Securities and Exchange Commission
Washington, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 For the fiscal year ended December 31, 1998
OR
[ ] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from to
Commission File Number 1-11484
HUNGARIAN TELEPHONE AND CABLE CORP.
(Exact Name of Registrant as specified in its charter)
Delaware 13-3652685
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 First Stamford Place, Stamford, CT 06902
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (203) 348-9069
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
Common Stock, par value $.001 per share American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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 requirement for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
As of March 25, 1999, 5,395,864 shares of the Registrant's Common Stock
were outstanding, of which 5,392,764 were held by non-affiliates of the
Registrant. The aggregate market value of the Registrant's Common Stock held by
non-affiliates, computed by reference to the closing price of the Common Stock
on the American Stock Exchange as of March 24, 1998, was $24,604,500. The
exclusion of shares owned by any person from such amount shall not be deemed an
admission by the Registrant that such person is an affiliate of the Registrant.
Documents Incorporated by Reference
Part III - Portions of the Registrant's proxy statement for the Annual
Meeting of Stockholders for the fiscal year ended December 31, 1998.
<PAGE>
Cautionary Statement Regarding Forward-Looking Statements
Certain statements contained herein which express "belief,"
"anticipation," "expectation," or "intention" or any other projection, insofar
as they may apply prospectively and are not historical facts, are
"forward-looking" statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Because such
statements include risks and uncertainties, actual results may differ materially
from those expressed or implied by such forward-looking statements. Factors that
could cause actual results to differ materially from those expressed or implied
by such forward-looking statements include, but are not limited to, the factors
set forth in "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations."
PART I
In this Part I of Form 10-K, all references to "$" or "U.S. Dollars"
are to United States Dollars and all references to "HUF" or `Forints" are to
Hungarian Forints. Certain amounts stated in Forints herein also have been
stated in U.S. Dollars solely for the informational purposes of the reader, and
should not be construed as a representation that such Forint amounts actually
represent such U.S. Dollar amounts or could be, or could have been, converted
into U.S. Dollars at the rate indicated or at any other rate. Unless otherwise
stated or the context otherwise requires, such amounts have been stated at
December 31, 1998 exchange rates. The Forint/U.S. Dollar middle exchange rate as
of December 31, 1998 was approximately 216.50 Forints per U.S. Dollar.
Item 1. Business
Company Overview
Hungarian Telephone and Cable Corp. ("HTCC" or the "Registrant" and,
together with its consolidated subsidiaries, the "Company") provides basic
telephone services in five defined regions within the Republic of Hungary (each,
an "Operating Area" and together, the "Operating Areas") pursuant to 25-year
telecommunications concessions granted by the Hungarian government. HTCC,
through its four majority-owned operating subsidiaries (each, an Operating
Company and together, the "Operating Companies"), owns and operates virtually
all existing public telephone exchanges and local loop telecommunications
network facilities in its Operating Areas and is the exclusive provider through
November 1, 2002 of non-cellular local voice telephone services in such areas.
The Company completed its significant network modernization and construction
program in all of its Operating Areas in 1997 which substantially met its demand
backlog, increased the number of basic telephone access lines in service and
modernized existing facilities. The Company's networks now have the capacity,
with some additional capital expenditures, to provide basic telephone services
to virtually all of the estimated 276,300 homes and 36,400 business and other
institutional subscribers (including government institutions) within its
Operating Areas.
The Company acquired its concession rights from the Hungarian Ministry
of Transportation, Telecommunications and Water Management (the "Ministry") for
$11.5 million (at historical exchange rates) and purchased the existing
telecommunications infrastructure in the Operating Areas, including
approximately 61,400 access lines, from Magyar Tavkozlesi Rt. ("MATAV"), the
formerly State-controlled monopoly telephone company, for $23.2 million (at
historical exchange rates). Kelet-Nograd Com Rt. ("KNC") and Raba Com. Rt.
("Raba-Com"), two of the Operating Companies, acquired the existing
telecommunications assets in their respective Operating Areas in the first
quarter of 1995, while Papa es Tersege Telefon Koncesszios Rt. ("Papatel") and
Hungarotel Tavkozlesi Rt. ("Hungarotel"), the other two Operating Companies,
acquired the existing telecommunications assets in their respective Operating
Areas on January 1, 1996. Since the acquisition of such existing networks, the
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Operating Companies have incurred capital expenditures through December 31, 1998
of $171 million (at historical exchange rates) to expand and upgrade their
network facilities which has resulted in the completion of a modern
communications network in each of the Operating Areas, which networks include
new digital switches and increased network capacity, utilizing the latest in
communications transmission technology. As of December 31, 1998, the Company's
telecommunications networks had approximately 185,000 access lines in service
(including pay phones). The completion of the Company's network construction
program has resulted in the addition of approximately 123,600 new access lines
in service (including pay phones) to the 61,400 access lines acquired from MATAV
and the replacement of all of the 10,810 manual exchange lines acquired from
MATAV.
The Company completed its network modernization and construction
program in each of its Operating Areas primarily through turnkey construction
contracts with Siemens Telefongyar Kft., Ericsson Technika and Fazis
Telecommunication System Design and Construction Corporation. The contracts were
primarily funded with the Company's $170 million 10-year credit facility with
Postabank es Takarekpenztar (the "Postabank Credit Facility"), a Hungarian
commercial bank ("Postabank"), and a $47.5 million contractor financing
facility. See Item 3 "Legal Proceedings", Item 7 Management Discussion and
Analysis of Financial Conditions and Results of Operations - Introduction" and
Notes 1(a) and 9(e) of Notes to Consolidated Financial Statements.
The following table sets forth certain information as of December 31,
1998 with respect to each of the Operating Companies.
<TABLE>
<S> <C> <C> <C> <C> <C>
Raba-Com KNC Papatel Hungarotel Total
Population............................... 67,600 152,300 64,000 398,500 682,400
Residences............................... 23,800 61,900 24,000 166,600 276,300
Businesses and other(1).................. 4,300 6,500 3,300 22,300 36,400
Access lines in operation:
Residential......................... 19,000 34,500 16,400 91,500 161,400
Business and other(2)............... 2,400 5,500 1,900 13,800 23,600
-------- -------- -------- --------- --------
Total......................... 21,400 40,000 18,300 105,300 185,000
Pay phones............................... 160 360 188 1,111 1,819
Population Penetration rate(3)........... 31.7 26.3 28.6 26.4 27.1
Residential Penetration rate (4)......... 79.8 55.7 68.3 54.9 58.4
- --------
</TABLE>
(1) Represents Company estimates of business and other institutional subscribers
or potential subscribers (including government institutions).
(2) Represents Company estimates of subscribers which are businesses and other
institutional subscribers (including government institutions), leased lines
and pay phones. Includes ISDN equivalent lines.
(3) Population Penetration rate is defined as the number of access lines per 100
inhabitants.
(4) Residential Penetration rate is defined as the number of residential access
lines per 100 residences.
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The following table sets forth the number of access lines served by
each of the Operating Companies at takeover from MATAV and at the end of 1995,
1996, 1997 and 1998.
<TABLE>
<S> <C> <C> <C> <C> <C>
Takeover 1995 1996 1997 1998
-------- ---- ---- ---- ----
Raba-Com 2,500(1) 5,100 14,000 20,600 21,400
KNC 13,000(1) 14,200 20,500 35,500 40,000
Papatel 3,800(2) 3,800 11,100 17,000 18,300
Hungarotel 42,100(2) 42,100 47,800 102,000 105,300
----------- ----------- ---------- ---------- ----------
Total 61,400 65,200 93,400 175,100 185,000
</TABLE>
(1) 1st Quarter 1995
(2) Year-End 1995
History
Overview of Hungarian Telecommunications Industry
The Company believes that Hungary is an attractive market for
telecommunications services. The Hungarian telecommunications market was
historically significantly underdeveloped without the necessary investment in
the Hungarian telecommunications infrastructure necessary to achieve a
comparable level of teledensity to that of Western Europe. As of December 31,
1995, Hungary had a basic telephone penetration rate of approximately 21
telephone access lines per 100 inhabitants compared to a European Union average
of approximately 48 access lines per 100 inhabitants and a United States average
of approximately 60 access lines per 100 inhabitants. Of such access lines in
Hungary, approximately 40% were located in Budapest (in which approximately 20%
of Hungary's population resides). In the Company's Operating Areas, access line
penetration was approximately nine access lines per 100 inhabitants as of
December 31, 1995. By comparison, basic telephone penetration rates in other
Eastern European countries such as the Czech Republic, Poland, Slovakia and
Bulgaria, as of December 31, 1995, were 23, 15, 21 and 28 access lines per 100
inhabitants, respectively. However, MATAV invested approximately HUF 171 billion
($790 million) in its fixed telecommunications network from 1994 to 1996 and
currently has approximately 2.7 million access lines connected to its networks.
As of September 1998, all of the LTOs (as defined below) excluding MATAV had
invested approximately $822 million in their telecommunications network. Due to
the completion of the Company's network modernization and construction program,
access line penetration in the Company's Operating Areas has increased to 27
access lines per 100 inhabitants as of December 31, 1998. Given that the
Company's, MATAV's, and the other LTOs' investments in the Hungarian
telecommunications market over the last several years produced a significant
increase in the overall penetration rate in Hungary to approximately 34%, the
Company expects to benefit from a continued increase in the use of its
telecommunications services by its customer base.
In addition, since 1989 Hungary has been the most successful country in
Central Europe in attracting foreign investment, due to its early start in, and
ongoing commitment to, economic reform. According to the Hungarian Ministry of
Industry, Trade and Tourism, total foreign direct investment in Hungary was
valued at $19 billion at the end of 1998. Hungary's gross domestic product rose
5% in 1998, up from a 4% increase in 1997. Hungary's exports increased 14% in
1998 from the 1997 level to $22 billion while imports totaled $24 billion, an
increase of 15% from 1997.
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Historically, the exclusive provider of telecommunications services in
Hungary was MATAV, once a part of the Hungarian Post Office. Beginning in 1992,
the Hungarian government began the process of privatizing Hungary's
telecommunications industry by selling an initial 30% stake in MATAV (raised to
67% in 1995) to a consortium called MagyarCom, a company wholly owned by
Deutsche Telekom, the German public telephone operator, and Ameritech, a U.S.
regional bell operating company. In addition, the Ministry divided the country
into 54 primary telecommunications service areas in order to take some of such
primary telecommunications service areas out of MATAV's national network with
respect to the provision of local basic telephone service while allowing MATAV
to continue its monopoly in the provision of domestic and international long
distance services. In 1993, the Ministry solicited bids for concessions to
build, own and operate telecommunications networks in the 25 service areas which
had been chosen to exit the MATAV system. As of December 31, 1998, 23 of the 25
concessions for which the Ministry solicited bids had been awarded. Winning
bidders (each a Local Telephone Operator, "LTO", and together the "LTOs")
included: the Company (presently 5 areas); UTI, a consortium formed by Alcatel
Austria AG and US Telecom East, Inc. (4 areas); affiliates of Vivendi SA of
France and General Electric Capital Corp. (4 areas) and the Swiss and Dutch PTTs
(1 area); a bidding group including United International Holdings of Denver,
Colorado (1 area); a consortium comprised of Bezeq, the Israeli PTO, and MATAV
(3 areas); and MATAV (5 areas). MATAV also retained the rights to service 2
areas for which there were no successful bidders. In addition to the fees paid
to the government which aggregated approximately $80.0 million (at historical
exchange rates), each of the non-MATAV LTOs negotiated a separate asset purchase
agreement with MATAV for each concession area's existing basic telephone plant
and equipment, which led to the transfer of approximately 260,000 access lines
from a total of 1.2 million access lines in the MATAV system. MATAV's concession
areas presently cover approximately 75% of Hungary's population and
approximately 70% of its geographic area.
In addition to the liberalization of basic telephone services, the
Ministry also selected two consortia to provide nationwide cellular telephone
services. A consortium comprised of MATAV and Mediaone Group Inc., formerly part
of U.S. West ("Westel") was granted two licenses to provide both analog
(NMT-450) and digital (GSM-900) services while Pannon GSM Tavkozlesi, a
consortium formed by various Scandinavian PTOs (including Tele Danmark A/S) and
the Dutch PTT ("Pannon"), was granted a license to provide only digital cellular
services. The Company believes that there are currently approximately 1,000,000
cellular subscribers in Hungary.
Hungary and the Ministry continue to pursue industry liberalization
efforts. In 1997, MATAV completed its initial public offering pursuant to which
MagyarCom's stake in MATAV was reduced to approximately 60% and the Hungarian
State's stake was reduced to approximately 6%. The Hungarian State retained
certain shareholder rights by retaining one "golden share." The Hungarian State
recently announced plans to sell its remaining ownership interests in MATAV. In
2002, MATAV's right to provide exclusive domestic and international long
distance voice transmission is expected to end as are the exclusive rights of
MATAV and the other LTOs, including the Operating Companies, to provide
non-cellular local voice telephone services. In 1998, the Ministry awarded
Pan-Tel Rt., a newly formed Hungarian company ("Pan-Tel"), the licenses to
provide such services as data transmission, voice mail and other services which
are not subject to exclusive concessions. Pan-Tel started building its
telecommunications network in 1998. If the current regulatory framework remains
unchanged, the Ministry may invite tenders for concessions to provide local,
long distance and international basic telephone services when the monopolies of
the Operating Companies, the other LTOs and MATAV expire. Pan-Tel would be
entitled to submit a bid as would any other telephone operator. The current
shareholders of Pan-Tel include MAV Rt. (the Hungarian railway company), MOL Rt.
(the Hungarian oil company), KFKI Computer Systems Kft. (a Hungarian information
technology research firm) and the Dutch PTT KPN NV. In February 1999, the
Hungarian State issued a tender for the 1800-megahertz, or DCS frequency, for
mobile communications. It is expected that three licenses will be awarded.
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In March 1999, Hungary joined the North Atlantic Treaty Organization.
In addition, Hungary's application for membership in the European Union ("EU")
was accepted. Hungary is now in the process of negotiating the terms of
Hungary's official accession into the EU. The EU has adopted numerous directives
providing for an open telecommunications market among its member nations. The
Company believes that Hungary's potential EU membership will not affect its
exclusivity rights and if Hungary joins the EU prior to the expiration of the
Company's exclusivity rights, Hungary may enter into certain transitional
arrangements to preserve these exclusivity rights. Furthermore, Hungary, as a
member of the World Trade Organization ("WTO"), ratified the WTO's
Telecommunications Agreement, which agreement began liberalizing the market for
telecommunications services effective January 1, 1998. Hungary's ratification
postponed Hungary's liberalization of its telecommunications market until 2002.
See also "- Competition."
HTCC and its Operating Companies
In 1994, the Ministry awarded KNC and Raba-Com concession rights to
construct local telephone exchanges and provide non-cellular local voice
telephone services for a period of 25 years, with exclusivity for the first
eight years. The Company subsequently acquired two other Operating Companies,
Hungarotel and Papatel, that had been awarded substantially identical concession
rights by the Ministry. MATAV continues to be the sole provider of domestic and
international long distance non-cellular voice telephone services through 2002.
HTCC conducts its operations through the Operating Companies. Set forth
below is an organizational chart of the Company and its principal stockholders
as of March 26, 1999. Share ownership percentages of HTCC are based on shares of
HTCC's common stock (the "Common Stock") owned as of March 26, 1999, without
giving effect to outstanding options or warrants. Additionally, ownership
percentages for the Operating Companies do not give effect to future Hungarian
equity ownership requirements. See "-Regulation - Hungarian Equity Ownership
Requirements."
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Citizens Public Tele Danmark
18.6% 63.0% 18.4%
HTCC
Papatel Raba-Com KNC Hungarotel
79.2% 90.7% 94.8% 99.0%
Other Other Other Other
Stockholders: Stockholders: Stockholders: Stockholders:
IFC - 20.0% Municipalities - 9.3% Municipalities 5.0% Private
Municipalities - 0.8% Antenna Hungarian
Hungaria - 0.2% Investor - 1.0%
HTCC was organized under the laws of the State of Delaware on March 23,
1992. The Common Stock is traded on the American Stock Exchange under the symbol
"HTC." The Company's United States office is located at 100 First Stamford
Place, Stamford, Connecticut 06902; telephone (203) 348-9069. The Company's
principal office in Hungary is located at Kiralyhago u.2, H-1126, Budapest;
telephone (361) 457-6300.
Certain Stockholders
The Company has benefited from the extensive telecommunications
experience and capabilities of certain of its stockholders. Set forth below is a
brief description of such stockholders.
Citizens Utilities Company
Citizens Utilities Company (together with its subsidiaries, "Citizens")
is a New York Stock Exchange listed diversified growth company which provides
communications services, competitive local exchange carrier ("CLEC") services
and public services including gas transmission and distribution, electric
transmission and distribution, water distribution and wastewater treatment
services to approximately 1.82 million customers in 22 states throughout the
United States. Citizens also owns approximately 83% of Electric Lightwave Inc.,
a CLEC operating in the western United States. At December 31, 1998, Citizens
had $5.3 billion in assets and $2 billion in equity. For the twelve months ended
December 31, 1998, Citizens had net income of $57.1 million and $1.5 billion of
revenues. Telecommunications services accounted for 60% of total revenues.
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In May 1995, Citizens purchased 300,000 shares of Common Stock from a
former executive of the Company and has since acquired an additional 602,908
shares pursuant to certain agreements entered into with HTCC (as amended and
restated in certain cases to date, the "Citizens Agreements") and 103,000 shares
pursuant to certain open market purchases bringing its ownership of the
outstanding Common Stock as of March 26, 1999, to 18.6%. In addition, as a
result of the Citizens Agreements, Citizens has received certain options to
purchase 4.5 million shares of Common Stock. These options expire in September
2000, with per share exercise prices ranging from $12.75 to $18.00. Citizens
also has an option to purchase 2.1 million shares of Common Stock at an exercise
price of $13.00 per share with an expiration date of July 1, 1999. The Citizens
Agreements provide Citizens with certain preemptive rights to purchase, upon the
issuance of Common Stock in certain circumstances to third parties, shares of
Common Stock in order to maintain its percentage ownership interest on a fully
diluted basis. Assuming the exercise of all of its outstanding rights, options
and warrants to purchase Common Stock as of March 26, 1999, Citizens would own
58.7% of the Common Stock on a fully-diluted basis. The Citizens Agreements
include a certain Replacement and Termination Agreement dated as of September
30, 1998 ("the Termination Agreement") which provides for, among other things,
payments by HTCC to Citizens in the aggregate amount of $21 million payable in
28 quarterly installments of $750,000 each year from 2004 through and including
2010 in part as agreement for Citizens' agreement to terminate a management
services agreement and in part as consideration for certain consulting services
to be provided by Citizens to the Company from 2004 through and including 2010.
Pursuant to the Termination Agreement, HTCC issued 100,000 shares of its Common
Stock and a $8.4 million promissory note to Citizens in settlement of accrued
management fees pursuant to the terminated management services agreement. The
principal on the note is payable in full in September 2004 and bears interest at
a varying rate per annum which is 2-1/2% per annum above the one-year LIBOR
rate. Accrued interest is payable annually. For a more detailed description of
some of the Citizens Agreements, see Note 14 of Notes to Consolidated Financial
Statements, Item 13 "Certain Relationships and Related Party Transactions." See
also Item 12 "Security Ownership of Certain Beneficial Owners and Management".
Tele Danmark A/S
Tele Danmark A/S (together with its affiliates, "Tele Danmark") is the
preeminent provider of telecommunications services in Denmark. Tele Danmark is
the leader in a number of important growth segments of the market, including
domestic and international telephone services, mobile services, data
communications, Internet, leased lines, cable television and directory services.
Tele Danmark markets these services and products to a broad and growing customer
base - 3.5 million telephone access lines, 220,000 Internet customers, 995,000
cellular users and 812,000 cable television customers.
At December 31, 1998, Tele Danmark had total assets of Danish Kroner
45.816 billion (approximately $7.2 billion at current exchange rates) and
shareholders' equity of Danish Kroner 20.157 billion (approximately $3.2 billion
at current exchange rates). During 1998, Tele Danmark had net income of Danish
Kroner 4.013 billion (approximately $628 million at current exchange rates) on
net revenues of Danish Kroner 33.989 billion (approximately $5.3 billion at
current exchange rates).
Over the past few years, Tele Danmark's activities abroad have been an
important growth area. Tele Danmark has investments in the Nordic region,
continental Western Europe as well as Central and Eastern Europe among them
Belgacom (Belgium), Sunrise (Switzerland), Talkline (Germany), Connect Austria
(Austria), Polkomtel GSM (Poland) and UMC (Ukraine). In Hungary, Tele Danmark
has a 6.6% holding in Pannon (defined above), one of the two Hungarian digital
cellular operators.
Tele Danmark's stock trades on the Copenhagen Stock Exchange and the
New York Stock Exchange. Ameritech owns 42% of the shares in Tele Danmark. The
remaining shares are owned by individual and institutional shareholders all over
the world.
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International Finance Corporation
The International Finance Corporation (the "IFC") is the private-sector
financing organization of the World Bank, a global cooperative which provides
financial and other aid to developing countries. The IFC owns 20.0% of the
capital stock of Papatel.
Recent Developments
Management Changes
Ole Bertram, a former senior executive of Tele Danmark, joined the
Company on January 1, 1999 as its new President and Chief Executive Officer. Mr.
Bertram brings 36 years of telecommunications experience to the Company.
Postabank Credit Facility
The first installment of the repayment of the Postabank Credit Facility
is due on March 31, 1999. To date, the Company has suffered from recurring
losses from operations and has a working capital deficiency and a net capital
deficiency. The Company does not presently have sufficient funds on hand to pay
the first installment on the Postabank Credit Facility. Under the Postabank
Credit Facility, a failure to pay any installment constitutes an "Event of
Default". Upon notice to the Company of an Event of Default, the Company is
entitled to the benefit of a 60 day cure period. If such Event of Default is not
cured within 60 days, Postabank could declare all amounts outstanding under the
Postabank Credit Facility due and payable upon 60 days notice. The Company, with
assistance from its financial advisors, is currently in negotiations with
Postabank and its financial advisors regarding a restructuring of the Company's
obligations with the goal of reducing the Company's cash repayment obligations
so that the Company can sufficiently fund its working capital requirements,
capital expenditures and meet its financing obligations with cash flows from
operations. The Company is also reviewing various other financing alternatives
with several entities. While the result of such negotiations and the
availability of alternative sources of financing cannot be predicted with
certainty, the Company believes that it will be able to resolve its financial
issues so that it will be able to meet its obligations during 1999. However,
there can be no assurance that the Company will be able to resolve these issues
on commercially reasonable terms, or at all. Such negotiations and/or
discussions could result in the issuance of equity and/or debt securities of the
Company or one or more of the Operating Companies.
Year 2000 Issue
In 1998 the Company initiated a project designed to identify and
mitigate Year 2000 computer deficiencies. The Company formed a Year 2K project
team (the "Project Team") with the mandate to identify problems, set
methodologies for resolution, and budget expenses all in order to minimize the
impact of any Y2K problems from the Company's computer systems.
The Project Team consists of employees from senior and mid-level
management from various business units within the Company. The Project Team also
includes several of the Company's computer technicians and representatives from
the systems' vendors. The Project Team has 10 permanent members from the Company
and 3 permanent members from the switching and billing system vendors. Other
vendors are consulted on an "as needed" basis. The Company also formed an
oversight committee comprised of senior management to oversee the Y2K issue.
The Project Team is examining the Company's telecommunications
networks, IT business systems, and miscellaneous support systems. These systems
include computers that support telephone services, bill production, customer
accounting, plant records, payroll, and a variety of systems such as air
conditioners and building entry systems. The project has five primary phases:
(I) inventory, (II) assessment, (III) remediation, (IV) testing and (V)
contingency planning and certification. Phase I is complete and consisted of the
development of a comprehensive working list which documents all software and
microprocessor reliant materials used by the Company to ensure that phase II
covers the entire population of potential Y2K issues. Phase II consisted of
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evaluating the inventory list developed during Phase I and determining which
systems need replacement, modification or retirement during 1999. Phase II is
complete. Phase III is currently underway and consists of replacing those
hardware and software components identified as non-compliant and should be
completed by the middle of the second quarter 1999. At this time, some systems
have already been modified to make them Y2K compliant and other systems have
been placed on retirement schedules. Major switching components are scheduled
for replacement in April, May and June of this year. Phase IV will consist of
testing of existing and new hardware and software components and will be
completed during the second and third quarters of this year. Phase V consists of
developing a written plan for alternative methods of completing critical
processes should failure occur at the turn of the century. Contingency plans are
being developed currently for all systems. Written contingency plans will be
provided to the employees by September. The Company will begin awareness
campaigns to draw employee and customer attention to the potential problems
associated with Y2K by April 1, 1999.
The Company relies upon its network construction vendors to provide
compliant hardware and software. The Project Team believes that compliance of
the telephone switching systems and the automatic message accounting interface
with the billing system present the most significant Y2K exposure for the
Company. In cooperation with representatives from the switch manufacturers who
are active members of the Project Team, the Project Team has developed a plan
for Y2K Compliance of the switching systems. The switching system vendors have
provided the Company with delivery schedules that will bring the switching
systems into compliance by June of this year, at which time compliance
certificates will be issued by the vendors. Compliance of the switching systems
by June should allow sufficient time to test the switching/billing system
Automatic Message Accounting ("AMA") interface and allow problems to be solved
in a timely manner before the turn of the century.
The Company relies upon MATAV's telecommunication network for all
long-distance interconnections. Should MATAV's telephone switching systems be
non-Y2K compliant, the systems could fail resulting in lost revenue for the
Company. The Company is working directly with MATAV to reduce the risk of
failure. A member of the Project Team employed by one of the Company's
telecommunications switching vendors also sits on MATAV's Y2K committee and is
actively involved in the issue. The Company believes that no costs will be
incurred related to this matter. MATAV will also provide the Company with
certification for the 2MB backbone of the Company's internal wide area network.
The Company's recently implemented Billing and Customer Care system
(BACC) is Y2K compliant according to its vendor, representatives of which
participate on the Project Team. During phase IV of the program, beginning in
April, and following the upgrades of the Company's switching systems, the BACC
system will be fully tested in cooperation with the vendor to ensure Y2K
compliance has been reached. The vendor will issue a compliance certificate
following successful completion of these tests.
Various other IT systems have been identified to be replaced or
upgraded in association with the Company's efforts to become Y2K compliant. The
Company believes that all such systems will have completed all phases of the
project by the end of the third quarter of 1999. The Company maintains
approximately 2 million lines of computer code developed internally which will
be tested and modified by the end of the third quarter.
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The Company currently estimates that the total costs of remediation
will be approximately $785,000, which includes the replacement and/or upgrade of
certain equipment. $630,000 of such cost will allow the Company to provide
additional services in addition to bringing the Company into Y2K compliance. At
this time, no material costs have been incurred for remediation of the Y2K
problem. It is expected that most costs will be incurred during the second and
third quarters of 1999. Management cannot provide assurance that the result of
the project or that the remediation costs will not be materially different from
estimates. Accordingly, contingency plans are currently being developed to
address high-risk systems. The contingency plans are expected to be in place by
the third quarter of 1999.
The Company is dependent on network switch manufacturers to provide
compliant hardware and software in a timely manner. Within IT, the Company is
dependent on the development of software by external experts, and the
availability of critical resources with the requisite skill sets. At worst case,
failure by the Company or by certain of its vendors to remediate Y2K compliance
issues could result in disruption of the Company's operations, possibly
impacting its telecommunication network and the Company's ability to bill and
collect revenues. However, management believes that this worst case scenario is
unlikely, and that its efforts to mitigate Y2K issues will be successful.
Strategy
With the completion of the construction program in all of the Operating
Areas in 1997, the Company's primary focus in 1998 was to increase call revenues
and reduce operating costs while continuing to add residential and business
customers to its networks. To accomplish these goals, the Company improved
operational efficiencies, increased its marketing efforts, and increased the
services and support provided to its entire customer base. The Company has
implemented the following operational strategies in order to further its
business objectives.
Revenue Growth
The Company plans to continue its revenue growth by increasing the
penetration levels in the business and residential sectors. The Company intends
to continue to increase its call revenues with increased marketing to each
customer segment. The Company has placed emphasis on increasing the installation
and usage levels of the Company's business customers, who currently generate
approximately 46% of the Company's total call revenues. The Company is also
focusing on the marketing and sales of deregulated services including managed
lease lines, PBX sales and services, ISDN, Internet and Digifon Services. The
Company is also providing special tariffs for Internet usage.
Operational Efficiency
The Company is increasing its productivity and operational efficiency
by achieving certain economies of scale with respect to network management,
administration, customer service, billing, accounts receivable, payroll
processing, purchasing and network maintenance. For example, the Company has
implemented its own centralized operating and accounting system in all of its
Operating Areas. A significant increase in operational efficiency has resulted
from the implementation of this system specifically in the areas of customer
billing and financial accountability. In addition, some of the Company's
Operating Areas are contiguous, which facilitates the realization of certain
economies of scale. For example, by using fiber optic technology between
contiguous Operating Areas, the Company realizes certain operational
efficiencies by centralizing certain functions. As of February 28, 1999, the
Operating Companies had a total of 278 access lines per employee.
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Marketing
As the exclusive provider of basic telephone services in the Operating
Areas, the Company's primary marketing objective is to increase the usage of its
telephone services by its existing residential and business customers. In
addition, the Company intends to attract new subscribers by targeting the needs
of various market segments, while maintaining superior customer service and
reliability based on current "state of the art" telecommunications technology.
The Company's targeted market segments are: (i) residential customers; (ii)
small businesses and professionals; (iii) medium and large businesses; and (iv)
government institutions. For its larger business customers, the Company has
trained account managers to service these customers and potential customers by
educating them on the availability of "turn-key" business communications
solutions and several "value added services" including the premium rate
services, voice mail and all of the Digifon services (e.g. call forwarding, call
waiting, call barring). The Company will also emphasize ISDN and CCS-7 (high
speed data transfer) services in 1999. The Company believes that this effort
will result in a greater understanding by its business customers and potential
business customers of the potential revenue gains that can be achieved with
advanced telecommunications technology. For its residential customers and
potential customers, the Company's marketing efforts include advertising on
radio and television, door-to-door marketing surveys, newspaper advertising,
participation in local trade shows, direct mail, community meetings and
billboard advertising. The Company is also offering discounts for Internet
users.
Customer Service
The Company believes that providing a high level of customer service is
important to achieving its objective of attracting additional customers and
increasing the usage of existing services by its current customer base. Prior to
completion of the construction program, some customers waited for over 20 years
for telephone service. Today, most residences and businesses can be connected to
one of the Company's networks within 10 days. The Company also operates full
time operator service centers in each of the Operating Areas which are staffed
by operators capable of providing, among other things, call completion
assistance, directory assistance and trouble reporting on a 24 hour basis. In
addition, the Company operates customer service centers in each of the Operating
Areas which offer facsimile, Internet, photocopying and telephone bill payment
services. These offices also sell communications equipment, process telephone
service applications and handle billing inquiries. During 1998, the Company
began to reorganize its customer service centers by implementing the necessary
changes to make such centers more "customer friendly." The Company is providing
more choices for its customers and more product information instruction. For its
business customers, the Company has account representatives for each customer.
Most of the Company's subscriber base consists of residential
customers. As of December 31, 1998, 88% of subscribers were residential
customers and 12% were business and other institutional subscribers (including
government institutions).
Operations
Services
The Company provides non-cellular local voice telephone service in the
Operating Areas which allows subscribers to have facsimile, and modem
transmission capabilities and makes available to its subscribers, through
interconnection with MATAV, domestic and international long distance services.
In addition to these standard services, the Company currently offers its
subscribers data transmission and other value-added services, including
Internet, voice mail, call waiting, call forwarding, and three-way calling. The
Company intends to provide ISDN, caller ID and audio text services in all of its
Operating Areas in 1999.
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The Company's revenues are derived from the provision of local and
domestic and international long distance telephone services which consist of (i)
charges for measured telephone service, which vary depending on the day, the
time of day, distance and duration of the call, (ii) connection and subscription
fees, and (iii) other operating revenues consisting principally of charges and
fees from leased lines, public phones, detailed billing and other customer
services, including revenues from the sale and lease of telephone equipment.
Measured Service. Charges for local and domestic and international long
distance measured service vary with the number of pulses generated by a call.
The number of pulses generated for a particular call depends upon the day, the
time of day, the distance covered and the duration of the call. Currently, the
Company charges HUF 12.0 ($.06) per pulse. The Ministry adjusts such fees
annually based on the Hungarian Consumer Price Index. For all local calls within
an Operating Area, the Company retains all of the revenues associated with the
call. For domestic long distance calls outside of an Operating Area (including
those between Operating Areas, including adjacent Operating Areas) and all
international calls, the Company has a revenue sharing arrangement with MATAV
the terms of which are governed by a decree of the Ministry. Mobile telephone
calls to customers in the Operating Areas and calls from customers in the
Operating Areas to mobile phones are included in long-distance service revenues
shared with MATAV. In February 1999, the Ministry adopted a new decree to
regulate the interconnection revenue sharing arrangement with MATAV. The Company
believes that the new regulation will result in an overall increase in the
Company's revenue per call in 1999 for domestic long distance and international
calls over the amount received in 1998. See "- Regulation - Rate Setting and
Revenue Sharing."
Subscription and Connection Fees. The Company collects a monthly
subscription fee from its customers. Such fees vary depending on such factors as
whether the services are provided to a residential or business or other customer
(including government institutions), and whether the customer is linked to a
digital or analog exchange. The Company charges a monthly subscription fee to
digital and single-party exchange customers of HUF 1,160 ($5.36) for residential
customers and HUF 1,670 ($7.71) for business and other institutional subscribers
(including government institutions). Prior to 1999, the subscription fee for
residential customers included local calling usage. Effective January 1, 1999,
the monthly subscription fee for residential customers does not include any
fixed amount of local calling usage. See "- Regulation - Rate Setting and
Revenue Sharing."
Connection fees are earned when a customer is added to the network. The
Company may collect the full connection fee provided that the customer is
connected within 30 days; otherwise, the Company may only collect a portion of
the connection fee and must connect the subscriber within one year. Upon
connection, the Company may collect the remaining portion of the fee. The
connection fee is not recognized as income until the customer receives a
telephone and the connection is made. Currently, connection fees are HUF 30,000
($138.57) (plus VAT) for residential customers and HUF 90,000 ($415.70) (plus
VAT) for business and other institutional subscribers (including government
institutions), which are the maximum allowable fees, pursuant to a decree of the
Ministry. Customers requesting additional access lines are charged an additional
connection fee per line.
Other Operating Revenue. The Company supplies private line service
(point-to-point and point-to-multi-point) primarily to businesses. As of
December 31, 1998, approximately 1176 leased lines were in service. In addition,
as of December 31, 1998, the Company had 1,819 public pay phones in the
Operating Areas in accordance with the terms of the Concession Contracts (as
defined under "- Network Design, Construction and Performance - Milestones").
The Company generates additional revenues from the provision of value-added
services, including voice mail, call waiting, call forwarding, and three-way
calling, as well as through the sale and leasing of telephone equipment.
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Pricing
Maximum pricing levels are set by the Ministry and historically rate
increases have tracked inflation, as measured by the Hungarian Producer Price
Index ("PPI"). In 1997, the Ministry, pursuant to a decree, set forth a new
regulatory framework for regulating annual increases in the fees for (a) local
calls, (b) domestic long distance and international calls and (c) subscription
fees based on the Hungarian Consumer Price Index ("CPI"). In addition to
separate price caps for such categories of services, the Ministry enacted a
rebalancing formula which provides for greater increases in charges for
subscription fees and local calls than in domestic long distance and
international calls. See also "- Regulation - Rate Setting and Revenue Sharing."
The Company's customers are on a one-month billing cycle. For domestic long
distance and international calls, the Company is required to charge the same
tariffs as MATAV. For local calls, the Company may choose to increase its rates
up to the permitted amount; however, price increases in the past generally have
conformed to the price increases promulgated by MATAV. Measured service rate
increases are effected by the Ministry by either increasing charges per pulse or
reducing the time interval between pulses, depending on the time of day and
other factors. In addition, the Company charges additional fees for services
such as data transmission, voice mail, call waiting and call transfer in all of
its Operating Areas. The fees charged for these services are not subject to
regulation by the Ministry.
The Company has been allowing its subscribers to pay connection fees on
various installment basis plans and encourages customers to lease their
telephones. The Company believes that to date the various installment plans have
resulted in an increase in the number of subscribers in the Operating Areas.
The Company currently purchases telephone sets in bulk from a variety
of manufactures. Customers can choose to buy the phone or lease the phone and
pay a monthly fee of HUF 180 ($0.83). Although there is no Ministry or other
governmental regulation relating to lease rates, the Company adjusts such rates
annually according to the Hungarian PPI. Approximately 58% of the Company's
subscribers as of December 31, 1998 leased their phones from the Company.
Network Design, Construction and Performance
The Company has constructed a versatile modern communications network
which substantially replaced the antiquated system purchased from MATAV. This
new system provides many of the technologically advanced services currently
available in the United States and Western Europe. The Company's networks
maintain the North American standard, or "P01", grade of service. The P01
standard means that one call out of 100 will be blocked in the busiest hour of
the busiest season. The Company believes that its ability to meet the
telecommunications requirements of its customers through a combination of
conventional fiber optic and wireless local loop technology affords it
significant flexibility with respect to network development and network capital
expenditures. The Company has replaced all manually operated local battery and
common battery cord type switchboards purchased from MATAV while retaining
certain analog switching systems. The Company upgraded such analog switching
systems allowing such systems to mimic many of the features available in modern
digital switching systems with a minimal investment.
Conventional Network Design
In developing its networks, the Company has implemented service quality
and redundancy objectives on par with Western European and North American
digital network standards. Certain of the networks constructed are based on
digital hosts and remotes with fiber optic rings and copper feeder and
distribution. Such a distribution system is the conventional system used in the
United States and Western Europe. Telecommunications services are transmitted to
the home through twisted pair copper wire telephone cable.
The Company's conventional networks have been designed to employ an
open architecture, generally using Synchronous Digital Hierarchy ("SDH")
technology for system resilience. The Company's networks are designed to provide
voice and high speed data services. The Company believes that the flexible
design of the conventional networks it has constructed allows it to readily
implement new technologies and provide enhanced or new services. The Company's
switches in its conventional networks allow it to connect to networks operated
by other LTOs or by MATAV in order to route voice and data transmissions between
subscribers.
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Wireless Network Design
In certain portions of the Operating Areas, the Company is deploying
wireless network technology based upon the Digital Enhanced Cordless
Telecommunications ("DECT") system which interfaces radio technology to
fiber-optic, digital microwave or fixed copper networks. The use of DECT
technology generally reduces the time and expense of installation and securing
rights of way. In a conventional network build, significant investment must be
made in order to offer service to a large proportion of potential customers
whether or not they become actual customers. By contrast, the use of the DECT
system in a network build-out provides for capital investment proportional to
the number of customers actually connected because the radio links and other
required equipment are installed only for those households choosing to take the
service and are installed only at the time service is requested.
In many areas in which the Company is utilizing a wireless network
design, the Company is deploying a fiber optic cable to the node in the same
fashion as in a conventional network build-out. At each newly constructed node,
the Company has constructed a radio base station ("RBS"), rather than switching
to twisted pair copper wire distribution to the home. Each RBS has the capacity
to provide service to between 200 and 600 customers. As additional customers are
brought onto the network, the Company will install a transceiver unit at the
subscriber's premises. Such transceiver's operating software is digitally
encrypted so that it will operate only with its supporting RBS. A conventional
telephone jack is then installed in the subscriber's household near an
electrical outlet which is used to power the transceiver unit. The subscriber
then uses a conventional phone to make outgoing and receive incoming calls.
The DECT-based wireless local loop system provides the same grade of
service as a conventional telephone network. In addition, a DECT-based network
is able to provide many of the same services as a conventional copper network
including voice mail, call forwarding and call barring.
Network Administration
The Company actively monitors the switching centers and all critical
network operational parameters in each Operating Area. As digital features are
introduced into their respective networks, the network technicians have the
ability to monitor the networks and evaluate and respond accordingly. The
Company will also be able to analyze the performance data generated by these
systems in order to make the operating adjustments or capital expenditures
necessary to enhance individual network operations.
The Operating Companies
The following is a brief description of each of the Operating
Companies:
Hungarotel
The Company holds a 99.0% interest in Hungarotel while a private
Hungarian investor owns the remaining 1.0%. The Hungarotel Operating Area
encompasses the southern portion of Bekes County, which borders Romania. The
Hungarotel Operating Area is comprised of 75 municipalities and has a population
of approximately 398,500 with an estimated 166,600 residences and 22,300
business and other potential subscribers (including government institutions).
Bekes is the most intensively cultivated agrarian region in Hungary and produces
a substantial portion of Hungary's total wheat production. Industry, generally
related to food processing, glass and textile production, is also a strong
employer in the region. Foreign investors in the Operating Area include Owens
Illinois of the United States and a number of European manufacturers. The region
is also a center for natural gas exploration and production. As of December 31,
1998, Hungarotel had 105,300 access lines connected to its network. The
Hungarotel network utilizes a combination of a conventional build, fiber optic
and wireless local loop technology.
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<PAGE>
KNC
The Company holds a 94.8% interest in KNC. The KNC Operating Area
municipalities own 5.0% and Antenna Hungaria owns the remaining 0.2%. The KNC
Operating Area is comprised of 74 municipalities in the eastern portion of
Nograd County, which borders Slovakia. The KNC Operating Area has a population
of approximately 152,300, with an estimated 61,900 residences and 6,500 business
and other potential subscribers (including government institutions). The
principal economic activities in the KNC Operating Area include light
manufacturing, tourism, some coal mining and agriculture. Foreign investors in
the region include the Irish dairy producer, Avonmore, and the Japanese company,
Paramount Glass. The Operating Area's proximity to Budapest, 1-1/2 hours by car,
and its many cultural attractions makes it a desirable weekend and tourist
destination. As of December 31, 1998, KNC had 40,000 access lines connected to
its network. The KNC network utilizes a combination of a conventional build,
fiber optic and wireless local loop technology.
Papatel
The Company holds a 79.2% interest in Papatel. The IFC owns a 20.0%
interest and Papa, the principal city in the Papatel Operating Area, owns the
remainder. The Operating Area is composed of 51 municipalities located in the
northern portion of Veszprem County and is contiguous with the Raba-Com
Operating Area. The population of the Papatel Operating Area is approximately
64,000 with an estimated 24,000 residences and 3,300 business and other
potential subscribers (including government institutions). The region is
relatively underdeveloped economically with the principal economic activities
centering around light industry, appliance manufacturing, agriculture and forest
products. Significant foreign investors in the Operating Area include ATAG, the
Dutch appliance maker, and Electricite de France. As of December 31, 1998,
Papatel had 18,300 access lines connected to its network. The Papatel network
utilizes a combination of a conventional build, fiber optic and wireless local
loop technology.
Raba-Com
The Company holds a 90.7% interest in Raba-Com. Municipalities in the
Raba-Com Operating Area own the remaining 9.3%. The Raba-Com Operating Area is
comprised of 63 municipalities in Vas County, which borders Austria and
Slovenia. The Raba-Com Operating Area has a population of approximately 67,600,
with an estimated 23,800 residences and 4,300 business and other institutional
subscribers (including government institutions). The principal economic
activities in the Raba-Com Operating Area include heavy manufacturing,
agriculture and tourism. Significant employers include: Linde (the Hungarian
central natural gas distributor): Phillips (a Dutch-owned electronics
manufacturer); EcoPlast (a plastics producer); and Saga (a British-owned poultry
processor). As of December 31, 1998, Raba-Com had 21,400 access lines connected
to its network. The Raba-Com network utilizes a combination of a conventional
build and fiber optic infrastructure.
Regulation
In November 1992, the Hungarian Parliament enacted the Hungarian
Telecommunications Act of 1992 (the "Telecom Act") which took effect in 1993.
The Hungarian Telecom Act provided for, among other things, the establishment of
the conditions under which individuals and companies (including MATAV, foreign
persons and foreign owned companies) could bid for concessions to build, own and
operate local telecommunications networks in designated service areas. The
Hungarian Telecom Act also gave the Ministry the authority to regulate the
industry, including the setting of local, domestic long distance and
international rates, the sharing of revenues between the LTOs and MATAV, the
accrediting of equipment vendors and the setting of standards in respect of
network development and services offered. In order to meet these obligations,
the Hungarian Telecom Act created a professional supervisory body, the
Telecommunications Chief Inspectorate (the "Inspectorate") which is supervised
by the Ministry. Its tasks include supervising the progress of the LTOs with
respect to build-out scheduling, equipment purchases and the quality of network
construction.
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Concession Contracts
Pursuant to the Hungarian Telecom Act and in accordance with the
Concession Act of 1991, in connection with the award of a concession, each of
the LTOs entered into a Concession Contract with the Ministry governing the
rights and obligations of the LTO with respect to each concession. Topics
addressed by individual concession contracts include the royalties to be paid to
the Ministry, guidelines concerning LTO capital structure, build-out milestones,
employment guidelines and the level of required contributions to meet social and
educational requirements. For example, the Concession Contracts stipulate that
an LTO may not change its capital structure by more than 10% without the express
written consent of the Ministry and that former MATAV employees generally must
be retained for the first five to eight years of operation. The Company may,
however, enter into termination agreements with its employees.
Corporate Governance. The amended Concession Contracts for Hungarotel
and Papatel provide that two out of every five members of their Boards of
Directors and one-half of the members of their Supervisory Boards be Hungarian
citizens.
Exclusivity. The Concession Contracts provide that each Operating
Company has the exclusive right to provide non-cellular local voice telephone
services for eight years. Commencing in 2002, the Ministry will have the right
to grant additional concessions for non-cellular local voice telephone services.
Milestones/Network Construction. Each of the Concession Contracts
prescribe certain build-out obligations ("milestones") that require each
Operating Company to install a specified number of access lines within
prescribed time periods. Each of the Operating Companies met their build-out
requirements in 1998.
See "- Fines."
Presently, only three vendors have been accredited to provide
telecommunications switching equipment to LTOs, namely, Siemens, Ericsson and a
Hungarian subsidiary of Northern Telecom. Although only these three vendors have
been accredited, the Operating Companies have not encountered any equipment
supply shortfalls.
Royalties. Each of the LTOs is required by the terms of its individual
concession contract to pay annual royalties to the Ministry equal to a
percentage of net revenue from basic telephone services. Net revenue for this
purpose are generally defined as gross revenue from basic telephone services
less interconnect fees paid to MATAV. The royalty percentage may also differ by
region. For example, the Operating Companies must pay royalties in the following
percentage amounts: KNC 0.1%; Raba-Com 1.5%; Hungarotel (Bekescsaba) 2.3%;
Hungarotel (Oroshaza) 0.3%; and Papatel 2.3%. These amounts are paid annually,
in arrears.
Social and Educational Contributions. In addition to the royalties
described above, Concession Contracts may also call for social and educational
contributions based on revenues of the Operating Company, excluding VAT. The
Concession Contracts for KNC and Raba-Com require them to contribute 1.5% and
1.0% of such revenues, respectively, to support social and educational projects
in their Operating Areas. The Concession Contracts for Hungarotel require it to
pay an amount equal to 10 times the local occupational excise tax. The
applicability and enforceability of such obligation is presently uncertain.
Therefore, it is not possible to predict with certainty the effect, if any, such
provision will have on the Company.
Renewal. Each Concession Contract provides for a 25-year term with the
right to submit a proposal, within 18 months prior to the expiration of the
Concession Contract to apply for an additional 12-1/2 years which the Ministry
may grant if it approves the Operating Company's proposal, subject to
consultation with local authorities and professional and consumer protection
bodies. Such extension would involve the payment of an additional concession fee
to be set by the Ministry prior to the submission of the proposal. In the event
the proposal is rejected or is not timely filed, the concession would be
auctioned by the Ministry, although the existing Operating Company would have
priority in the event the Operating Company's proposal provides for the same
terms and conditions as that of another bidder.
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<PAGE>
Fines. The failure to meet required construction milestones may
result in the levying of fines by the Ministry. Such fines are computed based
on a contractual formula and may be substantial. Each of the Operating
Companies met their build-out requirements in 1998.
Termination upon Lack of Performance. If an LTO is unable to comply
with its Concession Contracts, the Ministry has the right to abrogate the
Concession Contract. In such an instance, the Ministry has authority to
determine alternative provisions for such service, which may include the sale of
the LTO's telecommunications assets to another provider. In such case, the LTO
would be obligated to sell its assets under the terms of a contract to the
provider to whom the concession is transferred. The Company believes that it has
demonstrated substantial performance to date under its Concession Contracts and
that its relations with the Ministry are good and, therefore, the chance of any
termination of any Concession Contract are remote.
Dispute Resolution. Any disputes arising with respect to the
interpretation of a Concession Contract will be adjudicated by a Hungarian
court.
Hungarian Equity Ownership Requirements.
The Ministry has stipulated in the Concession Contracts for Hungarotel
and Papatel, as amended in June 1996, that each of the Operating Companies must
meet certain Hungarian ownership requirements so that by the end of the seventh
year of their Concession Contracts Hungarian ownership must consist of 25% plus
one share of the relevant Operating Company. For the first three months after
assuming operations of an Operating Area from MATAV, no Hungarian ownership was
required. For the seven-year period following the date or amendment of a
Concession Contract, as the case may be, Hungarian ownership must be at least
10%, except that during such period, such ownership may be reduced to as low as
1% for a period of up to two years. During such seven-year period, while the
Hungarian ownership block is required to be at least 10%, such block must have
voting power of at least 25% plus one share, thus providing Hungarian owners the
right to block certain transactions which, under Hungarian corporate law,
require a supermajority (75%) of stockholders voting on the matter, such as
mergers and consolidations, increases in share capital and winding-up.
For these purposes, Hungarian ownership of shares means shares owned by
Hungarian citizens. Shares owned by a corporation are considered Hungarian owned
only in proportion to the Hungarian ownership of such corporation. The LTOs can
also fulfill the 25% plus one share Hungarian ownership requirement by listing
such shares on the Budapest Stock Exchange.
The equity ownership requirements and exceptions described above are
contained in the June 1996 amended Concession Contracts for Hungarotel and
Papatel. The equity ownership requirements expressly set forth in KNC's and
Raba-Com's Concession Contracts call for a stricter 25% plus one share Hungarian
ownership requirement. However, the Ministry has stated, pursuant to a letter
dated September 18, 1996, that it intends that all of the Operating Companies be
treated equally with respect to such ownership requirements which requirements
KNC and Raba-Com are currently in compliance.
Each of the Operating Companies, other than Papatel, is currently in
compliance with the 1% ownership requirement but not the 10% ownership
requirement which was supposed to be effective in June 1998. Papatel's
Concession Contract permits an initial Hungarian ownership level of its current
0.8%. If the Hungarian ownership does not meet the required levels, the LTO is
required to give notice to the Ministry, which may then require the LTO to
rectify the situation within three months, or a shorter period if the Ministry
considers that there has been a delay in the required notification. The Ministry
is currently reviewing the Hungarian equity ownership requirements. In the case
of one other LTO, the Ministry has granted a waiver on the 10% ownership issue.
Presently, the Ministry has indicated that it is not going to enforce at this
time the 10% Hungarian equity ownership requirement. In the event that the
Ministry decides to enforce the existing Hungarian ownership requirements or
adopts new Hungarian equity ownership requirements, the Company will formulate
plans to meet the Hungarian equity ownership requirements. Failure to do so, or
failure to comply with the greater than 25% Hungarian ownership requirement at
the end of the seven-year period might be considered a serious breach of a
Concession Contract, giving the Ministry the right, among other things, to
terminate the Concession Contract. There can be no assurance that the Company
will be able to increase the Hungarian ownership in the Operating Companies in a
manner sufficient to comply with such requirements in the future.
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The Hungarian ownership requirements would effectively give minority
Hungarian stockholders in the Operating Companies the ability to block certain
corporate transactions requiring the approval of 75% of stockholders voting on
the matter, including mergers and consolidations, increases in share capital and
winding-up. In addition, unless the Hungarian ownership requirements are
formally changed, compliance would result in a reduction in the Company's
ownership in the Operating Companies, and, consequently, the Company's share of
income, if any, or loss of the Operating Companies will be reduced
proportionately.
Rate-Setting and Revenue Sharing
Pursuant to the Hungarian Act LXXXVII of 1990 on Pricing (the "Pricing
Act") and the Telecom Act, the Ministry, issues, in agreement with the Hungarian
Ministry of Finance, decrees regulating the tariffs for telecommunications
services provided by the Company, MATAV and the other LTOs. Through December 31,
1997 the Ministry regulated, pursuant to Decree No. 30/1993 (XL.23) KHVM, as
amended, on the Rates Charged for Public Telephone Services (the "1993 Tariff
Decree"), the revenue sharing arrangements between the Company and MATAV
applicable to long distance and international calls and the fees the Company
could charge its customers for services. The Ministry regulates the subscriber
connection fees pursuant to Decree 11/1995 (VII.12) KHVM, as amended, on the
One-Time Access Fee Payable for Establishment of Public Telephone Service Access
Points (the "Connection Fee Decree").
Through December 31, 1997, the 1993 Tariff Decree regulated the prices
that the Company could charge its customers for: (a) subscription fees, (b)
local calls, and (c) long distance and international calls. The 1993 Tariff
Decree provided for an aggregate price cap and separate price caps for each
separate service. The 1993 Tariff Decree permitted annual increases in these
categories of services according to a formula tied to the PPI. The Operating
Companies were required to charge the same tariffs as MATAV for long distance
and international calls. The Company increased its tariffs 28.3% and 23.3% for
1996 and 1997, respectively. In December 1997 the Ministry adopted Decree No.
31/1997 of the KHVM on Fees Related to Telecommunication Services Subject to
Concession (the "1997 Tariff Decree") which regulated the Operating Companies'
tariffs for services effective January 1, 1998. The 1997 Tariff Decree set
separate price caps for each category of service through 2000, which price caps
provided for annual rate increases based on the CPI for the prior year. Based on
the 1997 Tariff Decree, the Operating Companies' aggregate tariffs in 1998
increased by up to 18.0% from the Operating Companies' 1997 rates. The 1997
Decree also provided for a rebalancing formula which allowed greater increases
in the charges for subscription fees and local calls than in domestic long
distance or international calls. For 1999, in accordance with the policies set
forth in the 1997 Tariff Decree, the Ministry amended the 1997 Tariff Decree by
adopting Decree No. 31/1998 (XII.23) (the "1998 Tariff Decree") which provides
for an aggregate retail tariff increase of approximately 11.2% as compared to
the 12.5% increase in the benchmark CPI. According to the 1997 Tariff Decree,
the Ministry may reduce the CPI percentage increase by as much as a 2%
efficiency factor to obtain the maximum allowable price increase. The efficiency
factor applied to the Company in the 1997 Tariff Decree was zero and in the 1998
Tariff Decree is about 1.3%. With respect to rebalancing, the 1998 Tariff Decree
provided for rebalancing factors in addition to the price increase as follows:
plus 10% for subscription rates, plus 6.4% for local calling rates and minus
8.0% for long distance and international call rates. The total increase provided
for a 12.47% weighted average increase in local call rates, a 27.49% weighted
average increase in subscription fees and a 3.6% weighted average increase in
long distance and international call rates. The 1998 Tariff Decree also provided
for the shifting of a local calling allowance for residential customers (HUF
240, about 17% of the residential subscription fee) to local call revenue.
-19-
<PAGE>
Pursuant to the 1993 Tariff Decree, the Ministry set the revenue
sharing arrangements between the Operating Companies and MATAV with respect to
long distance and international calls through December 31, 1997. The revenue
sharing arrangements provided for the Operating Companies to retain an
interconnection fee from the fees collected from the Operating Companies'
customers for long distance and international calls. The interconnection fees
were fixed based on a complex formula which was intended to result in the LTOs
(including MATAV, in its role as an LTO, and the Operating Companies) receiving
67% of the telecommunications revenue and MATAV, in its role as the long
distance and international provider, receiving 33% of such revenue. For 1997,
the weighted average interconnection fee was fixed at HUF 12.82/minute for long
distance and international calls, depending on the tariff period. An LTO
received 60% of the interconnection fee for a domestic long distance or
international call initiated by such LTO's customer and an LTO received 40% of
the interconnection fee for domestic long distance or international calls
terminating with one of such LTO's customers. In January 1998 the Ministry
adopted Decree 1/1998 of the KHVM on Distribution of Revenues Related to
Telecommunication Services Subject to Concession, on Fees of Leased Line
Services Utilized for Provision of Telecommunication Services Subject to
Concession and on Settlement of Fees ("the 1998 Interconnection Decree") which
regulated the interconnection fees for 1998 and provided for each LTO to receive
an average interconnection fee of HUF 8.14/minute for either the initiation or
termination of a domestic long distance or international call. For 1999 and
future years, the Ministry announced that it intended to start regulating the
interconnection fees based on internationally accepted benchmarks with the goal
of creating a cost-based interconnection fee regime. To that end, the Ministry
adopted Decree 6/1999 (II.19) (the "1999 Interconnection Decree") which amended
the 1998 Interconnection Decree. The 1999 Interconnection Decree provides for
each LTO to receive in 1999 an average interconnection fee of HUF 16.28/minute
for the initiation of a domestic long distance or international call and an
average fee of HUF 7.5/minute for the termination of a domestic long distance or
international call. For 2000 and future years, the Ministry has asked MATAV and
the other LTOs to provide cost based data for January to June 1999 to the
Ministry by September 30, 1999 so that the Ministry could use such data to
introduce a cost-based interconnection fee regime, which is already a
requirement for EU members. See " - Competition."
The Connection Fee Decree provides for maximum subscriber connection
fees at HUF 90,000 ($415.70) for business customers and HUF 30,000 ($138.57) for
residential customers. See "- Operations - Services Subscription and Connection
Fees."
Wireless Networks
The use of radio frequencies for wireless communications technology is
licensed and regulated by the Ministry and the Inspectorate, which have the
authority to grant such licenses after a formal review process, including
licenses for use of the DECT system frequency band of 1880 MHz to 1900 MHz. In
Hungary, the service provider having the concession, after acquiring the
necessary permits and licenses, will have the authority to: (i) establish
subscriber radio lines with fixed service or with DECT; (ii) establish a radio
telecommunication system to be accessed by a building or group of buildings,
with fixed service or with DECT; and (iii) provide PBX service with fixed
service or with DECT.
-20-
<PAGE>
Hungarian Taxation
Corporate Income Tax. The operations of the Company's Hungarian
subsidiaries, including the Operating Companies, are subject to Hungarian
corporate income tax. Generally, Hungarian corporations are subject to tax at an
annual rate of 18.0%. Companies which fulfilled certain criteria were entitled
to a 100.0% reduction in income taxes for the five year period ending December
31, 1998 and a 60.0% reduction in income taxes for the subsequent five year
period ending December 31, 2003, provided certain criteria continue to be met.
See Note 1(j) of Notes to Consolidated Financial Statements. The Operating
Companies are currently eligible for such tax treatment. However, the corporate
income tax is reviewed, and subject to change, annually. Any tax increase or
change in the tax exempt status of the Operating Companies could have a material
adverse effect on the Company.
Value Added Tax ("VAT"). The Hungarian VAT system is virtually
identical to the one used in most European countries. VAT is a consumption tax
which is fully borne by the final consumer of a product or service. The current
rates of VAT in Hungary vary between 0.0% and 25.0%, depending on the type of
product or service.
Social Insurance Contributions. The level of contributions for social
insurance in Hungary is one of the highest in Europe. In 1998 employers were
required to pay the state 39% (reduced to 33% for 1999) of an employee's gross
salary as a social security contribution and 4.5% (reduced to 3.0% for 1999) of
an employee's gross salary as the employer's contribution to the unemployment
fund. In addition, the Company must pay HUF 3600 ($16.63) per month for each
employee for health insurance. The Company's share of pension, unemployment,
social security and health insurance payments are reflected in operating and
maintenance expenses.
Competition
The Concession Contracts provide for an eight-year period of
exclusivity in the provision of non-cellular local voice telephone services,
which ends in 2002, while the initial 25-year terms of the Concession Contracts
are scheduled to expire in 2019. Other telecommunications service providers
presently are permitted to apply for licenses to provide non-exclusive services
(e.g., data transmission and voice mail) throughout Hungary, including the
Operating Areas. In addition, beginning in 2002, other competitors may choose to
enter the non-cellular local voice telephone services market, but the terms and
conditions upon which such market entry will be effected are today unclear.
In 1998, the Ministry awarded Pan-Tel the license to provide
non-exclusive telecommunications services such as data transmission and voice
mail. Pan-Tel started building its telecommunications network in 1998. The
current shareholders of Pan-Tel include MAV Rt. (the Hungarian railway company),
MOL Rt. (the Hungarian oil and gas company), KFKI Computer Systems Rt. (a
Hungarian information technology research firm) and Koninklijke PTT Nederland NV
(the Dutch telephone company). Another entrant into the marketplace, Novacom Rt.
("Novacom") owned by affiliates of RWE Telliance AG, a German telecommunications
company and EnBW AG, a German electricity provider, is expanding the fiber optic
infrastructure of the Budapest electricity distributor Elmu Rt. in order to
enter the telecommunications market. There are also several companies entering
the market by building new wireless networks. The Hungarian cable television
industry is undergoing consolidation. United Pan-Europe Communications, a
subsidiary of the global television operator United International Holdings, Inc.
of Denver, Colorado, is the largest cable television operator in Hungary.
-21-
<PAGE>
The Company faces competition from the three Hungarian cellular
providers-Westel 900 GSM Mobil Tavkozlesi ("Westel 900"), Westel Radiotelefon
Kft. ("Westel") and Pannon, which are able to provide consumers with mobile
telephones rather than fixed telephones. Westel 900 and Westel, both joint
ventures between Mediaone Group Inc. (formerly part of US West) and MATAV have
the national licenses to provide both digital and analog cellular services,
while Pannon, a consortium comprised of the Scandinavian PTOs (including Tele
Danmark) and the Dutch PTT, may only provide digital cellular services.
Presently, the airtime and monthly fees charged by the cellular operators are
generally more than the fees for comparable services charged by the Company. In
addition, Hungary issued a tender in February 1999 for the 1800-megahertz, or
DCS frequency for mobile communications. It is expected that three licenses will
be awarded at least one of which will be awarded to a new entrant into the
cellular market.
If the current regulatory framework remains unchanged, the Ministry may
invite tenders for concessions to provide local, long distance and international
basic telephone services when the monopolies of the Operating Companies, the
other LTOs and MATAV expire. Pan-Tel and these other entities would be entitled
to submit a bid as will any other telephone operator.
Hungary's application for membership in the European Union (the "EU")
was accepted. Hungary is now in the process of negotiating the terms of its
accession into the EU. The EU has adopted numerous directives providing for an
open telecommunications market among its member nations. The Company believes
that its exclusivity rights will not be affected by Hungary's accession in the
EU.
Furthermore, Hungary, as a member of the World Trade Organization
("WTO"), ratified the WTO's Telecommunications Agreement, which agreement began
liberalizing the market for telecommunications services effective January 1,
1998. Hungary's ratification postponed Hungary's liberalization of its
telecommunications market until 2002. In the event Pan-Tel or any other
competitor builds a telecommunications infrastructure with the capacity to
provide non-exclusive services prior to 2002 and non-cellular local voice
telephone services beginning in 2002 in an Operating Area, such competitor
could, assuming it obtains the proper authorizations, directly compete with the
Company in the Operating Areas with respect to such services. Prior to 2002, the
Company may consider adopting plans to compete in other local telecommunications
concession areas in Hungary or in the long distance and international
telecommunications markets in Hungary, which may include joint ventures with
Hungarian or international entities.
Employees
The Company had a total of approximately 665 employees, including 11
expatriates, as of March 1999. The Company hired approximately 700 persons in
connection with the assets acquired from MATAV for its five Operating Areas. The
Company has recently completed the 1999 wage negotiations with its unions. The
Company considers its relations with its employees to be satisfactory.
-22-
<PAGE>
Item 2. Properties
The Company leases 1,157 square feet of office space at 100 First
Stamford Place, Stamford, CT at a monthly rental of $2,508. The lease expires
March 31, 2000. The Company owns 365 square meters of office space in Budapest
at Kiralyhago u.2. The Company believes that its leased and owned office space
is adequate for its present needs but is currently reviewing its alternatives as
to its future needs.
In addition, each Operating Company owns or leases the following office
or customer service space in its respective Operating Area: KNC owns or leases
57,000 square feet of total space; Raba-Com owns or leases 15,000 square feet of
total space; Hungarotel owns or leases 119,594 square feet of total space; and
Papatel owns or leases 18,000 square feet of total space.
Item 3. Legal Proceedings
Hungarotel is a defendant in a lawsuit filed by Dialcont Kft.
("Dialcont") on March 28, 1996 in Hungary alleging a breach of contract for
services allegedly provided by Dialcont during 1994 and 1995. The Company
believes that Dialcont's claim is without merit. Dialcont is seeking HUF 270
million ($1.2 million). This action is still pending in the Hungarian court
system.
Raba-Com is a defendant in a lawsuit filed by an individual residential
customer in Hungary on December 4, 1997. The plaintiff sought a refund of a
minimal amount alleging that his home was connected to Raba-Com's network in an
untimely fashion. Raba-Com prevailed on the merits in the lower court. The
plaintiff appealed the case in the appellate court which court overturned the
lower court's decision. Raba-Com filed an appeal with the Hungarian Supreme
Court which is still pending. Should, however, Raba-Com lose its appeal at the
Supreme Court level, the Company could be subject to additional claims for
refunds. The Company believes its meritorious defense to this claim and any
others that may be filed regarding this matter.
In January 1999, the Company settled a lawsuit brought by one of its
former employees alleging wrongful termination of the plaintiff's employment.
HTCC Consulting Rt. ("Consulting"), Papatel and KNC are involved in
several disputes with the Hungarian taxing authorities (the "APEH") pursuant to
which the APEH alleges that Consulting owes HUF 105 million (approximately
$485,000), Papatel owes HUF 26 million (approximately $120,000) and KNC owes HUF
26 million (approximately $122,000) for various reasons. The Operating Companies
believe that the APEH claims are without merit and are vigorously defending
themselves against such claims.
During 1996 and 1997, the Company entered into several construction
contracts with a Hungarian contractor which totaled $59.0 million in the
aggregate, $47.5 of which was financed by a contractor financing facility. To
date, the balance on the contractor financing facility is $36.6 million. The
Company and the contractor have a disagreement with respect to several issues
relating to the quality and quantity of the work done by the contractor. The
Company has rejected invoices totaling $3.2 million. The Company has claims
against the contractor for substantially more than the amount being claimed by
the contractor. During 1998 the Company and the contractor engaged in settlement
discussions but were unable to reach a settlement. The Company is reviewing its
options with respect to such dispute. At this time the outcome of such dispute
can not be predicted with certainty. The Company believes that it will prevail
on the merits such that it will not be responsible for the full payment on the
aggregate contractual amount. There can, however, be no assurances as to the
final outcome or course of action of such dispute.
-23-
<PAGE>
The Company and its subsidiaries are involved in various other legal
actions arising in the ordinary course of business. The Company is contesting
these legal actions in addition to the suits noted above; however, the outcome
of individual matters is not predictable with assurance. Although the ultimate
resolution of these actions (including the actions discussed above) is not
presently determinable, the Company believes that any liability resulting from
the current pending legal actions involving the Company, in excess of amounts
provided therefor, will not have a material adverse effect on the Company's
consolidated financial position, results of operations or liquidity.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of the Company's security holders
during the quarter ended December 31, 1998.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Market Information
The Company's Common Stock trades on the American Stock Exchange (the
"Amex") under the symbol "HTCC." Trading of the Common Stock on the Amex
commenced on December 20, 1995. From December 8, 1994 through December 19, 1995,
the Common Stock was quoted on the Nasdaq National Market and from December 28,
1992 through December 7, 1994 the Common Stock was quoted on the Nasdaq
Small-Cap Market. In 1998, NASD, parent of The Nasdaq Stock Market, merged with
the American Stock Exchange. Subsequent to the merger, The Nasdaq-Amex Market
Group was created as a holding company under which both The Nasdaq Stock Market
and the American Stock Exchange function as independent subsidiaries, with
separate listed companies.
The following table sets forth the high and low sale prices for the
Common Stock as reported by the Amex for each quarter in 1997 and 1998.
High Low
Quarter Ended:
1997
March 31, 1997 . . . . . . . . . . . . $11-3/8 $ 9-1/4
June 30, 1997. . . . . . . . . . . . . 10-5/8 8-1/4
September 30, 1997 . . . . . . . . . . 12-7/8 8-3/8
December 31, 1997. . . . . . . . . . . 13-3/4 9-3/8
1998
March 31, 1998 . . . . . . . . . . . . $11-1/8 $ 7-1/2
June 30, 1998. . . . . . . . . . . . . 8-3/4 4-7/8
September 30, 1998 . . . . . . . . . . 6-1/8 2-1/8
December 31, 1998. . . . . . . . . . . 6-5/8 3
On March 24, 1999, the closing sale price for the Common Stock on the
Amex was $4.5625.
Stockholders
As of March 25, 1999, the Company had 5,395,864 shares of Common Stock
outstanding held by 103 holders of record. The Company believes that it has
approximately 1,500 beneficial owners who hold their shares in street names.
-24-
<PAGE>
The Company will furnish, without charge, on the written request of any
stockholder, a copy of the Company's Annual Report on Form 10-K for the year
ended December 31, 1998, including financial statements filed therewith.
Stockholders wishing a copy may send their request to the Company at 100 First
Stamford Place, Suite 204, Stamford, CT 06902.
Dividend Policy
It is the present policy of the Company to retain earnings, if any, to
finance the development and growth of its businesses. Accordingly, the Board of
Directors does not anticipate that cash dividends will be paid until earnings of
the Company warrant such dividends, and there can be no assurance that the
Company can achieve such earnings or any earnings.
At present, HTCC's only source of revenues is payments, including
repayment of any intercompany loans, payments under its management service
agreements and dividends, if any, from the Operating Companies. The Operating
Companies' ability to pay dividends or make other capital distributions to the
Company is governed by Hungarian law, and is significantly restricted by certain
obligations of the Operating Companies.
Item 6. Selected Financial Data
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
<TABLE>
<S> <C> <C> <C> <C> <C>
Selected Financial and Operating Data
(Dollars in Thousands, Except Per Share Amounts)
1998 1997 1996 1995 1994
--------- --------- -------- --------- --------
For the Year
Operating revenues $ 38,707 $ 37,891 $20,910 $ 4,070 $ ---
Operating income (loss) $ (6,059) $ (1,263) $(20,553) $(17,829) $ (5,272)
-
Net loss $ (50,612) $ (36,236) $(54,769) $(20,024) $ (4,597)
-
Net loss per common share $ (9.53) $ (7.97) $ (13.14) $ (6.30) $ (2.13)
At Year-End
Total assets $ 177,067 $ 186,485 $156,615 $110,387 $ 27,577
Long-term debt, excluding
current installments $ 202,881 $ 194,537 $148,472 $ 23,467 $ 2,299
Total stockholders' (deficiency)
equity $ (89,037) $ (41,837) $(23,790) $ 15,739 $ 12,563
</TABLE>
-25-
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Introduction
HTCC is engaged primarily in the provision of telecommunications
services through its majority-owned operating subsidiaries, KNC, Raba-Com,
Papatel and Hungarotel. The Company earns substantially all of its
telecommunications revenue from measured service fees, monthly line rental fees,
connection fees, public pay telephone services and ancillary services (including
charges for additional services purchased at the customer's discretion).
During 1996 and 1997 the Company embarked on a significant network
development program which met its substantial demand backlog, increased the
number of basic telephone access lines in service and modernized existing
facilities. The development and installation of the network in each of the
Company's Operating Areas required significant capital expenditures.
The ability of the Company to generate sufficient revenues to satisfy
cash requirements and become profitable will depend upon a number of factors,
including the Company's ability to attract additional customers, revenues per
customer and construction costs. These factors are expected to be primarily
influenced by the success of the Company's operating and marketing strategies as
well as market acceptance of telecommunications services in the Company's
Operating Areas. In addition, the Company's profitability may be affected by
changes in the Company's regulatory environment and other factors that are
beyond the Company's control. The success of the Company's strategy is dependent
upon its ability to increase revenues through increased usage and the addition
of new subscribers.
To date, the Company's activities have involved the acquisition of the
concessions and telecommunications networks from MATAV and the subsequent
design, development and construction of the modern telecommunications
infrastructure that the Company now has in service. The Company paid the
Ministry $11.5 million (at historical exchange rates) for its concessions, spent
approximately $23.2 million (at historical exchange rates) to acquire the
existing telecommunications assets in its Operating Areas from MATAV, and spent
$171 million through December 31, 1998 (at historical exchange rates) on the
development and construction of its telecommunications infrastructure. Since
commencing the provision of telecommunications services in the first quarter of
1995, the Company's network construction and expansion program has added 123,600
access lines through December 31, 1998 to the 61,400 access lines acquired
directly from MATAV. As a result, the Company had 185,000 access lines in
operation at year end 1998.
The Company funded its construction costs primarily through the $170
million Postabank Credit Facility and a $47.5 million contractor financing
facility. The Company and the Hungarian contractor which granted the contractor
financing facility have a disagreement with respect to several issues relating
to the quality and quantity of the work done by the contractor. During 1998 the
Company and the contractor engaged in settlement discussions but were unable to
reach a settlement. The Company is currently reviewing its options with respect
to this dispute. See Item 3 "Legal Proceedings", and Note 9(e) of Notes to the
Consolidated Financial Statements.
The first installment of the repayment of the Postabank Credit Facility
is due on March 31, 1999. To date, the Company has suffered from recurring
losses from operations and has a working capital deficiency and a net capital
deficiency. The Company does not presently have sufficient funds on hand to pay
the first installment on the Postabank Credit Facility. Under the Postabank
Credit Facility, a failure to pay any installment constitutes an "Event of
Default". Upon notice to the Company of an Event of Default, the Company is
entitled to the benefit of a 60 day cure period. If such Event of Default is not
cured within 60 days, Postabank could declare all amounts outstanding under the
Postabank Credit Facility due and payable upon 60 days notice.
-26-
<PAGE>
The Company, with assistance from its financial advisors, is currently
in negotiations with Postabank and its financial advisors regarding a
restructuring of the Company's obligations with the goal of reducing the
Company's cash repayment obligations so that the Company can sufficiently fund
its working capital requirements, capital expenditures and meet its financing
obligations with cash flows from operations. The Company is also reviewing
various other financing alternatives with several entities. While the result of
such negotiations and the availability of alternative sources of financing
cannot be predicted with certainty, the Company believes that it will be able to
resolve its financial issues so that it will be able to meet its obligations
during 1999. However, there can be no assurance that the Company will be able to
resolve these issues on commercially reasonable terms, or at all. Such
negotiations and/or discussions could result in the issuance of equity and/or
debt securities of the Company or one or more of the Operating Companies. In
addition, the Company relies on its ability to generate cash from operations
which is dependent upon the Company's ability to attract additional customers
and increase revenues per customer. These factors are expected to be primarily
influenced by the success of the Company's operating and marketing strategies as
well as market acceptance of the Company's services.
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.
The Company has granted various options to purchase the Company's
Common Stock, including those previously granted to Citizens, and has provided
certain preemptive rights to Citizens and Tele Danmark. For the term of these
options, the holders will have the opportunity to exercise and dilute the
interests of other security holders or, in the case of Citizens, acquire a
controlling interest in the Company. As long as these options remain
unexercised, the Company's ability to obtain additional equity capital may be
adversely affected.
-27-
<PAGE>
Comparison of Year Ended December 31, 1998 to Year Ended December 31, 1997
Net Revenues
<TABLE>
<S> <C> <C>
Year ended
(dollars in millions) 1998 1997
Measured service revenues $ 32.2 $ 26.2
Subscription revenues 10.7 7.2
Net interconnect charges (9.8) (10.2)
------ ------
Net measured service and subscription revenues 33.1 23.2
Connection fees 2.0 12.9
Other operating revenues, net 3.6 1.8
------ ------
Telephone Service Revenues, Net $ 38.7 $ 37.9
======= =======
</TABLE>
The Company recorded a 2.1% increase in net telephone service revenues
to $38.7 million for the year ended December 31, 1998 from $37.9 million for the
year ended December 31, 1997.
Net measured service and subscription revenues increased 42.7% to $33.1
million for the year ended December 31, 1998 from $23.2 million for the year
ended December 31, 1997. Measured service revenues increased 22.9% to $32.2
million in 1998 from $26.2 million in 1997 while subscription revenues increased
48.6% to $10.7 million in 1998 from $7.2 million in 1997. These increases in
call and subscription fee revenues are the result of a 35% increase in average
access lines in service from approximately 132,000 lines for the year ended
December 31, 1997 to approximately 178,000 lines for the year ended December 31,
1998. The growth in access lines is not fully reflected in increased measured
service revenues as newer customers require a period of maturity before
producing revenues similar to established telephone customers.
These revenues have been offset by net interconnect charges which
totaled $9.8 million for the year ended December 31, 1998 as compared to $10.2
million for the year ended December 31, 1997. As a percentage of call and
subscription revenues, net interconnect charges have declined from 31% for the
year ended December 31, 1997 to 23% for the year ended December 31, 1998, due to
a higher proportion of local traffic as additional access lines are placed in
service plus a negotiated reduction in interconnect fees effective January 1,
1998. Based upon recent negotiations with MATAV and the Hungarian Ministry of
Telecommunications, the Company expects net interconnect, as a percentage of
call and subscription revenues, to decrease in 1999.
Connection fees for the year ended December 31, 1998 totaled $2.0
million as compared to $12.9 million for the year ended December 31, 1997. This
decrease reflects the reduction in the number of new access lines connected from
approximately 81,700 during the year ended December 31, 1997 to approximately
9,900 lines during the year ended December 31, 1998. Connection fees were
expected to decline substantially during the year as the majority of wait-listed
customers have been provided with access lines. The Company expects connection
fees to continue to decline as no significant backlog of wait-listed customers
exists.
Other operating revenues increased 100% to $3.6 million during the year
ended December 31, 1998 compared to $1.8 million during the year ended December
31, 1997 due to revenues generated from the provision of direct lines and
revenues generated from Lucent PBX sales and related maintenance services. The
Company does not expect as large of an increase in other operating revenues in
1999 as was experienced in 1998.
-28-
<PAGE>
Operating and Maintenance Expenses
Operating and maintenance expenses for the year ended December 31, 1998
decreased to $19.6 million compared to $25.0 million for the year ended December
31, 1997. On a per line basis, operating and maintenance expenses decreased to
approximately $110 per average access line for the year ended December 31, 1998
from $190 for the year ended December 31, 1997 as the Company achieved
productivity improvements, including discontinuing the use of labor intensive
manual switchboards through the use of modern switching technology, as well as
increased focus on reducing operating expenses. The Company does not expect
significant decreases in operating and maintenance expenses in 1999. However, on
a per line basis, operating and maintenance costs are expected to decline as
additional access lines are added during 1999.
Termination of Management Services Agreement
For the year ended December 31, 1998, the Company recorded a charge
totaling $11.1 million representing the present value of payments due to
Citizens International Management Services Company under a termination and
consulting agreement. See Note 14 of Notes to Consolidated Financial Statements.
Depreciation and Amortization
Depreciation and amortization charges increased to $11.6 million for
the year ended December 31, 1998 from $8.3 million for the year ended December
31, 1997. The Company expects depreciation and amortization charges in 1999 to
increase in functional currency terms due to additional capital expenditures in
its operating subsidiaries, however, in U.S. Dollar terms the Company expects
depreciation and amortization to remain consistent with 1998 amounts due to
devaluation of the operating subsidiaries' functional currency.
Management Fees
Management fees pursuant to management service agreements decreased to
$2.5 million for the year ended December 31, 1998 from $5.8 million for the year
ended December 31, 1997. This decrease was due to the termination of management
services agreement between the Company and Citizens International Management
Services Company. See Note 14 of Notes to Consolidated Financial Statements. The
Company does not have any continuing management services agreement.
Loss from Operations
Loss from operations increased to $6.1 million for the year ended
December 31, 1998 compared to $1.3 million for the year ended December 31, 1997.
Excluding the cost of terminating the management services agreement and
management fees, income from operations for the years ended December 31, 1998
and 1997 would have been $7.6 million and $4.5 million, respectively.
Contributing to such improvements were higher revenues and lower operating and
maintenance expenses during the year ended December 31, 1998 as compared to the
year ended December 31, 1997, offset by increased depreciation and amortization
charges during the year
Foreign Exchange Loss
Foreign exchange losses decreased to $0.2 million for the year ended
December 31, 1998 from $0.5 million for the year ended December 31, 1997. Such
foreign exchange losses resulted from the devaluation of the Hungarian Forint
against the U.S. Dollar and the German Mark.
-29-
<PAGE>
Interest Expense
Interest expense increased to $45.9 million for the year ended December
31, 1998 from $35.2 million for the year ended December 31, 1997. This increase
was attributable to higher average debt levels during the year ended December
31, 1998 as compared to the year ended December 31, 1997 as the Company incurred
additional indebtedness in order to continue the construction of its
telecommunications networks and repay other loan obligations. Interest
capitalized and included in the cost of construction of certain long term assets
amounted to approximately $0.3 million during 1998 and $4.5 million in 1997. As
stated above, the Company is presently in negotiations to restructure its
current debt agreements.
Other, net
Other, net income amounted to $0.8 million for the year ended December
31, 1998 as compared to $13,000 for the year ended December 31, 1997. This
increase during the year ended December 31, 1998 is due to an approximate $0.8
million gain realized related to the termination of the former management
services agreement between the Company and Citizens International Management
Services Company. Under such termination agreement, the Company satisfied its
obligations, under a previous management services agreement, of $9.6 million by
issuing 100,000 shares of Common Stock valued at $513,000 and a promissory note
in the amount of $8.4 million. See Note 14 of Notes to Consolidated Financial
Statements.
Net Loss
As a result of the factors discussed above, the Company recorded a net
loss of $50.6 million, or $9.53 per share, for the year ended December 31, 1998
as compared to a net loss of $36.2 million, or $7.97 per share, for the year
ended December 31, 1997.
Comparison of Year Ended December 31, 1997 to Year Ended December 31, 1996
Net Revenues
<TABLE>
<S> <C> <C>
Year ended
(dollars in millions) 1997 1996
Measured service revenues $ 26.2 $ 20.5
Subscription revenues 7.2 3.8
Net interconnect charges (10.2) (8.9)
------- -------
Net measured service and subscription revenues 23.2 15.4
Connection fees 12.9 4.1
Other operating revenues, net 1.8 1.4
------- -------
Telephone Service Revenues, Net $ 37.9 $ 20.9
======= =======
</TABLE>
The Company recorded an 81.3% increase in net telephone service
revenues to $37.9 million for the year ended December 31, 1997 from $20.9
million for the year ended December 31, 1996.
Net measured service and subscription revenues increased 50.7% to $23.2
million for the year ended December 31, 1997 from $15.4 million for the year
ended December 31, 1996. Measured service revenues increased 27.8% to $26.2
million in 1997 from $20.5 million in 1996 while subscription revenues increased
89.5% to $7.2 million in 1997 from $3.8 million in 1996. These increases in call
and subscription fee revenues are the result of a 74% increase in average access
lines in service from approximately 76,000 lines for the year ended December 31,
1996 to approximately 132,000 lines for the year ended December 31, 1997. In
addition, approximately 28,000 lines, representing 35% of the total increase in
access lines in 1997, were placed in service during the fourth quarter of 1997.
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<PAGE>
These revenues have been offset by net interconnect charges which
totaled $10.2 million for the year ended December 31, 1997 as compared to $8.9
million for the year ended December 31, 1996. As a percentage of call and
subscription revenues, net interconnect charges have declined from 37% for the
year ended December 31, 1996 to 31% for the year ended December 31, 1997, due to
a higher proportion of local traffic as additional access lines are placed in
service.
Connection fees for the year ended December 31, 1997 totaled $12.9
million as compared to $4.1 million for the year ended December 31, 1996. This
increase reflects the connection of 81,700 access lines during the year ended
December 31, 1997 as compared to the connection of 28,200 access lines during
the year ended December 31, 1996.
Other operating revenues increased 28.6% to $1.8 million during the
year ended December 31, 1997 compared to $1.4 million during the year ended
December 31, 1996 due to higher revenues from the provision of direct lines,
telephone leasing, PBX and telephone sales.
Operating and Maintenance Expenses
Operating and maintenance expenses for the year ended December 31, 1997
increased to $25.0 million compared to $22.0 million for the year ended December
31, 1996. On a per line basis, operating and maintenance expenses decreased to
approximately $190 per average access line for the year ended December 31, 1997
from $285 for the year ended December 31, 1996 as the Company achieved
productivity improvements, including the decreased use of labor intensive manual
switchboards and the increased use of modern switching technology.
Depreciation and Amortization
Depreciation and amortization charges increased to $8.3 million for the
year ended December 31, 1997 from $4.3 million for the year ended December 31,
1996. This increase was due to the substantial increase in property, plant and
equipment placed in service in 1997 as a result of the network construction
program.
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<PAGE>
Management Fees
Management fees pursuant to management service agreements decreased to
$5.8 million for the year ended December 31, 1997 from $6.9 million for the year
ended December 31, 1996. This decrease was due primarily to the termination of
certain management agreements with Tele Danmark in August 1996.
Asset Write-downs
During the year ended December 31, 1996, the Company recorded asset
write-downs totaling $2.0 million, which represented the decommissioning and
write-off of redundant assets as a result of the network construction in 1996.
Cost of Termination of Former Officers and Directors
During the year ended December 31, 1996, the Company recorded a charge
totaling $6.3 million representing the present value of payments due and options
granted to former executive officers and directors under separate termination
and release agreements, consulting agreements and noncompetition agreements.
Loss from Operations
Loss from operations decreased to $1.3 million for the year ended
December 31, 1997 from a loss from operations of $20.6 million for the year
ended December 31, 1996. Adjusted for asset write-downs and the cost of
termination of former officers and directors, the loss from operations totaled
$12.3 million for the year ended December 31, 1996. The decreasing operating
loss in 1997 was principally due to the additional revenue generated by the
network development program, offset by increases in operating and maintenance
and depreciation expenses.
Foreign Exchange Loss
Foreign exchange losses decreased to $0.5 million for the year ended
December 31, 1997 from $6.3 million for the year ended December 31, 1996. Such
foreign exchange losses resulted from the devaluation of the Hungarian Forint
against the U.S. Dollar and the German Mark. The decrease in the foreign
exchange loss is due to a significant reduction in debt and other obligations
denominated in U.S. Dollars and German Marks.
Interest Expense
Interest expense increased to $35.2 million for the year ended December
31, 1997 from $23.2 million for the year ended December 31, 1996. This increase
was attributable to higher average debt levels during the year ended December
31, 1997 as compared to the year ended December 31, 1996 as the Company incurred
additional indebtedness in order to fund construction of its telecommunications
networks. Interest capitalized and included in the cost of construction of
certain long term assets amounted to approximately $4.5 million during 1997 and
$2.1 million in 1996.
Included in interest expense in 1996 is $4.9 million, the value of
consideration provided to Citizens for assistance in fulfilling the Company's
obligations under the Citicorp Credit Facility (as defined herein). See Notes 5
and 14 of Notes to Consolidated Financial Statements.
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<PAGE>
Interest Income
Interest income decreased to $0.7 million for the year ended December
31, 1997 from $1.5 million for the year ended December 31, 1996. This decrease
is due to decreased average cash balances outstanding during 1997.
Abandonment of Financing
During the year ended 1996, the Company canceled a planned bond
offering in favor of a Hungarian Bank Credit Facility. The costs of abandonment
of financing were $3.0 million and included $2.0 million in settlement of fees
and costs of the underwriter and $1.0 million for professional fees and various
out of pocket expenses.
Other, net
Other, net income decreased to $13,000 for the year ended December 31,
1997 from $1.1 million for the year ended December 31, 1996 principally due to a
decrease in non-operating income and ancillary services.
Loss Before Extraordinary Items
As a result of the factors discussed above, the Company recorded a loss
before extraordinary items of $36.2 million, or $7.97 per share, for the year
ended December 31, 1997 compared to a loss before extraordinary items of $47.5
million, or $11.38 per share, for the year ended December 31, 1996.
Extraordinary Item
The Company did not record any extraordinary items in 1997 as compared
to the year ended December 31, 1996, during which the Company recorded an
extraordinary item of $7.3 million, $1.76 per share, comprised of a non-cash
charge of $8.2 million related to the write-off of the remaining unamortized
deferred financing costs pertaining to the Citizens Loan Agreements, offset by
extraordinary income of $0.9 million relating to a gain on early retirement of a
vendor credit facility. See Notes 5 and 14 of Notes to Consolidated Financial
Statements.
Net Loss
As a result of the factors discussed above, the Company recorded a net
loss of $36.2 million, or $7.97 per share, for the year ended December 31, 1997
as compared to a net loss of $54.8 million, or $13.14 per share, for the year
ended December 31, 1996.
Liquidity and Capital Resources
The Company has historically funded its capital requirements primarily
through a combination of debt, equity and vendor financing. The ongoing
development and installation of the network in each of the Company's operating
areas required significant capital expenditures ($171 million at historical
exchange rates through December 31, 1998). The Company's networks now have the
capacity, with some additional capital expenditures, to provide basic telephone
services to virtually all of the potential subscribers within its Operating
Areas.
In 1995 the Company entered into a financing agreement with Citizens
pursuant to which Citizens guaranteed a $33.2 million loan from Chemical Bank in
November 1995. During February and March 1996, the Company borrowed $18.2
million under a second financing agreement with Citizens.
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<PAGE>
On March 29, 1996, the Company entered into a $75.0 million Secured
Term Loan Credit Facility (the "Citicorp Credit Facility") and, together with
HTCC Consulting, a related Pledge and Security Agreement with Citicorp North
America, Inc. ("Citicorp"). On April 3, 1996, the Company used $50.8 million
from the Citicorp Credit Facility to repay all the funds advanced or guaranteed
by Citizens and Chemical Bank. As of such date, all loan agreements with
Citizens and Chemical Bank were terminated. Accordingly, in April 1996, the
Company incurred a non-cash charge of approximately $8.2 million representing
the remaining unamortized deferred financing costs pertaining to the loan
agreements with Citizens.
In order to meet contractual commitments pursuant to construction
contracts in addition to ongoing operating expenses, the Company used an
additional $24.0 million from the Citicorp Credit Facility.
On October 15, 1996, the Company entered into a $170 million 10-year
Multi-Currency Credit Facility with Postabank. Proceeds from the Postabank
Credit Facility may be drawn entirely in Hungarian Forints and up to 20% of the
principal may be drawn in U.S. Dollars through March 31, 1999. Drawdowns in
Hungarian Forints bear interest at a rate of 2.5% above the average of the yield
on six- and twelve-month discounted Hungarian treasury bills while drawdowns in
U.S. Dollars bear interest at 2.5% above LIBOR. Interest for the first two years
has been deferred at the Company's option. Amounts outstanding in Hungarian
Forints, including any deferred interest, are payable in 32 equal quarterly
installments beginning on March 31, 1999.
In October 1996, the Company borrowed the equivalent of $82.3 million
in Hungarian Forints under the Postabank Credit Facility. Approximately $75.2
million of this amount was used to repay Citicorp all funds advanced pursuant to
the Citicorp Credit Facility, as amended, and $2.0 million in fees and costs
representing settlement in connection with the cancellation of the Company's
proposed private placement of debt securities. The remaining $5.1 million was
used to pay management fees and reimbursable costs owed to Citizens pursuant to
the Management Services Agreement with Citizens. An additional $5.6 million of
the facility was used to pay loan origination fees and costs to Postabank under
the terms of the loan agreement, $2 million of which are being reimbursed to the
Company in equal quarterly installments over a two year period, and is being
amortized over the life of the loan facility. The remainder of the proceeds have
been used to complete construction of the Company's telecommunication networks,
provide additional working capital, and refinance or repay other existing debt
obligations. As of December 31, 1998, the Company had borrowed the entire $170
million under the Postabank Credit Facility.
In 1996, the Company's subsidiary Hungarotel entered into a $47.5
million construction contract for the construction of a telephone network with a
capacity of 40,000 lines in its Bekescsaba service area. Financing was provided
by the contractor for the full contract amount. The financing agreement requires
repayment in 20 quarterly installments commencing on March 31, 1998, with final
payment due December 31, 2002. Interest is charged at a variable rate computed
as the weighted average of the six and 12 month Hungarian National Treasury Bill
interest rate for each quarter plus 2.5%. The Company may elect, and has
elected, to defer repayment of 20% of the total debt repayments due in 1998 and
1999.
In 1995, the Company applied for network construction subsidies from
the Hungarian government. In December 1995, certain of the Company's
applications were approved, subject to certain conditions, which resulted in the
Company being awarded subsidies aggregating $0.9 million. The Company received
such subsidies in installments in the fourth quarter of 1996 and the first
quarter of 1997. One-half of such funds were received in the form of a grant and
one-half in the form of a non-interest bearing loan repayable over a three year
period beginning in 1997.
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<PAGE>
Net cash provided by operating activities totaled $11.1 million for the
year ended December 31, 1998 compared to $4.9 million for the year ended
December 31, 1997. For the years ended December 31, 1998 and 1997, the Company
used $15.6 million and $73.3 million, respectively, in investing activities,
which was primarily used to fund the construction of the Company's
telecommunications networks. Financing activities provided net cash of $9.3
million and $58.4 million for the years ended December 31, 1998 and 1997,
respectively.
Inflation and Foreign Currency
For the year ended December 31, 1998, inflation in Hungary was
approximately 12% on an annualized basis. It is the stated policy goal of the
Hungarian government to keep inflation from exceeding approximately 9% in 1999.
The Company's Hungarian operations generate revenues in Hungarian
Forints and incur operating and other expenses, including capital expenditures,
predominately in Hungarian Forints but also in U.S. Dollars. The Company's
resulting foreign currency exposure is difficult to hedge due to the significant
costs involved and the lack of a market for such hedging. In addition, certain
of the Company's balance sheet accounts are expressed in foreign currencies
other than the Hungarian Forint, the Company's functional currency. Accordingly,
when such accounts are converted into Hungarian Forints, the Company is subject
to foreign exchange gains and losses which are reflected as a component of net
income or loss. When the Company and its subsidiaries' Forint-denominated
accounts are translated into U.S. Dollars for financial reporting purposes, the
Company is subject to translation adjustments, the effect of which is reflected
as a component of stockholders' deficiency.
While the Company has the ability to increase the prices it charges for
its services commensurate with increases in the Hungarian Consumer Price Index
("CPI") pursuant to its licenses from the Hungarian government, it may choose
not to implement the full amount of the increase permitted due to competitive
and other concerns. In addition, the rate of increase in the Hungarian CPI may
be less than the rate at which the Hungarian Forint devalues. As a result, the
Company may be unable to generate cash flows to the degree necessary to meet its
obligation in currencies other than the Hungarian Forint.
Year 2000
In 1998 the Company initiated a project designed to identify and
mitigate Year 2000 computer deficiencies. The Company formed a Year 2K project
team (the "Project Team") with the mandate to identify problems, set
methodologies for resolution, and budget expenses all in order to minimize the
impact of any Y2K problems from the Company's computer systems.
The Project Team consists of employees from senior and mid-level
management from various business units within the Company. The Project Team also
includes several of the Company's computer technicians and representatives from
the systems' vendors. The Project Team has 10 permanent members from the Company
and 3 permanent members from the switching and billing system vendors. Other
vendors are consulted on an "as needed" basis. The Company also formed an
oversight committee comprised of senior management to oversee the Y2K issue.
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<PAGE>
The Project Team is examining the Company's telecommunications
networks, IT business systems, and miscellaneous support systems. These systems
include computers that support telephone services, bill production, customer
accounting, plant records, payroll, and a variety of systems such as air
conditioners and building entry systems. The project has five primary phases:
(I) inventory, (II) assessment, (III) remediation, (IV) testing and (V)
contingency planning and certification. Phase I is complete and consisted of the
development of a comprehensive working list which documents all software and
microprocessor reliant materials used by the Company to ensure that phase II
covers the entire population of potential Y2K issues. Phase II consisted of
evaluating the inventory list developed during Phase I and determining which
systems need replacement, modification or retirement during 1999. Phase II is
complete. Phase III is currently underway and consists of replacing those
hardware and software components identified as non-compliant and should be
completed by the middle of the second quarter 1999. At this time, some systems
have already been modified to make them Y2K compliant and other systems have
been placed on retirement schedules. Major switching components are scheduled
for replacement in April, May and June of this year. Phase IV will consist of
testing of existing and new hardware and software components and will be
completed during the second and third quarters of this year. Phase V consists of
developing a written plan for alternative methods of completing critical
processes should failure occur at the turn of the century. Contingency plans are
being developed currently for all systems. Written contingency plans will be
provided to the employees by September. The Company will begin awareness
campaigns to draw employee and customer attention to the potential problems
associated with Y2K by April 1, 1999.
The Company relies upon its network construction vendors to provide
compliant hardware and software. The Project Team believes that compliance of
the telephone switching systems and the automatic message accounting interface
with the billing system present the most significant Y2K exposure for the
Company. In cooperation with representatives from the switch manufacturers who
are active members of the Project Team, the Project Team has developed a plan
for Y2K Compliance of the switching systems. The switching system vendors have
provided the Company with delivery schedules that will bring the switching
systems into compliance by June of this year, at which time compliance
certificates will be issued by the vendors. Compliance of the switching systems
by June should allow sufficient time to test the switching/billing system
Automatic Message Accounting ("AMA") interface and allow problems to be solved
in a timely manner before the turn of the century.
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<PAGE>
The Company relies upon MATAV's telecommunication network for all
long-distance interconnections. Should MATAV's telephone switching systems be
non-Y2K compliant, the systems could fail resulting in lost revenue for the
Company. The Company is working directly with MATAV to reduce the risk of
failure. A member of the Project Team employed by one of the Company's
telecommunications switching vendors also sits on MATAV's Y2K committee and is
actively involved in the issue. The Company believes that no costs will be
incurred related to this matter. MATAV will also provide the Company with
certification for the 2MB backbone of the Company's internal wide area network.
The Company's recently implemented Billing and Customer Care system
(BACC) is Y2K compliant according to its vendor, representatives of which
participate on the Project Team. During phase IV of the program, beginning in
April, and following the upgrades of the Company's switching systems, the BACC
system will be fully tested in cooperation with the vendor to ensure Y2K
compliance has been reached. The vendor will issue a compliance certificate
following successful completion of these tests.
Various other IT systems have been identified to be replaced or
upgraded in association with the Company's efforts to become Y2K compliant. The
Company believes that all such systems will have completed all phases of the
project by the end of the third quarter of 1999. The Company maintains
approximately 2 million lines of computer code developed internally which will
be tested and modified by the end of the third quarter.
The Company currently estimates that the total costs of remediation
will be approximately $785,000, which includes the replacement and/or upgrade of
certain equipment. $630,000 of such cost will allow the Company to provide
additional services in addition to bringing the Company into Y2K compliance. At
this time, no material costs have been incurred for remediation of the Y2K
problem. It is expected that most costs will be incurred during the second and
third quarters of 1999. Management cannot provide assurance that the result of
the project or that the remediation costs will not be materially different from
estimates. Accordingly, contingency plans are currently being developed to
address high-risk systems. The contingency plans are expected to be in place by
the third quarter of 1999.
The Company is dependent on network switch manufacturers to provide
compliant hardware and software in a timely manner. Within IT, the Company is
dependent on the development of software by external experts, and the
availability of critical resources with the requisite skill sets. At worst case,
failure by the Company or by certain of its vendors to remediate Y2K compliance
issues could result in disruption of the Company's operations, possibly
impacting its telecommunication network and the Company's ability to bill and
collect revenues. However, management believes that this worst case scenario is
unlikely, and that its efforts to mitigate Y2K issues will be successful.
Prospective Accounting Pronouncements
In June 1998, Statement of Financial Account 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 does not
utilize derivative instruments and accordingly it is anticipated that the
adoption of SFAS 133 will not have a material impact on the Company's
consolidated financial position and results of operations.
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 is required to adopt both new statements
in the first quarter of 1999. The adoption of these statements is not expected
to have a material effect on the Company's consolidated financial statements.
Market Risk Exposure
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<PAGE>
The Company is exposed to various types of risk in the normal course
of its business, including the impact of foreign currency exchange rate
fluctuations and interest rate changes. Company operations, including all
revenues and approximately 75% of operational costs are Hungarian Forint based
and are therefore subject to exchange rate variability between the Hungarian
Forint and U.S. Dollar. This variability is mitigated by several factors,
including the Hungarian National Bank policy to peg the Hungarian Forint to a
currency basket and the telecommunications pricing law. The "crawling peg"
policy of the National Bank of Hungary maintains a scheduled daily devaluation
of the Hungarian Forint through a currency basket consisting of 70% Euros and
30% U.S. Dollars. The Hungarian Forint is allowed to trade within 2.25% of the
mid-point of this trading band. As of Mid-March 1999, the Hungarian government
devaluation policy is 0.6% per month, totaling approximately 7.4% for the year.
The telecommunications pricing law allows prices to increase by the Consumer
Price Index (CPI) adjusted for an efficiency factor of up to 2%. Thus, to the
extent that adjusted CPI follows devaluation, revenues are somewhat insulated
from exchange rate risk.
The debt obligations of the Company are primarily denominated in
Hungarian Forint. The interest rate on the Hungarian Forint debt obligations is
based on the weighted average of the Hungarian National Bank 6 month and 12
month Treasury Bill rates. Over the medium to long term, these rates are
expected to follow inflation and devaluation trends and the Company does not
currently believe it has any material interest rate risk on any of its debt
obligations. If a 1% change in interest rates were to occur, the Company's
interest expense would increase or decrease by approximately $2.25 million based
upon the Company's current debt level. However, should the Company refinance its
debt obligations in a currency other than the Hungarian Forint, exchange rate
risk could increase.
Item 8. Financial Statements and Supplementary Data
Reference is made to the Consolidated Financial Statements of the
Company, beginning with the index thereto on page F-1.
Item 9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
During the three fiscal years ended December 31, 1998, the Company was
not involved in any disagreement with its independent certified public
accountants on accounting principles or practices or on financial statement
disclosure.
PART III
Item 10. Directors and Executive Officers of the Registrant
There is incorporated in this Item 10 by reference the information
appearing under the captions "Election of Directors - Nominees for Director,"
"Executive Officers Who Are Not Directors" and "- Section 16(a) Beneficial
Ownership Reporting Compliance" in the Company's definitive proxy statement for
the 1999 Annual Meeting of Stockholders, a copy of which will be filed not later
than 120 days after the close of the fiscal year.
Item 11. Executive Compensation
There is incorporated in this Item 11 by reference the information
appearing under the caption "Election of Directors" in the Company's definitive
proxy statement for the 1999 Annual Meeting of Stockholders, a copy of which
will be filed not later than 120 days after the close of the fiscal year.
Item 12. Security Ownership of Certain Beneficial Owners and Management
There is incorporated in this Item 12 by reference the information
appearing under the captions "Introduction - Stock Ownership of Certain
Beneficial Owners," "- Stock Ownership of Management," and "- Potential Change
in Control," and "Election of Directors - Nominees for Director" in the
Company's definitive proxy statement for the 1999 Annual Meeting of
Stockholders, a copy of which will be filed not later than 120 days after the
close of the fiscal year.
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<PAGE>
Item 13. Certain Relationships And Related Transactions
There is incorporated in this Item 13 by reference the information
appearing under the caption "Election of Directors - Certain Relationships and
Related Party Transactions," and "- Indebtedness of Management" in the Company's
definitive proxy statement for the 1999 Annual Meeting of Stockholders, a copy
of which will be filed not later than 120 days after the close of the fiscal
year.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) List of Financial Statements
Reference is made to the index on page F-1 for a list of all
financial statements filed as part of this Form 10-K.
(a)(2) List of Financial Statement Schedules
Reference is made to the index on page F-1 for a list of all
financial statement schedules filed as part of this Form 10-K.
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<PAGE>
(a)(3) List of Exhibits
Exhibit
Number Description
2 Plan of acquisition, reorganization, arrangement, liquidation
or succession (None)
3(i) Certificate of Incorporation of the Registrant, as amended,
filed as Exhibit 4.1 to the Registrant's Registration
Statement on Form S-8 filed on June 24, 1997 and incorporated
herein by reference
3(ii) By-laws of the Registrant, as amended, filed as Exhibit 4.2 to
the Registrant's Registration Statement on Form S-8 filed on
June 24, 1997 and incorporated herein by reference
4 Specimen Common Stock Certificate, filed as Exhibit 4(a)
to the Registrant's Registration Statement on Form SB-2 filed
on October 20, 1992
9 Voting trust agreement (None)
10 Material contracts:
10.1 Concession Agreement dated May 10, 1994 between the Ministry
of Transportation, Telecommunications and Water Management of
the Republic of Hungary and Raba-Com Rt., filed as Exhibit
10(y)(y) to the Registrant's Current Report on Form 8-K for
February 28, 1994 and incorporated herein by reference
10.2 Concession Agreement dated May 10, 1994 between the Ministry
of Transportation, Telecommunications and Water Management of
the Republic of Hungary and Kelet-Nograd Com Rt., filed as
Exhibit 10(z)(z) to the Registrant's Current Report on Form
8-K for February 28, 1994 and incorporated herein by reference
10.3 English translation of Amended and Restated Concession
Contract between Papa es Tersege Telefon Koncesszios Rt. and
the Hungarian Ministry for Transportation, Telecommunications
and Water Management dated as of June 3, 1996, filed as
Exhibit 10.78 to the Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1996 and incorporated
herein by reference
10.4 English translation of Amended and Restated Concession
Contract between Hungarotel Tavkozlesi Rt. and the Hungarian
Ministry for Transportation, Telecommunications and Water
Management dated as of June 3, 1996 (Oroshaza), filed as
Exhibit 10.79 to the Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1996 and incorporated
herein by reference
10.5 English translation of Amended and Restated Concession
Contract between Hungarotel Tavkozlesi Rt. and the Hungarian
Ministry for Transportation, Telecommunications and Water
Management dated as of June 3, 1996 (Bekescsaba), filed as
Exhibit 10.80 to the Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1996 and incorporated
herein by reference
10.6 English translation of Construction Contract between Papa es
Tersege Telefon Koncesszios Rt. and Fazis Telecommunications
System Design and Construction Corporation dated May 10, 1996,
filed as Exhibit 10.74 to the Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1996 and incorporated
herein by reference
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<PAGE>
Exhibit
Number Description
10.7 English translation of Construction Contract between
Hungarotel Tavkozlesi Rt. and Ericsson Kft. dated May 17,
1996. (as amended), filed as Exhibit 10.75 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September
30, 1996 and incorporated herein by reference
10.8 English translation of Construction Contract between Papa es
Tersege Telefon Koncesszios Rt. and Ericsson Kft. dated May
31, 1996, filed as Exhibit 10.76 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1996 and
incorporated herein by reference
10.9 English translation of Construction Contract between
Hungarotel Tavkozlesi Rt. and Fazis Telecommunications System
Design and Construction Corporation dated June 28, 1996, filed
as Exhibit 10.77 to the Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1996 and incorporated
herein by reference
10.10 Non-Employee Director Stock Option Plan dated as of February
6, 1997, filed as Exhibit 10.91 to the Registrant's Form 10-K
for the fiscal year ending December 31, 1996 and incorporated
herein by reference
10.11 1992 Incentive Stock Option Plan of the Registrant, as
amended, filed as Exhibit 4.3 to the Registrant's Form S-8
filed on June 24, 1997 and incorporated herein by reference
10.12 Employment Agreement dated December 4, 1998 between the
Registrant and Ole Bertram.
10.13 Termination and Release Agreement dated as of July 26, 1996
between the Registrant and Robert Genova, filed as Exhibit
10.62 to the Registrant's Current Report on Form 8-K for July
26, 1996 and incorporated herein by reference
10.14 Consulting Agreement dated as of July 26, 1996 between the
Registrant and Robert Genova, filed as Exhibit 10.63 to the
Registrant's Current Report on Form 8-K for July 26, 1996
and incorporated herein by reference
10.15 Noncompetition Agreement dated as of July 26, 1996 between the
Registrant and Robert Genova, filed as Exhibit 10.64 to the
Registrant's Current Report on Form 8-K for July 26, 1996
and incorporated herein by reference
10.16 Irrevocable Proxy dated July 26, 1996 executed by Robert
Genova appointing Hungarian Telephone and Cable Corp. as his
proxy, filed as Exhibit 10.65 to the Registrant's Current
Report on Form 8-K for July 26, 1996 and incorporated herein
by reference
10.17 Termination and Release Agreement dated as of July 26, 1996
between the Registrant and Frank R. Cohen, filed as Exhibit
10.66 to the Registrant's Current Report on Form 8-K for July
26, 1996 and incorporated herein by reference
10.18 Consulting Agreement dated as of July 26, 1996 between the
Registrant and Frank R. Cohen, filed as Exhibit 10.67 to the
Registrant's Current Report on Form 8-K for July 26, 1996
and incorporated herein by reference
-41-
<PAGE>
Exhibit
Number Description
10.19 Noncompetition Agreement dated as of July 26, 1996 between the
Registrant and Frank R. Cohen, filed as Exhibit 10.68 to the
Registrant's Current Report on Form 8-K for July 26, 1996
and incorporated herein by reference
10.20 Irrevocable Proxy dated July 26, 1996 executed by Frank R.
Cohen appointing Hungarian Telephone and Cable Corp. as his
proxy, filed as Exhibit 10.69 to the Registrant's Current
Report on Form 8-K for July 26, 1996 and incorporated herein
by reference
10.21 Termination and Release Agreement dated as of July 26, 1996
between the Registrant and Donald K. Roberton, filed as
Exhibit 10.70 to the Registrant's Current Report on Form 8-K
for July 26, 1996 and incorporated herein by reference
10.22 Consulting Agreement dated as of July 26, 1996 between the
Registrant and Donald K. Roberton, filed as Exhibit 10.71 to
the Registrant's Current Report on Form 8-K for July 26,
1996 and incorporated herein by reference
10.23 Noncompetition Agreement dated as of July 26, 1996 between the
Registrant and Donald K. Roberton, filed as Exhibit 10.72 to
the Registrant's Current Report on Form 8-K for July 26, 1996
and incorporated herein by reference
10.24 Irrevocable Proxy dated July 26, 1996 executed by Donald K.
Roberton appointing Hungarian Telephone and Cable Corp. as his
proxy, filed as Exhibit 10.73 to the Registrant's Current
Report on Form 8-K for July 26, 1996 and incorporated herein
by reference
10.25 Stock Purchase Agreement dated as of July 1, 1997 between the
Registrant and Tele Danmark A/S, filed as Exhibit 10.96 to the
Registrant's Current Report on Form 8-K for July 1, 1997 and
incorporated herein by reference
10.26 Stock Purchase Agreement dated as of September 30, 1997
between the Registrant and Tele Danmark A/S filed as Exhibit
10.97 to the Registrant's Current Report on Form 8-K for
September 30, 1997 and incorporated herein by reference
10.27 Exchange Agreement dated as of September 30, 1997 between the
Registrant and Tele Danmark A/S, filed as Exhibit 10.98 to the
Registrant's Current Report on Form 8-K for September 30, 1997
and incorporated herein by reference
10.28 Multi-Currency Credit Facility among Postabank Rt., as Lender,
the Registrant, as Guarantor, HTCC Consulting Rt., Hungarotel
Tavkozlesi Rt., Kelet-Nograd Com Rt. and Papa es Tersege
Telefon Koncesszios Rt. and Raba Com Rt., as Borrowers entered
into as of October 15, 1996, filed as Exhibit 10.84 to the
Registrant's Current Report on Form 8-K for October 15, 1996
and incorporated herein by reference
10.29 Form of Loan Agreement entered into as of October 15, 1996
among Postabank Rt., as Lender, the Registrant, as Guarantor,
and each of certain subsidiaries, as Borrowers, filed as
Exhibit 10.85 to the Registrant's Current Report on Form 8-K
for October 15, 1996 and incorporated herein by reference
-42-
<PAGE>
Exhibit
Number Description
10.30 Form of Mortgage and Pledge Agreement Securing Bank Loan
entered into as of October 15, 1996 between Postabank Rt. and
each of certain subsidiaries, filed as Exhibit 10.86 to the
Registrant's Current Report on Form 8-K for October 15, 1996
and incorporated herein by reference
10.31 Form of Security Agreement entered into as of October 15, 1996
among Postabank Rt., as the secured party, ABN AMRO Rt., as
the Escrow Agent, and the Registrant and HTCC Consulting Rt.,
as the pledgors, filed as Exhibit 10.87 to the Registrant's
Current Report on Form 8-K for October 15, 1996 and
incorporated herein by reference
10.32 Registration Agreement, dated May 31, 1995, between the
Registrant and CU CapitalCorp., filed as Exhibit 10(f)(f) to
the Registrant's Current Report on Form 8-K for May 31, 1995
and incorporated herein by reference
10.33 Replacement and Termination Agreement, dated as of September
30, 1998, between the Registrant and Citizens International
Management Services Company and CU CapitalCorp. filed as
Exhibit 10.69 to the Registrant's Current Report on Form 8-K
for September 30, 1998 and incorporated herein by reference
10.34 Form of Promissory Note dated September 30, 1998 issued by the
Registrant payable to Citizens International Management
Services Company filed as Exhibit 10.70 to the Registrant's
Current Report on Form 8-K for September 30, 1998 and
incorporated herein by reference
10.35 Amended, Restated and Consolidated Stock Option Agreement
dated as of September 30, 1998, between the Registrant and CU
CapitalCorp. filed as Exhibit 10.71 to the Registrant's
Current Report on Form 8-K for September 30, 1998 and
incorporated herein by reference
11 Statement re computation of per share earnings (not required)
12 Statement re computation of ratios (not required)
13 Annual report to security holders (not required)
16 Letter re change in certifying accountant (not required)
18 Letter re change in accounting principles (None)
21 Subsidiaries of the Registrant, filed as Exhibit 21 to the
Registrant's Form 10-K for the fiscal year ending December 31,
1997 and incorporated herein by reference
22 Published report regarding matters submitted to vote of
security holders (not required)
23 Consents of experts and counsel (not required)
24 Power of Attorney (not required)
27.1 Financial Data Schedule
-43-
<PAGE>
(b) Reports on Form 8-K
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized, on March 29, 1999.
HUNGARIAN TELEPHONE AND CABLE CORP.
(Registrant)
By /s/ Ole Bertram
Ole Bertram
President and Chief Executive Officer,
Director
Pursuant to the requirements of the Securities Exchange of 1934, this
Report has been signed below by the following persons and on behalf of the
Registrant and in the capacities indicated as of March 29, 1999.
Signature/Name Title
/s/Francis J. Busacca, Jr. Executive Vice President - Chief Financial Officer
Francis J. Busacca, Jr. (Principal Financial Officer)
/s/William T. McGann Treasurer and Controller
William T. McGann (Chief Accounting Officer)
/s/David A. Finley Director, Chairman of the Board
David A. Finley
/s/Daryl A. Ferguson Director
Daryl A. Ferguson
/s/Torben V. Holm Director
Torben V. Holm
-44-
<PAGE>
Signature/Name Title
/s/John B. Ryan Director
John B. Ryan
Director
Finn Schkolnik
/s/James H. Season Director
James H. Season
/s/William E. Starkey Director
William E. Starkey
/s/Leonard Tow Director
Leonard Tow
-45-
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Index to Consolidated Financial Statements
The following information is included on the pages indicated:
Consolidated Financial Statements: Page
Independent Auditor's Report F-2
Consolidated Balance Sheets F-3
Consolidated Statements of Operations and Comprehensive Loss F-4
Consolidated Statements of Stockholders' (Deficiency) F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-7 - F-32
Financial Statements Schedules:
All financial statement schedules are omitted as the required information
is not applicable or the information is presented in the consolidated financial
statements or related notes.
F-1
<PAGE>
Independent Auditors' Report
The Board of Directors and Stockholders
Hungarian Telephone and Cable Corp.
We have audited the accompanying consolidated balance sheets of Hungarian
Telephone and Cable Corp. and subsidiaries as of December 31, 1998 and 1997, and
the related consolidated statements of operations and comprehensive loss,
stockholders' deficit 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 Hungarian Telephone
and Cable Corp. 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 1 to the
consolidated financial statements, the Company has suffered recurring losses
from operations, has a net capital deficiency and a working capital deficiency,
and does not presently have sufficient funds on hand to meet its current debt
service obligations. These factors raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans in regard to these
matters are described in Note 1. The consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
KPMG LLP
New York, New York
March 24, 1999
F-2
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1998 and 1997
(In thousands, except share data)
<TABLE>
<S> <C> <C>
Assets 1998 1997
------ ---- ----
Current assets:
Cash $ 8,489 4,031
Restricted cash 64 536
Accounts receivable, net of allowance
of $962 in 1998 and $540 in 1997 6,703 9,437
VAT receivable, net - 2,641
Inventories 1,111 1,231
Prepayments and other current assets 187 2,146
--------- ---------
Total current assets 16,554 20,022
Property, plant and equipment, net 136,489 138,885
Goodwill, net of accumulated amortization
of $1,303 in 1998 and $1,011 in 1997 10,000 11,299
Other intangibles, net of accumulated amortization
of $1,238 in 1998 and $670 in 1997 5,592 6,168
Other assets 8,432 10,111
--------- ---------
Total assets $ 177,067 186,485
======= ========
Liabilities and Stockholders' Deficiency
Current liabilities:
Current installments of long-term debt $ 31,804 7,489
Accounts payable 2,061 7,996
Accruals 3,552 4,364
Other current liabilities 932 1,040
Due to related parties 1,011 7,932
--------- ---------
Total current liabilities 39,360 28,821
Long-term debt, excluding current installments 202,881 194,537
Due to related parties 22,372 3,476
Deferred credits and other liabilities 1,491 1,488
--------- ---------
Total liabilities 266,104 228,322
--------- ---------
Stockholders' deficiency:
Common stock, $.001 par value. Authorized
25,000,000 shares; issued 5,395,864
in 1998 and 5,235,370 in 1997 5 5
Additional paid-in capital 71,467 70,772
Accumulated deficit (167,809) (117,197)
Accumulated other comprehensive income 7,300 4,964
Deferred compensation - (381)
--------- ---------
Total stockholders' deficiency (89,037) (41,837)
--------- ---------
Total liabilities and stockholders' deficiency $ 177,067 186,485
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Loss
Years ended December 31, 1998, 1997 and 1996
(In thousands, except share and per share data)
<TABLE>
<S> <C> <C> <C>
1998 1997 1996
---- ---- ----
Telephone services revenues, net $ 38,707 37,891 20,910
----------- ---------- ----------
Operating expenses:
Operating and maintenance expenses 19,575 25,044 22,011
Depreciation and amortization 11,560 8,349 4,270
Management fees 2,500 5,761 6,917
Termination of management
services agreement 11,131 - -
Termination of former officers and directors - - 6,260
Asset write-downs - - 2,005
----------- ---------- ----------
Total Operating Expenses 44,766 39,154 41,463
----------- ---------- ----------
Loss from operations (6,059) (1,263) (20,553)
Other income (expenses):
Foreign exchange losses (230) (517) (6,278)
Interest expense (45,856) (35,159) (23,240)
Interest income 686 690 1,488
Costs of abandoned financing - - (2,985)
Other, net 847 13 1,123
----------- ---------- ----------
Loss before minority interest (50,612) (36,236) (50,445)
Minority interest - - 2,994
----------- ---------- ----------
Loss before extraordinary item (50,612) (36,236) (47,451)
Extraordinary item, net - - (7,318)
----------- ---------- -----------
Net loss $ (50,612) (36,236) (54,769)
Comprehensive income 2,336 6,458 887
----------- ---------- ----------
Comprehensive loss $ (48,276) (29,778) (53,882)
============= =========== ===========
Loss per common share - basic:
Before extraordinary item $ (9.53) (7.97) (11.38)
Extraordinary item $ - - (1.76)
----------- ---------- ----------
Net loss $ (9.53) (7.97) (13.14)
=========== ========== ==========
Weighted average number of
Common shares outstanding - basic and diluted 5,309,985 4,546,163 4,169,532
=========== ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Deficiency
Years ended December 31, 1998, 1997 and 1996
(In thousands, except share data)
<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C>
Accumulated
Additional Other Total
Common Paid-in Accumulated Comprehensive Deferred Stockholders'
Shares Stock Capital Deficit Income Compensation Deficiency
- --------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1995 4,015,039 $ 4 45,358 (26,192) (2,381) (1,050) $ 15,739
Common stock issuance 250,000 3,219 3,219
Exercise of options and warrants 8,016 81 81
Cancellation of shares (101,429) (1,775) (1,775)
Options granted in connection
with termination agreement 1,125 1,125
Options issued and extended as
consideration for financial support 11,218 11,218
Shares issued as compensation 8,000 101 101
Earned compensation 384 384
Foreign currency translation adjustment 887 887
Net loss (54,769) (54,769)
- --------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1996 4,179,626 $ 4 59,327 (80,961) (1,494) (666) $(23,790)
Exercise of options and warrants 81,586 635 635
Shares issued as compensation 5,000 52 52
Options issued to officers 70 70
Shares issued to Tele Danmark A/S 969,158 1 10,688 10,689
Earned compensation 285 285
Foreign currency translation adjustment 6,458 6,458
Net loss (36,236) (36,236)
- --------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1997 5,235,370 $ 5 70,772 (117,197) 4,964 (381) $(41,837)
Earned compensation 125 125
Cancellation of shares (25,000) (256) 256 -
Exercise of options and warrants 56,400 224 224
Shares issued as compensation 10,625 93 93
Shares issued to Citizens 100,000 513 513
Shares issued as contingent consideration
relating to former acquisitions 18,469 - -
Options granted in connection with
termination agreement 121 121
Net loss (50,612) (50,612)
Foreign currency translation adjustment 2,336 2,336
- --------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1998 5,395,864 $ 5 71,467 (167,809) 7,300 - $(89,037)
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 1998, 1997 and 1996
(In thousands)
<TABLE>
<S> <C> <C> C>
1998 1997 1996
---- ---- ----
Net cash provided by (used in) operating activities $ 11,118 4,937 (35,841)
--------- -------- ---------
Cash flows from investing activities:
Acquisition and construction of
telecommunications networks (16,451) (83,055) (49,086)
Decrease (increase) in construction deposits 520 9,780 (7,466)
Other 301 - 136
--------- -------- ---------
Net cash used in investing activities (15,630) (73,275) (56,416)
---------- -------- ---------
Cash flows from financing activities:
Borrowings under long-term debt agreement 16,099 72,064 132,307
Proceeds from short-term loans - - 108,729
Proceeds from exercise of options and warrants 224 635 81
Repayment of long-term debt (7,048) (14,326) (9,026)
Repayment of short-term loans - - (142,607)
Repayment of notes payable - - (300)
--------- -------- ----------
Net cash provided by financing activities 9,275 58,373 89,184
--------- -------- ---------
Effect of foreign exchange rate changes on cash (305) (1,880) 2,757
---------- --------- ---------
Net increase (decrease) in cash 4,458 (11,845) (316)
Cash at beginning of year 4,031 15,876 16,192
--------- -------- ---------
Cash at end of year $ 8,489 4,031 15,876
========= ======== =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(1) Summary of Significant Accounting Policies
(a) Description of Business
Hungarian Telephone and Cable Corp. was organized on March 23,
1992 to own and manage telecommunications companies in Hungary.
Four subsidiaries of the Company are presently engaged in
the ownership, construction and operation of public switched
telephone service.
The Company, through two of its subsidiaries, commenced operations
in two concession regions in 1995 and through two other
subsidiaries, commenced operations in three additional concession
areas effective January 1, 1996. Accordingly, the Company devoted
substantially all of its efforts through 1994 and a considerable
portion of 1995 to obtaining concession rights, negotiating
acquisitions, raising capital in the form of debt and equity and
preparing to commence operations. As a result, the Company
recognized no revenues until 1995.
Since 1995 and into 1998, the Company's activities have involved
the acquisition of the concessions and telecommunications networks
from MATAV and the subsequent design, development and construction
of the modern telecommunications infrastructure that the Company
now has in service. The Company paid the Ministry $11.5 million
(at historical exchange rates) for its concessions, spent
approximately $23.2 million (at historical exchange rates) to
acquire the existing telecommunications assets in its Operating
Areas from MATAV, and spent $171 million through December 31, 1998
(at historical exchange rates) on the development and construction
of its telecommunications infrastructure. The Company funded these
costs and working capital needs primarily through the $170 million
Postabank Credit Facility and a $47.5 million contractor financing
facility. The Company and the Hungarian contractor which granted
the contractor financing facility have a disagreement with respect
to several issues relating to the quality and quantity of the work
done by the contractor. During 1998 the Company and the contractor
engaged in settlement discussions but were unable to reach a
settlement. The Company is currently reviewing its options with
respect to this dispute. The Company made the required principal
and interest payments under the contractor financing facility
during 1998. See Note 9(e).
The first installment of the repayment of the Postabank Credit
Facility is due on March 31, 1999. To date, the Company has
suffered from recurring losses from operations and has a working
capital deficiency and a net capital deficiency. The Company does
not presently have sufficient funds on hand to pay the first
installment on the Postabank Credit Facility. Under the Postabank
Credit Facility, a failure to pay any installment constitutes an
"Event of Default". Upon notice to the Company of an Event of
Default, the Company is entitled to the benefit of a 60 day cure
period. If such Event of Default is not cured within 60 days,
Postabank could declare all amounts outstanding under the
Postabank Credit Facility due and payable upon 60 days notice.
The Company, with assistance from its financial advisors, is
currently in negotiations with Postabank and its financial
advisors regarding a restructuring of the Company's obligations
with the goal of reducing the Company's cash repayment obligations
so that the Company can sufficiently fund its working capital
requirements, capital expenditures and meet its financing
F-7
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
obligations with cash flows from operations. The Company is also
reviewing various other financing alternatives with several
entities. While the result of such negotiations and the
availability of alternative sources of financing cannot be
predicted with certainty, the Company believes that it will be
able to resolve its financial issues so that it will be able to
meet its obligations during 1999. However, there can be no
assurance that the Company will be able to resolve these issues on
commercially reasonable terms, or at all. Such negotiations and/or
discussions could result in the issuance of equity and/or debt
securities of the Company or one or more of the Operating
Companies. In addition, the Company relies on its ability to
generate cash from operations which is dependent upon the
Company's ability to attract additional customers and revenues per
customer. These factors are expected to be primarily influenced by
the success of the Company's operating and marketing strategies as
well as market acceptance of the Company's services.
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.
The Company has granted various options to purchase the Company's
Common Stock, including those previously granted to Citizens, and
has provided certain preemptive rights to Citizens and Tele
Danmark. For the term of these options, the holders will have the
opportunity to exercise and dilute the interests of other security
holders or, in the case of Citizens, acquire a controlling
interest in the Company. As long as these options remain
unexercised, the Company's ability to obtain additional equity
capital may be adversely affected.
(b) Principles of Consolidation and the Use of Estimates
The consolidated financial statements include the financial
statements of the Company and its majority owned subsidiaries;
Kelet-Nograd Com Rt., ("KNC"), Raba-Com Rt., ("Raba-Com"),
Hungarotel Tavkozlesi Rt. ("Hungarotel"), Papa es Tersege Telefon
Koncesszios Rt. ("Papatel"), HTCC Consulting Rt. ("HTCC
Consulting") and Pilistav Rt. ("Pilistav"). All material
intercompany balances and transactions have been eliminated.
Investments in affiliates representing less than 50% ownership,
and in which the Company exercises significant influence, are
accounted for using the equity method.
The consolidated financial statements are prepared in accordance
with U.S. generally accepted accounting principles (U.S. GAAP). In
preparing financial statements in conformity with U.S. GAAP,
management is required to make estimates and assumptions that
affect reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the
financial statements and revenue and expenses during the reporting
period. Actual results could differ from those estimates.
(c) Revenue Recognition
Telephone service revenues are recognized when earned and are
primarily derived from usage of the Company's local exchange
networks and facilities or under revenue sharing agreements with
the former state controlled monopoly telephone company which is
MATAV, the international and national long distance interconnect
service provider.
F-8
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
Advance subscriber payments represent advance connection fees
received from telephone subscribers and are recognized as income
when the subscriber is connected to the telephone network. Advance
fees received are required to be repaid with interest if the
subscriber is not connected to the local telephone network.
(d) Foreign Currency Translation
The statutory accounts of the Company's consolidated subsidiaries
and affiliates 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, "Accounting for Foreign Currency Translation" ("SFAS 52").
Since commencement of revenue generating activities, the Company
has used the Hungarian Forint ("HUF") as the functional currency
for its majority owned Hungarian subsidiaries. Accordingly,
foreign currency assets and liabilities are translated using the
exchange rates in effect at the balance sheet date. Results of
operations are generally translated using the average exchange
rates prevailing throughout the year. The effects of exchange rate
fluctuations on translating foreign currency assets and
liabilities into U.S. dollars are accumulated as part of other
comprehensive income in stockholders' equity. Foreign exchange
fluctuations related to intercompany balances are included in
equity if such balances are intended to be long-term in nature. At
the time the Company settles such balances, the resulting gain or
loss is reflected in the consolidated statement of operations.
Gains and losses from foreign currency transactions are included
in net loss in the period in which they occur.
(e) Cash Equivalents
For the purposes of the consolidated statements of cash flows, the
Company considers all highly liquid debt instruments purchased
with a maturity of three months or less to be cash equivalents.
(f) Inventories
Inventories consist primarily of telephones for resale and spare
parts and are stated at the lower of cost or market.
(g) Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation is
computed using the straight-line method over the estimated useful
lives of the respective assets.
(h) Intangible Assets
Intangible assets are comprised of concession fees paid and the
excess of cost over net assets acquired. The concession fees are
being amortized over the 25-year concession period using the
straight-line method. Excess of cost over net assets acquired is
also amortized over 25 years using the straight-line method.
F-9
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(i) Stock Based Compensation
The Company accounts for its stock option plans in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 123 which
allows entities to continue to apply the provisions of Accounting
Principles Board ("APB") Opinion No. 25 and provide pro forma net
income and pro forma earnings per share disclosures for employee
stock option grants made in 1995 and future years as if the
fair-value-based method, as defined in SFAS No. 123, had been
applied. The Company has elected to apply the provisions of APB
Opinion No. 25 and provide the pro forma disclosure required by
SFAS No. 123. See Note 11.
(j) Income Taxes
Deferred tax assets and liabilities, net of appropriate valuation
allowances, are recognized for the future tax consequences
attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit
carry-forwards. Deferred tax assets and liabilities, if any, are
measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
The Company's Hungarian operating subsidiaries are 100% exempt
from Hungarian income tax for a period of five years beginning
from January 1, 1994 and 60% exempt for the subsequent five years
as long as (1) capitalization stays above 50,000,000 HUF
(approximately $231,000 at December 31, 1998 exchange rates), (2)
foreign ownership exceeds 30% of the registered capital, and (3)
more than 50% of the revenue earned arises from telecommunication
services.
(k) Net Loss Per Share
Basic earnings per share ("EPS") is computed by dividing income or
loss attributable to common stockholders by the weighted average
number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution from the exercise or conversion of
securities into common stock.
Net loss and weighted average shares outstanding used for
computing diluted loss per common share were the same as that used
for computing basic loss per common share for each of the years
ended December 31, 1998, 1997 and 1996.
The Company had potentially dilutive common stock equivalents of
7,474,915, 7,200,859 and 5,627,775 for the years ended December
31, 1998, 1997 and 1996, respectively, which were not included in
the computation of diluted net loss per common share because they
were antidilutive for the periods presented.
(l) Impairment of Long-Lived Assets and Long-Lived Assets to Be
Disposed Of
Long-lived assets and certain identifiable intangibles are
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
recognized is measured by the amount by which the carrying amount
of the assets exceed 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.
F-10
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(m) Reclassifications
Certain amounts from 1997 and 1996 have been reclassified to
conform with the 1998 presentation.
(2) Acquisitions
On August 31, 1995, the Company acquired 45.12% of the outstanding Common
Stock and voting rights to an additional 6% of the outstanding Common
Stock of Papatel and 65% of the outstanding Common Stock and the right to
acquire a further 20% of Hungarotel from Alcatel Austria AG, US Telecom
East, Inc. and Central Euro TeleKom, Inc. ("CET") for 571,429 shares of
its Common Stock (subject to reduction based upon certain post-closing
purchase price adjustments). The value of the Common Stock issued in the
exchange was $10,000,000, however, pending resolution of the potential
post-closing adjustments, the Common Stock was not delivered. In
September 1995, the Company entered into agreements with MATAV to acquire
25.01% of the outstanding Common Stock of Papatel for $925,000, and
Microsystem Telecom Rt. and V.P. Consulting Kft. to acquire 9.19% of the
Common Stock and dividend rights to another 6% of the Common Stock of
Papatel for a purchase price of $300,000. These acquisitions resulted in
a total purchase price of $11,225,000 for 79.24% of Papatel and 65% of
Hungarotel.
On March 13, 1996, the Company acquired the remaining 35% of Hungarotel
for $330,000 in cash and adjusted the minority interest and intangible
assets acquired.
On May 21, 1996, the Company and CET entered into a Settlement Agreement
whereby the number of shares to be issued to CET in connection with the
acquisitions of Hungarotel and Papatel was reduced based upon certain
post-closing purchase price adjustments. Pursuant to the Settlement
Agreement, the number of shares was reduced by 101,429. The reduction in
purchase price of approximately $1.8 million was reflected as a reduction
of goodwill and a reduction of Common Stock and additional paid-in
capital. Additionally, in May 1996, Papatel entered into a settlement
agreement with a contractor for pre-acquisition claims for approximately
$0.7 million more than the amount recorded at acquisition. The Company
recorded this excess as an increase in goodwill.
Contingent consideration for the acquisition of Hungarotel and Papatel in
the form of Common Stock was payable in the event that the average
trading price for the Company's Common Stock during the twenty (20)
trading days preceding August 31, 1998 was less than $17.50 per share. On
August 31, 1998, the Company issued an additional 18,469 shares as
contingent consideration under the terms of the acquisition agreement.
(3) Cash and Restricted Cash
(a) Concentration
At December 31, 1998, cash of $8,173,000 ($317,000 denominated in
U.S. dollars and the equivalent of $7,856,000 denominated in
Hungarian Forints) was on deposit with banks in Hungary. In
addition, cash of $316,000 denominated in U.S. dollars was on
deposit with two major banks in the United States.
F-11
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(b) Restriction
At December 31, 1998, $22,000 of cash denominated in U.S. dollars
was deposited in escrow accounts under terms of construction
contracts. In addition, $42,000 was restricted pursuant to certain
arrangements with other parties.
(4) Property, Plant and Equipment
The components of property, plant and equipment at December 31, 1998 and
1997 are as follows:
<TABLE>
<S> <C> <C> <C>
1998 1997 Estimated Useful Lives
(in thousands)
Land and Buildings $ 7,402 5,629 25 to 50 years
Telecommunications equipment 141,752 133,183 7 to 25 years
Other equipment 5,891 3,237 5 years
Construction in progress 700 6,241
-------- --------
155,745 148,290
Less: accumulated depreciation (19,256) (9,405)
-------- --------
$ 136,489 138,885
======== ========
</TABLE>
Interest capitalized and included in the cost of construction of certain
long-term assets amounted to approximately $310,000 in 1998, $4,504,000
in 1997 and $2,076,000 in 1996.
(5) Short-Term Loans
There were no short-term loans outstanding at December 31, 1998 and 1997.
In 1995, the Company entered into a financing agreement (the "First
Citizens Loan Agreement") (see note 13) in which an affiliate of Citizens
Utilities Company (Citizens Utilities Company and its affiliates are
hereinafter referred to as "Citizens") provided a guaranty to Chemical
Bank that permitted the Company to borrow up to $33.2 million at the
bank's prime rate of interest + 2% through July 25, 1997. At December 31,
1995, the Company had borrowed $30.7 million under the financing. During
February and March of 1996, the Company borrowed from Citizens an
additional $18.2 million under a second financial agreement with Citizens
(the "Second Citizens Loan Agreement" together with the First Citizens
Loan Agreement, the "Citizens Loan Agreements") (see Note 14).
At December 31, 1995, the Company had a short-term loan payable to
ABN-AMRO for DM 2,250,000 (approximately $1,603,000 at December 31, 1995
exchange rates) which bore interest at DM LIBOR + .625%. This loan was
repaid in March 1996.
At December 31, 1995, the Company had short-term loans payable to
TeleDanmark A/S which bore interest at DM and U.S. dollar LIBOR + 3%. The
loans were repaid in January 1996.
F-12
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
On March 29, 1996, the Company entered into a $75.0 million Secured Term
Loan Credit Facility ("Credit Facility") and, together with HTCC
Consulting, a related Pledge and Security Agreement with Citicorp North
America, Inc. ("Citicorp"). This facility permitted the Company to borrow
funds through December 31, 1996 at interest rates ranging from 3.5% to
6.5% above LIBOR or Citicorp's announced based rate, at the Company's
option. In April, 1996, the Company used the Credit Facility to repay all
the funds advanced or guaranteed by Citizens and Chemical Bank and to
meet contractual commitments pursuant to construction contracts and
operating expenses and recorded an extraordinary loss on the early
extinguishment of the debt of approximately $8.2 million representing a
non-cash charge relating to the write off of the remaining unamortized
deferred financing costs included in other assets pertaining to the
Citizens Loan Agreements.
In October 1996, utilizing funds provided by the Postabank Credit
Facility (see Note 6), the Company paid Citicorp all funds owed pursuant
to the Credit Facility, as amended, plus $2.0 million in fees and costs
representing settlement in connection with the cancellation of the
Company's proposed bond offering for which Citicorp was to act as
underwriter (see Note 6).
(6) Long-term Debt
Long-term debt at December 31, 1998 and 1997 consists of the following:
<TABLE>
<S> <C> <C>
1998 1997
(in thousands)
Loan payable including deferred interest, interest at the National Bank
of Hungary weighted average Treasury Bill + 2.5% (19% and 22% at
December 31, 1998 and 1997, respectively), payable in 32 quarterly
installments beginning March 31, 1999 with final payment due December
21, 2006; HUF 42,863,437,000 and HUF 31,736,164,000 outstanding at
December 31, 1998 and 1997, respectively. 197,984 155,630
Construction loan including deferred interest, interest at the National
Bank of Hungary average Treasury Bill + 2.5% (19% and 22% at
December 31, 1998 and 1997, respectively) payable in 20 quarterly
installments beginning March 31, 1998 with final payment due December
31, 2002; HUF 7,926,002,000 and HUF 9,421,554,000 outstanding at
December 31, 1998 and 1997, respectively. 36,610 46,202
Loan payable, without interest due in equal annual installments
over three years 91 194
------------ ------------
Total long-term debt $ 234,685 202,026
Less current installments 31,804 7,489
------------ ------------
Long-term debt, excluding current installments $ 202,881 194,537
============ ============
</TABLE>
The aggregate maturities of long-term debt based on U.S. dollar
equivalents at December 31, 1998 exchange rates for each of the
subsequent five years are as follows: 1999, $31,804,000; 2000,
$34,612,000; 2001, $34,612,000; 2002, $34,667,000; 2003, $24,748,000; and
thereafter $74,242,000. The carrying value of long-term debt approximates
its fair value at December 31, 1998.
F-13
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
On October 15, 1996, the Company and its subsidiaries entered into a $170
million 10-year Multi-Currency Credit Facility with Postabank es
Takarekpenztar ("Postabank"), a Hungarian commercial bank (the "Postabank
Credit Facility"). Concurrently upon entering into the loan agreement
with Postabank, the Company terminated its planned bond offering and
recorded a charge of $2,985,000 representing all related costs.
Under the terms of the Postabank Credit Facility, drawdowns in Hungarian
Forints bear interest at a rate of 2.5% above the weighted average of the
yield on six- and twelve-month discounted Hungarian treasury bills while
drawdowns in U.S. dollars bear interest at 2.5% above LIBOR. Interest
payments for the first two years were deferred at the Company's option.
Amounts outstanding in Hungarian Forints, including any deferred
interest, will be payable in 32 equal quarterly installments beginning on
March 31, 1999. As discussed in Note 1, the Company does not have
sufficient funds to meet the required repayments on March 31, 1999. See
Note 1 for management's plans in this regard.
Concurrently with the Postabank Credit Facility, each subsidiary entered
into a Mortgage and Pledge Agreement pursuant to which each subsidiary
granted a security interest to Postabank in all assets acquired or to be
acquired with the funds provided by the loan. In addition, HTCC and HTCC
Consulting entered into a Security Agreement whereby each pledged,
subject to certain consents, their respective ownership interests in each
subsidiary as collateral.
In October 1996, pursuant to the Postabank Credit Facility, the Company
borrowed the equivalent of $82.3 million in Hungarian Forints.
Approximately $75.2 million of this amount was used to repay Citicorp all
funds advanced pursuant to the Credit Facility, as amended, and $2.0
million was paid to Citicorp for fees representing settlement in
connection with the cancellation of the Company's proposed bond offering.
The remaining $5.1 million was used to pay management fees and
reimbursable costs owed to Citizens pursuant to the Management Services
Agreement (see Note 14). An additional $5.6 million of the facility was
used to pay loan origination fees and costs to Postabank under the terms
of the loan agreement, $2 million of which was reimbursed to the Company
in equal quarterly installments over a two year period, and which is
being amortized over the life of the loan facility. At December 31, 1998,
the remaining unamortized deferred financing costs have been included in
other assets. Additionally, certain costs were incurred as a result of
Citizens' financial support (see Note 14).
In 1997, proceeds from the loan were used to continue construction of the
Company's telecommunications networks, provide additional working
capital, and refinance or repay other existing debt. In 1998, the
remaining proceeds of the loan were used to fund the expansion of the
Company's telecommunications networks and repay other existing debt.
In the first quarter of 1997, the Company repaid amounts payable to MATAV
and the Danish Fund under long-term agreements with proceeds of the
Postabank Credit Facility.
F-14
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
In 1996, Hungarotel entered into a $47.5 million construction contract
for the construction of a telephone network in one of its concession
areas. Financing for the full amount was provided by the contractor. The
financing agreement requires repayment of principal and interest in 20
quarterly installments commencing March 31, 1998, with final payment due
December 31, 2002. Interest is charged at a variable rate computed as the
weighted average of the six and 12 month Hungarian National Treasury Bill
interest rate for each quarter plus 2.5%. According to the loan
agreement, the Company may elect to defer repayment of 20% of the total
debt repayments due in 1998 and 1999. The Company has elected this 20%
deferral option for 1998. Security pursuant to the loan represents all
assets acquired with the funds provided by the loan. The Company and the
contractor have a disagreement with respect to several issues relating to
the quality and quantity of the work done by the contractor. During 1998
the Company and the contractor engaged in settlement discussions but were
unable to reach a settlement. The Company is currently reviewing its
options with respect to this dispute. The Company made the required
principal and interest payments under the contractor financing facility
during 1998. See Note 9(e).
In 1995, the Company was awarded subsidies from the Ministry aggregating
HUF 118,720,000 (approximately $850,000 at December 31, 1995 exchange
rates). The required conditions were satisfied in 1996 and the funds were
received one-half in the form of a grant and one-half in the form of a
non-interest bearing loan repayable over a three year period.
(7) Transactions with Tele Danmark A/S
On July 1, 1997, the Company entered into an agreement with Tele Danmark
A/S ("TDI") pursuant to which TDI agreed to exchange its 20% interest in
each of two operating subsidiaries for 420,908 shares of the Company's
common stock. The value of shares on the date of issue totaled
$3,630,000. Under the agreement, TDI was granted the preemptive right to
maintain its equity ownership percentage in addition to giving TDI the
right, if TDI acquired the 4.8% stake in each of the operating
subsidiaries owned by the Danish Fund for Central and Eastern Europe
("Danish Fund"), to sell such shares to the Company on similar terms.
On September 30, 1997, TDI exercised its right and agreed to exchange the
4.8% interest in each of two operating subsidiaries purchased from the
Danish Fund for 101,018 shares of the Company's common stock. The value
of shares on the date of issue totalled $1,301,000.
The total value of shares issued relating to these two transactions has
been recorded as an increase to goodwill and to Common Stock and
additional paid-in capital.
On September 30, 1997, the Company and TDI entered into an agreement
whereby TDI agreed to exchange loans and accrued interest totalling
$5,534,000 to two operating subsidiaries for 447,232 shares of the
Company's common stock.
As a result of these transactions, TDI's share ownership in the Company
is 18.4% of the shares outstanding at December 31, 1998.
(8) Income Taxes
The statutory U.S. Federal tax rate for the years ended December 31,
1998, 1997 and 1996 was 35%. For Hungarian income tax purposes, the
concession companies are entitled to a 100% reduction in income taxes for
the five year period ending December 31, 1998 and a 60% reduction in
income taxes for the subsequent five year period ending December 31,
2003. The effective tax rate was zero for the years ended December 31,
1998, 1997 and 1996 due to the Company incurring net operating losses for
which no tax benefit was recorded.
F-15
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
For U.S. Federal income tax purposes, the Company has unused net
operating loss carryforwards at December 31, 1998 of approximately
$17,090,000 which expire in 2007, $142,000; 2008, $422,000; 2009,
$950,000; 2010, $6,507,000; 2011, $6,328,000; 2012, $1,906,000; and 2018,
$835,000. The availability of the loss carryforwards to offset income in
future years may also be restricted as a result of an ownership change
which may occur as a result of future sales of the Company's Common Stock
and other events.
For Hungarian corporate income tax purposes, the Hungarian subsidiaries
have unused net operating loss carryforwards at December 31, 1998, at
current exchange rates, of approximately $88,864,000. Of this amount,
$17,951,000 may be carried forward indefinitely while $1,613,000 may be
carried forward until 2000, $9,051,000 until 2001, $28,968,000 until 2002
and $31,281,000 until 2003.
The tax effect of temporary differences that give rise to significant
portions of deferred tax assets are as follows:
<TABLE>
<S> <C> <C>
December 31
---------------------
1998 1997
---- ----
($ thousand)
Net operating loss carryforwards $ 5,982 5,696
Write down of assets 418 418
Stock compensation 1,467 1,310
Citizen's options 2,205 1,991
Termination benefits 1,169 1,592
Citizen's termination agreement 3,896 -
Management fees 3,236 2,361
Interest expense 918 620
Other 674 966
-------- --------
Total gross deferred tax assets 19,965 14,954
Less valuation allowance (19,965) (14,954)
-------- --------
Net deferred tax assets $ 0 0
======== ========
</TABLE>
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable
income during the periods in which those temporary differences become
deductible. Management considers projected future taxable income and tax
planning in making these assessments. During 1998 and 1997, the valuation
allowance increased by $5,011,000 and $2,864,000, respectively.
(9) Commitments and Contingencies
(a) Concession Agreements
Certain subsidiaries of the Company have been awarded concession
rights by the Hungarian Ministry of Transportation,
Telecommunications and Water Management ("the Ministry") to own
and operate local public telephone networks in five regions of
Hungary. Each of the concession agreements are for a term of 25
years and provide for an eight-year exclusivity period.
F-16
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
Agreements providing concession rights in two regions to
Hungarotel and one region to Papatel were entered into prior to
their acquisition by the Company and were renegotiated by the
Company. The renegotiated concession agreements provided for an
initial payment to the Ministry of HUF 938,250,000 (approximately
$6.7 at December 31, 1995 exchange rates) which was paid in
November 1995, and for annual concession fees based upon 2.3% and
0.3% of net telephone service revenues for the regions operated by
Hungarotel and 2.3% of net telephone service revenues for the
region operated by Papatel.
In 1994, the Ministry awarded concession rights to own and operate
local public telephone networks to KNC and Raba-Com under
agreements which provide for annual concession fees based upon
0.1% and 1.5% of net telephone service revenues for regions
operated by KNC and Raba-Com, respectively.
The concession agreements provide for, among other things, the
subsidiaries to provide telephone service to specific numbers of
customers by specified dates or be subject to possible monetary
penalties and possibly reduction in the period of exclusivity. As
of December 31, 1998, the Company believes it has fulfilled these
service requirements in their concession areas in all material
respects, and has not provided for any potential liability.
The activities of the subsidiaries which own concession rights are
regulated by the Ministry and by the terms of their respective
concession agreements. The Ministry regulates the construction,
operation and sale of local telephone exchanges and has been given
the authority to regulate the industry. This authority includes
approving local, long distance and international rates, the
sharing of revenues between concession companies and MATAV, the
equipment that can be used in the public switched telephone
network and requiring local companies to meet specified standards
as to growth and services.
The Ministry has stipulated in the Concession Contracts for
Hungarotel and Papatel, as amended in June 1996, that each of the
Operating Companies must meet certain Hungarian ownership
requirements so that by the end of the seventh year of their
Concession Contracts Hungarian ownership must consist of 25% plus
one share of the relevant Operating Company. For the first three
months after assuming operations of an Operating Area from MATAV,
no Hungarian ownership was required. For the seven-year period
following the date or amendment of a Concession Contract, as the
case may be, Hungarian ownership must be at least 10%, except that
during such period, such ownership may be reduced to as low as 1%
for a period of up to two years. During such seven-year period,
while the Hungarian ownership block is required to be at least
10%, such block must have voting power of at least 25% plus one
share, thus providing Hungarian owners the right to block certain
transactions which, under Hungarian corporate law, require a
supermajority (75%) of stockholders voting on the matter, such as
mergers and consolidations, increases in share capital and
winding-up.
For these purposes, Hungarian ownership of shares means shares
owned by Hungarian citizens. Shares owned by a corporation are
considered Hungarian owned only in proportion to the Hungarian
ownership of such corporation. The LTOs can also fulfill the 25%
plus one share Hungarian ownership requirement by listing such
shares on the Budapest Stock Exchange.
F-17
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
The equity ownership requirements and exceptions described above
are contained in the June 1996 amended Concession Contracts for
Hungarotel and Papatel. The equity ownership requirements
expressly set forth in KNC's and Raba-Com's Concession Contracts
call for a strict 25% plus one share Hungarian ownership.
However, the Ministry has stated, pursuant to a letter dated
September 18, 1996, that it intends that all of the Operating
Companies be treated equally with respect to such ownership
requirements which requirements KNC and Raba-Com are currently in
compliance.
Each of the Operating Companies, other than Papatel, is currently
in compliance with the 1% ownership requirement but not the 10%
ownership requirement which was supposed to be effective in June
1998. Papatel's Concession Contract permits an initial Hungarian
ownership level of its current 0.8%. If the Hungarian ownership
does not meet the required levels, the LTO is required to give
notice to the Ministry, which may then require the LTO to rectify
the situation within three months, or a shorter period if the
Ministry considers that there has been a delay in the required
notification. The Ministry is currently reviewing the Hungarian
equity ownership requirements. In the case of one other LTO, the
Ministry has granted a waiver on the 10% ownership issue.
Presently, the Ministry has indicated that it is not going to
enforce at this time the 10% Hungarian equity ownership
requirement. In the event that the Ministry decides to enforce
the existing Hungarian ownership requirements or adopts new
Hungarian equity ownership requirements, the Company will
formulate plans to meet the Hungarian equity ownership
requirements. Failure to do so, or failure to comply with the
greater than 25% Hungarian ownership requirement at the end of
the seven-year period might be considered a serious breach of a
Concession Contract, giving the Ministry the right, among other
things, to terminate the Concession Contract. There can be no
assurance that the Company will be able to increase the Hungarian
ownership in the Operating Companies in a manner sufficient to
comply with such requirements in the future.
The Hungarian ownership requirements would effectively give
minority Hungarian stockholders in the Operating Companies the
ability to block certain corporate transactions requiring the
approval of 75% of stockholders voting on the matter, including
mergers and consolidations, increases in share capital and
winding-up. In addition, unless the Hungarian ownership
requirements are formally changed, compliance would result in a
reduction in the Company's ownership in the Operating Companies,
and, consequently, the Company's share of income, if any, or loss
of the Operating Companies may be reduced proportionately.
(b) Construction Commitments
KNC has a continuing contract which provides for the continued
construction of a local telephone network and the addition of new
subscribers in its service area. This contract totals
approximately $18.3 million, $5.0 million of which remains to be
spent.
(c) Settlement of Claim
In connection with the settlement of a claim relating to the
termination of a management agreement with an unrelated
corporation to operate certain concessions, the Company issued a
promissory note for $300,000 which was repaid in 1996 and 25,000
five-year assignable warrants with an estimated market value of
$100,000, entitling the holder to purchase 25,000 shares of the
Company's Common Stock at $20 per share. These warrants expire in
September 1999. The corporation also has a "put option" to require
the Company to purchase the warrants from the proceeds of any
public offering of the Company's securities at an aggregate price
of $300,000.
F-18
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(d) Leases
The Company leases office facilities in Stamford, Connecticut,
which require minimum annual rentals of approximately $30,000.
During a portion of 1996, the Company also leased offices in
Budapest, Hungary from Hungarian Teleconstruct Corp.
("Teleconstruct"), a company whose officers and directors consist
of certain former officers and directors of the Company (see note
13(b)). Certain operating subsidiaries also rent office space and
other facilities. Rent expense for the years ended December 31,
1998, 1997 and 1996, including rental amounts paid to
Teleconstruct, was $199,000, $160,000, $221,000, respectively.
Lease obligations for the subsequent five years are as follows:
1999, $30,000; and 2000, $7,500.
(e) Legal Proceedings
Hungarotel is a defendant in a lawsuit brought in Hungary that
alleges breach of contract. The plaintiff is seeking payment of
outstanding invoices and alleged damages totaling approximately
HUF 270 million (approximately $1,250,000 at December 31, 1998
exchange rates). The Company believes it has meritorious defenses
to the claim and does not believe there will be any material
adverse effect from the outcome of this proceeding.
Raba-Com is a defendant in a lawsuit seeking refund of the
connection fee paid by a residential customer due to delay in
providing telephone service. Management believes there are
meritorious defenses to the claim and expects to prevail. Should,
however, the legal proceedings result in a final unfavorable
outcome, the Company could be subject to additional claims for
refunds of connection fees received.
HTCC Consulting, Papatel and KNC are involved in several disputes
with the Hungarian taxing authorities (the "APEH") pursuant to
which the APEH alleges Consulting owes HUF 105 million
(approximately $485,000), Papatel owes HUF 26 million
(approximately $120,000 at December 31, 1998 exchange rates) and
KNC owes HUF 26 million (approximately $122,000 at December 31,
1998 exchange rates) for various reasons. The Operating Companies
believe that the APEH claims are without merit and are vigorously
defending themselves against such claims.
During 1996 and 1997, the Company entered into several
construction contracts with a Hungarian contractor which totaled
$59.0 million in the aggregate, $47.5 million of which was
financed by a contractor financing facility. To date, the balance
on the contractor financing facility is $36.6 million. The Company
and the contractor have a disagreement with respect to several
issues relating to the quality and quantity of the work done by
the contractor. The Company has rejected invoices of approximately
HUF 700 million (approximately $3.2 million at December 31, 1998
exchange rates). The Company has claims against the contractor for
substantially more than the amount being demanded by the
contractor. During 1998 the Company and the contractor engaged in
settlement discussions in order to resolve these issues but were
unable to reach a settlement. The Company is reviewing its options
with respect to such dispute. At this time the outcome of such
dispute cannot be predicted with certainty. The Company believes
that it will prevail on the merits such that it will not be
responsible for the full payment on the aggregate contractual
amount. There can, however, be no assurances as to the final
outcome or course of action of such dispute.
F-19
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
The Company and its subsidiaries are involved in various other
claims and legal actions arising in the ordinary course of
business. In the opinion of management, the ultimate disposition
of these matters will not have a material adverse effect on the
Company's consolidated financial position, results of operations
or liquidity.
(f) Agreements with Lucent Technologies
In October 1997, the Company entered into an agreement with Lucent
Technologies to become the exclusive distributor of Lucent PBX and
Key System products in Hungary. As part of the agreement, the
Company purchased fixed assets and inventory valued at $470,000
and agreed to purchase commitments starting at $6 million for each
of the next three years. The agreement provided for the imposition
of penalties of up to $500,000 annually for failure to meet the
purchase requirements. The Company also assumed the employment of
36 employees. During the first quarter of 1998, the Company
amended the original agreement with Lucent. Under the amended
agreement, the Company is the exclusive supplier of PBX and Key
System products in its Operating Areas while retaining the
non-exclusive rights to service other Hungarian customers outside
its Operating Areas. In addition, the Company will be entitled to
sell large call centers on a commission basis. The Company's
minimum purchase commitments have been reduced to $2 million
annually with potential penalties reduced to a maximum of $200,000
annually for failure to meet the purchase requirements. As a part
of the amended agreement, the Company transferred back $400,000 of
assets to Lucent and paid $150,000 to Lucent. In addition, the
Company transferred to a third party subcontractor, 28 of the 36
employees originally assumed. The Company has had continued
discussions with Lucent in order to reduce its potential penalty
exposure. Based upon discussions between Lucent and the Company,
the Company believes that the maximum potential penalty for 1998
is approximately $24,000 and this will be settled during 1999 in
the form of marketing and sales promotions expenses.
(g) Social and Educational Contributions
Hungarotel's Concession Contracts require Hungarotel to pay an
amount equal to 10 times the local occupational excise tax. The
applicability and enforceability of such obligation is not certain
at this time. Therefore, it is not possible to predict with
certainty the effect, if any, such provision will have on the
Company. The Company has not accrued any amounts related to such
tax.
F-20
<PAGE>
(h) Subsidiary Capital Requirements
In July 1998, Hungary adopted a law requiring corrective action by
certain Hungarian companies which have negative net equity for
more than two years. Each of the Operating Companies currently
have negative net equity. The effective date of the applicability
of the law to the Operating Companies is not certain at this time.
As part of the Company's restructuring negotiations (see Note 1(a)
above), the Company is reviewing its options with respect to the
capital structure of each of the Operating Companies. While the
Company believes that each of the Operating Companies will be able
to comply with the law if and when it affects the Operating
Companies, there can be no assurance that the Operating Companies
will be able to comply with such law.
(10) Common Stock
In connection with a 1992 private placement and public offering, in
addition to a 1994 private placement, the Company issued warrants to
purchase 141,950 shares of Common Stock at prices ranging from $3.60 to
$14.00 per share. During 1996, warrants to purchase 3,016 shares of
Common Stock at $10.15 were exercised. Proceeds from the exercise of
these warrants totaled $31,000 in 1996. During 1998, warrants to purchase
4,650 shares of Common Stock at $3.60 were exercised. Proceeds from the
exercise of these warrants totaled $17,000 in 1998.
During 1996, options to purchase 5,000 shares of Common Stock at $10 per
share were exercised. Proceeds from the exercise of these options
amounted to $50,000. During 1998, a former officer exercised options to
purchase 51,750 shares of Common Stock at $4.00 per share. Proceeds from
the exercise of these options totaled $207,000.
During 1997, options to purchase 70,000 shares of Common Stock at prices
ranging from $7.00 to $10.00 per share and warrants to purchase 11,586
shares of Common Stock at $10.15 per share were exercised. Proceeds from
the exercise of these options and warrants amounted to approximately
$635,000. In addition, the company issued options to purchase up to
70,000 shares of Common Stock at below market prices to three officers as
compensation, resulting in a $70,000 increase to additional paid-in
capital.
F-21
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
During the third quarter of 1997, the Company entered into various
agreements with TDI pursuant to which TDI agreed to exchange its
ownership interest and outstanding loans in each of two operating
subsidiaries for a total of 969,158 shares of the Company's Common Stock.
The value of shares on the dates of issue totaled $10,689,000 which was
recorded as an increase to Common Stock and additional paid-in capital.
As a result of these transactions, TDI's share ownership in the Company
amounts to 18.4% of shares presently outstanding. TDI was granted
preemptive rights to maintain its ownership percentage (see Note 7).
During the third quarter of 1998, the Company entered into certain
agreements with certain wholly-owned subsidiaries of Citizens Utilities
Company (Citizens Utilities Company and its subsidiaries are hereinafter
referred to as "Citizens") pursuant to which the Company settled its
disagreements with Citizens regarding certain issues with respect to (i)
2.1 million shares of the Company's common stock subject to Citizens'
accrued preemptive rights and (ii) the Company's management services
agreement with Citizens dated as of May 31, 1995 as amended (the
"Management Services Agreement"). As part of the settlement of the
Management Services Agreement with Citizens, the Company issued 100,000
shares of Common Stock. The value of the shares on the date of issue
totaled $513,000 which was recorded as an increase to Common Stock and
additional paid-in capital. As a result of this transaction, Citizens has
increased its share ownership in the Company to 18.6% of shares presently
outstanding (see Note 14).
During 1998, the Company issued 18,469 shares of Common Stock as
contingent consideration related to the acquisition of Hungarotel and
Papatel (see Note 2).
The Company has reserved 7,474,915 shares as of December 31, 1998 for
issuance under stock option plans and agreements and warrants.
(11) Stock Based Compensation
Stock Option Plans
The Company adopted a stock option plan (the "Plan") in April 1992 which
provided for the issuance of an aggregate of 90,000 stock options which
was increased to 250,000 at the 1994 Annual Meeting of Stockholders. In
1996, the stockholders of the Company approved an increase in the number
of shares available under the plan from 250,000 to 750,000. In 1998, the
stockholders of the Company approved an increase in the number of shares
available under the plan from 750,000 to 1,000,000. Under the Plan,
incentive and non-qualified options may be granted to officers, directors
and consultants to the Company. The plan is administered by the Board of
Directors, which may designate a committee to fulfill its
responsibilities. Options granted under the Plan are exercisable for up
to 10 years from the date of grant. As of December 31, 1998, 676,000
options provided for by the Plan had been issued, of which 167,500 were
exercised and 508,500 remained outstanding.
In 1997, the Company adopted a director stock option plan (the
"Directors' Plan") which provides for the issuance of an aggregate of
250,000 stock options. Options granted under the Directors' Plan are
exercisable for up to 10 years from the date of grant. As of December 31,
1998, 65,000 options provided for by the Directors' Plan had been issued,
of which 5,000 were exercised and 60,000 remained outstanding.
F-22
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
The Company applies APB Opinion No. 25 and related interpretations in
accounting for stock options issued under the Plan and the Directors'
Plan. Had the Company determined compensation cost for options issued
under the plans based on the fair value at the grant date according to
SFAS No. 123, the Company's net pro forma income and Earnings Per Share
would have been as follows:
<TABLE>
<S> <C> <C> <C>
1998 1997 1996
(in thousands)
Net Loss As reported ($50,612) ($36,236) ($54,769)
Pro forma ($51,065) ($36,468) ($54,982)
Earnings Per Share As reported ($9.53) ($7.97) ($13.14)
Pro forma ($9.62) ($8.02) ($13.19)
</TABLE>
For purposes of the pro forma calculation under SFAS 123, the fair value
of each option grant has been estimated on the date of grant using the
Black Scholes option-pricing model with the following assumptions: (1) a
risk free rate of 5.58% in 1998, 6.56% in 1997 and 5.4% in 1996, (2) an
expected life of 6 years for 1998, 7 years for 1997 and 6 years for 1996,
and (3) volatility of approximately 84% for 1998, 33% for 1997 and 53%
for 1996.
Pro forma net loss reflects only options granted since January 1, 1995.
Therefore, the full impact of calculating compensation cost for stock
under SFAS 123 is not reflected in the pro forma net loss amounts because
compensation cost is reflected over the options' vesting period and
compensation cost for options granted prior to January 1, 1995 is not
considered.
The following is a summary of stock options and warrants, including those
issued under the Plan and Directors' Plan referred to above, and other
agreements which were granted, exercised and cancelled for the three
years ended December 31, 1998:
<TABLE>
<S> <C> <C>
Outstanding Option/Warrant Price
Options/Warrants Per Share
-------------------------------------------------------- -----------------------
December 31, 1995 518,492 $3.60-$20.00
Granted 200,000 $14.00
Exercised (8,016) $10.00-$10.15
Cancelled (5,000) $14.00
-------------------------------------------------------- -----------------------
December 31, 1996 705,476 $3.60-$20.00
Granted 140,000 $8.75-$11.69
Exercised (81,586) $7.00-$10.15
Cancelled (5,793) $10.15
-------------------------------------------------------- -----------------------
December 31, 1997 758,097 $3.60-$20.00
Granted 151,000 $5.81-$8.00
Exercised (56,400) $3.60-$4.00
Cancelled - -
-------------------------------------------------------- -----------------------
December 31, 1998 852,697 $4.00-$20.00
-------------------------------------------------------- -----------------------
</TABLE>
F-23
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
The following table summarizes information about shares subject to
outstanding options and warrants as of December 31, 1998 which were
issued to current or former employees, directors or consultants pursuant
to the Plan, Directors' Plan, employment or other agreements.
<TABLE>
<S> <C> <C> <C> <C> <C>
Options/Warrants Outstanding Options/Warrants Exercisable
Weighted-
Weighted- Average Weighted-
Number Range of Average Exercise Remaining Life Number Average
Outstanding Exercise Prices Price in Years Exercisable Exercise Price
218,247 $4.00-$6.78 $4.26 5.97 197,747 $4.00
250,000 $8.00-$9.44 $8.50 4.60 230,000 $8.54
97,500 $11.69-$12.25 $12.16 1.50 97,500 $12.16
261,950 $14.00 $14.00 2.05 261,950 $14.00
25,000 $20.00 $20.00 0.75 25,000 $20.00
------ ------
852,697 $4.00-$20.00 $9.86 3.70 812,197 $9.98
======= =======
</TABLE>
Stock Grants
During the second quarter of 1998, the Company issued 10,625 shares of
Common Stock to two former officers as compensation. An amount of
$93,000, representing the fair market value of the stock on the date of
grant, has been recorded as compensation expense and as an increase in
Common Stock and additional paid-in-capital.
In March 1997, the Company issued 5,000 shares to a former officer as
compensation. An amount of $51,875, representing the fair market value of
the stock on the date of grant, has been recorded as compensation expense
and as an increase in Common Stock and additional paid-in-capital.
In October 1996, the Board of Directors of the Company amended and
restated employment agreements with three executive officers. As part of
these agreements, in March 1997, based on performance in 1996, options to
purchase 70,000 shares of stock at an exercise price of $8.75 were
granted which became effective April 1, 1997.
In October 1996, the Company issued 8,000 shares to three executives as
compensation. An amount of $101,000, representing the fair market value
of the stock on the date of grant, was recorded as compensation expense
and as an increase in Common Stock and additional paid-in-capital.
In December 1995, the Company entered into employment agreement with
three executives which provided for, among other things, the granting of
a total of 102,500 shares of Common Stock. The Common Stock grants vest
over a four year period from the effective date of each agreement. As a
result of these employment agreements, in 1995 the Company recorded an
increase in additional paid-in-capital of $1,050,000, and a corresponding
increase in deferred compensation which is being amortized over the
vesting period. During 1998, the Company canceled 25,000 shares of the
total 102,500 shares granted in December 1995. As a result of the
cancellation, the Company recorded a decrease in additional
paid-in-capital of $256,000, and a corresponding decrease in deferred
compensation.
F-24
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(12) Reconciliation of Net Income to Net Cash Used in Operating Activities
The reconciliation of net loss to net cash provided by (used in)
operating activities for the years ended December 31, 1998, 1997 and 1996
follows:
<TABLE>
<S> <C> <C> <C>
1998 1997 1996
(in thousands)
Net loss $ (50,612) (36,236) (54,769)
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization of
property, plant and equipment 10,598 7,445 3,477
Amortization of intangibles 962 904 793
Asset write-downs 45 162 2,005
Non-cash compensation 339 407 485
Unrealized foreign currency loss 353 209 1,084
Extraordinary items - - 7,318
Termination charges 11,131 - 6,260
Other (income)/expense (787) 224 -
Minority interest - - (2,994)
Unpaid interest 36,494 34,963 6,279
Changes in operating assets and liabilities
net of effects of
acquisitions:
Accounts receivable 2,199 (6,273) (3,663)
Restricted cash 444 4,797 (4,974)
VAT receivable 2,503 1,864 (1,757)
Other assets 1,461 (3,938) (4,910)
Accounts payable and accruals (6,156) (3,955) 10,955
Due to related parties 2,144 4,364 (1,430)
------- ------- --------
Net cash provided by (used in) operating activities $ 11,118 4,937 (35,841)
======= ======= =======
Cash paid during the year for:
Interest $ 9,362 196 16,961
======= ======= =======
</TABLE>
Summary of non-cash transactions (figures in dollars):
During 1998 the Company:
Issued 100,000 shares of Common Stock valued at $513,000
and a promissory note in the amount of $8.4 million to
Citizens in settlement of $9.6 million of accrued fees and
expenses due and payable to Citizens under the terminated
management services agreement.
Issued 10,625 shares of Common Stock as compensation to
two former executive officers valued at $93,000.
Cancelled 25,000 restricted shares to a former executive
pursuant to a retirement agreement.
Issued 2,110,896 options to purchase Common Stock valued
at $121,000 in settlement of Citizens' accrued preemptive
rights.
F-25
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
During 1997 the Company:
Issued 969,158 shares of Common Stock valued at
$10,689,000 to TDI in exchange for interests and loans in
two operating subsidiaries. -
Issued 5,000 shares of Common Stock to a former officer and
options to purchase 70,000 shares of Common Stock to three
officers at exercise prices below market as compensation.
During 1996 the Company:
Issued 250,000 shares of Common Stock valued at
$3,219,000 and also issued 875,850 options and modified the
terms of other options to purchase Common Stock valued at
$11,219,000 in consideration for certain financial support
from Citizens.
Retired 101,429 shares of Common Stock valued at
$1,775,000, not yet delivered as a purchase price
adjustment related to acquisitions.
Issued 8,000 shares as compensation to three executive
officers valued at $101,000.
(13) Related Parties
Transactions entered into with certain related parties are as follows:
(a) Transactions with former officers and directors
On July 26, 1996, the Company entered into Termination and Release
Agreements, Consulting Agreements and Non-competition Agreements
with its former Chairman and Chief Executive Officer, former Vice
Chairman and former Chief Financial Officer, Treasurer, Secretary
and Director. Pursuant to these agreements, the Company agreed to
make payments for severance, consulting fees and non-compete
agreements amounting to $7.25 million, in equal monthly
installments over a 72 month period commencing August 31, 1996,
and also issued options to purchase 200,000 shares of Common Stock
at an exercise price of $14.00 per share. These commitments are
supported by letters of credit. The Company recorded a charge of
approximately $6.3 million in 1996 and made payments aggregating
approximately $1,208,000 in 1998 and 1997 and $503,000 in 1996
related to these agreements.
In 1996, the Company paid legal fees to the former Chief Financial
Officer, Treasurer, Secretary and Director of approximately
$146,000.
(b) Transactions with Teleconstruct
In 1996, the Company purchased the premises used as offices by the
Company and a residential apartment in Budapest, Hungary from
Teleconstruct in two separate transactions for an aggregate
purchase price of $643,000.
(c) Agreements with TDI
Amounts paid to TDI in 1996 under previously existing management
services agreements amounted to approximately $976,000. The
management services agreements with TDI were terminated in August
1996.
F-26
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(d) Transactions with Citizens Utilities Company
Transactions with Citizens including those under the Management
Service Agreements are discussed in Footnote 14.
Amounts payable to related parties as of December 31, 1998 and 1997, were
as follows:
<TABLE>
<S> <C> <C>
1998 1997
---- ----
Payable to former officers and directors $ 3,476,000 $ 4,199,000
Due to Citizens 19,873,000 7,175,000
Due to Teleconstruct 34,000 34,000
----------- ----------
$ 23,383,000 $ 11,408,000
========== ==========
</TABLE>
(14) Agreements with Citizens
During 1995, the Company and certain subsidiaries of Citizens entered
into a Master Agreement, a Loan Agreement and related Promissory Note, a
Warrant to Purchase Shares of Common Stock to Citizens (the Warrant), a
Stock Pledge Agreement, a Stock Option Agreement and second Stock Option
Agreement, a Registration Agreement and a Management Services Agreement
(the "Citizens Agreements"). Simultaneously, Citizens entered into voting
agreements with three affiliates of the Company and consummated the
purchase of 300,000 shares of Common Stock of the Company from the then
President, Chief Executive Officer and Chief Financial Officer and
Director of the Company. Certain of these agreements were subsequently
amended in connection with Citizens providing additional financial
support to the Company and expanding its management services
responsibilities as a result of the Company's acquisition of additional
concession companies.
The Citizens Agreements, as amended, resulted in and provided for the
following:
The nomination by Citizens of one representative to the Company's
board of directors (out of a minimum of six directors) for as long
as Citizens owns at least 300,000 shares of Common Stock of the
Company.
Citizen's receipt of options and a warrant to purchase an
aggregate of 3,635,472 (as adjusted for items described below)
additional shares of Common Stock of the Company at exercise
prices ranging from $13 to $18 per share under the Stock Option
Agreement and Warrant, as amended (the "Citizens Options and
Warrant"). The Citizens Options and Warrant were originally due to
expire at various dates from May 31, 1997 to September 12, 2000.
Expiration dates of the warrant and certain options were extended
as discussed below. All of the options were subject to
anti-dilution provisions.
Financial support under the Citizens Loan Agreements, as amended,
to the Company by Citizens through advances or the arrangement of
advances through Chemical Bank of approximately $31 million and
guarantees by Citibank of $16 million totaling $47 million as of
December 31, 1995. Chemical Bank provided such advances based upon
a guarantee provided by Citizens on the Company's behalf.
Consideration for Citizens commitment to provide the financial
support in excess of the approximately $5.2 million provided in
the First Citizens Loan Agreement included the grant to Citizens
of an additional five year option to purchase 626,155 shares of
Common Stock and its subsequent repricing, and the issuance of
250,000 shares of Common Stock to Citizens. The cost of this
consideration to the Company, representing the fair value of the
newly granted options and the subsequent repricing, and the fair
value of the Common Stock amounted to $6,917,000. The fair value
of the options granted and repriced were determined using the
Black Scholes option pricing model.
F-27
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
The First Citizens Loan Agreement provided for certain events of
default and remedies. Advances under the Loan Agreement bore
interest at a variable rate equal to the prime rate plus 2%,
payable quarterly in cash. To the extent the interest rate payable
by the Company to Chemical was less than the applicable interest
rate under the First Citizens Loan Agreement, the Company was
required to pay to Citizens the difference, as partial
consideration for Citizens making its guaranty. The Company's
option to repay advances and interest in Common Stock under the
terms of the First Citizens Loan Agreement was waived in
connection with Citizen's commitment in February 1996 to provide
additional financial support to the Company as described below.
The maturity date of the loan was July 25, 1997; however, the
First Citizens Loan Agreement provided that in the event the
Company issues or sells for cash, pursuant to any public or
private offering, any shares of its capital stock (or any other
securities or any obligations convertible into or exchangeable for
Common Stock) or receives a bank loan or any bridge financing
related to such offering, then the Company must repay the
outstanding principal and accrued but unpaid interest from such
net offering proceeds or related financing, subject to the prior
repayment of any such advances made through third party lenders.
On February 26, 1996, the Company and Citizens entered into, among
other agreements, the Second Citizens Loan Agreement pursuant to
which Citizens agreed to lend the Company up to an additional $46
million (the "Additional Citizens Financial Support"), including
(i) an advance of up to $16 million to enable the Company to
satisfy its obligations to Citibank, if Citibank's payment
obligations to MATAV arose pursuant to its payment guaranty to
secure Hungarotel's asset purchase and (ii) advances of up to $30
million, composed of up to $20 million for certain limited
purposes and up to $10 million reserved for anticipated
obligations under construction contracts to be approved by
Citizens.
Citizens commitment to provide the loan advances of up to $16
million in connection with the Hungarotel asset purchase expired
on the earlier of June 28, 1996 or the termination of Citibank's
payment guaranty. Citizens commitment to provide the loan advances
in connection with the remaining $30 million of Additional
Citizens Financial Support expired on June 28, 1996, with respect
to the $20 million reserved for other limited purposes.
Consideration for Citizen's commitment to provide the Additional
Citizens Financial Support included the issuance of an additional
250,000 shares of Common Stock. The cost of this consideration to
the Company representing the fair value of the Common Stock
amounted to $3,219,000.
Total consideration to Citizens related to these transactions
amounted to $10,136,000 and was capitalized as deferred financing
fees. As discussed in note 5, all amounts outstanding in
connection with the Citizens Loan Agreements and additional
Citizens' financial support were repaid in April 1996 and any
remaining unamortized deferred financing costs pertaining to such
agreements were expensed and reflected as an extraordinary loss.
F-28
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
Certain corporate, financial, technical, construction, marketing
and operational services were to be provided by Citizens to the
Company under the terms of the Management Services Agreement. Such
services commenced on July 1, 1995 and were to continue through
December 31, 2007. All services rendered by Citizens were subject
to the oversight, supervision and approval of the Company. The
management fee payable to Citizens was the greater of 5% of
Adjusted Gross Revenues, as defined, or a fixed amount ranging
from $100,000 to $395,800 per month from July 1995 through
December 31, 1996, and $416,600 per month for each month
commencing January 1997 for the remainder of the term, subject to
adjustment for inflation. The monthly management fees during 1995
and 1996 were payable in cash or, with Citizen's consent, in
shares of Common Stock of the Company equal in value to the fee,
based upon a three-month market price average. Management fees
payable to Citizens during 1998 amounted to $2,500,000, 1997 fees
amounted to $5,000,000 plus reimbursable costs of $691,000, while
in 1996 such fees amounted to $3,640,000 plus reimbursable costs
of $1,862,000. Cash payments made to Citizens in 1996 for
management services totaled $5,865,000.
The right for Citizens to purchase additional shares of Common
Stock, if the Company issues, in connection with any public or
private offering, shares of Common Stock, other stock of the
Company or any securities convertible into, or exchangeable or
exercisable for shares of Common Stock or other stock of the
Company at the applicable offering price the number of shares as
is necessary to maintain Citizens' then existing percentage
ownership on a fully diluted basis.
In connection with the Postabank Credit Facility (see note 6), on
October 18, 1996, the Company entered into certain agreements with
Citizens in consideration for, among other things, Citizens'
support in fulfilling all terms under the Citicorp Credit
Facility, as amended, and in obtaining the Postabank Credit
Facility. Under such agreements, the Company agreed to (i) extend
to September 12, 2000 the exercise periods of a warrant and
certain stock options to purchase approximately 2,139,801 shares
of Common Stock (as adjusted), (ii) grant Citizens the option to
purchase an additional 875,850 shares of Common Stock at an
exercise price of $12.75 exercisable through September 12, 2000,
and (iii) pay Citizens $750,000 in cash. The cost of this
consideration to the Company representing the increase in fair
value of the options previously granted, the fair value of the
newly granted options and the cash payment amounted to $11.97
million. The fair value of the options was determined using the
Black Scholes option pricing model. The Company has reflected the
portion of the cost related to the financial support in fulfilling
the terms of the Citicorp Credit Facility, $5.7 million, as a
current period charge in 1996. The remaining $6.27 million has
been capitalized in other assets with other direct costs incurred
in obtaining the Postabank Credit Facility and is being amortized
over the term of the related debt.
On September 30, 1998, the Company entered into certain agreements
with certain wholly-owned subsidiaries of Citizens Utilities
Company (Citizens Utilities Company and its subsidiaries are
hereinafter referred to as "Citizens") pursuant to which the
Company settled disagreements with Citizens regarding certain
issues with respect to (i) 2.1 million shares of the Company's
common stock subject to Citizens' accrued preemptive rights and
(ii) the Company's management services agreement with Citizens
dated as of May 31, 1995, as amended (the "Management Services
Agreement").
F-29
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
Such agreements provided for, among other things, (i) the
termination of the Master Agreement dated as of May 31, 1995
between the Company and Citizens; (ii) the issuance by the Company
to Citizens of 100,000 shares of the Company's common stock and a
promissory note in the principal amount of $8,374,498 (the "Note")
in settlement of $9.6 million accrued fees and expenses due and
payable to Citizens under the Management Services Agreement; (iii)
the termination of the Management Services Agreement; (iv)
payments by the Company to Citizens in the aggregate amount of
$21,000,000 payable in 28 quarterly installments from 2004 through
and including 2010 in part as consideration for Citizens'
agreement to terminate the Management Services Agreement and in
part as consideration for certain consulting services to be
provided by Citizens to the Company from 2004 through and
including 2010; (v) the grant by the Company to Citizens of
certain preemptive rights in connection with any public or private
issuances by the Company of shares of its common stock to purchase
within 30 days for cash such number of shares of the Company's
common stock sufficient to maintain Citizens' then existing
percentage ownership interest of the Company's common stock on a
fully diluted basis; and (vi) the right of one Citizens designee
to the Company's Board of Directors to be renominated for
reelection to the Company's Board of Directors for so long as
Citizens owns at least 300,000 shares of the Company's common
stock.
The principal on the promissory note is payable in full on
September 15, 2004 and bears interest at a varying rate per annum
which is 2-1/2% per annum above the one-year LIBOR rate with
monthly adjustments in such varying rate. Accrued interest shall
be payable annually.
The Company has recorded a charge totaling $11.1 million in 1998
representing the present value of the $21 million aggregate amount
payable to Citizens beginning in 2004 in part as consideration for
Citizens' agreement to terminate the Management Services Agreement
and in part as consideration for certain consulting services to be
provided by Citizens to the Company from 2004 through and
including 2010.
The agreements include an Amended, Restated and Consolidated Stock
Option Agreement (the "Restated Stock Option Agreement") pursuant
to which the Company granted Citizens an option to purchase
2,110,896 shares of the Company's common stock at a price of
$13.00 per share with an expiration date of July 1, 1999 in
settlement of Citizens' accrued preemptive rights. The Restated
Stock Option agreement also acknowledged Citizens existing options
to date to purchase an aggregate of 4,511,322 shares of the
Company's common stock at exercise prices ranging from $12.75 to
$18.00 per share with an expiration date of September 12, 2000.
The cost of this consideration to the Company representing the
fair value of the newly granted options in settlement of Citizen's
accrued preemptive rights amounted to $121,000. The fair value of
the newly granted options was determined using the Black Scholes
option pricing model. The Company has reflected this cost as a
current period charge in 1998.
Additionally, the Company is also obligated to bear the cost of
registering shares it has issued to Citizens, including shares issuable
under the Citizens Options. As a result of the above transactions, on
December 31, 1998 Citizens held 18.6% of the Company's outstanding Common
Stock and 6,622,218 options to purchase Common Stock. Citizens ownership
of the Company's outstanding shares on a fully diluted basis is
approximately 59.2% at December 31, 1998.
F-30
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
(15) Employee Benefit Plan
Effective December 1996, the Company established a 401(k) salary deferral
plan (the "401(k) Plan") on behalf of its U.S. employees. The 401(k) Plan
is a qualified defined contribution plan and allows participating
employees to defer up to 15% of their compensation, subject to certain
limitations. Under the 401(k) Plan, the Company has the discretion to
match contributions made by the employee. No matching contributions were
made by the Company in 1998, 1997 or 1996.
(16) Segment Disclosures
The Company operates in a single industry segment, communications
services. The Company's operations involve developing and constructing a
modern telecommunications infrastructure in order to provide a full range
of the Company's products and services in its five concession areas in
Hungary. While the Company's chief operating decision maker monitors the
revenue streams of the various products and services, operations are
managed and financial performance is evaluated based on the delivery of
multiple services to customers over an integrated network. Substantially
all of the Company's assets are located in Hungary and all of its
revenues are generated in Hungary.
Products and Services
The Company groups its products and services into the following
categories:
Telephone Services - local dial tone and switched products and services
that provide incoming and outgoing calls over the public switched
network. This category includes reciprocal compensation revenues and
expenses (i.e. interconnect).
Network Services - point-to-point dedicated services that provide a
private transmission channel for the Company's customers' exclusive use
between two or more locations, both in local and long distance
applications.
Other Service and Product Revenues - PBX hardware sales and service
revenues, as well as miscellaneous other telephony service revenues.
The revenues generated by these products and services for the years ended
December 31 were as follows:
($ in thousands) 1998 1997 1996
---- ---- ----
Telephone services $35,969 $36,738 $19,826
Network services 1,402 797 625
Other service and product
revenues 1,336 356 459
------ ------ ------
$38,707 $37,891 $20,910
======= ======= =======
Included in telephone services are connection fee revenues amounting to
$1,958,000, $12,925,000 and $4,107,000 for the years ended December 31,
1998, 1997 and 1996, respectively.
F-31
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
Major Customers
For the years ended December 31, 1998, 1997 and 1996, none of the
Company's customers accounted for more than 10% of the Company's total
revenue.
(17) Quarterly Financial Data (unaudited)
($ in thousands)
Net loss
Revenue Net Loss Per share
1998
First quarter 9,372 (11,700) (2.22)
Second quarter 9,718 (10,955) (2.07)
Third quarter 9,412 (19,073) (3.61)
Fourth quarter 10,205 (8,884) (1.65)
1997
First quarter 7,924 (6,948) (1.66)
Second quarter 9,297 (8,183) (1.95)
Third quarter 9,669 (9,050) (1.96)
Fourth quarter 11,001 (12,055) (2.33)
The net loss for the third quarter of 1997 was restated in 1997 to
reflect a decrease in capitalized interest of $1.65 million as a result
of revisions to estimated completion dates of construction work in
process amounts outstanding during the period.
F-32
<PAGE>
HUNGARIAN TELEPHONE AND CABLE CORP.
Index to Exhibits
Exhibit No. Description
10.12 Employment Agreement dated as of December 4, 1998, by and between
Hungarian Telephone and Cable Corp. and Ole Bertram
27.1 Financial Data Schedule
EXHIBIT 10.12
EMPLOYMENT AGREEMENT
This Employment Agreement (this "Agreement") is made and entered
into as of December 4, 1998, by and between Hungarian Telephone and Cable Corp.,
a corporation organized under the laws of the State of Delaware, United States
of America (the "Company") and Ole Bertram ("Executive").
RECITALS:
A. The Company desires to retain Executive as its President and
Chief Executive Officer.
B. Executive desires to work for the Company as its President and
Chief Executive Officer.
C. The parties desire to set forth the terms and conditions under
which Executive shall serve in the above-stated capacity of
President and Chief Executive Officer.
NOW, THEREFORE, in consideration of the respective covenants and
agreements of the parties set forth herein, it is agreed as follows:
1. Employment and Duties. The Company agrees to employ Executive and
Executive accepts the employment, subject to the terms and conditions herein, to
serve as President and Chief Executive Officer of the Company. Executive shall
report to the Board of Directors of the Company (the "Board"). Executive's
duties and responsibilities shall include the duties and responsibilities as set
forth in the Company's bylaws from time to time in effect and such other duties
and responsibilities as the Board may from time to time reasonably assign
Executive, in all cases consistent with Executive's position. Executive shall
perform faithfully the executive duties assigned to him to the best of his
ability.
2. Place of Employment. Executive shall be employed at the Company's
offices located in Budapest, Hungary.
3. Term. The term of employment under this Agreement shall commence on
January 1, 1999 and continue through December 31, 2000, unless earlier
terminated in accordance with the terms of this Agreement (the "Employment
Period").
4. Effective Date. The effective date of this Agreement is December 4,
1998.
5. Annual Salary. Executive will receive a monthly salary based on an
annualized rate of Two Hundred Ten Thousand Dollars ($210,000). The Company
shall be entitled to deduct or withhold all taxes and charges which the Company
may be required by law to deduct or withhold therefrom. The Compensation - Stock
Option Committee of the Board (the "Compensation Committee") shall annually
review Executive's base salary in light of the performance of Executive and, if
it finds Executive's performance to be satisfactory, the Compensation Committee
shall increase such base salary by an amount it determines to be appropriate.
<PAGE>
6. Option Award. In consideration of Executive entering into this
Agreement, the Company hereby agrees to grant to Executive, by a separate stock
option agreement(s), options to purchase 100,000 shares ("First Tranche
Options") of the Company's common stock from the Company's 1992 Incentive Stock
Option Plan, as amended (the "Plan"). Provided that Executive has maintained
continuous service with the Company through January 1, 2000, the Company shall
grant Executive options to purchase an additional 100,000 shares ("Second
Tranche Options") of the Company's common stock from the Plan on January 3,
2000. Executive's rights to the Options will vest according to the following
schedule, provided that if Executive has not maintained continuous service with
the Company from the date hereof until the related vesting date (other than in
circumstances set forth in Paragraphs 19(b) and (c)) all as yet unvested options
shall be forfeited and cancelled:
Vesting Date Options Vested
June 30, 1999 50,000
December 31, 1999 50,000
June 30, 2000 50,000
December 31, 2000 50,000
The options shall have a five-year exercise period. The initial purchase
price per share for the First Tranche Options shall be the fair market value per
share of the Company's common stock as of the date hereof and the initial
purchase price per share for the Second Tranche Options, if granted, shall be
the fair market value per share of the Company's Common Stock on December 31,
1999. The "fair market value" per share of the Company's common stock means the
average of the high and low quoted sales price on the date of grant (or, if
there is no reported sale on such date, on the last preceding date on which any
reported sale occurred) of a share on the American Stock Exchange.
7. Annual Performance Bonus. Executive shall be entitled to receive an
annual target bonus of Ninety Thousand Dollars ($90,000) if the Company achieves
certain pre-determined objectives to be mutually agreed upon by the Executive
and the Compensation Committee. The Company's objectives for 1999 shall be
initially set by January 31, 1999 and shall be finalized upon the approval by
the Board of the Company's 1999 business plan, and such bonus, if any, shall be
payable by April 1, 2000. The Company's objectives for 2000 shall be initially
set by December 31, 1999, and shall be finalized upon the approval by the Board
of the Company's 2000 business plan, and such bonus, if any, shall be payable by
December 31, 2000 subject to an agreement between Executive and Committee on a
final bonus settlement upon the completion of the 2000 audited financial
results. For any year in which the Company's performance reaches at least 95%,
but less than 100.5% of such year's objectives, Executive shall be entitled to
receive the following appropriate bonus:
-2-
<PAGE>
95%: $45,000
96%: $54,000
97%: $63,000
98%: $72,000
99%: $81,000
100%: $90,000
For any year in which the Company's performance reaches 100.5% or
more of such year's objectives, Executive shall be entitled to receive the
following appropriate bonus:
101%: $93,000
102%: $96,000
103%: $99,000
104%: $102,000
105%: $105,000
106%: $108,000
107%: $111,000
108%: $114,000
109%: $117,000
110% or
more: $120,000
8. Annual Housing Allowance. Executive will receive an annual housing
allowance (the "Housing Allowance") of Thirty-Six Thousand Dollars ($36,000),
payable in equal monthly installments.
9. Employee Taxes. Executive shall be solely responsible for any and all of
Executive's (i) income and (ii) social security, medicare or any other
miscellaneous taxes applicable to any salary, bonus, option grant, allowance,
severance benefit or any other type of compensation or benefit received by
Executive pursuant to this Agreement which is subject to taxation and payable by
Executive to any governmental taxing authority including, but not limited to,
any governmental taxing authority in the Republic of Hungary, the United States
of America or Denmark.
10. Pension Account. The Company shall make an annual contribution for the
term of this Agreement to the Danish pension account of Executive which account
Executive may not withdraw therefrom until the retirement of Executive.
11. Insurance. If requested by Executive, the Company shall provide
Executive, his spouse and his minor dependents with health insurance
coverage under a fully comprehensive international scheme.
12. Automobile. The Company will provide Executive with the use of a
private Company automobile to be maintained by the Company.
-3-
<PAGE>
13. Vacation. Executive will be entitled to thirty (30) business days
annual paid vacation.
14. Work Permits. With the Company's assistance, Executive shall obtain and
keep current any Hungarian work permits, residency permits or other similar
licenses as may be required by Hungarian law as a result of Executive's
employment by the Company.
15. Covenant Not to Compete. Executive hereby agrees that during the term
of this Agreement, he will not, either through any kind of ownership (other than
ownership of securities of a publicly held corporation of which Executive owns
less than five percent (5%) of any class of outstanding securities), or as a
director, officer, principal, agent, employee, employer, advisor, consultant,
co-partner, or in any individual or representative capacity whatever, either for
his own benefit or for the benefit of any other person, firm, or corporation,
without the prior written consent of the Company's Board of Directors, compete
with the Company by engaging in any act, including, but not limited to, any of
the following: (a) canvass, solicit, accept, or perform any type of work
performed by the Company for any "customer" (as hereinafter defined) of the
Company; (b) develop, design, market any services that may be sold by the
Company during the term of this Agreement; (c) request or advise any firm to
withdraw, curtail, or cancel its business with the Company; (d) give or attempt
to give any person, partnership, or corporation the right to solicit or canvass
any customer for the performance of services provided by the Company; and (e)
induce or attempt to influence any employee of the Company or any employee of
any customer to terminate his employment with the view toward competing with the
Company or any customer. As used herein, the term "customer" includes any of the
Company customers at any time during the term of this Agreement.
16. Confidential Information.
(a) Nondisclosure. Executive expressly covenants and agrees that he will
not during the term of this Agreement or at any time after the termination
hereof, irrespective of the time, manner, or cause of termination, reveal,
divulge, disclose, or communicate to any person, firm, or corporation, other
than authorized officers, directors, and employees of the Company, in any manner
whatsoever, any "confidential information" (as hereinafter defined) of the
Company that would be inconsistent with the position held by Executive or the
duties being performed by Executive at the direction of the Company.
(b) Return of Confidential Information and Other Property. Upon termination
of this Agreement, Executive will surrender to the Company all confidential
information including, without limitation, all lists, charts, schedules,
reports, financial statements, books and records, and all copies thereof, of the
Company and all other property belonging to the Company whatsoever. As used
herein, "confidential information" means information disclosed to or known by
Executive as a consequence of or through his employment for the Company, not
generally known in the business in which the Company is or may become engaged,
about the Company, its business, products and processes.
-4-
<PAGE>
17. Breach of Covenant Not to Compete and Confidentiality Provision.
Executive agrees that a substantial violation on his part of any covenant
contained in Paragraphs 15 and 16 above will cause such damage to the Company as
will be irreparable and for that reason, Executive further agrees that the
Company shall be entitled as a matter of right, to an injunction out of any
court of competent jurisdiction, restraining any further violation of said
covenants by Executive, his employer, employees, partners, or agents. Such right
to injunction shall be cumulative and in addition to whatever other remedies the
Company may have, including, specifically, recovery of liquidated and additional
damages. Executive expressly acknowledges and agrees that the respective
covenants and agreements shall be construed in such a manner as to be
enforceable under applicable laws if a more limited scope of time is determined
by a court or competent jurisdiction to be required.
18. Indemnification. The Company agrees that if Executive is made a party,
or is threatened to be made a party, to any action, suit or proceeding, whether
civil, criminal, administrative or investigative (a "Proceeding"), by reason of
the fact that he is or was a director, officer or employee of the Company,
Executive shall be indemnified and held harmless by the Company to the fullest
extent legally permitted or authorized by the Company's certificate of
incorporation or bylaws or resolutions of the Board or, if greater, by the laws
of the State of Delaware, against all cost, expense, liability and loss
(including, without limitation, attorney's fees, judgments, fines, ERISA excise
taxes or penalties and amounts paid or to be paid in settlement) reasonably
incurred or suffered by Executive in connection therewith. The Company agrees to
continue to maintain a directors' and officers' liability insurance policy
covering Executive to the extent the Company provides such coverage for any of
its other executive officers.
19. Termination.
(a) Reasons for Termination. The employment of Executive with the Company
shall terminate automatically upon Executive's death and may be terminated by
written notice (i) by the Company, upon Executive's disability which renders him
unable to perform his usual and customary duties for a period of 180 consecutive
days; (ii) by the Company, with or without "cause" (as hereinafter defined);
(iii) by Executive upon 90 days notice; (iv) by Executive, if he suffers a
demotion or a lower status with the Company other than for cause; or (v) by
Executive, in the event of a "change in control" (as hereinafter defined),
whether or not Executive suffers a demotion or a lower status with the Company.
For purposes of this Agreement, "cause" shall mean (i) a failure by Executive to
substantially perform Executive's reasonable and legal duties and as defined by
goals established by the Board and agreed to by Executive, other than a failure
resulting from Executive's complete or partial incapacity due to physical or
mental illness or impairment, (ii) a willful act by Executive that constitutes
gross misconduct and that is injurious to the Company, (iii) a willful breach by
Executive of a material provision of this Agreement, or (iv) a material and
willful violation of a federal or state law or regulation applicable to the
business of the Company. No act, or failure to act, by Executive shall be
considered "willful" unless committed without good faith and without a
reasonable belief that the act or omission was in the Company's best interest.
For purposes of this Agreement, a "change of control" shall be deemed to have
occurred if (1) any "person" (as such term is used in Sections 13(d) and 14(d)
of the U.S. Securities and Exchange Act (the "Exchange Act")), other than (x)
Citizens Utilities Company and/or any one or more direct or indirect
wholly-owned subsidiary of Citizens Utilities Company (together, "Citizens"), or
(y) Tele Danmark A/S and/or any one or more direct or indirect wholly-owned
subsidiary of Tele Danmark A/S (together, Tele Danmark"), is or becomes the
"beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly
-5-
<PAGE>
or indirectly, of securities of the Company representing thirty-five percent
(35%) or more of the combined voting power (with respect to the election of
directors) of the Company's then outstanding securities; (2) at any time after
the execution of this Agreement, a majority of the Board shall be replaced, over
a two-year period, from the directors who constituted the Board at the beginning
of such period, and such replacement shall not have been approved by either
two-thirds (2/3) of the Board as constituted at the beginning of such period or
Citizens or Tele Danmark; (3) the consummation of a merger or consolidation of
the Company with or into any other corporation (other than with Citizens or Tele
Danmark), other than a merger or consolidation which would result in the voting
securities of the Company outstanding immediately prior thereto continuing to
represent (either by remaining outstanding or by being converted into voting
securities of the surviving entity) more than sixty-five percent (65%) of the
combined voting power (with respect to the election of directors) of the
securities of the Company or of such surviving entity outstanding immediately
after such merger or consolidation; or (4) the consummation of a plan of
complete liquidation of the Company or of an agreement for the sale or
disposition by the Company of all or substantially all of the Company's business
or assets.
(b) Termination Benefits. If Executive's employment is terminated pursuant
to Section 19(a) prior to the expiration of the term of this Agreement for any
reason noted above other than by the Company for "cause" or by Executive upon 90
days notice as set forth in clause (iii) of Section 19(a), Executive will be
entitled to receive the following benefits as severance (the "Severance
Benefits"):
(i) a lump sum payment equal to six (6) months' salary at Executive's
then-current annual salary level;
(ii) payment of any salary, expenses,
allowances and benefits accrued by Executive up to the date of the
termination; and
(iii)the immediate vesting and release of any unvested unreleased portion of
the options granted as of the date of such termination pursuant to this
agreement, without restriction.
(c) Benefits in the Event of Executive's Death. Except as set forth below,
if Executive's employment terminates automatically in the event of Executive's
death, Executive's estate will be entitled to receive the Severance Benefits.
The Company may, at its option, maintain a life insurance policy for Executive
in an amount deemed to be appropriate by the Board and designating Executive's
estate as the beneficiary. If the Company elects to maintain such life insurance
and the policy amount equals or exceeds the value of the Severance Benefits (as
determined by the Board), Executive's estate shall only be entitled to receive
the proceeds of the insurance policy. If the policy amount is less than the
value of the Severance Benefits, the Company shall pay to Executive's estate an
amount equal to the difference between the value of the Severance Benefits and
the amount to which the estate would be entitled to under the insurance policy.
The Company shall determine the value of the Severance Benefits as soon as
practicable after Executive's death but in no event later than thirty (30) days
thereafter.
-6-
<PAGE>
(d) Date of Termination; Provision of Severance Benefits. The date of
termination of Executive's employment by the Company under this Paragraph 19
shall be one (1) month after receipt by Executive of written notice of
termination, provided, however, that if the termination is for cause the date of
termination shall be the date specified in the notice of termination or if no
date is specified then the date on which such notice is received by the
Executive. The date of termination by Executive under this Paragraph 19 shall be
one (1) month after receipt by the Company of written notice of termination
except in the case of termination by Executive as set forth in clause (iii) of
Section 19(a) pursuant to which Executive is required to give the Company 90
days notice. All benefits to which Executive is entitled under subparagraph (b)
hereof shall be provided within thirty (30) days of termination. In the case of
automatic termination in the event of Executive's death, the benefits shall be
provided no later than thirty (30) days from the date of Executive's death.
20. Miscellaneous.
(a) Rights Under Plans and Programs. Notwithstanding anything in this
Agreement to the contrary no provision of this Agreement is intended, nor shall
it be construed, to reduce or in any way restrict any benefit to which Executive
may be entitled under any agreement, plan, arrangement, or program providing
benefits for Executive.
(b) Entire Agreement. This Agreement constitutes the entire agreement
between the parties with respect to the subject matter of this Agreement and
supersedes all prior written and oral and all contemporaneous oral agreements
and understandings with respect to the subject matter of this Agreement.
(c) Notices. Any notice or request to be given hereunder by any party to
the other shall be in writing and shall be deemed to have been duly given on the
next business day after the same is sent, if delivered personally or sent by
telecopy or overnight delivery, or five calendar days after the same is sent, if
sent by registered or certified mail, return receipt requested, postage prepaid,
as set forth below, or to such other persons or addresses as may be designated
in writing in accordance with the terms hereof by the party to receive such
notice.
-7-
<PAGE>
If to the Company, to:
Hungarian Telephone and Cable Corp.
100 First Stamford Place, Suite 204
Stamford, CT 06902
Facsimile No.: 203/348-9128
Attn: General Counsel
If to Executive, to:
the address or facsimile number
for Executive as set forth
in the Company's records
with a required copy to:
(to be provided by Executive)
(d) Governing Law; Forum; Consent to Jurisdiction. This Agreement shall be
governed by and construed in accordance with the laws of the State of New York
without giving effect to the principles of conflict of laws thereof. Each of the
parties to this Agreement hereby irrevocably and unconditionally (i) consents to
submit to the exclusive jurisdiction of the courts of the State of New York for
any proceeding arising in connection with this Agreement (and each such party
agrees not to commence any such proceeding, except in such courts), (ii) to the
extent such party is not a resident of the State of New York, agrees to appoint
an agent in the State of New York as such party's agent for acceptance of legal
process in any such proceeding against such party with the same legal force and
validity as if served upon such party personally within the State of New York,
and to notify promptly each other party hereto of the name and address of such
agent, (iii) waives any objection to the laying of venue of any such proceeding
in the courts of the State of New York, and (iv) waives, and agrees not to plead
or to make, any claim that any such proceeding brought in any court of the State
of New York has been brought in an improper or otherwise inconvenient forum.
(e) Counterparts. This Agreement may be executed in one or more
counterparts, and each of such counterparts shall for all purposes be deemed to
be an original, but all such counterparts together shall constitute but one
instrument.
(f) Executive's Successors. This Agreement and all rights of Executive
hereunder shall inure to the benefit of, and be enforceable by, Executive's
personal or legal representatives, executors, administrators, successors, heirs,
distributees, devisees and legatees.
-8-
<PAGE>
(g) Assignment. Neither this Agreement, nor the rights and obligations
hereunder, may be assigned by either party without the prior written consent of
the other party.
(h) Parties in Interest. Nothing in this Agreement, expressed or implied,
is intended to confer on any person other than the parties hereto or their
respective successors or assigns, any rights, remedies, obligations or
liabilities under or by reason of this Agreement.
(i) Amendment. This Agreement may not be amended except by an instrument in
writing signed on behalf of each of the parties.
(j) Extension; Waiver. Either party to this Agreement may (a) extend the
time for the performance of any of the obligations or other acts of the other
party to this Agreement or (b) waive compliance by the other party with any of
the agreements or conditions contained herein or any breach thereof. Any
agreement on the part of a party to any such extension or waiver shall be valid
only if set forth in an instrument in writing signed on behalf of such party.
(k) Severability. The provisions of this Agreement are severable and, if
any provision of this Agreement is determined to be invalid or unenforceable by
any court of competent jurisdiction, such provision (in any other jurisdiction)
and the other provisions hereof (in any jurisdiction) shall not be rendered
otherwise invalid or unenforceable and such provision shall be deemed to be
modified to the extent necessary to render it legal, valid and enforceable, and
if no such modification shall render it legal, valid and enforceable, then this
Agreement shall be construed as if not containing the provision held to be
invalid, and the rights and obligations of the parties shall be construed and
enforced accordingly.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the day
and year first above written.
HUNGARIAN TELEPHONE AND CABLE CORP.
By: /s/David A. Finley
------------------------------------
David A. Finley
Chairman of the Board of Directors
OLE BERTRAM
/s/Ole Bertram
------------------------------------
[SIGNATURE PAGE TO BERTRAM EMPLOYMENT AGREEMENT
DATED AS OF DECEMBER 4, 1998]
-9-
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM HUNGARIAN
TELEPHONE AND CABLE CORP.'S CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR
ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000889949
<NAME> HUNGARIAN TELEPHONE AND CABLE CORP.
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<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-1-1998
<PERIOD-END> DEC-31-1998
<CASH> 8,553
<SECURITIES> 0
<RECEIVABLES> 7,665
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