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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                            ------------------------

                                  FORM 10-K/A
(MARK ONE)
[X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
      ACT OF 1934
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998.

[ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934
        FOR THE TRANSITION PERIOD FROM                TO
                         COMMISSION FILE NUMBER 1-12866

                          GST TELECOMMUNICATIONS, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

<TABLE>
<S>                                                 <C>
                      CANADA                                                N/A
          (STATE OR OTHER JURISDICTION OF                  (IRS EMPLOYER IDENTIFICATION NUMBER)
          INCORPORATION OR ORGANIZATION)
</TABLE>

                 4001 MAIN STREET, VANCOUVER, WASHINGTON 98663
             (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)    (ZIP CODE)

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (360) 356-7100

          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
                                      NONE

          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                        COMMON SHARES, WITHOUT PAR VALUE

     Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes  [X] No  [ ]

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]

     The aggregate market value at March 5, 1999 of the Registrant's Common
Shares, without par value (based upon the closing price of $7 per share of such
Common Shares on NASDAQ), held by non-affiliates of the Company was
$254,038,365. Solely for the purposes of this calculation, shares held by
directors and officers of the Registrant have been excluded. Such exclusion
should not be deemed a determination or an admission by the Registrant that such
individuals are, in fact, affiliates of the Registrant.

     Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: At March 5, 1999, there were
outstanding 36,470,526 of the Registrant's Common Shares, without par value.

     Except where otherwise indicated, all amounts expressed as "$" or "dollars"
in this Annual Report refer to United States currency.

                      DOCUMENTS INCORPORATED BY REFERENCE

     Certain portions of the Registrant's definitive proxy statement to be filed
with the Securities and Exchange Commission (the "Commission") no later than
April 30, 1999 pursuant to Regulation 14A are incorporated by reference in Items
10 through 12 of Part III of this Annual Report on Form 10-K.

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
        FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

OVERVIEW

     GST Telecommunications, Inc. (the "Company") provides a broad range of
integrated telecommunications products and services, primarily to business
customers located in California, Hawaii and other western continental states. As
a facilities-based integrated communications provider ("ICP"), the Company
operates state-of-the-art, digital telecommunications networks that represent an
alternative to incumbent local exchange carriers ("ILECs"). The Company's full
line of products, which offer a "one-stop" customer-focused solution to the
telecommunications services requirements of its customers, include local dial
tone, long distance, Internet, data transmission and private line services. With
the turn-up of its Virtual Integrated Transport and Access ("VITA") network in
the fiscal year ended December 31, 1998 ("Fiscal 1998"), the Company became one
of the first ICPs to develop and deploy a converged network. At the end of
Fiscal 1998, the VITA network was operational in 13 of the Company's markets,
positioning the Company for deployment of advanced Internet Protocol ("IP")
services in those markets.

RECENT DEVELOPMENTS

     In February 1998, the Company sold its remaining 63% interest in NACT for
net proceeds of approximately $85.0 million (the "NACT Sale"). NACT produces
advanced telecommunications switching platforms with integrated applications
software and network telemanagement capabilities.

     In May 1998, GST Network sold $500.0 million principal amount at maturity
of the 1998 Notes in a private placement (the "1998 Offering"). The net proceeds
of the 1998 Offering of approximately $288.9 million will be used to finance the
purchase and installation of acquired equipment. Until such time as purchases
are made, such net proceeds have been invested in United States government
securities in which the holders have been granted a first priority security
interest.

     On June 15, 1998 the Company announced that Mr. John Warta had retired as
Chairman of the Board and Chief Executive Officer of the Company. Effective
September 15, 1998, Mr. Warta resigned as a director of the Company. The Board
of Directors of the Company appointed Mr. Robert A. Ferchat, a director of the
Company and the Chairman of the Board and Chief Executive Officer of BCE Mobile
Communications, Inc. to the position of Chairman of the Board of the Company on
June 15, 1998, and Mr. Joseph A. Basile, Jr., the President, Chief Operating
Officer and a director of the Company, as Chief Executive Officer on October 20,
1998.

     On October 28, 1998, Magnacom, a company controlled by Mr. Warta, filed a
petition for reorganization under Chapter 11 of the United States Bankruptcy
Code. As of December 31, 1998, the Company had paid Magnacom approximately $14.6
million as prepayments for future PCS services and had recorded approximately
$1.1 million in other receivables from Magnacom. In September 1998, the Company
recorded a loss reserve of $15.7 million for the full amount of the prepayments
and receivables related to Magnacom. See "Business -- Magnacom."

     The Company, GST Network, GST USA, and GST Funding are parties to certain
indentures and have issued or guaranteed notes governed by those indentures. In
November 1998, the Company notified United States Trust Company of New York, as
trustee under the indentures, that certain actions by the Company and its
subsidiaries may not have been in compliance with the technical requirements of
the restrictive covenants contained in the indentures.

     In particular, the Company has been advised that the transfer of its
interest in a telecommunications project to be developed in Mexico to Global
Light Telecommunications, Inc. ("Global") may constitute a violation of
provisions in the indentures limiting investments in entities that conduct
business outside of the continental United States and Hawaii. In addition, the
Company has not yet received any consideration for this transfer to Global,
which may constitute a violation of provisions in the indentures respecting
consideration to be received in connection with Asset Sales to affiliated
entities. The Company has initiated litigation to recover this asset or its fair
market value. See "Legal Proceedings." The Company has also been advised that
certain transactions relating to Guam and the Northern Mariana Islands --
particularly, an investment in an entity that conducted business in Guam and the
Northern Mariana Islands and the Company's 1998 acquisition of certain operating
assets located in Guam -- may constitute violations of provisions in the
indentures limiting investments in entities that conduct business outside of the
continental United States and Hawaii. With respect to the operating assets
located in Guam, the Company is currently seeking to divest these assets in a
transaction complying with the indentures. The Company intends to vigorously
pursue any necessary action to cure the potential non-compliances.

     In February 1999, the trustee informed the note holders of the potential
violations. Pursuant to the definitions contained within the indentures of each
of the notes described above, no default has been declared and no event of
default has occurred. The Company has not classified the related debt
obligations as current in its consolidated financial statements because
management believes it is probable that, in the event that the holders declared
a default, the Company would be able to take corrective actions to cure any
objectively determinable violations within the prescribed grace period.

     While the Company believes that any non-compliances can be cured, the
Company cannot offer any assurance that the litigation will be successful or
that any other potential cures will be effected in a timely manner or be
sufficient. In the

                                        2
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event that the Company has violated its indentures and does not cure the
violations, the holders of the notes issued under the indentures could demand
repayment of the notes, discontinue disbursements of cash proceeds of the most
recent notes and assert other remedies against the Company. If any of these
events occurred, the Company would not have sufficient liquid assets to repay
the notes.

     The Company reported the following special charges for the year ended
December 31, 1998:

<TABLE>
<S>                                                            <C>
Write-off of amounts paid to Magnacom pursuant to a reseller
  agreement.................................................   $      14,600
Write-off of operating advances paid to Magnacom............           1,068
Write-off of costs related to abandoned projects............           9,918
Impairment of assets........................................           3,881
                                                               -------------
     Non-cash special charges...............................          29,467
Accrual of severance-related costs..........................           1,113
                                                               -------------
     Total special charges..................................   $      30,580
                                                               =============
</TABLE>

     In 1998, the Company changed its strategic direction to focus on its core,
domestic business. In conjunction with the change, management identified certain
in-process network construction projects no longer considered useful due to
geographic location or technological compatibility. The write-off totaled $9,918
and represented the entire amount of the costs related to these in-process
projects, including the costs of fiber optic networks and electronic equipment.
These assets had never been placed in service and, as such, were not an integral
part of the Company's ongoing operations. While the historical cost of these
assets has been written-off of the Company's December 31, 1998 balance sheet,
the Company holds these assets for disposal and is considering disposal
alternatives for such assets.

     In conjunction with the change in strategic direction, management halted
further development of and investment in shared tenant services. The decision
resulted in an impairment charge of $2,728 for property, plant and equipment,
and $1,153 for customer lists associated with such services. At December 31,
1998, the Company held its shared tenant services assets for sell and
anticipates that it will sell the related operations and assets during 1999. The
impairment loss was measured as the amount by which the carrying amount of these
assets exceeded the estimated fair value of the assets, which was determined
based on current market prices for similar assets. The loss reserve was recorded
by increasing accumulated depreciation for the property, plant and equipment,
and accumulated amortization for the customer lists. The amount of the write-off
of customer lists represents the remaining unamortized balance of such lists,
which were related to a 1996 acquisition. No goodwill had been recorded in
conjunction with the acquisition.

     In the fourth quarter of 1998, management consummated a plan to
involuntarily terminate approximately 40 employees, including former members of
management, and to pay termination benefits to such employees. The Company does
not anticipate that the termination of these employees will have a material
impact on its business functions. At December 31, 1998, the Company had accrued
$1,113 in severance-related costs, the majority of which is expected to be paid
out in the first quarter of 1999.

     See "BUSINESS -- Magnacom" for a discussion of the amounts paid to
Magnacom.

RESULTS OF OPERATIONS

FISCAL 1998 COMPARED TO THE UNAUDITED YEAR ENDED DECEMBER 31, 1997

     Revenues.  Total revenues for Fiscal 1998 increased $44.3 million, or
37.2%, to $163.3 million from $119.0 million for the comparable twelve months
ended December 31, 1997. Telecommunications and other services revenues for
Fiscal 1998 increased $66.9 million, or 73.0%, to $158.6 million from $91.7
million for the twelve months ended December 31, 1997. The increase in
telecommunications and other services revenues resulted primarily from strategic
acquisitions, including the acquisitions of ICON in April 1998, and from
increased local service revenue generated by the Company's networks. To a lesser
extent, the increase in telecommunications and other services revenues resulted
from increased long distance, Internet and data services. The increase was also
attributable to a $2.0 million increase in revenue from the construction of
network conduit and fiber systems. Telecommunications products revenues for
Fiscal 1998 decreased $22.6 million, or 82.8%, to $4.7 million from $27.3
million for the twelve months ended December 31, 1997. The decrease in product
revenues resulted from the sale of the Company's 63% interest in NACT.

     Operating Expenses.  Total operating expenses for Fiscal 1998 increased
$89.1 million, or 42.5%, to $298.5 million from $209.4 million for the 12 months
ended December 31, 1997. Network expenses, which include direct local and long
distance circuit costs, were 66.7% of telecommunications and other services
revenues for Fiscal 1998 compared to 76.3% for the comparable period in the
previous year. The decrease in network expenses as a percentage of revenue
resulted from the inclusion of strategic acquisitions and an increase in
revenues for traffic carried on the Company's network as a percentage of total
telecommunications and other services revenues. Facilities administration and
maintenance expenses for Fiscal 1998 were 10.5% of telecommunications and other
services revenues compared to 13.6% for the comparable period ended December 31,
1997. The primary reason for the decrease in these expenses as a percentage of
telecommunications and other services revenues is the inclusion of revenues from
strategic acquisitions, substantially all of which are not generated on the
Company's networks.

                                        3
<PAGE>   4

     Cost of product revenues for Fiscal 1998 decreased $6.3 million, or 67.7%,
to $3.0 million from $9.3 million for the twelve months ended December 31, 1997.
For Fiscal 1998, cost of product revenues were 63.7% of telecommunications
products revenues compared to 34.0% for the comparable period ended December 31,
1997. The decrease in the dollar amount of cost of product revenues and the
increase in cost of product revenues as a percent of product sales resulted from
the sale of NACT. Research and development costs reported in the twelve months
ended December 31, 1997 were related to activities at NACT.

     Selling, general and administrative expenses for Fiscal 1998 increased
$17.3 million, or 21.8%, to $96.5 million from $79.2 million for the twelve
months ended December 31, 1997. The increase is due to the expansion of the
Company's local and enhanced services operations, which has resulted in
additional marketing, management information and sales staff, and to selling,
general and administrative expenses related to strategic acquisitions. As a
percentage of total revenue, selling, general and administrative expenses for
Fiscal 1998 were 59.1%, compared to 66.6% for the comparable period ended
December 31, 1997.

     Depreciation and amortization for Fiscal 1998 increased $17.7 million, or
62.2%, to $46.0 million from $28.3 for the twelve months ended December 31,
1997. The increase is attributable to newly-constructed networks and related
equipment being placed into service and to the amortization of intangible assets
related to the Company's acquisitions. The Company expects that depreciation
will continue to increase as it expands its networks and longhaul fiber optic
facilities and installs additional switches. Depreciation and amortization
expense was 28.1% of total revenue for Fiscal 1998 compared to 23.8% for the
comparable period ended December 31, 1997.

     Special charges for the twelve months ended December 31, 1997 represent a
one-time $7.4 million non-cash charge recorded when 750,000 Common Shares were
released from escrow to certain of the Company's former executives, which the
Company views as a potential actionable claim. See "Legal Proceedings -- GST v.
Sander." See "Recent Developments" for a discussion of special charges incurred
in fiscal 1998.

     Other Expenses and Income.  For Fiscal 1998, the Company recorded net other
expense of $19.5 million, compared to $39.9 million for the comparable period
ended December 31, 1997. For Fiscal 1998, net other income includes a $61.3
million gain resulting from the sale of NACT. Excluding such gain, net other
expense would have increased $40.9 million for Fiscal 1998 as compared to the
same period in the previous year. The increase in net other expense relates
primarily to increased interest expense resulting from the issuance in November
and December 1997 of the Accrual Notes and the issuance in May 1998 of the 1998
Notes.

     Net Loss.  Net loss for Fiscal 1998 increased $24.4 million, or 18.7%, to
$154.7 million from $130.3 million for the twelve months ended December 31,
1997. Excluding the $61.3 million gain on the sale of NACT, net loss would have
been $216.0 million for Fiscal 1998, an increase of $85.7 million as compared to
the twelve months ended December 31, 1997. Such increase in net loss resulted
primarily from a $50.5 million increase in interest expense and a $44.8 million
increase in operating loss.

1997 THREE MONTH PERIOD COMPARED TO THE UNAUDITED 1996 THREE MONTH PERIOD

     Revenues.  Total revenue for the 1997 Three Month Period increased $13.1
million, or 56.2%, to $36.3 million from $23.2 million for the 1996 Three Month
Period. Telecommunications services revenue for the 1997 Three Month Period
increased $9.1 million, or 49.4%, to $27.6 million from $18.4 million for the
1996 Three Month Period. The increase in telecommunications services revenue
resulted primarily from increased local service revenue generated by the
Company's networks and from increased long distance service revenue. To a lesser
extent, the increase in revenue resulted from the acquisitions of Action Telcom,
Inc. ("Action Telcom") in May 1997 and the Guam operations of Sprint
Communications Company, L.P. ("Sprint"), in October 1997. Additionally, during
the 1997 Three Month Period, the Company completed a $1.5 million longhaul
conduit sale. Product revenue for the 1997 Three Month Period increased $3.9
million, or 82.1%, to $8.7 million from $4.8 million for the 1996 Three Month
Period. The increase in product revenues resulted from increased unit sales of
NACT's STX switch and, to a lesser extent, the inclusion of Action Telcom's
sales of NAMS. Excluding NACT, product revenue totalled $1.4 million and $0 for
the 1997 Three Month Period and the 1996 Three Month Period, respectively.

     Operating Expenses.  Total operating expenses for the 1997 Three Month
Period increased $16.9 million, or 41.0%, to $58.1 million from $41.2 million
for the 1996 Three Month Period. Network expenses, which include direct local
and long distance circuit costs, increased $3.7 million, or 23.5%, to $19.4
million, or 70.5% of telecommunications services revenue for the 1997 Three
Month Period compared to $15.7 million, or 85.3% of telecommunications services
revenue for the 1996 Three Month Period. The primary reason for the decrease in
network expenses as a percent of revenue is the increase in on-net revenues
generated for traffic carried on the Company's network as a percent of total
revenues. Facilities administration and maintenance expenses (consisting
primarily of costs related to personnel providing maintenance, monitoring and
technical assistance for the Company's networks) for the 1997 Three Month Period
increased $.2 million, or 5.6%, to $3.5 million, or 12.7% of telecommunications
services revenue, compared to $3.3 million, or 18.0% of telecommunications
services revenue, for the 1996 Three Month Period.

     Cost of product revenue, which includes the costs associated with product
revenue of NACT and Action Telcom, increased $1.3 million, or 70.4%, to $3.1
million for the 1997 Three Month Period from $1.8 million for the 1996 Three

                                        4
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Month Period. Cost of product revenue was 35.6% of product revenue for the 1997
Three Month Period compared to 38.1% for the 1996 Three Month Period. The
decrease in cost of product revenue as a percentage of product revenue resulted
primarily from economies of scale related to increased unit sales of NACT's STX
switch. Excluding NACT, cost of product revenue totalled $.8 million and $0 for
the 1997 Three Month Period and the 1996 Three Month Period, respectively.
Research and development costs for the 1997 Three Month Period increased $.4
million, or 90.5%, to $.8 million from $.4 million for the 1996 Three Month
Period. The increase was due to the addition of personnel to enhance NACT's
switch product line and to facilitate the development of new switching products
and applications.

     Selling, general and administrative expenses for the 1997 Three Month
Period increased $7.2 million, or 47.2%, to $22.4 million from $15.2 million for
the 1996 Three Month Period. The increase is due to the expansion of the
Company's CLEC and enhanced services operations, the acquisition of two
companies between May and October 1997 and the hiring of a significant number of
marketing, management information and sales personnel to implement the Company's
integrated services strategy. Selling, general and administrative expenses were
61.9% of total revenue for the 1997 Three Month Period compared to 65.6% of
total revenue for the 1996 Three Month Period.

     Depreciation and amortization for the 1997 Three Month Period increased
$4.2 million, or 89.0%, to $8.9 million from $4.7 million for the 1996 Three
Month Period. The increase was attributable to newly-constructed networks
becoming operational and to the amortization of intangible assets related to the
Company's acquisitions. The Company expects that depreciation will continue to
increase as it expands its networks and longhaul fiber optic facilities and
installs additional switches. Depreciation and amortization was 24.4% of total
revenue for the 1997 Three Month Period compared to 20.2% for the 1996 Three
Month Period.

     Other Expenses/Income.  For the 1997 Three Month Period, net other expenses
increased $13.1 million, or 281.8%, to $17.7 million, or 48.9% of total revenue,
from $4.6 million, or 20.0% of total revenue, for the 1996 Three Month Period.
The primary reason for the increase was the inclusion of interest expense
associated with the Secured Notes and Accrual Notes. The increase in interest
expense was partially offset by interest income earned on the investment of a
portion of the proceeds of the sale of such notes. To a lesser extent, net other
expenses increased due to the Company's share of Global's losses and to NACT's
income tax expense as well as minority interest in the income of NACT.

     Net Loss.  Net loss for the 1997 Three Month Period increased $17.0
million, or 74.9%, to $39.6 million from $22.6 million for the 1996 Three Month
Period. The increase in net loss resulted primarily from a $3.9 million increase
in operating loss and a $13.5 million increase in interest expense.

FISCAL 1997 COMPARED TO FISCAL 1996

     Revenues.  Total revenue for Fiscal 1997 increased $64.7 million, or
156.6%, to $106.0 million from $41.3 million for Fiscal 1996. Telecommunications
services revenue for Fiscal 1997 increased $50.9 million, or 160.3%, to $82.6
million from $31.7 million for Fiscal 1996. The increase in telecommunications
services revenue resulted from the inclusion of a full year of revenue from
strategic acquisitions, including GST Call America, Inc., f/k/a Call America
Business Communications Corp., ("GST Call America") and TotalNet Communications,
Inc. ("Total Net"), as well as increased CLEC service revenue generated by the
Company's networks. To a lesser extent, the increase in telecommunications
services revenue resulted from increased Internet, shared tenant and data
services. Product revenue for Fiscal 1997 increased $13.8 million, or 144.2%, to
$23.4 million from $9.6 million for Fiscal 1996. The increase in product revenue
resulted primarily from the introduction in April 1996 of NACT's STX switch and
subsequent increased unit sales. To a lesser extent, the increase in product
revenue is due to the inclusion of sales of network management and fraud
protection systems by Action Telcom, which was acquired on May 31, 1997.

     Operating Expenses.  Total operating expenses for Fiscal 1997 increased
$108.6 million, or 129.5%, to $192.5 million from $83.9 million for Fiscal 1996.
Network expenses, which include direct local and long distance circuit costs,
increased $39.7 million, or 149.2%, to $66.3 million, or 80.2% of
telecommunications services revenue for Fiscal 1997 compared to $26.6 million,
or 83.8% of telecommunications services revenue for Fiscal 1996. Facilities
administration and maintenance expenses (consisting primarily of costs related
to personnel providing maintenance, monitoring and technical assistance for the
Company's networks) for Fiscal 1997 increased $2.0 million, or 19.3%, to $12.3
million, or 14.9% of telecommunications services revenue, compared to $10.3
million, or 32.5% of telecommunications services revenue, for Fiscal 1996. The
primary reason for the decrease in facilities administration and maintenance
expenses as a percent of telecommunications services revenue was the inclusion
of revenue from 1996 strategic acquisitions, a significant portion of which was
generated off-net.

     Cost of product revenue, which includes the costs associated with product
revenue of NACT and Action Telcom, increased $4.0 million, or 101.1%, to $8.0
million for Fiscal 1997 from $4.0 million for Fiscal 1996. Cost of product
revenue was 34.2% of product revenue for Fiscal 1997 compared to 41.5% for
Fiscal 1996. The decrease in cost of product revenue as a percentage of product
revenue resulted primarily from economies of scale related to increased unit
sales of NACT's STX switch. Research and development costs for Fiscal 1997
increased $1.0 million, or 71.3%, to $2.3 million from $1.3 million for Fiscal
1996. The increase was due to the addition of NACT personnel to enhance the
current switch product line and to facilitate the development of new switching
products and applications.

                                        5
<PAGE>   6

     Selling, general and administrative expenses for Fiscal 1997 increased
$38.6 million, or 115.9%, to $72.0 million from $33.4 million for Fiscal 1996.
The increase is due to the expansion of the Company's ICP and enhanced services
operations, the acquisition of four companies from September 1996 to May 1997
and the hiring of a significant number of marketing, management information and
sales personnel to implement the Company's integrated services strategy.
Selling, general and administrative expenses were 68.0% of total revenue for
Fiscal 1997 compared to 80.8% of total revenue for Fiscal 1996.

     Depreciation and amortization for Fiscal 1997 increased $15.9 million, or
191.1%, to $24.2 million from $8.3 million for Fiscal 1996. The increase was
attributable to newly-constructed networks becoming operational and to the
amortization of intangible assets related to the Company's acquisitions.
Depreciation and amortization was 22.8% of total revenue for Fiscal 1997
compared to 20.1% for Fiscal 1996.

     Special charges for Fiscal 1997 represents a one-time $7.4 million non-cash
charge recorded when 750,000 Common Shares were released from escrow to certain
of the Company's former executives, which the Company views as a potential
actionable claim. See "Legal Proceedings -- GST v. Sander."

     Other Expenses/Income.  For Fiscal 1997, net other expenses increased $9.0
million, or 50.7%, to $26.8 million, or 25.3% of total revenue, from $17.8
million, or 43.1% of total revenue, for Fiscal 1996. Fiscal 1997 net other
expenses included a $7.4 million gain recognized on the sale of one million of
the Company's shares of NACT in February 1997. If the gain had been excluded,
other expenses for Fiscal 1997 would have increased $16.4 million over Fiscal
1996. Such increase primarily resulted from increased interest expense due to
the issuance of the 1995 Notes in December 1995 and the issuance of the Secured
Notes in May 1997. To a lesser extent, other expenses increased due to income
tax expense attributable to income of NACT.

     Net Loss.  Net loss for Fiscal 1997 increased $52.9 million, or 87.7%, to
$113.3 million from $60.4 million for Fiscal 1996. The increase in net loss
resulted primarily from a $43.9 million increase in operating loss and a $16.4
million increase in interest expense.

LIQUIDITY AND CAPITAL RESOURCES

     The Company has incurred significant operating and net losses as a result
of the development and operation of its networks. The Company expects that such
losses will continue as the Company emphasizes the development, construction and
expansion of its networks and builds its customer base. Cash provided by the
Company's operations will not be sufficient to fund the expansion of its
networks, longhaul fiber optic facilities and services.

     At December 31, 1998, the Company had approximately $1,131.8 million of
indebtedness outstanding and $61.7 million of 11.875% mandatorily redeemable
preference shares. Although the Company's liquidity was substantially improved
as a result of proceeds received from the sale of the 13.875% 1995 Notes, the
13.25% Secured Notes, the 12.75% Accrual Notes and the 10.5% 1998 Notes, the
Company has significant debt service obligations. The Company will be required
to make principal and interest payments of approximately $67.5 million (of which
$35.1 million will be made from funds securing the Secured Notes), $66.6 million
(of which $17.6 million will be made from funds securing the Secured Notes),
$113.5 million, $111.9 million and $154.7 million in 1999, 2000, 2001, 2002 and
2003, respectively. In addition, the Company anticipates that cash flow from
operations will be insufficient to pay interest in cash on the 1995 Notes when
such interest becomes payable in September 2001 and on the Secured Notes
starting in November 2000 once the amount pledged to fund the first six
scheduled interest payments on the Secured Notes is paid and to repay the 1995
Notes, the Secured Notes and the Accrual Notes in full and that such notes will
need to be refinanced. The ability of the Company to effect such refinancings
will be dependent upon the future performance of the Company, which will be
subject to prevailing economic conditions and to financial, business and other
factors beyond the control of the Company. There can be no assurance that the
Company will be able to improve its operating results or that the Company will
be able to meet its debt service obligations.

     At December 31, 1998, the Company had cash, cash equivalents, and
investments, including restricted investments of approximately $383.7 million.
The Company believes that such amounts will be sufficient to fund the Company's
operations through the end of Fiscal 1999. Divestitures and other management
actions may prolong capital availability into the fiscal year 2000 and beyond.
Thereafter, the Company expects to require additional financing. The extent of
additional financing will depend on, among other things, the rate of the
Company's expansion and the success of the Company's businesses. In the event
that the Company's plans or assumptions change or prove to be inaccurate, the
Company incurs significant unexpected expenses, or the Company's cash resources,
together with borrowings under the current financing arrangements prove to be
insufficient to fund the Company's growth and operations, or if the Company
consummates additional acquisitions, the Company may be required to seek
additional sources of capital (or seek additional capital sooner than currently
anticipated). The Company may also seek to raise additional capital to take
advantage of favorable conditions in the capital markets. There can be no
assurance that additional financing will be available to the Company or, if
available, that it can be concluded on terms acceptable to the Company or within
the limitations contained within the Company's financing arrangements. Failure
to obtain such financing could result in the delay or abandonment of some or all
of the Company's development or expansion plans and could have a material
adverse

                                        6
<PAGE>   7

effect on the Company's business. Such failure could also limit the ability of
the Company to make principal and interest payments on its outstanding
indebtedness. The Company has no material working capital or other credit
facility under which it may borrow for working capital and other general
corporate purposes. There can be no assurance that such a facility will be
available to the Company in the future or that if such a facility were
available, that it would be available on terms and conditions acceptable to the
Company.

     The Company's net cash used in operating and investing activities was
$428.1 million and $319.4 million for Fiscal 1998 and the twelve months ended
December 31, 1997, respectively. Net cash provided by financing activities from
borrowings and equity issuances to fund capital expenditures, acquisitions and
operating losses was $315.1 million and $505.1 million for Fiscal 1998 and the
twelve months ended December 31, 1997, respectively.

     Capital expenditures for Fiscal 1998 and the twelve months ended December
31, 1997 were $247.7 million and $214.4 million, respectively. The Company
estimates capital expenditures of $250 million and $150 million in Fiscal 1999
and Fiscal 2000, respectively. The majority of these expenditures is expected to
be made for the construction of network and longhaul fiber optic facilities and
the purchase of switches and related equipment to facilitate the offering of the
Company's services. Continued significant capital expenditures are expected to
be made thereafter. In addition, the Company expects to continue to incur
operating losses while it expands its business and builds its customer base.
Actual capital expenditures and operating losses will depend on numerous
factors, including the extent of future expansion, acquisition opportunities and
other factors beyond the Company's control, including economic conditions,
competition, regulatory developments and the availability of capital.

     In addition to the Company's capital expenditures, the Company has also
made cash expenditures for strategic acquisitions. In March 1998, the Company
acquired Call America-Phoenix, a Phoenix-based reseller of long distance, for
approximately $3.8 million in cash and the business of Whole Earth Networks,
Inc., a San Francisco-based ISP, for approximately $9.1 million in cash and the
assumption of approximately $1.3 million of liabilities. In April 1998, the
Company acquired ICON, a switch-based reseller of long distance and local
service located in Seattle, for approximately $23.9 million in cash.

     In May 1998, the Company completed the offering of $500.0 million principal
amount at maturity of 1998 Notes. The 1998 Notes fully accrete to face value on
May 1, 2003. From and after May 1, 2003, the 1998 Notes bear interest, which
will be payable in cash, at a rate of 10.5% per annum on each May 1 and November
1, commencing November 1, 2003. The net proceeds from the sale of the 1998 Notes
of approximately $288.9 million are restricted for the purchase of
telecommunications equipment and network infrastructure. The indenture relating
to the 1998 Notes includes restrictive covenants which, among other items, limit
or restrict additional indebtedness incurred by the Company, investment in
certain subsidiaries, the sale of assets and the payment of dividends. The
Company is a party to a registration rights agreement relating to the 1998 Notes
whereby it has agreed to consummate an exchange offer for the 1998 Notes
pursuant to an effective registration statement or cause the 1998 Notes to be
registered under the Securities Act of 1933, as amended, pursuant to a shelf
registration statement by November 4, 1998. Although the Company has filed a
registration statement on Form S-4 with respect to an exchange offer for the
1998 Notes, it has not yet been declared effective. Therefore, in accordance
with the terms of the registration rights agreement, interest (in addition to
the accrual of original issue discount and interest otherwise due on the 1998
Notes after such date) on the 1998 Notes will accrue, at an annual rate of 0.5%,
from November 4, 1998 and be payable in cash semiannually in arrears, on each
May 1 and November 1, commencing May 1, 1999 until such exchange offer is
consummated or a shelf registration statement is declared effective.

     The Company may have committed certain technical indenture covenant
violations, and the Company has notified the indenture trustee in this regard.
See "Recent Developments."

INCOME TAXES AND ADOPTION OF NEW ACCOUNTING STANDARDS

     At December 31, 1998, the Company had a U.S. net operating loss
carryforward of approximately $208.9 million available to offset future taxable
income of GST USA and the other U.S. operating subsidiaries. Substantially all
of the Company's operations are conducted in the United States. In addition, at
that date, the Company had a net operating loss carryforward of approximately
Cdn. $49.6 million (U.S. $35.5 million) available to offset future taxable
income of the parent holding company in Canada. While such loss carryforwards
are available to offset future taxable income of the Company in each respective
tax jurisdiction, the Company may not generate sufficient taxable income so as
to utilize all or a substantial portion of such loss carryforwards prior to
their expiration. Further, the utilization of net operating loss carryforwards
against future taxable income is subject to limitation if the Company
experiences an "ownership change" as defined in Section 382 of the Code and the
analogous provision of the Canada Act.

     In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 standardizes the accounting
for derivative instruments, including certain derivative instruments embedded in
other contracts. Under SFAS No. 133, entities are now required to carry all
derivative instruments in the balance sheet at fair value. The accounting for
changes in fair value (i.e., gains and losses) of a derivative instrument
depends on whether it has been designated and qualifies as part of a hedging
relationship and, if so, on the reason for holding it. The
                                        7
<PAGE>   8

Company must adopt SFAS No. 133 by January 1, 2000. The Company has not
determined the impact that SFAS No. 133 will have on its financial statements
and believes that such determination will not be meaningful until closer to the
date of initial adoption.

     In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5, Reporting on the Costs of Start-Up Activities
(SOP 98-5). SOP 98-5 requires that costs incurred during start-up activities,
including organization costs, be expensed as incurred and that previously
capitalized costs related to such activities be expensed as a cumulative effect
of a change in accounting principle upon adoption. The Company will adopt the
provisions of SOP 98-5 at the beginning of 1999 and does not anticipate that
this new standard will have a material impact on future results of operations.

YEAR 2000 PROGRAM

     The year 2000 issue is the result of computer-controlled systems using two
digits rather than four to define the applicable year. For example, computer
programs that have time-sensitive software may recognize a date ending in "00"
as the year 1900 rather than the year 2000. This could result in system failure
or miscalculations causing disruptions of operations including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities.

     The Company is currently verifying system readiness for the processing of
date-sensitive information by its information technology ("IT") systems
(applications, hardware, system software and interfaces) and its network
operations. The review of IT systems and network operations is centrally managed
through a year 2000 Program Management Office (PMO).

     The Company's State of Readiness.  In general, the Company's year 2000
project is divided into three phases: (1) inventory and assessment ("Phase
One"), (2) strategy and contingency planning ("Phase Two"), and (3) conversion
and remediation ("Phase Three").

     The Company completed its Phase One assessment for IT systems in October
1998. Phase One for network operations is expected to be concluded by the end of
first quarter 1999. The Company has focused its independent testing activities
principally on those systems whose failure would pose the greatest risk to the
Company. The Company may not independently test all of its equipment and will
rely upon vendor representations, if received by the Company, where tests are
not conducted. There can be no assurance of the accuracy or completeness of such
representations. The Company is continuing to contact all of its significant
suppliers and large customers to determine the extent to which the Company's
interface systems are vulnerable to those third parties' failure to remediate
their own year 2000 issues.

     With respect to IT systems, the Company completed Phase Two, wherein
remedial actions were planned and a contingency plan was formulated, in December
1998. The Company expects to complete Phase Three for IT systems, wherein
remedial actions will be implemented and tested, by third quarter 1999. The
Company anticipates conclusion of Phase Two and Phase Three activities for
network operations by the third quarter 1999.

     Costs.  The total amount expended on the project through December 31, 1998
was approximately $.5 million. The total cost of the year 2000 project is
estimated to be $3.3 million, including $.3 million in internal staffing costs,
$1.8 million in external staffing costs and $1.2 million in hardware and
software upgrade costs. This cost may be reduced if software and hardware are
replaced with compliant systems as a result of other currently scheduled capital
projects. The Company does not expect remediation costs to have a material
adverse effect on its financial position, results of operation or cash flows.
There can be no assurance, however, that there will not be a delay in, or
increased costs associated with, the implementation of changes as the program
progresses, and failure to implement such changes could have an adverse effect
on future results of operations.

     Risks.  The failure to correct a material year 2000 problem could result in
an interruption in, or a failure of, certain normal business activities or
operations. Such failures could materially and adversely affect the Company's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the year 2000 problem, resulting in part from the
uncertainty of the year 2000 readiness of third-party suppliers and customers,
the Company is unable to determine at this time whether the consequences of year
2000 failures will have a material impact on the Company's results of
operations, liquidity or financial condition. The year 2000 project is expected
to significantly reduce the Company's level of uncertainty about the year 2000
problem. The Company believes that, with the implementation of new business
systems and completion of the project as scheduled, the possibility of
significant interruptions of normal operations should be reduced.

     Readers are cautioned that forward-looking statements contained in the year
2000 update should be read in conjunction with the Company's Cautionary
Statements as supplemented by the following statements regarding the year 2000
project in particular. See "Risk Factors -- Year 2000 Issues."

                                        8
<PAGE>   9

                                  RISK FACTORS

FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS

     This annual report contains forward-looking statements, including
statements regarding the Company's expected financial position, business and
financing plans. These forward-looking statements reflect the Company's views
with respect to future events and financial performance. The words, "believe,"
"expect," "plans" and "anticipate" and similar expressions identify
forward-looking statements. Although the Company believes that the expectations
reflected in such forward-looking statements are reasonable, it can give no
assurance that such expectations will prove to have been correct. Important
factors that could cause actual results to differ materially from such
expectations (the "Cautionary Statements") include, but are not limited to those
matters addressed under "Risk Factors." All subsequent written and oral
forward-looking statements attributable to the Company, its subsidiaries or
persons acting on the Company's behalf are expressly qualified in their entirety
by the Cautionary Statements. Readers are cautioned not to place undue reliance
on these forward-looking statements, which speak only as of their dates. The
Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.

HISTORICAL AND ANTICIPATED FUTURE OPERATING LOSSES AND NEGATIVE ADJUSTED EBITDA

     The Company has incurred and expects to continue to incur operating losses
and negative Adjusted EBITDA while it expands its business and builds its
customer base. The Company has incurred significant increases in expenses
associated with these activities and there can be no assurance that an adequate
customer base with respect to any or all of its services will be achieved or
sustained. The Company had a net loss of approximately $154.7 million, an
operating loss of approximately $135.2 million and negative Adjusted EBITDA of
$60.5 million for Fiscal 1998, a net loss of approximately $39.6 million, an
operating loss of approximately $21.9 million and negative Adjusted EBITDA of
$12.0 million for the 1997 Three Month Period and a net loss of approximately
$113.3 million, an operating loss of approximately $86.5 million and negative
Adjusted EBITDA of $51.9 million for Fiscal 1997. There can be no assurance that
the Company will achieve or sustain profitability or generate positive Adjusted
EBITDA. In February 1998, the Company consummated the NACT Sale, yielding net
proceeds of approximately $85.0 million. Without the operations of NACT, the
Company would have had a net loss of $40.4 million and negative Adjusted EBITDA
of $14.4 million for the 1997 Three Month Period and a net loss of $117.8
million and negative Adjusted EBITDA of $59.0 million for Fiscal 1997. Adjusted
EBITDA consists of loss before interest, income taxes, depreciation and
amortization, minority interest, gains and losses on the disposition of assets
and noncash charges. Management believes that Adjusted EBITDA provides a
meaningful measure of operating cash flow (without the effects of working
capital changes) for the continuing operations of the Company by excluding the
effects of noncash expenses and non-operating activities. However, Adjusted
EBITDA should not be used as an alternative to operating loss and net loss as
determined in accordance with GAAP. See footnote (h) to the Company's "Selected
Financial Data" and "Selected Financial Data."

     At December 31, 1998, the Company had a U.S. net operating loss
carryforward of approximately $208.9 million available to offset future taxable
income of GST USA and the other U.S. operating subsidiaries. Substantially all
of the Company's operations are conducted in the United States. In addition, at
that date, the Company had a net operating loss carryforward of approximately
Cdn. $49.6 million (U.S. $35.5 million) available to offset future taxable
income of the parent holding company in Canada. While such loss carryforwards
are available to offset future taxable income of the Company in each respective
tax jurisdiction, the Company may not generate sufficient taxable income so as
to utilize all or a substantial portion of such loss carryforwards prior to
their expiration. Further, the utilization of net operating loss carryforwards
against future taxable income is subject to limitation if the Company
experiences an "ownership change" as defined in Section 382 of the Internal
Revenue Code of 1986, as amended (the "Code"), and the analogous provision of
the Income Tax Act (Canada) (the "Canada Act").

                                        9
<PAGE>   10

DEVELOPMENT AND EXPANSION RISK AND POSSIBLE INABILITY TO MANAGE GROWTH

     The Company is in the early stages of its operations. Certain of its
networks have only recently become commercially operational, and the Company has
only recently begun to deploy switches in its networks. The success of the
Company will depend, among other things, upon the Company's ability to "smart
build" and assess potential markets, design fiber backbone routes that provide
ready access to a substantial customer base, secure financing, obtain required
rights-of-way, building access and governmental permits, implement expanded
interconnection and collocation with facilities owned by ILECs, achieve a
sufficient customer base, service customers it has targeted using its "smart
build" approach, and upon subsequent developments in state and federal
regulations. The Company has begun to target Tier 1 cities, and competition in
such markets is expected to be significantly greater than in the Tier 2 and Tier
3 cities in which the Company is currently operating. There can be no assurance
that any networks to be developed or further developed will be completed on
schedule, at a commercially reasonable cost or within the Company's
specifications. In addition, the expansion of the Company's business has
involved and is expected to continue to involve acquisitions, which could divert
the resources and management time of the Company and require integration with
the Company's existing operations. There can be no assurance that any acquired
business will be successfully integrated into the Company's operations or that
any such business will meet the Company's expectations. The Company's future
performance will depend, in part, upon its ability to manage its growth
effectively, which will require it to continue to implement and improve its
operating, financial and accounting systems, to expand, train and manage its
employee base and to effectively manage the integration of acquired businesses.
These factors and others could adversely affect the expansion of the Company's
customer base and service offerings. The Company's inability either to expand in
accordance with its plans or to manage its growth could have a material adverse
effect on its business, financial condition and results of operations.

SIGNIFICANT CAPITAL REQUIREMENTS

     The Company estimates that its capital expenditures will be approximately
$250 million in Fiscal 1999 and $150 million in Fiscal 2000. The Company
believes that the cash on hand will provide sufficient funds for the Company to
expand its business as presently planned and to fund its operating expenses
through the end of Fiscal 1999. Divestitures and other management actions may
prolong capital availability into Fiscal 2000 and beyond. Thereafter, the
Company expects to require additional financing. In the event that the Company's
plans or assumptions change or prove to be inaccurate, or the foregoing sources
of funds prove to be insufficient to fund the Company's growth and operations,
or if the Company consummates acquisitions, the Company may be required to seek
additional capital (or seek additional capital sooner than currently
anticipated). Sources of financing may include public or private debt or equity
financing by the Company or its subsidiaries, sales of assets or other financing
arrangements. There can be no assurance that additional financing would be
available to the Company, or, if available, that it could be obtained on
acceptable terms or within the limitations contained in the Company's financing
arrangements. Failure to obtain such financing could result in the delay or
abandonment of some or all of the Company's development and expansion plans and
expenditures and could have a material adverse effect on the Company. Such
failure could also limit the ability of the Company to make principal and
interest payments on its outstanding indebtedness. The Company has no material
working capital or other credit facility under which it may borrow for working
capital and other general corporate purposes. There can be no assurance that
such a facility will be available to the Company in the future or that if such a
facility were available, that it would be available on terms and conditions
acceptable to the Company. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources."

SUBSTANTIAL INDEBTEDNESS

     At December 31, 1998, the Company had outstanding on a consolidated basis
approximately $1,131.8 million of indebtedness and $61.7 million of mandatorily
redeemable preferred stock. In addition, the accretion of original issue
discount will cause an $81.1 million increase in liabilities by December 15,
2000 relating to the 1995 Notes sold in December 1995, a $101.5 million increase
in liabilities relating to the Accrual Notes by November 15, 2002 and a $179.0
million increase in liabilities by May 1, 2003 relating to

                                       10
<PAGE>   11

the 1998 Notes. The indentures relating to the 1995 Notes (the "1995
Indentures"), the indenture relating to the Secured Notes (the "Secured Notes
Indenture"), the indenture relating to the Accrual Notes (the "Accrual Notes
Indenture") and the indenture relating to the 1998 Notes (the "Indenture" and
together with the 1995 Indentures, the Secured Notes Indenture and the Accrual
Notes Indenture, the "Indentures") limit, but do not prohibit, the incurrence of
additional indebtedness by the Company. The Company expects to incur substantial
additional indebtedness in the future. The Company has entered into an agreement
with Siemens (the "Siemens Loan Agreement") that provides for up to an aggregate
of $226.0 million in equipment financing, of which $9.5 million had been
provided at December 31, 1998. The Company also entered into an agreement (the
"NTFC Loan Agreement") with NTFC Capital Corp. for up to $50.0 million of
additional equipment financing (all of which had been provided at December 31,
1998). There can be no assurance that any additional financing will be available
to the Company on acceptable terms or at all.

     The level of the Company's indebtedness could have important consequences
to its future prospects, including the following: (i) limiting the ability of
the Company to obtain any necessary financing in the future for working capital,
capital expenditures, debt service requirements or other purposes; (ii)
requiring that a substantial portion of the Company's cash flow from operations,
if any, be dedicated to the payment of principal of and interest on its
indebtedness and other obligations; (iii) limiting its flexibility in planning
for, or reacting to changes in, its business; (iv) the Company will be more
highly leveraged than some of its competitors, which may place it at a
competitive disadvantage; and (v) increasing its vulnerability in the event of a
downturn in its business.

POSSIBLE INABILITY TO SERVICE DEBT; REFINANCING RISKS

     In connection with the buildout of its networks and expansion of ICP
services, the Company has been experiencing increasing negative Adjusted EBITDA.
The Company's earnings before fixed charges were insufficient to cover fixed
charges for Fiscal 1998, the 1997 Three Month Period, Fiscal 1997 and Fiscal
1996 by $187.6 million, $45.1 million, $130.0 million and $62.9 million,
respectively, and the Company's Adjusted EBITDA minus capital expenditures and
interest expense for Fiscal 1998, the 1997 Three Month Period, Fiscal 1997 and
Fiscal 1996 were negative $409.9 million, negative $77.6 million, negative
$315.3 million and negative $152.7 million, respectively. There can be no
assurance that the Company will be able to improve its earnings before fixed
charges or Adjusted EBITDA or that it will be able to meet its debt service
obligations. As the Company does not currently have a revolving credit facility,
if a shortfall occurs, alternative financing would be necessary in order for the
Company to meet its liquidity requirements, and there can be no assurance that
such financing would be available. In such event, the Company could face
substantial liquidity problems. In addition, the Company anticipates that cash
flow from operations will be insufficient to pay interest in cash on both the
1995 Notes when such interest becomes payable in June 2001 and on the Secured
Notes starting in November 2000 once the amount pledged to fund the first six
interest payments on the Secured Notes is paid and to repay the 1995 Notes, the
Secured Notes, the Accrual Notes and the 1998 Notes at maturity and that such
indebtedness will need to be refinanced. There can be no assurance that the
Company will be able to effect such refinancings. The ability of the Company to
meet its obligations and to effect such refinancings will be dependent upon,
among other things, the future performance of the Company, which will be subject
to prevailing economic conditions and to financial, business and other factors,
including factors beyond the control of the Company. Failure by the Company to
meet its obligations could result in a default on its indebtedness, including
the 1995 Notes, the Secured Notes, the Accrual Notes and the 1998 Notes, which
would permit the holders of substantially all of the Company's indebtedness to
accelerate the maturity thereof.

FINANCIAL AND OPERATING RESTRICTIONS IMPOSED BY EXISTING INDEBTEDNESS

     The Company's financing arrangements impose significant operating and
financial restrictions on the Company. Such restrictions affect, and in certain
cases significantly limit or prohibit, among other things, the ability of the
Company to incur additional indebtedness or to create liens on its assets, sell
assets, engage in mergers or acquisitions or make investments. Failure to comply
with any such covenant could result in a default thereunder, which could result
in an acceleration of such indebtedness.

                                       11
<PAGE>   12

POSSIBLE INABILITY TO REMEDY CURRENT NON-COMPLIANCES UNDER THE INDENTURES

     The Company, GST Network, GST USA, and GST Funding are parties to certain
indentures and have issued or guaranteed notes governed by those indentures. In
November 1998, the Company notified United States Trust Company of New York, as
trustee under the indentures, that certain actions by the Company and its
subsidiaries may not have been in compliance with the technical requirements of
the restrictive covenants contained in the indentures. In particular, the
Company disclosed that a series of transactions with Global may have resulted in
technical non-compliances with the indentures. See "Business -- Global Light
Telecommunications." The Company is currently conducting a review of the
relevant transactions and intends to vigorously pursue any necessary action to
cure the potential non-compliances. The Company has already initiated litigation
against Global and others in an effort to cure any technical covenant violations
that may have resulted from the transactions with Global. See "Legal
Proceedings."

     In February 1999, the trustee informed the note holders of the potential
violations. Pursuant to the definitions contained within the indentures of each
of the notes described above, no default has been declared and no event of
default has occurred. The Company has not classified the related debt
obligations as current in its consolidated financial statements because
management believes it is probable that, in the event that the holders declared
a default, the Company would be able to take corrective actions to cure any
objectively-determinable violations within the prescribed grace period.

     While the Company believes that any non-compliances can be cured, the
Company cannot offer any assurance that the litigation will be successful or
that any other potential cures will be effected in a timely manner or be
sufficient. In the event that the Company has violated its indentures and does
not cure the violations, the holders of the notes issued under the indentures
could demand repayment of the notes, discontinue disbursements of cash proceeds
of the most recent notes and assert other remedies against the Company. If any
of these events occurred, the Company would not have sufficient liquid assets to
repay the notes.

DIFFICULTIES IN IMPLEMENTING LOCAL AND ENHANCED SERVICES

     The Company has deployed and plans to continue to deploy high capacity
digital switches in the cities in which it operates or plans to operate
networks, as well as in certain cities where the Company will rely on ILEC
facilities for transmission. This enables the Company to offer a variety of
switched access services, enhanced services and local dial tone. The Company
expects negative Adjusted EBITDA from its switched services during the 24-to-36
month period after a switch is deployed. For switches operating in conjunction
with the Company's networks, the Company expects operating margins to improve as
the network is expanded and larger volumes of traffic are carried on the
Company's network. For switches operating in cities where the Company relies on
ILEC facilities for transmission, the Company will experience lower or negative
operating margins. The ILECs will be required to unbundle local tariffs and
permit the Company to purchase only the origination and termination services it
needs, thereby decreasing operating expenses. There can be no assurance that
such unbundling will be effected in a timely manner and result in prices
favorable to the Company. In addition, the Company's ability to successfully
implement its switched and enhanced services will require the negotiation of
resale agreements with ILECs and other CLECs and the negotiation of
interconnection agreements with ILECs, which can take considerable time, effort
and expense.

     In August 1996, the FCC released its Interconnection Decision implementing
the interconnection portions of the Telecommunications Act. The Interconnection
Decision establishes rules for negotiating interconnection agreements and
guidelines for review of such agreements by state public utilities commissions.
On July 18, 1997, the Eighth Circuit vacated certain portions of the
Interconnection Decision, including provisions establishing a pricing
methodology for unbundled elements and a procedure permitting new entrants to
"pick and choose" among various provisions of existing interconnection
agreements between ILECs and their competitors. On January 25, 1999, the Supreme
Court reversed the Eighth Circuit. The Supreme Court and the Eighth Circuit
decisions create uncertainty about the rules governing pricing, terms and
conditions of interconnection agreements, and could make negotiating and
enforcing such agreements more difficult and protracted and may require
renegotiation of existing agreements. There can be no assurance

                                       12
<PAGE>   13

that the Company will be able to obtain interconnection agreements on terms
acceptable to the Company. See "Business -- Regulation".

     The Company will generally be dependent on ILECs for provision of local
telephone service through access to local loops, termination service and, in
some markets, central office switches of such carriers. In addition, in certain
markets the Company intends to obtain the local telephone services of the ILEC
on a wholesale basis and resell that service to end users. Any successful effort
by the ILEC to deny or substantially limit the Company's access to the ILEC's
network elements or wholesale services could have a material adverse effect on
the Company's ability to provide local telephone services in those markets where
the Company relies on such network elements to provision local dial tone
service. Although the Telecommunications Act imposes interconnection obligations
on ILECs, there can be no assurance that the Company will be able to obtain
access to such network elements or services at rates, and on terms and
conditions, that permit the Company to offer local services at rates that are
both profitable and competitive.

     Many new carriers, including the Company, have experienced certain
difficulties with respect to provisioning, interconnection and the operational
support systems used by new carriers to order and receive network elements and
wholesale services from the ILECs. These systems are necessary for new carriers
such as the Company to provide local service to customers on a timely and
competitive basis. In addition, the Telecommunications Act creates incentives
for RBOCs to permit access to their facilities by denying such carriers the
ability to provide long distance services in their regions until they have met
specified conditions opening the market to competition at the local level. The
RBOCs in the Company's markets have indicated their intent to seek authority to
provide in-region long distance services but are not yet permitted to do so.
There can be no assurance that the RBOCs will be accommodating to the Company
once they are permitted to offer in-region long distance service. Should the
Company be unable to obtain the cooperation of an ILEC in a region, whether or
not such ILEC has been authorized to offer in-region long distance service, the
Company's ability to offer local services in such region on a timely and
cost-effective basis would be adversely affected.

     The Company is a recent entrant into the newly created competitive local
telecommunications services industry. The local dial tone services market was
opened to competition due to the passage of the Telecommunications Act and
related state and federal regulatory rulings. There are numerous operating
complexities associated with providing these services. The Company is required
to develop new products, services and systems and to develop new marketing
initiatives to sell these services.

     The Company's switched services may not be profitable due to, among other
factors, lack of customer demand, inability to secure access to facilities of
ILECs at acceptable rates, competition from other CLECs and pricing pressure
from the ILECs. The Company has very limited experience providing switched
access and local dial tone services and there can be no assurance that the
Company will be able to successfully implement its switched and enhanced
services strategy. See "Business -- Telecommunications Services Strategy."

RECENT COMMENCEMENT OF INTEGRATED MARKETING EFFORT

     The Company has only recently begun an integrated marketing effort of its
telecommunication service offerings. Historically, the Company has marketed its
access services primarily to long distance carriers and significant end-users of
telecommunications services, and its long distance services to small businesses
and consumers. Although the Company expects to market a variety of
telecommunications services to all of its customers, there can be no assurance
that the Company will be able to attract and retain new customers or retain and
sell additional services to existing customers.

DEPENDENCE ON KEY CUSTOMERS

     The Company's five largest telecommunications services customers accounted
for approximately 16.4%, 16.8%, 20.8% and 46.9% of the Company's consolidated
telecommunication and other services revenues for Fiscal 1998, the 1997 Three
Month Period, Fiscal 1997 and Fiscal 1996, respectively. It is anticipated that
during the early stages of development of individual networks, before obtaining
a sufficient amount of end-user
                                       13
<PAGE>   14

revenues, the Company will be dependent on a limited number of long distance
carriers for a significant portion of its local revenues. While long distance
carriers have high volume requirements and have utilized CLECs and ICPs, they
generally are more price sensitive than end-users. The loss of, or decrease of
business from, one or more significant customers could have a material adverse
effect on the business, financial condition and results of operations of the
Company.

RISKS RELATING TO LONG DISTANCE BUSINESS

     For Fiscal 1998, the 1997 Three Month Period, Fiscal 1997 and Fiscal 1996,
long distance represented 41.4%, 45.8%, 54.5% and 54.2% of the Company's
consolidated telecommunications services revenues, respectively. The long
distance business is extremely competitive, and prices have declined
substantially in recent years and are expected to continue to decline. In
addition, the long distance industry has historically had a high average churn
rate, as customers frequently change long distance providers in response to the
offering of lower rates or promotional incentives by competitors. The Company
has resale agreements with long distance carriers to provide it with
transmission services. Such agreements typically provide for the resale of long
distance services on a per minute basis with minimum volume commitments.
Negotiation of these agreements involves estimates of future supply and demand
for transmission capacity, as well as estimates of the calling pattern and
traffic levels of the Company's future customers. In the event the Company fails
to meet its minimum volume commitments, it may be obligated to pay
underutilization charges, and in the event it underestimates its need for
transmission capacity, the Company may be required to obtain capacity through
more expensive means.

     Charges for access service for the origination and termination of long
distance traffic have made up a significant portion of the Company's overall
cost of providing long distance service. In May 1997, the FCC adopted changes to
its interstate access rules that among other things reduce per-minute access
charges and substitute new per-line flat rate monthly charges. The FCC also
approved reductions in overall access rates, and established new rules to
recover subsidies to support universal service and other public policies. The
impact on these changes on the Company or its competitors is not yet clear. The
Company could be adversely affected if it does not experience access cost
reductions proportionally equivalent to those of its competitors. Insofar as
Internet-based competitors continue to be exempt from these charges, they could
enjoy a significant cost advantage in this area. See "Business -- Regulation."

PRICING PRESSURES AND RISKS OF INDUSTRY OVER-CAPACITY

     The long distance industry has generally been characterized by
over-capacity and declining prices since shortly after the AT&T Corp. ("AT&T")
divestiture in 1984. The Company believes that, in the last several years,
increasing demand has ameliorated the over-capacity and that pricing pressure
has been reduced. However, the Company anticipates that prices for its wholesale
longhaul services will continue to decline over the next several years. While
demand continues to increase, the Company is aware that certain long distance
carriers are expanding their capacity and believes that other long distance
carriers, as well as potential new entrants to the industry, are constructing
new fiber optic and other long distance transmission networks in the United
States. Since the cost of the actual fiber (as opposed to construction costs) is
a relatively small portion of the cost of building new transmission lines,
persons building such lines are likely to install fiber that provides
substantially more transmission capacity than will be needed over the short or
medium term. Further, recent technological advances may greatly expand the
capacity of existing and new fiber optic cable. Although such technological
advances may enable the Company to increase its capacity, an increase in the
capacity of the Company's competitors could adversely affect the Company's
business. If industry expansion results in capacity that exceeds overall demand
along any of the Company's routes, severe additional pricing pressure could
develop. In addition, strategic alliances or similar transactions, such as the
long distance capacity purchasing alliance among certain RBOCs announced in the
spring of 1996, could result in additional pricing pressure on long distance
carriers. Furthermore, the marginal cost of carrying an additional call over
existing fiber optic cable is extremely low. As a result, within a few years,
there may be dramatic and substantial price reductions. See "Competition."

                                       14
<PAGE>   15

DEPENDENCE ON BILLING, CUSTOMER SERVICES AND INFORMATION SYSTEMS

     Sophisticated information and processing systems are vital to the Company's
growth and its ability to monitor costs, bill customers, provision customer
orders and achieve operating efficiencies. Billing and information systems for
the Company's historical lines of business have been produced largely in-house
with partial reliance on third-party vendors. These systems have generally met
the Company's needs due in part to the low volume of customer billing. As the
Company transitions to the provisioning of local services and as its long
distance and Internet operations continue to expand, the need for sophisticated
billing and information systems will continue to increase. The Company's plans
for the development and implementation of its billing systems rely, for the most
part, on the delivery of products and services by third-party vendors.
Similarly, the Company is developing customer call centers to provision service
orders. Information systems are vital to the success of the call centers, and
the information systems for these call centers are largely being developed by
third-party vendors. Failure of these vendors to deliver proposed products and
services in a timely and effective manner and at acceptable costs, failure of
the Company to adequately identify all of its information and processing needs,
failure of the Company's related processing or information systems, or the
failure of the Company to upgrade systems as necessary could have a material
adverse effect on the ability of the Company to reach its objectives, its
financial condition and its results of operations.

YEAR 2000 ISSUES

     The dates on which the Company believes the year 2000 project will be
completed are based on management's best estimates, which were derived utilizing
numerous assumptions of future events, including the continued availability of
certain resources, third-party modification plans and other factors. However,
there can be no guarantee that these estimates will be achieved, or that there
will not be a delay in, or increased costs associated with, the implementation
of the year 2000 project. Specific factors that might cause differences between
the estimates and actual results include, but are not limited to, the
availability and cost of personnel trained in these areas, the ability to locate
and correct all relevant computer code, timely responses to and corrections by
third-parties and suppliers, the ability to implement interfaces between the new
systems and the systems not being replaced, and similar uncertainties. Due to
the general uncertainty inherent in the year 2000 problem resulting in part from
the uncertainty of the year 2000 readiness of third parties, the Company cannot
ensure its ability to timely and cost-effectively resolve problems associated
with the year 2000 issue that may affect its operations and business, or expose
it to third-party liability. See "Management's Discussion and Analysis -- Year
2000 Program."

COMPETITION

     The telecommunications industry is highly competitive. In most markets, the
Company's principal competitor for local exchange services is the RBOC or the
GTE Companies. Other competitors may include other ICPs, CLECs, microwave and
satellite carriers, wireless telecommunications providers and private networks
built by large end-users. Potential competitors (using similar or different
technologies) include cable television companies, utilities and RBOCs outside
their current local service areas. In addition, the Company anticipates future
competition from large long distance carriers, such as AT&T, MCI WorldCom, Inc.
("MCI WorldCom") and Sprint, which have begun to offer integrated local and long
distance telecommunications services. AT&T also has announced its intention to
offer local services using a new wireless technology. Several companies have
begun to offer telecommunications services over the Internet at rates
substantially below current long distance rates. Companies offering
telecommunications services over the Internet could enjoy a significant cost
advantage because at this time they do not pay carrier access charges or
universal service fees. The influx of competitors into the Company's markets and
into markets that the Company may subsequently enter may result in more
participants than can ultimately be successful in a given market. Consolidation
of telecommunications companies and the formation of strategic alliances within
the telecommunications industry, as well as the development of new technologies,
could give rise to significant new competitors to the Company. In addition, a
continuing trend toward business combinations and strategic alliances in the
telecommunications industry may further enhance competition. For example,
WorldCom Inc. acquired MFS Communications Company, Inc. Brooks Fiber Properties
Inc. and MCI Communications

                                       15
<PAGE>   16

Corp., each of which compete with the Company in several of the markets in which
the Company operates. AT&T has acquired Teleport Communications Group, Inc., a
CLEC that also competes with the Company in several markets. The Company cannot
determine what effect such acquisitions will have on the Company's business,
financial condition and results of operations.

     As a recent entrant in the integrated telecommunications services industry,
the Company may not achieve a significant market share for any of its services.
In particular, the RBOCs, the GTE Companies and other local telephone companies
have long-standing relationships with their customers, have financial, technical
and marketing resources substantially greater than those of the Company, have
the potential to subsidize competitive services with revenues from a variety of
businesses and currently benefit from certain existing regulations that favor
the ILECs over the Company in certain respects. While recent regulatory
initiatives, which allow CLECs such as the Company to interconnect with ILEC
facilities, provide increased business opportunities for the Company, such
interconnection opportunities have been accompanied by increased pricing
flexibility for and relaxation of regulatory oversight of the ILECs. For
example, the FCC granted ILECs additional flexibility in pricing their
interstate special and switched access services on a central office specific
basis. Under this pricing scheme, ILECs may establish pricing zones based on
access traffic density and charge different prices for central offices in each
zone. On February 8, 1997, new FCC rules became effective allowing ILECs to file
streamlined tariffs on 15 days' notice for rate increases and seven days' notice
for rate decreases. Unless the FCC acts during the notice period, such tariffs
become effective at its end. The Company has begun to target Tier 1 cities and
competition in such markets is expected to be significantly greater than in Tier
2 and Tier 3 cities in which the Company is currently operating.

     To the extent the Company interconnects with and uses ILEC networks to
service its customers, the Company will be dependent upon the technology and
capabilities of the ILECs to meet certain telecommunications needs of the
Company's customers and to maintain its service standards. The Company will
become increasingly dependent on interconnection with ILECs as switched services
become a greater percentage of the Company's business. The Telecommunications
Act imposes interconnection obligations on ILECs, but there can be no assurance
that the Company will be able to obtain the interconnection it requires at
rates, and on terms and conditions, that permit the Company to offer switched
services at rates that are simultaneously competitive and profitable. See
"-- Difficulties in Implementing Local and Enhanced Services." In the event that
the Company experiences difficulties in obtaining high quality, reliable and
reasonably priced service from the ILECs, the attractiveness of the Company's
services to its customers could be impaired.

     The long distance telecommunications industry has relatively insignificant
barriers to entry, numerous entities competing for the same customers and a high
average churn rate, as customers frequently change long distance providers in
response to the offering of lower rates or promotional incentives by
competitors. The Company competes with major carriers such as AT&T, Sprint and
MCI WorldCom, as well as other national and regional long distance carriers and
resellers, many of whom are able to provide services at costs that are lower
than the Company's current costs. Many of these competitors have greater
financial, technological and marketing resources than the Company. In addition,
as a result of the Telecommunications Act, the RBOCs are expected to become
competitors in the long distance telecommunications industry both outside of
their service territory and upon the satisfaction of certain conditions, within
their service territory.

     The Company believes that the principal competitive factors affecting its
long distance operations are pricing, customer service, accurate billing, clear
pricing policies and, to a lesser extent, variety of services. The ability of
the Company to compete effectively will depend upon its continued ability to
maintain high quality, market driven services at prices generally equal to or
below those charged by its competitors. To maintain its competitive posture, the
Company believes that it must be in a position to reduce its prices in order to
meet reductions in rates, if any, by others. Any such reductions could adversely
affect the Company.

     The Company's longhaul business is subject to intense competition. See
"Pricing Pressures and Risks of Industry Over-Capacity."

     The Internet services market is highly competitive. There are no
substantial barriers to entry, and the Company expects that competition will
continue to intensify. The Company's competitors in this market include Internet
service providers, other telecommunications companies, online services providers
and Internet
                                       16
<PAGE>   17

software providers. Many of these competitors have greater financial,
technological and marketing resources than those available to the Company.

     On February 25, 1998, US WEST petitioned the FCC to allow it to build and
operate packet- and cell-switched data networks across LATA boundaries, to
permit it to carry interLATA data traffic incident to its provision of digital
subscriber line services, to not require it to make those data services
available on a discounted resale basis and to not require it to make the
non-bottleneck elements of such services available on an unbundled basis. On
June 9, 1998, SBC Communications, Inc. ("SBC") filed a similar petition with the
FCC. The Company provides certain services with which US WEST and SBC's proposed
services would compete if the petitions were granted by the FCC. While the FCC
denied these requests, it initiated a rulemaking which, if adopted, would permit
ILECs to provide advanced services through a structurally separated, and largely
deregulated subsidiary. The proposed rulemaking would not permit the RBOC
provision of such services across LATA boundaries.

     The World Trade Organization ("WTO") agreement on basic telecommunications
services could increase the Company's competition for telecommunication services
both domestically and internationally. Under this agreement, the United States
and other members of the WTO committed themselves to opening their
telecommunications markets to competition and foreign ownership and to adopting
regulatory measures to protect competitors against anticompetitive behavior by
dominant telephone companies, effective in some cases as early as January 1,
1998.

GOVERNMENT REGULATION

     The Company's networks and the provision of switched and private line
services are subject to significant regulation at the federal, state and local
levels. Delays in receiving required regulatory approvals or the enactment of
new adverse regulation or regulatory requirements may have a material adverse
effect upon the Company. The FCC exercises jurisdiction over the Company with
respect to interstate and international services. Additionally, the Company
files tariffs with the FCC. State regulatory commissions exercise jurisdiction
over the Company to the extent it provides intrastate services. As such a
provider, the Company is required to obtain regulatory authorization and/or file
tariffs at state agencies in most of the states in which it operates.
Certificates of authority to provide services can generally be conditioned,
modified, canceled, terminated or revoked for failure to comply with rules and
regulations. Fines and other penalties may also be imposed. Local authorities
regulate the Company's access to municipal rights-of-way. The networks are also
subject to numerous local regulations such as building codes and licensing. Such
regulations vary on a city by city and county by county basis. See
"Business -- Regulation." There can be no assurance that the FCC or state
commissions will grant required authority or refrain from taking action against
the Company if it is found to have provided services without obtaining the
necessary authorizations. If authority is not obtained or if tariffs are not
filed, or are not updated, or otherwise do not fully comply with the tariff
filing rules of the FCC or state regulatory agencies, third parties or
regulators could challenge these actions. Such challenges could cause the
Company to incur substantial legal and administrative expenses.

     The Telecommunications Act provides for a significant deregulation of the
domestic telecommunications industry, including the local exchange, long
distance and cable television industries. The Telecommunications Act remains
subject to judicial review and additional FCC and state rulemakings, and thus it
is difficult to predict what effect the legislation will have on the Company and
its operations. There are currently many regulatory actions underway and being
contemplated by federal and state authorities regarding interconnection pricing
and other issues that could result in significant changes to the business
conditions in the telecommunications industry. There can be no assurance that
these changes will not have a material adverse effect upon the Company.

     The FCC released a Report to Congress on April 10, 1998 concerning its
implementation of the telecommunications subsidy provisions of the
Telecommunications Act. The FCC clarified that entities that provide
transmission capacity to Internet service providers are providing
telecommunications services subject to contribution requirements. The FCC
indicated that it would address the issue of whether ISPs would contribute to a
universal service fund based on the utilization of their own transmission
facilities at a later date

                                       17
<PAGE>   18

and whether certain ISP services such as phone-to-phone IP telephony are
telecommunications services subject to universal service fund contribution and
access charge payments.

     Beginning in June 1997, every RBOC advised CLEC's that they did not
consider calls in the same local calling area from their customers to CLEC
customers, who are ISPs, to be local calls under the interconnection agreements
between the RBOCs and the CLECs. The RBOCs claim that these calls are exchange
access calls for which exchange access charges would be owed. The RBOCs claimed,
however, that the FCC exempted these calls from access charges so that no
compensation is owed to the CLECs for transporting and terminating such calls.
As a result, the RBOCs threatened to withhold and in many cases did withhold,
reciprocal compensation for the transport and termination of such calls. To
date, twenty-nine state commissions have ruled on this issue in the context of
state commission arbitration proceedings or enforcement proceedings. In every
state, to date, the state commission has determined that reciprocal compensation
is owed for such calls. Several of these cases are presently on appeal.
Reviewing courts have upheld the state commissions in the four decisions
rendered to date on appeal. Appeals from these decisions are pending in the
Fifth, Seventh and Ninth U.S. Circuit Courts of Appeal. On February 25, 1999,
the FCC issued a Declaratory Ruling on the issue of inter-carrier compensation
for calls bound to ISPs. The FCC ruled that the calls are jurisdictionally
interstate calls, not local calls. The FCC, however, determined that this issue
was not dispositive of whether inter-carrier compensation is owed. The FCC noted
a number of factors which would allow the state commissions to leave their
decisions requiring the payment of compensation undisturbed. The Company cannot
predict the impact of the FCC's ruling on existing state decisions, or the
outcome of pending appeals or of additional pending cases.

     In a combined Report and Order and Notice of Proposed Rulemaking released
on December 24, 1996, the FCC made changes and proposed further changes in the
interstate access charge structure. In the Report and Order, the FCC removed
restrictions on ILECs' ability to lower access prices and relaxed the regulation
of new switched access services in those markets where there are other providers
of access services. If this increased pricing flexibility is not effectively
monitored by federal regulators, it could have a material adverse effect on the
Company's ability to compete in providing interstate access services. On May 16,
1997, the FCC released an order revising its access charge rate structure. The
new rules substantially increase the costs that ILECs subject to the FCC's price
cap rules ("price cap LECs") recover through monthly, non-traffic sensitive
access charges and substantially decrease the costs that price cap LECs recover
through traffic sensitive access charges. In the May 16th order, the FCC also
announced its plan to bring interstate access rate levels more in line with
cost. The plan will include rules that grant price cap LECs increased pricing
flexibility upon demonstrations of increased competition (or potential
competition) in relevant markets.

     Under the Communications Act and other federal regulations, foreign
nationals may not own more than 20% of a company, or have more than a 20% voting
interest in a company, that directly holds a common carrier radio license. The
Communications Act also prohibits foreign nationals from owning 25% or more of a
company which, in turn, controls a company holding a radio license, if the FCC
finds that such alien participation would not serve the public interest. Under
the WTO agreement, the United States agreed to permit foreign nationals to own
up to 100% of a company that directly holds a common carrier radio license. On
November 25, 1997, the FCC adopted rules implementing the WTO policies for WTO
member states to acquire up to a 100% indirect interest in a U.S. radio license.
Prior approval will still be required. The operations of GST Telecom Hawaii,
Inc. use, among other facilities, microwave radio facilities operating pursuant
to FCC licenses granted to Pacwest Network, Inc. ("PNI"), an entity controlled
by John Warta, the Company's former Chairman of the Board and Chief Executive
Officer. As a result of changes in federal policies, there is no regulatory
impediment to preclude PNI from transferring such microwave facilities and
associated licenses to the Company, subject to FCC approval. The FCC also has
the authority, which it is not presently exercising, to impose restrictions on
foreign ownership of communications service providers not utilizing radio
frequencies, which, if exercised, could have a material adverse effect on the
Company's business. In addition, the Company may subsequently need to obtain
radio licenses to "fill in" certain customers in the networks that are not
practical to reach by wire.

                                       18
<PAGE>   19

NEED TO ADAPT TO TECHNOLOGICAL CHANGE

     The telecommunications industry is subject to rapid and significant changes
in technology, with the Company relying on third parties for the development of
and access to new technology. The effect of technological changes on the
business of the Company cannot be predicted although, historically,
telecommunications companies have been required to adopt new technologies to
enhance the services provided to customers, thereby requiring continuing
investment in capital equipment. The Company believes its future success will
depend, in part, on its ability to anticipate or adapt to such changes and to
offer, on a timely basis, services that meet customer demands, which may require
significant continued capital expenditures to provide enhanced services to the
Company's customers.

LITIGATION RISKS

     The Company is involved in various legal proceedings. An unfavorable
decision in one or more of such actions could have a material adverse effect on
the Company. See "Legal Proceedings."

POSSIBLE INABILITY TO RECOVER PAYMENTS MADE TO MAGNACOM

     See "Business -- Magnacom" for a discussion of the risks relating to the
Company's prior payments made to Magnacom.

DEPENDENCE ON KEY PERSONNEL

     The efforts of a small number of key management and operating personnel
will largely determine the Company's success and the loss of any of such persons
could adversely affect the Company. The success of the Company also depends in
part upon its ability to hire and retain highly skilled and qualified operating,
marketing, financial and technical personnel. The competition for qualified
personnel in the telecommunications industry is intense and, accordingly, there
can be no assurance that the Company will be able to hire or retain necessary
personnel.

DEPENDENCE ON RIGHTS-OF-WAY AND OTHER THIRD PARTY AGREEMENTS

     The Company must obtain easements, rights-of-way, entry to premises,
franchises and licenses from various private parties, actual and potential
competitors and state and local governments in order to construct and operate
its networks. There can be no assurance that the Company will obtain
rights-of-way and franchise agreements on acceptable terms or that current or
potential competitors will not obtain similar rights-of-way and franchise
agreements that will allow them to compete against the Company. If any of the
existing franchise or license agreements were terminated or not renewed and the
Company were forced to remove its fiber optic cables or abandon its networks in
place, such termination could have a material adverse effect on the Company. See
"Legal Proceedings" and "Business -- Regulation."

RISKS OF INVESTMENT IN A CANADIAN CORPORATION

     The Company is incorporated under the Canada Business Corporations Act.
Certain of the directors and the Company's professional advisors are residents
of Canada or otherwise reside outside of the U.S. All or a substantial portion
of the assets of such persons are or may be located outside of the U.S. It may
be difficult for U.S. security holders to effect service of process within the
United States upon such directors or professional advisors or to realize in the
U.S. upon judgments of U.S. courts predicated upon civil liability of the
Company or such persons under U.S. federal securities laws. The Company has been
advised that there is doubt as to whether Canadian courts would (i) enforce
judgments of U.S. courts obtained against the Company or such directors or
professional advisors predicated solely upon the civil liabilities provisions of
U.S. federal securities laws, or (ii) impose liabilities in original actions
against the Company or such directors and professional advisors predicated
solely upon such U.S. laws. However, a judgment against the Company predicated
solely upon civil liabilities provisions of such U.S. federal securities laws
may be enforceable in Canada if the U.S. court in which such judgment was
obtained has a basis for jurisdiction in that matter that would be recognized by
a Canadian court. In addition, the Company's status as a Canadian corporation
could,
                                       19
<PAGE>   20

under certain circumstances, limit the ability of the Company to hold or control
radio frequency licenses in the United States.

ITEM 7A.  QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK.

INTEREST RATE MARKET RISK

     The Company has fixed income investments consisting of cash equivalents,
short-term investments in U.S. government debt instruments and certificates of
deposit. See note 1 to the Consolidated Financial Statements for information
about investments in U.S. government debt instruments and certificates of
deposit.

     Interest income earned on the Company's investment portfolio is affected by
changes in the general level of U.S. interest rates. The Company believes that
it is not exposed to significant changes in fair value because such investments
are composed of U.S. Government debt instruments, certificates of deposit and
commercial paper and the maturities are predominantly short-term. The fair value
of each investment approximates its amortized cost, and long-term securities
have maturities of less than two years.

     The following table provides information about the Company's risk exposure
associated with changing interest rates. Currently, the Company does not use
derivative financial instruments to manage its interest rate risk.

<TABLE>
<CAPTION>
                                                                EXPECTED MATURITY
                                                            (IN THOUSANDS OF DOLLARS)
                            ------------------------------------------------------------------------------------------
                                                                                                             MARKET
                                                                                                            VALUE AT
                                                                                                          DECEMBER 31,
                             1999      2000      2001      2002      2003     THEREAFTER      TOTAL         1998(1)
                            ------------------------------------------------------------------------------------------
<S>                         <C>       <C>       <C>       <C>       <C>       <C>           <C>           <C>
Long-term Debt:
  Fixed rate..............  $ 1,466                                           $1,260,300(2) $1,261,766(2)  $1,116,385
    Average interest
      rate................     8.50%                                               12.28%
  Variable rate...........  $11,951   $17,041   $20,216   $20,898   $21,132   $   13,487    $  104,725
    Average interest rate
      (LIBOR plus)........     3.37%     3.26%     3.29%     3.34%     3.34%        3.06%
Capital Leases:
  Fixed rate..............  $ 6,476   $ 5,227   $ 2,279   $ 1,974   $ 1,981   $    7,453    $   25,390
    Average interest
      rate................    12.36%    12.36%    12.36%    12.36%    12.36%       12.36%
Redeemable Preferred
  Stock:
  Fixed rate..............                                                    $  112,000    $  112,000
    Average interest
      rate................                                                         11.88%
</TABLE>

---------------
(1) Based on quoted market prices at December 31, 1998.

(2) Includes $260.1 million of unaccreted discount.

MARKET PRICE RISK

     The Company has risk exposure associated with the market price on its
publicly traded long-term debt These bonds are recorded at book value, which
could vary from current market prices.

     The Company is also exposed to market risk related to its 19% equity
interest in Global Light Telecommunications, Inc. Such investment is recorded at
a market value of $16.2 million in the Company's consolidated financial
statements at December 31, 1998.

FOREIGN CURRENCY MARKET RISK

     Although the Company is a federally chartered Canadian corporation,
international operations were not material to the Company's consolidated
financial position. Accordingly, the Company was not subject to material foreign
currency exchange rate risk from the effects that exchange rate movements of
foreign currencies would have on the Company's future costs or on future cash
flows it would receive.

                                       20
<PAGE>   21

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

        See page F-1.

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULE

<TABLE>
<S>     <C>
(a)(1)  Consolidated Financial Statements: see the Index to
        Consolidated Financial Statements.
 (2)    Financial Statement Schedule: see page S-1.
 (3)    Exhibits:
 3(a)   Certificate of Incorporation of the Company, as amended to
        date, incorporated by reference to Exhibit 3(a) to the
        Company's Form 10-K for the fiscal year ended September 30,
        1996, as amended (the "1996 Form 10-K").
 3(b)   By-Laws of the Company as amended to date, incorporated by
        reference to Exhibit 3.1 to the Company's Form S-3 (No.
        333-38091) (the "Form S-3").
 4(a)   Senior Notes Indenture dated as of December 19, 1995, by and
        among GST USA, Inc., the Company and United States Trust
        Company of New York, incorporated by reference to Exhibit
        2.3 to the Company's Form 20-F for the fiscal year ended
        September 30, 1995 (the "1995 Form 20-F").
 4(b)   Convertible Notes Indenture dated as of December 19, 1995,
        by and among the Company, GST USA, Inc. and United States
        Trust Company of New York, incorporated by reference to
        Exhibit 2.4 to the 1995 Form 20-F.
 4(c)   Indenture dated as of May 13, 1997, by and among GST
        Equipment Funding, Inc., the Company, GST USA, Inc. and
        United States Trust Company of New York, incorporated by
        reference to Exhibit 10.2 to the Company's Form 10-Q for the
        period ended June 30, 1997 (the "June 1997 10-Q").
 4(d)   Indenture dated as of November 19, 1997, by and between the
        Company and United States Trust Company of New York,
        incorporated by reference to Exhibit 4.1 to the Company's
        Form S-3 (No. 333-38301) (the "Debt Form S-3").
 4(e)   Indenture dated May 4, 1998 by and among GST
        Telecommunications, Inc., GST USA, Inc., GST Network
        Funding, Inc. and the United States Trust Company of New
        York, as trustee, incorporated by reference to Exhibit 4.1
        of the Company's Form 8-K filed May 19, 1998.
10(a)   1995 Stock Option Plan of the Company, as amended to date;
        incorporated by reference to Exhibit 10(a) to the Company
        Form 10-K for the fiscal year ended September 30, 1997 (the
        "1997 Form 10-K").
10(b)   1996 Stock Option Plan of the Company, as amended to date,
        incorporated by reference to Exhibit 10(b) to the 1997 Form
        10-K.
10(c)   1996 Employee Stock Purchase Plan of the Company,
        incorporated by reference to Exhibit 10(c) to the 1997 Form
        10-K.
10(d)   1996 Senior Executive Officer Stock Option Plan of the
        Company, incorporated by reference to Exhibit 10(d) to the
        1997 Form 10-K.
10(e)   1996 Senior Operating Officer Stock Option Plan of the
        Company, incorporated by reference to Exhibit 10(e) to the
        1997 Form 10-K.
10(f)   Amended and Restated Credit Agreement dated as of April 26,
        1995, by and between GST Pacific Lightwave, Inc. and Tomen
        America Inc., incorporated by reference to Exhibit 1.2 to
        the 1995 Form 20-F.
10(g)   Collateral Pledge and Security Agreement dated as of May 13,
        1997, by and among GST Equipment Funding, Inc., United
        States Trust Company of New York and the holders of the
        Notes as defined therein, incorporated by reference to
        Exhibit 10.4 to the June 1997 Form 10-Q.
</TABLE>

                                       21
<PAGE>   22
<TABLE>
<S>     <C>
10(h)   Amended and Restated Master Agreement dated as of May 24,
        1996, by and among Tomen America Inc., the Company, GST
        Telecom Inc., GST Pacific Lightwave, Inc., Pacwest Network
        L.L.C., Pacwest Network Inc., GST Tucson Lightwave, Inc. and
        GST New Mexico Lightwave, Inc., incorporated by reference to
        Exhibit 10(l) to the 1996 Form 10-K.
10(i)   Credit Agreement dated as of May 24, 1996, by and between
        GST New Mexico Lightwave, Inc. and TM Communications LLC,
        incorporated by reference to Exhibit 10(n) to the 1996 Form
        10-K.
10(j)   Credit Agreement dated as of May 24, 1996, by and between
        GST Tucson Lightwave, Inc. and TM Communications LLC,
        incorporated by reference to Exhibit 10(o) to the 1996 Form
        10-K.
10(s)   Employment Agreement dated March 11, 1997, by and between
        GST USA, Inc. and Joseph Basile, Jr, incorporated by
        reference to Exhibit 10.1 to the Company's Form 10-Q for the
        period ended March 31, 1997 (the "March 1997 10-Q").
10(t)   Employment Agreement dated February 10, 1997, by and between
        GST USA, Inc. and GST Telecom Inc. and Daniel L. Trampush,
        incorporated by reference to Exhibit 10.2 to the March 1997
        Form 10-Q.
10(u)   Reseller Agreement dated as of October 30, 1996, by and
        between Magnacom Wireless, L.L.C., and GST Telecom Inc.,
        incorporated by reference to Exhibit 10(z) to the 1996 Form
        10-K.
10(w)   Agreement and Plan of Merger dated as of May 31, 1997, by
        and among Action Telcom Co., Britt E. Bilberry, Timothy
        Harding Bilberry, Paul S Bilberry, GST Action Telecom, Inc.
        and the Company, incorporated by reference to Exhibit 2.1 to
        the Company's Form 8-K dated May 31, 1997.
10(x)   Equipment Loan and Security Agreement dated December 19,
        1996 by and between NTFC Capital Corporation and GST
        Equipco, incorporated by reference to Exhibit 10(v) to the
        1996 Form 10-K.
10(y)   Loan and Security Agreement dated as of September 4, 1996 by
        and between Siemens Stromberg-Carlson ("Siemens") and GST
        Switchco, Inc. ("GST Switchco"), incorporated by reference
        to Exhibit 10(d) to the Company's Form 10-Q for the period
        ended December 31, 1996 (the "December 1996 Form 10-Q").
10(z)   Unconditional Continuing Guaranty dated as of September 4,
        1996 by and between Siemens and GST USA, Inc., incorporated
        by reference to Exhibit 10(e) to the December 1996 Form
        10-Q.
10(aa)  Unconditional Limited Guaranty Agreement dated as of
        December 19, 1996 made by GST USA, Inc., in favor of NTFC
        Capital Corporation, incorporated by reference to Exhibit
        10(f) to the December 1996 Form 10-Q.
10(bb)  Securities Purchase Agreement, dated as of February 28,
        1997, between the Company and Ocean Horizon SRL,
        incorporated by reference to Exhibit 4.1 to the Company's
        Form 8-K dated February 28, 1997 (the "February Form 8-K").
10(cc)  Securityholders Agreement, dated as of February 28, 1997,
        between the Registrant and Ocean Horizon SRL, incorporated
        by reference to Exhibit 4.2 to the Company's February Form
        8-K.
10(dd)  Credit Agreement dated as of September 30, 1997 by and
        between GST Telecom Hawaii, Inc. and TM Communications
        Hawaii LLC, incorporated by reference to Exhibit 99.1 to the
        Company's Form 8-K dated September 30, 1997 (the "September
        8-K").
10(ee)  Service Agreement dated as of September 30, 1997 by and
        between Pacwest Network, Inc. and GST Telecom Hawaii, Inc,
        incorporated by reference to Exhibit 99.2 to the September
        8-K.
10(ff)  Management Agreement dated as of September 30, 1997 by and
        between Pacwest Network, Inc. and GST Telecom Hawaii, Inc.,
        incorporated by reference to Exhibit 99.3 to the September
        8-K.
</TABLE>

                                       22
<PAGE>   23
<TABLE>
<S>     <C>
10(gg)  Agreement dated as of September 30, 1997 by and among GST
        Telecom Hawaii, Inc., GST Telecom Inc. and Pacwest Network,
        Inc., incorporated by reference to Exhibit 99.4 to the
        September 8-K.
10(hh)  Stock Purchase Agreement dated December 31, 1997 by and
        among GST Telecommunications, Inc., GST USA, Inc. and World
        Access, Inc., incorporated by reference to Exhibit 99.2 to
        the Company's Form 8-K dated January 6, 1998.
10(ii)  1997 Stock Option Plan of the Company, as amended to date,
        incorporated by reference to Exhibit (ii) to the 1997
        transition report on Form 10-K for the three month period
        ended December 31, 1997.
10(jj)  Placement Agreement dated April 29, 1998 by and among GST
        Telecommunications, Inc., GST USA, Inc., GST Network
        Funding, Inc, and the several Placement Agents named in
        Schedule I thereto, incorporated by reference to Exhibit
        10.1 to the Company's Form 8-K filed May 19, 1998.
10(kk)  Registration Rights Agreement dated May 4, 1998 by and among
        GST Telecommunications, Inc., GST USA, Inc., GST Network
        Funding, Inc. and Morgan Stanley & Co. Incorporated, Bear,
        Stearns & Co. Inc., Credit Suisse First Boston Corporation
        and SBC Warburg Dillon Read Inc., incorporated by reference
        to Exhibit 10.2 to the Company's Form 8-K filed May 19,
        1998.
10(ll)  Collateral Pledge and Security Agreement dated as of May 4,
        1998 from GST Network Funding, Inc. to United States Trust
        Company of New York, as trustee, incorporated by reference
        to Exhibit 10.3 to the Company's Form 8-K filed May 19,
        1998.
10(mm)  Reimbursement and Commitment Fee Agreement dated May 4, 1998
        among GST Telecommunications, Inc., GST USA, Inc. and GST
        Network Funding, Inc., incorporated by reference to Exhibit
        10.4 to the Company's Form 8-K filed May 19, 1998.
10(nn)  Employment Agreement dated March 3, 1999, effective as of
        October 20, 1998, by and between GST USA, Inc. and Joseph A.
        Basile, Jr.
*21     Subsidiaries of the Company.
*23     Consent to the incorporation by reference in the Company's
        Registration Statements on Forms S-3 and S-8 of the
        independent auditors' report included herein.
*27     Financial Data Schedule.
</TABLE>

---------------
* Filed herewith.

                                       23
<PAGE>   24

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                              PAGE
                                                              ----
<S>                                                           <C>
GST TELECOMMUNICATIONS, INC.
Independent Auditors' Report................................  F-2
Consolidated Balance Sheets at December 31, 1998 and 1997...  F-3
Consolidated Statements of Operations for the year ended
  December 31, 1998, the three-month period ended December
  31, 1997 and the years ended September 30, 1997 and
  1996......................................................  F-4
Consolidated Statements of Shareholders' (Deficit) Equity
  for the year ended December 31, 1998, the three-month
  period ended December 31, 1997 and the years ended
  September 30, 1997 and 1996...............................  F-5
Consolidated Statements of Cash Flows for the year ended
  December 31, 1998,the three-month period ended December
  31, 1997 and the years ended September 30, 1997 and
  1996......................................................  F-6
Notes to Consolidated Financial Statements..................  F-8
Independent Auditors' Report on Schedule....................  S-1
Schedule of Valuation and Qualifying Accounts...............  S-2
</TABLE>

                                       F-1
<PAGE>   25

                          INDEPENDENT AUDITORS' REPORT

THE BOARD OF DIRECTORS AND SHAREHOLDERS
GST TELECOMMUNICATIONS, INC.:

     We have audited the accompanying consolidated balance sheets of GST
Telecommunications, Inc. and subsidiaries as of December 31, 1998 and 1997, and
the related consolidated statements of operations, shareholders' (deficit)
equity, and cash flows for the year ended December 31, 1998, the three-month
period ended December 31, 1997, and for each of the years in the two-year period
ended September 30, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated 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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of GST
Telecommunications, Inc. and subsidiaries as of December 31, 1998 and 1997, and
the results of its operations, and cash flows for the year ended December 31,
1998, the three-month period ended December 31, 1997, and for each of the years
in the two-year period ended September 30, 1997 in conformity with generally
accepted accounting principles in the United States.

                                               /s/ KPMG PEAT MARWICK LLP

Portland, Oregon
March 1, 1999

                                       F-2
<PAGE>   26

                          GST TELECOMMUNICATIONS, INC.

                          CONSOLIDATED BALANCE SHEETS
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                              -----------------------
                                                                 1998         1997
                           ASSETS                             ----------    ---------
<S>                                                           <C>           <C>
Current assets:
  Cash and cash equivalents.................................  $   86,070    $ 199,053
  Restricted investments....................................      34,107       31,731
  Accounts receivable, net..................................      32,935       27,324
  Investments...............................................      16,246        7,619
  Inventory, net............................................       1,485        3,412
  Prepaid and other current assets..........................      11,454       13,127
                                                              ----------    ---------
                                                                 182,297      282,266
Restricted investments......................................     247,257      112,719
Property and equipment, net.................................     615,852      406,895
Goodwill, net...............................................      51,091       36,056
Other assets, net...........................................      54,786       60,238
                                                              ----------    ---------
     Total assets...........................................  $1,151,283    $ 898,174
                                                              ==========    =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
  Accounts payable..........................................  $   26,411    $  14,798
  Accrued expenses..........................................      37,445       30,869
  Deferred revenue..........................................       6,030          993
  Current portion of capital lease obligations..............       5,649        6,286
  Current portion of long-term debt.........................      13,417        4,579
                                                              ----------    ---------
                                                                  88,952       57,525
                                                              ----------    ---------
Other liabilities...........................................      21,377        3,551
Capital lease obligations, less current portion.............      19,741       13,994
Long-term debt, less current portion........................   1,092,959      763,292
Minority interest...........................................          --       12,732
Commitments and contingencies
Redeemable preference shares:
  Authorized -- 10,000,000 no par shares; 500 shares issued
     and outstanding at December 31, 1998 and 1997..........      61,741       54,635
Shareholders' deficit:
  Common shares:
  Authorized -- unlimited number of no par common shares;
     issued and outstanding -- December 31,
     1998 -- 36,264,066 shares, December 31,
     1997 -- 34,564,898 Shares..............................     234,267      221,105
  Commitment to issue common shares:
  December 31, 1998 -- no shares, December 31,
     1997 -- 50,887 shares..................................          --          604
  Accumulated deficit.......................................    (383,954)    (229,264)
  Accumulated other comprehensive income....................      16,200           --
                                                              ----------    ---------
                                                                (133,487)      (7,555)
                                                              ----------    ---------
     Total liabilities and shareholders' deficit............  $1,151,283    $ 898,174
                                                              ==========    =========
</TABLE>

          See accompanying notes to consolidated financial statements.
                                       F-3
<PAGE>   27

                          GST TELECOMMUNICATIONS, INC.

                      CONSOLIDATED STATEMENT OF OPERATIONS
               (IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                             THREE-MONTH          YEARS ENDED
                                               YEAR ENDED    PERIOD ENDED        SEPTEMBER 30,
                                              DECEMBER 31,   DECEMBER 31,   -----------------------
                                                  1998           1997          1997         1996
                                              ------------   ------------   ----------   ----------
<S>                                           <C>            <C>            <C>          <C>
Revenues:
  Telecommunications and other services.....   $  158,609     $   27,552    $   82,593   $   31,726
  Product...................................        4,708          8,706        23,374        9,573
                                               ----------     ----------    ----------   ----------
     Total revenues.........................      163,317         36,258       105,967       41,299
                                               ----------     ----------    ----------   ----------
Operating costs and expenses:
  Network expenses..........................      105,744         19,427        66,250       26,580
  Facilities administration and
     maintenance............................       16,703          3,511        12,304       10,317
  Cost of product revenues..................        2,999          3,102         7,990        3,974
  Selling, general and administrative.......       96,506         22,428        72,046       33,375
  Research and development..................           --            781         2,316        1,352
  Depreciation and amortization.............       45,957          8,864        24,159        8,298
  Special charges...........................       30,580             --         7,445           --
                                               ----------     ----------    ----------   ----------
     Total operating costs and expenses.....      298,489         58,113       192,510       83,896
                                               ----------     ----------    ----------   ----------
     Loss from operations...................     (135,172)       (21,855)      (86,543)     (42,597)
                                               ----------     ----------    ----------   ----------
Other expenses (income):
  Interest income...........................      (24,145)        (4,101)       (7,026)      (5,549)
  Interest expense, net of amounts
     capitalized............................      101,648         18,948        37,665       21,224
  Gain on sale of subsidiary shares.........      (61,266)            --        (7,376)          --
  Other.....................................        3,281          1,569         2,017        2,360
                                               ----------     ----------    ----------   ----------
                                                   19,518         16,416        25,280       18,035
                                               ----------     ----------    ----------   ----------
     Loss before minority interest in
       (income) loss of subsidiaries and
       income tax...........................     (154,690)       (38,271)     (111,823)     (60,632)
                                               ----------     ----------    ----------   ----------
Income tax expense:
  Current...................................           --            758         1,802          157
  Deferred..................................           --             92          (899)          --
                                               ----------     ----------    ----------   ----------
                                                       --            850           903          157
                                               ----------     ----------    ----------   ----------
     Loss before minority interest in
       (income) loss of subsidiaries........     (154,690)       (39,121)     (112,726)     (60,789)
Minority interest in (income) loss of
  subsidiaries..............................           --           (472)         (612)         411
                                               ----------     ----------    ----------   ----------
     Net loss...............................   $ (154,690)    $  (39,593)   $ (113,338)  $  (60,378)
                                               ==========     ==========    ==========   ==========
Net loss per share, basic and diluted.......   $    (4.52)    $    (1.39)   $    (4.71)  $    (3.18)
                                               ==========     ==========    ==========   ==========
Weighted average common shares, basic and
  diluted...................................   35,834,196     30,804,376    24,702,870   18,988,127
</TABLE>

          See accompanying notes to consolidated financial statements.
                                       F-4
<PAGE>   28

                          GST TELECOMMUNICATIONS, INC.

            CONSOLIDATED STATEMENT OF SHAREHOLDERS' (DEFICIT) EQUITY
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                                                                                              ACCUMU-
                                                                                                               LATED      TOTAL
                                                               COMMITMENT TO ISSUE                             OTHER     SHARE-
                                          COMMON SHARES           COMMON SHARES        COMPRE-     ACCUMU-    COMPRE-   HOLDERS'
                                      ---------------------   ---------------------    HENSIVE      LATED     HENSIVE   (DEFICIT)
                                        SHARES      AMOUNT      SHARES      AMOUNT      LOSS       DEFICIT    INCOME     EQUITY
                                      ----------   --------   ----------   --------   ---------   ---------   -------   ---------
<S>                                   <C>          <C>        <C>          <C>        <C>         <C>         <C>       <C>
Balance, September 30, 1995.........  18,700,290   $ 50,166      336,498   $  1,494   $      --   $ (15,955)  $    --   $  35,705
Issuance of shares for services.....      85,627        621           --         --          --          --        --         621
Issuance of shares in business
  combinations......................   1,200,873     11,097     (168,249)      (747)         --          --        --      10,350
Issuance of common shares, net......   1,189,849      9,672           --         --          --          --        --       9,672
Issuance of shares under option
  plans.............................      67,500        293           --         --          --          --        --         293
Commitment to issue shares for
  business combinations.............          --         --    1,819,981     24,707          --          --        --      24,707
Issuance of shares under employee
  share purchase plan...............      13,558        132           --         --          --          --        --         132
Accrual of compensation costs for
  share awards and option plans.....          --        666           --         --          --          --        --         666
Net loss............................          --         --           --         --          --     (60,378)       --     (60,378)
                                      ----------   --------   ----------   --------   ---------   ---------   -------   ---------
Balance, September 30, 1996.........  21,257,697     72,647    1,988,230     25,454          --     (76,333)       --      21,768
Issuance of shares for services.....      25,000        221           --         --          --          --        --         221
Issuance of shares in business
  combinations......................   3,132,854     29,394   (1,700,169)   (21,049)         --          --        --       8,345
Issuance of shares and warrants,
  net...............................   2,505,882     32,666           --         --          --          --        --      32,666
Issuance of shares under option
  plans.............................     643,016      3,309           --         --          --          --        --       3,309
Issuance of shares under employee
  share purchase plan...............      62,993        400           --         --          --          --        --         400
Accrual of compensation costs for
  share awards and option plans.....          --      9,807           --         --          --          --        --       9,807
Accretion of redeemable preference
  shares............................          --     (2,969)          --         --          --          --        --      (2,969)
Net loss............................          --         --           --         --          --    (113,338)       --    (113,338)
                                      ----------   --------   ----------   --------   ---------   ---------   -------   ---------
Balance, September 30, 1997.........  27,627,442    145,475      288,061      4,405          --    (189,671)       --     (39,791)
Issuance of shares in business
  combinations......................     246,392      3,801     (237,174)    (3,801)         --          --        --          --
Issuance of shares, net.............   6,440,000     73,092           --         --          --          --        --      73,092
Issuance of shares under option
  plans.............................     158,209      1,107           --         --          --          --        --       1,107
Issuance of shares under employee
  share purchase plan...............      75,198        463           --         --          --          --        --         463
Accrual of compensation costs for
  share awards and option plans.....          --        179           --         --          --          --        --         179
Accretion of redeemable preference
  shares............................          --     (3,145)          --         --          --          --        --      (3,145)
Conversion of senior subordinated
  discount notes....................      17,657        133           --         --          --          --        --         133
Net loss............................          --         --           --         --          --     (39,593)       --     (39,593)
                                      ----------   --------   ----------   --------   ---------   ---------   -------   ---------
Balance, December 31, 1997..........  34,564,898    221,105       50,887        604          --    (229,264)       --      (7,555)
Issuance of shares for business
  combinations......................      57,632      2,952      (50,887)      (604)         --          --        --       2,348
Issuance of shares under option
  plans.............................     429,350      3,258           --         --          --          --        --       3,258
Issuance of shares for warrant
  exercise..........................     991,343     12,852           --         --          --          --        --      12,852
Issuance of shares under employee
  share purchase plan...............     220,843      1,563           --         --          --          --        --       1,563
Accrual of compensation costs for
  share award and option plans......          --       (357)          --         --          --          --        --        (357)
Accretion of redeemable preference
  shares............................          --     (7,106)          --         --          --          --        --      (7,106)
Comprehensive loss:
  Net loss..........................          --         --           --         --    (154,690)   (154,690)       --    (154,690)
  Other comprehensive income --
    unrealized gain on securities...          --         --           --         --      16,200          --    16,200      16,200
                                                                                      ---------
Comprehensive loss..................                                                  $(138,490)
                                      ----------   --------   ----------   --------   =========   ---------   -------   ---------
Balance, December 31, 1998..........  36,264,066   $234,267           --   $     --               $(383,954)  $16,200   $(133,487)
                                      ==========   ========   ==========   ========               =========   =======   =========
</TABLE>

          See accompanying notes to consolidated financial statements.
                                       F-5
<PAGE>   29

                          GST TELECOMMUNICATIONS, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                    THREE-MONTH          YEARS ENDED
                                                     YEAR ENDED     PERIOD ENDED        SEPTEMBER 30,
                                                    DECEMBER 31,    DECEMBER 31,    ----------------------
                                                        1998            1997          1997         1996
                                                    ------------    ------------    ---------    ---------
<S>                                                 <C>             <C>             <C>          <C>
Operations:
  Net loss........................................   $(154,690)       $(39,593)     $(113,338)   $ (60,378)
  Adjustments to reconcile net loss to net cash
    used in operations:
    Minority interest in income (loss) of
      subsidiary..................................          --             472            612         (411)
    Depreciation and amortization.................      51,328          10,115         26,634        9,496
    Deferred income taxes.........................          --              92           (899)          --
    Accretion and accrual of interest.............      59,783           8,276         19,236       19,978
    Non-cash stock compensation and other
      expense.....................................        (253)            374          2,583        1,293
    Loss on disposal of assets....................         239              --            679        1,012
    Non-cash special charges......................      29,467              --          7,445           --
    Equity in losses of investments and joint
      venture.....................................         593           1,286          1,482        1,521
    Gain on sale of subsidiary shares.............     (61,266)             --         (7,376)          --
    Changes in non-cash operating working capital:
      Accounts receivable, net....................     (15,321)         (3,547)       (11,284)      (1,066)
      Inventory...................................       1,927              46           (455)      (2,019)
      Prepaid, other current and other assets,
         net......................................      (1,406)           (631)        (7,172)      (5,304)
      Accounts payable and accrued liabilities....        (754)        (18,177)        24,970        2,387
      Other liabilities...........................       6,430             707           (119)         185
                                                     ---------        --------      ---------    ---------
         Cash used in operations..................     (83,923)        (40,580)       (57,002)     (33,306)
                                                     ---------        --------      ---------    ---------
Investments:
  Acquisition of subsidiaries, net of cash
    acquired......................................     (35,471)         (2,105)        (1,618)      (1,441)
  Purchase of investments.........................          --          (4,297)        (3,247)      (9,799)
  Proceeds from sale of investments...............         327              --          5,176        5,493
  Purchase of property and equipment..............    (219,129)        (45,970)      (222,001)     (76,192)
  Proceeds from sale of property and equipment....       3,589              --          5,774            8
  Purchase of other assets........................      (3,014)         (1,866)       (14,058)      (7,743)
  Change in investments restricted for the
    purchase of property and equipment............    (170,288)         11,143        (58,701)     (16,000)
  Proceeds from the sale of subsidiary shares,
    net...........................................      85,048             141         27,105           --
  Cash disposed of in sale of subsidiary..........      (5,252)             --             --           --
                                                     ---------        --------      ---------    ---------
         Cash used in investing activities........    (344,190)        (42,954)      (261,570)    (105,674)
                                                     ---------        --------      ---------    ---------
Financing:
  Proceeds from long-term debt....................     300,955         151,420        353,257      196,207
  Issuance of redeemable preference shares, net...          --              --         48,679           --
  Principal payments on long-term debt and capital
    leases........................................     (23,769)        (10,101)        (7,455)      (2,112)
  Issuance of common shares, net of issuance
    costs.........................................      17,673          74,629         27,692       10,098
  Deferred debt financing costs...................     (13,103)         (5,380)       (12,033)      (9,894)
  Change in investments restricted to finance
    interest payments.............................      33,374          16,157        (97,049)          --
                                                     ---------        --------      ---------    ---------
         Cash provided by financing activities....     315,130         226,725        313,091      194,299
                                                     ---------        --------      ---------    ---------
         Increase (decrease) in cash and cash
           equivalents............................    (112,983)        143,191         (5,481)      55,319
Cash and cash equivalents, beginning of period....     199,053          55,862         61,343        6,024
                                                     ---------        --------      ---------    ---------
Cash and cash equivalents, end of period..........   $  86,070        $199,053      $  55,862    $  61,343
                                                     =========        ========      =========    =========
</TABLE>

                                                                     (Continued)

                                       F-6
<PAGE>   30

                          GST TELECOMMUNICATIONS, INC.

              CONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED)
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                        THREE-MONTH        YEARS ENDED
                                                         YEAR ENDED     PERIOD ENDED      SEPTEMBER 30,
                                                        DECEMBER 31,    DECEMBER 31,    ------------------
                                                            1998            1997         1997       1996
                                                        ------------    ------------    -------    -------
<S>                                                     <C>             <C>             <C>        <C>
Supplemental disclosure of cash flow information:
  Cash paid for interest..............................    $50,315         $21,684       $ 4,982    $ 1,813
  Cash paid for income taxes..........................         --           1,038           638         --
Supplemental schedule of non-cash investing and
  financing activities:
  Recorded in business combinations:
    Assets............................................     45,719           2,605        14,148     45,477
    Liabilities.......................................      7,900             500         4,369     11,665
    Minority interest.................................         --              --            --     (2,686)
    Commitment to issue shares........................         --              --            --      5,613
    Common shares.....................................      2,348              --         8,161     29,444
  Disposition of subsidiary:
    Assets............................................     35,480              --            --         --
    Liabilities.......................................      4,218              --            --         --
    Minority interest.................................     12,732              --            --         --
  Amounts in accounts payable and accrued liabilities
    for the purchase of fixed assets at end of
    period............................................     25,945          19,029        19,718     18,291
  Unrealized gain on securities.......................     16,200              --            --         --
  Accretion of redeemable preference shares...........      7,106           3,145         2,969         --
  Assets acquired through capital leases..............     10,079             480        21,765         --
  Debt converted to equity............................         --             133            --         --
</TABLE>

          See accompanying notes to consolidated financial statements.
                                       F-7
<PAGE>   31

                          GST TELECOMMUNICATIONS, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
               (IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
                           DECEMBER 31, 1998 AND 1997

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

DESCRIPTION OF THE COMPANY

     GST Telecommunications, Inc. (the Company or GST), is a Canadian company in
the business of providing competitive local exchange services primarily in the
western United States. In addition, the Company provides a range of
telecommunications services, including long distance, Internet and data
services, and constructs telecommunication networks for other providers, and
produces telecommunications software.

     The consolidated financial statements for the year ended December 31, 1998,
the three-month period ended December 31, 1997 and the years ended September 30,
1997 and 1996 have been reported in U.S. dollars, the functional currency of the
Company. These consolidated financial statements are prepared in conformity with
generally accepted accounting principles in the United States. The Company also
prepares separate consolidated financial statements in accordance with Canadian
generally accepted accounting principles.

CHANGE IN FISCAL YEAR-END

     In 1997, the Company changed its fiscal year-end from September 30 to
December 31. Included in the accompanying audited financial statements are the
results of operations for the three-month transition period ended December 31,
1997. Unaudited results of operations for the comparable three-month period
ended December 31, 1996 are summarized below:

<TABLE>
<S>                                                           <C>
Revenues....................................................  $ 23,217
Loss from operations........................................   (17,988)
Other expenses, net.........................................    (4,646)
Income tax expense..........................................        --
Net loss....................................................   (22,634)
Loss per share, basic and diluted...........................     (1.02)
</TABLE>

BASIS OF CONSOLIDATION

     These consolidated financial statements include the accounts of the Company
and its greater than 50% owned subsidiaries. The Company's investments in
unconsolidated companies owned 20% or more are accounted for using the equity
method. At December 31, 1998, the Company held no investments accounted for
pursuant to the equity method. All significant intercompany accounts have been
eliminated.

CASH AND CASH EQUIVALENTS

     Cash equivalents consist of short-term, highly liquid investments with
original maturities of ninety days or less.

ACCOUNTS AND NOTES RECEIVABLE AND CONCENTRATION OF RISK

     Gross trade accounts receivable total $38,209 and $27,225 at December 31,
1998 and 1997, respectively. Notes receivable from customers total $208 and
$4,055 at December 31, 1998 and 1997, respectively. Management provides an
allowance for doubtful accounts and notes based on current customer information
and historical statistics. The allowance for doubtful accounts was $5,482 and
$3,956 at December 31, 1998 and 1997, respectively.

                                       F-8
<PAGE>   32
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Results of operations are derived from United States operations and
substantially all assets reside in the United States. The Company is exposed to
concentration of credit risk principally from accounts receivable. The Company's
five largest telecommunications and other services customers accounted for
approximately 16.4%, 16.8%, 20.8% and 46.9% of the Company's consolidated
telecommunications and other services revenue for the year ended December 31,
1998, the three-month period ended December 31, 1997 and the years ended
September 30, 1997 and 1996, respectively.

     The Company relies on incumbent local exchange companies for the provision
of local telephone service. In addition, the Company relies on other carriers to
provide transmission and termination services for a majority of its long
distance traffic. The inability of any of these companies or carriers to fulfill
service delivery requirements could impact the Company's future results.

RESTRICTED AND UNRESTRICTED INVESTMENTS

     Restricted investments classified as available-for-sale consist primarily
of U.S. Treasury securities maturing between one and eight months which are
restricted for the purchase and installation of network assets. Held-to-maturity
investments consist of U.S. Treasury securities and certificates of deposit
maturing between four months and eighteen months which are primarily restricted
for interest payments. Restricted investments are recorded at amortized cost
which approximates fair value for all periods presented.

     Unrestricted available-for-sale investments consist of the Company's 19%
equity interest in Global Light Telecommunications, Inc. (Global) at December
31, 1998 and U.S. government securities and certificates of deposit at December
31, 1997. An unrealized gain of $16,200 related to the Company's interest in
Global, which is carried at fair value, is included in comprehensive income for
the year ended December 31, 1998.

     Under Financial Accounting Standards Board (the FASB) Statement of
Financial Accounting Standards (SFAS) No. 115, Accounting for Certain
Investments in Debt and Equity Securities, the Company classifies its
investments as follows:

<TABLE>
<CAPTION>
                                                             DECEMBER 31,
                                                          -------------------
                                                            1998       1997
                                                          --------    -------
<S>                                                       <C>         <C>
Restricted investments:
  Available-for-sale....................................  $230,014    $62,484
  Held-to-maturity......................................    51,350     81,966
Unrestricted investments:
  Available-for-sale....................................    16,246      7,619
</TABLE>

INVESTMENTS IN FORMER AFFILIATE

     At December 31, 1997, the Company held a greater than 20% equity interest
in Global, a publicly-traded corporation listed on the Vancouver Stock Exchange,
which conducts telecommunications operations on a worldwide basis. The carrying
value of this investment at December 31, 1997 totaled $593 and was included in
other assets in the accompanying consolidated balance sheet. At December 31,
1998, the Company holds less than a 20% interest in Global. As discussed in note
11(a), the Company is currently in litigation with Global.

MINORITY INTEREST

     In March 1997, the Company's then wholly-owned subsidiary, NACT
Telecommunications, Inc. (NACT), completed an initial public offering of its
common stock, pursuant to which the Company and NACT sold one and two million
shares, respectively, of NACT's common stock, resulting in net proceeds of
approximately $9,000 and $18,100, respectively. As a result of the offering, the
Company's ownership was

                                       F-9
<PAGE>   33
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

reduced to 63%. Minority interest represents the non-Company owned shareholder
interest in NACT's equity resulting from the 1997 offering.

     In February 1998, the Company sold its remaining interest in NACT for net
proceeds of $85,048, which resulted in a gain of $61,266.

PROPERTY AND EQUIPMENT

     Property and equipment are recorded at cost and are depreciated on the
straight-line basis over their estimated useful lives, which are as follows:

<TABLE>
<S>                                                           <C>
Telecommunications networks.................................     20 years
Electronic and related equipment............................     10 years
Leasehold improvements......................................     10 years
Computer equipment, office equipment and other..............  3 - 7 years
Buildings...................................................     40 years
</TABLE>

     Construction, engineering and overhead costs directly related to the
development of the Company's networks are capitalized. The Company capitalizes
internal information systems costs in accordance with Statement of Position
98-1, Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use. The Company begins depreciating these costs when the assets become
operational. Depreciation expense totaled $30,056, $6,240, $14,985 and $5,569
for the year ended December 31, 1998, the three-month period ended December 31,
1997 and the years ended September 30, 1997 and 1996, respectively.

GOODWILL

     Goodwill is amortized using the straight-line method over periods ranging
from five to ten years. Amortization charged to operations was $6,218, $1,054,
$4,044 and $1,690 for the year ended December 31, 1998, the three-month period
ended December 31, 1997 and the years ended September 30, 1997 and 1996,
respectively.

ASSET IMPAIRMENT

     The Company reviews long-lived assets, goodwill and certain identifiable
intangibles for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable.

     During 1998, the Company recorded a non-cash special charge of $3,881
related to the impairment of certain long-lived assets associated with the
Company's shared tenant services operations. The impaired assets primarily
consist of customer lists and electronic and related equipment. As the projected
future cash flows were less than the assets' carrying value, an impairment loss
was recognized. The impairment loss was measured as the amount by which the
carrying amount of the assets exceeded the estimated fair value of the assets,
which was determined based on current market prices for similar assets.

     As discussed in note 12, the Company also recorded a non-cash special
charge of $15,668 during 1998 related to the impairment of a prepaid reseller
agreement and advances to Magnacom Wireless LLC.

REVENUE RECOGNITION

     Telecommunication services revenue is recognized monthly as services are
provided. Amounts billed in advance of the service month are recorded as
deferred revenue. Product revenue is recorded upon installation of products and
is presented in the accompanying consolidated statements of operations net of
product returns. Network construction services revenue is recognized using the
percentage of completion method. Accordingly,

                                      F-10
<PAGE>   34
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the Company recognizes revenues and expenses as construction progresses.
Included in other current assets are costs and income in excess of billings
relating to certain contracts.

NET LOSS PER SHARE

     Basic and diluted net loss per share is computed using the weighted average
number of common shares outstanding during the period. Common equivalent shares,
consisting of options, warrants and convertible securities, were antidilutive
for all periods presented and were not included in determining diluted weighted
average shares outstanding. If the Company had reported net income for the
periods presented, the weighted average number of common equivalent shares used
to determine diluted net loss per share would have increased by 10,411,640,
9,741,498, 8,186,050 and 5,963,647 for the year ended December 31, 1998, the
three-month period ended December 31, 1997 and the years ended September 30,
1997 and 1996, respectively.

     Net loss per share is increased for redeemable preference shares' accretion
totaling $7,106, $3,145, $2,969 and $0 for the year ended December 31, 1998, the
three-month period ended December 31, 1997 and the years ended September 30,
1997 and 1996, respectively.

ISSUANCE OF SUBSIDIARY STOCK

     Issuances of subsidiary stock are accounted for as capital transactions in
the accompanying consolidated financial statements.

INCOME TAXES

     The Company accounts for income taxes under the asset and liability method.
Under the asset and liability method, deferred income taxes reflect the future
tax consequences of differences between the tax basis of assets and liabilities
and their financial reporting amounts at each year-end. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the year in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in the tax rates is recognized in income in the period that includes the
enactment date. Valuation allowances are established when necessary to reduce
deferred tax assets to the amounts expected to be realized.

COMPREHENSIVE INCOME

     The Company adopted SFAS No. 130, Reporting Comprehensive Income, on
January 1, 1998. Comprehensive income is defined as changes in stockholders'
equity exclusive of transactions with owners such as capital contributions and
dividends. For the year ended December 31, 1998, comprehensive income includes a
$16,200 unrealized gain on available-for-sale securities. There are no
differences between net loss and comprehensive loss for all other periods
presented.

USE OF ESTIMATES

     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

ADVERTISING COSTS

     The Company expenses advertising costs as incurred.

                                      F-11
<PAGE>   35
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

RECLASSIFICATIONS

     Certain reclassifications have been made in the accompanying consolidated
financial statements for December 31, 1997 and September 30, 1997 and 1996 to
conform with the December 31, 1998 presentation.

(2) ACQUISITIONS

     The Company has made the acquisitions set forth below, each of which was
accounted for as a purchase. The consolidated financial statements include the
operating results from the effective date of acquisition.

ICON COMMUNICATIONS CORP. (ICON)

     In April 1998, the Company acquired 100% of the outstanding capital stock
of ICON, a Washington company which provides long distance and ancillary
communications services. Consideration paid for this acquisition consisted of
$23,916 in cash. Goodwill of $15,957 was recorded as a result of this
acquisition.

KLP, INC. (D/B/A CALL AMERICA) (CALL AMERICA PHOENIX)

     In March 1998, the Company acquired 100% of the outstanding capital stock
of Call America Phoenix, an Arizona company which provides long distance
services. Consideration paid for this acquisition consisted of $3,838 in cash.
Goodwill of $2,405 was recorded as a result of this acquisition.

WHOLE EARTH NETWORKS, LLC (WHOLE EARTH)

     In March 1998, the Company acquired the business of Whole Earth, a
California Internet services provider. Consideration paid for this acquisition
consisted of $9,053 in cash and the assumption of $1,273 in liabilities.
Goodwill of $3,293 was recorded as a result of this acquisition.

ACTION TELCOM CO. (ACTION TELCOM)

     In May 1997, the Company acquired 100% of the outstanding capital stock of
Action Telcom, a Texas company which provides long distance and ancillary
telecommunications services and produces software used in the telecommunications
industry. The Company acquired Action Telcom for consideration of 903,000 common
shares valued at $8,161, $1,290 in cash and $2,580 in notes payable. The
purchase agreement provides for an additional payment of up to 120,000 common
shares in 1999, contingent on future market values of the Company's common
shares. Goodwill of $3,863 was recorded as a result of this acquisition.

PHOENIX FIBER ACCESS, INC. (PHOENIX FIBER)

     In December 1996, the Company paid $2,000 in cash to acquire the remaining
50% of Phoenix Fiber, previously 50% owned by the Company through a joint
venture with ICG Telecom Group, Inc. (ICG). In addition, the Company assumed the
repayment of up to $2,000 of intercompany indebtedness, under certain
circumstances, and indemnified ICG in respect of all indebtedness of Phoenix
Fiber to the Company and third parties, other than certain liabilities of
Phoenix Fiber that were assumed by ICG. Phoenix Fiber is an Arizona company
engaged in providing competitive local exchange services in the Phoenix
metropolitan area.

CALL AMERICA BUSINESS COMMUNICATIONS, CORP. (CALL AMERICA)

     In September 1996, the Company acquired 100% of the outstanding capital
stock of Call America, a California company that provides long distance and
ancillary communications services. The Company acquired Call America for
consideration of 1,443,505 common shares valued at $16,311. Additionally, $415
in notes receivable due from the former owners of Call America will be forgiven
if certain operating milestones are met over the next 8 years. Goodwill of
$11,581 was recorded as a result of this acquisition.

                                      F-12
<PAGE>   36
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

TOTALNET COMMUNICATIONS, INC. (TOTALNET)

     In September 1996, the Company acquired 100% of the outstanding capital
stock of TotalNet, a long distance service provider. The Company acquired
TotalNet for consideration of 703,229 common shares valued at $8,814. Goodwill
of $5,717 was recorded as a result of this acquisition.

GST TELECOM INC. (GST TELECOM)

     In a series of transactions between 1994 and 1996, the Company purchased
100% of the outstanding shares of GST Telecom, which develops, constructs and
operates competitive local exchange networks and other communications systems.
Consideration paid for GST Telecom consisted of 2,100,000 common shares valued
at $15,447, which shares were paid to Pacwest, LLC (Pacwest), an entity
controlled by the former Chairman and Chief Executive Officer of the Company.
Goodwill of $15,330 was recorded as a result of this acquisition.

OTHERS

     In October 1997, the Company purchased the assets of the Guam operations of
Sprint Communications Company L.P. (Sprint) which provide long distance and
ancillary services in Guam. Consideration paid for this acquisition consisted of
$2,000 in cash and $500 in liabilities for services to be provided to Sprint.

     In May 1996, the Company purchased from Tomen America, Inc. (Tomen) the
remaining 10% interest in GST Pacific Lightwave, Inc., a GST Telecom subsidiary
which operates a fiber optic competitive local exchange network in southern
California. The consideration paid for this acquisition consisted of $1,250 in
cash, which was recorded as goodwill.

     During 1996, the Company acquired the assets of Reservations, Inc. dba
Hawaii OnLine (Hawaii OnLine), the assets of Texas-Ohio Communications, Inc.
(Texas-Ohio), and 100% of the outstanding capital stock of Tri-Star Residential
Communications, Inc. (Tri-Star). Hawaii OnLine is an Internet service provider;
Texas-Ohio is a long distance service provider; and Tri-Star provides shared
tenant services consisting of long distance, cable television and security
service to tenants of multi-dwelling apartment units. Consideration paid for
these acquisitions consisted of 266,519 common shares valued at $2,463, and $719
of cash. Goodwill of $1,044 was recorded as a result of these acquisitions.

     The unaudited pro forma results shown below reflect results of operations
as if the 1998 and 1997 acquisitions described above occurred as of the
beginning of each of the periods presented.

<TABLE>
<CAPTION>
                                                               THREE-MONTH
                                                YEAR ENDED     PERIOD ENDED     YEAR ENDED
                                               DECEMBER 31,    DECEMBER 31,    SEPTEMBER 30,
                                                   1998            1997            1997
                                               ------------    ------------    -------------
<S>                                            <C>             <C>             <C>
Revenues.....................................   $ 167,556        $ 40,521        $ 133,958
Net loss.....................................    (155,236)        (39,655)        (115,266)
Net loss per share...........................       (4.33)          (1.29)           (4.67)
</TABLE>

     The pro forma results are not necessarily indicative of what actually would
have occurred had the acquisitions been in effect for the entire periods
presented. In addition, they are not intended to be a projection of future
results that may be achieved from the combined operations.

                                      F-13
<PAGE>   37
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(3) PROPERTY AND EQUIPMENT

<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                              --------------------
                                                                1998        1997
                                                              --------    --------
<S>                                                           <C>         <C>
Telecommunications networks.................................  $178,008    $125,966
Electronic and related equipment............................   181,270      63,977
Leasehold improvements......................................    24,509      21,673
Computer equipment, office equipment and other..............    40,585      25,810
Buildings...................................................     2,803       3,366
Construction in progress....................................   251,199     192,888
                                                              --------    --------
                                                               678,374     433,680
Less accumulated depreciation...............................   (62,522)    (26,785)
                                                              --------    --------
                                                              $615,852    $406,895
                                                              ========    ========
</TABLE>

     Property and equipment includes $251,199 and $192,888 of equipment which
had not been placed in service at December 31, 1998 and 1997, respectively, and
accordingly, was not being depreciated. During the year ended December 31, 1998,
the three-month period ended December 31, 1997 and the years ended September 30,
1997 and 1996, $25,920, $3,726, $15,170 and $2,316 of interest, respectively,
was capitalized as part of property and equipment.

(4) ACCRUED EXPENSES

<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                              ------------------
                                                               1998       1997
                                                              -------    -------
<S>                                                           <C>        <C>
Fixed asset purchases.......................................  $ 9,552    $12,157
Carrier costs...............................................    4,885         98
Interest payable............................................    9,272      8,096
Payroll and related liabilities.............................    5,252      2,721
Other.......................................................    8,484      7,797
                                                              -------    -------
     Total..................................................  $37,445    $30,869
                                                              =======    =======
</TABLE>

                                      F-14
<PAGE>   38
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(5) LONG-TERM DEBT

<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                              ----------------------
                                                                 1998         1997
                                                              ----------    --------
<S>                                                           <C>           <C>
13.25% senior secured notes due May 1, 2007.................  $  265,000    $265,000
10.5% senior secured discount notes due May 1, 2008.........     320,997          --
Note payable to Tomen, LIBOR plus 3.0% (8.1% at December 31,
  1998).....................................................      45,262      61,793
Note payable to NTFC, LIBOR plus 3.5% (8.6% at December 31,
  1998).....................................................      50,000      50,000
Note payable to Siemens, LIBOR plus 3.5% (8.6% at December
  31, 1998).................................................       9,463       7,889
13.875% senior discount notes due December 15, 2005.........     240,304     210,136
13.875% convertible senior subordinated discount notes, due
  December 15, 2005.........................................      29,884      26,133
12.75% senior subordinated accrual notes due November 15,
  2007......................................................     144,000     144,000
Other.......................................................       1,466       2,920
                                                              ----------    --------
                                                               1,106,376     767,871
Less current portion of long-term debt......................      13,417       4,579
                                                              ----------    --------
                                                              $1,092,959    $763,292
                                                              ==========    ========
</TABLE>

     The schedule of future principal payments on long-term debt is as follows:

<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31:
------------------------
<S>                                                             <C>
1999........................................................    $   13,417
2000........................................................        17,041
2001........................................................        20,216
2002........................................................        20,898
2003........................................................        21,132
Thereafter(a)...............................................     1,273,787
                                                                ----------
Less unaccreted discount....................................      (260,115)
                                                                ----------
                                                                $1,106,376
                                                                ==========
</TABLE>

---------------
(a) Includes $500,000, $312,448 and $38,852 of 10.5% senior secured discount
    notes, 13.875% senior discount notes and 13.875% convertible senior
    subordinated discount notes, respectively, due at maturity.

SENIOR SECURED NOTES

     In May 1997, the Company issued $265,000 in senior secured notes (the
Secured Notes) due May 1, 2007. The Secured Notes bear interest at a rate of
13.25% with semiannual interest payments due beginning November 1, 1997.
Approximately $93,790 of the proceeds were set aside to fund the first six
scheduled interest payments. The remainder of the net proceeds were restricted
to finance the cost of design, development, construction, acquisition,
installation and integration of telecommunications equipment. The Secured Notes
are secured by the assets financed with the proceeds and are subject to certain
debt covenants.

SENIOR SECURED DISCOUNT NOTES

     In May 1998, the Company issued $300,000 in 10.5% senior secured discount
notes (the Senior Secured Discount Notes) maturing on May 1, 2008. The Senior
Secured Discount Notes were sold at a substantial

                                      F-15
<PAGE>   39
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

discount and there will be no accrual of cash interest prior to May 1, 2003, or
payment of interest until November 1, 2003. The Senior Secured Discount Notes
accrete to a total principal amount, due May 1, 2008, of approximately $500,000.
The net proceeds from the sale of the Senior Secured Discount Notes are
restricted to finance the cost of design, development, construction,
acquisition, installation and integration of telecommunications equipment. The
Senior Secured Discount Notes are secured by the assets financed with the
proceeds and are subject to certain debt covenants.

     The Company is a party to a registration rights agreement relating to the
Senior Secured Discount Notes whereby it agreed to consummate an exchange offer
for the Senior Secured Discount Notes pursuant to an effective registration
statement or cause the Senior Secured Discount Notes to be registered under the
Securities Act of 1933, as amended, pursuant to a shelf registration statement
by November 4, 1998. Although the Company has filed a registration statement on
Form S-4 with respect to an exchange offer for the Senior Secured Discount
Notes, it has not yet been declared effective. Therefore, in accordance with the
terms of the registration rights agreement, interest (in addition to the accrual
of original issue discount and interest otherwise due on the Senior Secured
Discount Notes after such date) on the Senior Secured Discount Notes accrue at
an annual rate of 0.5%, beginning November 4, 1998, and are payable in cash
semiannually in arrears, on each May 1 and November 1, commencing May 1, 1999,
until such exchange offer is consummated or a shelf registration statement is
declared effective. At December 31, 1998, the Company had accrued $396 in
additional interest related to the Senior Secured Discount Notes.

TOMEN FACILITY

     In October 1994, the Company entered into a master financing agreement with
Tomen. Under the agreement, Tomen will loan up to $100,000 to subsidiaries of
the Company for development and construction of network projects. As of December
31, 1998, Tomen had provided a total of $69,468 (of which $45,262 was
outstanding at December 31, 1998) in debt financing to the Company's
subsidiaries for construction and operation of fiber optic networks in southern
California, New Mexico, Arizona and Hawaii. The Tomen financing is secured by
equipment at the funded network locations and is subject to certain debt
covenants.

NTFC CAPITAL CORPORATION (NTFC) AGREEMENT

     In March 1997, the Company entered into a $50,000 (all of which was
outstanding at December 31, 1998) loan and security agreement with NTFC to
finance the purchase of certain equipment from Northern Telecom, Inc. Amounts
borrowed under the agreement bear interest at LIBOR plus 3.5% and will be repaid
in twenty quarterly installments beginning in March 1999. The loan is secured by
the equipment purchased with the proceeds and subject to certain debt covenants.

SIEMENS TELECOM NETWORKS (SIEMENS) AGREEMENT

     In September 1996, the Company entered into a loan and security agreement
with Siemens. Under the terms of the agreement, Siemens will loan up to $226,000
to the Company for the purchase and installation of telecommunications switching
and related equipment. At December 31, 1998, $116,000 was available to the
Company and $9,463 was outstanding. Amounts borrowed under the agreement
initially bear interest at LIBOR plus 4.5% and are secured by the equipment.
Such interest decreases to LIBOR plus 3.5% at the time each initial loan is
converted to a term loan, which conversion occurs at the first calendar quarter
following the initial loan. Amounts borrowed under the agreement will be repaid
in twenty-four quarterly installments beginning five quarters after the initial
loan is converted to a term loan. The loan is subject to certain debt covenants.

                                      F-16
<PAGE>   40
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

SENIOR DISCOUNT NOTES AND CONVERTIBLE SENIOR SUBORDINATED DISCOUNT NOTES

     In December 1995, the Company issued approximately $160,000 in 13.875%
senior discount notes (the Senior Notes) and $20,000 in 13.875% convertible
senior subordinated discount notes (the Convertible Notes) maturing on December
15, 2005 (together the Notes). The Notes were sold at a substantial discount and
there is no accrual of cash interest prior to December 15, 2000 or payment of
interest until June 15, 2001. The Notes accrete to a total principal amount, due
December 15, 2005, of approximately $351,300 by December 15, 2000. The Senior
Notes rank in right of payment with all unsubordinated indebtedness of the
Company while the Convertible Notes are junior to all senior Company debt.

     Each of the Convertible Notes is convertible at the option of the holder
into common shares. The number of shares to be issued upon conversion is based
on an accreted value on the conversion date divided by $7.563. In addition, all
of the Convertible Notes may be automatically converted to common shares by the
Company if the Company's common shares sustain certain market value levels for
thirty consecutive trading days. On or after December 15, 2000, the Notes will
be redeemable at the option of the Company. The Notes are subject to certain
debt covenants.

SENIOR SUBORDINATED ACCRUAL NOTES

     In November and December 1997, the Company issued $144,000 in 12.75% senior
subordinated accrual notes (the Accrual Notes). Cash interest on the Accrual
Notes will not be paid until May 15, 2003. The Accrual Notes are subordinated to
all senior indebtedness, including the Notes.

     The Accrual Notes are redeemable at the option of the Company, in whole or
in part, after November 15, 2002. Prior to November 15, 2000, up to one-third of
the aggregate principal amount of the Accrual Notes may be redeemed by the
Company from the proceeds of one or more sales of the Company's common shares.
The Accrual Notes are subject to certain debt covenants.

DEBT COVENANTS AND CLASSIFICATION OF LONG TERM DEBT

     In November 1998, the Company informed the Trustee who represents the
holders of the Senior Secured Notes, the Senior Secured Discount Notes, the
Senior Notes, the Convertible Notes and the Accrual Notes that it may have
violated certain technical covenants contained in the indentures related to each
of the aforementioned debt issuances. In February 1999, the Trustee informed the
note holders of the potential violations. The note holders have not declared a
default, as defined within the indentures of each of the notes. The Company has
classified the related debt obligations as non-current in the accompanying
consolidated balance sheets as management believes it is probable that, in the
event the note holders declare a default, the Company would be able to take
corrective actions to cure, within the prescribed grace period, those technical
violations deemed objectively-determinable.

(6) REDEEMABLE PREFERENCE SHARES

     The Company's Board of Directors has the authority, without any further
vote or action by the Company's shareholders, to issue up to 10,000,000
Preference Shares, without par value, in one or more series and to determine the
designations, powers, preferences and relative, participating, optional or other
rights thereof, including, without limitation, the dividend rate (and whether
dividends are cumulative), conversion rights, voting rights, rights and terms of
redemption, redemption price and liquidation preference.

     In February 1997, the Company consummated a $50,000 private placement of
500 Redeemable Preference Shares. The Redeemable Preference Shares do not pay
dividends in cash, except to the extent such dividends are paid on Common
Shares. In addition, the liquidation, conversion and redemption prices of the
Redeemable Preference Shares accrete semiannually at a rate of 11.875%.

                                      F-17
<PAGE>   41
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     The Company is required to redeem the Redeemable Preference Shares on
February 28, 2004 (the Mandatory Redemption Date) in cash at a redemption price
of approximately $224,000 per share (the Mandatory Redemption Price); provided
that to the extent the Company is prohibited from paying such redemption price
in cash, the holders of Redeemable Preference Shares have the option to convert
each Redeemable Preference Share into a number of Common Shares equal to the
Mandatory Redemption Price divided by 95% of the then market price for Common
Shares.

     In the event the Company is prevented from paying the redemption price for
Redeemable Preference Shares in cash and any holder of Redeemable Preference
Shares does not exercise such conversion option, the Company has the option of
extending the Mandatory Redemption Date to August 28, 2007. The Company has the
option of redeeming the Redeemable Preference Shares at any time after February,
2000 in cash at a redemption price per Redeemable Preference Share equal to the
number of Common Shares into which such Redeemable Preference Share is then
convertible multiplied by the price at which such Redeemable Preference Share
would become subject to mandatory conversion.

     Redeemable Preference Shares are convertible at the option of the holders
into Common Shares at any time after February 28, 2000 or earlier upon a change
of control of the Company. The holders of Redeemable Preference Shares have the
right to require the Company to repurchase their shares upon a change of control
of the Company after February 28, 2002; prior to that time, holders have a right
to convert their Redeemable Preference Shares into Common Shares upon a change
of control. Further, the Redeemable Preference Shares are subject to mandatory
conversion into Common Shares if the market price of Common Shares exceeds
$15.925 per share (subject to adjustment) for a specified period after February
28, 2000.

(7) SHAREHOLDERS' (DEFICIT) EQUITY

STOCK-BASED COMPENSATION

     The Company has six stock-based compensation plans, which are described
below. The Company follows SFAS No. 123, Accounting for Stock-Based Compensation
(SFAS 123). In accordance with SFAS 123, the Company applies APB Opinion No. 25
and related Interpretations in accounting for its plans. Accordingly,
compensation cost is generally not recognized for options awarded in the 1995,
1996 and 1997 Stock Incentive Plans, the Employee Stock Purchase Plan and fixed
stock option awards under the Senior Operating and Executive Officer Stock
Option Plans. Compensation cost recognized in the statements of operations for
the year ended December 31, 1998, the three-month period ended December 31, 1997
and the years ended September 30, 1997 and 1996 totaled $(357), $149, $9,747 and
$666, respectively. The fair value of each option grant is estimated on the date
of the grant using the Black-Scholes option-pricing model assuming no dividend
yield and the following weighted average assumptions for options granted during
the year ended December 31, 1998, the three-month period ended December 31, 1997
and for the years ended September 30, 1997 and 1996 are as follows:

<TABLE>
<CAPTION>
                                                                   OPTION AWARDS
                                                           ------------------------------
                                                           DECEMBER 31,    SEPTEMBER 30,
                                                           ------------    --------------
                                                           1998    1997    1997     1996
                                                           ----    ----    -----    -----
<S>                                                        <C>     <C>     <C>      <C>
Expected volatility......................................   62%     58%      56%      60%
Risk free interest rate..................................  5.2%    5.4%     6.3%     6.1%
Expected life (in years).................................  3.5     3.5      3.5      3.5
</TABLE>

                                      F-18
<PAGE>   42
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

<TABLE>
<CAPTION>
                                                            EMPLOYEE STOCK PURCHASE PLAN
                                                           ------------------------------
                                                           DECEMBER 31,    SEPTEMBER 30,
                                                           ------------    --------------
                                                           1998    1997    1997     1996
                                                           ----    ----    -----    -----
<S>                                                        <C>     <C>     <C>      <C>
Expected volatility......................................   62%     58%      56%      60%
Risk free interest rate..................................  4.8%    5.3%     5.4%     5.3%
Expected life (in years).................................   .5      .5       .5       .5
</TABLE>

     The weighted average fair value of stock awards granted under the various
plans are as follows:

<TABLE>
<CAPTION>
                                                            THREE-MONTH       YEAR ENDED
                                             YEAR ENDED     PERIOD ENDED    SEPTEMBER 30,
                                            DECEMBER 31,    DECEMBER 31,    --------------
                                                1998            1997        1997     1996
                                            ------------    ------------    -----    -----
<S>                                         <C>             <C>             <C>      <C>
Stock option awards.......................     $6.50           $6.17        $4.68    $4.71
Employee stock purchase plan..............      2.16            1.81         1.81     2.85
</TABLE>

     Had compensation cost for the Company's six stock-based compensation plans
been determined pursuant SFAS 123, the Company's net loss and net loss per share
would have increased to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                                     THREE-MONTH          YEAR ENDED
                                      YEAR ENDED     PERIOD ENDED        SEPTEMBER 30,
                                     DECEMBER 31,    DECEMBER 31,    ---------------------
                                         1998            1997          1997         1996
                                     ------------    ------------    ---------    --------
<S>                                  <C>             <C>             <C>          <C>
Net loss:
  As reported......................   $(154,690)       $(39,593)     $(113,338)   $(60,378)
  Pro forma........................    (163,078)        (41,342)      (116,214)    (61,949)
Net loss per share, basic and
  diluted:
  As reported......................   $   (4.52)       $  (1.39)     $   (4.71)      (3.18)
  Pro forma........................       (4.75)          (1.44)         (4.82)      (3.24)
</TABLE>

     Pro forma net loss reflects only options granted since October 1, 1995.
Therefore, the full impact of calculating compensation cost for stock options
under SFAS 123 is not reflected in the pro forma net loss amounts presented
above because compensation cost is reflected over the options' vesting period
and compensation cost for options granted prior to September 30, 1995 is not
considered.

STOCK OPTION AWARDS

     Under the 1995, 1996 and 1997 Stock Option Plans (the Plans), the Company
has authorized the issuance of 1,750,000, 1,000,000 and 1,000,000 common shares,
respectively. The Plans provide for the granting of incentive stock options and
non-statutory stock options to employees, officers and employee directors and
consultants at an exercise price no less that 100% of the market value on the
last trading day prior to the date of grant. The options have a maximum term of
five years and become exercisable at such times and in such installments, for
each individual option, as determined by the Board of Directors; however, no
option vests until at least six months after the date of grant.

     In addition, the Company grants fixed option awards under the 1996 Senior
Operating Officer Stock Option Plan (Operating Officer Plan). These options have
a term of five years and become exercisable at such time and in such
installments for each individual option, as determined by the Board of
Directors.

     Under the Operating Officer Plan and the 1996 Senior Executive Officer
Stock Option Plan (Executive Plan), the Company may grant stock options to
purchase up to 900,000 and 600,000 common shares, respectively, to selected
individuals. Vesting for certain performance-based awards is based upon the

                                      F-19
<PAGE>   43
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

achievement of certain Company operating and common share price milestones. The
options have a maximum term of six years.

     A summary of the status of the Company's fixed and performance-based stock
option awards as of December 31, 1998 and 1997 and September 30, 1997 and 1996
and the changes during the period and years ended on those dates is presented
below:

<TABLE>
<CAPTION>
                                                               STOCK OPTIONS AWARDS
                                                              ----------------------
                                                                            WEIGHTED
                                                                            AVERAGE
                                                                            EXERCISE
                                                                SHARES       PRICE
                                                              ----------    --------
<S>                                                           <C>           <C>
Outstanding at September 30, 1995...........................   1,605,553     $5.81
Granted.....................................................   1,563,373      9.43
Exercised...................................................     (67,500)     4.33
Canceled....................................................     (40,221)     6.54
                                                              ----------
Outstanding at September 30, 1996...........................   3,061,205      7.68
Granted.....................................................   1,490,000      9.91
Exercised...................................................    (643,016)     5.15
Canceled....................................................     (83,655)     8.89
                                                              ----------
Outstanding at September 30, 1997...........................   3,824,534      8.95
Granted.....................................................     175,000     10.29
Exercised...................................................    (158,209)     7.00
Canceled....................................................    (236,218)    10.94
                                                              ----------
Outstanding at December 31, 1997............................   3,605,107      8.97
Granted.....................................................   2,927,357     11.02
Exercised...................................................    (429,350)     7.58
Canceled....................................................  (1,807,987)    12.20
                                                              ----------
Outstanding at December 31, 1998............................   4,295,127      9.15
                                                              ==========
Number of options exercisable at end of period..............   1,413,134     $8.14
                                                              ==========
</TABLE>

     The following table summarizes information about stock options outstanding
at December 31, 1998:

<TABLE>
<CAPTION>
                 OPTIONS OUTSTANDING                      OPTIONS EXERCISABLE
------------------------------------------------------   ----------------------
                                 WEIGHTED
                                  AVERAGE     WEIGHTED                 WEIGHTED
                    NUMBER       REMAINING    AVERAGE      NUMBER      AVERAGE
   RANGE OF        OF SHARES    CONTRACTUAL   EXERCISE    OF SHARES    EXERCISE
EXERCISE PRICES   OUTSTANDING      LIFE        PRICE     EXERCISABLE    PRICE
---------------   -----------   -----------   --------   -----------   --------
<S>               <C>           <C>           <C>        <C>           <C>
$ 3.00 -  5.99        93,510      .2 years     $ 5.00       92,472      $5.00
  6.00 -  8.99     1,899,739     3.2 years       7.01      695,295       6.90
  9.00 - 11.99     1,812,800     3.6 years      10.09      625,367       9.98
 12.00 - 15.00       489,078     3.5 years      14.77           --         --
</TABLE>

     On December 14, 1998, options to purchase 1,197,830 shares were repriced
from prices ranging between $8.25 and $15.00 per share, to $7.15 per share. The
vesting terms for the repriced options were extended from three to four years
from the original date of grant. The options were repriced to incent employees
to remain with the Company during an extended decline in the market value of the
Company's common shares. Options for directors, officers and key executives were
not repriced. No additional compensation expense was recorded as a result of the
repricing of options.

                                      F-20
<PAGE>   44
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

EMPLOYEE STOCK PURCHASE PLAN

     Under the 1996 Employee Stock Purchase Plan (the Purchase Plan), the
Company has authorized the issuance of 500,000 common shares which allows
eligible employees of the Company to purchase common shares of the Company at
85% of the market value on the date of grant. Employees who own 5% or more of
the voting rights of the Company's outstanding common shares may not participate
in the Purchase Plan. Employees purchased 220,843, 75,198, 62,993 and 13,558
shares under the purchase plan during the year ended December 31, 1998, the
three-month period ended December 31, 1997 and the years ended September 30,
1997 and 1996, respectively.

WARRANTS OUTSTANDING

     Warrants outstanding and exercisable at December 31, 1998:

<TABLE>
<CAPTION>
  NUMBER OF
COMMON SHARES
  ISSUABLE      EXERCISE PRICE   EXPIRATION DATE
-------------   --------------   ---------------
<S>             <C>              <C>
    50,000          $10.00         April 1999
    75,000           12.61       September 1999
   300,000            6.75       September 2000
</TABLE>

     The 50,000 warrants expiring in April 1999 were granted in conjunction with
a private placement of common shares during 1994. The 75,000 warrants expiring
in September 1999 were granted to Tomen in conjunction with the Tomen financing
agreements. The 300,000 warrants expiring in September 2000 were granted to a
director of the Company.

DIVIDEND RESTRICTIONS

     The indentures related to the Secured Notes, the Senior Secured Discount
Notes, the Notes and the Accrual Notes prohibit the payment of dividends.

(8) INCOME TAXES

     The provision for income taxes differs from the amount computed by applying
the Canadian statutory income tax rate to net income before taxes for the year
ended December 31, 1998, the three-month period ended December 31, 1997 and the
years ended September 30, 1997 and 1996 as follows:

<TABLE>
<CAPTION>
                                            DECEMBER 31,    DECEMBER 31,    SEPTEMBER 30,    SEPTEMBER
                                                1998            1997            1997           1996
                                            ------------    ------------    -------------    ---------
<S>                                         <C>             <C>             <C>              <C>
Computed expected income tax expense
  (benefit) at Canadian statutory rate....      (39)%           (39)%            (39)%          (39)%
Expected state/province income tax expense
  (benefit)...............................       (5)             (4)              (4)            (4)
Increase in valuation allowance...........       41              37               30             21
Amortization of goodwill..................        1               1                1              1
Effect of difference in United States
  statutory rate..........................        5               5                5              5
Effect of acquisition of new
  subsidiaries............................        1              --                2             10
Non-deductible interest...................       --               2                2              2
Other.....................................       (4)             --                4              4
                                                ---             ---              ---            ---
Income tax expense........................       --%              2%               1%            --%
                                                ===             ===              ===            ===
</TABLE>

                                      F-21
<PAGE>   45
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The tax effects of
significant items comprising the Company's deferred tax asset and liability are
as follows:

<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                              ---------------------
                                                                1998         1997
                                                              ---------    --------
<S>                                                           <C>          <C>
Deferred tax assets:
  United States Federal and state net operating loss
     carryforwards..........................................  $  76,241    $ 47,550
  Canadian net operating loss carryforwards.................     15,975       5,001
  Non-deductible interest...................................     39,199      18,365
  Canadian non-deductible interest..........................      5,269       2,859
  Canadian capital loss carryforward........................        128         128
  Other.....................................................      3,361       4,528
                                                              ---------    --------
     Total gross deferred tax assets........................    140,173      78,431
  Less valuation allowance..................................   (129,757)    (67,970)
                                                              ---------    --------
     Total deferred tax assets..............................     10,416      10,461
                                                              ---------    --------
Deferred tax liabilities:
  Furniture, fixtures and equipment, due to differences in
     depreciation...........................................      6,217       5,398
  Capitalized software/intangibles..........................      4,199       5,498
                                                              ---------    --------
     Total gross deferred tax liabilities...................     10,416      10,896
                                                              ---------    --------
     Net deferred tax liabilities...........................  $      --    $   (435)
                                                              =========    ========
</TABLE>

     The valuation allowance for deferred tax assets as of October 1, 1995 was
$6,734. The net change in total valuation allowance for the year ended December
31, 1998, the three-month period ended December 31, 1997 and for the years ended
September 30, 1997 and 1996 was an increase of $61,787, $14,490, $34,051 and
$12,695, respectively.

     The Company has non-capital losses for income tax purposes of approximately
$35,501 available to reduce Canadian taxable income of future years, expiring as
follows:

<TABLE>
<S>                                                  <C>
1999...............................................  $ 2,043
2000...............................................       --
2001...............................................    1,574
2002...............................................    1,877
2003...............................................    3,079
2004...............................................    2,909
2005...............................................   24,019
                                                     -------
                                                     $35,501
                                                     =======
</TABLE>

     Based on a history of recurring losses, it is questionable whether the
Company will be allowed to utilize these Canadian losses if the tax authority
determines that the Company has no reasonable expectation of profit. As of
December 31, 1998, the Company also has a Canadian net capital loss carryforward
of $280. Net capital losses can be carried forward indefinitely but can only be
utilized to offset taxable capital gains.

                                      F-22
<PAGE>   46
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     The Company has net operating losses for income tax purposes of
approximately $208,923 available to reduce United States taxable income of
future years, expiring as follows:

<TABLE>
<S>                                                 <C>
2006..............................................  $    405
2007..............................................       537
2008..............................................     2,800
2009..............................................     5,020
2010..............................................    36,922
2011..............................................    64,283
2017..............................................    36,621
2018..............................................    62,335
                                                    --------
                                                    $208,923
                                                    ========
</TABLE>

     Approximately 58% of these net operating losses may be utilized for state
income tax purposes.

     For United States income tax purposes, utilization of net operating losses
may be subject to limitation in the event of certain substantial stock ownership
changes pursuant to IRC Section 382 and referred to hereinafter as an ownership
change. An ownership change would limit the utilization of any net operating
losses incurred prior to the change in ownership date. The Company has completed
an analysis under IRC Section 382 and has determined that no ownership change
has occurred.

(9) LEASES

     The Company is obligated under capital lease agreements for equipment and
network facilities which expire at various dates during the next twenty years.
Certain of these agreements contain clauses which allow the lessor to cancel the
agreement upon twelve-month written notice. However, the Company believes that
the likelihood of such clauses being exercised is remote. Gross amounts of
assets and related accumulated amortization recorded under capital leases were
as follows:

<TABLE>
<CAPTION>
                                                             DECEMBER 31,
                                                         --------------------
                                                           1998        1997
                                                         --------    --------
<S>                                                      <C>         <C>
Network facilities and equipment.......................  $ 33,540    $ 27,003
Less accumulated amortization..........................    (9,307)     (6,408)
                                                         --------    --------
                                                         $ 24,233    $ 20,595
                                                         ========    ========
</TABLE>

     Amortization of assets held under capital leases is included in
depreciation expense.

     The Company also has noncancelable operating leases, primarily for
facilities, which expire over the next five years. Rental expense under
operating leases was $6,281, $1,114, $3,385, and $1,501 for the year ended
December 31, 1998, the three-month period ended December 31, 1997 and the years
ended September 30, 1997 and 1996, respectively.

                                      F-23
<PAGE>   47
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Future minimum lease payments under noncancelable leases (with initial or
remaining lease terms in excess of one year) and future minimum capital lease
payments as of December 31, 1998 are:

<TABLE>
<CAPTION>
                                                           CAPITAL    OPERATING
                                                           LEASES      LEASES
                                                           -------    ---------
<S>                                                        <C>        <C>
Year ending December 31:
1999.....................................................  $10,661     $ 5,369
2000.....................................................    7,430       4,298
2001.....................................................    4,043       3,540
2002.....................................................    3,476       3,422
2003.....................................................    3,229       3,217
Thereafter...............................................   12,578       9,418
                                                           -------     -------
     Total minimum lease payments........................   41,417     $29,264
                                                           -------     =======
Less amounts representing interest (at rates ranging from
  9% to 17%).............................................   16,027
                                                           -------
Net minimum lease payments...............................   25,390
Less current portion of obligations under capital
  leases.................................................    5,649
                                                           -------
Obligations under capital leases, excluding current
  portion................................................  $19,741
                                                           =======
</TABLE>

(10) COMMITMENTS AND CONTINGENCIES

PENSION AND PROFIT SHARING PLANS

     In 1995, the Company adopted a defined contribution 401(k) plan (the Plan).
Employees are eligible to participate in the Plan upon commencement of service.
Participants may defer up to 15% of eligible compensation. Currently, the
Company does not provide matching contributions for the Plan.

EMPLOYMENT AGREEMENTS

     The Company has entered into employment agreements with key members of
management. These agreements provide for certain payments in the event of death,
disability and change of control. The agreements also contain covenants not to
compete.

CONSTRUCTION CONTRACTS

     The Company has entered into an agreement to jointly construct a longhaul
fiber and conduit network system. Pursuant to the agreement, the Company is
committed to pay approximately $50,000 in construction costs during 1999. The
Company is party to various other construction contracts arising in the ordinary
course of business

(11) LEGAL PROCEEDINGS

(a) GLOBAL AND CURRENT AND FORMER OFFICERS AND DIRECTORS

     On October 20, 1998, the Company and GST Telecom, filed a Complaint in the
Superior Court of California, County of Santa Clara, against Global and six
current and former GST officers and directors (the Defendants). The Complaint
includes claims for fraud, negligent misrepresentation, unjust enrichment, and
unfair competition primarily related to the alleged misappropriation of a
Mexican business opportunity. The complaint seeks an accounting, a constructive
trust, and restitution of GST's interest in the opportunity and also seeks
unspecified exemplary and punitive damages and attorneys' fees.

     On December 23, 1998, Defendants filed a motion to stay or dismiss the
action on grounds of inconvenient forum, and four of the individual defendants
filed a motion to dismiss the action for lack of

                                      F-24
<PAGE>   48
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

personal jurisdiction. The Superior Court granted Defendants' motion to stay the
proceedings on February 5, 1999, and GST and GST Telecom filed a notice of
appeal on February 9, 1999.

     On January 27, 1999, Global and GST Mextel, Inc. ("Mextel") filed a
Complaint in the Supreme Court of British Columbia, against GST and GST Telecom.
The Complaint, which arises from the same matters for which GST and GST Telecom
brought such against Global et al. in the Superior Court of California, includes
claims for declaratory and injunctive relief and unspecified general and special
damages. The Company denies liability, and will vigorously dispute the
allegations in the Complaint.

     On January 28, 1999, five current or former GST officers or directors filed
a Complaint in the Supreme Court of British Columbia against the Company, GST
Telecom and four current GST directors. The Complaint, which arises from the
same matters for which GST and GST Telecom brought such against Global, et al,
in the Superior Court of California, includes claims for oppression and
declaratory relief, and seeks unspecified actual and punitive damages, cost, and
attorneys' fees. The Company and its directors deny liability, and will
vigorously dispute the allegations in the Complaint.

(b) DIRECTOR AND FORMER COUNSEL

     On December 16, 1998, GST, GST USA, Inc. (GST USA) and GST Telecom filed a
Complaint in the United States District Court, Southern District of New York,
against a current director and a law firm which previously represented the
Company as general counsel. The Complaint includes claims for professional
negligence, breach of fiduciary duty, and breach of contract, and seeks
compensatory damages and attorneys' fees.

     On February 12, 1999, the current director filed his Answer to the
Complaint. The law firm filed its Answer and Counterclaims to the Complaint on
February 17, 1999. The law firm counterclaimed against GST, GST USA and GST
Telecom for breach of contract, unjust enrichment, quantum meruit, and "account
stated," based on invoices submitted to GST of approximately $250. No trial date
has been set.

(c) FORMER CHAIRMAN AND CHIEF EXECUTIVE OFFICER

     On January 25, 1999, the Company's former Chairman and Chief Executive
Officer, filed a Complaint in the Superior Court of Washington, King County,
against GST, GST USA and GST Telecom. The Complaint, which relates to the
circumstances under which the former Chairman and Chief Executive Officer ceased
to serve as an officer and director of GST, includes claims for breach of
employment agreement, breach of the covenant of good faith and fair dealing,
violation of wage statutes, and indemnity.

     On February 23, 1999, the Company answered by denying all liability and
filed counterclaims against the former Chairman and Chief Executive Officer,
Global and five other current or former officers and directors for liability
with respect to the matters leading to the termination of the former Chairman
and Chief Executive Officer's employment. In particular, GST seeks recovery
under Washington law for matters described in note 11(a), above, as well as for
breaches committed with respect to the wrongful use of GST funds for the
purchase of telecommunications licenses.

(d) FORMER TREASURER

     On February 9, 1999, the Company filed a Complaint in the Superior Court
for the State of Washington, Clark County, against the former treasurer of the
Company. The Complaint is based on alleged misconduct and includes claims for
fraud, breach of fiduciary duty, unjust enrichment, and unfair business
practices, and seeks an accounting, imposition of a constructive trust,
compensatory damages, costs of suit, attorneys' fees, and treble damages. In
particular, the Complaint seeks relief based on misuse of insider information in
the purchase of stock, wrongful disbursements to third parties, and involvement
in a fraudulent release of stock from escrow. The defendant has not yet
responded to the Complaint.

                                      F-25
<PAGE>   49
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     Pursuant to the guidance set forth in SFAS 5, Accounting for Contingencies,
the Company has accrued certain loss provisions related to the legal proceedings
detailed above. In the opinion of management, the ultimate disposition of such
matters will not have a material adverse effect on the Company's consolidated
financial position, results of operations or cash flows.

     The Company is also involved in various other claims and legal actions
arising in the ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material effect on the
Company's consolidated financial position, results of operations or cash flows.

(12) RELATED PARTY TRANSACTIONS

MAGNACOM WIRELESS, LLC (MAGNACOM)

     In 1996, the Company and Magnacom, a company owned by the Company's former
Chairman and Chief Executive Officer, entered into a reseller agreement pursuant
to which (i) the Company was to become a reseller of PCS services in markets in
which Magnacom had obtained FCC licenses and (ii) Magnacom was to use the
Company to provide switched local and long distance services in markets where
the Company had operational networks. Pursuant to such agreement, the Company
paid Magnacom $200, $0, $8,403 and $5,997 during the year ended December 31,
1998, the three months ended December 31, 1997, and the years ended September
30, 1997 and 1996, respectively. In addition, the Company made operating
advances to Magnacom of $925, $91 and $52 during the year ended December 31,
1998, the three months ended December 31, 1997 and the year ended September 30,
1997, respectively.

     In October 1998, Magnacom filed a petition for reorganization under Chapter
11 of the United States Bankruptcy Code. Although the reseller agreement has not
been terminated, due to the bankruptcy filing and its status as an unsecured
creditor of Magnacom, the Company wrote-off all amounts previously paid to
Magnacom in the third quarter of 1998. The total write-off of approximately
$15,668 is included in special charges in the accompanying consolidated
statement of operations for the year ending December 31, 1998. At the time of
the write-off, the payments made pursuant to the reseller agreement were
included in "other assets, net" and the operating advances were included in
"prepaid and other assets." The losses resulting from the transactions with
Magnacom form the basis for certain of the legal proceedings described in notes
11(b), 11(c) and 11(d).

PACWEST NETWORK, INC. (PNI)

     The operations of the Company's Hawaiian microware network require the use
of radio licenses from the FCC. Such licenses are owned by PNI, a company
controlled by the Company's former Chairman and Chief Executive Officer. Under
agreements between the Company and PNI, (1) the Company pays a monthly fee to
PNI to utilize PNI's licenses for its communications traffic and (2) PNI pays an
equal monthly fee to the Company for the right to utilize the Company's
facilities for other communications traffic using up to 10% of PNI's license
capacity.

GLOBAL

     In a series of transactions during the third and fourth quarters of 1996,
the Company acquired 3,600,000 shares of Canadian Programming Concepts, Inc.
(CPC), a Canadian corporation which is publicly traded on the Vancouver Stock
Exchange, for consideration of $3,659. CPC's name was subsequently changed to
Global. The Company's shares constitute approximately 19% of Global's total
outstanding shares at December 31, 1998. Global owes the Company $456 at
December 31, 1998 for reimbursement of expenses made by the Company on behalf of
Global. As noted in note 11(a), the Company is currently in litigation with
Global.

                                      F-26
<PAGE>   50
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

TOMEN

     Under the Tomen facility, Tomen has the right to act as procurement agent
for each network project it finances. The Company has purchased equipment
through Tomen at competitive prices. Additionally, an up front fee of 1.50% of
the aggregate principal amount of each project loan advanced and a commitment
fee of .50% per annum on the unused portion of each project loan is payable to
Tomen.

     Pursuant to the Tomen agreements, Tomen has purchased 1,586,595 shares of
common stock for total cash consideration of $10,400 and holds a warrant to
purchase an additional 75,000 shares of common stock at $12.61 per share,
expiring in September 1999.

OTHER

     The Company paid approximately $1,929, $104, $2,066 and $2,264 in legal
fees during the year ended December 31, 1998, the three-month period ended
December 31, 1997 and the years ended September 30, 1997 and 1996, respectively,
to a law firm having a member who is a director of the Company. As noted in note
11(b), the Company is currently in litigation with both the director and the
related law firm.

     Prior to June 1997, the Company's former Chairman and Chief Executive
Officer served as a paid consultant to Tomen. Additionally, Pacwest received a
fee equal to 1% of the aggregate debt and equity financing provided by Tomen to
the Company through October 1997. Such fees incurred by the Company totaled $437
and $195 during the years ended September 30, 1997 and 1996.

(13) SEGMENTS

     The Company has adopted SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. As an integrated communications provider,
the Company has one reportable operating segment. While the Company's chief
decision-makers monitor the revenue streams of various services, operations are
managed and financial performance is evaluated based upon the delivery of
multiple services over common network and facilities. This allows the Company to
leverage its network costs in an effort to maximize return. As a result, there
are many shared expenses generated by the various revenue streams; because
management believes that any allocation of the expenses to multiple revenue
streams would be impractical and arbitrary, management does not currently make
such allocations internally. The chief decision-makers do, however, monitor
revenue streams at a more detailed level than those depicted in the Company's
historical general purpose financial statements. The following table presents
revenues by service type:

<TABLE>
<CAPTION>
                                                               THREE-MONTH         YEAR ENDED
                                                YEAR ENDED     PERIOD ENDED       SEPTEMBER 30,
                                               DECEMBER 31,    DECEMBER 31,    -------------------
                                                   1998            1997          1997       1996
                                               ------------    ------------    --------    -------
<S>                                            <C>             <C>             <C>         <C>
Local services...............................    $ 48,859        $ 7,034       $ 16,993    $ 3,934
Long distance services.......................      65,701         12,609         44,981     17,205
Data services................................       8,770          1,100          2,000         --
Internet services............................       8,404          1,013          3,006      1,311
Longhaul services............................      23,499          4,883         12,057      9,068
Product......................................       4,708          8,706         23,374      9,573
Other........................................       3,376            913          3,556        208
                                                 --------        -------       --------    -------
Total revenue................................    $163,317        $36,258       $105,967    $41,299
                                                 ========        =======       ========    =======
</TABLE>

     Substantially all of the Company's revenue is attributable to customers in
the United States. Additionally, all significant operating assets are located
within the United States.

                                      F-27
<PAGE>   51
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(14) SPECIAL CHARGES

     Special charges for the year ended December 31, 1998 consist of the
following:

<TABLE>
<S>                                                            <C>
Write-off of amounts paid to Magnacom pursuant to a reseller
  agreement.................................................   $      14,600
Write-off of operating advances paid to Magnacom............           1,068
Write-off of costs related to abandoned projects............           9,918
Impairment of assets........................................           3,881
                                                               -------------
     Non-cash special charges...............................          29,467
Accrual of severance-related costs..........................           1,113
                                                               -------------
     Total special charges..................................   $      30,580
                                                               =============
</TABLE>

     In 1998, the Company changed its strategic direction to focus on its core,
domestic business. In conjunction with the change, management identified certain
in-process network construction projects no longer considered useful due to
geographic location or technological compatibility. The write-off totalled
$9,918 and represented the entire amount of the costs related to these
in-process projects, including the costs of fiber optic networks and electronic
equipment. These assets had never been placed in service and, as such, were not
an integral part of the Company's ongoing operations. While the historical cost
of these assets has been written-off of the Company's December 31, 1998 balance
sheet, the Company holds these assets for disposal and is considering its
disposal alternatives for such assets.

     In conjunction with the change in strategic direction, management halted
further development of and investment in shared tenant services. The decision
resulted in an impairment charge of $2,728 for property, plant and equipment,
and $1,153 for customer lists associated with such services. At December 31,
1998, the Company held its shared tenant services assets for sell and
anticipates that it will sell the related operations and assets during 1999. The
impairment loss was measured as the amount by which the carrying amount of these
assets exceeded the estimated fair value of the assets, which was determined
based on current market prices for similar assets. The loss reserve was recorded
by increasing accumulated depreciation for the property, plant and equipment,
and accumulated amortization for the customer lists. The amount of the write-
off of customer lists represents the remaining unamortized balance of such
lists, which were related to the acquisition of Tri-Star (see Note 2). No
goodwill had been recorded in conjunction with the acquisition of Tri-Star.

     In the fourth quarter of 1998, management consummated a plan to
involuntarily terminate approximately 40 employees, including former members of
management, and to pay termination benefits to such employees. The Company does
not anticipate that the termination of these employees will have a material
impact on its business functions. At December 31, 1998, the Company had accrued
$1,113 in severance-related costs, the majority of which is expected to be paid
out in the first quarter of 1999.

     See footnote 12 for a discussion of the amounts paid to Magnacom.

     Of the special charges recorded for the year ended December 31, 1998, only
the severance costs are recorded as an accrued liability on the Company's
balance sheet as of December 31, 1998.

     Special charges for the year ended September 30, 1997 relate to a $7,445
non-cash compensation charge incurred when 750,000 common shares were released
from escrow to former members of management. This transaction is part of the
litigation described in note 11(d).

                                      F-28
<PAGE>   52
                          GST TELECOMMUNICATIONS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(15) FAIR VALUE OF FINANCIAL INSTRUMENTS

     The carrying amounts reported in the balance sheet for cash and cash
equivalents, accounts and notes receivable, accounts payable and accrued
expenses approximate fair values due to the short term maturities of those
instruments. The carrying amounts for current and non-current restricted
investments approximate fair value due to the composition of such investments
and the related maturities. The carrying amount of unrestricted investments is
based upon fair value as determined by quoted market prices.

     The following table details the carrying amounts and estimated fair values
of long-term debt and redeemable preference shares (the financial instruments
for which carrying value and estimated fair value differ at December 31, 1998):

<TABLE>
<CAPTION>
                                                               DECEMBER 31, 1998
                                                              --------------------
                                                              CARRYING      FAIR
                                                               AMOUNT      VALUE
                                                              --------    --------
<S>                                                           <C>         <C>
Long-term debt:
  Senior secured notes, 13.25%..............................  $265,000    $273,933
  Senior secured discount notes, 10.5%......................   320,997     239,555
  Senior discount notes, 13.875%............................   240,304     228,415
  Convertible senior subordinated Discount notes, 13.875%...    29,884      28,406
  Senior subordinated accrual notes, 12.75%.................   144,000     133,920
Redeemable preference shares, 11.875%.......................    61,741      54,950
</TABLE>

     The fair value of publicly traded long-term debt is estimated based on
quoted market prices. For substantially all other long-term debt, carrying
amounts approximate fair values as incremental borrowings available to the
Company are at similar rates and terms. The fair value of redeemable preference
shares is estimated based upon rates available to the Company for redeemable
preferred equity with similar maturities and features.

     Fair value estimates are made at a specific point in time based on relevant
market information about the financial instrument. These estimates are
subjective in nature and involve uncertainties and matters of significant
judgment and therefore cannot be determined with precision. Changes in
assumptions could significantly impact the estimates.

                                      F-29
<PAGE>   53

                          INDEPENDENT AUDITORS' REPORT

The Board of Directors and Shareholders
GST Telecommunications, Inc.:

     Under date of March 1, 1999, we reported on the consolidated balance sheets
of GST Telecommunications, Inc. and subsidiaries as of December 31, 1998 and
1997, and the related consolidated statements of operations, shareholders'
(deficit) equity, and cash flows for the year ended December 31, 1998, the
three-month period ended December 31, 1997, and for each of the years in the
two-year period ended September 30, 1997, which are included in the annual
report on Form 10-K for the year ended December 31, 1998. In connection with our
audits of the aforementioned consolidated financial statements, we also have
audited the related consolidated financial statement schedule as listed in the
accompanying index. This financial statement schedule is the responsibility of
the Company's management. Our responsibility is to express an opinion on this
financial statement schedule based on our audits.

     In our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.

                                          /s/ KPMG PEAT MARWICK LLP

Portland, Oregon
March 1, 1999

                                       S-1
<PAGE>   54

                          GST TELECOMMUNICATIONS, INC.

                       VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
                                                  BALANCE AT      CHARGED      WRITTEN OFF    BALANCE AT
                                                  BEGINNING     TO BAD DEBT      AGAINST         END
ALLOWANCE FOR DOUBTFUL ACCOUNTS                   OF PERIOD       EXPENSE        EXPENSE      OF PERIOD
-------------------------------                   ----------    -----------    -----------    ----------
<S>                                               <C>           <C>            <C>            <C>
Year ended December 31, 1998....................    3,956          4,776          3,250         5,482
Three months ended December 31, 1997............    3,582          1,541          1,167         3,956
Year ended September 30, 1997...................    1,264          5,737          3,419         3,582
Year ended September 30, 1996...................    1,402          1,809          1,947         1,264
</TABLE>

                                       S-2
<PAGE>   55

                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of Vancouver, State of Washington, on the 29th day of June, 1999.

                                          GST TELECOMMUNICATIONS, INC.

                                          By:                  *
                                            ------------------------------------
                                                     Robert A. Ferchat,
                                                   Chairman of the Board

     Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been duly signed by the following persons in the
capacities and on the dates indicated.

<TABLE>
<CAPTION>
                  SIGNATURE                                     TITLE                        DATE
                  ---------                                     -----                        ----
<C>                                              <S>                                     <C>

                      *                          Chairman of the Board and Director      June 29, 1999
---------------------------------------------
             (Robert A. Ferchat)

                      *                          President, Chief Executive Officer      June 29, 1999
---------------------------------------------      (Principal Executive Officer) and
             (Joseph A. Basile)                    Director

           /s/ DANIEL L. TRAMPUSH                Senior Vice President and Chief         June 29, 1999
---------------------------------------------      Financial Officer (Principal
            (Daniel L. Trampush)                   Financial Officer)

                      *                          Treasurer (Principal Accounting         June 29, 1999
---------------------------------------------      Officer)
             (Michael R. Vestal)

                      *                          Director                                June 29, 1999
---------------------------------------------
               (Stanley Beck)

                      *                          Director                                June 29, 1999
---------------------------------------------
              (George B. Cobbe)

                      *                          Director                                June 29, 1999
---------------------------------------------
            (Joseph G. Fogg, III)

                      *                          Director                                June 29, 1999
---------------------------------------------
             (David W. Garrison)

                      *                          Director                                June 29, 1999
---------------------------------------------
              (A. Roy Megarry)

         *By:/s/ DANIEL L. TRAMPUSH
   ---------------------------------------
             Daniel L. Trampush
              Attorney-in-fact
</TABLE>
<PAGE>   56
                                EXHIBIT INDEX

Exhibit                 Description
  No.

<TABLE>
<S>     <C>
(a)(1)  Consolidated Financial Statements: see the Index to
        Consolidated Financial Statements.
 (2)    Financial Statement Schedule: see page S-1.
 (3)    Exhibits:
 3(a)   Certificate of Incorporation of the Company, as amended to
        date, incorporated by reference to Exhibit 3(a) to the
        Company's Form 10-K for the fiscal year ended September 30,
        1996, as amended (the "1996 Form 10-K").
 3(b)   By-Laws of the Company as amended to date, incorporated by
        reference to Exhibit 3.1 to the Company's Form S-3 (No.
        333-38091) (the "Form S-3").
 4(a)   Senior Notes Indenture dated as of December 19, 1995, by and
        among GST USA, Inc., the Company and United States Trust
        Company of New York, incorporated by reference to Exhibit
        2.3 to the Company's Form 20-F for the fiscal year ended
        September 30, 1995 (the "1995 Form 20-F").
 4(b)   Convertible Notes Indenture dated as of December 19, 1995,
        by and among the Company, GST USA, Inc. and United States
        Trust Company of New York, incorporated by reference to
        Exhibit 2.4 to the 1995 Form 20-F.
 4(c)   Indenture dated as of May 13, 1997, by and among GST
        Equipment Funding, Inc., the Company, GST USA, Inc. and
        United States Trust Company of New York, incorporated by
        reference to Exhibit 10.2 to the Company's Form 10-Q for the
        period ended June 30, 1997 (the "June 1997 10-Q").
 4(d)   Indenture dated as of November 19, 1997, by and between the
        Company and United States Trust Company of New York,
        incorporated by reference to Exhibit 4.1 to the Company's
        Form S-3 (No. 333-38301) (the "Debt Form S-3").
 4(e)   Indenture dated May 4, 1998 by and among GST
        Telecommunications, Inc., GST USA, Inc., GST Network
        Funding, Inc. and the United States Trust Company of New
        York, as trustee, incorporated by reference to Exhibit 4.1
        of the Company's Form 8-K filed May 19, 1998.
10(a)   1995 Stock Option Plan of the Company, as amended to date;
        incorporated by reference to Exhibit 10(a) to the Company
        Form 10-K for the fiscal year ended September 30, 1997 (the
        "1997 Form 10-K").
10(b)   1996 Stock Option Plan of the Company, as amended to date,
        incorporated by reference to Exhibit 10(b) to the 1997 Form
        10-K.
10(c)   1996 Employee Stock Purchase Plan of the Company,
        incorporated by reference to Exhibit 10(c) to the 1997 Form
        10-K.
10(d)   1996 Senior Executive Officer Stock Option Plan of the
        Company, incorporated by reference to Exhibit 10(d) to the
        1997 Form 10-K.
10(e)   1996 Senior Operating Officer Stock Option Plan of the
        Company, incorporated by reference to Exhibit 10(e) to the
        1997 Form 10-K.
10(f)   Amended and Restated Credit Agreement dated as of April 26,
        1995, by and between GST Pacific Lightwave, Inc. and Tomen
        America Inc., incorporated by reference to Exhibit 1.2 to
        the 1995 Form 20-F.
10(g)   Collateral Pledge and Security Agreement dated as of May 13,
        1997, by and among GST Equipment Funding, Inc., United
        States Trust Company of New York and the holders of the
        Notes as defined therein, incorporated by reference to
        Exhibit 10.4 to the June 1997 Form 10-Q.
</TABLE>


<PAGE>   57
                                EXHIBIT INDEX

Exhibit                  Description
   No.

<TABLE>
<S>     <C>
10(h)   Amended and Restated Master Agreement dated as of May 24,
        1996, by and among Tomen America Inc., the Company, GST
        Telecom Inc., GST Pacific Lightwave, Inc., Pacwest Network
        L.L.C., Pacwest Network Inc., GST Tucson Lightwave, Inc. and
        GST New Mexico Lightwave, Inc., incorporated by reference to
        Exhibit 10(l) to the 1996 Form 10-K.
10(i)   Credit Agreement dated as of May 24, 1996, by and between
        GST New Mexico Lightwave, Inc. and TM Communications LLC,
        incorporated by reference to Exhibit 10(n) to the 1996 Form
        10-K.
10(j)   Credit Agreement dated as of May 24, 1996, by and between
        GST Tucson Lightwave, Inc. and TM Communications LLC,
        incorporated by reference to Exhibit 10(o) to the 1996 Form
        10-K.
10(s)   Employment Agreement dated March 11, 1997, by and between
        GST USA, Inc. and Joseph Basile, Jr, incorporated by
        reference to Exhibit 10.1 to the Company's Form 10-Q for the
        period ended March 31, 1997 (the "March 1997 10-Q").
10(t)   Employment Agreement dated February 10, 1997, by and between
        GST USA, Inc. and GST Telecom Inc. and Daniel L. Trampush,
        incorporated by reference to Exhibit 10.2 to the March 1997
        Form 10-Q.
10(u)   Reseller Agreement dated as of October 30, 1996, by and
        between Magnacom Wireless, L.L.C., and GST Telecom Inc.,
        incorporated by reference to Exhibit 10(z) to the 1996 Form
        10-K.
10(w)   Agreement and Plan of Merger dated as of May 31, 1997, by
        and among Action Telcom Co., Britt E. Bilberry, Timothy
        Harding Bilberry, Paul S Bilberry, GST Action Telecom, Inc.
        and the Company, incorporated by reference to Exhibit 2.1 to
        the Company's Form 8-K dated May 31, 1997.
10(x)   Equipment Loan and Security Agreement dated December 19,
        1996 by and between NTFC Capital Corporation and GST
        Equipco, incorporated by reference to Exhibit 10(v) to the
        1996 Form 10-K.
10(y)   Loan and Security Agreement dated as of September 4, 1996 by
        and between Siemens Stromberg-Carlson ("Siemens") and GST
        Switchco, Inc. ("GST Switchco"), incorporated by reference
        to Exhibit 10(d) to the Company's Form 10-Q for the period
        ended December 31, 1996 (the "December 1996 Form 10-Q").
10(z)   Unconditional Continuing Guaranty dated as of September 4,
        1996 by and between Siemens and GST USA, Inc., incorporated
        by reference to Exhibit 10(e) to the December 1996 Form
        10-Q.
10(aa)  Unconditional Limited Guaranty Agreement dated as of
        December 19, 1996 made by GST USA, Inc., in favor of NTFC
        Capital Corporation, incorporated by reference to Exhibit
        10(f) to the December 1996 Form 10-Q.
10(bb)  Securities Purchase Agreement, dated as of February 28,
        1997, between the Company and Ocean Horizon SRL,
        incorporated by reference to Exhibit 4.1 to the Company's
        Form 8-K dated February 28, 1997 (the "February Form 8-K").
10(cc)  Securityholders Agreement, dated as of February 28, 1997,
        between the Registrant and Ocean Horizon SRL, incorporated
        by reference to Exhibit 4.2 to the Company's February Form
        8-K.
10(dd)  Credit Agreement dated as of September 30, 1997 by and
        between GST Telecom Hawaii, Inc. and TM Communications
        Hawaii LLC, incorporated by reference to Exhibit 99.1 to the
        Company's Form 8-K dated September 30, 1997 (the "September
        8-K").
10(ee)  Service Agreement dated as of September 30, 1997 by and
        between Pacwest Network, Inc. and GST Telecom Hawaii, Inc,
        incorporated by reference to Exhibit 99.2 to the September
        8-K.
10(ff)  Management Agreement dated as of September 30, 1997 by and
        between Pacwest Network, Inc. and GST Telecom Hawaii, Inc.,
        incorporated by reference to Exhibit 99.3 to the September
        8-K.
</TABLE>


<PAGE>   58
                                EXHIBIT INDEX

Exhibit              Description
  No.

<TABLE>
<S>     <C>
10(gg)  Agreement dated as of September 30, 1997 by and among GST
        Telecom Hawaii, Inc., GST Telecom Inc. and Pacwest Network,
        Inc., incorporated by reference to Exhibit 99.4 to the
        September 8-K.
10(hh)  Stock Purchase Agreement dated December 31, 1997 by and
        among GST Telecommunications, Inc., GST USA, Inc. and World
        Access, Inc., incorporated by reference to Exhibit 99.2 to
        the Company's Form 8-K dated January 6, 1998.
10(ii)  1997 Stock Option Plan of the Company, as amended to date,
        incorporated by reference to Exhibit (ii) to the 1997
        transition report on Form 10-K for the three month period
        ended December 31, 1997.
10(jj)  Placement Agreement dated April 29, 1998 by and among GST
        Telecommunications, Inc., GST USA, Inc., GST Network
        Funding, Inc, and the several Placement Agents named in
        Schedule I thereto, incorporated by reference to Exhibit
        10.1 to the Company's Form 8-K filed May 19, 1998.
10(kk)  Registration Rights Agreement dated May 4, 1998 by and among
        GST Telecommunications, Inc., GST USA, Inc., GST Network
        Funding, Inc. and Morgan Stanley & Co. Incorporated, Bear,
        Stearns & Co. Inc., Credit Suisse First Boston Corporation
        and SBC Warburg Dillon Read Inc., incorporated by reference
        to Exhibit 10.2 to the Company's Form 8-K filed May 19,
        1998.
10(ll)  Collateral Pledge and Security Agreement dated as of May 4,
        1998 from GST Network Funding, Inc. to United States Trust
        Company of New York, as trustee, incorporated by reference
        to Exhibit 10.3 to the Company's Form 8-K filed May 19,
        1998.
10(mm)  Reimbursement and Commitment Fee Agreement dated May 4, 1998
        among GST Telecommunications, Inc., GST USA, Inc. and GST
        Network Funding, Inc., incorporated by reference to Exhibit
        10.4 to the Company's Form 8-K filed May 19, 1998.
10(nn)  Employment Agreement dated March 3, 1999, effective as of
        October 20, 1998, by and between GST USA, Inc. and Joseph A.
        Basile, Jr.
 21     Subsidiaries of the Company.
*23     Consent to the incorporation by reference in the Company's
        Registration Statements on Forms S-3 and S-8 of the
        independent auditors' report included herein.
 27     Financial Data Schedule.
</TABLE>

---------------
* Filed herewith.