (see Note 20).
In conjunction with the recapitalization pursuant to which the Company entered into the Term Loan Agreement, on August 27, 2007, STT Crossing Ltd converted $250 original principal amount of 4.7% payable-in-kind mandatory convertible notes (the “Mandatorily Convertible Notes”) into approximately 16.58 million shares of common stock. Upon such conversion, the debt interests of STT Crossing Ltd. were terminated. As consideration for the subordination of the Mandatorily Convertible Notes to the Term Loan Agreement through the conversion date, the Company paid STT Crossing Ltd. a consent fee of $7.5 in cash shortly after closing in the second quarter 2007 and, at conversion of the Mandatorily Convertible Notes, an additional fee paid in shares of common stock valued at $10.5. The 16.58 million shares of common stock received by STT Crossing Ltd. included the shares representing the $10.5 consent fee as well as shares valued at $30 representing foregone interest through the original scheduled maturity date of the Mandatorily Convertible Notes. The $18 of consent fees was considered a debt modification and was recorded as a reduction in the carrying value of the Mandatorily Convertible Notes in the second quarter of 2007. The $30 of foregone interest was considered an inducement to convert and was recorded in other income, net upon conversion of the Mandatorily Convertible Notes in the third quarter of 2007. At conversion, the carrying value of and all accrued interest on the notes, as well as the consent fee paid in common shares, all of which together totaled $329, were reclassified to common stock and additional paid in capital.
Other Financing Activities
During 2008, the Company entered into debt agreements to finance various equipment purchases and software licenses. The total debt obligation resulting from these agreements is $5. These agreements have terms that range from 23 to 49 months and annual interest rates that generally range from 3.2% to 11%, with a weighted average effective interest rate of 8.1%. In addition, the Company also entered into various capital leasing arrangements that amounted to $43. These agreements have terms that range from 18 to 55 months and implicit interest rates that range generally from 3.4% to 16.7% with a weighted average effective interest rate of 6.9%.
During 2008, the Company entered into debt agreements and received approximately $10 of cash proceeds. These agreements have terms that range from 12 to 60 months, $7 of which have variable interest rates based on a spread over LIBOR and $3 of which have variable interest rates based on a spread over the Brazilian Inter-bank Lending Rate.
At December 31, 2008, the company was not in compliance with certain non-financial covenants for debt and capital lease agreements representing $2 of indebtedness which is classified in current liabilities in the accompanying consolidated balance sheet. The failure to meet these covenants allows the counterparty to accelerate payments under these agreements, but does not trigger any cross defaults in other debt agreements.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
13. OBLIGATIONS UNDER CAPITAL LEASES
The Company has capitalized the future minimum lease payments of property and equipment under leases that qualify as capital leases.
At December 31, 2008, future minimum payments under these capital leases are as follows and are included in other current liabilities and obligations under capital lease in the accompanying consolidated balance sheet:
14. SHAREHOLDERS’ DEFICIT
Preferred Stock
On the Effective Date, GCL issued 18,000,000 shares of 2% cumulative senior convertible preferred stock to a subsidiary of ST Telemedia (the “GCL Preferred Stock”). The GCL Preferred Stock accumulates dividends at the rate of 2% per annum. Those dividends will be payable in cash after GCL and its subsidiaries achieve cumulative operating earnings before interest, taxes, depreciation and amortization (but excluding the contribution of (i) sales-type lease revenue (ii) revenue recognized from the amortization of indefeasible rights of use not recognized as sales-type leases and (iii) any revenue recognized from extraordinary transactions or from the disposition of assets by the Company or any subsidiary other than in the ordinary course of business) of $650 or more. The GCL Preferred Stock has a par value of $.10 per share and a liquidation preference of $10 per share (for an aggregate liquidation preference of $180). The GCL Preferred Stock ranks senior to all other capital stock of GCL, provided that any distribution to shareholders following a disposition of all or any portion of the assets of GCL will be shared pro rata by the holders of Common Stock and Preferred Stock on an as-converted basis. Each share of GCL Preferred Stock is convertible into one share of GCL Common Stock at the option of the holder.
The preferred stock votes on an as-converted basis with the GCL common stock, but has class voting rights with respect to any amendments to the terms of the GCL Preferred Stock. As long as ST Telemedia beneficially owns at least 15% or more of GCL Common Stock on a non-diluted and as-converted basis, excluding up to 3,478,261 shares of GCL common stock reserved or issued under the new management stock incentive plan (“Stock Incentive Plan”) adopted by GCL on the Effective Date, its approval will be required for certain major corporate actions of the Company and/or its subsidiaries. Those corporate actions include (i) the appointment or replacement of the chief executive officer, (ii) material acquisitions or dispositions, (iii) mergers, consolidations
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
or reorganizations, (iv) issuance of additional equity securities (other than enumerated exceptions), (v) incurrence of indebtedness above specified amounts, (vi) capital expenditures in excess of specified amounts, (vii) the commencement of bankruptcy or other insolvency proceedings, and (viii) certain affiliate transactions.
At December 31, 2008 and 2007, accrued dividends were $18 and $14, respectively, and are included in other deferred liabilities in the accompanying consolidated balance sheets.
Common Stock
On the Effective Date, GCL was authorized to issue 55,000,000 shares of common stock. In 2006, upon approval from shareholders, the number of authorized shares was increased to 85,000,000. In 2007, upon approval from shareholders, the number of authorized shares was increased to 110,000,000. Pursuant to the Plan of Reorganization, upon the Company’s emergence from bankruptcy, GCL issued 15,400,000 shares of common stock to its pre-petition creditors and issued 6,600,000 shares of common stock to a subsidiary of ST Telemedia. 18,000,000 shares of common stock were reserved for the conversion of the GCL Preferred Stock, while an additional 3,478,261 shares of common stock were reserved for issuance under GCL’s 2003 Stock Incentive Plan. During 2005 the shares of common stock reserved for issuance under the Stock Incentive Plan was increased to 8,378,261. In 2007, upon approval from shareholders, shares of common stock reserved for issuance under the Stock Incentive Plan was increased to 11,378,261. In 2008, upon approval from shareholders, shares of common stock reserved for issuance under the Stock Incentive Plan was increased to 19,378,261.
On May 30, 2006, the Company completed a public offering of 12,000,000 shares of common stock at $20 per share for gross proceeds of $240. A subsidiary of ST Telemedia purchased 6,226,145 shares of common stock in the offering.
In conjunction with the recapitalization pursuant to which the Company entered into the Term Loan Agreement, on August 27, 2007, STT Crossing Ltd converted $250 original principal amount of mandatorily convertible notes due December 2008 (the “Mandatorily Convertible Notes”) into approximately 16.58 million shares of common stock. Upon such conversion, the debt interests of STT Crossing Ltd. were terminated. As consideration for the subordination of the Mandatorily Convertible Notes to the Term Loan Agreement through the conversion date, the Company paid STT Crossing Ltd. a consent fee of $7.5 in cash shortly after closing in the second quarter 2007 and, at conversion of the Mandatorily Convertible Notes, an additional fee paid in shares of common stock valued at $10.5. The 16.58 million shares of common stock received by STT Crossing Ltd. included the shares representing the $10.5 consent fee as well as shares valued at $30 representing foregone interest through the original scheduled maturity date of the Mandatorily Convertible Notes. The $18 of consent fees was considered a debt modification and was recorded as a reduction in the carrying value of the Mandatorily Convertible Notes. The $30 of unearned accrued interest was considered an inducement to convert and was recorded in other expense, net upon conversion of the Mandatorily Convertible Notes. At conversion, the carrying value of and all accrued interest on the notes, as well as the consent fee paid in common shares, all of which together totaled $329, were reclassified to common stock and additional paid in capital.
Each share of GCL common stock has a par value of $.01 and entitles the holder thereof to one vote on all matters to be approved by stockholders. The amended and restated by-laws of GCL contain certain special protections for minority shareholders, including certain obligations of ST Telemedia, or other third parties, to offer to purchase shares of GCL Common Stock under certain circumstances.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
15. INCOME TAX
The provision for income taxes is comprised of the following:
Income taxes have been provided based upon the tax laws and rates in the countries in which operations are conducted and income is earned. Bermuda does not impose a statutory income tax and consequently the provision for income taxes recorded relates to income earned by certain subsidiaries of the Company which are located in jurisdictions that impose income taxes.
The current tax provision includes income, asset and withholding taxes for the years ended December 31, 2008, 2007 and 2006 of $14, $9, and $1, respectively. Fresh start accounting has resulted in a net deferred tax provision of $30, $41, and $45 in 2008, 2007 and 2006, respectively, resulting from the utilization of pre-emergence net deferred tax assets that were offset by a full valuation allowance. In accordance with SOP 90-7, the reversal of the valuation allowance that existed at the fresh start date has been first recorded as a reduction of intangibles to zero and thereafter as an increase in additional paid-in-capital.
The deferred income tax provision reflects the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and amounts used for income tax purposes.
The following is a summary of the significant items giving rise to components of the Company’s deferred tax assets and liabilities:
The Company’s valuation allowance changed in the amount of $(369), $131 and $164 for the years ended December 31, 2008, 2007 and 2006, respectively. In evaluating the amount of valuation allowance required, the Company considers each subsidiary’s prior operating results and future plans and expectations. The utilization period of the NOL carry forwards and the turnaround period of other temporary differences are also considered. The pre-emergence valuation allowance on net deferred tax assets was $1,900 and $2,262 at December 31, 2008
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
and 2007, respectively, which if realized would have been accounted for in accordance with SOP 90-7 as a reduction of intangible assets established on the Effective Date to zero and thereafter as an increase in additional paid-in capital. The Company has reduced all intangible assets to zero. Therefore, as of December 31, 2008 all remaining utilizations have been recorded as an increase in additional paid-in capital. SFAS No. 141R amends SOP 90-7 such that, upon adoption of SFAS No. 141R on January 1, 2009, the reversal of pre-emergence valuation allowances will be recorded as a reduction of income tax expense.
A substantial amount of the Company’s pre-emergence NOL’s and other deferred assets generated prior to the bankruptcy have been reduced as a result of the discharge and cancellation of various pre-petition liabilities. As of December 31, 2008 the Company has NOL carry forwards of $4,170, $1,014, $285 and $1 in Europe, North America, Latin America and Asia, respectively.
During the year ended December 31, 2006, the Company sold entities with NOL’s that were not expected to be utilized. The Company received $19 in gross cash proceeds ($17 after deduction of costs associated with the sale). In accordance with SOP 90-7, as the sale represented a utilization of net pre-emergence deferred tax assets that were offset by a valuation allowance, the $17 of net proceeds was recorded as an increase in additional paid-in capital.
During 2008 and 2007, the Company realized $5 and $4, respectively of tax benefits as a result of the reversal of valuation allowances for deferred tax assets acquired as part of the Impsat acquisition. The recognition of the tax benefits for those items (by elimination of the valuation allowance) after the acquisition date resulted in a reduction of goodwill. This accounting treatment does not result in any change in liabilities to taxing authorities or in cash flows. SFAS No. 141R amends SFAS 109, “Accounting for Income Taxes” (“SFAS No. 109”), such that, upon adoption of SFAS No. 141R on January 1, 2009, the reversal of pre-acquisition valuation allowances will be recorded as a reduction of tax expense.
During 2007 and 2006, the Company increased its valuation allowance to reduce the U.K. deferred tax assets by $9 and $21, respectively, to reflect the amount considered more likely than not to be realized. At December 31, 2008 and 2007, the U.K. deferred tax assets have a full valuation allowance recorded against them.
The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes: an interpretation of FASB Statement No. 109” (“FIN 48”), on January 1, 2007. This interpretation states that an “enterprise shall initially recognize the financial statement effects of a tax position where it is more likely than not, based on the technical merits, that the position will be sustained upon examination.” “More likely than not” is defined as a likelihood of greater than 50% based on the facts, circumstances and information available at the reporting date.
The total amount of the unrecognized tax benefits as of the date of adoption and December 31, 2007 and 2008 was $11, $20 and $32, respectively. There was no impact to the January 1, 2007 balance of accumulated deficit upon adoption of FIN 48.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
Included in the balance of unrecognized tax benefits at January 1, 2007, December 31, 2007 and 2008, are $4, $6 and $22, respectively of tax benefits that, if recognized, would affect the effective tax rate. The increase in the amount affecting the effective tax rate at December 31, 2008 is due to the adoption of SFAS No. 141R on January 1, 2009. The Company also recognizes interest accrued related to unrecognized tax benefits in interest expense, and penalties in income tax expense. The Company had approximately $18, $15 and $11 for the payment of interest and penalties accrued in other current liabilities and other deferred liabilities at December 31, 2008, 2007 and 2006, respectively. It is not expected that the amount of unrecognized tax benefits will change significantly in the next 12 months.
During 2007, the Company received notification from the Internal Revenue Service that its audit of the Company’s 2002, 2003 and 2004 tax years had resulted in the tax returns being accepted as filed, without change. Accordingly, the Company is no longer subject to U.S. federal income tax examination for periods prior to 2005. With respect to the United Kingdom, as of December 31, 2008, the Company is no longer subject to income tax inquiries by Her Majesty’s Revenue & Customs for the years up to and including 2004. The Company is also subject to taxation in various states and other foreign jurisdictions.
The Company and its subsidiaries’ income tax returns are routinely examined by various tax authorities. In connection with such examinations, tax authorities have raised issues and proposed tax adjustments. The Company is reviewing the issues raised and will contest any adjustments it deems inappropriate. In management’s opinion, adequate provision for income taxes has been made for all years that are open to audit.
16. REORGANIZATION ITEMS
Pre-confirmation Contingencies
During the years ended December 31, 2008, 2007 and 2006, the Company settled various third-party disputes and revised its estimated liability for other disputes related to periods prior to the emergence from chapter 11 proceedings. The Company has accounted for this in accordance with AICPA Practice Bulletin 11. The resulting net gain on the settlements and change in estimated liability of $10, $33, and $32 is included within net gain on pre-confirmation contingencies in the consolidated statement of operations for the years ended December 31, 2008, 2007 and 2006, respectively. The most significant portion of the gain is a result of settlements with certain tax authorities and changes in the estimated liability for other income and non-income tax contingencies. During 2007, the Company released a significant accrual relating to a foreign customs tax audit (see Note 21).
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
17. LOSS PER COMMON SHARE
The following is a reconciliation of the numerators and the denominators of the basic and diluted loss per share:
The Company reported losses for the years ended December 31, 2008, 2007 and 2006. As a result, diluted loss per share is the same as basic in those periods, as any potentially dilutive securities would reduce the loss per share from continuing operations.
Diluted loss per share for the years ended December 31, 2008, 2007 and 2006 does not include the effect of the following potential shares, as they are anti-dilutive:
18. STOCK-BASED COMPENSATION
The Company recognized $55, $51, and $24, respectively, of non-cash stock related expenses for the year ended December 31, 2008, 2007 and 2006. These expenses are included in selling, general and administrative expenses and real estate, network and operations in the consolidated statements of operations. Stock-related expenses for each period relate to share-based awards granted under Global Crossing Limited 2003 Stock Incentive Plan (the “2003 Stock Incentive Plan”) and reflect awards outstanding during such period, including awards granted both prior to and during such period. Under the 2003 Stock Incentive Plan, the Company is authorized to issue, in the aggregate, share-based awards of up to 19,378,261 common shares to employees, directors and consultants who are selected to participate. As of December 31, 2008, unrecognized compensation expense related to the unvested portion of all restricted stock units was approximately $33 and is expected to be recognized over the next 2.2 years.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
Sales Equity Program
During 2008, the Company adopted the Global Crossing Sales Equity Program (“Sales Equity Program”) for the Company’s sales, sales support and sales engineering employees excluding those in Latin America, Canada and Asia. This program allows management level employees to elect to receive 100% of their earned commissions in fully vested shares of common stock of GCL. Non-management employees can elect to receive 50% of their earned commissions in fully vested shares of common stock and the remaining 50% will be paid in cash. As an additional incentive for participating in the Sales Equity Program, the value of the portion to be paid in stock was increased by 5%, which was subsequently increased to 7.5% effective June 1, 2008. Included in the total 2008 non-cash stock related expenses was $10 related to this program. This program was cancelled in the fourth quarter of 2008.
Stock Options
Stock options are exercisable over a ten-year period, vest over a three-year period and have an exercise price range of $10.16 to $15.39 per share. No stock options were granted during 2006, 2007 and 2008.
Information regarding options outstanding for the years ended December 31, 2008, 2007 and 2006 is summarized below:
The following table summarizes information concerning outstanding and exercisable options for the year ended December 31, 2008:
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
The weighted average remaining contractual term was 5.2 years for stock options exercisable as of December 31, 2008. Options outstanding and exercisable had no intrinsic value as of December 31, 2008 as all options have an exercise price exceeding the market price of a common share. The total intrinsic value for stock options exercised was $1, $5 and $5, during 2008, 2007 and 2006, respectively.
At December 31, 2008, there was no unrecognized compensation expense for stock options.
Restricted Stock Units
During the year ended December 31, 2008, the members of the Board of Directors and its Executive Committee were granted awards totaling 17,686 fully vested shares of common stock, representing both installments of the directors’ annual retainer fees that is payable in shares rather than cash. Also, during the year ended December 31, 2008, the members of the Board of Directors and its Executive Committee were granted awards totaling 50,112 restricted shares of common stock with a one year cliff vesting on June 24, 2009. These awards were made in accordance with the Company’s annual long-term incentive program for Board of Directors and Executive Committee members.
During the year ended 2008, in conjunction with the Company’s annual long-term incentive program for 2008, the Company awarded to certain employees 568,500 restricted stock units which vest on March 4, 2011. In addition, during 2008 several employees were granted small awards of unrestricted shares of common stock and restricted stock units which will vest in 2009.
During the year ended December 31, 2007, the members of the Board of Directors were granted awards totaling 15,402 fully vested unrestricted shares of common stock, representing both installments of the directors’ annual retainer fees that is payable in shares rather than cash. Also, during the year ended December 31, 2007, the members of the Board of Directors were granted awards totaling 29,040 unrestricted shares of common stock with a one year cliff vesting on June 12, 2008. These awards were made in accordance with the Company’s annual long-term incentive program for Board members.
During the year ended 2007, the Board of Directors approved a grant of awards under a special program to substantially all non-sales employees of the Company. The program was intended to retain and motivate the Company’s employees. The awards granted aggregated: (i) $3 of cash; and (ii) 1,194,880 restricted stock units that vest over a period of either six or twelve months from the date of grant. Also, during 2007, the Board of Directors approved a grant of awards under a special program related to the Impsat acquisition to key employees of the GC Impsat Segment and a limited group of ROW Segment employees involved in the Impsat integration. The program was intended to retain and motivate these employees through the integration of Impsat. The awards granted to non-executives aggregated 32,600 restricted stock units that vest over a period of twelve months from the date of grant. The awards granted to executives aggregated 20,736 restricted stock units that vest one-third per year over a three year period. In addition, in 2007 in conjunction with the Company’s annual long-term incentive program for 2007, the Company awarded to certain employees 333,400 restricted stock units which vest on March 13, 2010.
During the year ended December 31, 2007, certain executives of Impsat entered into employment agreements with the Company which included a special bonus program to encourage executive continuity to maximize the benefit of GCL’s acquisition of Impsat. This bonus program consisted of both time based and performance based components. The time based component vested on the earlier of: (a) 7.5 months from the acquisition date or (b) the date in which the executive is terminated without cause.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
During the year ended December 31, 2006 the Company awarded 440,200 restricted stock units to employees and 39,528 restricted stock units to members of the Company’s Board of Directors. The 39,528 restricted stock units awarded to members of the Board of Directors vested on August 15, 2007, subject to continued service on the board through the vesting date. The 440,200 restricted stock units awarded to employees are scheduled to vest on March 7, 2009; however, the chief executive officer’s performance shares also vest in full upon actual or constructive termination without cause (as determined in accordance with his employment agreement).
The following table summarizes restricted stock units granted, forfeited and canceled for the years ended December 31, 2008, 2007 and 2006:
Performance Share Grants
In connection with the Company’s annual long-term incentive program for 2008, the Company awarded to certain employees 936,500 performance share opportunities which vest on December 31, 2010 and must be paid out by March 15, 2011, subject to continued employment through the vesting date and subject to earlier pro-rata payout in the event of death or long-term disability. Each participant’s target performance share opportunity is based on total shareholder return over a three year period as compared to two peer groups. Depending on how the Company ranks in total shareholder return as compared to the two peer groups, each performance share grantee may earn 0% to 200% of the target number of performance shares. No payout will be made if the average ranking of the Company’s total shareholder return relative to each of the two peer groups (weighted equally) is below the 30th percentile, and the maximum payout of 200% will be made if such average ranking is at or above the 80th percentile.
In connection with the Company’s annual long-term incentive program for 2007, the Company awarded to certain employees 397,000 performance share opportunities which vest on December 31, 2009, in each case
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
subject to continued employment through the vesting date and subject to earlier pro-rata payout in the event of death or long-term disability. Each performance share grantee can earn (i) 50% of his or her target award for a given opportunity if the threshold financial performance goal for that opportunity is achieved, (ii) 100% of his or her target award for a given opportunity if the target financial performance goal for that opportunity is achieved or (iii) 150% of his or her target award for a given opportunity if the maximum financial performance goal for that opportunity is achieved. No payout will be made for performance below threshold, and the payout for performance above maximum is capped at 150% of the target opportunity. Actual payouts will be calculated using interpolation between threshold and target or target and maximum, as applicable. The total performance share opportunity of each participant in this program comprises three separate award opportunities based on measures of combined 2007 and 2008 earnings, cash use, and adjusted gross margin attributable to the Company’s enterprise, carrier data and indirect sales channels.
During the year ended December 31, 2007, certain executives of Impsat entered into employment agreements with the Company which include a special bonus program to encourage executive continuity to maximize the benefit of GCL’s acquisition of Impsat. This bonus program consists of both time based and performance based components. The performance based component was paid on August 31, 2008, based on the achievement of certain performance metrics for a performance period of July 1, 2007 to June 30, 2008. These executives are also entitled to participate in the 2007 Bonus Program, as modified such that the targets for the portion of the year prior to the acquisition of Impsat are based on Impsat’s standalone financial results, and to receive a guaranteed annual bonus to be paid out to these executives regardless of whether Company targets are met. These bonuses were paid in unrestricted shares of common stock of GCL; however GCL retains discretion to use cash rather than shares.
During the year ended December 31, 2006, the Company awarded 522,800 performance share opportunities to officers of the Company under the 2003 Stock Incentive Plan. The performance share opportunities vest and convert into common shares on December 31, 2008, and are subject to continued employment through the vesting date and subject to earlier pro-rata payout in the event of death or long-term disability. Each performance share grantee can earn (i) 50% of his or her target award for a given opportunity if the threshold financial performance goal for that opportunity is achieved, (ii) 100% of his or her target award for a given opportunity if the target financial performance goal for that opportunity is achieved or (iii) 150% of his or her target award for a given opportunity if the maximum financial performance goal for that opportunity is achieved or exceeded. No payout will be made for performance below threshold. Actual payouts will be calculated using interpolation between threshold and target or target and maximum, as applicable. The total performance share opportunity of each participant in this program comprises three separate award opportunities based on measures of combined 2006 and 2007 earnings, cash use, and gross margin attributable to the Company’s enterprise, carrier data, and indirect sales channels. Under the 2006 long term incentive program, 43,216 common shares vested of which 10,031 were withheld in connection with the payment of related withholding taxes for executive officers and certain other employees restricted from selling their shares of Company stock due to legal restrictions applicable to corporate insiders.
Annual Bonus Program
During 2008, the Board of Directors of the Company adopted the 2008 Annual Bonus Program (the “2008 Bonus Program”). The 2008 Bonus Program is an annual bonus applicable to substantially all non-sales employees of the Company, which is intended to retain such employees and to motivate them to achieve the Company’s financial and business goals. Each participant is provided a target award under the 2008 Bonus Program expressed
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
as a percentage of base salary. Actual awards under the 2008 Bonus Program are paid only if the Company achieves specified thresholds for earnings, net change in unrestricted cash and cash equivalents and/or customer satisfaction. The payout for each performance opportunity is calculated independently. Effective February 12, 2009, the Compensation Committee and Board of Directors certified the financial results and approved the payout which will be made primarily in restricted stock units vesting no later than April 8, 2009 (see Note 26). The amount of the shares to be paid was set using a 30-day average of the Company’s Common Stock. As of December 31, 2008, $31 has been accrued for this bonus plan, including employer liability for payroll taxes and charges which is included in other current liabilities and other deferred liabilities.
During the year ended December 31, 2007, the Board of Directors adopted the 2007 Annual Bonus Program (the “2007 Bonus Program”). The 2007 Bonus Program was an annual bonus program for substantially all non-sales employees of the Company intended to retain such employees and to motivate them to help the Company achieve its financial goals. Each participant was provided a target award under the 2007 Bonus Program expressed as a percentage of base salary. Actual awards under the 2007 Bonus Program were paid only if the Company achieved specified earnings and cash use goals. Bonus payouts under the 2007 Bonus Program were made in unrestricted shares of common stock of the Company; provided that the Compensation Committee of the Board of Directors retained discretion to use cash rather than shares as it deemed fit. To the extent common shares were used for payment of bonus awards, such shares were valued based on the closing price on the NASDAQ National Market on the date determined by the Compensation Committee of the Board of Directors at the time the Committee certified the financial results. Under the 2007 annual bonus program, 690,159 common shares vested in March 2008 of which 28,877 were withheld in connection with the payment of related withholding taxes for executive officers and certain other employees restricted from selling their shares of Company stock due to legal restrictions applicable to corporate insiders.
During the year ended December 31, 2006, the Board of Directors of the Company adopted the 2006 Annual Bonus Program (the “2006 Bonus Program”). The 2006 Bonus Program was an annual bonus applicable to substantially all employees of the Company, which was intended to retain such employees and to motivate them to help the Company achieve its financial goals. Each participant was provided a target award under the 2006 Bonus Program expressed as a percentage of base salary. Actual awards under the 2006 Bonus Program were to be paid only if the Company achieved specified earnings and cash flow goals. No payouts were awarded under this program as none of the financial target thresholds were met.
19. EMPLOYEE BENEFIT PLANS
Defined Contribution Plans
The Company sponsors a number of defined contribution plans. The principal defined contribution plans are discussed individually below. Other defined contribution plans are not individually significant and therefore have been summarized in aggregate below.
The Global Crossing Employees’ Retirement Savings Plan (the “401(k) Plan”) qualifies under Section 401(k) of the Internal Revenue Code. Each eligible employee may contribute on a tax-deferred basis a portion of his or her annual earnings not to exceed certain limits. The Company provides 100% matching contributions up to the first 1% of eligible compensation and 50% matching contributions up to the next 5% of eligible compensation. The Company’s contributions to the 401(k) Plan vest immediately. Expenses recorded by the Company relating to the 401(k) Plan for the years ended December 31, 2008, 2007 and 2006 were approximately $5, $4, and $4, respectively. Effective March 2009 the Company will suspend matching employee contributions to this plan.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
The Company maintains a defined contribution plan, the Global Crossing Pension Scheme, for the employees of GCUK. Each eligible employee contributes on a tax-deferred basis 4% of his or her annual basic salary. The Company contributes 8% of salary. Expenses recorded by the Company relating to this plan were approximately $3, $2, and $3 for the years ended December 31, 2008, 2007 and 2006, respectively.
Other defined contribution plans sponsored by the Company are individually not significant. On an aggregate basis the expenses recorded by the Company relating to these plans were approximately $3, $2, and $2, for the years ended December 31, 2008, 2007 and 2006, respectively.
Defined Benefit Plans
The Company sponsors both contributory and non-contributory employee pension plans available to eligible employees of Global Crossing North America, Inc. and GCUK. The plans provide defined benefits based on years of service and final average salary.
Global Crossing North America, Inc.’s pension plan was frozen on December 31, 1996. As of that date, all existing plan participants became 100% vested and all employees hired thereafter are not eligible to participate in the plan.
GCUK has two separate pension plans: the Global Crossing Pension Scheme (“GCUK Pension Plan”) and the Global Crossing Shared Cost Section of the Railways Pension Scheme (“GCUK Railway Pension Plan”). Both pension plans were closed to new employees on December 31, 1999. The GCUK Railway Pension Plan is a pension plan that splits the costs 60%/40% between the Company and the employees, respectively.
The Company uses a December 31 measurement date for all pension plans.
Changes in the projected benefit obligation for all pension plans sponsored by the Company are as follows:
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
Change in the fair value of assets for all pension plans sponsored by the Company are as follows:
The funded status for all pension plans sponsored by the Company is as follows:
The total accumulated benefit obligation for all pension plans sponsored by the Company is $70 and $91, at December 31, 2008 and 2007, respectively.
The GCUK Railway Pension Plan projected benefit obligation exceeded the fair value of plan assets at December 31, 2008 and 2007. The projected benefit obligation and fair value of plan assets for this plan was $51 and $40, respectively at December 31, 2008 and $76 and $73, respectively at December 31, 2007.
The GCUK Pension Plan projected benefit obligation exceeded the fair value of plan assets at December 31, 2008 and 2007. The projected benefit obligation and fair value of plan assets for this plan is $13 and $8, respectively at December 31, 2008 and $20 and $10, respectively at December 31, 2007.
Details on the effect on operations of the Company’s pension plans are as follows:
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
Actuarial assumptions used to determine benefit obligations for the Company’s pension plans are as follows:
Actuarial assumptions used to determine net periodic benefit costs for the Company’s pension plans are as follows:
Investment strategies for the two significant pension plans are as follows:
The GCUK Railway Pension Plan, which represents approximately 64% of the Company’s total plan assets as at December 31, 2008, is invested in 56% equity securities, 14% bonds, 20% real estate and 10% other assets. The current planned asset allocation strategy was determined with regard to actuarial characteristics of the GCUK Railway Pension Plan. It is based on the assumption that equities would outperform bonds over the long term and is consistent with the overall objective of long-term capital growth. The expected long-term rate of return on plan assets was calculated by the plan actuary and is based on historic returns each asset class held by the plan at the beginning of the year.
The Global Crossing North America, Inc. pension plan, which represents approximately 23% of the Company’s total plan assets at December 31, 2008, is invested 67% in equity securities and 33% bonds, which matches the target asset allocation. The target asset allocation has been derived based on the assumption that equities would outperform bonds over the long term and is consistent with the objective of long-term capital growth. The expected long-term rate of return on plan assets was calculated by the plan actuary and is based on historic returns each asset class held by the plan at the beginning of the year.
Total plan assets are invested as follows:
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
The Company expects to make total contributions of approximately $2 in 2009 in respect of all pension plans.
Information for pension plan with an accumulated benefit obligation in excess of plan assets
As at December 31, 2008 and 2007 the accumulated benefit obligation (“ABO”) of the GCUK Pension Plan exceeded the fair value of the GCUK Pension Plan’s assets by $1 and $5, respectively. The ABO and fair value of assets relating to the GCUK Pension Plan were $9 and $8, respectively, at December 31, 2008, and $15 and $10, respectively, at December 31, 2007.
As at December 31, 2008 the ABO of the GCUK Railway Pension Plan exceeded the fair value of the GCUK Railway Plan’s assets by $7. The ABO and fair value of assets relating these plans were $47 and $40, respectively.
Details of the effect on operations of the GCUK Pension Plan and GCUK Railway Pension Plan are as follows:
None of the Company’s other pension plans’ ABO exceeded the fair value of their respective pension plans assets at December 31, 2008.
Benefit Payments
The following table summarizes expected benefit payments from the Company’s various pension plans through 2018. Actual benefits payments may differ from expected benefit payments.
20. FINANCIAL INSTRUMENTS
The carrying amounts for cash and cash equivalents, restricted cash and cash equivalents, accounts receivable, accrued expenses and obligations under capital leases approximate their fair value. The fair values of the Company’s debt and derivative instruments are based on market quotes and management estimates.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
Management believes the carrying value of other debt approximates fair value as of December 31, 2008 and 2007, respectively. The fair values of our debt, derivative instruments and marketable securities are as follows:
21. COMMITMENTS, CONTINGENCIES AND OTHER
Contingencies
Amounts accrued for contingent liabilities are included in other current liabilities and other deferred liabilities at December 31, 2008 and 2007. In accordance with SFAS 5, “Accounting for Contingencies,” the Company makes a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. In accordance with FASB Interpretation No. 14, “Reasonable Estimation of the Amount of a Loss (an interpretation of FASB Statement No. 5)”, where it is probable that a liability has been incurred and there is a range in the expected loss and no amount in the range is more likely than any other amount, the Company accrues the low end of the range. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. Although the Company believes it has adequate provisions for the following matters, litigation is inherently unpredictable and it is possible that cash flows or results of operations could be materially and adversely affected in any particular period by the unfavorable resolution or disposition of one or more of these contingencies. The following is a description of the material legal proceedings involving the Company commenced or pending during 2008.
AT&T Corp. (SBC Communications) Claim
On November 17, 2004, AT&T’s LEC affiliates commenced an action against the Company and other defendants in the U.S. District Court for the Eastern District of Missouri. The complaint alleges that the Company, through certain unnamed intermediaries, which are characterized as “least cost routers,” terminated long distance traffic to avoid the payment of interstate and intrastate access charges.
The complaint alleges five causes of action: (1) breach of federal tariffs; (2) breach of state tariffs; (3) unjust enrichment (in the alternative to the tariff claims); (4) fraud; and (5) civil conspiracy. Although the complaint does not contain a specific claim for damages, plaintiffs allege that they have been damaged in the amount of approximately $20 for the time period of February 2002 through August 2004. The complaint also seeks an injunction against the use of “least cost routers” and the avoidance of access charges. The Company filed a
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
motion to dismiss the complaint on January 18, 2005, which motion was mooted by the filing of a first amended complaint on February 4, 2005. The first amended complaint added as defendants five competitive local exchange carriers and certain of their affiliates (none of which is affiliated with the Company) and re-alleged the same five causes of action. The Company filed a motion to dismiss the first amended complaint on March 4, 2005. On August 23, 2005, the Court referred a comparable case to the Federal Communications Commission (“FCC”) and the FCC has sought comments on the issues referred by the Court. The Company filed comments in the two declaratory judgment proceedings occasioned by the Court’s referral. On February 7, 2006, the Court entered an order: (a) dismissing AT&T’s claims against Global Crossing to the extent that such claims arose prior to December 9, 2003 by virtue of the injunction contained in the joint plan of reorganization (the “Plan of Reorganization”) of the Company’s predecessor and a number of its subsidiaries (collectively, the “GC Debtors”) which became effective on that date; and (b) staying the remainder of the action pending the outcome of the referral to the FCC described above. On February 22, 2006, AT&T moved the Court to reconsider its decision of February 7, 2006 to the extent that it dismissed claims that arose prior to December 9, 2003. The Company filed its response to the motion on March 6, 2006, requesting that the Court deny the motion. On May 31, 2006, the Court entered an order denying plaintiffs’ motion for reconsideration without prejudice. On April 15, 2008, plaintiffs moved to vacate the stay entered by the Court on the grounds of inaction by the FCC. The Court denied the motion to vacate and the plaintiffs have requested reconsideration. That request is presently pending before the Court.
Claim by the U.S. Department of Commerce
A claim was filed in the Company’s bankruptcy proceedings by the U.S. Department of Commerce (the “Commerce Department”) on October 30, 2002 asserting that an undersea cable owned by Pacific Crossing Ltd., a former subsidiary of the Company (“PCL”) violates the terms of a Special Use permit issued by the National Oceanic and Atmospheric Administration (“NOAA”). The Company believes responsibility for the asserted claim rests entirely with the Company’s former subsidiary. On November 7, 2003, the Company and the Global Crossing Creditors’ Committee filed an objection to this claim with the Bankruptcy Court. Subsequently, the Commerce Department agreed to limit the size of the pre-petition portion of its claim to $14. An identical claim that had been filed in the bankruptcy proceedings of PCL was settled in principle in September 2005 and was subsequently approved by the court as part of the PCL plan of reorganization confirmed in an order dated November 10, 2005. The Company initiated preliminary discussions with the Commerce Department and its Justice Department attorneys as to the impact that settlement has on the claim against the Company. The Commerce Department continues to consider its position on the matter.
Qwest Rights-of-Way Litigation
In May 2001, a purported class action was commenced against three of the Company’s subsidiaries in the U.S. District Court for the Southern District of Illinois. The complaint alleges that the Company had no right to install a fiber-optic cable in rights-of-way granted by the plaintiffs to certain railroads. Pursuant to an agreement with Qwest Communications Corporation, the Company has an indefeasible right to use certain fiber-optic cables in a fiber-optic communications system constructed by Qwest within the rights-of-way. The complaint alleges that the railroads had only limited rights-of-way granted to them that did not include permission to install fiber-optic cable for use by Qwest or any other entities. The action has been brought on behalf of a national class of landowners whose property underlies or is adjacent to a railroad right-of-way within which the fiber-optic cables have been installed. The action seeks actual damages in an unstated amount and alleges that the wrongs done by the Company involve fraud, malice, intentional wrongdoing, willful or wanton conduct and/or reckless disregard
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
for the rights of the plaintiff landowners. As a result, plaintiffs also request an award of punitive damages. The Company made a demand of Qwest to defend and indemnify the Company in the lawsuit. In response, Qwest has appointed defense counsel to protect the Company’s interests.
The Company’s North American network includes capacity purchased from Qwest on an IRU basis. Although the amount of the claim is unstated, an adverse outcome could have an adverse impact on the Company’s ability to utilize large portions of the Company’s North American network. This litigation was stayed against the Company pending the effective date of the Plan of Reorganization, and the plaintiffs’ pre-petition claims against the Company were discharged at that time in accordance with the Plan of Reorganization. By agreement between the parties, the Plan of Reorganization preserved plaintiffs’ rights to pursue any post-confirmation claims of trespass or ejectment. If the plaintiffs were to prevail, the Company could lose its ability to operate large portions of its North American network, although it believes that it would be entitled to indemnification from Qwest for any losses under the terms of the IRU agreement under which the Company originally purchased this capacity. As part of a global resolution of all bankruptcy claims asserted against the Company by Qwest, Qwest agreed to reaffirm its obligations of defense and indemnity to the Company for the assertions made in this claim. In September 2002, Qwest and certain of the other telecommunication carrier defendants filed a proposed settlement agreement in the U.S. District Court for the Northern District of Illinois. On July 25, 2003, the court granted preliminary approval of the settlement and entered an order enjoining competing class action claims, except those in Louisiana. The settlement and the court’s injunction were opposed by a number of parties who intervened and an appeal was taken to the U.S. Court of Appeals for the Seventh Circuit (“Court of Appeals”). In a decision dated October 19, 2004, the Court of Appeals reversed the approval of the settlement and lifted the injunction. The case has been remanded to the District Court for further proceedings.
Foreign Income Tax Audit
A tax authority in South America issued a preliminary notice of findings based on an income tax audit for calendar years 2001 and 2002. The examiner’s initial findings took the position that the Company incorrectly documented its importations and incorrectly deducted its foreign exchange losses against its foreign exchange gains on loan balances. An official assessment of $26, including potential interest and penalties, was issued in 2005. Due to accrued interest and foreign exchange effects the total exposure has increased to $50. The Company challenged the assessment and commenced litigation in September 2006 to resolve its dispute with the tax authority.
Claim by Pacific Crossing Limited
This claim arises out of the management of the PC-1 trans-Pacific fiber-optic cable, which was constructed, owned and operated by PCL. PCL asserts that the Company and Asia Global Crossing, another former subsidiary of the Company, breached their fiduciary duties to PCL, improperly diverted revenue derived from sales of capacity on PC-1, and failed to account for the way revenue was allocated among the corporate entities involved with the ownership and operation of PC-1. The claim also asserts that revenues derived from operation and maintenance fees were also improperly diverted and that PCL’s expenses increased unjustifiably through agreements executed by the Company and Asia Global Crossing Limited on behalf of PCL. To the extent that PCL asserted the foregoing claims were prepetition claims, PCL has settled and released such claims against the Company.
During the pendency of the Company’s Chapter 11 proceedings, on January 14, 2003, PCL filed an administrative expense claim in the GC Debtors’ bankruptcy court for approximately $8 in post-petition services
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
plus unliquidated amounts arising from the Company’s alleged breaches of fiduciary duty and misallocation of PCL’s revenues. The Company objected to the claim and asserted that the losses claimed were the result of operational decisions made by PCL management and its corporate parent, Asia Global Crossing. On February 4, 2005, PCL filed an amended claim in the amount of approximately $79 claiming the Company failed to pay revenue for services and maintenance charges relating to PC-1 capacity and failed to pay PCL for use of the related cable stations and seeking to recover a portion of the monies received by the Company under a settlement agreement entered into with Microsoft Corporation and an arbitration award against Softbank. The Company filed an objection to the amended claim seeking to dismiss, expunge and/or reclassify the claim and PCL responded by filing a motion for partial summary judgment claiming approximately $22 for the capacity, operations and maintenance charges and co-location charges and up to approximately $78 for the Microsoft and Softbank proceeds. PCL’s claim for co-location charges (which comprised approximately $2 of the total claim) was settled.
Subsequently (and pursuant to a new scheduling order agreed to by the parties), the parties agreed to hold the Company’s motion to dismiss in abatement and PCL agreed not to proceed with its partial summary judgment motion and to file a new summary judgment motion. On June 5, 2006 PCL filed a new motion for partial summary judgment claiming not less than $2 for revenues for short term leases on PC-1, not less than $6 in respect of operation and maintenance fees paid to the Company by its customers for capacity on PC-1 and an unspecified amount to be determined at trial in respect of the Microsoft/ Softbank Claim. The Company filed a response to that motion on June 26, 2006, together with a cross motion for partial summary judgment on certain of PCL’s administrative claims. On August 28, 2006, PCL replied to the Company’s response to PCL’s new motion for partial summary judgment and responded to the Company’s cross motion for partial summary judgment. On November 20, 2006, the Company filed its reply to PCL’s response to the Company’s cross motion for partial summary judgment.
The parties have agreed to a non-binding mediation of their competing administrative claims (including the Company’s claim filed against PCL in its separate bankruptcy case). The parties have completed one day of mediation and have exchanged certain documents in connection with the mediation, but have not yet concluded the mediation. The current court proceedings have been stayed until completion of mediation.
Impsat Employee Severance Disputes
A number of former directors and executive officers of Impsat have asserted claims (including accrued interest and attorney fees) in excess of $30 for separation pay, severance, commissions, pension benefits, unpaid vacation pay, breach of employment contracts and unpaid performance bonuses as a result of their separation from Impsat shortly after the acquisition of Impsat by the Company.
The Company has been in negotiations with the claimants over the amount of their claims and other issues arising out of their departure. In October 2007, a former director and officer commenced litigation seeking to recover damages from the Company for alleged separation benefits and compensation. The Company has responded seeking dismissal of the claim based on lack of jurisdiction but such defense was rejected by the court and the case has moved to the evidentiary stage. In November 2007, a former officer served the Company a complaint claiming damages. The case is now in the evidentiary stage. In July 2008, a former officer commenced formal judicial proceedings on his claim and the Company responded seeking dismissal of the claim based on lack of jurisdiction. Such defense was rejected by the court and the case will now continue. The Company has replied timely in each case and will be vigorously defending against these claims.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
Buenos Aires Antenna Tax Liability
The Government of the City of Buenos Aires (“GCBA”) established a tax applicable to private companies owning antennas with supporting structures, whether in service or not, in the amount set forth in the annual tariff law for the use of the public and private air space (the “Antenna Fees”).
Since September 2003, the GCBA has periodically notified Impsat of the Antenna Fees which aggregates approximately $62, including interest, and requested payment. Impsat has administratively disputed each of these notifications and in the administrative proceeding questioned the legality and constitutionality of the tax on various grounds, including that: (1) air rights belong to the owner of the underlying private property and GCBA’s charge for use of privately owned air rights is confiscatory and incompatible with the constitutional right of property; (2) Argentine federal telecommunications law exempts the use and occupation of public air space for the purposes of providing public telecommunications service from any charge; (3) the tax that GCBA is trying to impose is excessive and confiscatory; and (4) the GCBA has significantly overstated the number and height of the antennas owned by Impsat that are subject to the tax. Impsat continues to dispute the Antenna Fees and, to date, no summary collection action has been commenced by GCBA on the unpaid Antenna Fees.
In July 2008, Impsat filed an action in the Argentine Federal Courts in Buenos Aires seeking a declaration that the Antenna Fees are unconstitutional and illegal. The request is still pending. In December 2008, the GCBA amended its regulations and those amendments resulted in a significant reduction in the Antenna Fees. The Company is working to determine the final impact those changes will have on its exposure.
Brazilian Tax Claims
In October 2004, the Brazilian tax authorities issued two tax infraction notices against Impsat for the collection of the Import Duty and the Tax on Manufactured Products, plus fines and interests. The notice informed Impsat Brazil that the taxes were levied because a specific document (Declaração de Necessidade-”Statement of Necessity”) was not provided by Impsat Brazil at the time of importation, in breach of MERCOSUR rules. Oppositions were filed on behalf of Impsat Brazil arguing that the Argentine exporter (Corning Cable Systems Argentina S.A.) complied with the MERCOSUR rules and a favorable first instance decision was granted. However, due to the amount involved, the case was remitted to the official compulsory review by the Federal Taxpayers Council. The administrative final decision is still pending.
In addition, in December 2004, the tax authorities of the State of São Paulo, in Brazil, issued an infraction notice against Impsat Brazil for collection of Tax on Distribution of Goods and Services (“ICMS”) supposedly due on the lease of movable properties by comparing such activity to communications services, on which the ICMS state tax is actually levied. A defense was filed on behalf of Impsat Brazil, arguing that the lease of assets could not be treated as a communication service subject to ICMS. The defense was rejected in the first administrative level, and an appeal to State Administrative Court was then filed, which is pending judgment. Impsat believes there are good grounds to have the tax assessment cancelled. However, if the tax assessment is not cancelled at the administrative level for any reason, judicial measures may be adopted to remove such tax assessment.
Paraguayan Government Contract Claim
The National Telecommunications Commission of Paraguay (“CONATEL”) has commenced administrative investigations against a joint venture between GC Impsat’s Argentine subsidiary and Electro Import
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
S.A. (“JV 1”) and another joint venture between GC Impsat’s Argentine subsidiary and Loma Plata S.A. (“JV 2”), for breach of contract and breach of licensee’s obligations by each of such joint ventures.
In December 2000, after a public bidding process, JV 1 was awarded a contract, with funding, and a universal service license for the design, supply, installation, launch, operation and maintenance of a telecommunications system for public telephones and/or phone booths in certain specified locations in Paraguay. In 2005, CONATEL initiated an administrative investigation due to an alleged breach of contract by JV 1, as well as a criminal investigation pursuant to which two officers of Impsat’s Argentine subsidiary were preliminarily indicted. As a result of such investigation, CONATEL resolved to: (i) determine JV 1’s liability as to the breach of its contract and its legal obligations as licensee of the Universal Service; (ii) revoke the license granted; (iii) terminate the contract due to JV 1’s default; (iv) impose a fine; (v) foreclose on the insurance policy; and (vi) seize the equipment already installed by JV 1.
JV 1 moved for injunctive protection and the reconsideration and annulment of the above referred resolution, based on force majeure and violation of due process defenses. CONATEL filed a motion to dismiss such action, based on the lack of standing to sue, as well as on failure to state a claim upon which relief may be granted. A final judgment regarding CONATEL’s motions must be obtained, prior to moving forward with the following stages on this administrative claim (answer to the claim, evidentiary stage, etc.).
In September 2007, an agreement was reached with the prosecution to conditionally suspend the criminal proceedings against the Company’s employees, and to have the charges ultimately dismissed. The agreement was approved by the Court on November 28, 2007. In a decision dated February 3, 2009, the conditional suspension of criminal charges was finalized by the Court and all criminal charges against the individual employees of the Company have now been dismissed.
In 2001, after a public bidding process, JV 2 was awarded a contract, with funding, for the installation and deployment of public telephones and/or telephone booths in certain specified locations in Paraguay. JV 2 was required to install and start operating all the required equipment within twelve months of the execution of the contract. In January 2003, JV 2 requested an extension of the twelve month term from CONATEL as a result of force majeure which prevented it from completing the installation of the committed number of remote terminals within the agreed time period. CONATEL denied the request and decided to terminate the contract based on JV 2’s default.
JV 2 then filed a claim before the Administrative Court requesting the annulment of the termination and seeking a stay of the challenged administrative acts. After the legal term to respond to JV 2’s request had lapsed, JV 2 filed a motion to continue the proceedings in CONATEL’s absence. The Administrative Court denied the motion and accepted CONATEL’s late presentation, opening the proceeding’s evidentiary period. JV2 filed an appeal before the Supreme Court, which was rejected on August 31, 2007. JV2 filed a reinstatement and clarification motion against the Supreme Court’s resolution on September 5, 2007. The Supreme Court dismissed the reinstatement motion and remitted the proceedings back to the Administrative Court on February 4, 2008. The parties were instructed to file evidence in connection with deadlines set forth for the evidentiary period. On May 2, 2008, the Company timely filed its evidence before the Court.
Customer Bankruptcy Claim
During 2007 the Company commenced default and disconnect procedures against a customer for breach of a sales contract based on the nature of the customer’s traffic, which renders the contract highly unprofitable to the
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
Company. After the process was begun, the customer filed for bankruptcy protection, thereby barring the Company from taking further disconnection actions against the customer. The Company commenced an adversary proceeding in the bankruptcy court, asserting a claim for damages for the customer’s alleged breaches of the contract and for a declaration that, as a result of these breaches, the customer may not assume the contract in its reorganization proceedings.
The customer has filed several counterclaims against the Company alleging various breaches of contract for attempting improperly to terminate service, for improperly blocking international traffic, for violations of the Communications Act of 1934 and related tort-based claims. The Company notified the customer that the Company would be raising its rates and the Company subsequently filed a motion with the court seeking additional adequate assurance, or an order allowing the Company to terminate the customer’s service, based upon the rate change. The customer amended its counter claims to assert claims for breach of contract based upon the rate increase.
After the filing of motions and responses, the Court issued an opinion on these matters on July 3, 2008. The Court held that the agreement did not permit the Company to increase the rates in the manner it did and that the Company: (a) breached the sales contract in so doing; and (b) is therefore not entitled to additional adequate assurance. The Court did, however, permit the Company to amend its complaint to plead a rescission claim, which the Company filed on July 14, 2008. The Company also filed notices of appeal of these rulings with the United States District Court of the Southern District of New York, but those appeals were ultimately dismissed for untimeliness, without prejudice to later appeals on the merits. In the meantime, the case is continuing in the bankruptcy court with respect to the remaining liability issues and damages in the adversary proceeding. While the customer has alleged damages in amounts that would be very material to the Company, we believe that we have valid defenses to limit the amount of these damages. The parties exchanged expert reports in 2008 and the matter is presently scheduled for trial in 2009. The Company has also moved to dismiss the customer’s bankruptcy case for failure to comply with the “small business” provisions of the Bankruptcy Code. That motion is scheduled to be heard by the Bankruptcy Court on March 5, 2009. The Company anticipates that the customer will oppose the motion.
Universal Service Notice of Apparent Liability
On April 9, 2008, the FCC released a Notice of Apparent Liability for Forfeiture finding that subsidiaries of Global Crossing North America, Inc. apparently violated the Communications Act of 1934, as amended, and the FCC’s rules, by willfully and repeatedly failing to contribute fully and timely to the federal Universal Service Fund and the Telecommunications Relay Service Fund. The FCC alleges that, since emergence from bankruptcy, the Company has had a history of making its contributions to the funds late or, in certain months, making only partial contributions or not making any contributions. The FCC has proposed to assess a forfeiture of approximately $11. The Company believes that it has several defenses to the proposed forfeiture. The Company and the FCC are attempting to negotiate a resolution and the due date for the Company’s response has been held in abeyance.
Commitments
Cost of Access, Third Party Maintenance and Other Purchase Commitment Obligations
The Company has purchase commitments with third-party access vendors that require it to make payments to purchase network services, capacity and telecommunications equipment through 2013. Some of these access vendor commitments require the Company to maintain minimum monthly and/or annual billings, in certain cases
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
based on usage. In addition, the Company has purchase commitments with third parties that require it to make payments for maintenance services for certain portions of its network through 2026. Further, the Company has purchase commitments with other vendors.
The following table summarizes the Company’s purchase commitments at December 31, 2008:
Operating leases-The Company as Lessee
The Company has commitments under various non-cancelable operating leases for office and equipment space, automobiles, equipment rentals, network capacity contracts and other leases. Estimated future minimum lease payments on operating leases are approximately as follows:
The schedule of future minimum lease payments above does not include operating lease obligations related to restructured properties (see note 3).
Rental expense related to office and equipment space, automobiles, equipment rentals and other leases for the years ended December 31, 2008, 2007 and 2006 was $121, $99 and $86, respectively.
Sublease Income
The Company has various sublet arrangements with third parties. Estimated future minimum lease receipts are approximately as follows:
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
The schedule of future minimum lease receipts above does not include lease obligations related to restructured properties.
Sublease income for the years ended December 31, 2008, 2007 and 2006 was $7, $7 and $5 respectively.
22. RELATED PARTY TRANSACTIONS
Commercial and other relationships between the Company and ST Telemedia
During the years ended December 31, 2008, 2007 and 2006 the Company provided approximately $0.3, $0.3, and $0.2, respectively, of telecommunications services to subsidiaries and affiliates of the Company’s indirect majority shareholder and parent company, ST Telemedia. Also, during the years ended December 31, 2008, 2007 and 2006 the Company received approximately $6.0, $3.4, and $2.0 of co-location services from an affiliate of ST Telemedia. Additionally, during the years ended December 31, 2008, 2007 and 2006, the Company accrued dividends of $3.6, $3.6 and $3.6, respectively, related to preferred stock held by affiliates of ST Telemedia. Further, for the years ended December 31, 2008, 2007 and 2006, the Company accrued interest of nil, $26.0 and $31.5, respectively, related to the Mandatorily Convertible Notes held by affiliates of ST Telemedia.
As of December 31, 2008 and 2007, the Company had approximately $19.1 and $15.0, respectively, due to ST Telemedia and its subsidiaries and affiliates, and no amounts due from ST Telemedia and its subsidiaries and affiliates. The amounts due to ST Telemedia and its subsidiaries and affiliates at December 31, 2008 and 2007 primarily relate to dividends accrued on the GCL Preferred Stock, and are included in “other deferred liabilities” in the accompanying condensed consolidated balance sheets. During the year ended December 31, 2007 ST Telemedia converted the Mandatorily Convertible Notes into 16.58 million shares of common stock (see Note 12). During the years ended December 31, 2008, 2007 and 2006, nil, $6.4, and $12.5 of accrued interest related to the Mandatorily Convertible Notes was converted to additional Mandatorily Convertible Notes.
On May 30, 2006, a wholly-owned subsidiary of ST Telemedia purchased 6,226,145 shares of common stock as part of the Company’s public offering of common stock.
During 2006, the Company reimbursed ST Telemedia for an immaterial amount of out-of-pocket expenses incurred by ST Telemedia representing legal fees incurred in connection with waivers granted by ST Telemedia at the request of the Company of certain covenants in the indenture governing the Mandatorily Convertible Notes.
Commercial relationships between the Company and the Slim Family
According to filings made with the SEC, Carlos Slim Helu and members of his family (collectively, the “Slim Family”), together with entities controlled by the Slim Family, held greater than 10% of the Company’s common stock prior to May 2, 2006. Accordingly, the members of the Slim Family may therefore be considered related parties of the Company prior to that date. During the four months ended April 30, 2006, the Company engaged in various commercial transactions in the ordinary course of business with telecommunications companies controlled by or subject to significant influence from the Slim Family (“Slim-Related Entities”). Specifically telecommunications services provided to Slim-Related Entities during the four months ended April 30, 2006 was approximately $5.5. Purchases of access-related services from Slim-Related Entities was approximately $2.5 for the four months ended April 30, 2006.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
Settlement with Asia Global Crossing Bankruptcy Trustee
In November 2004, the bankruptcy trustee for Asia Global Crossing Ltd, a former majority-owned subsidiary of the Company now in liquidation under Chapter 7 of the U.S. Bankruptcy Code (“AGC”), filed a lawsuit against a number of former directors and officers of AGC, including the chief executive officer and certain other senior officers of the Company (collectively, the “Company Parties”). The lawsuit alleged, among other things, breaches of fiduciary duty and duty of loyalty, preferential transfers, and fraudulent conveyances, in each case arising prior to the AGC bankruptcy filing in November 2002. The Company was not named as a defendant in the lawsuit. To avoid adverse consequences to the Company that might result from protracted litigation of the matter, the Company entered into a stipulation of settlement on November 30, 2005 with (among others) the AGC bankruptcy trustee and agreed to contribute $4 to a larger settlement fund. The stipulation was approved by Judge Lynch of the U.S. District Court for the Southern District of New York on March 23, 2006. Under the terms of the settlement, the Company contributed $2 to the settlement fund in June 2006 and the remaining $2 in January 2007.
23. SEGMENT REPORTING
SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS No. 131”) defines operating segments as components of an enterprise for which separate financial information is available and which is evaluated regularly by the Company’s chief operating decision makers (“CODMs”) in deciding how to assess performance and allocate resources. As a result of the Impsat acquisition (see Note 4) and the establishment of a business unit management structure, the Company’s CODMs assess performance and allocate resources based on three separate operating segments which management operates and manages as strategic business units: (i) the GCUK Segment; (ii) the GC Impsat Segment; and (iii) the ROW Segment.
The GCUK Segment is a provider of managed network communications services providing a wide range of telecommunications services, including data, IP and voice services to government and other public sector organizations, major corporations and other communications companies in the United Kingdom (“UK”). GC Impsat is a provider of telecommunications services including IP, voice, data center and information technology services to corporate and government clients in Latin America. The ROW Segment represents all the operations of Global Crossing Limited and its subsidiaries excluding the GCUK and GC Impsat segments and comprises operations primarily in North America, with smaller operations in Europe, Asia and Latin America, serving many of the world’s largest corporations and many other telecommunications carriers with a full range of managed telecommunications services including data, IP and voice products. The services provided by the Company’s segments support a migration path to a fully converged IP environment.
During 2008, the Company transferred its legacy Brazilian and Chilean operations from the ROW Segment to the GC Impsat Segment. As these transfers were between entities under common control, the Company has retroactively restated the GC Impsat Segment results to include the results of the Brazilian and Chilean operations and removed the results of the Brazilian and Chilean operations from the ROW Segment for all applicable periods presented. The Company anticipates transferring its Argentine operations from the ROW Segment to the GC Impsat Segment during 2009 in a continuing effort to streamline its operations.
The CODMs have measured and evaluated the Company’s reportable segments based on Adjusted Cash EBITDA. Adjusted Cash EBITDA, as defined by the Company, is earnings before non-cash stock compensation, depreciation and amortization, interest income, interest expense, other income (expense), net, net gain on pre-confirmation contingencies, provision for income taxes and preferred stock dividends.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
Management believes that Adjusted Cash EBITDA has been an important part of the Company’s internal reporting and is a key measure used by management to evaluate profitability and operating performance of the Company and to make resource allocation decisions. Management believes such measure is especially important in a capital-intensive industry such as telecommunications. However, there may be important differences between the Company’s Adjusted Cash EBITDA measure and similar performance measures used by other companies. Additionally, this financial measure does not include certain significant items such as non-cash stock compensation, depreciation and amortization, interest income, interest expense, other income (expense) net, net gain on pre-confirmation contingencies, provision for income taxes and preferred stock dividends. Adjusted Cash EBITDA should not be considered a substitute for net income, operating income, operating cash flows or other measures of financial performance.
In 2009, the Company’s CODMs will begin to assess performance and allocate resources based on operating income before depreciation and amortization (“OIBDA”). OIBDA differs from Adjusted Cash EBITDA in that OIBDA includes non-cash stock compensation. As the Company expects to reduce its reliance on non-cash stock compensation over time, in particular for the annual incentive plan, the Company believes this change is appropriate and allows cash or stock to be used to fund the bonus program without impacting the measure.
Segment information
The following tables provide operating financial information for the Company’s three reportable segments and a reconciliation of segment results to consolidated results. Prior period amounts are revised to reflect the change in reportable segments as discussed above.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
A reconciliation of Adjusted Cash EBITDA to Income (Loss) Applicable to Common Shareholders follows:
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
Eliminations include intersegment eliminations and other reconciling items.
The Company accounts for intersegment sales of products and services and asset transfers at current market prices.
Geographic Information
Company information provided on geographic sales is based on the order location of the customer. Long- lived assets are based on the physical location of the assets. The following table presents revenue and long-lived asset information for geographic areas:
(1)
There were no individual customers for the years ended December 31, 2008, 2007 and 2006 that accounted for more than 10% of consolidated revenue.
(2)
Long-lived assets include property and equipment and intangible assets.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
24. SUPPLEMENTAL CASH FLOW INFORMATION
During the year ended December 31, 2007, STT Crossing Ltd. converted the Mandatorily Convertible Notes into approximately 16.58 million shares of common stock (see Note 12).
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
25. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following tables present the unaudited quarterly results for the years ended December 31, 2008 and 2007.
GLOBAL CROSSING LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in millions, except countries, cities, number of sites,
percentage, share and per share information)
During the second quarter of 2007, the Company purchased Impsat and consolidated its results from May 9, 2007 to December 31, 2007. As a result of the purchase, the Company recorded a $27 non-cash, non-taxable gain from the deemed settlement of pre-existing arrangements.
During the second quarter of 2007, the Company announced a restructuring plan resulting in involuntary work force reductions of approximately 220 positions. The total one-time severance and other post-termination benefits including employer burden related to the positions being eliminated was approximately $12.
During the second and fourth quarters of 2007, the Company decreased its restructuring facilities reserve for facility closings by $2 and $31, respectively, related to changes in the use of restructured facilities from idle assets to productive assets. During the third quarter of 2007, the Company decreased its restructuring facilities reserve for facility closings by $10 related to the settlement and termination of existing real estate lease agreements for technical facilities.
During the third quarter of 2007, STT Crossing Ltd. converted $250 of Mandatorily Convertible Notes into approximately 16.58 million shares of common stock. The Company recorded a $30 inducement fee related to the early conversion of STT debt to equity in other income (expense), net. During the fourth quarter of 2007, the Company released a contingent liability and interest accrued on that liability as a result of a tax court dismissing the claim and recorded a $27 net gain on settlement of pre-confirmation contingencies and $8 reduction in interest expense.
The sum of the quarterly net loss per share amounts may not equal the full-year amount since the computations of the weighted average number of shares outstanding for each quarter and the full year are made independently.
26. SUBSEQUENT EVENT
2008 Annual Bonus Share Grant
Effective February 12, 2009, the Company granted approximately, 4.7 million shares of restricted stock units to its employees in connection with the 2008 Annual Bonus Program (see Note 18). The restricted stock units vest no later than April 9, 2009 and upon vesting approximately 1.6 million shares will be withheld to cover tax withholding obligations resulting in 3.1 million shares being distributed.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(in millions)