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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
(MARK ONE)
[ ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (12g) OF THE SECURITIES
EXCHANGE ACT OF 1934 OR
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED] FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM
TO
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 333-5396-02
NWE CAPITAL (CYPRUS) LIMITED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
REPUBLIC OF CYPRUS
(JURISDICTION OF INCORPORATION OR ORGANIZATION)
STASSINOS COURT
CORNER STASSINOS AVENUE AND ST. HELENS STREET, NO. 2
3RD FLOOR
NICOSIA, CYPRUS
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
SECURITIES REGISTERED OR TO BE REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
<TABLE>
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TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
<S> <C>
NONE NONE
</TABLE>
SECURITIES REGISTERED OR TO BE REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE
(TITLE OF CLASS)
SECURITIES FOR WHICH THERE IS A REPORTING OBLIGATION PURSUANT TO SECTION 15(d)
OF THE ACT:
GUARANTEE OF THE OUTSTANDING 14% SENIOR DISCOUNT NOTES DUE 2004 OF PLD TELEKOM
INC.
GUARANTEE OF THE OUTSTANDING 9% CONVERTIBLE SUBORDINATED NOTES DUE 2006 OF PLD
TELEKOM INC.
(TITLE OF CLASS)
Indicate the number of outstanding shares of each of the issuer's classes
of capital or common stock at of the close of the period covered by the annual
report: 3,246,174 shares of Common Stock.
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 [ ]
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NWE CAPITAL (CYPRUS) LIMITED
FORM 20-F ANNUAL REPORT FOR FISCAL YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
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PART I
Item 1. Description of Business..................................... 1
Item 2. Description of Property..................................... 35
Item 3. Legal Proceedings........................................... 35
Item 4. Control of Registrant....................................... 35
Item 5. Nature of Trading Market.................................... 35
Item 6. Exchange Controls and Other Limitations Affecting Security
Holders..................................................... 36
Item 7. Taxation.................................................... 38
Item 8. Selected Financial Data..................................... 38
Item 9. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 39
Item 9A. Quantitative and Qualitative Disclosure About Market Risk... 45
Item 10. Directors and Officers of the Registrant.................... 45
Item 11. Compensation of Directors and Officers...................... 46
Item 12. Options to Purchase Securities from Registrant or
Subsidiaries................................................ 46
Item 13. Interest of Management in Certain Transactions.............. 46
PART II
Item 14. Description of Securities to be Registered.................. 46
PART III
Item 15. Defaults Upon Senior Securities............................. 46
Item 16. Changes in Securities, Changes in Security for Registered
Securities and Use of Proceeds.............................. 46
PART IV
Item 17. Financial Statements........................................ 46
Item 19. Financial Statements and Exhibits........................... 47
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
OVERVIEW
NWE Capital (Cyprus) Limited (the "Company") is a wholly owned subsidiary
of PLD Telekom Inc. ("PLD") which serves as a holding company for certain of
PLD's interests in telecommunications companies in the Russian Federation and
Kazakhstan. Through the Company, PLD holds (i) a 60% interest in PeterStar
Company Limited ("PeterStar"), which provides integrated local, long distance
and international telecommunications services in St. Petersburg through a fully
digital fiber optic network; (ii) a 50% interest in ALTEL (known until May 1998
as BECET International), which provides national cellular service in Kazakhstan;
and (iii) a 100% interest in C.P.Y. Yellow Pages Ltd. ("Yellow Pages"), which
publishes a yellow pages directory in St. Petersburg.
The Company is subject to the periodic reporting requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), solely because
of the guarantees it has issued in respect of PLD's outstanding 14% Senior
Discount Notes due 2004 (the "Senior Notes") and 9% Convertible Subordinated
Notes due 2006 (the "Convertible Notes"). Upon the completion of PLD's merger
with Metromedia International Group, Inc. described below under "PLD Telekom
Inc.", the Company's guarantees will be terminated and it will cease to be
subject to the periodic reporting requirements of the Exchange Act.
The Company conducts no business other than the holding of its interests in
PeterStar, ALTEL and Yellow Pages.
PLD TELEKOM INC.
PLD, through its operating subsidiaries, is a major provider of local, long
distance and international telecommunications services in the Russian
Federation, Kazakhstan and Belarus. PLD's five principal operating businesses
are: (i) PeterStar; (ii) Technocom Limited ("Technocom"), which, through
Teleport-TP, provides dedicated international telecommunications services to
Russian and foreign businesses in Moscow and operates a satellite-based
pan-Russian long distance network; (iii) Baltic Communications Limited ("BCL"),
which provides dedicated international telecommunications services in St.
Petersburg; (iv) ALTEL; and (v) Belarus-Netherlands Belcel Joint Venture
("BELCEL"), which provides the only national cellular service in Belarus. In
addition, PLD is developing a portfolio of international long distance products
and services, under the name "PLDncompass", targeted at carriers and corporate
customers in the United States, the United Kingdom and Europe which require
telecommunications services to and from the countries of the former Soviet
Union. PLD's Common Stock is traded on the Nasdaq National Market under the
symbol "PLDI" and the Toronto Stock Exchange under the symbol "PLD".
In August 1998, News America Incorporated, through an affiliate ("News"),
acquired a 38% stake in PLD in a series of transactions with PLD and Cable and
Wireless plc ("Cable & Wireless"). Prior to the completion of these
transactions, Cable & Wireless had been, since 1994, PLD's principal
shareholder. As part of these transactions, PLD acquired an additional 11%
interest in PeterStar and its 50% interest in BELCEL.
On May 18, 1999, PLD entered into an agreement (the "Merger Agreement")
with Metromedia International Group, Inc. ("MMG") pursuant to which PLD would
merge with Moscow Communications, Inc., a newly formed, wholly owned subsidiary
of MMG. Upon consummation of the merger, PLD will become a wholly owned
subsidiary of MMG, and the holders of shares of common stock of PLD will receive
shares of MMG on the basis of an exchange ratio specified in the Merger
Agreement.
In connection with the merger, PLD's existing Senior Notes and Convertible
Notes, which are currently guaranteed by the Company, will be exchanged for
senior indebtedness of MMG and the Company's guarantees will be terminated. The
new MMG notes will not be guaranteed by the Company or any other subsidiary of
PLD.
MMG is a global communications company engaged in the development and
operation of a variety of communications businesses, including cellular
telecommunications, fixed telephony, international and long distance telephony,
cable television, paging and radio broadcasting, in Eastern Europe, the former
Soviet Union,
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China and other selected emerging markets. Its common stock is listed on the
American and Pacific Stock Exchanges, under the symbol MMG.
TELECOMMUNICATIONS IN THE FORMER SOVIET UNION
In the Soviet era, telecommunications in the Russian Federation and other
republics of the former Soviet Union were government owned and designed
principally to serve the defense and security needs of the state. The telephone
network itself was highly centralized, reflecting the centralized nature of the
Soviet economy. Telephonic links were directed towards the center of the network
while neglecting inter-regional links. As a result, the ability to direct calls
between regions without going through the center remains limited, which in turn
has been a major constraint on economic growth in regional markets. Being
committed to a "hub and spoke" network, the former Soviet Union never developed
a trunk "backbone" capable of providing network expansion on a nationwide basis.
Consistent with a political philosophy which limited access to the world
outside the former Soviet Union, all international calls originating in the
former Soviet Union until 1992 were routed through a single international
exchange in Moscow which had a capacity of only 3,200 circuits. Due to the
inadequacies of the public network, as well as to ensure secrecy, many
individual ministries and security organizations, including the Communist Party
itself, established their own private nationwide networks. These private
networks absorbed a substantial amount of the relatively limited resources
available for investment in telecommunications. At the same time, these networks
currently present an opportunity for the development of a national network apart
from the existing public network.
With the break-up of the Soviet Union and the liberalization of the
economies of its former republics, the demand for telecommunications services
increased significantly. However, the governments of the countries of the former
Soviet Union did not have the significant capital necessary for the development
of the telecommunications infrastructure. As a result, they have actively
encouraged market liberalization, privatization and foreign investment in the
telecommunications sector. This has resulted in significant development in the
areas of fixed wire overlay systems, private networks and cellular and data
services. They have also made their own efforts to develop a basic
telecommunications infrastructure, but lack of capital, exacerbated by recent
difficult economic conditions, has made progress towards this goal slow.
TELECOMMUNICATIONS IN THE RUSSIAN FEDERATION
The Russian telecommunications sector has experienced substantial
difficulty in meeting the rapidly growing demand for telecommunications services
in the Russian Federation. At the local level, there has been a significant
growth in joint ventures providing discrete telecommunications services, such as
international access and cellular service. While the bulk of this activity has
been in Moscow and St. Petersburg, it has occurred in other regions as well.
This trend has been encouraged by the Russian government which has issued over
10,000 licenses through the Ministry of Communications of the Russian Federation
(the "Former MOC") (which as of March 17, 1997 has been replaced by the Russian
Federal Committee on Telecommunications and Informatics (the "RFCTI")) to these
new service providers. Most joint ventures involve a Russian and a foreign
partner. Many of these joint ventures have remained moribund; however, where
they have commenced operations, there has been an immediate improvement in
telecommunications services in the targeted areas. Since much of the marketing
activity has been aimed at the business community, the benefits of these
improvements have not been (and for the foreseeable future are not likely to be)
widely felt by residential customers, particularly those outside major
metropolitan areas.
When the Former MOC was reorganized in 1991, the Russian government decided
to convert each regional telephone center into a separate, privatized company
with the government maintaining the controlling interest in the company. There
are 89 of these regional telephone companies. The government's interests in most
of these companies are now held through Sviazinvest.
The national and international long distance market in the Russian
Federation is dominated by Rostelecom, a formerly state-owned enterprise which
has been privatized, but in which the Russian government continues to hold a 38%
equity and 51% voting interest through Sviazinvest. Until 1991, Rostelecom was
the monopoly
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provider of national and international long distance service. Since then, the
Former MOC has issued licenses to approximately twenty other providers of
international services. Rostelecom itself has entered into a number of joint
ventures to develop its network and services, including through its
participation in Teleport-TP.
Sviazinvest, which was originally 100% owned by the Russian State Property
Committee (now the Ministry of State Property), is a holding company for the
Russian government's interests in the local and regional telephone companies
across the Russian Federation. In general, Sviazinvest has a portfolio that
comprises holdings of 35% of the equity interest and 51% of the voting
interests, with a number of notable exceptions, in these telephone companies.
Sviazinvest is represented on the board of directors of each of these companies,
but does not participate in the day-to-day management of the operations.
In 1997, it was reported that, notwithstanding previously announced plans
to have Sviazinvest compete with Rostelecom, the Russian government had
consolidated its telecommunications holdings in Sviazinvest and Rostelecom by
transferring its shareholding in Rostelecom (38% of the common stock, and 51% of
the voting stock) to Sviazinvest. The balance of the shares in Rostelecom remain
in the hands of private investors. In April 1997, the government announced that
it was seeking to sell 49% of Sviazinvest in two auctions, one as to a 25% stake
open to Russian and foreign investors and the other as to a 24% stake open only
to Russian investors. In July 1997, the government announced that the 25% stake
had been sold to a consortium which included Oneximbank and Renaissance Capital,
for a purchase price of $1.875 billion. Following this auction, the Russian
government announced its intention to increase the size of the other stake being
sold to 25% minus two shares. The schedule for the sale of the second stake has
been delayed following the August 1998 financial crisis, and the structure of
any such sale (including whether foreign participation will be permitted) has
not been announced. While it is not yet clear how the proceeds of this sale will
be employed, it is understood that the government wishes to have a substantial
part, if not all, of the proceeds allocated to its current budget deficit. Prior
to the August 1998 crisis, Sviazinvest had announced plans to raise $400 million
through a Eurobond offering in 1998, but that offering was also delayed as a
result of the Russian financial crisis. In light of all of the foregoing, it is
unclear what impact the consolidation of the government's telecommunications
holdings and the auction of significant stakes in Sviazinvest will have on the
Russian telecommunications market in general and the Company in particular.
The provision of telecommunications services is currently regulated by the
Law on Telecommunications which came into effect on February 22, 1995 (the
"Telecommunications Law"). While the Former MOC had significant regulatory
powers prior to the passage of the Telecommunications Law, principally through
the issuance of new licenses, telecommunications had traditionally been viewed
as the province of the military and security services. The Telecommunications
Law placed control of the Russian telecommunications network (except for the
networks of the government, military and security forces) in the hands of a
civilian regulatory authority. Under the Telecommunications Law, the Former MOC
was, and now the RFCTI is, charged with the responsibility of coordinating the
development of telecommunications in the Russian Federation and regulating the
provision of services. Specifically, the Former MOC was and now the RFCTI is,
given authority to issue telecommunications licenses, allocate frequencies and
certify equipment for use in Russia. The Telecommunications Law also establishes
a number of important principles in the telecommunications area, including the
guarantee of equal access for all providers of telecommunications services and
safeguards for private business activity in the telecommunications sector. The
Telecommunications Law extends these principles to foreign companies and
individuals, thereby recognizing the need to encourage foreign participation in
the development of the Russian telecommunications sector.
The Federal Committee for Regulating Natural Monopolies in
Telecommunications (now under the government of the Russian Federation) has been
empowered to regulate international and, since mid-1997, domestic long distance
tariffs, together with interconnect fees for public operators in the Russian
Federation. In addition, this Committee has the authority to establish the
framework for local fees and tariffs which, in the future, will be regulated by
newly-established Regional Committees for Regulating Natural Monopolies. At the
current time, regional governments set and regulate local tariffs, and it is
currently uncertain as to how, and when, local tariff regulation will be
transferred to the Regional Committees. While the Company's businesses are not
public operators and will therefore not be directly affected by any tariff
regulation imposed by the Federal or
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Regional Committees, their own pricing policies are inevitably influenced by the
tariffs charged by public operators.
While the RFCTI appears to have succeeded to all of the powers and
authorities of the Former MOC (with the exception of tariff regulation), it is
not yet clear whether it will in fact continue to operate in the same manner,
and wield the same influence as the Former MOC. In particular, it is not clear
whether the RFCTI will be able to control the actions of local governmental and
other regulatory authorities who may endeavor to impose their own informal
licensing and other regulatory requirements or conditions on operators. In
addition, in the area of tariff regulation, it is not yet clear how the various
Committees will interact with the regional governments, and the regional
governments may continue to seek to regulate tariffs in their regions. See "Risk
Factors -- Risks Involving the Company -- Regulatory Uncertainties."
St. Petersburg. The telephone network serving St. Petersburg is operated by
Petersburg Telephone Network ("PTN"), the local telephone company which was
privatized in May 1993. PTN has 1,800,000 lines in operation, amounting to a
nominal penetration rate of 36%. PTN's intra-city traffic is carried through a
network of thirty-four transit exchanges distributed throughout St. Petersburg
and all connected to each other in a "cobweb" fashion. The existing PTN network
is outdated and overloaded, producing congestion, interference, "crossed lines"
and poor transmission quality. Only 23% of PTN's exchanges are
digital/electronic, and some of its equipment is over 40 years old. PTN has
recently installed a modern fiber optic loop which, once fully operational, will
significantly enhance its ability to deliver traffic throughout its service
area. PTN has also entered into a number of other, primarily wireless,
telecommunications joint ventures.
PTN routes long distance traffic through a gateway exchange operated by St.
Petersburg Intercity and International Telephone ("SPMMTS"). This traffic is
then passed to the Rostelecom long distance network for delivery throughout the
rest of the Russian Federation and the other countries of the former Soviet
Union. PLD held a 10.4% equity interest in SPMMTS from 1994 to June 1997.
SPMMTS is the gateway for international calls to and from St. Petersburg.
SPMMTS has a number of options for the forwarding of international calls. Such
calls can be directed to an international gateway owned by St. Petersburg
International ("SPI"), a joint venture between British Telecommunications plc
("BT") and SPMMTS which has satellite connections to the UK. In addition, SPMMTS
has access, via Rostelecom, to the undersea cable between Russia and Denmark for
international traffic. Finally, SPMMTS has the option to route international
traffic through the international gateway in Moscow. In addition to SPMMTS,
there are several independent dedicated networks which provide international
telecommunications access in St. Petersburg, including BCL. Under the terms of
its license, PeterStar is required to route its long distance and international
traffic via the public network gateway.
The telecommunications market in St. Petersburg also supports three
cellular operators (two analog and one digital) and a number of paging networks.
In 1994, PTN and SPMMTS formed Telecominvest, originally as a joint venture
to act as a holding company for their respective interests in a number of
telecommunications ventures in Northwest Russia. Subsequently, in 1996, a
Commerzbank affiliate acquired a 51% interest in Telecominvest. Currently
Telecominvest owns 29% of PeterStar, 31% of North West GSM ("NW GSM"), the
digital 900 MHZ operator for St. Petersburg, 49% of Neva Cable and 5% of Neda
Paging. It is understood that PTN intends to transfer all or part of its
interests in Delta Telecom and Neda Paging to Telecominvest, subject to final
agreement with their joint venture partners. Although as a result of this
activity Telecominvest will hold interests in regional cellular operators which
are customers of PeterStar, as well as other ventures which may be possible
customers for PeterStar, it is unclear what the exact nature of Telecominvest's
plans are with respect to these holdings or how such plans will affect
PeterStar.
TELECOMMUNICATIONS IN KAZAKHSTAN
At the time of Kazakhstan's independence in 1991, the Kazakh telephone
system consisted of the same outdated network equipment as the other telephone
systems in the former Soviet republics. Currently, only 11% of Kazakhstan's
population of approximately 17,000,000 has telephone lines. The existing
national telephone
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network consists of approximately 1,900,000 lines, of which 330,000 are in
Almaty. Due to the poor condition of much of the telecommunications
infrastructure in Kazakhstan, basic telephone service is characterized by poor
transmission quality. However, some modernization has taken place during the
last few years and quality is improving. While the installed exchange switching
capacity has not increased significantly, the introduction of digital exchanges
will make for easier future expansion.
The national network is served by trunk switches in what were the 19
original regional centers throughout the country. New transit switches supplied
by Alcatel, Lucent and others have been installed in 15 of the 19 regional
centers, and three more will be installed by the summer of 1999. Some digital
local exchanges have been installed in 16 of the regional centers, although many
electromechanical exchanges are expected to remain in use throughout the country
for some time.
While the majority of inter-regional transmission capacity is still analog,
a limited amount of digital transmission has been added over some routes. Low
capacity digital microwave has been introduced on several routes, and a high
capacity microwave has been installed between Astana and Petropavlovsk. The
existing fiber optic cable between Astana and Karaganda will be extended to
Almaty by the summer of 1999, and there is a fiber optic spur from Petropavlovsk
to Omsk connecting to the Vladivostok-Moscow-Europe cable.
Until 1992, the sole means of international access to and from Kazakhstan
was through a central switch located in Moscow. Kazakhstan acquired its own
international gateway in August 1992 when a new AT&T 5ESS switch was installed
in Almaty. It now has approximately 800 direct international circuits via
satellite with 22 countries, including the United States, Japan, Australia,
Germany, France, Israel and Turkey and via analog cables to Moscow. Kazakhstan
is also participating in the fiber optic link between China and the countries of
Central Asia and Europe, and this system is already being used to provide
inter-regional capacity between Almaty, Taraz and Chimkent.
The Kazakh Law on Enterprises dated February 13, 1991 authorizes the
Cabinet of Ministers to issue licenses for certain types of activities in
Kazakhstan, including the provision of telecommunications services. The Cabinet
of Ministers delegated the authority to license telecommunication providers,
allocate frequencies and certify telecommunications equipment to the Kazakh
Ministry of Transport and Communications (the "KMOC"). Pursuant to this
delegation of authority, the KMOC adopted temporary procedures for the
consideration of applications for and the issuance of such licenses. In April
1995, President Nazarbayev issued a decree setting forth the licensing
procedures in greater detail. The decree also confirmed the authority of the
Cabinet of Ministers to grant licenses and the right of non-Kazakh companies and
individuals to equal treatment in the granting of licenses. However, apart from
these licensing procedures, there is virtually no other regulation in the
telecommunications sector, and no comprehensive regulatory framework.
Administration of the telecommunications sector is essentially left to the
discretion of the KMOC.
Actual operation of the public telephone network is carried out by
Kazakhtelekom, which was created for this purpose in June 1994, as well as
regional operators. A variety of functions previously carried out by other
governmental entities, including representation of the Kazakh government in
international telecommunications matters and the planning and development of the
network in Kazakhstan, have been transferred to Kazakhtelekom. Kazakhtelekom has
been granted a revised license giving it specific authority to act as the
exclusive operator of the Kazakh national network and to represent the Kazakh
government in international telecommunications matters, along with a broad
series of powers to enable it to fulfil this function. Kazakhtelekom carries out
its functions under the oversight and direction of the KMOC. In May 1997, the
Kazakh government announced that it had sold a 40% stake in Kazakhtelekom to
Daewoo. However, in March 1998, it was reported that Daewoo had sold a portion
of its stake (reported to be approximately 10%) to an unnamed third party. It
was later confirmed that Daewoo had sold its entire stake in Kazakhtelekom to
Kazcommertzbank, a commercial bank based in Kazakhstan. It is understood that
the Kazakh government is seeking to sell a 15% stake in Kazakhtelekom to private
investors.
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PETERSTAR COMPANY LIMITED
OVERVIEW
PeterStar, in which the Company owns a 60% interest (and in which PLD holds
an additional 11% through PLD Holdings Limited ("PLD Holdings"), a Bermuda
company), operates a fully digital, city-wide fiber optic telecommunications
network in St. Petersburg that is interconnected with the network of PTN, the
local telephone company, as well as the Russian national and international long
distance systems. PeterStar provides integrated, high quality, digital
telecommunications services with modern transmission equipment, including local,
national and international long distance and value-added services, to businesses
in St. Petersburg. The PeterStar network provides an alternative to the PTN
network, which to date has been characterized by significant capacity
constraints. PeterStar is able to provide integrated telecommunications services
to business customers, including users of high bandwidth voice, data and video
communications services. PeterStar's network is designed to support a wide range
of telecommunications products and services with a high degree of reliability.
Additionally, PeterStar provides the three cellular operators in St. Petersburg
with access to digital switching and transmission capacity which significantly
improves their ability to consistently receive and deliver their customers'
traffic. As of December 31, 1998, PeterStar had a total of 168,166 active lines,
of which 108,278 were provided to cellular operators.
PeterStar, which started limited service in 1993, generated net income for
the year ended December 31, 1998 of $17.8 million on operating revenues of $72.4
million, as compared to net income of $16.5 million on operating revenues of
$54.5 million for the year ended December 31, 1997. Subscriber lines installed
increased from 114,774 at the end of 1997 to 168,166 at December 31, 1998,
reflecting increased penetration of the business community, residential and
cellular operators. PeterStar accounted for 49.8% of PLD's operating revenues
for the year ended December 31, 1998, as compared to 47.6% for the year ended
December 31, 1997.
PeterStar, a Russian closed joint stock company, was incorporated in 1992.
STRATEGY
PeterStar's strategy is to continue to meet the growing demands of business
customers and other network operators in St. Petersburg. PeterStar has recently
added incremental transmission capacity and upgraded its transmission network
from STM-4 to STM-16, as well as introducing new service features such as ISDN
capability, which allows simultaneous transmission of voice, data, video and
still images. In addition, as part of its strategic relationship with PTN,
PeterStar intends to continue to provide targeted support to PTN in its efforts
to upgrade and modernize its network. While the August 1998 financial crisis and
its aftermath have caused some slowdown in business activity, the business
environment in St. Petersburg remains stable, and the prospects for continued
growth of small to mid-sized Russian and foreign businesses remain reasonably
positive. PeterStar has placed increased emphasis on this market segment in
order to capitalize on what it considers to be a significant market opportunity.
PeterStar is involved in several projects designed to expand its direct
dial services in St. Petersburg and Northwest Russia. PeterStar has undertaken
with PTN a major infrastructure project involving the replacement of analog
exchanges with digital exchanges for certain parts of the network on
Vassilievski Island, a city district in St. Petersburg. This project requires
the conversion of approximately 30,000 business and residential lines that have
previously been operated by PTN, after which such lines become a part of the
PeterStar network. In addition, PeterStar plans to further enhance its transit
network capabilities in order to provide continued support to the cellular and
other network providers in terminating traffic in St. Petersburg and to the
national and international gateway.
PRODUCTS AND SERVICES
PeterStar currently provides: (i) voice and data services to business and
residential customers; (ii) switched transit services for cellular and other
network operators; and (iii) value-added voice and data services. PeterStar
markets its products and services through its own direct sales force and agents
which target mainly corporate accounts.
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PeterStar also provides a number of value-added voice and data services to
complement the basic fixed network services it currently provides. PeterStar
believes that the ability to provide such services on the PeterStar digital
network is a key competitive advantage in the St. Petersburg marketplace.
Current services include the following:
Data Services. PeterStar provides high speed data links across the city of
St. Petersburg. These connections provide links between the computer networks of
banks and large companies, allowing for data interchange between a variety of
back office systems. The target customer for such services is the financial
sector, with the Russian Stock Market, Sberbank, Promstroibank, and Bank St.
Petersburg all currently using PeterStar's services. Other applications for
these high speed links, such as Reuters, utilize PeterStar to deliver
value-added services to their own customers.
Frame Relay. PeterStar operates a frame relay data network service as an
enhanced feature of its current service offering. Customers include Citibank,
the Russian Central Bank and the Russian Stock Market.
ATM. PeterStar has installed an ATM service, including eight switches, for
selected customers to complement its existing service offering. Customers
include Coca-Cola and financial institutions such as Promstroibank and Bank St.
Petersburg, and it is anticipated that an expansion of this service will take
place once market demand has been confirmed.
Operator services. PeterStar has provided operator assistance service since
the third quarter of 1995 pursuant to a 1995 agreement with SPMMTS. The
agreement with SPMMTS provides PeterStar with primary access to the "07" (long
distance) operators connecting customers on a non-automatic dial destination
throughout the Russian Federation and the other countries of the former Soviet
Union. Other operator services offered include conference calling and
person-to-person calling. PeterStar also plans to provide access to wider
databases including those provided by Yellow Pages.
Calling Card Services. In November 1995, PeterStar launched a direct dial
calling card service, enabling customers to dial directly through to the
PeterStar network when using a tone dial telephone. The service, which provides
both debit and credit card service, is also available via the PeterStar operator
service for pulse and rotary dial telephones. PeterStar has expanded this
service offering through co-operation with Comstar, a network operator in
Moscow, providing PeterStar customers access in Moscow. PeterStar is currently
considering a further expansion of its calling card platform in conjunction with
the development of the Teleport-TP national network facilities.
Equipment Sales. PeterStar offers customers a wide range of
telecommunications equipment as a means of enhancing its service. It offers
PBXs, key systems, handsets, and the full range of customer terminals including
Partner, Partner Plus, Eurogenesis and Definity. PeterStar also offers a
maintenance service for the equipment.
ISDN. PeterStar has installed an ISDN platform to service the demand in the
local marketplace. PeterStar also offers international ISDN services, following
agreement on the standard for C-7 signaling and the upgrading of the
international gateway.
Internet. Since August 1996, PeterStar has provided its subscribers access
to the Internet via WEBplus, a local Internet service provider. PeterStar
provides dial-up and dedicated network access to customers wishing to use the
WEBplus service.
CUSTOMERS AND MARKETING
PeterStar's customer base currently consists of three general categories:
(i) business customers; (ii) cellular and other network operators; and (iii)
residential customers. PeterStar's primary focus is the provision of voice and
data services to business customers, focusing on those which generate large
amounts of outgoing long distance and international traffic.
PeterStar continues to experience a shift in its customer base, from
foreign companies (which tend to use the higher priced international services)
to predominantly Russian businesses and, to a lesser extent, residential
customers (for whom local calling is the principal usage).
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<PAGE> 10
The following table illustrates, as of December 31, 1998, 1997, 1996 and
1995, the number of lines on the PeterStar network, set forth by customer
segment:
<TABLE>
<CAPTION>
NO. OF NO. OF NO. OF NO. OF
LINES LINES LINES LINES
AS OF % OF AS OF % OF AS OF % OF AS OF % OF
DEC. 31, 1998 DEC. 31, 1997 DEC. 31, 1996 DEC. 31, 1995
TYPE OF CUSTOMER 1998 TOTAL 1997 TOTAL 1996 TOTAL 1995 TOTAL
- ---------------- -------- ----- -------- ----- -------- ----- -------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Direct dial -- business......... 42,388 25% 24,344 21% 12,482 24% 4,840 23%
Direct dial -- consumer......... 17,500 11% 4,482 4% 2,310 4% 2,029 9%
Cellular........................ 108,278 64% 85,948 75% 37,213 72% 14,659 68%
------- --- ------- --- ------ --- ------ ---
Total................. 168,166 100% 114,774 100% 52,005 100% 21,528 100%
======= === ======= === ====== === ====== ===
</TABLE>
COMMERCIAL VOICE AND DATA SERVICES
PeterStar's digital overlay network provides its customers with improved
connectivity, as well as a package of exchange services such as call waiting,
call forwarding and three-way conferencing. PeterStar offers its customers a
choice between new digital installations or the upgrading of existing PTN analog
connections to digital capability. New lines are provided via either traditional
copper connections or fiber optic cables.
For domestic long distance connections, PeterStar offers dedicated digital
circuits to Moscow. Moscow is the destination of approximately 40% of the long
distance traffic from St. Petersburg, all other national traffic being directed
to the national switching center of Rostelecom in Moscow for delivery throughout
the Russian Federation.
SPMMTS is the gateway for international calls to and from St. Petersburg
and SPMMTS has a number of options for the forwarding of international calls.
Such calls can be directed to an international gateway owned by SPI, a joint
venture between BT and SPMMTS which has satellite connections to the UK. In
addition, SPMMTS has access, via Rostelecom, to the undersea cable between
Russia and Denmark for international traffic. Finally, SPMMTS has the option to
route international traffic through the international gateway in Moscow. In
addition to SPMMTS, there are several independent dedicated networks which
provide international telecommunications access in St. Petersburg, including
BCL.
Call revenues and total minutes in the commercial voice and data services
segment (i.e, non-cellular) amounted to $30.9 million, $22.5 million, $12.8
million and $6.2 million, and 220,022,000, 126,220,000, 71,128,000 and
19,995,000, in 1998, 1997, 1996 and 1995, respectively.
Business Customers. PeterStar's primary focus has been the provision of
telecommunications products and services to business customers, focusing on
those which generate large amounts of outgoing long distance and international
traffic. PeterStar targets both foreign and, increasingly, Russian businesses
which have requirements for high quality local, long distance and international
telecommunications services. As of December 31, 1998, Russian businesses, such
as Baltika Brewery and LenEnergo, represented approximately 70% of PeterStar's
42,388 business subscriber lines and foreign businesses, such as ABB, Rothmans
Inc., Pepsi, Alcatel, Nokia, McDonalds, Volvo, PricewaterhouseCoopers and Philip
Morris, represented the balance. Total call revenues from PeterStar's directly
connected business customers were $30.5 million in 1998.
Residential Customers. As of December 31, 1998, PeterStar had connected
17,500 residential customers to its network. Revenues from direct dial
residential customers (principally connection charges and line rentals) totaled
$0.7 million in 1998 (of which $0.4 million was call revenue). At present,
PeterStar does not directly receive any local call revenues from its residential
customers, but does bill and collect revenues for national and international
calls at the SPMMTS tariff. In 1999, PeterStar will complete a project with PTN
to upgrade telecommunications services on Vassilievski Island, a project which
is increasing the number of residential customers on the PeterStar network.
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<PAGE> 11
EXPANSION OF VOICE AND DATA SERVICES
PeterStar has undertaken with PTN an infrastructure project centering on
the replacement of analog step-by-step and cross-bar exchanges with digital
telecommunications equipment for Vassilievski Island, a city district in St.
Petersburg. The project requires the conversion of a total of approximately
30,000 business and residential lines that were previously operated by PTN,
after which such lines become part of the PeterStar network and the users become
PeterStar customers. As of December 31, 1998, approximately 13,000 lines had
been converted, with the balance expected to completed in the first half of
1999. While the business customers are charged either PeterStar or PTN tariffs
(based on their traffic patterns), the residential customers pay PeterStar the
equivalent PTN rate for the line rental. PeterStar collects the revenues on
national and international calling from these customers, although the level of
such calling for residential customers, who are the bulk of the new customers,
is not substantial. The total cost of the project is estimated at approximately
$25 million, of which $13 million is for network infrastructure and the balance
for civil works and local network upgrades. This amount also includes
approximately $3 million for an upgrade to the core PeterStar overlay network.
As of December 31, 1998, a total of $23.7 million had been spent, representing
approximately 95% of the project's total cost.
PeterStar also expects to increase its operating presence in Northwest
Russia through the targeted development of digital infrastructure to connect
business customers and to develop operational relationships with the regional
telephone companies. PeterStar is exploring the possibilities for closer
cooperation with both Teleport-TP and BCL (both of which are subsidiaries of
PLD) in connection with the expansion of its core business in St. Petersburg and
the implementation of its strategy in Northwest Russia.
The implementation of this expansion in direct dial services involves a
variety of risks, including those set forth in "-- Risk Factors -- Risks
Involving PeterStar Company Limited."
CELLULAR SERVICES
The three cellular operators in St. Petersburg currently utilize the
PeterStar network to deliver high quality services to their customers and
provide reliable access to the local, long distance and international networks.
PeterStar's digital infrastructure enhances the ability of the cellular
operators to consistently receive and deliver their customer's traffic, a
benefit that is not achievable by using the outdated PTN transmission network.
In addition, the lack of capacity on the PTN network provides a significant
constraint on the ability of the cellular operators to expand their capacity to
meet market demand. Access to the PeterStar network provides these cellular
operators with the additional capacity necessary to accommodate their planned
growth.
The number of cellular customers in St. Petersburg has increased from
approximately 6,400 at December 31, 1994 to over 110,000 at December 31, 1998,
as St. Petersburg has become one of the fastest growing cellular markets in
Russia. The cellular operators in St. Petersburg experienced a drop-off in the
number of subscribers following the August 1998 crisis, although there are signs
that the subscriber numbers are beginning to recover. Subscribers are primarily
business customers who use cellular service as a mobile telecommunications tool
rather than as an alternative to the wireline network.
The three cellular operators in St. Petersburg are:
Delta Telecom. Delta, the NMT 450 operator which is a joint venture between
PTN and an affiliate of MediaOne (formerly U.S. West Media Group, Inc.), was
connected to the PeterStar network in September 1995. As of December 31, 1998,
the majority of Delta's subscribers (of which 20,789 were active) were connected
to the PeterStar network.
North West GSM. NW GSM, the digital 900 MHZ operator for the city which is
a joint venture between Sonera, Telia, Telenor, Lensvyaz and Telecominvest, has
been connected to the PeterStar system since September 1994. As of December 31,
1998, all of NW GSM's subscribers (of which 73,673 were active) were connected
to the PeterStar network.
Fora Communications. Fora, a joint venture between Millicom International
Cellular ("Millicom") and the City of St. Petersburg, is an AMPS 800 cellular
system that has been connected to the PeterStar network since
9
<PAGE> 12
July 1994. As of December 31, 1998, all of Fora's subscribers (of which 13,816
were active) were connected to the PeterStar network.
The following table sets forth, for each cellular operator, the number of
active lines connected to PeterStar at December 31, 1995, 1996, 1997 and 1998:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
OPERATOR 1998 1997 1996 1995
- -------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Fora Communications................... 13,816 16,671 8,603 3,410
NorthWest GSM......................... 73,673 52,681 22,210 7,049
Delta Telecom......................... 20,789 16,596 6,400 4,200
</TABLE>
Call revenues and total minutes in the cellular segment amounted to $12.2
million, $9.0 million, $5.2 million and $2.2 million, and 178,370,000,
119,096,000, 57,729,000 and 17,830,000 minutes, in 1998, 1997, 1996 and 1995,
respectively.
NETWORK AND FACILITIES
PeterStar's network and facilities give it the ability to provide advanced
digital services to the telecommunications market in St. Petersburg, services
that the Company believes PTN, with its primarily analog network, will be unable
to provide in the near term due to internal funding constraints. The PeterStar
network consists of digital exchanges which are connected by fiber optic cables,
advanced transmission systems and remote switching units and concentrators. The
fiber optic network forms twelve rings, permitting traffic to be re-routed in
the event that a cable is cut or damaged. The network is fully interconnected
with the PTN network, with direct and indirect connections via approximately 680
kilometers of fiber optic cable to all thirty-four PTN transit exchanges
distributed throughout St. Petersburg. These direct connections to all of the
primary PTN exchanges enable callers to by-pass congestion on the PTN network.
The fiber optic cables also provide direct links to the national and
international switch, providing PeterStar customers with high quality long
distance and international access. PeterStar expects that it will continue to
incrementally add switching, transmission capacity and local loop infrastructure
to its core network in order to address its target market in St. Petersburg and
regional points of presence.
In addition to core network development, PeterStar, as part of its goal to
be the full service telecommunications provider to the business community in St.
Petersburg, has undertaken a number of specialized customer connections to its
network, tailoring the solution to the specific customers' needs. This involved
investment in, among other things, new cable, trunked radio, and customer
premises equipment. Customer contracts concluded in 1998 include those with the
Customs Authority, the Russian Mint, Lenexpo and Siemens.
PeterStar has signed a contract with Tadiran, an Israeli wireless equipment
manufacturer, to supply 1,500 lines of wireless local loop infrastructure.
PeterStar has deployed such equipment where: (i) local loop infrastructure is
non-existent or of poor quality; and (ii) the cost of installing cable would be
prohibitive. As of December 31, 1998, PeterStar had in operation 809 wireless
local loop lines and plans on expanding the wireless local loop service offering
during 1999 based on customer demand.
The PeterStar network currently consists of three AT&T 5ESS exchanges and
several remote concentrators. PeterStar's Vassilievski Island exchange now
serves as its main transit exchange, and is linked to the other PeterStar
exchange located in Ligovskaia, in the central business district of St.
Petersburg, as well as with PTN and SPMMTS. The Ligovskaia switch is being
upgraded in order to provide redundancy to the main Vassilievski Island transit
exchange. The Vassilievski Island exchange has the capacity to serve a large
number of customers, both in the immediate vicinity of Vassilievski Island and
at remote locations via the fiber optic network. This capacity enables PeterStar
to carry substantial volumes of traffic to and from the PTN network to other
network operators, such as cellular, Internet and paging operators, and to
provide high quality links for long distance and international calls. PeterStar
has added incremental transmission capacity and upgraded its transmission
network from STM-4 to STM-16, as well as working on the provision of new service
features. In addition, as part of its strategic relationship with PTN, PeterStar
intends to continue to provide targeted support to PTN in its effort to
10
<PAGE> 13
upgrade and modernize its network. See "-- Expansion of Voice and Data Services"
and "-- Risk Factors -- Risks Involving PeterStar Company Limited -- Dependence
on PTN Facilities."
BILLING, TARIFFS AND INTERCONNECTION CHARGES
Billing
Except for the residential and business customers on Vassilievski Island
(which are billed in Roubles at the PTN rate), PeterStar denominates its tariffs
in U.S. Dollars, with its customers paying the monthly invoice in Roubles at the
U.S. Dollar/Rouble exchange rate on the date when the customer instructs its
bank to make payment. By denominating its tariffs in U.S. Dollars (and
exchanging Roubles at the then current U.S. Dollar/ Rouble exchange rate),
PeterStar reduces the exchange rate risk otherwise associated with transacting
business in a foreign currency. However, during the third and, to a lesser
extent, fourth quarters of 1998, significant delays occurred in the processing
of payments within the Russian banking system and led to exchange losses in
those periods. See "-- Risk Factors -- Country Risks -- Restrictions on Currency
Conversion; Historical Volatility in Currency Prices."
Tariffs
There are no specific regulations regarding tariffs charged by PeterStar
(except for customers on Vassilievski Island which are charged the PTN tariff).
PeterStar sets its tariffs taking into account those charged by PeterStar's
interconnect parties, namely PTN, SPMMTS and SPI, as well as competitive
pressures in the marketplace. PeterStar charges its customers for the
installation of equipment and initiation of service, line rental, local, long
distance and international calls and special services.
In the period during which PeterStar has operated, there has been
significant price convergence between PeterStar and public network national and
international call tariffs. As PeterStar has widened its customer base, it has
reduced its national and international call tariffs. At the same time, public
network tariffs have increased for long distance access. Until PTN introduces
local call metering to its customers, PeterStar will not receive any local
calling revenues from its residential customers, and the timing of the
introduction of such metering remains unclear.
PeterStar's published tariff for local calls differs according to whether
the call is made during peak times (8 AM to 8 PM) or at other times. For
domestic and international long distance calls, tariffs are based on the call's
destination and the time of the call. PeterStar offers discounts, based on call
volumes, for customers who make a large number of calls per month.
PeterStar charges a flat per line installation charge for telephone lines
and for 2Mb/s digital circuits, regardless of the number of lines or circuits
installed. In addition, customers are charged a monthly rental charge for the
telephone lines and digital circuits.
Business Customers. PeterStar business customers are charged the full
PeterStar published tariffs for installation and initiation charges, line rental
and local, long distance and international calls. Certain discounts are given
for installations based on the number of lines installed at a single customer
location and for call volumes.
Cellular Operators. The cellular companies pay PeterStar for the
installation and lease of 2 Mb/s links, a connection charge for each number
connected and a monthly rental fee for each number, plus volume related call
charges.
Residential Customers. PeterStar currently receives line rental and
connection charges from residential customers at the PTN rate. PeterStar will
not receive local call charges from residential customers until PTN imposes such
charges and then will only receive charges at the PTN rate. Long distance and
international calls are billed directly by PeterStar. For residential customers
connected as part of the Vassilievski Island project, PeterStar collects all
revenues for long distance and international calling, with charges at the PTN
tariff level.
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<PAGE> 14
Interconnection Charges
PeterStar has been able to negotiate favorable tariffs for interconnection
fees and carrier charges with both PTN and SPMMTS. PeterStar's current
interconnect agreements with PTN and SPMMTS are open-ended agreements, while the
interconnection fees and carrier charges payable under the interconnect
agreements are subject to renegotiation between the parties from time to time.
Commencing in 1998, PeterStar has been required to pay a local line rental
charge to PTN, although roughly half of the fee otherwise payable during 1998
was offset against amounts owed to PeterStar by PTN in respect of the
Vassilievski Island project. The aggregate amount paid to PTN in 1998 for line
rental charges was $1.3 million. The amount of the 1999 line rental charged has
not yet been determined, but PeterStar expects once again to be able to offset
amounts owing from PTN against such charges during 1999. See "-- Risk Factors --
Risks Involving PeterStar Company Limited -- Dependence on Interconnect
Parties."
TELECOMMUNICATIONS LICENSES
In June 1996, PeterStar was granted a license, which superseded a license
granted in November 1994, for an eight year term expiring November 2004 to
provide local, national and international telecommunications services within St.
Petersburg and the surrounding region. One of the conditions of this license is
that access to long distance and international communications be through the
public network. Other licenses that have been issued to PeterStar include a
dedicated network license (expiring September 2001), a data communications
license (expiring May 2001), a telematics license (expiring May 2001) and a
videoconferencing license (expiring June 2001). Based on its experience in
renewing existing, and obtaining new, licenses and its general knowledge of the
licensing environment in Russia, management of PeterStar believes that, so long
as they are being actively utilized, all such licenses will be renewed at the
end of their respective terms.
The main PeterStar license, governing the provision of public
telecommunications services, sets the number of lines which PeterStar may have
in St. Petersburg and the surrounding region at 106,000, and requires that
capacity equal to 74,200 lines be introduced by June 1999. Based on its
experience in renewing existing, and obtaining new, licenses and its general
knowledge of the licensing environment in Russia, management of PeterStar
believes that the maximum and minimum number of lines are not strict
requirements but are instead designed to provide general guidance as to the
number of lines intended to be included on the system. As of December 31, 1998,
PeterStar had 168,166 lines, of which 108,278 were provided to cellular
operators. PeterStar does not believe that its license would be terminated or
re-negotiated, that it would be forced to reduce the number of its subscribers,
or that other penalties would be imposed, by reason of its exceeding its 106,000
line ceiling, but there can be no assurance that the RFCTI would not take a
different position which in turn could result in the revocation of the license
or its renegotiation on terms unfavorable to PeterStar or the imposition of
penalties. It is not possible to calculate the amount of any penalties which
might be imposed, which are in the discretion of the RFCTI.
The dedicated network license permits PeterStar to provide long distance
and international telephone transmission services to dedicated network operators
(such as BCL) in St. Petersburg and the surrounding region for a term expiring
in September 2001. The dedicated network license sets the number of lines which
PeterStar may have at 30,000 and requires that capacity equal to 21,000 lines be
introduced by September 1999. Once again, based on its experience in renewing
existing, and obtaining new, licenses and its general knowledge of the licensing
environment in Russia, management of PeterStar believes that the maximum and
minimum number of lines are not strict requirements but are instead designed to
provide general guidance as to the number of lines intended to be included on
the system. However, there can be no assurance that the RFCTI would not take a
different position which in turn could result in the revocation of the licenses
or their renegotiation on terms unfavorable to PeterStar or the imposition of
penalties. It is not possible to calculate the amount of any penalties which
might be imposed, which are in the discretion of the RFCTI. See "-- Risk Factors
- -- Risks Involving PeterStar Company Limited -- Reliance on Telecommunications
Licenses; Risks of Revocation or Renegotiation of Licenses."
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<PAGE> 15
EQUIPMENT AND OTHER OPERATING AGREEMENTS
Equipment. Lucent is PeterStar's primary network equipment supplier. In
recent years, equipment supply agreements have been entered into with Lucent for
the purchase of telecommunications equipment, including transmission systems,
switching equipment and related software, for the PeterStar network, including
for the Vassilievski Island project. In some cases, Lucent has provided vendor
financing, using Dutch export credit guarantees.
Cellular and Other Operators. Pursuant to interconnect agreements with
Delta, NW GSM and Fora, PeterStar provides interconnect service from the
cellular networks to the local network and a gateway for long distance and
international networks. Traffic interconnections are linked and made through
PeterStar's switch system. The interconnect agreements provide for the following
payments to be made by each cellular operator to PeterStar based on 2 Mb/s trunk
connections: monthly lease fees for each trunk; per-subscriber number fees and
per-minute tariffs. The Delta agreement is for a one year term, renewable for
additional one year periods by mutual agreement. The NW GSM agreement is for a
minimum period of two years, after which either party may terminate upon not
less than three months prior written notice. The agreement with Fora is for two
years and may be extended by mutual agreement for successive five year periods.
EMPLOYEES
As of December 31, 1998, PeterStar had 412 employees, all of whom were
full-time. Of these employees, 411 were Russian nationals and one was an
expatriate manager. None of its employees is subject to a collective bargaining
agreement. PeterStar believes that its relations with its employees are good.
ALTEL
OVERVIEW
ALTEL, in which the Company (through a wholly owned British Virgin Islands
subsidiary, Wireless Technology Corporations Limited ("WTC")) owns a 50%
interest, currently operates the only nationwide cellular network in Kazakhstan.
ALTEL was formerly known as BECET International, although marketing its services
under the name "ALTEL". In May 1998 ALTEL changed its corporate name to the name
under which it was doing business. Also in 1998, ALTEL introduced a prepaid
cellular service (marketed under the name "TUMAR") in Almaty which, as of
December 31, 1998, had 6,964 active subscribers.
The other 50% of ALTEL is held by Kazakhtelekom, the operator of the
national telephone network in Kazakhstan. In May 1997, the Kazakh government
announced the sale of a 40% stake in Kazakhtelekom, the state-owned
telecommunications company, to Daewoo. However, in March 1998, it was reported
that Daewoo had sold a portion of its stake (reported to be approximately 10% of
Kazakhtelekom) to an unnamed third party. It was later confirmed that Daewoo had
sold its entire stake in Kazakhtelekom to Kazcommertzbank, a commercial bank
based in Kazakhstan. It is understood that the Kazakh government is seeking to
sell a 15% stake in Kazakhtelekom to private investors. Kazakhtelekom recently
received a revised license specifically naming it as the exclusive national
network operator in Kazakhstan, and giving it a wide range of powers to carry
out this function. During 1998, the KMOC issued two GSM licenses for the
development of national GSM networks in Kazakhstan. The two license recipients
(one of which is a joint venture including Kazakhtelekom) commenced active
marketing of their services in February 1999.
The Company's primary objectives for ALTEL are to increase revenues and
cash flows through increased penetration, usage and network coverage. Cellular
service provides a rapid and relatively inexpensive way to overcome the
deficiencies of the wireline telecommunications infrastructure in Kazakhstan.
ALTEL's cellular telecommunications network in Kazakhstan currently consists of
separate systems in Almaty, South Kazakhstan (Chimkent), Karaganda, Pavlodar,
Astana (formerly known as Akmola), Aktyubinsk, Kustanai, East Kazakhstan
(Ust-Kamenogorsk), Atyrau, Taraz, Petropavlovsk and Kyzl Orda. As of December
31, 1998, ALTEL's cellular telecommunications network covered a geographic area
of approximately 4,200,000 people, representing 24% of the total population, in
12 cities. ALTEL commenced cellular service in September 1994 and has since
experienced significant subscriber and revenue growth. As of December 31, 1998,
ALTEL had 21,395 active
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<PAGE> 16
subscribers, of which 6,964 were customers of ALTEL's prepaid service. This
compares with 11,102 subscribers as of December 31, 1997.
ALTEL, which began operations in September 1994, generated net income for
the year ended December 31, 1998 of $9.2 million on operating revenues of $39.5
million, as compared to net income of $7.2 million on operating revenues of
$30.0 million for the year ended December 31, 1997. The subscriber base grew
from 2,882 at the end of 1995 to 21,395 at December 31, 1998 (of which 6,964
were customers of ALTEL's prepaid service). ALTEL accounted for 27.2% of PLD's
operating revenues for the year ended December 31, 1998, as compared to 26.2%
for the year ended December 31, 1997.
ALTEL, a Kazakh closed joint stock company, was incorporated in 1994.
STRATEGY
The Company believes the development of a market economy in Kazakhstan is
likely to increase demand for modern telecommunications services, including
wireless communications, as demonstrated by the subscriber growth experienced to
date by ALTEL. While the Kazakh telephone network is slowly being modernized,
the Company believes this is likely to be an expensive and lengthy process. The
Company believes that this environment provides ALTEL with the opportunity to
provide customers in Kazakhstan with a viable, high quality alternative to
wireline telephone service during the period it will take to modernize the basic
public network. Management of ALTEL currently believes that, by virtue of its
cost structure and its market penetration to date, together with its recently
introduced prepaid service, it is in a good position to compete with the new GSM
operations. However, ALTEL is currently assessing the impact of the GSM licenses
on its business, and there can be no assurance that ALTEL will in fact be able
to compete successfully with the new licensees.
NETWORK AND FACILITIES
As of December 31, 1998, ALTEL's cellular telecommunications network in
Kazakhstan consisted of separate systems in Almaty, South Kazakhstan (Chimkent),
Karaganda, Pavlodar, Astana, Aktyubinsk, Kustanai, East Kazakhstan
(Ust-Kamenogorsk), Atyrau, Taraz, Petropavlovsk and Kyzl Orda. Further
installations remain dependent upon many factors including the successful
location of additional cell sites and the results of marketing and other
studies. As of December 31, 1998, investment in ALTEL's cellular network
infrastructure and support facilities totaled approximately $43.4 million. ALTEL
anticipates that its capital expenditure program in 1999 will total
approximately $8.6 million and will be used to develop new installations, expand
network capacity in the existing cities and to upgrade equipment. The Company
currently believes that this funding will be provided by internally generated
cashflows.
All ALTEL systems are connected to the local telephone network and the
regional trunk switch in the cities where they are located. The system in Almaty
is also linked to an international trunk exchange and the Astana system will be
linked to a new international switch in that city when it becomes operational.
Long distance and international calls are completed using the national and
international network of Kazakhtelekom. International calls are switched through
a digital exchange in Almaty.
Space for most ALTEL switches, cell sites and associated equipment is
provided by Kazakhtelekom. ALTEL also uses space in a Kazakhtelekom exchange
building in Almaty for office and administrative purposes and leases other
premises in Almaty which combines its central warehouse and a larger customer
service center and retail outlet. ALTEL has also established, and will continue
to establish, customer service centers in each city in which service is offered.
Virtually all space for customer service centers and equipment not provided by
Kazakhtelekom is leased, although ALTEL has purchased its facilities in Taraz,
one base station site and building in Chimkent and a base station building in
Karaganda.
In November 1997, the official political capital of Kazakhstan was moved
from Almaty to Astana. Although ALTEL does have a presence in Astana, the
long-term effect of this move on ALTEL's business remains uncertain. For
example, ALTEL could need to incur the cost of moving its administrative
functions to Astana. Currently, both the number of customers in Astana and the
traffic between Almaty and Astana are increasing, but there is a risk that the
move could result in reduced cellular activity in Almaty in the future.
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<PAGE> 17
PRODUCTS AND SERVICES
ALTEL customers may choose from three types of cellular service: service
within a single city, service within Kazakhstan as a whole, and full service
including international access. Optional services include call waiting, three
party conferencing, call forwarding, voice mail and busy transfer. ALTEL markets
cellular telephones and related equipment manufactured by Motorola and Philips.
ALTEL offers a roaming facility between the home city of the subscriber and
other cities served by the ALTEL network. In addition, as of December 31, 1998,
ALTEL had established roaming agreements with a total of 18 other cellular
operators, including: (i) BEELINE (Vimpelcom) in Moscow and Samara; (ii) Fora in
St. Petersburg; (iii) Digital Sotovaya Svyaz in the Ukraine; (iv) Katel in
Kyrgyzstan; and (v) Uzdunrobita in Uzbekistan.
ALTEL introduced a prepaid cellular service in Almaty in August 1998 (under
the name "TUMAR"), thereby adding to its existing service offerings. ALTEL
expects to introduce the prepaid service in additional regions, include Astana,
during 1999. In addition to further reducing the potential for bad debts, this
system also permits ALTEL to market a portable unit having fewer features and
more economical pricing, thus enabling ALTEL to expand into a new and
potentially much larger market segment than that to which it has addressed its
marketing efforts to date. As of December 31, 1998, TUMAR had 6,964 active
subscribers.
ALTEL markets its cellular services through its own outside direct sales
force, which targets corporate and government accounts and high volume
consumers, together with customer service centers. Although ALTEL's standard
service includes individuals, it has most appeal to businesses which constitute
around 90% of the customer base. In contrast, the TUMAR prepaid services are
targeted almost exclusively to middle income domestic individuals (including
students). With this differentiation, ALTEL believes that it has broad appeal
across the community.
ALTEL does business under the registered trade names "ALTEL" and "TUMAR"
and features these names in all of its marketing and promotional activity. ALTEL
uses a variety of marketing channels to promote its services, including
television, radio, newspapers, billboards and sponsorship of concerts and other
popular events. ALTEL believes that both the identification of the "ALTEL" and
"TUMAR" trade names with its services, and its marketing activities, have been
effective in stimulating demand for its products and services.
OPERATIONS
Billing and Tariffs
Tariffs for ALTEL customers are posted in U.S. Dollars. Government
regulations determine the currency in which invoices may be paid, which depends
upon the residency status of the customer. Domestic subscribers may pay only in
Tenge, while foreign subscribers are permitted to pay in Tenge or U.S. Dollars.
Commencing March 1998, ALTEL is now required to issue a tax invoice with each
bill stating the amount in Tenge as of the billing date. However, to date, ALTEL
has still been able to receive payment in Tenge at the U.S. dollar exchange rate
on the date payment is made.
Under the terms of its license, ALTEL is free to establish the rates for
all cellular services provided on its network, without prior approval from the
KMOC. ALTEL's pricing is subject to review by the Kazakh Anti-Monopoly
Commission. ALTEL currently employs one pricing structure for all of its
customers, but Kazakh government agencies are offered a 25% discount on
activation and a 35-40% discount on monthly access fees and airtime charges.
Currently, ALTEL has 123 subscribers in this category and management does not
expect this number to increase significantly over time.
A new ALTEL subscriber currently pays a one-time activation fee and makes a
security advance to cover monthly fees and usage charges which depends on
whether the subscriber has international, inter-city or local access,
respectively. Non-residents of Kazakhstan pay higher security advances. Monthly
access fees vary depending on whether the customer chooses local service alone,
inter-city service or full international service. Basic usage charges vary
between peak and off-peak calls, plus the applicable tariffs for international
and inter-city calls. In addition, there is a monthly fee for each optional
service, including call waiting, three party
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<PAGE> 18
conferencing, call forwarding, itemized billing and busy transfer. ALTEL also
charges its subscribers a fee for the ability to roam to other regional cities.
ALTEL periodically offers special tariff-related promotions which include
discounts on certain elements of the tariff schedule when packaged together. In
addition, certain customers are offered volume discounts on the tariff schedule.
ALTEL has also introduced air-time tariff plans, providing discounts to users,
based on the periods that they intend to use the phone and whether their calls
are predominantly incoming or outgoing. All tariffs include VAT at the rate of
20%.
The basic connection fee for the TUMAR prepaid service is a one time fee,
depending on whether the customer provides the handset or if the customer
purchases the handset from ALTEL. No monthly access fees are charged to TUMAR
customers, and the usage charges are higher for outgoing calls than they are for
incoming calls, but do not vary depending on the time the call is made or
received. TUMAR introduced a new tariff plan in February 1999, with a connection
fee, a per day usage charge and a charge for outgoing calls, but no charge for
incoming calls. TUMAR expects to introduce discounts to its air-time tariffs
during March 1999. TUMAR customers can currently only make local calls within
Almaty.
ALTEL's tariffs have been recently revised in light of competition from the
GSM licenseholders, which have offered low introductory tariffs to attract
customers. ALTEL expects that competition from the GSM operators will continue
to exert downward pressure on the tariffs for both ALTEL and TUMAR.
Interconnection
ALTEL is dependent on its interconnection to networks operated by
Kazakhtelekom for the completion of its local, long distance and international
calls. ALTEL pays an annual license fee to the KMOC in lieu of all frequency or
interconnection charges, equal to up to 6% of its after-tax profits as
calculated by the Kazakh statutory audit. ALTEL pays Kazakhtelekom a tariff in
respect of local calls, and enjoys a preferential tariff in respect of long
distance and international calls which provides ALTEL with an average margin of
25% on such calls. Kazakhtelekom has recently been authorized, in connection
with its appointment as the exclusive operator of the Kazakh national network,
to levy interconnection charges, and to do this on a basis which yields it a
profit. There can be no assurance that Kazakhtelekom will not use this authority
to start assessing interconnection charges against ALTEL, notwithstanding that
ALTEL is already paying a license fee expressly stated to be in lieu of
interconnection charges.
TELECOMMUNICATIONS LICENSE
ALTEL holds a 15-year renewable license issued in February 1994 for the
creation and operation of cellular communications networks in Kazakhstan for
local, long distance and international calling, using the 800 MHZ frequency band
and "AMPS" technology. Under the terms of the license ALTEL was required to
provide cellular services to Almaty and ten to twelve additional regional
centers by the end of 1996, a condition which has been met. See "-- Network and
Facilities."
The license specifies that ALTEL is to be the exclusive provider of
cellular service in Kazakhstan for the first five years of the license term, a
period which expired in February 1999. The license is transferable upon approval
by 75% of ALTEL's shareholders.
In 1998, before the expiration of the exclusivity period, ALTEL commenced
discussions with the KMOC on substituting a new license with revised terms for
its existing license. One aspect of such new license would have been the
elimination of the exclusivity provisions in return for other concessions,
including an extension of the basic term of the license. Although the
exclusivity period has since expired according to the terms of the license,
ALTEL and the KMOC are continuing to discuss the terms of a new license for
ALTEL.
EQUIPMENT AND OTHER OPERATING AGREEMENTS
ALTEL purchased from Motorola the infrastructure equipment required for the
cellular systems to be installed in Almaty and eighteen other regional centers
throughout Kazakhstan. Pursuant to a separate agreement, Motorola agreed to
furnish services with respect to the equipment, which included system design,
installation, optimization, system engineering, program management, software
maintenance and on-site switch maintenance.
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Both agreements expire in May 1999. Motorola and ALTEL are currently in
discussions regarding a new agreement.
EMPLOYEES
As of December 31, 1998, ALTEL had 340 employees, all of whom were
full-time. Of these employees, 337 were Kazakh nationals and three were
expatriate managers. The number of employees involved in branch operations was
140. None of its employees is subject to a collective bargaining agreement.
ALTEL believes that its relations with its employees are good.
CPY YELLOW PAGES LIMITED
Yellow Pages, a Cyprus company in which the Company holds a 100% interest,
is the owner of one of the most comprehensive databases of Russian and foreign
businesses in St. Petersburg and publisher of what is primarily a business to
business directory. As of December 31, 1998, Yellow Pages had 68 employees in
St. Petersburg who handle all of the graphic design and database management.
Yellow Pages hires part-time workers for the periodic update of the directory.
The Company utilizes the database of Yellow Pages to the benefit of PeterStar
and BCL, particularly in achieving more effective target marketing and in
operator services.
COMPETITION
PETERSTAR COMPANY LIMITED
PeterStar is building and operating its business in a highly competitive
environment. PeterStar does not have an exclusive license to provide
telecommunications services in St. Petersburg, and a number of other entities,
including Russian companies and international joint ventures, are competing with
PeterStar for a share of the St. Petersburg telecommunications market. A number
of such companies (or their joint venture partners) are larger than PeterStar
and have greater access to capital or resources.
Although PTN has historically supported the development of PeterStar, PTN
and PeterStar must be regarded as competitors in the telephony segment. PTN can
offer its customers the same core services as PeterStar, notwithstanding the
lower transmission quality and call completion rates of the PTN network.
Furthermore, PTN has recently completed the installation of a modern fiber optic
loop in St. Petersburg which, when fully operational, will significantly enhance
its ability to carry traffic and could therefore compete with PeterStar.
Although PeterStar believes that PTN will require substantial additional capital
to completely modernize its network, PTN, either alone or through Telecominvest,
is free at any time to enter into joint venture arrangements with other foreign
partners to modernize its network independently of PeterStar. While PeterStar
believes that there is a constructive working relationship between PeterStar and
PTN, there can be no assurance that PTN will not in the future start to compete
more aggressively with PeterStar and/or that future disputes between the
partners will not occur and/or that PTN will not seek another partner. See
"-- Risk Factors -- Risks Involving PeterStar Company Limited -- Dependence on
Interconnect Parties" and "-- Ownership and Management of Operating
Subsidiaries -- PeterStar Company Limited."
The other major competitors to PeterStar are: (i) Global One, the
international joint venture between Sprint, DT, France Telecom and its Russian
partner, the telegraph office, which provides national and international voice
and data services to certain destinations; and (ii) Sovintel, a joint venture
between Rostelecom and GTS, which is currently based in Moscow, both of which
have been expanding their operations in St. Petersburg. Since they are generally
unable to compete effectively with PeterStar based on quality, these competitors
principally compete on the basis of price, thereby exerting some price pressure
on PeterStar.
Other competitors include: (i) Combellga, a joint venture of CominCom,
BelgaCom, Alcatel Bell and MMTS which operates an international overlay network
in Moscow and has been attempting to penetrate the St. Petersburg market,
offering international access similar to BCL, as well as long distance access to
Moscow; (ii) JS Leivo, a joint venture of LenEnergo and Imatran Voima of Finland
which provides outgoing international access; (iii) St. Petersburg Teleport,
which offers only outgoing international services and offers lower priced
services; and (iv) Metrocom, which provides local data access in St. Petersburg.
In addition, the three cellular
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<PAGE> 20
operators in St. Petersburg are competitors of PeterStar because they offer
local, long distance and international access. At the same time, each cellular
operator uses PeterStar to deliver its traffic.
ALTEL
Until 1998, ALTEL was the only licensed national cellular operator in
Kazakhstan. In 1998, the KMOC awarded two licenses for the development of a
national GSM network in Kazakhstan. One license was issued to Kcell, a joint
venture of TurkCell and Kazakhtelekom, and the other license was issued to
Kmobile, a joint venture of Telsim, a Turkish company, and local Kazakh
interests. Active marketing was begun by Kcell in early February 1999 and by
Kmobile in mid-February 1999. Management of ALTEL currently believes that, by
virtue of its cost structure and its market penetration to date, together with
its recently introduced prepaid service, it is in a good position to compete
with the new GSM operations. However, ALTEL is currently assessing the impact of
the GSM licenses on its business, and there can be no assurance that ALTEL will
in fact be able to compete successfully with the new licensees.
YELLOW PAGES
Yellow Pages faces a number of competitors in St. Petersburg which provide
similar directory and database services. Many of these competitors have greater
financial resources than does Yellow Pages and there can be no assurance that
Yellow Pages will be able to continue to compete successfully with the other
ventures.
OWNERSHIP AND MANAGEMENT OF OPERATING SUBSIDIARIES
PETERSTAR COMPANY LIMITED
Ownership Structure
PLD holds its 71% interest in PeterStar through the Company (60%) and PLD
Holdings (11%). PLD acquired its 60% interest held through the Company at
various times over the period 1992-96. PLD acquired PLD Holdings in August 1998
as part of the transactions with News and Cable & Wireless.
The remaining 29% of PeterStar is held by Telecominvest, which is in turn
owned 51% by an affiliate of Commerzbank AG, a major German bank, 25% by PTN and
24% by SPMMTS. Telecominvest was originally a joint venture between PTN and
SPMMTS formed to act as a holding company for their respective interests in a
number of telecommunications ventures in Northwest Russia.
Relationship with Other Equity Holders
Under the PeterStar foundation documents, a general meeting of shareholders
may take action through a simple majority of those present. Accordingly, since
PLD has a 71% interest in PeterStar, it should be assured of being able to take
whatever action it requires once a meeting is constituted. However,
representatives of 75% of the ordinary shares must first be present to
constitute a quorum. Thus, it is possible for Telecominvest (and Commerzbank,
through its control position in Telecominvest) to prevent action from being
taken by ensuring that there is no quorum at a shareholders meeting.
Also, pursuant to the PeterStar foundation documents, the shareholders have
rights of first refusal to purchase any shares which any shareholder wishes to
transfer, and to purchase any shares held by any shareholder who is bankrupt or
goes into liquidation.
PeterStar is dependent on PTN for the completion of most of its calls, and
the PeterStar network is linked to the PTN network, giving PeterStar access to
PTN's large local subscriber base. In addition, PeterStar is dependent on PTN's
buildings, ducts and tunnels in order to house its exchanges and to reach its
customers. Until 1998, PTN permitted PeterStar to house its exchanges in PTN
buildings and use its other facilities without paying rent or call charges.
Commencing in 1998, PeterStar has been required to pay a local line rental
charge to PTN, although roughly half of the fee otherwise payable during 1998
was offset against amounts owed to PeterStar by PTN in respect of the
Vassilievski Island project. The aggregate amount paid to PTN in 1998 for line
rental charges was $1.3 million. The amount of the 1999 line rental charged has
not yet been determined, but PeterStar
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expects once again to offset amounts due from PTN against such charges during
1999. However, any change in the terms on which PeterStar has access to PTN's
facilities, or any restrictions imposed by PTN on the completion of calls from
the PeterStar network, could have a material adverse effect on PeterStar and, in
turn, the Company. Given the extent of the reliance of PeterStar upon PTN, PTN
is clearly in a position to exercise a high degree of influence over PeterStar's
affairs as a practical matter, even as an indirect minority shareholder.
Notwithstanding its ability to influence PeterStar's affairs, the Company
believes that PTN will continue to support the development of PeterStar's
business as presently planned, and that PTN's business objectives are basically
consistent with PeterStar's own plans.
Management
The board of directors of PeterStar consists of eight individuals, with
three each being appointed by the Company and Telecominvest, and one being
appointed by PLD Holdings. The eighth director is the General Director, who is
nominated by the Company subject to final approval by the shareholders. As the
owner of the Company and PLD Holdings, PLD has the indirect right to appoint
four of the eight directors of PeterStar, and to nominate the General Director
who also sits on the Board.
Inasmuch as six of the eight directors must be present to constitute a
quorum, the possibility exists that the Telecominvest directors (or any three
other directors) may be able from time to time to prevent the creation of a
quorum. Once a quorum is present, however, PLD is currently reasonably assured
of a majority of the votes on the board, on the basis that the General Director,
who is a Company appointee, will vote with the four PLD-appointed directors.
Even if the General Director votes with the Telecominvest directors, PLD can
still achieve a majority of votes because the PeterStar foundation documents
specify that the person designated as Chairman of the Board (whom the Company is
entitled to appoint) also has a casting vote in the event of a tie vote among
the board of directors.
The day-to-day management of PeterStar is the responsibility of the General
Director and a management board which is composed of the PeterStar divisional
directors. The PeterStar operational divisions are: Sales and Marketing,
Finance, Technical and Operations and Administration.
The officers of PeterStar are as follows:
<TABLE>
<S> <C>
Sergei Kuznetsov..................................... General Director
Rick Macy............................................ Commercial Director
</TABLE>
Sergei Kuznetsov became General Director of PeterStar in September 1998.
Prior to joining PeterStar, he had been, since July 1995, the General Director
of Telecominvest, the company formed by PTN and SPMMTS to hold their interests
in St. Petersburg and Northwest Russia. Before that, Mr. Kuznetsov was the
initial General Director of Delta Telecom, Russia's first mobile
telecommunications company. Prior to that time Mr. Kuznetsov's career had been
in PTN where he rose to become the chief engineer of the Necrasovski regional
node. He received his degree from the North West Scientific Institute in St.
Petersburg. He received an MBA degree from Columbia University and attended the
management program at the Fuqua School of Management of Duke University. He is a
director of a number of companies including PTN, Telecominvest and PeterStar.
Rick Macy joined PeterStar as Commercial Director in April 1998, replacing
Stephen Gardner who then became Vice President -- Commercial, Russia for PLD.
Prior to joining PeterStar, Mr. Macy was the Commercial Director, Moscow for
Millicom, where he was responsible for the sales and marketing of all of
Millicom's Russian cellular joint ventures. Previously, he was Area Sales
Manager for Harris Corporation, responsible for their European markets. He also
spent four years as an electronics technician in the U.S. Navy.
Service Agreement
PeterStar entered into a service agreement, dated as of January 1, 1999,
with the Company, pursuant to which, for a one-year term, the Company will
provide management services to PeterStar, including advice and assistance with
respect to the design, implementation, operations, marketing and expansion of
PeterStar's
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network for a one-year term. PeterStar has had similar agreements with the
Company for all years dating back to 1992.
ALTEL
Ownership Structure
The Company's 50% interest in ALTEL is held by WTC, a British Virgin
Islands corporation and a wholly owned subsidiary of the Company. The other 50%
interest in ALTEL is currently held by Kazakhtelekom, a joint stock company
which is owned by the government of Kazakhstan and which operates the public
telephone network in that country (the authority to operate such network having
been recently confirmed by the grant to Kazakhtelekom of specific authority to
act as the exclusive operator of the public network in Kazakhstan and as
representative of the Kazakh government in international telecommunications
matters).
Relationship with Other Equity Holders
The relationship between WTC and Kazakhtelekom is governed principally by
the terms of a joint venture agreement entered into in December 1993. The
agreement sets forth the respective capital contributions of the parties. In the
case of the Kazakh partner, these consisted of the cellular license and
frequencies, as well as all physical facilities required for the operation of
the cellular network. As required, WTC contributed cash, equipment, property and
services with an aggregate value of $20.0 million by February 1995. WTC has no
obligation to make any additional contributions. Should the board of directors
of ALTEL determine that ALTEL requires an additional capital contribution, then
each shareholder will be required to contribute its proportionate share of the
capital contribution or face dilution.
Each ALTEL shareholder has the same voting, distribution and liquidation
rights, except that upon a liquidation, WTC is entitled to receive out of any
distributions the first $20.0 million for its capital contribution plus any
subsequent capital contributions not matched by Kazakhtelekom.
Under current Kazakh legislation, neither party is permitted to sell,
assign, pledge or otherwise transfer its equity interest in ALTEL without first
offering such interest to the other party
ALTEL and Kazakhtelekom entered into an interconnection agreement pursuant
to which Kazakhtelekom agreed to provide ALTEL with access to the public
switched telephone network in Kazakhstan for the fifteen year term of ALTEL's
current license free of charge (but subject to payment of certain charges to
local operators for carriage and termination of calls from ALTEL's network).
While there is no reason to suppose that Kazakhtelekom will not honor this
commitment, the loss of, or any significant limitation on its access to the
network could have a material adverse effect on the operations of ALTEL.
While WTC may have the power, pursuant to the management structure
described below, to direct the operations or determine the strategies of ALTEL,
management believes that it is unlikely, in view of the pivotal importance of
Kazakhtelekom to the business of ALTEL, that any significant initiatives would
be undertaken by WTC without the consent of Kazakhtelekom. To date,
Kazakhtelekom has not used its position to undermine initiatives proposed by
WTC, nor to cause ALTEL to take any action to WTC's detriment; however, there
can be no assurance that it will not do so in the future.
It is not known what effect on ALTEL, or its license or business, the
recent designation of Kazakhtelekom as the exclusive operator of the public
network will have. In addition, Kazakhtelekom is a participant in one of the
joint ventures which was recently granted a national GSM license in Kazakhstan
and it remains unclear what impact this participation will have on ALTEL's
business. All of these developments will present new uncertainties and
challenges for ALTEL. See "-- Risk Factors -- Risks Involving ALTEL."
In connection with the grant of its telecommunications license in 1994, WTC
agreed to lend the KMOC up to $3 million on commercial terms for use for various
KMOC projects. During 1995, PLD advanced $3 million to Monogram Finance Group
Limited ("MFGL") in exchange for a convertible promissory note due on February
20, 2000. The note is convertible at any time prior to February 29, 2000 into
common stock of MFGL representing 50% of its total issued and outstanding common
stock. Its sole asset is an agreement to acquire a
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50% interest in Monogram Telecommunications Limited, a Bermuda company ("MTL").
MTL has an agreement to acquire 100% of an Irish company known as Kazakhstan
Telecommunications Development Corporation Limited ("KTDC"). KTDC has agreed in
principle with the government of Kazakhstan to assist the government in
connection with the privatization of Kazakhtelekom. While the Company believes
that this arrangement satisfies the commitment given by WTC to the KMOC, there
can be no assurance that the KMOC will not still call upon WTC to advance, and
that WTC will not be obligated to pay, the $3 million.
Management
ALTEL is currently managed by a board of directors consisting of six
members, three designated by Kazakhtelekom and three by WTC. WTC designates the
Chairman of the Board who has a casting vote in the event of a tie vote. At
least four members of the board are required to approve any of the following
actions: amendment of ALTEL's charter, dissolution, voluntary bankruptcy,
approval of the annual budget, acquisition of assets or businesses in excess of
$5 million or any disposition or transfer of the ALTEL license, other
investments in excess of $1 million or incurring indebtedness in excess of $2
million. These arrangements cannot be changed without WTC's consent.
Accordingly, while there may be some question about the enforceability of these
arrangements, WTC believes that it has the ongoing ability to make all
significant strategic, operating, financing and investing decisions on behalf of
ALTEL through the arrangements described above, although it is not likely that
it would choose to take action without the approval of Kazakhtelekom.
ALTEL has two co-chief executive officers ("Co-CEOs") and a treasurer who
is also the chief financial officer ("CFO"), and may appoint other officers as
the board determines. In addition, ALTEL has a chief Kazakh financial officer
("CKFO") who reports directly to the CFO and who is responsible for accounting
matters under Kazakh law as well as serving as a liaison between ALTEL and the
Kazakh tax authorities. One of the Co-CEOs and the CKFO are appointed by the
directors who are designees of Kazakhtelekom and the other Co-CEO and the CFO
are appointed by the directors who are designees of WTC. The Co-CEO appointed by
the WTC directors has the ultimate responsibility for the management of ALTEL,
subject to the authority of the board of directors.
The current officers are as follows:
<TABLE>
<S> <C>
Rex Power............................... Co-Chief Executive Officer
Maxut Sauranbekov....................... Co-Chief Executive Officer
Michael Leaver.......................... Chief Financial Officer
</TABLE>
Rex Power joined ALTEL in June 1997. He is a registered chartered engineer
and a registered European engineer. Prior to joining ALTEL, he worked for Cable
& Wireless for over 30 years, mostly in overseas assignments, including
management positions in Nigeria, Saudi Arabia and Macau. Additional positions
with Cable & Wireless included Regional Business Manager for the Bermuda,
Caribbean and Atlantic Islands Region and General Manager, Eastern
Russia/Director, Special Projects in the Northeast Asia Region, Hong Kong and
Japan.
Maxut Sauranbekov became Co-Chief Executive Officer of ALTEL in June 1997.
He joined ALTEL in October 1994 as Vice President for Marketing, Sales and
Customer Service and then served as Vice President for Corporate Affairs. Prior
to joining ALTEL, he worked for eight years in various other commercial and
financial ventures.
Michael Leaver joined ALTEL as Chief Financial Officer in April 1998. From
1995 until joining ALTEL, he was Deputy General Director of Uralwestcom, a
cellular telephony operator in Yekaterinburg. Previously, Mr. Leaver was the
Financial Director for Kiev Tetra Pak, a Ukrainian joint venture, for three
years during its start-up phase.
Recent changes in applicable Kazakh legislation will require that the
management arrangements described above will need to be revised. However,
although it seems clear that the existing arrangements cannot be completely
preserved in their present form, because of the imprecision in some of the
drafting and also because of the lack of precedents due to the newness of the
legislation, it is difficult to state to what extent these arrangements will
need to be revised. In addition, ALTEL is actively exploring the option of
converting to a different legal form which may permit the preservation of, if
not all, at least a substantial portion of the
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management arrangements described above in their current form. ALTEL does not
expect to resolve this issue before the middle of 1999.
ALTEL entered into Consulting and Information Services Agreements with PLD
and Kazakhtelekom, each dated January 1, 1998, pursuant to which such parties
provide certain consulting, information, management services and personnel
expertise to ALTEL. In consideration for these services, ALTEL pays consulting
fees, in the case of PLD, of $25,000 per month plus 3.4% of ALTEL's gross
revenues, and, in the case of Kazakhtelekom, of 300,000 Tenge per month plus 1%
of ALTEL's gross revenues. These contracts are each for a one year term
automatically renewable for successive one year periods unless terminated by
either party.
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RISK FACTORS
This document contains certain forward-looking statements that are subject
to risks and uncertainties. Forward-looking statements include certain
information relating to political, social and economic conditions in the
countries of the former Soviet Union and the Commonwealth of Independent States,
the commencement of certain programs and the proposed offering of certain
services by the Company's operating subsidiaries, proposed changes in the
Company's corporate structure and centers of operations and interpretations and
actions of certain regulatory authorities, including in Russia and Kazakhstan,
as well as information contained elsewhere in this Report where statements are
preceded by, followed by or include the words "believes," "expects,"
"anticipates" or similar expressions. For such statements the Company claims the
protection of the safe harbor for forward-looking statements contained in the
private Securities Litigation Reform Act of 1995. Actual events or results may
differ materially from those discussed in forward-looking statements as a result
of various factors, including without limitation, those discussed elsewhere in
this Report and in the documents incorporated herein by reference. Furthermore,
this document constitutes a Year 2000 Readiness Disclosure Statement, and the
statements herein are subject to the Year 2000 Information and Readiness
Disclosure Act, and the Company hereby claims the protection of such Act for
this document and all information contained herein.
COUNTRY RISKS
General. Foreign companies conducting operations through affiliates in the
Russian Federation and Kazakhstan face significant political, economic,
currency, legal and social risks. For example, a report released February 20,
1997 by the United States Embassy in Moscow on the commercial environment in the
Russian Federation listed the following general difficulties affecting trade and
investment in the Russian Federation, most of which are also encountered in
Kazakhstan, and some or all of which could affect the ability of the Company or
its operating businesses to conduct or realize income from their businesses:
- ownership disputes
- high taxes, and a frequently changing tax regime
- high operating costs
- lack of systematic and accessible credit information
- corruption and commercial crime
- financial illiquidity of many firms
- changing requirements from regulatory bodies
- lack of market information
- an infant commercial legal framework
- cultural and language differences
- infrastructure problems
- payments, arrears and frozen accounts
- frequent changes in governmental personnel
Political Risks. Since the breakup of the Soviet Union, the political
situation in the Russian Federation and Kazakhstan has been characterized by
uncertainty and instability.
Russia. In the Russian Federation, there have been significant tensions
between the executive and legislative branches of the government and efforts by
the regions and autonomous republics of the Russian Federation to gain a greater
degree of independence (the most dramatic example of which was the conflict in
Chechnya). Lack of consensus between local and regional authorities and the
federal government often results in the enactment of conflicting legislation at
various levels and may result in political instability. This lack of consensus
may have negative economic effects on the Company, which could be material to
its operations.
In addition, Communist and nationalist parties wield strong influence in
the lower house of Parliament (the Duma) and have made gains in regional
governorships which could result in a slow down or reversal of the development
of a free market economy.
During the transformation to a market-oriented economy in the Russian
Federation, legislation has been enacted to protect property against
expropriation and nationalization. However, a resurgence in nationalism could
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<PAGE> 26
result in pressures for the reduction or even elimination of non-Russian
ownership of Russian businesses, and there can be no assurance that such
recently enacted protections would be enforced in the event of an attempted
expropriation or nationalization. Legislation to restrict foreign ownership in
the telecommunications industry is introduced from time to time and, while not
expected to become law, is symptomatic of these increasingly nationalistic
attitudes.
There is also significant instability in the executive branch. Boris
Yeltsin, President of the Russian Federation, has been unable because of
ill-health to carry out the many and significant responsibilities of that
office. Instead, he has increasingly delegated his responsibilities to
ministerial appointees, while at the same time endeavoring to retain, and
demonstrate, his continuing constitutional powers by making frequent changes in
his appointments. All of this has served to create significant uncertainty, not
only as to the policies his government will pursue, but also as to whether the
government is likely to take any action to deal with the many significant
problems which the Russian Federation faces.
Additionally, he has announced that he will not run for re-election in
2000, which has set off a race between a number of candidates anxious to succeed
him. The efforts of these other candidates to be elected as President, and the
resulting change in leadership at that time, could result in additional
political instability and also substantial changes in government policies. Any
such matters could have a material adverse effect on the Company.
Kazakhstan. The political situation in Kazakhstan is characterized by
one-man rule by President Nursultan Nazarbayev who demonstrates considerable
political power. While such concentration of power may at times be perceived as
providing a stabilizing influence, it also increases the risk of nepotism,
arbitrary decision-making and significant policy changes in the event of
succession.
Russian Economic and Political Turmoil. During 1998 there was considerable
turmoil and uncertainty in the Russian financial markets, prompted in large part
by a drop in commodity prices and economic problems in Russia, together with the
crisis in the Asian financial markets which began in late 1997. These
developments were accompanied by a substantial decline in the Russian stock
market. These developments led the Russian government to raise interest rates
significantly and to seek special assistance from the International Monetary
Fund. In August 1998, the Russian government announced a substantial widening of
the trading band in which the Russian Rouble would be permitted to float,
together with a moratorium on certain foreign debt payments. Thereafter the
Rouble dropped substantially in value and traded outside of the high end of the
band, and the Russian government did not intervene to stop this trading, thereby
effectively acquiescing to a major devaluation of the Rouble. In the latter part
of 1998 and the first months of 1999, the Rouble has further declined in value
and this process is expected to continue.
Also in August 1998 the Russian government announced a 90-day moratorium on
debt repayments. This moratorium caused considerable difficulties for Russian
banks and businesses with hard currency obligations, as well as significantly
impairing the ability of such banks and businesses, as well as the Russian
government itself, to access the Western capital markets. The difficulties
experienced by the Russian banks in turn caused difficulties for their
customers, as bank transfers and deposits were frozen in many cases. The Russian
government itself has effectively defaulted on substantial amounts of its debt,
and is engaged in negotiations with Western banks and institutions (which reach
back several months) to restructure this indebtedness. Continuation of these
conditions for any significant period of time could have serious long-term
effects on the Russian economy. At the present time, it is impossible to predict
whether or when any resolution of these problems is likely.
In August 1998, the Russian government experienced a significant upheaval,
with the dismissal of the reformist government led by Sergei Kiriyenko and its
replacement by one led by Yevgeny Primakov. The Primakov government did not
propose a plan to address Russia's economic and financial difficulties, one
result of which has been to cause the International Monetary Fund to delay
further assistance to the Russian government. In May 1999, another political
upheaval occurred, when President Boris Yeltsin dismissed the Primakov
government and selected Sergei Stepashin as the new Prime Minister. It is too
soon to predict what policies will be adopted by the new Stepashin government.
This most recent governmental reshuffling creates increased uncertainty about
the future political situation in Russia, which in turn creates additional
concern about the ability of the government to deal with the many problems
currently afflicting the Russian economic system.
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At the present time, it is not possible to predict the complete effect of
the continuing economic, financial and political difficulties in Russia,
although they have made for a difficult business environment in Russia. Although
demand for the Company's telecommunications services continued during the
economic and banking crisis in the second half of 1998, the economic
difficulties in Russia have adversely affected the Company's operating
subsidiaries and the Company's consolidated results for the year ended December
31, 1998 and the first six months of 1999. As described in more detail in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," the Company's operating subsidiaries incurred a significant foreign
exchange loss in 1998 and an increased exchange loss in the first six months of
1999 as compared to the same period in 1998, together with a reduction in
revenues on a year-on-year basis, and the Company expects that revenues and
margins will remain under pressure, and that the average age of its receivables
is likely to continue to grow. The Company is not yet able to predict the
effects of the ongoing difficulties on its results for 1999 as a whole, but the
continuing economic difficulties in Russia will likely continue to have an
adverse effect on the Company in current and future reporting periods, and there
can be no assurance that such adverse effects will not be material.
Economic Risks -- Uncertain Pace of, and Difficulties Experienced in,
Economic Reform; Reliance on Foreign Economic Aid. Until recently, the economies
of the Russian Federation and Kazakhstan were administered by the central
authorities of the former Soviet Union. Following the collapse of those
authorities and the command economy they managed, the governments of both the
Russian Federation and Kazakhstan sought to implement policies designed to
introduce free market economies into their respective countries. While these
policies have met with some success, the economies of both the Russian
Federation and Kazakhstan have been characterized by high unemployment, high
rates of business failure, the deterioration of certain sectors of the economy,
high government debt relative to gross domestic product and declining real
wages. In both the Russian Federation and Kazakhstan real economic improvement
has been limited to specific regions (the Moscow and St. Petersburg regions in
Russia, and Almaty in Kazakhstan). The Russian Federation is still experiencing
a lack of political consensus as to the scope, content and pace of free market
reforms. No assurance can be given that policies to introduce or support a free
market economy will continue to be implemented in either the Russian Federation
or Kazakhstan, that these countries will remain receptive to foreign investment
or that the economies of the Russian Federation or Kazakhstan will stabilize.
The failure of any of these to occur could have a material adverse effect on the
Company. In addition, the Russian Federation currently receives substantial
financial assistance from several foreign governments and international
organizations. To the extent any of this financial assistance is reduced or
eliminated, economic development in the Russian Federation may be adversely
affected, and any resulting difficulties in the Russian economy could have a
material adverse effect on the Company.
-- Limited Experience with Free Market Economy. Russian and Kazakh
businesses have limited operating history in free market conditions and have had
limited experience compared with Western companies with the entering into and
performance of contractual obligations. Accordingly, as compared to Western
companies, such businesses are often characterized by management that lacks
experience in responding to changing market conditions and limited capital
resources with which to develop their operations. In addition, the Russian
Federation and Kazakhstan have limited infrastructure to support a market
system, and banks and other financial systems are not well developed or well
regulated. Businesses therefore may experience difficulty in obtaining working
capital facilities. Moreover, these countries' banking system have faced and may
encounter in the future liquidity crises as well as other problems arising as a
result of under-capitalization of the banking sector as a whole. The experiences
gained from the financial and banking crisis in Russia in the last two quarters
of 1998 demonstrate how fragile the Russian banking system is, and at the same
time how dependent Western investors are on such system. Another general Russian
banking crisis in particular could have a material adverse effect on the
Company's operations and financial performance and on the ability of its
customers to pay amounts due. While Kazakhstan has not experienced a similar
crisis, there is the potential for such a crisis in that country and the effects
of any such crisis would likely be as severe.
Restrictions on Currency Conversion; Historical Volatility in Currency
Prices. Neither the Russian Rouble nor the Kazakh Tenge is convertible outside
of their home countries.
In Russia and Kazakhstan, a market exists for the conversion of Roubles and
Tenge into other currencies, but it is limited in size and is subject to rules
limiting the purposes for which conversion may be effected. The history of
trading in the Russian Rouble and Kazakh Tenge against the U.S. Dollar has been
characterized by significant
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declines in value and considerable volatility, although the Russian Rouble and
the Kazakh Tenge experienced relative stability against the U.S. dollar during
1996 and 1997. However, during 1998 and 1999, the Russian Rouble has been under
considerable pressure and suffered substantial declines against the U.S. Dollar
and other currencies. After remaining relatively stable during 1998, the Kazakh
Tenge has lost significant value in the first six months of 1999, reflecting
concerns about the health of the country's economy and a decision by the
government of Kazakhstan to cease providing support for its currency. See
"-- Russian Economic and Political Turmoil."
In general, PeterStar and ALTEL post their tariffs in U.S. Dollars, and
receive payment in local currency at the U.S. dollar exchange rate prevailing on
the date of payment. These operating businesses face an exchange risk to the
extent that they experience any difficulty in converting the local currency
payment received into U.S. Dollars. In addition, they face a risk that the local
currency weakens against the U.S. Dollar during the period between the customer
instructing its bank to pay the operating business and the day the payment is
actually received by the operating business. Historically, this time period has
been short and the exchange risks arising from this particular issue have
therefore been minimal. However, the Company's operating businesses experienced
significant foreign exchange losses in the third and, to a lesser extent,
fourth, quarter of 1998, due principally to delays in clearing payments within
the Russian banking system.
All of these factors, and others, may serve to increase the Company's
exposure to foreign exchange losses in the future, the effect of which cannot
currently be predicted. No assurance can be given that the Company's operating
businesses which bill in U.S. dollar equivalents will be able to continue to
post their tariffs in U.S. Dollars and collect payments in local currencies in
amounts determined by reference to the value of the U.S. Dollar, or that they
will continue be able to process such payments without banking delays or to
exchange local currencies for U.S. Dollars without significant difficulties,
delays or costs.
It is not practical or economical for the Company to hedge its exchange
risks. See "Quantitative and Qualitative Disclosure About Market Risk." Any of
these factors, in conjunction with further declines, or volatility, in the value
of the Russian Rouble or the Tenge against the U.S. Dollar, could have a
material adverse effect on the Company. See also "-- Risks Involving the
Company -- Currency Controls."
Legal Risks -- Underdeveloped Legal System. The Russian Federation and
Kazakhstan lack fully developed legal systems. Russian and Kazakh law is
evolving rapidly and in ways that may not always coincide with market
developments, resulting in ambiguities, inconsistencies and anomalies, and
ultimately in investment risk that would not exist in more developed legal
systems. Furthermore, effective redress in Russian and Kazakh courts in respect
of a breach of law or regulation, or in an ownership dispute, may be difficult
to obtain.
Risks associated with the Russian and Kazakh legal systems include: (i) the
untested nature of the independence of the judiciary and its immunity from
economic, political or nationalistic influences; (ii) the relative inexperience
of judges and courts in commercial dispute resolution, and generally in
interpreting legal norms; (iii) inconsistencies among laws, presidential decrees
and governmental and ministerial orders and resolutions; (iv) often times
conflicting local, regional and national laws, rules and regulations; (v) the
lack of judicial or administrative guidance on interpreting the applicable
rules; (vi) retroactive changes in laws and regulations; and (vii) a high degree
of discretion on the part of government authorities and arbitrary decision-
making which increases, among other things, the risk of property expropriation.
The result has been considerable legal confusion, particularly in areas such as
company law, property, commercial and contract law, securities law, foreign
trade and investment law and tax law. No assurance can be given that the
uncertainties associated with the existing and future laws and regulations of
the Russian Federation or Kazakhstan will not have a material adverse effect on
the Company. In addition, there is no guarantee that a foreign investor would
obtain effective redress in any court. No treaty exists between the United
States and the Russian Federation or Kazakhstan for the reciprocal enforcement
of foreign court judgments.
Furthermore, the relative infancy of business and legal cultures in the
Russian Federation and Kazakhstan are reflected in the inadequate commitment of
local business people, government officials, agencies and the judicial system to
honor legal rights and agreements, and generally to uphold the rule of law.
Accordingly, the Company may, from time to time, confront threats of, or actual,
arbitrary or illegal revision or cancellation of its
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<PAGE> 29
licenses and agreements, and face uncertainty or delays in obtaining legal
redress, any of which could have a material adverse effect on the Company.
-- Possible Additional Liability of Shareholders. The Civil Code of the
Russian Federation and the Law of the Russian Federation on Joint Stock
Companies generally provide that shareholders in a Russian joint stock company
are not liable for the obligations of the joint stock company, and only bear the
risk of loss of their investment. However, if a company (an "effective parent")
is capable of determining decisions by another company (an "effective
subsidiary"), and such capability is provided for in the charter of the
effective subsidiary or in a contract between the companies, and if the
effective parent gives obligatory directions to the effective subsidiary, such
effective parent bears joint and several responsibility for transactions
concluded by such effective subsidiary in carrying out such directions. In
addition, an effective parent is secondarily liable for an effective
subsidiary's debts in the event an effective subsidiary becomes insolvent or
bankrupt resulting from the action or inaction of an effective parent which is
capable of determining decisions of the effective subsidiary whether as a result
of the effective parent's ownership interest, pursuant to the terms of a
contract between the companies or in any other way. In such instances, other
shareholders of the effective subsidiary may claim compensation for the
effective subsidiary's losses from the effective parent which caused the
effective subsidiary to take action(s) or fail to take action(s) knowing that
such action(s) or failure to take action(s) would result in losses. Accordingly,
it is possible that the Company may be deemed to be an effective parent of
certain of its subsidiaries and therefore be liable in certain cases for the
debts of its effective subsidiaries. Such liability could have a material
adverse effect on the Company.
The Company believes that the applicable legislation in Kazakhstan does not
contain any similar provisions.
-- Limited Protection of Minority Shareholders. Russian laws regulating
ownership, control and corporate governance of Russian companies may, in some
cases, provide limited protection to shareholders, particularly minority
shareholders. Disclosure and reporting requirements, and anti-fraud and insider
trading legislation have only recently been enacted and most Russian companies
and managers are not accustomed to such restrictions on their activities. The
concept of fiduciary duties on the part of management or directors to their
companies or shareholders is also new and is not well developed. See "-- Risks
Involving the Company -- Potential Conflicts of Interest." Additionally,
procedural protections to which U.S. shareholders are accustomed, such as
contingent fee arrangements or the ability to bring class actions, are as yet
still unknown in Russia.
The concept of minority shareholder rights has not yet been tested in
Kazakhstan, and it is therefore difficult to predict how a court confronted with
the issue would rule.
Social Risks. The political and economic changes in the Russian Federation
and Kazakhstan since the break up of the former Soviet Union have resulted in
significant social dislocations, as existing governing structures have collapsed
and new ones are only beginning to take shape. The resulting broad decline in
the standard of living has often resulted in substantial political pressure on
the government to slow or even reverse the economic policies currently being
pursued. In addition, such decline in the standard of living has led in the
past, and could lead in the future, to labor and social unrest. Such labor and
social unrest may have political, social and economic consequences, such as
increased support for a renewal of centralized authority, increased nationalism
(with restrictions on foreign investment in the Russian or Kazakh economy) and
increased violence, any of which could have a material adverse effect on the
Company.
In addition, the local and international press have reported significant
organized criminal activity, particularly in large metropolitan centers,
directed at revenue-generating businesses, and an increased integration of
Russian organized crime with major international criminal organizations. A
substantial increase in property crime in large cities has also been reported.
Finally, the local and international press have reported high levels of official
corruption in the locations where the Company's operating businesses operate. No
assurance can be given that organized or other crime or claims that the Company
or any of its operating businesses has been involved in official corruption will
not in the future have a material adverse effect on the Company.
Official Data Reliability. The official data published by Russian federal,
regional and local governments and federal agencies, and by the Kazakh
government and its agencies, are substantially less complete or reliable than
those of Western countries, and there can be no assurance that the official
sources from which certain of the
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information set forth herein has been drawn are reliable. Official statistics
may also be produced on different bases than those used in Western countries.
Any discussion of matters relating to the Russian Federation or Kazakhstan
herein must therefore be subject to uncertainty due to concerns about the
completeness or reliability of available official and public information.
RISKS INVOLVING THE COMPANY
Guarantee of PLD Debt. As it has disclosed in its Annual Report on Form
10-K, PLD has significant debt service requirements, including the payment of
interest on the Senior Notes and the Convertible Notes and amounts owing to The
Travelers Insurance Company and The Travelers Indemnity Company (together, the
"Travelers Parties"), and PLD does not presently have sufficient funds on hand
to meet its current debt obligations. The Company is a guarantor of the Senior
Notes and the Convertible Notes under the terms of the related indentures.
While an agreement has been reached with the holders of the Senior Notes
and the Convertible Notes and with the Travelers Parties on a restructuring of
PLD's indebtedness to such parties, those agreements are conditioned upon the
closing of PLD's merger with MMG. If the merger did not close, PLD would remain
obligated to pay the interest on the Senior Notes and the Convertible Notes and
there can be no assurance that the Travelers Parties would not demand payment in
full of PLD's obligations to them. PLD's failure to make the interest payments
on the Senior Notes and the Convertible Notes could result in a default under
and acceleration of those Notes for which the Company serves as guarantor.
Similarly, PLD's failure to make payment in full to the Travelers Parties could
result in a cross-default under and acceleration of the Senior Notes and the
Convertible Notes.
Any such events would have a material adverse effect on the Company and
would raise substantial doubt about the Company's ability to continue as a going
concern.
Year 2000. While the Company believes that it should not encounter material
problems as a result of its own equipment not being Year 2000 compliant, its
businesses may encounter disruptions in service as a result of noncompliance on
the part of other traffic carriers, particularly those in Russia and other
C.I.S. countries on which they are dependent for the completion of their calls.
The Company believes that the Year 2000 compliance of the Russian and other
C.I.S. parties with which the Company's operating businesses interact appears to
be substantially behind that of Western parties, and that it is unlikely that
those parties will be able to become fully Year 2000 compliant, given the
limited amount of time left for this, and the severe funding constraints faced
by those parties. Additionally, the Russian government has recently announced,
in response to the Kosovo crisis, an intention to limit its cooperation in
efforts to deal with potential Year 2000 problems. Accordingly, there is a
significant risk that the Company's operating businesses may experience
disruptions in their operations as a result of their C.I.S. interconnect
partners not being able to complete calls or pass traffic to those businesses.
Additionally, the billing systems of those interconnect partners may also be
disrupted, resulting in those partners being unable to make timely settlements
with the Company's operating businesses. All of these items have the potential
to adversely impact the operations of its operating subsidiaries, and such
adverse impact, on both the businesses of such subsidiaries and the Company's
own financial results, may be material. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Year 2000 Issues."
Holding Company Structure; Barriers to Realizing Cash from Subsidiaries. As
a holding company that conducts virtually all of its business through
subsidiaries, the Company has essentially no source of cash other than
distributions and other payments from its subsidiaries. The ability of the
Company's subsidiaries to make payments to the Company may be constrained by:
(i) their own ability to generate sufficient cash from their operations; (ii)
the level of taxation, particularly corporate profits and withholding taxes, in
the jurisdictions in which they operate; (iii) exchange controls and
repatriation restrictions in effect in the jurisdictions in which they operate;
and (iv) the ownership interests of other investors in the Company's
subsidiaries.
Taxation. Taxes payable by Russian and Kazakh companies are substantial and
include value-added taxes ("VAT"), excise taxes, export taxes and income taxes.
The tax risks of investing in the Russian Federation and Kazakhstan can be
substantial. Obtaining the benefits of any relevant tax treaties can be
extremely difficult due to the documentary and other requirements imposed by the
Russian and Kazakh authorities and the unfamiliarity of
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those administering the tax system with the international tax treaty system or
their unwillingness to recognize the treaty system. For example, a recent
instruction issued by the Russian State Tax Service mandates full withholding
regardless of tax treaty status and requires the recipient to seek to obtain a
refund for withholding in excess of treaty amounts. The need to deal with these
issues may negate or impair tax planning initiatives undertaken by the Company
to reduce its and its subsidiaries' overall tax obligations. Furthermore, the
taxation systems in the Russian Federation and Kazakhstan are at an early stage
of development and are subject to varying interpretations, frequent changes and
inconsistent and arbitrary enforcement at the federal, regional and local
levels. In certain instances, new taxes and tax regulations have been given
retroactive effect.
Currency Controls -- Risks of Changing Regulatory and Administrative
Environment. While applicable legislation in both the Russian Federation and
Kazakhstan currently permits the repatriation of profits and capital and the
making of other payments in hard currency, the ability of the Company to
repatriate such profits and capital and to make such other payments is dependent
upon the continuation of the existing legal regimes for currency control and
foreign investment, administrative policies and practices in the enforcement of
such legal regimes and the availability of foreign exchange in sufficient
quantities in those countries.
The Company's ability to repatriate distributions and other payments in
hard currency will be dependent upon the continued ability of the Company's
operating subsidiaries, where applicable, to bill their customers in U.S.
Dollars or the equivalent amount of local currency, as well as their ability to
freely exchange local currency receipts into U.S. Dollars. See "-- Country
Risks -- Restrictions on Currency Conversion; Historical Volatility in Currency
Prices." There can be no assurance that, because of future changes in Russian
and Kazakh currency regulations, the Company's ability to fully and/or on a
timely basis realize benefits from its operations in the Russian Federation and
Kazakhstan through the receipt of hard currency payments will continue.
-- Currency Licensing Requirements. Under current currency regulations in
the Russian Federation and Kazakhstan, while there do not appear to be
additional administrative requirements for the payment of dividends or interest
on debt, until January 1999, specific licenses from both the Central Bank and
the National Bank of Kazakhstan were required for repayments of principal on
debt with a term of more than 180 days. As of January 1999, the Central Bank
required licenses for any such obligations with a term of more than 90 days.
Failure to obtain such currency licenses where required can result in the
imposition of fines and penalties. While the requirements for obtaining such
licenses largely involve the production of documentation, not only are the
documentary requirements themselves burdensome, but there can be no assurance
that the entity granting the licenses may not impose additional, substantive
requirements for the grant of a license or deny a request for a license on an
arbitrary basis. See "-- Country Risks -- Legal Risks -- Underdeveloped Legal
System." Furthermore, the time typically taken by the Central Bank and the
National Bank of Kazakhstan to issue such licenses can be lengthy. In the case
of the Central Bank, delays of up to one year or more in the issuance of
licenses have not been uncommon. Failure to obtain currency licenses, where
required, can result in the imposition of fines and penalties, significant
delays in delivering equipment to the Company's operating businesses and
resulting difficulties in generating cash flows from the Company's operating
businesses in the Russian Federation.
Finally, the Company's ability to repatriate distributions and other
payments in hard currency will be dependent upon the continued ability of the
Company's operating subsidiaries in Russia and Kazakhstan to bill their
customers in the U.S. dollars or the equivalent amount of local currency, as
well as their ability to exchange freely local currency receipts into U.S.
dollars. There can be no assurance that, because of changes in Russian and
Kazakh currency regulations, and/or because of a recurrence of the financial,
banking and currency crises which afflicted the Russian Federation in the latter
part of 1998, the Company's ability to fully and/or on a timely basis realize
benefits from its operations in the Russian Federation and Kazakhstan through
the receipt of hard currency payments will continue.
-- Possible Effects of Currency Controls and Regulations on the Company's
Ability to Meet its Obligations. There can be no assurance that, due to the
risks outlined above, the Company will not experience difficulties or delays in
receiving cash flows from its operating subsidiaries. Any such difficulties or
delays could materially affect the Company's ability to make payments on its
outstanding indebtedness (including its guarantees of PLD's Senior Notes and
Convertible Notes) and could result in defaults in the Company's payment
obligations
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under that indebtedness. In addition, the Company's ability to meet its working
capital requirements or to declare and pay dividends to its shareholder could be
adversely affected by any cash flow restrictions experienced by the Company.
Anti-Monopoly Committee Approval. Under Russian anti-monopoly legislation,
transactions which potentially influence competition in the Russian Federation
are subject to the disclosure to and/or prior consent of the Russian
Anti-Monopoly Committee. The Anti-Monopoly Committee generally has wide
discretion to approve or disapprove transactions falling within the scope of its
authority, though in practice transactions are rarely challenged. The time
typically required by the Anti-Monopoly Committee to review a proposed
transaction varies between three and four months. Failure to obtain prior
consent may constitute grounds for the Anti-Monopoly Committee to seek a court
decision declaring the relevant transaction null and void. In particular,
transactions (including rental or lease transactions) which involve the
acquisition of more than 20% of a Russian company's stock or the transfer of
assets amounting to more than 10% of the assets of a transferor to a transferee,
are subject to prior consent of the Anti-Monopoly Committee.
Absence of Complete Control; Dependence on Local Partners. The Company's
principal assets are its interests in its operating subsidiaries. The Company
holds a 60% ordinary share interest in PeterStar, a 50% interest in ALTEL and a
100% interest in Yellow Pages. While PLD and the Company may have the ability,
in the case of PeterStar and ALTEL, to direct the operations or determine the
strategies of such subsidiaries under the terms of their respective constituent
documents, the enforceability of some of the Company's rights is uncertain. See
"-- Country Risks -- Legal Risks." Further, the other shareholders may, as a
practical matter, be able to impede the Company's ability to exercise effective
control. In addition, PLD and the Company would be unlikely to take significant
initiatives without the approval, in the case of PeterStar, of Telecominvest and
PTN; and in the case of ALTEL, of Kazakhtelekom. See "-- Ownership and
Management of Operating Subsidiaries." PeterStar and ALTEL are dependent on
continued access, on favorable terms, to the facilities of certain of the
Company's partners, and this may adversely affect the Company's ability to rely
on its legal rights to influence the conduct of the business of its operating
subsidiaries. In summary, the absence of complete legal control by PLD and the
Company over the operations of PeterStar and ALTEL, coupled with the dependence
of these ventures on continued access to the facilities of PLD's partners, could
have a material adverse effect on the Company. Finally, PeterStar and ALTEL are
restricted subsidiaries under the Senior Note Indenture and the Convertible Note
Indenture, and PLD is required by the terms of such indentures not to permit its
restricted subsidiaries to violate the various covenants contained in such
Indentures. There can be no assurance that the Company will always be in a
position to comply with this obligation, and its failure to do so could cause a
default under the Senior Note Indenture or the Convertible Note Indenture.
Susceptibility to Political and Other Pressures. Although the governments
of the countries and regions in which the Company operates may be limited in the
extent to which they can legally direct the Company's policies, in practice they
may be able to exercise significant influence. As a consequence, not only may
the Company's activities be restrained if a governmental entity is not
supportive, but the Company may be forced to take action to support policies or
agendas of the government which are not in its commercial or other interests. In
addition, in order to maintain good working relationships with its partners, the
Company may need to take certain actions which may not necessarily be in its
commercial or business interests.
Competition. The Company is developing and operating its businesses in
highly competitive environments. A number of companies compete with the
Company's operating businesses, many of which have access to greater financial
and technical resources than the Company. There can be no assurance that the
Company will be able to overcome successfully the competitive pressures to which
it is subject, both in the markets in which it currently operates and in markets
into which it might expand. Furthermore, in many instances the Company's
partners in its operating businesses are also potential -- and in some cases
actual -- competitors. For example, PTN has recently completed the installation
of a fiber optic network in St. Petersburg which, when fully operational, will
improve call completion rates on the PTN network and could provide a serious
alternative to PeterStar's network and permit PTN to compete more effectively
for business in St. Petersburg. ALTEL's cellular network in Kazakhstan could be
seen as being in competition with the national network operated by
Kazakhtelekom. ALTEL also faces substantial competition from operators which
were recently awarded GSM licenses in Kazakhstan, one of which is a consortium
which includes Kazakhtelekom. At this time it is unclear what impact the
consolidation
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of the Russian government's holdings in Sviazinvest and Rostelecom and the sale
of significant stakes in Sviazinvest to Russian and foreign investors will have
on the Russian telecommunications market in general and the Company in
particular.
Potential Conflicts of Interest. Each of the Company's principal partners
in PeterStar and ALTEL have interests that may conflict with those of the
Company.
PTN, which holds its interest in PeterStar through Telecominvest and is the
main provider of basic telephony services in St. Petersburg, already competes to
some degree with PeterStar for customers and may increasingly become a
substantial competitor with the eventual upgrading of its telecommunications
network. Kazakhtelekom, the public switched telephone network operator and the
Company's partner in ALTEL, may be a significant competitor for ALTEL's cellular
operations when it improves the telephony services it provides in Kazakhstan by
upgrading its fixed wire telecommunications network. In addition, Kazakhtelekom
is a participant in one of the joint ventures which was recently awarded a
national GSM license in Kazakhstan. Finally, certain directors of the Company's
operating subsidiaries also act as directors or officers of its partners in the
Russian Federation and Kazakhstan.
In light of these competing interests, and, in particular, the extent of
the legal and practical control that the Company's partners have over the
affairs of the Company and its operating subsidiaries, any or all of the
companies named above may use their influence, through the directors they
appoint to the boards of the Company's operating subsidiaries or otherwise, to
benefit themselves or other businesses in which they have an interest at the
expense of the Company and its operating subsidiaries, subject to such limited
fiduciary duties as they may have under applicable law. Moreover, such persons
are not obliged (except for such obligations as they may have under applicable
law) to allocate to the Company's operating businesses corporate opportunities
of which they become aware through the directors referred to above or otherwise.
No assurance can be given that the fiduciary duty and corporate opportunity
doctrines that exist under United States law will provide adequate protections
to the Company's shareholders against the pursuit of such conflicting interests.
Kazakh law currently provide no protection in this regard and, while Russian
corporate law has recently introduced the concept of the fiduciary duties of
corporate officers and directors, the law is too new for any prediction to be
made as to how much protection it will, in fact, provide. The pursuit of
conflicting interests by the persons referred to above could have a material
adverse effect on the Company.
Impact of Auction of Stakes in Sviazinvest on the Company and the
Telecommunications Market in Russia. In 1997, it was reported that,
notwithstanding its previously announced plans to have Sviazinvest compete with
Rostelecom, the Russian government had consolidated its telecommunications
holdings in Sviazinvest and Rostelecom by transferring its shareholding in
Rostelecom (38% of the common stock, and 51% of the voting stock) to
Sviazinvest. The balance of the shares in Rostelecom remain in the hands of
private investors. In April 1997, the government announced that it was seeking
to sell 49% of Sviazinvest in two auctions, one as to a 25% stake open to
Russian and foreign investors and the other as to a 24% stake open only to
Russian investors. In July 1997, the government announced that the 25% stake had
been sold to a consortium which included Oneximbank and Renaissance Capital, for
a purchase price of $1.875 billion. Following this auction, the Russian
government announced its intention to increase the size of the other stake being
sold to 25% minus two shares. The schedule for the sale of the second stake has
been delayed following the August 1998 financial crisis, and the structure of
any such sale (including whether foreign participation will be permitted) has
not been announced. While it is not yet clear how the proceeds of this sale will
be employed, it is understood that the government wishes to have a substantial
part, if not all, of the proceeds allocated to its current budget deficit. Prior
to the August 1998 crisis, Sviazinvest had announced plans to raise $400 million
through a Eurobond offering in 1998, but that offering was also delayed as a
result of the Russian financial crisis. In light of all of the foregoing, it is
unclear what impact the consolidation of the government's telecommunications
holdings and the auction of significant stakes in Sviazinvest will have on the
Russian telecommunications market in general and the Company in particular.
Regulatory Uncertainties. The Company's operating businesses operate in
uncertain regulatory environments. The Russian telecommunications system is
currently regulated by the RFCTI and the Kazakh telecommunications system is
currently regulated by the KMOC, largely through the issuance of licenses.
Despite the 1995
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<PAGE> 34
enactment of the Telecommunications Law in Russia, considerable uncertainty
still exists as to the application and interpretation of many of its terms.
There is currently no comprehensive legal framework with respect to the
provision of telecommunications services in Kazakhstan, although a number of
laws, decrees and regulations govern or affect the telecommunications sector.
Further, the recently announced appointment of Kazakhtelekom as the exclusive
operator of the public telephone network in Kazakhstan and/or the participation
of Kazakhtelekom in one of the joint ventures recently granted a national GSM
license in Kazakhstan, may lead to restructuring of the telecommunications
sector in Kazakhstan, the effects of which are difficult to predict at the
present time.
While the RFCTI appears to have succeeded to all of the powers and
authorities of the Former MOC, it is not yet clear whether it will in fact
continue to operate in the same manner and wield the same influence as the
Former MOC. In particular, it is unclear whether the RFCTI will be able to
control the actions of local and regional governmental authorities who may
endeavor to impose new conditions upon operators in their respective
jurisdictions or areas of influence.
The absence of adequate regulation in the telecommunications sector has
meant that decisions, including the granting and renewal of licenses, may at
times be made by governmental officials without reference to precedent or
procedure.
Furthermore, the introduction of regulation of tariffs, or any other type
of regulation, could have far-reaching, and potentially materially adverse,
effects on the Company. In particular, there is considerable uncertainty as to
what impact the transfer of authority to regulate local tariffs to Regional
Committees will have on local tariffs in Russian. See "Telecommunications in the
Former Soviet Union -- Telecommunications in the Russian Federation."
Limitations on Ability to Transfer Interests. The terms of the PeterStar
and ALTEL shareholder and joint venture agreements impose restrictions on the
Company's ability to transfer its interests in such companies and give the other
shareholders in such companies certain pre-emptive and other similar rights. It
is likely that the Company's ability to transfer its interests in other future
investments will be similarly limited. The restrictions on, and other provisions
relating to the sale of these interests, and the lack of liquidity in the market
for interests the Company now holds or may acquire, may impede their resale by
the Company. While it may be possible to arrange for negotiated sales with one
or more buyers, the Company may not be able to realize value from these
interests, on acceptable terms, in a timely manner or at all.
RISKS INVOLVING PETERSTAR COMPANY LIMITED
Limited Operating History. PeterStar was formed in May 1992 and started
operating a modern digital telephone exchange network in St. Petersburg in
February 1993. While PeterStar generated a profit in the years ended December
31, 1997 and 1998, in view of its limited operating history there can be no
assurance that PeterStar will be able to generate sufficient revenues or control
its costs enough to remain profitable in the future.
Reliance on Telecommunications Licenses; Risks of Revocation or
Renegotiation of Licenses. PeterStar's business is dependent on the maintenance
of its principal telecommunications license which permits it to operate a public
telephone system in the Russian Federation for a term expiring in November 2004.
Other licenses that have been issued to PeterStar include a dedicated network
license (expiring September 2001), a data communications license (expiring May
2001), a telematics license (expiring May 2001) and a videoconferencing license
(expiring June 2001). The main PeterStar license, governing the provision of
public telecommunications services, sets the number of lines which PeterStar may
have in St. Petersburg and the surrounding region at 106,000, and requires that
capacity equal to 74,200 lines be introduced by June 1999. However, management
of PeterStar believes that the maximum and minimum number of lines are not
strict requirements but are instead designed to provide general guidance as to
the number of lines intended to be included on the system. As of December 31,
1998, PeterStar had 168,166 active lines, of which 108,278 were provided to
cellular operators. Based on its experience in renewing existing, and obtaining
new, licenses and its general knowledge of the licensing environment in Russia,
management of PeterStar does not believe that its license would be terminated or
re-negotiated, that it would be forced to reduce the number of its subscribers,
or that other penalties would be imposed, by reason of its exceeding its 106,000
line ceiling, but there can be no assurance that the RFCTI would
32
<PAGE> 35
not take a different position. The dedicated network license permits PeterStar
to provide long distance and international telephone transmission services to
dedicated network operators (such as BCL) in St. Petersburg and the surrounding
region for a term expiring in September 2001. The dedicated network license sets
the number of lines which PeterStar may have at no less than 30,000 and requires
that capacity equal to 21,000 lines be introduced by September 1999. Once again,
based on its experience in renewing existing, and obtaining new, licenses and
its general knowledge of the licensing environment in Russia, management of
PeterStar believes that these maximum and minimum number of lines are not strict
requirements but are instead designed to provide general guidance as to the
number of lines intended to be included on the system. There can be no assurance
that the RFCTI would not interpret the provisions of the licenses differently,
which in turn could result in the revocation of the licenses or their
renegotiation on terms unfavorable to PeterStar or the imposition of penalties.
It is not possible to calculate the amount of any penalties which might be
imposed, which are in the discretion of the RFCTI.
No assurance can be given that PeterStar will be able to maintain its
licenses, that the terms will not be interpreted, altered or renegotiated to its
disadvantage or that they will be renewed upon expiration. The loss of, or a
substantial limitation upon the terms of, PeterStar's licenses could have a
material adverse effect on the Company.
Dependence on Interconnect Parties. PeterStar is dependent on PTN, SPMMTS
and other operators for the completion of most of its calls. The PeterStar
network is linked to the PTN network, which gives PeterStar access to PTN's
large local subscriber base. PeterStar is required by the terms of its license
to route all long distance and international calls through the public network.
PeterStar has been able to negotiate favorable tariffs for interconnection fees
and carrier charges with both PTN and SPMMTS. PeterStar's current interconnect
agreements with PTN and SPMMTS are open-ended agreements, while the
interconnection fees and carrier charges payable under the interconnect
agreements are subject to renegotiation between the parties from time to time.
The agreements provide for automatic extensions at the end of their term unless
otherwise terminated by either party. The interconnection fees and carrier
charges payable under the interconnect agreements are subject to renegotiation
between the parties from time to time. There can be no assurance, however, that
PeterStar will continue to have access to the PTN network or that PeterStar will
continue to receive such favorable tariffs. The loss of access to such network
or increases in such tariffs could have a material adverse effect upon the
Company.
Dependence on PTN Facilities. PeterStar is also dependent on PTN's
buildings, ducts and tunnels in order to house its exchanges and to reach its
customers. Prior to 1998, PeterStar has not been required to pay rent to PTN to
house its exchanges in PTN buildings, nor has it paid rentals for ducts or
tunnels. Commencing in 1998, PeterStar has been required to pay a local line
rental charge to PTN, although roughly half of the fee otherwise payable during
1998 was offset against amounts owed to PeterStar by PTN in respect of the
Vassilievski Island project. The aggregate amount paid to PTN in 1998 for line
rental charges was $1.3 million. The amount of the 1999 line rental charged has
not yet been determined, but PeterStar expects to be able to offset amounts due
from PTN against such charges during 1999. However, any change in the terms on
which PeterStar has access to PTN's facilities, or any restrictions imposed by
PTN on the completion of calls from the PeterStar network, could have a material
adverse effect on PeterStar and, in turn, the Company.
Capital and Management Resources Required for Expansion of Direct Dial
Services; Management of Growth. PeterStar has commenced several projects
designed to expand its direct dial services in St. Petersburg and Northwest
Russia. PeterStar has undertaken with PTN an infrastructure project centering on
the replacement of analog exchanges with digital exchanges for certain parts of
the network on Vassilievski Island, a city district in St. Petersburg. This
project requires the conversion of approximately 30,000 business and residential
lines that have previously been operated by PTN, after which such lines become a
part of the PeterStar network. In addition, PeterStar plans to further enhance
its transit network capabilities in order to provide continued support to the
cellular and other network providers in terminating traffic in St. Petersburg
and to the national and international gateway. PeterStar also expects to
increase its operating presence in Northwest Russia through the targeted
development of digital infrastructure to connect business customers and develop
operational relationships with the regional telephone companies. These projects
represent a major expansion of PeterStar's operations which have and will
require substantial capital and special management efforts if they are to be
carried into effect successfully.
33
<PAGE> 36
Pressure to Provide Residential Service. The Vassilievski Island project
also represents part of a continuing effort on the part of PTN to modernize a
portion of its network. The local calling element of residential service is
presently provided free of charge (other than connection fees and line rental
charges), and there has been considerable political resistance to the
introduction of time-based charges for local calls. Even after calling charges
have been introduced, it is likely to remain a low margin business for the
foreseeable future. Even though PTN has now been privatized, the Company does
not believe that the pressures on PTN to improve residential service have
lessened. Although the Company believes that PeterStar has fulfilled its
commitment to the residential customers, there can be no assurance that PTN will
not continue to try to involve PeterStar in this effort, or that PTN's continued
support for PeterStar's access to the business market may be linked to
PeterStar's further commitment to develop the residential market in St.
Petersburg.
RISKS INVOLVING ALTEL
Limited Operating History. ALTEL was formed in January 1994 and commenced
commercial operations in September 1994. Although ALTEL generated profits for
the years ended December 31, 1997 and 1998, there can be no assurance that ALTEL
will be able to generate sufficient revenues or control its costs sufficiently
to remain profitable in the future.
Reliance on Telecommunications License. ALTEL's business is dependent on
the 15-year renewable license issued in February 1994 for the creation and
operation of cellular communications networks in Kazakhstan for local, long
distance and international calling, using the 800 MHZ frequency band and "AMPS"
technology. Under the terms of the license ALTEL was required to provide
cellular services to Almaty and ten to twelve additional regional centers by the
end of 1996, a condition which has been met. The license specifies that ALTEL is
to be the exclusive provider of cellular service in Kazakhstan for the first
five years of the license term, which period expired in February 1999. In 1998,
before the expiration of the exclusivity period, ALTEL commenced discussions
with the KMOC on substituting a new license with revised terms for its existing
license. One aspect of any such new license would have been the elimination of
the exclusivity provisions in exchange for other concessions. Although such
exclusivity has since terminated according to the terms of the license, ALTEL
and the KMOC are continuing to discuss the terms of a new license for ALTEL. See
"-- ALTEL -- Telecommunications License." Although such discussions are
continuing, there can be no assurance that any new license issued by the KMOC
will not contain revised terms which are detrimental to ALTEL's business.
Issuance of Additional Telecommunications Licenses. Until 1998, ALTEL was
the only licensed national cellular operator in Kazakhstan. In 1998, the KMOC
awarded two licenses for the development of a national GSM network in
Kazakhstan. One license was issued to Kcell, a joint venture of included
TurkCell and Kazakhtelekom, and the other license was issued to Kmobile, a joint
venture of Telsim, a Turkish company, and local Kazakh interests. Active
marketing was begun by Kcell in early February 1999 and by Kmobile in mid-
February 1999. Management of ALTEL currently believes that, by virtue of its
cost structure and its market penetration to date, it is in a good position to
compete with the new GSM operations. However, ALTEL has already experienced some
downward pressure on its tariffs as a result of competition from the new
licensees. ALTEL is currently assessing its response to the new competition, and
there can be no assurance that it will in fact be able to compete successfully
with the new licensees.
Effect of Network Expansion on Management Resources; Management of
Growth.ALTEL has engaged in a significant expansion of its cellular network,
from its initial base of operations in Almaty to a total of 12 cities throughout
Kazakhstan as of December 31, 1998. The timing of such expansion was dictated by
the terms of the license, so that in some regions it occurred at a time when
economic activity in those regions was still at a sufficiently low level as to
raise a question as to whether, and if so, when, cellular service in such
regions will be commercially viable. Furthermore, because of the distances
involved, the difficulty of hiring, training and supervising staff at remote
locations and the underdeveloped nature of the business infrastructure, such as
banks and professional advisers in many of the proposed locations for expansion,
the establishment and provision of cellular service have presented, and will
continue to present, significant challenges to the management of ALTEL, and
there can be no assurance that these challenges will be met successfully in all
cases. In addition, further network development is planned on a targeted basis
to address key market sectors. Failure to manage the ALTEL
34
<PAGE> 37
network, and any future expansion of the network, successfully could have a
material adverse effect on the Company.
Effect of Sale of Stake in Kazakhtelekom on ALTEL and the
Telecommunications Market in Kazakhstan. Since its formation, ALTEL has been 50%
owned, directly or indirectly, by the government of Kazakhstan. ALTEL believes
that the attitude of the government towards its operations has generally been
favorable and that this has derived in some part from the government's interest
in ALTEL. Currently, the government's 50% interest in ALTEL is held through
Kazakhtelekom, which until May 1997 was owned 100% by the government. In May
1997, the Kazakh government announced that it had sold a 40% interest in
Kazakhtelekom to Daewoo, creating considerable uncertainty as to the
government's attitude towards Kazakhtelekom. In March 1998, it was reported that
Daewoo had sold a portion of its stake (reported to be approximately 10%) to an
unnamed third party. It was later confirmed that Daewoo had sold its entire
stake in Kazakhtelekom to Kazcommertzbank, a commercial bank based in
Kazakhstan. It is understood that the Kazakh government is seeking to sell a 15%
stake in Kazakhtelekom to private investors. In addition, the KMOC recently
issued a revised license to Kazakhtelekom specifically naming it as the
exclusive national network operator in Kazakhstan, and giving it a wide range of
powers to carry out this function. The Company has not yet fully assessed what
impact these matters may or will have on ALTEL and its business. There can be no
assurance that the government's favorable attitude towards ALTEL will continue
to the same degree. Any significant change in the government's attitude toward
ALTEL could have a material adverse effect on the Company.
Dependence on Interconnect Parties. Under the terms of its license, ALTEL
is entitled to interconnection free of charge to networks operated by
Kazakhtelekom, the public switched telephone network operator, for the
completion of its local, long distance and international calls. The loss of, or
any significant limitation on, its access to such network could have a material
adverse effect on the Company. Further, under its revised license, Kazakhtelekom
was directed to assess interconnection charges for connection to its network,
and to levy such charges on a basis which will yield it a profit. Kazakhtelekom
may try to use this authority to endeavor to assess interconnection charges on
ALTEL, notwithstanding the fact that its license exempts it from payment of such
charges. The imposition of such interconnection charges would impact ALTEL's
profitability, perhaps materially.
ITEM 2. DESCRIPTION OF PROPERTY
PeterStar Company Limited. PeterStar's principal office, which it leases
from PTN, is located on Vassilievski Island, St. Petersburg, Russia. Its
principal switches are also located at this site. PeterStar also occupies other
space in St. Petersburg which is used to house other switching and transmission
equipment.
ALTEL. Space for most ALTEL switches, cell sites and associated equipment
is provided by Kazakhtelekom. ALTEL also uses space in a Kazakhtelekom exchange
building in Almaty for office and administrative purposes and leases other
premises in Almaty which combines its central warehouse and a larger customer
service center and retail outlet. ALTEL has also established, and will continue
to establish, customer service centers in each city in which service is offered.
Virtually all space for customer service centers and equipment not provided by
Kazakhtelekom is leased, although ALTEL has purchased its facilities in Taraz,
one base station site and building in Chimkent and a base station building in
Karaganda.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. CONTROL OF REGISTRANT
All of the issued and outstanding ordinary shares of the Company are held
directly by PLD.
ITEM 5. NATURE OF TRADING MARKET
None.
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<PAGE> 38
ITEM 6. EXCHANGE CONTROLS AND OTHER LIMITATIONS AFFECTING SECURITY HOLDERS
THE RUSSIAN FEDERATION
Exchange Controls. Following the economic crisis in August and September
1998, the Russian Federation introduced more stringent procedural requirements
on Russian residents wishing to pay non-residents in hard currency. The main
reason for this was to attempt to reduce the level of illegal hard currency
outflows from the country. Significant documentary requirements may have to be
satisfied in respect of payments in U.S. Dollars between Russian residents
(which generally includes all Russian companies and citizens resident in Russia)
and non-residents (which generally includes non-Russian companies even if they
have a representative office or other permanent establishment in Russia) for
current currency transactions (generally those where payment is made within 90
days of the provision of goods and services). Payments in U.S. Dollars
classified as movements of capital (which generally includes direct investments,
portfolio investments, acquisition of real estate and payments made pursuant to
loan agreements, or agreements for the lease or sale of goods and services
having terms of over 90 days) are subject to licensing by the Central Bank. The
Company believes that all of its operating subsidiaries hold, or have applied
for and expect eventually to receive, all required Central Bank licenses. The
need to apply for Central Bank licenses can be burdensome, because of the
substantial documentary and other requirements involved and because of the
considerable length of time involved, often running into several months. Failure
to apply for the appropriate licenses, or to receive the outstanding licenses
could result in fines and penalties. See "Business -- Risk Factors -- Risks
Involving the Company -- Currency Controls." Finally, banks in Russia require
that certain hard currency transfers be accompanied by a "transaction passport"
setting forth that all required tax and regulatory requirements have been
followed. Other requirements may be introduced in the future by the Russian
Federation to further control hard currency payments from the country.
Payments between Russian residents must generally be made in Roubles.
Russian companies may exchange Roubles for U.S. Dollars if they can document
U.S. Dollar-denominated liabilities that are due and payable within specified
periods. Russian companies are required to convert 75% of most hard currency
earnings into Roubles, but (as noted in the preceding sentence) may be able to
reconvert such amounts into hard currency if they can document hard currency
denominated liabilities that are due and payable within a specified period.
Roubles may not be lawfully exported from, or converted into, other currencies
outside of Russia.
Availability of Hard Currency for Conversion Purposes. The ability of
foreign investors to convert Roubles into hard currency is also subject to the
availability of hard currency in the Russian currency markets. Although there is
an existing market within Russia for the conversion of Roubles into other
currencies, including the interbank currency exchange, over-the-counter and
currency futures markets, conversion of Roubles at times of crisis, such as in
August 1998, may be difficult.
Exchange Rates. Significant fluctuations in the value of the Rouble against
the U.S. Dollar and other hard currencies can also have a material impact on the
value of a foreign investor's Rouble dividend income or Rouble proceeds from the
sale of Rouble denominated securities. The history of trading in the Russian
Rouble against the U.S. Dollar has been characterized by significant declines in
value and considerable volatility, although the Russian Rouble experienced
relative stability against the U.S. dollar during 1996 and 1997. However, during
1998 and 1999, the Russian Rouble has been under considerable pressure and
suffered substantial declines against the U.S. Dollar and other currencies. See
"Risk Factors -- Country Risks -- Russian Economic and Political Turmoil." These
substantial declines resulted in foreign exchange losses by the Company's
operating businesses during the second half of 1998, and may continue to
adversely affect the results of such businesses. See "Business -- Risk Factors
- -- Country Risks -- Restrictions on Currency Conversion; Historical Volatility
in Currency Prices."
Repatriation. Although Russian law governing foreign investment guarantees
foreign investors the right to repatriate their earnings from Russian
investments, the Russian exchange control regime, including licensing
requirements administered by the Central Bank, may materially affect their
ability to do so and may increase the cost of such repatriation. See "Business
- -- Risk Factors -- Risks Involving the Company -- Currency Controls."
36
<PAGE> 39
Impact upon the Company. In general, the impact on the Company of the
Russian exchange controls regime has not been particularly adverse. While no
dividends have been paid by any of the operating subsidiaries in Russia,
payments of interest and management fees have been made relatively freely. The
need to apply for Central Bank licenses for certain types of transactions, and
the delays in the receipt of such licenses, has delayed the completion of
certain transactions. Additionally, the process of applying for such licenses
has been time consuming and expensive. See "Business -- Risk Factors -- Risks
Involving the Company -- Currency Controls -- Currency Licensing Requirements."
KAZAKHSTAN
Exchange Controls. Kazakhstan currently has in place relatively liberal
policies governing hard currency transfers by Kazakh residents to non-residents.
Residents (which generally includes all Kazakh companies and citizens resident
in Kazakhstan) can use hard currency to pay non-residents (which generally
includes all non-Kazakh companies and their branch offices and representative
offices in Kazakhstan) for current currency transactions (generally those where
payment is made within 180 days of the provision of goods or services). Payments
in U.S. Dollars classified as movements of capital (which generally includes
direct investments, portfolio investments, payments with respect to real estate
and payments made after 180 days for goods and services) are subject to
licensing by the National Bank of Kazakhstan.
Payments between Kazakh residents must generally be made in Tenge. Kazakh
companies may exchange Tenge for U.S. Dollars if they can document U.S.
Dollar-denominated liabilities that are due and payable within specified
periods. The National Bank of Kazakhstan does not currently require the
conversion of hard currency earnings into Tenge. Tenge may not be lawfully
exported from Kazakhstan or converted into other currencies outside of
Kazakhstan.
Availability of Hard Currency for Conversion Purposes. The ability of
foreign investors to convert Tenge into hard currency is also subject to the
availability of hard currency in the Kazakh currency markets. Although there is
an existing market within Kazakhstan for the conversion of Tenge into other
currencies, including the interbank currency exchange and the over-the-counter
markets, the development of this market is uncertain.
Exchange Rates. Significant fluctuations in the value of the Tenge against
the U.S. Dollar and other hard currencies can also have a material impact on the
value of a foreign investor's Tenge dividend income or Tenge proceeds for the
sale of Tenge-denominated securities. In Kazakhstan a market exists for the
conversion of Tenge into other currencies, but it is limited in size and is
subject to rules limiting the purposes for which conversion may be effected. The
history of trading in the Kazakh Tenge against the U.S. Dollar has been
characterized by significant declines in value and considerable volatility,
although the Kazakh Tenge experienced relative stability against the U.S. dollar
during 1996 and 1997. After remaining relatively stable during 1998, the Kazakh
Tenge has lost significant value in the first six months of 1999, reflecting
concerns about the health of the country's economy as a result of Russia's
economic and financial problems, and a decision by the government of Kazakhstan
to cease providing support for its currency. See "Risk Factors -- Country Risks
- -- Russian Economic and Political Turmoil."
Repatriation. Kazakhstan's foreign investment legislation provides that
earnings from investments made by foreign investors may be freely repatriated
provided that all applicable fees and taxes have been paid. However, the
exchange control regime in Kazakhstan may materially affect an investor's
ability to do so and may increase the cost of such repatriation. See "Business
- -- Risk Factors -- Risks Involving the Company -- Currency Controls."
Impact upon the Company. The Company has not experienced particular
difficulties with the Kazakh exchange control regime. Both dividends and
management fees have been received from ALTEL during 1998. While there are
paperwork requirements in relation to hard currency transfers, these have not
delayed the making of such transfers.
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<PAGE> 40
ITEM 7. TAXATION
The Company and its subsidiaries are subject to a number of taxes in
different jurisdictions. The Company is subject to corporate income tax in
Cyprus at the rate of 4.25%. The most significant taxes affecting the Company's
subsidiaries are corporate income and other taxes in Russia and Kazakhstan
(including withholding taxes). Withholding taxes apply to distributions by the
Company's operating businesses in Russia and Kazakhstan and could apply to
distributions by intermediate level companies in jurisdictions outside Russia
and Kazakhstan. Obtaining the benefits of applicable tax treaties can be
extremely difficult due to the documentary and other requirements imposed by the
Russian and Kazakh authorities. For example, the Kazakh tax authorities require
withholding on almost any kind of out-payment, including management fees and
expense reimbursements, not just items of income, and additionally specify that
an exemption application be submitted in respect of every payment made (as
opposed to permitting blanket exemptions), while at the same time requiring
non-standard certifications from the home country taxing authority. In addition,
a recent instruction issued by the Russian State Tax Service mandates full
withholding regardless of any treaty and requires the recipient to seek to
obtain a refund for withholding in excess of treaty amounts, although in
practice those refunds can be difficult to obtain. The need to comply with these
provisions may negate or impair tax planning initiatives undertaken by the
Company to reduce its and its subsidiaries' overall tax obligations in Russia
and Kazakhstan.
In general, the Company's Russian and Kazakh operating businesses are faced
with a wide variety of taxes, including property taxes, advertising taxes, road
taxes, housing taxes, transport taxes and education taxes. In addition,
PeterStar and ALTEL are subject to corporate profits taxes of approximately 33%
and 30%, respectively. The tax systems in Russia and Kazakhstan have changed
rapidly in recent years and may undergo additional changes, which may have a
material adverse effect on the Company.
ITEM 8. SELECTED FINANCIAL DATA
The following summary consolidated financial and operating data was derived
from, and should be read in conjunction with, the audited Consolidated Financial
Statements of the Company and the related notes thereto, and Management's
Discussion and Analysis of Financial Condition and Results of Operations,
contained elsewhere herein.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS
DATA:
Operating revenues................. $113,041 $ 85,588 $ 52,651 $ 24,747 $ 8,526
Operating expenses................. 77,982 59,066 43,317 29,858 13,605
Operating income/(loss)............ 35,059 26,522 9,334 (5,111) (5,079)
Income/(loss) before income taxes
and minority interest........... 29,688 30,938 8,955 (3,072) (5,339)
Income taxes....................... 9,997 6,893 3,356 1,038 --
Income/(loss) before minority
interest........................ 19,691 24,045 5,599 (4,110) (5,339)
Minority interest.................. 11,721 12,336 2,615 -- --
-------- -------- -------- -------- --------
Net income/(loss).................. $ 7,970 $ 11,709 $ 2,984 $ (4,110) $ (5,339)
======== ======== ======== ======== ========
</TABLE>
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<PAGE> 41
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents.......... $ 2,816 $ 7,849 $ 5,185 2,898 $ 684
Non-cash working deficiency........ (32,298) (29,423) (41,808) (25,643) (17,489)
Property and equipment, net........ 106,542 79,002 56,613 39,101 21,059
Telecommunication license, net..... 37,663 42,286 46,715 49,583 54,098
Goodwill, net...................... 1,365 1,580 1,795 2,011 --
Other assets and receivables....... 2,422 3,292 369 765 103
Total assets....................... 168,168 155,188 120,168 102,313 79,752
Long-term debt (including advances
from other group companies)..... 11,834 14,602 7,370 -- 10,504
Shareholder's equity............... 78,563 70,593 58,884 (14,903) (10,793)
</TABLE>
ITEM 9. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This document contains certain forward-looking statements that are subject
to risks and uncertainties. Forward-looking statements include certain
information relating to political, social and economic conditions in the
countries of the former Soviet Union and the Commonwealth of Independent States,
the commencement of certain programs and the proposed offering of certain
services by the Company's operating subsidiaries, the impact of Year 2000 issues
on the Company's operations and interpretations and actions of certain
regulatory authorities, including in Russia and Kazakhstan, as well as
information contained elsewhere in this report where statements are preceded by,
followed by, or include the words "believes," "expects," "anticipates," and
similar expressions. For such statements, the Company claims the protection of
the safe harbor for forward-looking statements contained in the Private
Securities Litigation Reform Act of 1995. Actual events or results may differ
materially from those discussed in forward-looking statements as a result of
various factors, including without limitation, those discussed elsewhere in the
Report.
Furthermore, this document constitutes a Year 2000 Readiness Disclosure
Statement, and the statements herein are subject to the Year 2000 Information
and Readiness Disclosure Act, and the Company hereby claims the protection of
such Act for this document and all information contained herein.
BASIS OF PRESENTATION
The Company's key interests at December 31, 1998 include a 60% interest in
PeterStar, which provides telecommunications services in St. Petersburg, Russia;
a 100% equity interest in WTC, which, in turn, holds a 50% equity interest in
ALTEL, which provides cellular services in Kazakhstan; and a 100% interest in
Yellow Pages, the owner of one of the most comprehensive databases of Russian
and foreign businesses in St. Petersburg and publisher of the St. Petersburg
business-to-business Yellow Pages directory.
EBITDA is used as a measure of operating performance and is defined as
earnings (or loss) from continuing operations before income taxes and minority
interest plus net interest (interest expense less interest and other income)
plus depreciation and amortization. It is presented as supplemental disclosure
because it assists in understanding the Company's operating results. EBITDA,
however, may not be comparable to similarly titled measures of other companies
and should not be considered in isolation or as a substitute for net income,
cash flow provided by operating activities, or other income or cash flow data
prepared in accordance with generally accepted accounting principles, or as a
measure of a company's profitability or liquidity.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 VERSUS YEAR ENDED DECEMBER 31, 1997
Overview. For the year ended December 31, 1998, the Company reported net
income of $8.0 million and operating income of $35.1 million earned on revenues
of $113.0 million compared to net income of $11.7 million
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<PAGE> 42
and operating income of $26.5 million earned on revenues of $85.6 million in
1997. EBITDA of $45.4 million in 1998 compared to $43.3 million in 1997.
Revenues. Revenues increased 32.0% from $85.6 million to $113.0 million in
1998 reflecting the continued strong year-on-year growth in revenues achieved
within PeterStar and ALTEL which together account for 99.0% of NWE's
consolidated revenues. PeterStar's revenues increased 32.8% to $72.4 million in
1998 -- subscriber line numbers increased to 168,166 by the end of the year, up
53,392 over 1997. ALTEL's revenues increased 31.7% to $39.5 million in 1998 with
its number of subscribers increasing to 21,395, up 10,293 over 1997. Much of
ALTEL's revenue growth can be attributed to the introduction of prepaid cellular
service in August 1998. 1998 revenues at Yellow Pages remained relatively
unchanged from 1997 at $1.1 million.
Although still significant, NWE's 1998 revenue growth rate of 32.0% was
down from the 62.4% achieved in 1997. The reduced rate was largely the result of
a slow down in revenue growth late in the year attributable to the Russian and
Kazakh economic crises. These crises resulted in the loss of some customers
(principally customers of the three cellular operators in St. Petersburg whose
calls are routed over PeterStar's network) as well as reduced calling activity
among businesses that remained customers.
Management believes that revenues in 1999 are unlikely to grow at the same
rate as they have in recent years given the many uncertainties in the Russian
and Kazakh political and economic landscape at present. Further deterioration in
the Russian and Kazakh economic situation would likely impact the Company's
businesses adversely. See "Risk Factors". While management believes that it is
taking all available measures to protect the Company and its businesses from the
negative effects of any further problems in Russia and Kazakhstan, there can be
no assurance that those measures will be successful.
Gross profit. Gross profit increased 34.4% to $84.0 million in 1998 from
$62.5 million in 1997 reflecting the revenue growth discussed above, as well as
an increase in the Company's gross margin, as a percentage of revenues, from
73.0% in 1997 to 74.3% in 1998. Margins are generally expected to come under
pressure in 1999 due to the continuing impact of the Russian and Kazakh economic
crises.
General and administrative expenses and management fees. General and
administrative expenses include salaries, sales and marketing and overhead
expenses at PeterStar, ALTEL and Yellow Pages. Management fees were paid to PLD
and Telecominvest, in connection with PeterStar, and to PLD and Kazakhtelekom in
connection with ALTEL. Combined, these expenses increased 44.2% from $20.6
million in 1997 to $29.7 million in 1998 and were required to fuel continued
revenue growth and expand product offerings within these businesses.
Depreciation. Depreciation increased 43.1% in 1998 to $10.3 million from
$7.2 million in 1997. The increase reflects the investment of over $37.9 million
in capital equipment in 1998 as well as a full year's depreciation on assets
placed in service in 1997. Depreciation will continue to grow as a result of
further anticipated investments in capital equipment in 1999, albeit at a slower
pace than evidenced in prior years. As a percentage of revenues, these expenses
increased from 8.4% in 1997 to 9.1% in 1998 but should decrease as both
PeterStar and ALTEL near completion of the build-out of their core networks.
Amortization expense. In 1998, the Company incurred total amortization
charges of $4.9 million, unchanged from 1997, of which $2.6 million related to
telecommunications licenses held by PeterStar, $2.1 million related to
telecommunications licenses held by ALTEL and $0.2 million related to goodwill
incurred in connection with the Company's acquisition of Yellow Pages in 1995.
Telecommunications licenses held by PeterStar and ALTEL are being amortized over
their remaining terms, which expire in 2004 and 2009, respectively. Goodwill
related to Yellow Pages is being amortized over a 10-year period ending April,
2005.
Taxes other than income taxes. Taxes other than income taxes, which include
road tax, property tax, employee-related taxes, etc., increased 21.2% from $3.3
million in 1997 to $4.0 million in 1998. This reflects the overall growth during
the year in the operating businesses' revenues, earnings, number of employees,
etc. on which such taxes are based.
Interest and other income. Interest and other income earned in 1998,
primarily on cash balances held by the operating subsidiaries, remained
unchanged from 1997 at $0.3 million.
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<PAGE> 43
Interest on long-term debt. Interest on long-term debt increased marginally
in 1998 to $0.8 million from $0.6 million in 1997 as a result of a number of
long-term supplier financing contracts entered into by PeterStar with PLD
Capital Asset (U.S.) Inc., a wholly owned subsidiary of PLD, and third party
suppliers.
Foreign exchange loss. The foreign exchange loss incurred in 1998 of $2.9
million compared with $0.7 million recorded in 1997. The significant increase in
the loss incurred in 1998 related to the substantial devaluation of PeterStar's
rouble cash balances in August and September when extreme market conditions
resulting from the Russian economic crisis caused major disruptions in the
Russian banking system. This prevented PeterStar from converting roubles into
hard currency at a time when the value of the rouble was depreciating
significantly. The Company has sought, and will continue to seek, to limit the
effects of such conditions by minimizing the amount of rouble balances held by
its subsidiaries and by taking measures to accelerate collection and currency
conversion procedures in so far as this is possible in the current banking and
legislative environment.
Income taxes. Income taxes increased from $6.9 million in 1997 to $10.0
million in 1998, notwithstanding a lower reported pre-tax and minority interest
figure of $29.7 million in 1998 compared to $30.9 million in 1997. The increase
in taxes in 1998 reflects the non-deductibility of a number of expenses incurred
during the year as well as an adverse change in the valuation allowance related
to the Company's deferred tax assets.
Minority interest. Minority interest totaled $11.7 million in 1998 based on
a 40% minority interest in PeterStar and 50% minority interest in ALTEL applied
to their respective post-tax earnings. This compared with a total of $12.3
million in minority interest recorded in 1997.
YEAR ENDED DECEMBER 31, 1997 VERSUS YEAR ENDED DECEMBER 31, 1996
Overview. For the year ended December 31, 1997, the Company reported net
income of $11.7 million and operating income of $26.5 million on revenues of
$85.6 compared to $3.0 million in net income and $25.8 million in operating
income earned on revenues of $52.7 million in 1996. EBITDA of $43.3 million in
1997 compared to $18.2 million in 1996.
Revenues. Revenues increased 62.4% from $52.7 million to $85.6 million in
1997 reflecting the strong year-on-year growth in revenues achieved within
PeterStar and ALTEL which together account for 98.7% of NWE's consolidated
revenues. PeterStar's revenues increased 67.7% to $54.5 million in
1997 -- subscriber line numbers increased to 114,744 by the end of the year, up
from 52,005 in 1996. ALTEL's revenues increased 57.1% to $30.0 million in 1997
with its number of subscribers increasing to 11,102, up from 6,957 in 1996. 1997
revenues at Yellow Pages increased to $1.0 million from $0.8 million recorded in
1996.
Gross profit. Gross profit increased 78.1% to $62.5 million in 1997 from
$35.1 million in 1996 reflecting the revenue growth discussed above, as well as
an increase in the Company's gross margin, as a percentage of revenues, from
66.6% in 1996 to 73.0% in 1997.
General and administrative expenses and management fees. General and
administrative expenses include salaries, sales and marketing and overhead
expenses at PeterStar, ALTEL and Yellow Pages. Management fees were paid to PLD
and Telecominvest, in connection with PeterStar, and to PLD and Kazakhtelekom in
connection with ALTEL. Combined, these expenses increased 42.1% from $14.5
million in 1996 to $20.6 million in 1997 and were required to expand the revenue
bases of the operating businesses.
Depreciation. Depreciation increased 50.0% in 1997 to $7.2 million from
$4.8 million in 1996. The increase reflects the investment of over $30.0 million
in capital equipment in 1997 as well as a full year's depreciation on assets
placed in service in 1996.
Amortization expense. In 1997, the Company incurred total amortization
charges of $4.9 million, unchanged from 1996, of which $2.6 million related to
telecommunications licenses held by PeterStar, $2.1 million related to
telecommunications licenses held by ALTEL and $0.2 million related to goodwill
incurred in connection with the Company's acquisition of Yellow Pages in 1995.
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Taxes other than income taxes. Taxes other than income taxes increased
94.1% from $1.7 million in 1996 to $3.3 million in 1997 reflecting the overall
growth during the year in the operating businesses' revenues, earnings, number
of employees, etc. on which such taxes are based.
Interest and other income. Interest and other income earned in 1997,
primarily on cash balances held by the operating subsidiaries, decreased
marginally to $0.3 million in 1997 from $0.4 million in 1996.
Interest on long-term debt. Interest on long-term debt of $0.6 million was
incurred in 1997 as a result of long-term supplier financing contracts entered
into by PeterStar with PLD Asset Leasing Ltd., a wholly owned subsidiary of PLD,
and third party suppliers.
Foreign exchange loss. A foreign exchange loss in 1997 of $0.7 million was
unchanged from the loss recorded in 1996 and was the result of unfavorable
movements in the rouble and tenge, vis-a-vis the U.S. dollar, as applied to the
Company's rouble and tenge denominated net monetary assets.
Income taxes. Income taxes increased from $3.4 million in 1996 to $6.9
million in 1997 reflecting the overall improvement in pre-tax earnings at
PeterStar and ALTEL.
Minority interest. Minority interest totaled $12.3 million in 1997 based on
a 40% minority interest in PeterStar and 50% minority interest in ALTEL applied
to their respective post-tax earnings. This compared with a total of $2.6
million recorded in 1996. The increase is a direct result of the overall
improvement in post-tax earnings at PeterStar and ALTEL.
LIQUIDITY AND CAPITAL RESOURCES
For the year ended December 31, 1998, a total of $37.7 million in cash was
generated from operations (1997 -- $24.2 million; 1996 -- $15.0 million), $32.2
million was used in net investing activities (1997 -- $19.3 million;
1996 -- $20.7 million) and $10.5 million was used in net financing activities
(1997 -- $2.3 million; 1996 -- $8.0 million provided by net financing
activities). Investments consisted almost exclusively of capital expenditures on
telecommunications equipment within PeterStar and ALTEL while cash used in net
financing activities consisted primarily of repayment of long-term indebtedness
($2.6 million), intercompany indebtedness ($4.1 million) and dividends paid to
minorities ($3.0 million).
As of December 31, 1998, the Company reported a working capital deficiency
of $29.5 million (1997 -- $21.6 million). Excluding advances due to PLD and
other wholly-owned PLD subsidiaries, the Company's working capital position as
of December 31, 1998 improves to a positive $4.5 million (1997 -- $14.1
million).
As of December 31, 1998, consolidated total assets were $168.2 million
($155.2 million as of December 31, 1997) and consisted primarily of $20.2
million in current assets (including $2.8 million in cash and cash equivalents),
net property and equipment of $106.5 million and unamortized telecommunications
licenses and goodwill of $39.0 million.
Long-term debt of $11.8 million, including $4.7 million with related
companies and $7.2 million with third party suppliers, as a percentage of total
assets, was 7.0% as of December 31, 1998 as compared to 9.4% as of December 31,
1997.
Shareholder's equity of $78.6 million as of December 31, 1998, which
consisted of $70.8 million in share capital and contributed surplus and $7.8
million in retained earnings, compared to $70.6 million recorded at the end of
1997. The Company's ratio of long-term indebtedness to equity at December 31,
1998 was 15.0% compared to 20.7% at the end of 1997.
The Company's ongoing operations (including advances to and investments in
its existing subsidiaries and affiliates for capital expenditures and
operational expenses) will continue to be financed from advances from PLD and
dividends and management fees from its subsidiaries. The Company's operating
businesses are now, for the large part, self-sustaining and have the ability to
source third party supplier and bank financing on their own. However, to the
extent that the operating businesses experience lower than expected revenues,
higher operating costs, or higher development costs in connection with the
build-out of their networks, or as a result of continuing
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economic difficulties in Russia and Kazakhstan, the Company may need to seek
other sources of financing to fund such operations.
As it has disclosed in its Annual Report on Form 10-K, PLD has significant
debt service requirements, including the payment of interest on the Senior Notes
and the Convertible Notes and amounts owing to the Travelers Parties, and PLD
does not presently have sufficient funds on hand to meet its current debt
obligations. The Company is a guarantor of the Senior Notes and the Convertible
Notes under the terms of the related indentures.
While an agreement has been reached with the holders of the Senior Notes
and the Convertible Notes and with the Travelers Parties on a restructuring of
PLD's indebtedness to such parties, those agreements are conditioned upon the
closing of PLD's merger with MMG. If the merger did not close, PLD would remain
obligated to pay the interest on the Senior Notes and the Convertible Notes and
there can be no assurance that the Travelers Parties would not demand payment in
full of PLD's obligations to them. PLD's failure to make the interest payments
on the Senior Notes and the Convertible Notes could result in a default under
and acceleration of those Notes for which the Company serves as guarantor.
Similarly, PLD's failure to make payments in full to the Travelers Parties could
result in a cross-default under and acceleration of the Senior Notes and the
Convertible Notes. Any such events would have a material adverse effect on the
Company and would raise substantial doubt about the Company's ability to
continue as a going concern.
In connection with the Merger Agreement with MMG and the transactions
contemplated thereunder, the holders of the Senior and Convertible Notes have
agreed, subject to completion of the merger and other transactions contemplated
by the Merger Agreement, to exchange their outstanding notes for new notes
issued by MMG which will not be guaranteed by the Company.
EFFECTS OF NEWLY-ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1998, Statement of Financial Accounting Standards No. 133 ("SFAS
133"), "Accounting for Derivative Instruments and Hedging Activities", was
issued. SFAS 133 established accounting and reporting standards for derivative
instruments and for hedging activities. SFAS requires that an entity recognize
all derivatives as either assets or liabilities and measure those instruments at
fair value. SFAS 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. SFAS 133 cannot be applied retroactively to
financial statements of prior periods. At the current time the Company has not
evaluated the impact SFAS 133 will have, if any.
The American Institute of Certified Public Accountants issued Statement of
Position No. 98-1 (SOP 98-1) "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use," and Statement of Position No. 98-5 (SOP
98-5) "Reporting on the Costs of Start-Up Activities" in 1998. SOP 98-1 requires
that certain costs related to the development or purchase of internal-use
software be capitalized and amortized over the estimated useful life of the
software. SOP 98-5 requires costs of start-up activities and organization costs
to be expensed as incurred. The Company was required to adopt both new
statements in the first quarter of 1999. The adoption of these statements did
not have a material effect on the Company's consolidated financial statements.
YEAR 2000 ISSUE
The Year 2000 issue exists because many computer systems and applications,
particularly older systems and applications, use a two-digit, rather than a
four-digit, date field to designate a particular year. As a result of the
century change, date-sensitive systems may recognize dates in the twenty-first
century (i.e., after 2000) as dates in the twentieth century (i.e., the
corresponding year commencing with the prefix 19--). Equally, such systems may
not recognize dates in the twenty-first century at all. All of this could lead
to system failures or miscalculations which could lead to disruption of
operations such as data being lost, an inability to process transactions,
incorrect data being generated and critical deadlines being overlooked. The
impact of these disruptions could be significant.
PLD has conducted, and has caused each of its operating subsidiaries to
conduct a survey of the equipment and software used by them.
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The Company's business involves the supply of services. To the very limited
extent that it maintains actual inventory for sale (e.g., cellular telephone
equipment sold to subscribers for its cellular telephony services), it does not
manufacture such inventory itself but resells goods supplied by recognized
manufacturers of such goods.
Its survey has involved testing of equipment as well as contacting the
manufacturers of equipment and producers of software (or review of materials
published by such parties, including websites) to assess such parties' Year 2000
readiness. Such survey has indicated that, except in a few instances, the
equipment and software which it uses are Year 2000 compliant. The Company is
taking steps to upgrade or replace those items which are not compliant. In many
cases the items required to be upgraded or replaced were due to be upgraded or
replaced in any event, so that the Company's exposure has been the acceleration
of already planned expenditures, rather than new or unanticipated expenditures.
The Company expects that essentially all of its upgrading and replacement work,
and any remaining testing required, will be complete by the end of the third
quarter of 1999.
To date, PLD has expended approximately $400,000 for remediation efforts
and expects that its total remediation costs, including scheduled upgrades and
replacements of approximately $3,100,000, will be approximately $4,000,000.
Starting in January 1998, all operating businesses were required to use
their best efforts to obtain specific warranties of Year 2000 compliance from
parties with which they contract for products or services thereafter. While
almost all new contracts for products or services entered into since that date
have contained some form of warranty, these have generally been limited to
recovering of direct losses, and not indirect or consequential losses, such as
loss of revenues or profits. In consequence, the actual efficacy of such
warranties may be somewhat limited.
Additionally, all operating businesses have been required to review the
terms under which they have heretofore supplied products and/or services to
third parties. No case has been identified in which any operating business has
specifically guaranteed Year 2000 compliance, and the Company has instituted a
policy regarding the giving of such guarantees in the future in order to control
and limit possible exposure thereunder. Further, since none of the operating
businesses manufacture equipment or produce proprietary software for customers
other than in exceptional cases, virtually all such transactions involve the
re-sale or assignment of products and services supplied by others. Accordingly,
the Company believes that, to the extent that such products and services are
either warranted or shown to be Year 2000 compliant, its own exposure is
commensurately reduced.
While there can be no assurances that equipment failures will not occur,
the effect of such failures may be ameliorated by the fact that such equipment
is usually part of a network of facilities and equipment maintained by the
Company. This means that a failure in an individual component will not
necessarily cause a substantial disruption to the network as a whole, because no
individual item is critical to the operation of the network as a whole, and the
network also provides opportunities to by-pass the failure.
The foregoing indicates that, to the extent that its business depends upon
equipment, software, facilities and networks under its control, the Company
believes that, by the year 2000, it will have taken all steps reasonably
required to ensure that those items are Year 2000 compliant, and that it has
reasonable contingency arrangements to deal with failures.
The Company's principal Year 2000 risks arise from the fact that it is
dependent for the completion of its calls upon a variety of other traffic
carriers who provide interconnection and termination services. Since in many
cases there are a variety of routes over which traffic can be carried, it is
simply not possible for the Company to verify that each entity which could be
involved in providing telecommunications services to its operating subsidiaries
will be Year 2000 compliant. To a large extent, the Company is reliant in these
circumstances on the actions of the other telecommunications operators and
service providers to ensure that their counterparts are Year 2000 compliant.
While the Company believes that the parties providing these services which are
based in the United States and other Western countries are expected to be
substantially Year 2000 compliant, the Year 2000 compliance and readiness of the
Russian and other C.I.S. parties with which the Company's operating businesses
interact appears to be substantially behind that of Western parties. The Company
has been unable to determine with any degree of certainty the extent to which
its interconnect partners in the C.I.S. are non-compliant because those parties
have generally been reluctant to share this information. Nevertheless the
Company believes, based
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on such reluctance and anecdotal and other evidence, that many of those
partners, particularly in those in the less developed regions of the Russian
Federation or the C.I.S., are substantially non-compliant.
Furthermore, the likelihood that those parties will be able to become Year
2000 compliant seems problematical, given the limited amount of time left for
this, the severe funding constraints faced by those parties, principally as a
result of poor economic conditions in their home countries, and the possible
lack of governmental pressure on those parties.
Accordingly, there is a significant risk that the Company's operating
businesses may experience disruptions in their operations as a result of their
C.I.S. interconnect partners not being able to complete calls or pass traffic to
those businesses. While the Company is unable to predict the extent or duration
of such disruptions, the possibility exists that they could be extensive, and
also take considerable time, perhaps even months, to correct.
An additional risk is the likelihood that the billing systems of those
interconnect partners may also be disrupted, resulting in those partners being
unable to collect from their customers or to make timely settlements with the
Company's operating businesses.
Accordingly, the Company believes that there is a considerable risk that it
will experience disruptions in providing telecommunications services to and from
the countries of the C.I.S. which it serves, and that those disruptions may be
substantial. Given its inability to obtain an accurate assessment of the extent
to which its C.I.S. partners may be non-compliant, it is impossible for the
Company to predict either the extent or the magnitude of those disruptions.
Nevertheless, they have the potential to adversely impact the operations of its
operating subsidiaries, and such adverse impact may be material.
The Company has investigated the possibility of obtaining insurance against
liability arising out of claims that products or services supplied are not Year
2000 compliant, but has determined that such insurance is not obtainable upon
terms which are sufficiently comprehensive and/or is only obtainable upon terms
which are uneconomical given the level of perceived risk, and accordingly has
elected not to pursue such insurance.
ITEM 9A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
PLD's finance department is responsible for the evaluation and, to the
extent practicable, management of the Company's exposure to market risks.
The Company's primary market risk is related to the movement in foreign
currency exchange rates in the countries in which its operating businesses
operate: Russia and Kazakhstan. See "Risk Factors -- Country
Risks -- Restrictions on Currency Conversion; Historical Volatility in Currency
Prices" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Currency Controls." PLD and the Company periodically
evaluate the materiality of their foreign exchange exposures and the financial
instruments available to mitigate this exposure. However, PLD and the Company do
not currently believe that it is practical or economical to hedge these foreign
currency exchange risks and as a result will continue to experience foreign
currency gains and losses.
The Company does not use any derivative instruments, either as a trading or
non-trading activity.
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT
James R.S. Hatt has been a Director of the Company since 1996. Since 1995,
Mr. Hatt has been the Chairman, President and Chief Executive Officer of PLD,
the parent of the Company.
Clayton A. Waite has been a Director of the Company since 1996. Mr. Waite
is currently a consultant to PLD and has previously served as Vice President -
Administration and Group Financial Controller of PLD.
Christos Clerides has been a Director of the Company since 1994. Mr.
Clerides is currently a partner in a Cyprus law firm which provides legal and
corporate administrative services to the Company in Cyprus.
Phivos Clerides has been a Director of the Company since 1994.
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None of the directors of the Company are citizens or residents of the
United States.
The directors of the Company are elected for an unspecified term, until
their successors are elected and duly qualified.
There are no officers of the Company.
ITEM 11. COMPENSATION OF DIRECTORS AND OFFICERS
The directors of the Company are not compensated by the Company or its
subsidiaries in their roles as directors. The Company pays the Cyprus law firm
of which Mr. Christos Clerides is a partner certain fees in respect of legal and
corporate administration services in Cyprus.
ITEM 12. OPTIONS TO PURCHASE SECURITIES FROM REGISTRANT OR SUBSIDIARIES
None.
ITEM 13. INTEREST OF MANAGEMENT IN CERTAIN TRANSACTIONS
PeterStar entered into a service agreement, dated as of January 1, 1999,
with the Company, pursuant to which, for a one-year term, the Company will
provide management services to PeterStar, including advice and assistance with
respect to the design, implementation, operations, marketing and expansion of
PeterStar's network for a one-year term. PeterStar has had similar agreements
with the Company for all years dating back to 1992.
ALTEL entered into Consulting and Information Services Agreements with PLD
and Kazakhtelekom, each dated January 1, 1998, pursuant to which such parties
provide certain consulting, information, management services and personnel
expertise to ALTEL. In consideration for these services, ALTEL pays consulting
fees, in the case of PLD, of $25,000 per month plus 3.4% of ALTEL's gross
revenues, and, in the case of Kazakhtelekom, of 300,000 Tenge per month plus 1%
of ALTEL's gross revenues. These contracts are each for a one year term
automatically renewable for successive one year periods unless terminated by
either party.
PART II
ITEM 14. DESCRIPTION OF SECURITIES TO BE REGISTERED
None.
PART III
ITEM 15. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 16. CHANGES IN SECURITIES, CHANGES IN SECURITY FOR REGISTERED SECURITIES
AND USE OF PROCEEDS
None.
PART IV
ITEM 17. FINANCIAL STATEMENTS
The consolidated financial statements of the Company and its subsidiaries
are attached to this Report beginning on page F-1.
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ITEM 19. FINANCIAL STATEMENTS AND EXHIBITS
(a) Financial Statements
(i) Consolidated balance sheets of the Company as of December 31, 1998
and 1997;
(ii) Consolidated statements of operations of the Company for the years
ended December 31, 1998, 1997 and 1996;
(iii) Consolidated statements of cash flows of the Company for the years
ended December 31, 1998, 1997 and 1996; and
(iv) Consolidated statements of shareholder's equity of the Company for
the years ended December 31, 1998, 1997 and 1996.
(b) Exhibits
4.1 Indenture, dated as of May 31, 1996, among PLD Telekom Inc., as
Issuer, the Company, PLD Asset Leasing Limited, PLD Capital Limited,
Baltic Communications Limited and Wireless Technology Corporations
Limited as Guarantors, and The Bank of New York, as Trustee, with
respect to $123,000,000 aggregate principal amount at stated
maturity of 14% Senior Discount Notes due 2004 (the "Senior Note
Indenture") (Exhibit 4.1)(1)
4.2 Indenture, dated as of May 31, 1996, among PLD Telekom Inc. as
Issuer, the Company, PLD Asset Leasing Limited, PLD Capital Limited,
Baltic Communications Limited and Wireless Technology Corporations
Limited as Guarantors, and The Bank of New York, as Trustee, with
respect to $26,500,000 aggregate principal amount of 9% Convertible
Subordinated Notes due 2006. (Exhibit 4.1)(2)
4.3 First Supplemental Indenture, Amendment Agreement, Consent and
Waiver, dated as of March 20, 1998, among PLD Telekom Inc., as
Issuer, the Company, PLD Asset Leasing Limited, PLD Capital Limited,
Wireless Technology Corporations Limited and Baltic Communications
Limited, as Guarantors, Clayton A. Waite and Apropos Investments
Ltd., as nominee shareholders, and The Bank of New York, as Trustee.
(Exhibit 4.3)(1)
99.1 Consent of KPMG.
- ---------------
(1) Incorporated by reference to the Company's Registration Statement on Form
S-4 (File No. 333-5398).
(2) Incorporated by reference to the Company's Registration Statement on Form
S-3 (File No. 333-5396).
47
<PAGE> 50
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act
of 1934, the registrant certifies that it meets all of the requirements for
filing on Form 20-F and has duly caused this annual report to be signed on its
behalf by the undersigned, thereunto duly authorized, in New York, New York on
June 25, 1999.
NWE CAPITAL (CYPRUS) LIMITED
By: /s/ CLAYTON A. WAITE
------------------------------------
Clayton A. Waite
Director
48
<PAGE> 51
NWE CAPITAL (CYPRUS) LIMITED
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
ITEM PAGE
- ---- ----
<S> <C>
Independent auditors' report................................ F-2
Consolidated balance sheets as of December 31, 1998 and
1997...................................................... F-3
Consolidated statements of operations for the years ended
December 31, 1998, 1997 and 1996.......................... F-4
Consolidated statements of cash flows for the years ended
December 31, 1998, 1997 and 1996.......................... F-5
Consolidated statements of shareholder's equity for the
years ended December 31, 1998, 1997 and 1996.............. F-6
Notes to consolidated financial statements.................. F-7
</TABLE>
F-1
<PAGE> 52
INDEPENDENT AUDITORS' REPORT
Shareholder and Board of Directors of
NWE Capital (Cyprus) Ltd.:
We have audited the accompanying consolidated balance sheets of NWE Capital
(Cyprus) Ltd. and subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of operations, shareholder's equity and cash flows for
each of the years in the three year period ended December 31, 1998. 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 financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of NWE Capital
(Cyprus) Ltd. and subsidiaries as of December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the years in the three year
period ended December 31, 1998 in conformity with generally accepted accounting
principles.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in note
16(d) to the consolidated financial statements, the Company's parent, PLD
Telekom Inc. (PLD) does not presently have sufficient funds on hand to meet its
current debt obligations. PLD's failure to make payment in full when required
could result in a cross-default under and acceleration of other debt obligations
for which the Company is a guarantor. These factors raise substantial doubt
about the Company's ability to continue as a going concern. The consolidated
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
Without qualifying our opinion, we draw your attention to the information
contained in Note 1 to the financial statements regarding the uncertain
operating environment in Russia. The ultimate effect that these significant
economic uncertainties could have on the stated values, classification,
realisation or settlement of assets and liabilities stated in these financial
statements cannot presently be determined and accordingly no provisions have
been made.
Without qualifying our opinion, we draw your attention to the disclosures
in Note 16 to the financial statements concerning the uncertainty relating to
the effects of the Year 2000 problem.
KPMG
St. Petersburg, Russia
March 30, 1999
F-2
<PAGE> 53
NWE CAPITAL (CYPRUS) LTD.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
(IN THOUSANDS OF U.S. DOLLARS)
<TABLE>
<CAPTION>
1998 1997
-------- -------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents (note 7)........................ $ 2,816 7,849
Trade receivables, net of allowances of $1,788 and $3,002
respectively........................................... 11,260 12,725
VAT receivable............................................ -- 2,154
Other receivables and prepaids............................ 2,024 3,266
Due from related parties.................................. -- 468
Inventory................................................. 4,076 2,566
-------- -------
Total current assets.............................. 20,176 29,028
Property and equipment, net (note 6)........................ 106,542 79,002
Telecommunications licenses, net of amortization of $24,077
and $19,356, respectively (note 3)........................ 37,663 42,286
Other receivables (note 4).................................. 2,012 3,012
Goodwill, net of amortization $789 and $574, respectively
(note 5).................................................. 1,365 1,580
Other assets................................................ 410 280
-------- -------
Total assets...................................... $168,168 155,188
======== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Bank indebtedness (note 8)................................ $ -- 900
Accounts payable.......................................... 1,980 1,971
Accrued liabilities....................................... 2,640 3,044
Customer deposits and advances............................ 7,109 5,978
Advances from other group companies (note 10)............. 33,988 35,711
Due to related parties.................................... 462 818
Current portion of long-term debt (note 9)................ 3,479 2,180
-------- -------
Total current liabilities......................... 49,658 50,602
-------- -------
Long-term liabilities:
Advances from other group companies (note 10)............. 4,669 6,627
Long-term debt (note 9)................................... 7,165 7,975
-------- -------
Total long-term liabilities....................... 11,834 14,602
-------- -------
Minority interest........................................... 28,113 19,391
Commitments and contingencies (note 16)
Shareholder's equity (note 12):
Common stock, par value CY L1 per share. Authorised
3,246,174 shares in 1998 and 1997; Issued and
outstanding 3,246,174 shares in 1998 and 1997.......... 7,082 7,082
Contributed surplus....................................... 63,723 63,723
Accumulated surplus/(deficit)............................. 7,758 (212)
-------- -------
Total shareholders' equity........................ 78,563 70,593
-------- -------
Total liabilities and shareholders' equity........ $168,168 155,188
======== =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 54
NWE CAPITAL (CYPRUS) LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS OF U.S. DOLLARS)
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------- -------
<S> <C> <C> <C>
Telecommunications revenues................................. $113,041 85,588 52,651
Direct costs................................................ 29,081 23,120 17,527
-------- ------- -------
Gross profit...................................... 83,960 62,468 35,124
Operating expenses:
General and administrative................................ 28,030 15,742 12,396
Management fees........................................... 1,649 4,817 2,085
Depreciation.............................................. 10,266 7,194 4,758
Amortization.............................................. 4,935 4,936 4,884
Taxes other than income taxes............................. 4,021 3,257 1,667
-------- ------- -------
Total operating expenses.......................... 48,901 35,946 25,790
Operating income.................................. 35,059 26,522 9,334
Other income/(expense):
Interest and other income................................. 288 337 370
Interest on long-term debt................................ (769) (584) --
Foreign exchange loss (note 1)............................ (2,890) (676) (740)
Other expense............................................. (2,000) -- (9)
Settlement with minority shareholders (note 11)........... -- 5,339 --
-------- ------- -------
Income before income taxes and minority interest............ 29,688 30,938 8,955
Income taxes (note 13)...................................... 9,997 6,893 3,356
-------- ------- -------
Income before minority interest................... 19,691 24,045 5,599
Minority interest........................................... 11,721 12,336 2,615
-------- ------- -------
Net income........................................ $ 7,970 11,709 2,984
======== ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 55
NWE CAPITAL (CYPRUS) LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS OF U.S. DOLLARS)
<TABLE>
<CAPTION>
1998 1997 1996
------- -------- -------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income................................................ $ 7,970 11,709 2,984
Adjustments to reconcile net income to net cash provided
by/(used in) operating activities:
Depreciation and amortization.......................... 15,202 12,130 9,642
Minority interest...................................... 11,721 12,336 2,615
Settlement with minority shareholders (note 11)........ -- (5,339) --
Other.................................................. 2,000 133 9
Customer deposits and advances......................... 1,131 3,284 103
Changes in working capital (note 14)................... (332) (10,047) (331)
------- -------- -------
Net cash provided by operating activities............ 37,692 24,206 15,022
------- -------- -------
Cash flows from investing activities:
Capital expenditures...................................... (32,056) (19,367) (20,652)
Other assets.............................................. (130) 89 (58)
------- -------- -------
Net cash used in investing activities............. (32,186) (19,278) (20,710)
------- -------- -------
Cash flows from financing activities:
Bank indebtedness......................................... (900) 900 --
Long-term debt............................................ (2,558) -- 6,247
Advances from other group companies....................... (4,081) (3,591) 1,729
Recapitalisation of PeterStar............................. -- 1,427 --
Dividends paid............................................ (3,000) (1,000) --
------- -------- -------
Net cash (used in)/provided by financing
activities...................................... (10,539) (2,264) 7,976
------- -------- -------
(Decrease)/increase in cash and cash
equivalents..................................... (5,033) 2,664 2,288
Cash and cash equivalents at beginning of year............ 7,849 5,185 2,897
------- -------- -------
Cash and cash equivalents at end of year.................. $ 2,816 7,849 5,185
======= ======== =======
Supplementary disclosures:
Non-cash investing and financing activities:
Purchase of equipment with PLD advances and under
long-term contracts.................................... $ 5,833 10,641 1,597
======= ======== =======
Recapitalisation of PeterStar (note 4).................... $ -- 4,012 --
======= ======== =======
Interest paid............................................... $ 1,685 728 --
======= ======== =======
Income taxes paid........................................... $10,133 6,924 3,999
======= ======== =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 56
NWE CAPITAL (CYPRUS) LTD.
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT NUMBER OF SHARES)
<TABLE>
<CAPTION>
ACCUMULATED
NUMBER OF CONTRIBUTED SURPLUS/
SHARES AMOUNT SURPLUS (DEFICIT) TOTAL
--------- ------ ----------- ----------- --------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1996......... 1,000 $ 2 $ -- $(14,905) $(14,903)
Conversion of promissory note from
PLD Telekom Inc.................. 928,591 2,000 18,000 -- 20,000
Acquisition of WTC from PLD
Telekom Inc...................... 2,316,583 5,080 45,723 -- 50,803
Net income for the year............ -- -- -- 2,984 2,984
--------- ------ ------- -------- --------
Balance at December 31, 1996....... 3,246,174 7,082 63,723 $(11,921) $ 58,884
Net income for the year............ -- -- -- 11,709 11,709
--------- ------ ------- -------- --------
Balance at December 31, 1997....... 3,246,174 $7,082 $63,723 $ (212) $ 70,593
Net income for the year............ -- -- -- 7,970 7,970
--------- ------ ------- -------- --------
Balance at December 31, 1998....... 3,246,174 $7,082 $63,723 $ 7,758 $ 78,563
========= ====== ======= ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 57
NWE CAPITAL (CYPRUS) LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
(THOUSANDS OF U.S. DOLLARS)
(1) BUSINESS, OPERATIONS AND FUTURE ACTIVITIES
(a) Background
The Company is incorporated under the laws of Cyprus. The Company is a
wholly-owned subsidiary of PLD Telekom Inc. ("PLD" or the "Parent"). Through its
majority-owned and controlled subsidiaries, the Company is a provider of local,
long distance and international telecommunications services in the former Soviet
Union.
The Company's telecommunications businesses are at various stages of
development and are growing in emerging economies which, by their nature, have
uncertain economic, political and regulatory environments. The general risks of
operating businesses in the former Soviet Union include the possibility for
rapid change in government policies, economic conditions, the tax regime and
foreign currency regulations.
Ultimate recoverability of the Company's investments is dependent upon
their ability to maintain profitability, which is dependent to a certain extent
on the stabilisation of the economies of the former Soviet Union, the ability to
maintain the necessary telecommunications licenses and the ability to obtain
adequate financing to meet capital commitments.
The Company is in a net current liability position and will require the
continued support of PLD in order to meet its obligations as they fall due.
(b) Russian Business Environment
In recent years, Russia has undergone fundamental political and economic
change. As a result, operations carried out in Russia involve significant risks
which are not typically associated with many other environments.
The immediate and ongoing effects of severe economic instability in Russia
include or may include slower economic growth or decline, a reduction in the
availability of credit and the ability to service debt, volatile interest rates,
changes and increases in taxes, higher inflation or hyperinflation, further
devaluation of the rouble, restrictions on convertibility and movements of
funds, bankruptcies including bank failures, and other severe economic and
political consequences. These conditions and future policy changes could have a
material adverse effect on the operations of the Company and the realisation and
settlement of its assets and liabilities.
The accompanying financial statements reflect management's current
assessment of the impact of the economic situation on the financial position of
the Company. Actual results could differ from management's current assessments
and such differences could be material. In addition, the effect of future
developments on the Company's financial position and the ability of others to
continue to transact with the Company cannot presently be determined. The
financial statements therefore may not include all adjustments that might
ultimately result from these adverse conditions.
(c) Uncertain Operating Environment in Russia
The recoverability of the Company's assets, as well as the future operation
of the Company, may be significantly affected by the current and future economic
environment in Russia. The accompanying financial statements do not include any
adjustments with regard thereto.
(d) Convertibility of the Rouble
The Russian rouble is not a convertible currency outside the Russian
Federation and, accordingly, any conversion of Russian rouble amounts to US
dollars should not be construed as a representation that Russian rouble amounts
have been, could be, or will be in the future, convertible into US dollars at
the exchange rate used, or at any other exchange rate.
F-7
<PAGE> 58
NWE CAPITAL (CYPRUS) LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The ability of the Russian government to maintain the stability of the
rouble will depend on many political and economic factors, including its ability
to control inflation and the availability of sufficient reserves to support the
rouble. Uncertainty also exists with respect to the Central Bank's policy
direction. The possibility of further restrictions on convertibility and
currency movements cannot be ruled out.
As a result of the significant devaluation of the rouble during the latter
part of 1998 the Company's subsidiary PeterStar has suffered foreign exchange
losses of approximately $2.9 million. The corresponding loss in 1997 was
approximately $0.7 million and in 1996 was approximately $0.7 million. The major
portion of the loss in 1998 relates to a period in August/September 1998, when
it was difficult to convert roubles into other currencies.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company's significant accounting policies are summarised as follows:
(a) Basis of Presentation
The accompanying consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States
(U.S. GAAP) and present the financial position and results of operations of the
Company and subsidiaries (the "Company") on a stand-alone basis. The Company
incurs and pays its own expenses. Management assistance is provided by the
Parent under the terms of negotiated management agreements and specific costs
incurred by the Parent on behalf of the Company are charged thereto. All
intercompany transactions and charges are disclosed in note 15, "Related Party
Transactions".
Income tax expense is based upon a calculation of current tax expense and
deferred tax expense in accordance with Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes", on a stand-alone basis. Refer
to note 13, "Income Taxes".
Intercompany interest charges incurred are the result of, and are made
pursuant to, intercompany loan and/or lease agreements and are not a result of
allocations of interest by the Parent or its subsidiaries.
Telecommunications license amortization expense is based upon the cost of
the licenses. Amortization expense is calculated on a straight-line basis over
the terms of the licenses including the portion of the Parent's investment in
the Company which has been allocated to telecommunications licenses and pushed
down into the Company's consolidated financial statements.
There are no common costs allocated to the Company by the Parent. Direct
costs incurred by the Parent on behalf of the Company are reimbursed by the
Company. Services provided by the Parent are furnished under the terms of the
negotiated management agreements. Refer to note 15, "Related Party
Transactions". Management of the Company believes that the accompanying
consolidated financial statements include all the costs incurred by the Company
in its operations.
(b) Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its majority-owned and controlled subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation.
(c) Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents. At December 31, 1998
and 1997, the Company's cash equivalents consist of term deposits of $1.4
million and $4.6 million respectively.
F-8
<PAGE> 59
NWE CAPITAL (CYPRUS) LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(d) Revenue Recognition
The Company records telecommunication revenues as earned, at the time
services are provided with the exception of terminal sales. Terminal sales are
recognised when the equipment is delivered and the supporting contract is
signed.
(e) Inventory
Inventory is stated at the lower of average cost or net realisable value
and is comprised of telephony products held for resale to customers.
(f) Property and Equipment
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is provided using the straight-line method over the estimated
useful lives of the assets as follows:
<TABLE>
<S> <C>
Telecommunications equipment.................... 10 years
Buildings....................................... 10 years
Office furniture and equipment.................. 3-5 years
Leasehold improvements.......................... 15 years
</TABLE>
Interest costs incurred during the period of installation of
telecommunications equipment are capitalised. The interest cost capitalised in
1998 amounted to $1,289,628 (1997: $927,791, 1996: $0).
(g) Telecommunications Licenses
Telecommunications licenses are amortized on a straight-line basis over the
terms of the licenses.
(h) Goodwill
Goodwill represents the excess of the purchase price over the fair values
of the net assets acquired of C.P.Y. Yellow Pages Limited, and is being
amortized on a straight-line basis over ten years.
(i) Fair Value of Financial Instruments
The carrying amounts reported in the consolidated balance sheets for cash
and cash equivalents, trade and other receivables, amounts due from or to
related parties, bank indebtedness and accounts payable approximate fair value
due to their short maturities. The fair value of long-term debt is based on
discounted cash flow analysis.
(j) Reporting Currency and Foreign Currency Translation
The statutory accounts of the Company's consolidated subsidiaries are
maintained in accordance with local accounting regulations and are stated in
local currencies.
Local statements are adjusted to U.S. GAAP and then translated into U.S.
dollars in accordance with Statement of Financial Accounting Standards No. 52
(SFAS 52), "Foreign Currency Translation."
Under SFAS 52, the financial statements of foreign entities in highly
inflationary economies are measured in all cases using the U.S. dollar as the
functional currency. U.S. dollar transactions are shown at their historical
value. Monetary assets and liabilities denominated in local currencies are
translated into U.S. dollars at the prevailing period-end exchange rate. All
other assets and liabilities are translated at historical exchange rates.
Results of operations have been translated using the exchange rates effective at
the date of the transaction. Translation differences resulting from the use of
these different rates are included in the accompanying consolidated statements
of operations.
F-9
<PAGE> 60
NWE CAPITAL (CYPRUS) LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(k) Income Taxes
Tax on the profit or loss for the year comprises current tax and the change
in deferred tax. Current tax comprises tax payable calculated on the basis of
the expected taxable income for the year, using the tax rates enacted at the
balance sheet date, and any adjustment of tax payable for previous years.
Deferred tax is provided using the balance sheet liability method on all
temporary differences between the carrying amounts for financial reporting
purposes and the amounts used for taxation purposes, except differences relating
to the initial recognition of assets or liabilities which affect neither
accounting nor taxable profit (taxable loss).
The tax value of losses expected to be available for utilisation against
future taxable income is set off against the deferred tax liability within the
same legal tax unit and jurisdiction. Net deferred tax assets are reduced to the
extent that it is no longer probable that the related tax benefit will be
realised.
Deferred tax is calculated on the basis of the tax rates that are expected
to apply to the period when the asset is realised or the liability is settled.
The effect on deferred tax of any changes in tax rates is charged to the
statement of operations, except to the extent that it relates to items
previously charged or credited directly to equity.
(l) 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 liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the year. Actual results
could differ from those estimates.
(m) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 121 (SFAS 121), "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of", on January 1, 1996. SFAS
121 requires that long-lived assets and certain identifiable intangibles be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to future net cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment to be recognised is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell.
(n) Comprehensive Income
SFAS 130 "Reporting Comprehensive Income" was issued in June 1997. SFAS 130
establishes standards for reporting and display of comprehensive income and its
components in a full set of general purpose financial statements. SFAS 130
requires that all items that are required to be recognised under accounting
standards as components of comprehensive income be reported in an annual
financial statement that is displayed with the same prominence as other
financial statements. The Company adopted SFAS 130 as at January 1, 1998. For
the years ended December 31, 1998, 1997, and 1996 comprehensive income was equal
to net income reported in the statement of operations. As SFAS 130 only requires
additional disclosures in the Company's financial statements, its adoption did
not have any impact on the Company's financial position or results of
operations.
F-10
<PAGE> 61
NWE CAPITAL (CYPRUS) LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(o) Reclassifications
Certain reclassifications have been made to the prior year's financial
statements to conform to the current year's presentation.
(3) BUSINESSES AND ACQUISITIONS
The Company's key interests at December 31, 1998 include a 60% equity
interest in PeterStar Company Limited ("PeterStar") and a 50% indirect equity
interest in ALTEL (before April 1998 named BECET International).
(a) PeterStar
PeterStar is a joint stock company registered in 1992 under the laws of the
Russian Federation to provide international and domestic telecommunications
services to St. Petersburg, Russia. In November 1994, PeterStar was granted a
license to provide these services for a further ten years. The license was
reissued in June 1996 and sets the number of lines which PeterStar may have and
requires that at least 74,200 lines be introduced by June 1999. At December 31,
1998, PeterStar had 168,166 lines in place.
Other licenses, all of which expire in 2001, are for telematic services,
video conferencing, data services and the operation of a dedicated
national/international overlay network. These licenses are generally renewed on
application. Grounds for termination of licenses are broad and subjective and
there is little precedent upon which to determine the practical likelihood of
termination.
In October 1992, PLD acquired a 50% interest in PeterStar for consideration
of $20.0 million. All of the consideration was allocated to telecommunications
licenses. This interest was subsequently transferred to the Company in exchange
for a promissory note in the amount of $20.0 million. During 1996 the promissory
note was exchanged for 928,591 shares of the Company.
In March 1994, PLD acquired 90% of the outstanding shares of PMT Ltd., a
Russian company whose sole asset was a 10% interest in PeterStar, for
consideration of $8.2 million. PLD acquired the remaining 10% of PMT Ltd. in
April 1996 for consideration of $1.8 million. All of the consideration was
allocated to telecommunications licenses. In April 1996, PLD transferred its 10%
interest in PeterStar to the Company in exchange for a $10.0 million
non-interest bearing promissory note payable on demand and convertible to common
shares at the option of either PLD or the Company. This acquisition has been
accounted for using the continuity of interests method. Accordingly, PLD's
historical cost of the PeterStar telecommunications licenses transferred to the
Company is recorded in these financial statements and comparative figures have
been restated to reflect the historical net book value of the PeterStar licenses
and the related amortization expense.
(b) ALTEL
ALTEL provides cellular services pursuant to a 15 year license to operate a
cellular and mobile telephone system in Kazakstan until February 2009. The
Company's 50% interest in ALTEL is held by its wholly-owned subsidiary, Wireless
Technology Corporations Limited ("WTC"), a company incorporated in the territory
of the British Virgin Islands.
In March 1994, PLD acquired all the outstanding shares of WTC for
consideration of $30.0 million. The acquisition was accounted for by the
purchase method. As of the date of acquisition, ALTEL had not commenced
operations and did not have any tangible assets or liabilities. Therefore, the
entire purchase price, including acquisition costs of $0.8 million was allocated
to telecommunications licenses. ALTEL commenced commercial operations in
September 1994. During 1994 and 1995, PLD contributed additional equity of $20.0
million to WTC which in turn contributed $20.0 million of working capital and
equipment to ALTEL in exchange for its 50% equity interest.
F-11
<PAGE> 62
NWE CAPITAL (CYPRUS) LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
On January 5, 1996, PLD transferred its shares in WTC to the Company for
consideration of 2,316,583 shares of the Company. This acquisition has been
accounted for using the continuity of interests method. Accordingly, PLD's
historical cost of the ALTEL license is recorded in these financial statements
and comparative figures have been restated to reflect the historical net book
value of the licenses and the related expense.
(4) OTHER RECEIVABLES
During 1997, a $13.6 million receivable by PLD from PeterStar was assigned
to the Company. This amount was subsequently repaid by PeterStar with proceeds
from a share issue. $4.0 million was advanced to a minority shareholder of
PeterStar so that it could participate in the share issue. $4.0 million of the
assigned amount is outstanding at December 31, 1998, all of which is classified
as long-term (1997: $4.0 million, of which $3.0 million was classified as
long-term and $1.0 million was classified as short-term). At the end of 1998, as
a result of the economic conditions in Russia, the Company recorded a $2.0
million valuation allowance against the $4.0 million receivable.
(5) GOODWILL
Effective April 26, 1995, PLD acquired all the outstanding shares of C.P.Y.
Yellow Pages Limited ("Yellow Pages"), a company incorporated in the Republic of
Cyprus, for consideration of $2.1 million. Yellow Pages publishes a Yellow Pages
directory and owns a database of Russian and foreign businesses in St.
Petersburg. The acquisition was accounted for by the purchase method and
substantially all of the consideration was allocated to goodwill.
On March 1, 1996, PLD transferred the shares of Yellow Pages to the Company
in exchange for a non-interest bearing promissory note in the amount of $2.1
million. The note is payable in ten years and may be converted to common shares
at the option of either PLD or the Company. This transaction has been accounted
for as a transfer of assets between entities under common control and, as such,
the assets are reflected at PLD's historical cost.
(6) PROPERTY AND EQUIPMENT
Property and equipment at December 31, 1998 and 1997 consist of the
following (in thousands of U.S. dollars):
<TABLE>
<CAPTION>
1998 1997
-------- -------
<S> <C> <C>
Telecommunications equipment:
Installed................................................. $ 84,388 68,492
Uninstalled............................................... 31,289 11,473
Buildings................................................... 2,760 2,333
Office furniture and equipment.............................. 5,714 4,156
Leasehold improvements...................................... 5,929 5,277
Advances to equipment suppliers............................. 3,124 3,917
-------- -------
Total property and equipment...................... 133,204 95,648
Less accumulated depreciation............................... (26,662) (16,646)
-------- -------
Property and equipment, net............................... $106,542 79,002
======== =======
</TABLE>
Property and equipment includes telecommunications equipment with a cost of
$30.0 million (1997: $16.5 million) which has been pledged under the terms of
long-term instalment agreements and $0 (1997: $6.6 million) which has been
acquired under capital lease (notes 9 and 10).
F-12
<PAGE> 63
NWE CAPITAL (CYPRUS) LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) CASH AND CASH EQUIVALENTS
The Company's cash and cash equivalents at December 31, 1998 and 1997
consist of the following (in thousands of U.S. dollars):
<TABLE>
<CAPTION>
1998 1997
------ ------
<S> <C> <C>
Cash on deposit:
In Russia and Kazakstan................................... $2,816 $6,621
Outside Russia and Kazakstan.............................. -- 1,228
------ ------
$2,816 7,849
====== ======
</TABLE>
(8) BANK INDEBTEDNESS
At December 31, 1998, the Company had no bank indebtedness. In December
1997, PeterStar entered into a $2.0 million, one-year loan facility with BNP
Dresdner Bank for the purchase of telecommunications equipment. Interest was
charged on borrowed amounts at three-month LIBOR plus 2.5% per annum. The
amounts drawn on the loan facility at December 31, 1997 were $0.9 million. The
bank indebtedness was guaranteed by PLD.
(9) LONG-TERM INDEBTEDNESS
Amounts payable under the terms of the long-term instalment purchase
agreements are as follows (in thousands of U.S. dollars):
<TABLE>
<CAPTION>
1998 1997
------- ------
<S> <C> <C>
Less than one year.......................................... $ 4,381 3,060
One to two years............................................ 4,129 3,214
Two to three years.......................................... 2,424 2,595
Three to four years......................................... 1,158 1,927
Four to five years.......................................... 530 1,791
------- ------
Total minimum payments............................ 12,622 12,587
Amounts representing interest............................... (1,978) (2,432)
------- ------
10,644 10,155
Current portion............................................. 3,479 2,180
------- ------
Non-current portion......................................... $ 7,165 7,975
======= ======
</TABLE>
Amounts payable are in respect of purchases of telecommunications equipment
under long-term instalment purchase agreements. They represent future amounts
payable discounted at a rate of 8% per annum. They are secured by pledges of the
related assets until final payment is made in 2002.
F-13
<PAGE> 64
NWE CAPITAL (CYPRUS) LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(10) ADVANCES FROM OTHER GROUP COMPANIES
Amounts due to other group companies as of December 31, 1998 and 1997 are
as follows:
<TABLE>
<CAPTION>
1998 1997
------- -------
<S> <C> <C>
PLD Telekom Inc............................................. $28,222 $33,701
PLD Capital Asset (U.S.) Inc................................ 10,214 --
PLD Asset Leasing Limited................................... -- 7,384
PLD Management Services Ltd................................. 221 1,253
------- -------
Total............................................. 38,657 42,338
Current portion............................................. 33,988 35,711
------- -------
Non current portion......................................... $ 4,669 $ 6,627
======= =======
</TABLE>
The amounts due to PLD at December 31, 1998 and 1997, represent advances
($25.7 million) to PeterStar and NWE, and fees due to PLD for management
services ($2.3 million) provided to PeterStar and ALTEL. Such amounts have no
scheduled repayment terms and are classified as current.
In September 1996, PeterStar entered into a capital lease for switching
equipment. The lessor of the equipment was PLD Asset Leasing Limited (PLDAL), a
Cypriot company and a wholly owned subsidiary of PLD. During the first six
months of 1998, PeterStar entered into three additional leases, with PLD as the
lessor. On June 25, 1998, the interests in all of these leases were transferred
to PLD Capital Asset (U.S.) Inc. (PLDCA), a United States company, which is also
wholly owned by PLD. The three additional leases entered into during 1998
resulted in approximately $2.1 million of equipment acquired under capital
leases and a capital lease liability of an equal amount. At the date of
transfer, the net liability under capital leases amounted to approximately $1.8
million. On the date of transfer, the capital leases were restructured as
installment purchase agreements with substantially the same payment terms.
Additionally, during 1998, PeterStar entered into an additional installment
purchase agreement with PLDCA for approximately $1.1 million of equipment. All
installment purchase agreements carry interest rates ranging from 8% to 10%.
Future payments due under these installment purchase agreements, including
interest, are as follows:
<TABLE>
<S> <C>
1999........................................................ $ 6,220
2000........................................................ 2,623
2001........................................................ 2,338
2002........................................................ 350
-------
Total payments.................................... 11,531
Less: amount representing interest.......................... 2,436
-------
Principal amounts due....................................... 9,095
Add: accrued interest at December 31, 1998.................. 1,119
-------
Total due to PLDCA................................ $10,214
=======
</TABLE>
$12.1 million in advances from PLD Telekom Inc. arose on the acquisition of
a 10% interest in PeterStar and on the acquisition of Yellow Pages (notes 3(a)
and 5).
(11) SETTLEMENT WITH MINORITY SHAREHOLDERS
During 1997, the Company and the minority shareholders of PeterStar reached
a settlement regarding management fees and other costs previously charged by the
Company, and expensed by PeterStar. As a result of
F-14
<PAGE> 65
NWE CAPITAL (CYPRUS) LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
the settlement, a charge to PeterStar of $5.4 million was disallowed. This
amount was reflected by the Company as an increase in expenses.
(12) COMMON STOCK
At December 31, 1998 and 1997 the authorised capital stock of the Company
consists of 3,246,174 common shares with par value of CY (pound) 1 per share.
3,246,174 shares are issued and outstanding as of December 31, 1998 and 1997.
Distributable reserves are restricted to the retained earnings of the
Company's subsidiaries which are determined according to Russian, Cypriot and
British Virgin Islands legislation. At December 31, 1998, that amount is the
rouble equivalent of $6.7 million (1997 -- $14.8 million). No dividends have
been approved for payment.
(13) INCOME TAXES
PeterStar and ALTEL are subject to income tax at statutory rates of 33% and
30%, respectively. The provision for income taxes, which relates substantially
to current income taxes in PeterStar and ALTEL, differs from the U.S. federal
and state statutory tax rates as follows (in thousands of U.S. dollars):
<TABLE>
<CAPTION>
1998 1997 1996
------- ------ ------
<S> <C> <C> <C>
Provision for income taxes at statutory rates............ $10,391 10,828 3,134
Add/(deduct) the tax effect of:
Exchange differences................................... (7,661) -- --
Difference in rate..................................... (979) 58 692
Foreign withholding taxes.............................. 450 -- --
Other.................................................. (96) -- --
Non-deductible amortization of licenses and goodwill... 1,835 633 626
Other non-deductible expenses.......................... 4,075 1,045 1,348
Concessions on capital expenditures.................... (726) (3,775) (2,292)
Change in valuation allowance related to deferred tax
assets.............................................. 2,708 (1,896) (152)
------- ------ ------
Provision for income tax....................... $ 9,997 6,893 3,356
======= ====== ======
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at December 31, 1998 and
1997 are as follows (in thousands of U.S. dollars):
<TABLE>
<CAPTION>
1998 1997
------- ------
<S> <C> <C>
Deferred tax assets:
Expenses not yet deducted for Russian and Kazakh tax
purposes............................................... $ 3,571 863
Less: valuation allowance................................... (3,571) (863)
------- ------
$ -- --
======= ======
</TABLE>
As a result of the rapid change in the regulatory environment and
uncertainty surrounding the Russian and Kazakh tax regimes, the Company has
provided a valuation allowance against deferred tax assets.
F-15
<PAGE> 66
NWE CAPITAL (CYPRUS) LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(14) CHANGES IN WORKING CAPITAL
Changes in working capital in each of the years in the three year period
ended December 31, 1998 consist of the following (in thousands of U.S. dollars):
<TABLE>
<CAPTION>
1998 1997 1996
------- -------- -------
<S> <C> <C> <C>
Decrease/(Increase) in trade receivables.................... $ 1,465 (6,832) (2,465)
Decrease/(Increase) in VAT receivable....................... 2,154 (1,528) 281
(Increase)/Decrease in other receivables and prepaids....... (1,758) (1,088) 1,592
Increase in inventory....................................... (1,510) (868) (409)
Change in amounts due from or to related parties............ (288) 213 --
(Decrease)/Increase in amounts payable and accrued
liabilities............................................... (395) 56 670
------- -------- -------
Changes in working capital.................................. $ (332) (10,047) (331)
======= ======== =======
</TABLE>
(15) RELATED PARTY TRANSACTIONS
(a) Petersburg Telephone Network ("PTN"), an indirect minority
shareholder of PeterStar has provided PeterStar during the years
1998, 1997 and 1996 with office space in St. Petersburg for no
consideration.
(b) Lease payments for the office in Almaty and other premises of $0.3
million, $0.1 million and $0.1 million for each of the years ended
December 31, 1998, 1997 and 1996 were paid by ALTEL to Kazakhtelecom
("KT"), the other shareholder of ALTEL. There was no balance
outstanding in relation to these leases as of December 31, 1998 and
1997.
(c) PeterStar entered into a barter agreement with PTN under which the
two parties have exchanged services valued at $2.7 million, $3.4
million and $3.0 million during 1998, 1997 and 1996, respectively.
The amounts are recorded in the consolidated statements of operations
as telecommunications revenues and direct costs. During 1998 the
Company paid $1.2 million to PTN for certain of these services.
(d) Direct costs for the years ended December 31, 1998, 1997 and 1996
include $4.4 million, $4.2 million and $3.3 million, respectively,
paid to KT in relation to the carriage of traffic over the public
telephone network. Balances outstanding of $0.5 million, $0.8 million
and $0.2 million as of December 31, 1998, 1997 and 1996,
respectively, in relation to these charges, are included in due to
related parties.
(e) PeterStar entered into a capital lease with a wholly-owned subsidiary
of PLD in 1996 (see note 10).
(f) During 1998, PeterStar entered into a series of agreements with PTN
under which PeterStar exchanged telecommunications equipment for
telecommunications and other facility infrastructures. The total
value of equipment exchanged during 1998 is $2.6 million. The
infrastructure received under this exchange has been valued at the
same amount. As a result of this arrangement PeterStar will be the
sole provider of telecommunications services to one of the districts
of St. Petersburg.
(g) During 1998, PeterStar paid a total of $1.2 million on behalf of PTN.
This amount has been capitalised as a prepayment in relation to the
purchase of an exchange building.
(h) PLD charged management fees of $2.1 million related to PeterStar and
$1.6 million related to ALTEL during the year ended December 31, 1998
(1997 -- $2.0 million and $1.2 million, respectively; 1996 -- $1.2
million and $0.9 million, respectively). These amounts are recorded
in the consolidated statements of operations as management fee
expense. Balances outstanding of $0.1 million and $0.1 million as of
December 31, 1998 and 1997 respectively are included in advances from
other group companies.
F-16
<PAGE> 67
NWE CAPITAL (CYPRUS) LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(i) PeterStar was charged management fees of $5.6 million, $1.7 million
and $42,000 during 1998, 1997 and 1996, respectively, by OAO
Telecominvest, a minority shareholder. These are included as general
and administrative expenses in the consolidated statements of
operations. As at December 31, 1998, PeterStar has prepaid a further
$0.4 million in relation to management fees.
(j) Consulting fees of $0.4 million, $0.1 million and $0.1 million for
the years ended December 31, 1998, 1997 and 1996 respectively, were
paid by ALTEL to KT. These amounts are included in general and
administrative expenses, There was no balance outstanding as of
December 31, 1998 and 1997 in relation to these charges.
(k) Additional charges, related to management services of $0.1 million,
$0.2 million and $26,000 for the years ended December 31, 1998, 1997
and 1996 respectively, were charged to ALTEL by PLD and another PLD
subsidiary. These amounts are recorded in the consolidated statements
of operations as general and administrative expenses.
(l) PeterStar was charged $0 in service fees by PLD relating to recharged
expenses and capital equipment in 1998 (1997: $3.6 million, 1996:
$2.1 million). These amounts have been recorded in general and
administrative expenses in the consolidated statements of operations
or property and equipment in the consolidated balance sheets as
appropriate.
(m) During 1996 PeterStar entered into a five year instalment purchase
agreement with PTN, an indirect minority shareholder, for
telecommunications equipment. Total contract value was $13.7 million
(note 9).
(n) During 1998, PeterStar entered into three year (1997: three to five
year) instalment purchase agreements with wholly-owned subsidiaries
of PLD for telecommunications equipment. The total contract value was
$1.9 million (1997: $2.3 million) (note 10).
(o) During 1997, the Company forgave certain amounts due to it from
PeterStar, resulting in a loss to the Company of $5.4 million (note
11).
(16) COMMITMENTS AND CONTINGENCIES
(a) Purchase Commitments
At December 31, 1998 PeterStar has commitments of approximately $3.4
million under long-term instalment purchase agreements. All commitments relate
to acquisition of the undelivered portion of telecommunications equipment from
suppliers as outlined in note 9. The related contracts provide for financing of
the amounts over approximately five years.
(b) Russian and Kazak Taxation
The PeterStar and ALTEL subsidiaries have accrued profits and other taxes
based on interpretations of the law which may ultimately be disputed by the
local taxation authorities.
Russia currently has a number of laws related to various taxes imposed by
both federal and regional governmental authorities. Applicable taxes include
value added tax, corporation tax ("profit tax"), a number of turnover based
taxes, and payroll (social) taxes, together with others.
Laws related to these taxes have not been in force for significant periods,
in contrast to more developed market economies. Therefore, regulations are often
unclear, open to wide interpretation, and in some instances are conflicting.
Accordingly few precedents with regard to issues have been established. Often,
differing opinions regarding legal interpretation exist both among and within
government ministries and organisations (like the State Tax Service and its
various inspectorates), thus creating uncertainties and areas of conflict.
F-17
<PAGE> 68
NWE CAPITAL (CYPRUS) LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Tax declarations, together with other legal compliance areas (as examples,
customs and currency control matters) are subject to review and investigation by
a number of authorities, which are enabled by law to impose extremely severe
fines, penalties and interest charges. These facts create tax risks in Russia
substantially more significant than typically found in countries with more
developed tax systems.
PeterStar has had extensive tax inspections during the periods, which have
resulted in minimal penalties. These inspections have covered most of the taxes
applicable to PeterStar.
Management believes that it has adequately provided for tax liabilities in
the accompanying financial statements. However, the risk remains that the
relevant authorities could take differing positions with regard to
interpretative issues and the effect could be significant.
(c) Management Services
On January 1, 1995, WTC entered into a two year agreement with PLD, under
which PLD would provide certain consulting, informational services, management
support services and personnel expertise. Payments under this agreement were
$25,000 per month plus 3% of monthly gross revenues. This agreement was renewed
for a further year on January 1, 1997 and was terminated as of December 31,
1997. On January 1, 1998, ALTEL entered into an agreement directly with PLD
covering the same range of services, with payments of $25,000 per month plus
3.4% of monthly gross revenues. This agreement was for a one year term,
automatically renewable for successive one year periods unless terminated by
either party.
(d) Guarantee
In June 1996, PLD issued senior discount notes and convertible subordinated
notes with an aggregate principal amount of $149.5 million. The Company is a
guarantor of the debt under the terms of the related indentures.
As noted in its annual report on Form 10-K, PLD does not presently have
sufficient funds on hand to meet its current debt obligations. While management
of PLD believe that, as long as progress towards settlement of such obligations
is being made, the holders of such debt will agree to payment deferrals beyond
the present due date of April 30, 1999, there can be no assurance that the
holders will grant such deferrals or that they will not demand payment in full
of the obligations. PLD's failure to make payment in full could result in a
cross-default under and acceleration of senior discount notes and convertible
subordinated notes with an aggregate principal amount in excess of $150 million
for which the Company serves as a guarantor. These factors raise substantial
doubt about the Company's ability to continue as a going concern.
(e) Motorola, USA
Motorola, USA is the major supplier of ALTEL's network equipment. Under the
supply contract, ALTEL files preliminary purchase orders for the delivery of
equipment with a prepayment of 5% of the cost of the purchase order. Once a
purchase order is presented, ALTEL may be exposed to potential liabilities to
Motorola, USA in the amount of $1.2 million as at December 31, 1998.
(f) The Year 2000 Issue (unaudited)
The Year 2000 problem (or "Millennium Bug") arises as a result of
information systems and/or equipment with embedded chips that incorrectly read
the date 2000 and incorrectly perform calculations related to it. Any
information technology that relies on a time or date function may not operate
correctly, producing an inaccurate date when dealing with dates beyond 1999.
F-18
<PAGE> 69
NWE CAPITAL (CYPRUS) LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company may experience the effects of the Year 2000 problem before, on,
or after January 1, 2000 and the effects on operations and financial reporting,
if not addressed, may range from minor errors to significant systems failures
which could affect the Company's ability to conduct normal business operations.
It is not possible to be certain that all aspects of the Year 2000 issue
affecting the Company, including those related to the efforts of customers,
suppliers, or other third parties, will be fully resolved.
The Company is incurring significant costs in its efforts to mitigate any
possible effects of the Year 2000 problem.
F-19
<PAGE> 1
EXHIBIT 99.1
Independent Auditors' Consent
The Board of Directors
NWE Capital (Cyprus) Ltd.:
We consent to incorporation by reference in the registration statement (no.
333-5396) on Form S-3 of PLD Telekom Inc. of our report dated March 30, 1999,
relating to the consolidated balance sheets of NWE Capital (Cyprus) Ltd. and
subsidiaries as of December 31, 1998 and 1997, and the related consolidated
statements of operations, shareholder's equity, and cash flows for each of the
years in the three year period ended December 31, 1998, which report appears in
the Annual Report on Form 20-F for the year ended December 31, 1998 of NWE
Capital (Cyprus) Ltd.
Our report dated March 30, 1999 contains an explanatory paragraph that states
that the Company's parent, PLD Telekom Inc. (PLD) does not presently have
sufficient funds on hand to meet its current debt obligations. PLD's failure to
make payment in full when required could result in a cross-default under and
acceleration of other debt obligations for which the Company is a guarantor.
These factors raise substantial doubt about the Company's ability to continue as
a going concern. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
KPMG
St. Petersburg, Russia
June 25, 1999
