<PAGE> 1
FILED PURSUANT TO RULE 424 (b)(3)
REGISTRATION NO. 333-45915
PROSPECTUS
$144,787,000
8.75% SENIOR SUBORDINATED CONVERTIBLE BONDS DUE 2000
7,239,350 SHARES OF COMMON STOCK OF
GLOBAL TELESYSTEMS GROUP, INC.
[GLOBAL TELESYSTEMS GROUP, INC. LOGO]
---------------------
This Prospectus relates to the resale of $144,787,000 aggregate principal
amount of 8.75% Senior Subordinated Convertible Bonds due 2000 (the "Bonds" or
"Convertible Bonds") of Global TeleSystems Group, Inc. (the "Company") and the
resale of up to 7,239,350 shares ("Conversion Shares") of the Common Stock, par
value $.10 per share (the "Common Stock"), of the Company issuable upon
conversion of the Bonds. The Bonds were issued and sold (the "Original
Offering") on July 14, 1997, July 31, 1997 and August 29, 1997 (together, the
"Original Offering Dates") (a) to the Managers (as defined herein) and were
simultaneously sold by the Managers in transactions exempt from the registration
requirements of the Securities Act of 1933, as amended (the "Securities Act"),
in the United States to persons reasonably believed by the Managers to be
qualified institutional buyers as defined in Rule 144A under the Securities Act
and outside the United States to non-U.S. person or residents in reliance upon
Regulation S under the Securities Act and (b) to certain Accredited Investors.
The Bonds and the Conversion Shares issuable upon conversion of the bonds
(collectively, the "Offered Securities") may be offered and sold from time to
time by the holders named herein or in supplements to this Prospectus
("Prospectus Supplements") or by their transferees, pledgees, donees or their
successors (collectively, the "Selling Holders") pursuant to this Prospectus.
Information concerning the Selling Holders may change from time to time and will
be set forth in Prospectus Supplements. The Offered Securities may be sold by
the Selling Holders from time to time directly to purchasers or through agents,
underwriters or dealers. See "Selling Holders" and "Plan of Distribution." If
required the names of any such agents or underwriters involved in the sale of
the Offered Securities and the applicable agent's commission, dealers' purchase
price or underwriters's discount, if any, will be set forth in Prospectus
Supplement. The Selling Holders will receive all of the net proceeds from the
sale of the Offered Securities and will pay all underwriting discounts, selling
commission and transfer taxes, if any, applicable to any such sale. The Company
is responsible for payment of all other expenses incident to the registration of
the Offered Securities. The Selling Holders and any broker-dealers, agents or
underwriters that participate in the distribution of the Offered Securities may
be deemed to be "underwriters" within the meaning of the Securities Act, and any
commission received by them and any profit on the resale of the Offered
Securities purchased by them may be deemed to be underwriting commissions or
discounts under the Securities Act. See "Plan of Distribution" for a description
of indemnification arrangements.
(continued on next page)
The Conversion Shares have been approved for quotation on the Nasdaq
National Market under the symbol "GTSG", subject to official notice of issuance.
Application will be made to have the Conversion Shares admitted to trading on
the European Association of Securities Dealer's Automated Quotation ("EASDAQ")
Market under the symbol "GTSG".
SEE "RISK FACTORS" BEGINNING ON PAGE 9 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED
HEREBY.
---------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
---------------------
The date of this Prospectus is February 27, 1998.
<PAGE> 2
(continued from front cover)
Unless previously redeemed, converted or purchased and cancelled the Bonds
may be converted at the option of the holders from time to time, in whole or in
part, prior to the close of business on June 30, 2000 into shares of Common
Stock at a conversion price of $20 per share, subject to adjustment in certain
events. The Common Stock is quoted on the Nasdaq National Market and traded on
the EASDAQ Market under the symbol "GTSG." On February 26, 1998, the last
reported sale price of the Common Stock on the Nasdaq National Market was
$36 3/4 and on the EASDAQ market was $37 1/8. Outstanding Bonds not previously
redeemed or converted will be redeemed at their principal amount plus accrued
interest on June 30, 2000.
The Bonds are direct, unsecured, senior subordinated obligations of the
Company, and rank senior in right of payment to all subordinated indebtedness of
the Company and at least pari passu with each other and with all other present
and future unsecured, senior subordinated indebtedness of the Company. At
September 30, 1997, the Company had $502.5 million of indebtedness that would
rank senior to the Bonds.
The Bonds bear interest payable semi-annually, at a rate of 8.75%. The
Luxembourg Stock Exchange will be informed of each change in the interest rate
of the Bonds on the date of such change. See "Terms and Conditions of the
Bonds -- Interest."
The Bonds will be treated as issued with "original issue discount" for U.S.
tax purposes which initially will be includible in gross income by Bondholders
prior to the receipt of cash payments to which the income is attributable. See
"Certain U.S. Tax Considerations."
The Bonds are listed on the Luxembourg Stock Exchange. The Bonds have been
designated as eligible for trading on the Private Offerings, Resales and Trading
through Automated Linkages ("PORTAL") system of the National Association of
Securities Dealers, Inc. Bonds resold pursuant to the Registration Statement (of
which this Prospectus is a part) will no longer be eligible for trading in the
PORTAL system.
The Bonds are redeemable at the option of the Company, in whole but not in
part on or after February 10, 2000, on not less than 90 nor more than 120 days'
prior notice (as described herein) at the principal amount thereof plus accrued
interest to the Redemption Date, provided that the average Closing Price of the
Common Stock of the Company for the 20 consecutive Trading Days prior to the
date of the Company's notice of redemption was greater than $26 per share. Such
redemption may be prohibited by the terms of or result in an event of default
under the Indenture pertaining to the Bonds or require the consents of holders
of Senior Indebtedness of the Company as described herein. The Bonds may also be
redeemed at any time if the Company would be required to pay Additional Amounts
on the occasion of the next payment due with respect to such Bond.
The Company anticipates that it will complete offerings of 11,100,000
shares of Common Stock in the United States and Canada and outside the United
States and Canada at an initial public offering price of $20.00 per share (the
"Stock Offerings") pursuant to its Registration Statement on Form S-1 (No.
333-36555) and an offering of $105 million of 9 7/8% Senior Notes due 2005 (the
"Notes") pursuant to its Registration Statement on Form S-1 (No. 333-43155) on
or about February 10, 1998 (the "Notes Offering" and together with the Stock
Offerings, the "Offerings"). Each of such registration statements was declared
effective on February 4, 1998.
ii
<PAGE> 3
AVAILABLE INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") in Washington, D.C. a Registration Statement on Form S-1 (as
amended, the "Registration Statement") of which this Prospectus is a part under
the Securities Act with respect to the Offered Securities offered hereby. This
Prospectus does not contain all of the information set forth in the Registration
Statement and the exhibits and schedules thereto. Statements made in this
Prospectus as to the contents of any contract, agreement or other document are
summaries of the material terms of such contract, agreement or other document.
With respect to each such contract, agreement or other document filed as an
exhibit to the Registration Statement, reference is made to the exhibit. The
Registration Statement (including the exhibits and schedules thereto) may be
inspected and copied at the public reference facilities maintained by the
Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, NW, Washington, D.C.
20549 and will also be available for inspection and copying at the regional
offices of the Commission located at Seven World Trade Center, 13th Floor, New
York, New York 10048 and at Citicorp Center, 500 West Madison Street (Suite
1400), Chicago, Illinois 60661. Copies of such material may also be obtained
from the Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549 at prescribed rates. The Commission also maintains a Web
site that contains reports, proxy and information statements and other
information regarding registrants that file electronically with the Commission.
The address of such site is http://www.sec.gov.
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance
therewith, files reports, proxy and information statements and other information
with the Commission. Such reports, proxy and information statements and other
information can be inspected and copied at the addresses set forth above. The
Company intends to furnish its stockholders with annual reports containing
consolidated financial statements audited by its independent accountants and
with quarterly reports containing unaudited condensed consolidated financial
statements for each of the first three quarters of each fiscal year.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Any statements that express, or involve discussions as to, expectations,
beliefs, plans, objectives, assumptions or future events or performance (often,
but not always, through the use of words or phrases such as "will likely
result," "are expected to," "will continue," "is anticipated," "estimated,"
"intends," "plans," "projection" and "outlook") are not historical facts and may
be forward-looking and, accordingly, such statements involve estimates,
assumptions and uncertainties which could cause actual results to differ
materially from those expressed in the forward-looking statements. Accordingly,
any such statements are qualified in their entirety by reference to, and are
accompanied by, the factors discussed throughout this Prospectus, and
particularly in the risk factors set forth herein under "Risk Factors." Among
the key factors that have a direct bearing on the Company's results of
operations are the potential risk of delay in implementing the Company's
business plan; the political, economic and legal aspects of the markets in which
the Company operates; competition and the Company's need for additional
substantial financing. These and other factors are discussed herein under "Risk
Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations," "Business" and elsewhere in this Prospectus.
The risk factors described herein could cause actual results or outcomes to
differ materially from those expressed in any forward-looking statements of the
Company made by or on behalf of the Company, and investors, therefore, should
not place undue reliance on any such forward-looking statements. Further, any
forward-looking statement speaks only as of the date on which such statement is
made, and the Company undertakes no obligation to update any forward-looking
statement or statements to reflect events or circumstances after the date on
which such statement is made or to reflect the occurrence of unanticipated
events. New factors emerge from time to time, and it is not possible for
management to predict all of such factors. Further, management cannot assess the
impact of each such factor on the Company's business or the extent to which any
factor, or combination of factors, may cause actual results to differ materially
from those contained in any forward-looking statements.
---------------------
Russia On Line(TM) is a trademark of the Company.
iii
<PAGE> 4
SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial statements appearing elsewhere in this Prospectus
(this "Prospectus"). Unless otherwise indicated, (i) the term "GTS" or the
"Company" refers to Global TeleSystems Group, Inc. (and, when appropriate, to
its predecessor) and its subsidiaries, (ii) references to the number of shares
of common stock outstanding after the Stock Offerings assume the Underwriters'
over-allotment option has not been exercised and (iii) the information in this
Prospectus gives effect to a 3-for-2 stock split of the Common Stock effected on
December 1, 1997. See "Exhibit A -- Glossary of Telecommunications Industry
Terms" for definitions of acronyms and technical telecommunications terms used
in this Prospectus.
THE COMPANY
GTS is a provider of a broad range of telecommunications services to
businesses, other telecommunications service providers and consumers in Russia,
the Commonwealth of Independent States ("CIS") and Central Europe. Through its
subsidiary Hermes Europe Railtel B.V. ("HER"), GTS is developing, and operating
the initial segments of, a pan-European high capacity fiber optic network that
is designed to interconnect a majority of the largest Western and Central
European cities and to transport international voice, data and multimedia/image
traffic for other carriers throughout Western and Central Europe. GTS's strategy
to develop its businesses generally has been to establish joint ventures with a
strong local partner or partners while maintaining a significant degree of
operational control. The Company's business activities consist of the ownership
and operation of (i) international long distance businesses, which operate
through international gateways that provide international switching services and
transmission capacity, (ii) local access networks, which provide local telephone
service, (iii) cellular networks, which provide wireless telecommunications
services, (iv) a domestic long distance business, (v) data networks and (vi)
carriers' carrier networks, which provide high volume transmission capacity to
other carriers.
In Russia and the CIS, GTS's objective is to become the premier alternative
telecommunications operator. To attain its objective, the Company has partnered
with regional telephone companies and with Rostelecom, the national long
distance carrier in Russia. The Company currently operates in 24 oblasts
(regions) and the city of Moscow in Russia, as well as in 11 additional cities
in the CIS, and believes it is well-positioned to become the leading independent
telecommunications service provider in Russia. These businesses include: (i) EDN
Sovintel ("Sovintel"), which provides Moscow, and recently St. Petersburg, with
international long distance and local telephone services and access to the major
domestic long distance carriers; (ii) TeleCommunications of Moscow ("TCM"),
which provides local access services in Moscow; (iii) TeleRoss (as defined
herein), which provides domestic long distance services in fourteen cities in
Russia, including Moscow, as well as Very Small Aperture Terminal ("VSAT")
service to customers outside its primary long distance satellite network; (iv)
Sovam Teleport ("Sovam"), which provides data services, including high-speed
data transmission, electronic mail, Internet access services, as well as Russia
On Line, the first Russian language Internet service; and (v) the Company's
cellular operations ("GTS Cellular"), which operate cellular networks in twelve
regions in Russia and also in Kiev, Ukraine, with licenses covering regions with
an aggregate population of approximately 25 million people at the end of 1995.
Whenever practical, GTS's businesses integrate and co-market their service
offerings in Russia and the CIS, utilizing TeleRoss as the domestic long
distance provider, Sovintel as the international gateway, TCM and GTS Cellular
for local access, and Sovam as the data communications and Internet access
network for business applications and on-line services. Together, GTS's Russian
and CIS ventures carried 202.5 million and 291.3 million minutes of traffic for
the year ended December 31, 1996 and the nine months ended September 30, 1997,
respectively, and had approximately 24,600 customers, including approximately
16,300 cellular subscribers, as of September 30, 1997. See "Business -- Russia
and the CIS."
In Western Europe, GTS seeks to position itself as the leading independent
carriers' carrier through the development of two ventures, HER and GTS-Monaco
Access S.A.M. ("GTS-Monaco Access"). HER's objective is to become the leading
pan-European carriers' carrier by providing centrally managed cross-border
telecommunications transmission capacity to telecommunications companies
including traditional Public
1
<PAGE> 5
Telecommunications Operators ("PTOs") and new entrants, such as alternative
carriers, global consortia of telecommunications operators, international
carriers, Internet backbone networks, resellers, value-added networks and other
service providers ("New Entrants") on an approximately 18,000 kilometer high
capacity fiber optic network designed to interconnect a majority of the largest
Western and Central European cities. HER is currently operating over an
approximately 1,700-kilometer portion of the network linking Brussels, Antwerp,
Rotterdam, Amsterdam, London and Paris. HER expects to roll out full
telecommunications transport service over approximately 2,900 kilometers of
fiber optic cable linking the cities of London, Rotterdam, Amsterdam, Antwerp,
Brussels, Paris, Dusseldorf and Frankfurt (the "initial five country network")
in the second quarter of 1998. The full 18,000 kilometer network is expected to
become fully operational during the year 2000. HER also plans to lease capacity
on a transatlantic cable linking the European network to North America and is
exploring various interconnectivity options to Russia and Asia. Such
intercontinental interconnectivity will help HER satisfy the needs of its
European customers with respect to outgoing traffic and attract additional
non-European customers with traffic terminating in Europe. HER commenced
commercial service over the Brussels-Amsterdam portion of the network in late
1996 and the London-Paris portion in November 1997. GTS-Monaco Access operates
an international gateway in Monaco in partnership with, and utilizing the
existing gateway infrastructure of, the Principality of Monaco and provides
transit and routing of international calls to other telecommunications
operators. Through its HER and GTS-Monaco Access ventures, GTS is building a new
network for transporting voice, data and multimedia/image traffic for other
carriers throughout Western and Central Europe and for worldwide international
voice, data and multimedia/image traffic that either originates or terminates
in, or transits through, Western and Central Europe. See "Business -- Western
Europe."
In Central Europe, GTS's objective is to become one of the leading
alternative telecommunications providers in the region. GTS currently provides
private data communications services to government and commercial customers in
Hungary and the Czech Republic. In the Czech Republic, the Company provides
outgoing voice services and operates an international gateway and a data
services network. In Hungary, GTS operates a VSAT network, which GTS believes is
the largest VSAT network in Central Europe as measured by number of VSAT sites.
The Company has also signed an agreement to provide international data services
in Poland, subject to the receipt of necessary governmental approvals. GTS's
strategy is to expand its service offerings as the regulatory environment
permits, leverage its existing VSAT and international gateway infrastructure
where possible and provide a broad range of services to its target markets.
Although GTS does not currently own or operate significant
telecommunication assets in Asia, GTS's objective is to become an established
and diversified telecommunications provider in China and India. GTS seeks to
leverage its position in these countries to capitalize on opportunities as they
arise.
2
<PAGE> 6
The following table sets forth certain information for the principal
ventures through which the Company conducts its business:
<TABLE>
<CAPTION>
COUNTRY/REGION GTS PRINCIPAL
COMPANY NAME OF OPERATIONS OWNERSHIP PARTNER(S) BUSINESS
------------ -------------- ------------ ------------------- ------------------
<S> <C> <C> <C> <C>
CIS
Sovintel.................................... Russia 50% Rostelecom International Long
Distance; Local
Access
TCM......................................... Russia 50%(1) MTU Inform and Local Access Lines
others
TeleRoss.................................... Russia 50%(2) Various local PTOs Domestic Long
Distance
Sovam....................................... Russia 67%(3) Institute for Data and Internet
Automated Systems
GTS Cellular................................ CIS 25-70%(4) Primarily various Basic Cellular
local PTOs
WESTERN EUROPE
HER......................................... Western Europe 79%(5) Various Carriers' Carrier
GTS-Monaco Access........................... Monaco 50% Principality of Carriers' Carrier;
Monaco International
Gateway
CENTRAL EUROPE
GTS-Hungary................................. Hungary 99% -- VSAT Network
EuroHivo.................................... Hungary 70% Microsystems Paging Services
Telecom Rt.;
Gerard Aircraft
Sales and Leasing
Company
CzechNet.................................... Czech Republic 100% -- International Long
Distance
CzechCom.................................... Czech Republic 100% -- Data and Internet
ASIA
V-Tech...................................... China 75% Shanghai Science VSAT Network
and Technology
Investment
Corporation
Beijing Tianmu.............................. China 47% China International VSAT Network
Travel Service
Telecom Co.,
Ltd.(6)
CDI......................................... India 100% -- Voice, Data and
Internet
</TABLE>
- - ---------------
(1) GTS holds a 50% indirect interest in TCM through its 52.6% interest in
GTS-Vox Limited, an intermediate holding company.
(2) TeleRoss consists of (i) two wholly owned holding companies and a 99% owned
subsidiary that operates a domestic long distance network (collectively,
"TeleRoss Operating Company") and (ii) thirteen joint ventures that are 50%
beneficially-owned by GTS (the "TeleRoss Ventures"). See "Business -- Russia
and the CIS -- TeleRoss."
(3) GTS has reached an agreement in principle to purchase its minority partner's
33.3% interest in Sovam and expects to consummate the transaction in
February 1998, thereby making Sovam a wholly owned subsidiary of GTS.
(4) GTS conducts its cellular operations through (i) Vostok Mobile B.V. ("Vostok
Mobile"), a wholly owned GTS subsidiary, which owns between 50% and 70% of a
series of 11 cellular joint ventures in various regions in Russia, (ii)
PrimTelefone, a 50% owned venture in Vladivostok and four other cities in
the Primorsky region of Russia and (iii) Bancomsvyaz, an approximately 25%
beneficially owned venture in Kiev, Ukraine. GTS intends to enter into the
cellular markets of additional Russian regions through Vostok Mobile. See
"Business -- Russia and the CIS -- GTS Cellular."
(5) GTS currently owns approximately 79% of HER. The Company's interest is
expected to decrease due to the stock options for common shares of HER
issued to certain HER executives under the new HER stock option plan
established in the fourth quarter of 1997. See "Executive Compensation and
Other Information -- HER 1994 Stock Option Plan" and Note 6 -- Stock Option
Plan -- HER audited consolidated financial statements.
(6) GTS owns 75% of GTS China Investments LLC ("GCI"), which owns 90% of
American China Investment Corporation ("ACIC"). ACIC owns 70% of the Beijing
Tianmu China joint venture company.
3
<PAGE> 7
BUSINESS STRATEGY
GTS seeks to develop businesses to meet the rapidly expanding market demand
for telecommunications services. GTS's goal in emerging markets is to establish
itself as the leading alternative to the incumbent telecommunications service
providers and as a premier provider of value-added services. In addition, the
Company seeks to position itself as the leading independent carriers' carrier
within Western and Central Europe through the development of a pan-European
fiber optic network and an international gateway in Monaco.
GTS believes that it will be able to successfully operate its businesses
and develop business opportunities by pursuing the following strategies:
- Identify and Seize Early Market Opportunities. GTS's primary strategy is
to identify less developed markets in which the incumbent operator offers
inadequate service and where liberalization of telecommunications
regulations may be pending. The Company believes that entering these less
developed markets quickly is a key competitive advantage in the global
telecommunications market. GTS leverages its management's knowledge of
the markets in which the Company operates to assess and react quickly
when attractive business opportunities arise.
- Establish Joint Ventures with Experienced Local Partners. GTS seeks to
establish and maintain strategic partnerships and relationships with key
telecommunications operators and service providers in the countries in
which it operates. The Company believes that these relationships increase
its ability to anticipate and respond to changes in the regulatory and
legal environment and assist with license renewal and expansion of its
operating companies.
- Retain Significant Operational Control. In general, GTS actively
participates in the management of its ventures by (i) providing most of
the funding for the ventures' operations, (ii) selecting key members of
the local management team, (iii) developing business plans and marketing
strategies together with local management, (iv) monitoring operating
functions, (v) maintaining close working relationships with local
partners and (vi) integrating its networks and businesses in a manner
which is consistent with the Company's overall strategic objectives.
- Build Infrastructure to Provide High Quality Services. GTS continues to
develop and expand its network infrastructure. The Company believes that
its networks offer service, quality and cost advantages over incumbent
providers as a result of the Company's customer support, network
monitoring, management systems and its ability to integrate and co-market
its service offerings.
- Leverage Management Depth and Experience. GTS's management has
significant experience in the development and operation of
telecommunications businesses outside the United States. The Company
believes that this experience, together with the Company's extensive
operations, has provided its management with the ability to identify,
evaluate and pursue international telecommunications business
opportunities. Additionally, GTS has assembled a management team
comprised of executives with extensive experience managing
telecommunications companies in the respective local markets. GTS
believes that its management team possesses a broad knowledge of relevant
political and regulatory structures, as well as the cultural awareness
and fluency with international and local business practices necessary to
implement the Company's objectives.
- Ability to Access Capital. In general, the Company's financing strategy
is to establish parent level funding to meet general corporate needs and
the costs of start-ups and acquisitions and, when it is possible and
cost-effective, to finance ongoing operations at the venture level. Since
1993, the Company has raised approximately $268 million in equity and
approximately $215 million of debt (of which approximately $74 million
was raised through shareholders). In addition, HER completed a $265
million private placement of senior notes (of which $56.6 million was
placed into escrow for the first two years' interest payments) in 1997.
The Company's principal investors include affiliates of George Soros and
Alan B. Slifka and certain of his affiliates.
4
<PAGE> 8
In addition to its overall business strategy, GTS has developed specific
market strategies to achieve its goals in emerging markets and Western Europe.
Emerging Markets. The Company pursues its goals in emerging markets through
a three-stage approach of market entry, market expansion and market integration.
- Market Entry. GTS identifies a market as a suitable target for entry
based upon: (i) superior growth prospects for such market, demonstrated
by growing demand for high quality telecommunications services; (ii) the
provision of inadequate services by incumbent providers, typically
resulting from the incumbents' unwillingness to offer high quality
services with reliable customer support at attractive prices; and (iii)
attractive regulatory environments in which emerging alternative
telecommunications providers such as GTS have, or expect to have over a
clearly defined time horizon, the ability to compete on a substantially
equal basis with the incumbent providers in terms of certain services and
the cost of providing those services. Once GTS has identified a market as
suitable for entry, the Company seeks to establish its presence in that
market by establishing a venture with a strong local partner or partners.
In general, GTS maintains a significant degree of operational control in
such ventures. Through such ventures, the Company benefits from its
partners' ability to provide infrastructure, regulatory expertise and
personnel that will provide GTS with a competitive advantage in entering
that market. When entering a new market, GTS's strategy is to provide its
customers with higher quality service as compared to the services offered
by incumbent providers.
- Market Expansion. Having entered a market successfully and established a
limited service offering to its targeted customer base, GTS then seeks to
expand the range of services it offers to existing and potential
customers and to further develop its relationships with local partners.
By broadening its service offerings, GTS anticipates achieving increased
economies of scale through the common use of administrative and operating
functions already in place, increasing the Company's share of its
customers' telecommunications spending and expanding GTS's base of
potential customers through the provision of a bundled service offering.
The Company also seeks to expand its targeted geographic market by
forming new partnerships, installing infrastructure and offering services
in additional geographic regions, allowing the Company to further enhance
its operating leverage and ability to service its customers'
telecommunications needs.
- Market Integration. GTS ultimately intends to integrate and co-market its
service offerings in each of the markets in which it operates. The
Company believes such integration enables it to enhance its operating
efficiency by leveraging its distribution channels, infrastructure and
networks, and management information systems. As customers develop a need
for a broader variety of telecommunications services, the Company
believes GTS's integrated operations will represent an attractive service
alternative for customers seeking a single provider with the ability to
meet all their telecommunications needs.
Western Europe. The Company seeks to position itself as the leading
independent carriers' carrier within Western Europe through the development of
HER's pan-European fiber optic network and the operation of GTS-Monaco Access's
international gateway in partnership with, and utilizing the gateway
infrastructure of, the Principality of Monaco. The overall strategy of GTS in
Western Europe is to complement and enhance the services provided by PTOs and
New Entrants in a way that helps them to more successfully meet the needs of
their end-user customers. HER seeks to enter the market ahead of competition and
encourage a wide variety of carriers to use its network with service offerings
that meet their needs. To establish itself as the leading carriers' carrier for
international telecommunications within Europe, HER intends to provide its
customers with significantly higher quality transmission and advanced network
capabilities at a competitive price by utilizing advanced, uniform technology
across the region and providing redundant routing for higher levels of
reliability.
5
<PAGE> 9
FINANCING PLAN
In general, the Company's strategy is to finance general corporate cash
needs, the development of start-up ventures and acquisitions through the parent
company and, when possible and cost effective, to finance ongoing operations at
the venture level. Since 1993, the Company has raised approximately $268 million
in equity and approximately $215 million of debt (of which approximately $74
million was raised through shareholders). In addition, HER completed a $265
million private placement of senior notes (of which $56.6 million was placed
into escrow for the first two years' interest payments) in 1997.
Concurrently with the Stock Offerings, the Company has undertaken the Notes
Offering, which offering has been made by a separate prospectus. The
consummation of both the Notes Offering and the Stock Offerings are conditioned
upon the consummation of the other.
The Company believes that the net proceeds from the Offerings, together
with existing cash, will be sufficient to fund its expected capital needs until
at least June 1999. GTS expects that it may require additional capital to
execute its current business plan and to fund expected operating losses, as well
as to consummate future acquisitions and exploit opportunities to expand and
develop its businesses. Management expects that GTS and its ventures will incur
over $515 million of capital expenditures during the next three years, of which
approximately $235 million will be incurred in 1998. Of these amounts,
approximately $290 million will be used to fund construction of the HER network,
with approximately $35 million required for the roll out of the initial five
country network that is expected to be completed in the second quarter of 1998.
The Company also will need to fund operating losses of its ventures for at least
the next 12 months. In addition, as part of its business strategy, the Company
regularly evaluates potential acquisitions and joint ventures. The Company has
no definitive agreement with respect to any acquisition or joint venture,
although from time to time it has discussions with other companies and assesses
opportunities on an on-going basis. The Company may fund these acquisitions or
joint ventures with a portion of the net proceeds from the Offerings. See "Risk
Factors -- Additional Capital Requirements" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
As of December 31, 1997, after giving effect to the Stock Offerings,
certain affiliates of George Soros, Alan B. Slifka and certain affiliates, and
certain affiliates of Capital Research International beneficially owned
approximately 20.4%, 11.2% and 10.3% of the Common Stock (including rights to
acquire Common Stock), respectively. See "Principal Stockholders."
* * *
The Company was founded in 1983 as a not-for-profit company under the name
San Francisco/Moscow Teleport, Inc. The Company was incorporated as a California
for-profit corporation on September 25, 1986, and by way of a reincorporation
merger, merged with and into SFMT, Inc., a Delaware corporation formed for that
purpose on September 13, 1993. The Company was renamed Global TeleSystems Group,
Inc., on February 22, 1995. The Company's principal business office is located
at 1751 Pinnacle Drive, North Tower-12th Floor, McLean, Virginia 22102, United
States, and its telephone number is (703) 918-4500.
RISK FACTORS
See "Risk Factors" beginning on page 9 for a discussion of certain factors
that should be considered by prospective investors in evaluating an investment
in the Offered Securities.
6
<PAGE> 10
SUMMARY HISTORICAL CONSOLIDATED FINANCIAL DATA
The following summary historical consolidated financial data as of December
31, 1996 and September 30, 1997 and for the years ended December 31, 1994, 1995
and 1996 and for the nine months ended September 30, 1997 are derived from the
Company's audited Consolidated Financial Statements. The following unaudited
summary historical consolidated financial data for the nine months ended
September 30, 1996 are derived from the Company's unaudited Consolidated
Financial Statements. The summary historical consolidated financial data
presented below should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations," and the audited
Consolidated Financial Statements and related notes thereto appearing elsewhere
in this Prospectus.
Under generally accepted accounting principles, a majority of the Company's
ventures are accounted for by the equity method of accounting. Under this
method, the operating results of the ventures are included in the Company's
Consolidated Statement of Operations as a single line item, "Equity in losses of
ventures." The Company recognizes 100% of the losses in ventures where the
Company bears all of the financial risk (which includes all of the Company's
significant ventures except for Sovintel and, historically, HER). Also, the
assets, liabilities and equity of the ventures are included in the Company's
Consolidated Balance Sheets as a single line item, "Investments in and advances
to ventures." See Note 2 to the Company's audited Consolidated Financial
Statements and "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Overview." Financial information about the Company's
equity ventures is included below under "Supplemental Information -- Summary
Historical Financial Data -- Combined Equity Investments."
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------ ----------------------
1994 1995 1996 1996 1997(1)
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues, net........................... $ 2,468 $ 8,412 $ 24,117 $ 14,639 $ 30,216
Gross margin............................ 23 16 5,176 1,758 1,864
Operating expenses...................... 12,863 41,014 52,928 35,725 52,059
Equity in losses of ventures............ (135) (7,871) (10,150) (6,999) (18,234)
Other income (expense).................. 990 11,034 (8,729) (6,535) (16,902)
Net loss................................ (11,985) (40,400) (67,991) (48,473) (87,872)
Loss per share.......................... (0.69) (1.61) (2.22) (1.69) (2.37)
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1996 1997(1)
------------ -------------
(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................. $ 57,874 $366,841
Property and equipment, net............................... 35,463 69,051
Investments in and advances to ventures................... 104,459 84,068
Total assets.............................................. 237,378 647,788
Total debt................................................ 85,547 502,482
Minority interest and stock subject to repurchase......... 6,248 32,764
Shareholders' equity...................................... 113,668 57,403
</TABLE>
- - ---------------
(1) As a result of the Company's increase in ownership interest and amendment to
the HER Shareholders Agreement that was completed on July 16, 1997, the
Company accounts for its ownership interest in HER under the consolidation
method of accounting. Prior to this date, the Company accounted for HER
using the equity method of accounting.
7
<PAGE> 11
SUPPLEMENTAL INFORMATION -- SUMMARY HISTORICAL
FINANCIAL DATA -- COMBINED EQUITY INVESTMENTS
The following unaudited summary historical financial data -- equity
investments for the years ended December 31, 1995 and 1996 and for the nine
months ended September 30, 1996 and 1997, are derived from the Company's
financial records. It is intended to supplement the aforementioned summary
historical consolidated financial data, which were derived from the Company's
audited Consolidated Financial Statements.
The Company believes that this information provides additional insight on
the Company's unconsolidated equity method investments. Generally accepted
accounting principles prescribe inclusion of revenues and expenses for
consolidated interests (generally interests of more than 50%, absent some other
factors), but not for equity interests (generally interests of 20% to 50%) or
cost interests (generally interests of less than 20%). Equity accounting
ordinarily results in the same net income as consolidation; however, the net
operating results are reflected on one line within the income statement. More
detailed financial information about the Company's equity investments is
included under "Supplemental Information -- Selected Historical Financial
Data -- Combined Equity Investments."
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------- -------------------
1995 1996 1996 1997
--------- ---------- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues, net................................... $54,051 $143,472 $93,270 $159,006
Cost of revenues................................ 33,011 80,426 50,854 87,694
Operating expenses.............................. 22,958 55,018 34,174 60,447
Net loss........................................ (6,380) (5,220) (6,150) (3,680)
Income (loss) recognized by GTS................. (7,871) (10,150) (6,999) (18,234)
ADJUSTMENTS FOR INTER-AFFILIATE TRANSACTIONS(1):
Revenues, net................................... (2,270) (15,385) (9,675) (17,049)
Cost of revenues................................ (2,215) (13,562) (7,596) (15,853)
Operating expenses.............................. (6,967) (8,083) (7,134) (11,105)
</TABLE>
- - ---------------
(1) The adjustment amounts represent the effect of inter-affiliate transactions
between the Company's consolidated and equity method ventures. More detailed
information about inter-affiliate transactions is included under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Accounting Methodology."
8
<PAGE> 12
RISK FACTORS
ADDITIONAL CAPITAL REQUIREMENTS
GTS expects that it may require additional capital to execute its current
business plan and to fund expected operating losses, as well as to consummate
future acquisitions and exploit opportunities to expand and develop its
businesses. Management expects that GTS and its ventures will incur over $515
million of capital expenditures during the next three years, of which
approximately $235 million will be incurred in 1998. Of these amounts,
approximately $290 million will be used to fund construction of the HER network,
with approximately $35 million required for the roll out of the initial five
country network that is expected to be completed in the second quarter of 1998.
The Company also will need to fund operating losses of its ventures for at least
the next 12 months. In addition, as part of its business strategy, the Company
regularly evaluates potential acquisitions and joint ventures. The Company has
no definitive agreement with respect to any material acquisition or joint
venture, although from time to time it has discussions with other companies and
assesses opportunities on an on-going basis. The Company may fund such
acquisitions or joint ventures with a portion of the net proceeds from the
Offerings.
The Company believes that the net proceeds from the Offerings, together
with existing cash, will be sufficient to fund its expected capital needs until
at least June 1999. The actual amount and timing of the Company's future capital
requirements, however, may differ materially from management's estimates. In
particular, the accuracy of management's estimates are subject to changes and
fluctuations in the Company's revenues, operating costs and development
expenses, which can be affected by the Company's ability to (i) effectively and
efficiently manage the expansion of the HER network and operations, (ii) obtain
infrastructure contracts, rights-of-way, licenses and other regulatory approvals
necessary to complete and operate the HER network, (iii) negotiate favorable
contracts with suppliers, including large volume discounts on purchases of
capital equipment and (iv) access markets, attract sufficient numbers of
customers and provide and develop services for which customers will subscribe.
The Company's revenues and costs are also dependent upon factors that are not
within the Company's control such as regulatory changes, changes in technology,
increased competition and various factors such as strikes, weather, and
performance by third-parties in connection with the Company's operations. Due to
the uncertainty of these factors, actual revenues and costs may vary from
expected amounts, possibly to a material degree, and such variations are likely
to affect the Company's future capital requirements. Historically, GTS has
experienced liquidity problems resulting in part from the Company's need to meet
the capital requirements of certain of its joint ventures in excess of forecast
amounts. In addition, certain of the Company's joint ventures have not met
management's financial performance expectations or have not been able to secure
local country financing and thus have not been able to generate the expected
cash inflows. In addition, if the Company expands its operations at an
accelerated rate or consummates acquisitions, the Company's funding needs will
increase, possibly to a significant degree, and it will expend its capital
resources sooner than currently expected. The Company may also be required to
repay its Bonds upon maturity in the year 2000 to the extent such bonds are not
converted into Common Stock. As a result of the foregoing, or if the Company's
capital resources otherwise prove to be insufficient, the Company may need to
raise additional capital. See "-- Government Regulation," "-- Competition,"
"-- Technology," "-- HER Network Roll-out," "Management's Discussion and
Analysis of Financial Condition and Results of Operations," and "Use of
Proceeds."
If the Company decides to raise additional funds through the incurrence of
debt, it may become subject to additional or more restrictive financial
covenants and its interest obligations will increase. If the Company decides to
raise additional funds through the issuance of equity, the interests of holders
of the Common Stock, will be diluted. There can be no assurance that additional
financing will be available to GTS on favorable terms or at all, and failure to
generate sufficient funds in the future, whether from operations or by raising
additional debt or equity capital, may require the Company to delay or abandon
some or all of its anticipated expenditures, to sell assets, or both, and could
affect the Company's ability to compete, either of which could have a material
adverse effect on the operations of the Company, and could affect the value of
the Common Stock. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Use of Proceeds."
9
<PAGE> 13
HISTORY OF OPERATING LOSSES
The Company has historically sustained substantial operating and net
losses. The Company had net losses of $0.4 million in 1992, $2.4 million in
1993, $12.0 million in 1994, $40.4 million in 1995, $68.0 million in 1996 and
$87.9 million for the nine months ended September 30, 1997. The Company's
cumulative net losses totalled $213.8 million from inception through September
30, 1997. Further development of the Company's business will require significant
additional expenditures and the Company expects that it will have significant
operating and net losses and will record significant net cash outflow, before
financing, in coming years. There can be no assurance that the Company's
operations will achieve or sustain profitability or positive cash flow in the
future. If the Company cannot achieve and sustain operating profitability or
positive cash flow from operations, it may not be able to meet its debt service
obligations or working capital requirements. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
HER NETWORK ROLL-OUT
HER's ability to achieve its strategic objective will depend in large part
on the successful, timely and cost-effective completion of the HER network.
Although HER currently operates commercially over an approximately 1,700
kilometer portion of the network linking Brussels, Antwerp, Rotterdam,
Amsterdam, London and Paris, the development of the remainder of the network may
be delayed or adversely affected by a variety of factors, uncertainties and
contingencies. Many of these factors, such as strikes, natural disasters and
other casualties, are beyond HER's control. In addition, HER will need to
negotiate and conclude additional agreements with various parties regarding,
among other things, rights-of-way and development and maintenance of the network
infrastructure and equipment. Historically, HER has experienced substantial
delays in concluding these agreements and developing its network. There can be
no assurance that HER will be successful in concluding necessary agreements, or
that delays in concluding such agreements will not materially and adversely
affect the speed or successful completion of the network. The successful and
timely completion of the network will also depend on, among other things, (i)
the availability to HER of substantial amounts of additional capital and
financing, (ii) timely performance by various third parties of their contractual
obligations to engineer, design and construct portions of the network and (iii)
HER's ability to obtain and maintain applicable governmental approvals.
HER expects to roll out full telecommunications service over the initial
five country network in the second quarter of 1998, and the 18,000 kilometer
network to be operational during the year 2000. Although HER believes that its
cost estimates and the build-out schedule are reasonable, there can be no
assurance that the actual construction costs or time required to complete the
network build-out will not substantially exceed current estimates.
Any significant delay or increase in the costs associated with development
of the HER network could have a material adverse effect on HER and the Company.
Development of the HER network is capital intensive. Management expects
that approximately $290 million in capital expenditures will be incurred in
connection with the buildout of the HER network, with approximately $35 million
required for the roll out of the initial five country network that is expected
to be completed in the second quarter of 1998. While HER raised approximately
$265 million in a private placement of its senior notes in August 1997 (of which
$56.6 million has been placed in escrow for the first two years' interest
payments on the notes), additional financing must be obtained to construct the
HER network and there can be no assurance that such additional financing will be
completed. Failure to obtain necessary financing may require HER to delay or
abandon its plans for deploying the remainder of the network and would adversely
affect the viability of HER, or may require the Company to make additional
capital contributions to HER at the expense of the Company's other operations,
either of which could have a material adverse effect on the operations of the
Company. HER's revenues and the cost of deploying its network and operating its
business will depend upon a variety of factors including, among other things,
HER's ability to (i) effectively and efficiently manage the expansion of its
network and operations, (ii) negotiate favorable contracts with suppliers, (iii)
obtain additional licenses, regulatory approvals, rights-of-way and
infrastructure contracts to complete and operate the network, (iv) access
markets and attract sufficient numbers of
10
<PAGE> 14
customers and (v) provide and develop services for which customers will
subscribe. HER's revenues and costs are also dependent upon factors that are not
within HER's control such as regulatory changes, changes in technology,
increased competition and various factors such as strikes, weather and
performance by third-parties in connection with the development of the network.
Due to the uncertainty of these factors, actual costs and revenues may vary from
expected amounts, possibly to a material degree, and such variations would
likely affect HER's future capital requirements. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources." HER must obtain additional infrastructure provider
agreements for the long-term lease of dark fiber, rights-of-way and other
permits to install fiber optic cable from railroads, utilities and governmental
authorities to build out the network. There can be no assurance that HER will be
able to maintain all of its existing agreements, rights and permits or to obtain
and maintain the additional agreements, rights and permits needed to implement
its business plan on acceptable terms. Loss of substantial agreements, rights
and permits or the failure to enter into and maintain required arrangements for
the HER network could have a material adverse effect to enter on HER's business.
In addition, HER depends on third parties for leases of dark fiber for
substantial portions of its network. There can be no assurance that HER will be
able to enter into and maintain required arrangements for leased portions of the
HER network, which could have a material adverse effect on HER's business.
In order to operate and, in the case of some countries, even to construct
the network in accordance with current plans, HER must obtain the necessary
regulatory approvals. To date, HER has obtained licenses, authorizations and/or
registrations in the United Kingdom, the Netherlands, Belgium, Germany and
France and has obtained a trial concession to operate in Switzerland, which
expired on December 31, 1997. However, the Swiss regulator has invited HER to
submit a new application for a concession and HER expects to obtain a permanent
concession in due course. In addition, HER intends to file applications in other
countries in anticipation of service launch in accordance with the HER network
roll-out plan. The terms and conditions of these licenses, authorizations or
registrations may limit or otherwise affect HER's scope of operations. There can
be no assurance that HER will be able to obtain, maintain or renew licenses,
authorizations or registrations to provide the services it currently provides
and plans to provide, that such licenses, authorizations or registrations will
be issued or renewed on terms or with fees that are commercially viable, or that
the licenses, authorizations or registrations required in the future can be
obtained by HER. The loss of, or failure to obtain, these licenses,
authorizations or registrations or a substantial limitation upon the terms of
these licenses, authorizations or registrations could have a material adverse
effect on HER. See "Business -- Western Europe -- HER -- Licenses and Regulatory
Issues."
RISKS RELATING TO REORGANIZATION OF RUSSIAN TELECOMMUNICATIONS INDUSTRY
Svyazinvest was established by the Russian government in 1994 to hold the
government's interest in 88 regional telecommunication companies. In April 1997,
President Yeltsin approved the transfer of additional government-owned
telecommunications assets, including the government's 51% stake in Rostelecom
(the government controlled international and long distance operator), to
Svyazinvest. On July 30, 1997, Mustcom Ltd., a Cyprus-based company that
represents the interests of a consortium which includes ICFI Cyprus, Renaissance
International Ltd., Deutsche Morgan Grenfell, Morgan Stanley, and an affiliate
of George Soros, purchased a 25% stake in Svyazinvest for $1.87 billion. As of
September 30, 1997, affiliates of George Soros beneficially owned 25.8% of the
Company's Common Stock. The President has also authorized the sale of another
24% of Svyazinvest at a future date. This sale is scheduled to occur in the
first half of 1998 and is currently reserved solely for Russian investors. The
Russian government has announced that it will retain a controlling 51% interest
in Svyazinvest. As a result of the government's actions, a single entity,
Svyazinvest, now owns a majority interest in most of the Company's principal
venture partners and other telecommunication service providers in Russia which
together provide a range of international and domestic long distance and local
telecommunications services throughout Russia. The consolidation of many of its
partners under Svyazinvest and the possible sale of a significant interest in
Svyazinvest to foreign and/or Russian investors will likely subject the Company
to more coordinated competition from Svyazinvest, and may lead to material
adverse changes in the business relationships between the Company and such
partners, which business relationships represent a material component of the
Company's business strategy in Russia. There can be no assurance that the
continuing privatization of Svyazinvest, or the evolution of government policy
regarding
11
<PAGE> 15
Svyazinvest and Rostelecom, will not have a material adverse effect on the
Company or its ventures. See "-- Competition," "-- Dependence on Certain Local
Parties; Absence of Control" and "Business -- Russia and the CIS -- Overview"
and "Principal Stockholders."
MANAGING RAPID GROWTH
As a result of the Company's past and expected continued growth and
expansion, significant demands have been placed on the Company's management,
operational and financial resources and on its systems and controls. The Company
continues to construct segments of the HER network, expand its operations within
Russia and the CIS and expand into additional geographic and service markets
when business and regulatory conditions warrant. In order to manage its growth
effectively, the Company must continue to implement and improve its operational
and financial systems and controls, purchase and utilize additional
telecommunications facilities and expand, train and manage its employee base.
Inaccuracies in the Company's forecasts of market demand could result in
insufficient or excessive telecommunications facilities and disproportionate
fixed expenses for certain of its operations. There can be no assurance that the
Company will be able to construct and operate the entire HER network as
currently planned, expand with the markets in which its ventures are currently
operating or expand into additional markets at the rate presently planned by the
Company, or that any existing regulatory barriers to such expansion will be
reduced or eliminated. As the Company proceeds with its development and
expansion, there will be additional demands on the Company's customer support,
sales and marketing and administrative resources and network infrastructure.
There can be no assurance that the operating and financial control systems and
infrastructure of the Company and its ventures will be adequate to maintain and
effectively manage future growth. The failure to continue to upgrade the
administrative, operating and financial control systems or the emergence of
unexpected expansion difficulties could materially and adversely affect the
Company's business, results of operations and financial condition.
RISKS RELATING TO EMERGING MARKETS
Substantially all of the Company's revenue is derived from operations in
emerging markets, where the Company's businesses are subject to numerous risks
and uncertainties, including political, economic and legal risks, such as
unexpected changes in regulatory requirements, tariffs, customs, duties and
other trade barriers, difficulties in staffing and managing foreign operations,
problems in collecting accounts receivable, political risks, fluctuations in
currency exchange rates, foreign exchange controls which restrict or prohibit
repatriation of funds, technology export and import restrictions or
prohibitions, delays from customs brokers or government agencies, seasonal
reductions in business activity, and potentially adverse tax consequences
resulting from operating in multiple jurisdictions with different tax laws,
which could materially adversely impact the Company's business, results of
operations and financial condition.
The political systems of many of the emerging market countries in which the
Company operates or plans to operate are slowly emerging from a legacy of
totalitarian rule. Political conflict and, in some cases, civil unrest and
ethnic strife may continue in some of these countries for a period of time. Many
of the economies of these countries are weak, volatile and reliant on
substantial foreign assistance. Expropriation of private businesses in such
jurisdictions remains a possibility, whether by an outright taking or by
confiscatory tax or other policies. There can be no assurance that GTS's
operations will not be materially and adversely affected by such factors or by
actions to expropriate or seize its operations. The success of free market
reforms undertaken in certain of the emerging market countries in which the
Company operates is also uncertain, and further economic instability may occur.
These factors may reduce and delay business activity, economic development and
foreign investment.
Legal systems in emerging market countries frequently have little or no
experience with commercial transactions between private parties. The extent to
which contractual and other obligations will be honored and enforced in emerging
market countries is largely unknown. Accordingly, there can be no assurance that
difficulties in protecting and enforcing rights in emerging market countries
will not have a material adverse effect upon GTS and its operations.
Additionally, the Company's businesses operate in uncertain regulatory
environments. The laws and regulations applicable to GTS's activities in
emerging market countries are in general new and subject to change and, in some
cases, incomplete. There can be no assurance that local laws and regulations
will become stable in the future, or that changes thereto will not materially
adversely affect the
12
<PAGE> 16
operations of GTS. Additionally, telecommunications regulations in the more
developed Western European markets in which GTS participates are currently
undergoing changes initiated by the Commission of the European Union. See
"Business."
RISKS RELATING TO RUSSIA AND THE CIS
Substantially all of the Company's revenue is derived from operations in
Russia and the CIS. Foreign companies conducting operations in the former Soviet
Union face significant political, economic, and legal risks.
Political. The political systems of Russia and the other independent
countries of the CIS, which are in a stage of relative infancy, are vulnerable
to instability due to the populace's dissatisfaction with reform, social and
ethnic unrest and changes in government policies. Such instability could lead to
events that could have a material adverse effect on the Company's operations in
these countries. In recent years, Russia has been undergoing a substantial
political transformation. During this transformation, legislation has been
enacted to protect private property against expropriation and nationalization.
However, due to the lack of experience in enforcing these provisions in the
short time they have been in effect and due to potential political changes in
the future, there can be no assurance that such protections would be enforced in
the event of an attempted expropriation or nationalization. Expropriation or
nationalization of the Company, its assets or portions thereof, whether by an
outright taking or by confiscatory tax or other policies potentially without
adequate compensation, would have a material adverse effect on the Company.
The various government institutions and the relations between them, as well
as the government's policies and the political leaders who formulate and
implement them, are subject to rapid and potentially violent change. For
example, the Constitution of the Russian Federation gives the President of the
Russian Federation substantial authority, and any major changes in, or rejection
of, current policies favoring political and economic reform by the President may
have a material adverse effect on the Company. Furthermore, the political and
economic changes in Russia have resulted in significant dislocations of
authority. The local press and international press have reported that
significant organized criminal activity has arisen and high levels of corruption
among government officials exist where the Company operates. While the Company
does not believe it has been adversely affected by these factors to date, no
assurance can be given that organized or other crime will not in the future have
a material adverse effect on the Company.
Economic. Over the past five years the Russian government has enacted
reforms to create the conditions for a more market-oriented economy. Despite
some progress in implementing its reforms, including progress in reducing
inflation and stabilizing the currency and industrial production, there remains
generally rising unemployment and underemployment, high government debt relative
to gross domestic product and high levels of corporate insolvency. No assurance
can be given that reform policies will continue to be implemented and, if
implemented, will be successful, that Russia will remain receptive to foreign
trade and investment or that the economy will improve.
In addition, Russia, the CIS and other emerging countries in which the
Company operates currently receive substantial financial assistance from several
foreign governments and international organizations. To the extent any of this
financial assistance is reduced or eliminated, economic development in Russia,
the CIS and such other countries may be adversely affected.
Russian and CIS businesses have a limited operating history in
market-oriented conditions. The relative infancy of the business culture is
reflected in the Russian banking system's under-capitalization and liquidity
crises. There have been concerns about rumors that many Russian banks continue
to have cash shortages. The Russian Central Bank has reduced banks' reserve
requirements in order to inject more liquidity into the Russian financial
system, but has stressed that it will not bail out the weaker banks. Many of
these banks are expected to disappear over the next several years as a result of
bank failure and anticipated consolidation in the industry. A general Russian
banking crisis could have a material adverse effect on the Company's operations
and financial performance and on the viability of the Company's receivables.
13
<PAGE> 17
Regulation of the Telecommunications Industry. The Russian
telecommunications system is currently regulated largely through the issuance of
licenses. There is currently no comprehensive legal framework with respect to
the provision of telecommunications services in Russia, although a number of
laws, decrees and regulations govern or affect the telecommunications sector. As
a result, ministry officials have a fairly high degree of discretion to regulate
the industry. Although telecommunication licenses may not be transferred under
Russian law, the Russian Ministry of Communications (the "MOC") has adopted the
position that licensees may enter into agreements with third parties in
connection with the provision of services under the licensee's license; however,
the MOC does not generally review agreements entered into by licensees. There
can be no assurances that the current or future regulation of the Russian
telecommunications systems will not have a material adverse effect on the
Company.
Current Russian legislation governing foreign investment activities does
not prohibit or restrict foreign investment in the telecommunications industry.
However, on February 28, 1997, the State Duma, the lower house of parliament,
approved, on the first reading, draft foreign investment legislation which would
restrict any significant future foreign investment in numerous sectors of the
Russian economy, including telephone and radio communications. It is unlikely
that such restrictive legislation will be enacted, unless the political climate
changes dramatically. See "-- Political." More likely is the emergence of
restrictions on foreign investment in strategic industries, which could result
in foreign ownership limitations in industries such as telecommunications which
are not uncommon in many countries. The draft legislation has been referred to
the Russian government for comment. For such draft legislation to become Federal
law, it must be passed by a majority vote of the State Duma at another two
readings, then be approved by a majority of the Federation Council, the upper
house of parliament, and signed by the President of the Russian Federation.
Rejection of such legislation by the Federation Council can be overridden by a
two-thirds majority of the State Duma. Rejection of such legislation by the
President can be overridden by a two-thirds majority of each of the Federation
Council and the State Duma. There can be no assurance that future regulation of
foreign investment in the telecommunications industry will not have a material
adverse effect on the Company.
In addition, a lack of consensus exists over the manner and scope of
government control over the telecommunications industry. Because the
telecommunications industry is widely viewed as strategically important to
Russia, there can be no assurance that recent government policies liberalizing
control over the telecommunications industry will continue. Any change in or
reversal of such governmental policies could have a material adverse effect on
the Company. See "Business -- Russia and the CIS -- Licenses and Regulatory
Issues."
Legal Risks. As part of the effort to transform their economies into more
market-oriented economies, the Russian and other CIS governments have rapidly
introduced laws, regulations and legal structures intended to give participants
in the economy a greater degree of confidence in the legal validity and
enforceability of their obligations. Risks associated with the legal systems of
Russia and the other independent republics of the CIS include (i) the untested
nature of the independence of the judiciary and its immunity from economic,
political or nationalistic influence; (ii) the relative inexperience of judges
and courts in commercial dispute resolutions and generally in interpreting legal
norms; (iii) inconsistencies among laws, presidential decrees, government
resolutions and ministerial orders; (iv) frequently conflicting local, regional
and national laws, rules and regulations; (v) the lack of legislative, judicial
or administrative guidance on interpreting the applicable rules; and (vi) a high
degree of discretion on the part of government authorities and arbitrary
decision making which increases, among other things, the risk of property
expropriation. The result has been considerable legal confusion, particularly in
areas such as company law, commercial and contract law, securities and antitrust
law, foreign trade and investment law and tax law. Accordingly, there can be no
assurance that the Company will be able to enforce its rights in any disputes
with its joint venture partners or other parties in Russia or the CIS or that
its ventures will be able to enforce their respective rights in any disputes
with partners, customers, suppliers, regulatory agencies or other parties in
Russia or that the Company can be certain that it will be found to be in
compliance with all applicable laws, rules and regulations.
Russia has adopted currency and capital transfer regulations designed to
prevent the flight of capital from its borders. These regulations require
certain licenses for the movement of capital, which includes the incurrence and
repayment of indebtedness and the payment of capital contributions in foreign
exchange to
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Russian entities. The Company is resolving licensing issues with respect to
certain intercompany loans and capital contributions with the applicable
government agencies and believes that any licensing irregularities that may
arise will not have a material adverse effect on its financial condition or
results of operations. There can be no assurance, however, that Russian
government authorities will not take an unexpected adverse position which could
materially adversely affect the Company's business.
Taxes. Generally, taxes payable by Russian companies are substantial. In
addition, taxes payable by Russian companies are numerous and include taxes on
profits, revenue, assets and payroll as well as value-added tax ("VAT").
Moreover, statutory tax returns of Russian companies are not consolidated and
therefore, each company must pay its own Russian taxes. Because there is no
consolidation provision, dividends are subject to Russian taxes at each level.
Currently, dividends are taxed at 15% and the payor is required to withhold the
tax when paying the dividend, except with respect to dividends to foreign
entities that qualify for an exemption under treaties on the avoidance of double
taxation. To date, the system of tax collection has been relatively ineffective,
resulting in the continual imposition of new taxes in an attempt to raise
government revenues. This history, plus the existence of large government budget
deficits, raises the risk of a sudden imposition of arbitrary or onerous taxes,
which could adversely affect the Company.
Because of uncertainties associated with the laws and regulations of the
Russian tax system and the increasingly aggressive interpretation, enforcement
and collection activities of the Russian tax authorities, the Company's Russian
taxes may be in excess of the estimated amount expensed to date and accrued on
the Company's balance sheets. It is the opinion of management that the ultimate
resolution of the Company's Russian tax liability, to the extent not previously
provided for, will not have a material adverse effect on the financial condition
of the Company. However, depending on the amount and timing of an unfavorable
resolution of this contingency, it is possible that the Company's future results
of operations or cash flows could be materially affected in a particular period.
In various foreign jurisdictions, the Company is obligated to pay VAT on
the purchase or importation of assets, and for certain other transactions. In
many instances, VAT can be offset against VAT which the Company collects and
otherwise would remit to the tax authorities, or may be refundable. Because the
law in some jurisdictions is unclear, the local tax authorities could assert
that the Company is obligated to pay additional amounts of VAT. In the opinion
of management, any additional VAT which the Company may be obligated to pay
would not be material.
ADEQUACY OF MANAGEMENT, LEGAL AND FINANCIAL CONTROLS IN EMERGING MARKETS
Many of the emerging market countries in which the Company operates,
particularly in Russia and the CIS where the Company has to date derived most of
its revenues, are deficient in management and financial reporting concepts and
practices, as well as in modern banking, computer and other control systems. The
Company historically has had difficulty in hiring and retaining a sufficient
number of qualified employees to work in these markets. As a result of these
factors, the Company has experienced difficulty in establishing management,
legal and financial controls, collecting financial data and preparing financial
statements, books of account and corporate records and instituting business
practices that meet Western standards.
The Company has a policy worldwide of complying with all applicable laws
and seeks to ensure that all persons in its employ comprehend and comply with
such laws. The application of the laws of any particular country, however, is
not always clear, particularly in emerging market countries where commercial
practices differ significantly from practices in the United States and other
Western countries and the legal and regulatory frameworks are less developed. In
addition, some practices, such as the payment of fees for the purpose of
obtaining expedited customs clearance and other commercial benefits, that may be
common methods of doing business in these markets might be unlawful under the
laws of the United States. As a result of the difficulty the Company
historically has experienced in emerging markets in instituting business
practices that meet Western reporting and control standards, it historically has
been unable to ascertain whether certain practices by its ventures, which were
not in accordance with Company policy, were in compliance with applicable U.S.
and foreign laws. If it were to be determined that the Company or any of its
ventures were involved in unlawful practices and were the factual and legal
issues relating thereto to be resolved adversely,
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the Company or its ventures could be exposed, among other things, to significant
fines, risk of prosecution and loss of its licenses. See "-- Risks Relating to
Emerging Markets" and "-- Government Regulation."
In light of these circumstances, in the second half of 1996 the Company
increased its efforts to improve its management and financial controls and
business practices. The Company recruited a more experienced financial and legal
team, including a new Chief Financial Officer of the Company, a senior finance
officer overseeing all of the regions in which the Company operates, a senior
finance officer for the CIS region, and a senior legal officer for the CIS
region. The Company also established a Treasury group and adopted a more
rigorous Foreign Corrupt Practices Act ("FCPA") compliance program. The Company
has developed and implemented a training program for employees regarding U.S.
legal and foreign local law compliance. The Company also appointed a Compliance
Officer responsible for monitoring compliance with such laws and training
Company personnel around the world. In connection with these developments, the
Company expanded its corporate business practices policy to include, in addition
to compliance with U.S. laws such as the FCPA, compliance with applicable local
laws such as the conflict of interest rules under the 1996 Russian Joint Stock
Company Law, currency regulations and applicable tax laws.
In early 1997, the Company retained special outside counsel to conduct a
thorough review of certain business practices of the Company in the emerging
markets in which the Company operates in order to determine whether deficiencies
existed that needed to be remedied. As a result of this review, the Company
replaced certain senior employees in Russia and instituted additional and more
stringent management and financial controls. As a result of the review, the
Company has not identified any violations of law that management believes would
have a material adverse effect on the Company's financial condition. There can
be no assurances, however, that if the Company or any of its ventures were found
by government authorities to have committed violations of law that, depending on
the penalties assessed and the timing of any unfavorable resolution, the
Company's future results of operations and cash flows would not be materially
adversely affected in a particular period.
Although the Company believes that this review was properly conducted and
was sufficient in scope, there can be no assurance that all potential
deficiencies have been identified or that the control procedures and compliance
programs initiated by the Company will be effective. If the Company or any of
its ventures are ever found to have committed violations of law, depending on
the penalties assessed and the timing of any unfavorable resolution, the
Company's future results of operations and cash flows could be materially
adversely affected in a particular period. Management believes, however, that
the actions taken during the past twelve months to strengthen the Company's
management, financial controls and legal compliance, coupled with the
implementation of the recent recommendations from the review and the oversight
provided through the Audit Committee of the Board of Directors of the Company to
ensure compliance, will be adequate to address the recurrence of any past
possible deficiencies.
DEPENDENCE ON CERTAIN LOCAL PARTIES; ABSENCE OF CONTROL
Many GTS operations including Sovintel, TeleRoss and GTS Cellular have been
developed in cooperation or partnership with key local parties, such as regional
PTOs. The Company is substantially dependent on its local partners to provide
marketing expertise and knowledge of the local regulatory environment in order
to facilitate the acquisition of necessary licenses and permits. Any failure by
the Company to form or maintain alliances with local partners, or the preemption
or disruption of such alliances by the Company's competitors or otherwise, could
adversely affect the Company's ability to penetrate and compete successfully in
the emerging markets it operates in or enters. In addition, in the uncertain
legal environments in which GTS operates, certain GTS businesses may be
vulnerable to local government agencies or other parties who wish to renegotiate
the terms and conditions of, or terminate, their agreements or other
understandings with GTS.
While the Company may have the right to nominate key employees, direct the
operations and determine the strategies of such joint ventures, under the terms
of their respective constituent documents, the Company's partners in some of the
ventures have the ability to frustrate the exercise of such rights. Significant
actions by most of GTS's ventures, such as approving budgets and business plans,
declaring and paying dividends, and
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entering into significant corporate transactions effectively require the
approval of GTS's local partners. Further, the Company would be unlikely as a
practical matter to want to take significant initiatives without the approval of
its joint venture partners. Accordingly, the absence of unilateral control by
the Company over the operations of its joint ventures could have a material
adverse effect on the Company.
In addition, the Company and its venture partners frequently compete in the
same markets. For example, Rostelecom, GTS's partner in Sovintel, is the
dominant international and domestic long distance carrier in Russia. In
addition, many of the regional telephone companies partnered with GTS in the
TeleRoss Ventures offer cellular services in direct competition with certain of
the operations of GTS Cellular. Such competition with its partners may lead to
conflicts of interest for GTS and its partners in the operations of their
ventures. There can be no assurance that any such conflicts will be resolved in
favor of GTS. In addition, the combination under Svyazinvest of the Russian
government's majority interest in Rostelecom and 85 of the regional telephone
companies gives Svyazinvest a majority interest in entities that provide
international and domestic long distance and local telecommunications services
throughout Russia and may expose the Company to more coordinated competition
from its partners in the Russian telecommunications market. See "-- Risks
Relating to Reorganization of Russian Telecommunications Industry."
GOVERNMENT REGULATION
As a multinational telecommunications company, GTS through its ventures is
subject to varying degrees of regulation in each of the jurisdictions in which
its ventures provide services. Local laws and regulations, and the
interpretation of such laws and regulations, differ significantly among the
jurisdictions in which the Company and its ventures operate. There can be no
assurance that future regulatory, judicial and legislative changes will not have
a material adverse effect on the Company, that regulators or third parties will
not raise material issues with regard to the Company's or its ventures'
compliance or noncompliance with applicable regulations or that any changes in
applicable laws or regulations will not have a material adverse effect on the
Company or any of its ventures.
Many of GTS's ventures require telecommunications licenses, most of which
have been granted for periods of three to ten years. The terms and conditions of
these licenses may limit or otherwise affect the ventures' scope of operations.
The Company has had favorable experience obtaining, maintaining and renewing
licenses in the past. However, there can be no assurance that it will be able to
obtain, maintain or renew licenses to provide the services it currently provides
and plans to provide, that such licenses will be issued or renewed on terms or
with fees that are commercially viable, or that licenses required by future
ventures can be obtained by the Company or its partners. The loss of or a
substantial limitation upon the terms of these telecommunications licenses could
have a material adverse effect on the Company. See each section under "Business"
entitled "Licenses and Regulatory Issues."
A substantial portion of HER's strategy is based upon the timely
implementation of regulatory liberalization of the European Union ("EU")
telecommunications market on January 1, 1998 under existing European Community
("EC") directives. Although EU member states have a legal obligation to
liberalize their markets in accordance with their requirements, certain more
detailed aspects of the EU regulatory framework to apply in the liberalized
environment after January 1, 1998 still remain to be adopted. In addition,
Ireland, Portugal, Spain, Luxembourg and Greece have been granted extensions
from the January 1, 1998 deadline. There can be no assurance that each EU member
state will proceed with the expected liberalization on schedule, or at all, or
that the trend toward liberalization will not be stopped or reversed in any of
the countries. Accordingly, HER faces the risk that it will establish the HER
network and make capital expenditures in a given country in anticipation of
regulatory liberalization which does not subsequently occur.
In order to give effect to EC directives in each member state, national
governments must pass legislation liberalizing their respective markets. This
applies not only to the liberalization requirements set out in existing EC
directives, but also to requirements set out in directives which have yet to be
adopted. The implementation of EC directives in the telecommunications sector
has been inconsistent or ambiguous in some EU member states. Such implementation
could limit, constrain or otherwise adversely affect HER's ability to provide
certain services. Furthermore, national governments may not necessarily pass
legislation implementing an EC directive in the form required, or at all, or may
pass such legislation only after a significant delay. Even if a
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national legislature enacts appropriate regulation within the time frame
established by the EU, there may be significant resistance to the implementation
of such legislation from PTOs, regulators, trade unions and other sources.
Further, HER's provision of services in Europe may be materially adversely
affected if any EU member state imposes greater restrictions on non-EU
international services than on international services within the EU. These and
other potential obstacles to liberalization could have a material adverse effect
on HER's operations by preventing HER from establishing its network as currently
intended, as well as a material adverse effect on the Company.
COMPETITION
GTS faces significant competition in all of its existing telecommunications
businesses and for the types of acquisition and development opportunities it
seeks in both emerging and Western European markets. GTS's competition in these
markets includes national PTOs, multinational telecommunications carriers, other
telecommunications developers and certain niche telecommunications providers. In
addition, certain of the Company's joint venture partners, including Rostelecom
and the regional telephone companies in Russia, certain of HER's rail-based
shareholders and other entities in the emerging markets in which the Company
operates, are also competitors of the Company. As a result of the recent
combination under Svyazinvest of the government's majority interest in
Rostelecom and 85 of the regional telephone companies, the Company may in the
future be subject to more coordinated competition from its partners in the
Russian telecommunications market. Although the Company believes it has a
favorable and cooperative relationship with its joint venture partners, there
can be no assurance that these partners will continue to cooperate with the
Company in the future or that they will not increase competitive pressures on
the Company. Any measures taken by the partners that reduce the level of
cooperation with the Company could jeopardize the Company's ability to
participate in the management and operation of its joint ventures and could have
a material adverse effect on the Company.
WorldCom, Inc. ("WorldCom") recently announced the construction of a
pan-European fiber network, the first phase of which is expected to connect
London, Amsterdam, Brussels, Frankfurt and Paris by early 1998. Although the
Company believes that the proposed WorldCom pan-European network is primarily
intended to carry WorldCom traffic, WorldCom has stated that any excess capacity
on such network will be used to provide a competitive "carriers' carrier"
service.
Viatel, Inc. ("Viatel") also recently announced its intention to build a
pan-European fiber optic network connecting select cities in Belgium, France,
the Netherlands and the United Kingdom. Excess capacity would be available for
other carriers. Viatel has stated that, assuming that it obtains necessary
financing, construction would begin in spring 1998 and the network would become
operational in 1999.
HER also competes with respect to its "point-to-point" transborder service
offering against circuits currently provided by PTOs through International
Private Leased Circuits. In addition, the liberalization of the European
telecommunications market is likely to attract additional entrants to both the
"point-to-point" and other telecommunications markets. There can be no assurance
that HER will compete effectively against its current or future competitors.
Many of the Company's competitors have technical, financial, marketing and
other resources substantially greater than those of GTS. There can be no
assurance that the Company will be able to overcome successfully the competitive
pressures to which it is subject, both in the markets in which it currently
operates and in markets into which it might expand. See each section under
"Business" entitled "Competition." In addition, many of the Company's current
and potential competitors are not subject to, or constrained by the prohibitions
of, the FCPA, including the prohibition against making payments to government
officials in order to obtain commercial benefits. The Company is subject to and
seeks to comply with the limitations and prohibitions of such law, and
accordingly may be subject to competitive disadvantages to the extent that its
competitors are able to secure business, licenses or other preferential
treatment through the making of such payments. Accordingly, there can be no
assurances that the Company will be able to compete effectively against
companies free from such limitations in the emerging markets where such
commercial practices are commonplace. See "-- Adequacy of Management, Legal and
Financial Controls in Emerging Markets."
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CONTROL BY CERTAIN STOCKHOLDERS
Certain persons control substantial portions of the Company's voting stock.
At December 31, 1997, after giving effect to the Stock Offerings, Soros
Foundation-Hungary and certain of its affiliates (collectively the "Soros
Foundations"), Alan B. Slifka and certain of his affiliates, and affiliates of
Capital Research International beneficially owned approximately 20.4%, 11.2% and
10.3%, respectively, of the Common Stock (including rights to acquire Common
Stock). See "Principal Stockholders." In addition, three persons affiliated with
the Soros Foundations currently serve on the Company's Board of Directors (the
"Board of Directors"). Consequently, these entities are in a position to
exercise control over the outcome of matters submitted for stockholder actions,
including the election of members to the Board of Directors, and are able to
influence the management and affairs of the Company. Additionally, affiliates of
the Soros Foundations and of Capital International, Inc. have purchased debt
securities of the Company that include covenants that restrict the operating and
financing activities of the Company. In certain situations, the interests of
holders of the Company's equity securities may diverge from the interests of the
holders of the Company's debt securities, and holders of both equity and debt
securities of the Company may be in a position to require GTS to act in a way
that is not consistent with the general interests of the holders of the Common
Stock. See "-- Additional Capital Requirements," "Management," "Principal
Stockholders" and "Certain Related Party Transactions."
CURRENCY AND EXCHANGE RISKS
All of GTS's operations are conducted outside the United States. A
substantial portion of the Company's anticipated revenues (as well as the
majority of its operating expenses) will be in foreign currency. As a result,
the Company will be subject to significant foreign exchange risks. In
particular, GTS's ventures in countries whose currencies are considered "soft
currencies" subject the Company to the risk that it will accumulate currencies
which may not be readily convertible into hard currency and which may be subject
to significant limitations on repatriation. The Company does not enter into
hedging transactions to limit its foreign currency risk exposure, although the
Company may implement such practices in the future. There can be no assurance
that GTS's operations will not be adversely affected by such factors. In
addition, these factors may limit the ability of the Company to reinvest
earnings from ventures in one country to fund the capital requirements of
ventures in other countries.
In Russia, where the Company derives most of its revenue, the ruble has
generally experienced a steady depreciation relative to the U.S. Dollar over the
past three years, although there has been some instability in the ruble exchange
rate over this period of time. The Company's tariffs are denominated in U.S.
Dollars but charges are invoiced and collected in rubles, while the Company's
major capital expenditures are generally denominated and payable in various
foreign currencies. To the extent such major capital expenditures involve
importation of equipment and the like, current law permits the Company to
convert its ruble revenues into foreign currency to make such payments. The
ruble is generally not convertible outside Russia. A market exists within Russia
for the conversion of rubles into other currencies, but it is limited in size
and is subject to rules limiting the purposes for which conversion and payment
may be effected. The limited availability of other currencies may tend to
inflate their values relative to the ruble and there can be no assurance that
such a market will continue to exist indefinitely. Moreover, the banking system
in Russia is not yet as developed as its Western counterparts and considerable
delays may occur in the transfer of funds within, and the remittance of funds
out of, Russia. Any delay in converting rubles into a foreign currency in order
to make a payment or delay in the transfer of such foreign currency could have a
material adverse effect on the Company.
EXCHANGE CONTROLS AND REPATRIATION RISKS RELATING TO RUSSIAN SECURITIES
Russia has adopted currency and capital transfer regulations designed to
prevent the flight of capital from its borders. These regulations require
certain licenses for the movement of capital, which includes the incurrence and
repayment of indebtedness and the payment of capital contributions in foreign
exchange to Russian entities. The Company is resolving licensing issues with
respect to certain intercompany loans and capital contributions with the
applicable government agencies and believes that any licensing irregularities
that may arise will not have a material adverse effect on its financial
condition or results of operations. There can be no assurance, however, that
Russian government authorities will not take an unexpected adverse position
which could materially affect the Company's business.
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No assurance can be given that Russian foreign investment and currency
legislation will continue to permit repatriation of the proceeds from
investments. Furthermore, no assurance can be given that further restrictions
will not be imposed on the conversion of ruble earnings into foreign currency
for purposes of making dividend payments or on the repatriation of profits. If
any such further restrictions were imposed, they would have a material adverse
effect on the Company's interests in Russia.
TRANSACTIONS WITH AFFILIATES
The Company has entered into financing agreements with certain of its
affiliates. It is the Company's view that each such transaction has been on
terms no less favorable to the Company than other similar transactions available
to the Company with unaffiliated parties, if available at all. Generally, such
transactions have been the Company's only recourse to meet financing needs
and/or business goals. Despite the foregoing, prospective purchasers may wish to
consider the circumstances in which such transactions were made, the terms of
such transactions and the Company's possible alternative courses of action. The
Company may enter into transactions in the future with affiliates in order to
meet its financing needs and/or business goals. See "Certain Related Party
Transactions" and "Description of Certain Indebtedness."
DEPENDENCE ON KEY PERSONNEL
The Company believes that its growth and future success will depend in
large part upon the efforts of a small number of key executive officers, as well
as on its ability to attract and retain highly skilled and qualified personnel
to work in the emerging markets in which it operates. Henry Radzikowski, who
served as Chief Executive Officer -- CIS and Eastern Europe Operations from
February 1994 until January 1997 and who has extensive experience in the
telecommunications industry in Russia, resigned in 1997. Stewart Reich became
Senior Vice President-Russia effective September 1, 1997. The Company has also
replaced or reassigned executive officers and senior personnel. The competition
for qualified personnel in the telecommunications industry is intense,
particularly in emerging markets where the Company operates and, accordingly,
there can be no assurance that the Company will be able to hire and retain
qualified personnel. Although the Company believes it has maintained a strong
management team, despite the change of personnel in Russia and the CIS, there
can be no assurance as to what effect such personnel changes will have on the
Company's operations in Russia and the CIS.
DEPENDENCE ON EFFECTIVE INFORMATION SYSTEMS
To complete its billing, the Company must record and process massive
amounts of data quickly and accurately. While the Company believes its ventures'
management information systems are currently adequate, certain of such systems
will have to grow as the ventures' businesses expand. The Company believes that
the successful expansion of its information systems and administrative support
will be important to its continued growth, its ability to monitor and control
costs, to bill customers accurately and in a timely fashion and to achieve
operating efficiencies. There can be no assurance that the Company will not
encounter delays or cost-overruns or suffer adverse consequences in implementing
these systems. Any such delay or other malfunction of the Company's management
information systems could have a material adverse effect on the Company's
business, financial condition and results of operations.
TAXES; AVAILABILITY OF NET OPERATING LOSS CARRYFORWARDS
The tax rules and regimes prevailing in certain emerging market countries
in which the Company operates or plans to operate are, in many cases, new and
rapidly changing. Repatriation of profits may result in additional taxes. In
addition, other forms of taxation, including VAT, excise taxes and import
duties, change at an unpredictable pace and may have an adverse effect on the
Company's operations.
Availability of tax holidays and provisions of tax treaties with the United
States are subject to changes which may affect GTS's utilization of certain tax
benefits in the countries in which it operates as well as in the United States.
Certain ventures in the CIS and Hungary are operating under tax holidays granted
by local governments. Tax holidays are for periods ranging from five to several
years after achieving profitability under local tax regulations. In addition to
these holidays, certain of the Company's foreign ventures have foreign tax loss
carryforwards in excess of $50.0 million.
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As of September 30, 1997, the Company had net operating loss carryforwards
for U.S. federal income tax purposes of approximately $92.5 million expiring in
fiscal years 2003 through 2012. Because of the "change in ownership" provisions
of the Tax Reform Act of 1986, the utilization of the Company's net operating
loss carryforwards will be subject to an annual limitation as a result of the
consummation of the Offerings.
The Company's financial statements do not reflect any provision for
benefits that might be associated with the U.S. and non-U.S. loss carryforwards.
There can be no assurance that such loss carryforwards will be allowed, in part
or full, by local tax authorities against future income.
TECHNOLOGY
The telecommunications industry is subject to rapid and significant changes
in technology and such technological advances may reduce the relative
effectiveness of existing technology and equipment. The Company obtains
telecommunications equipment from a number of vendors, upon whom it is dependent
for the adaptation of such equipment to meet varying local telecommunications
standards. The cost of implementation of emerging and future technologies could
be significant. There can be no assurance that the Company will maintain
competitive services or that the Company will obtain appropriate new technology
on a timely basis or on satisfactory terms. Any failure by the Company to
maintain competitive services or obtain new technologies could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Development and operation of the HER network are also subject to certain
technological risks. The network has been designed to utilize SDH technology.
While SDH represents an advanced, new transmission technology, HER's ability to
upgrade technology from this platform may be important in establishing and/or
maintaining a cost advantage over competitive carriers. There can be no
assurance that the HER network will achieve the technical specifications for
which it was designed or that HER will be able to upgrade the network as
technological improvements in telecommunications equipment are introduced.
Failure to achieve current specifications for, or future upgrades of, the
network may materially and adversely affect the viability of the HER network and
could have a material adverse effect on the business and prospects of GTS.
DIFFICULTY IN OBTAINING RELIABLE MARKET INFORMATION
The Company operates in markets in which it is difficult to obtain reliable
market information. The Company's business planning has been based on certain
assumptions concerning subscriber base, usage levels, pricing and operating
expenses based on the Company's experience and the Company's own investigation
of market conditions in the emerging market countries in which it operates. No
assurances can be given as to the accuracy of such assumptions, and such
assumptions may not be indicative of the actual performance of the Company's
operations.
DILUTION
The Conversion Price (as defined herein) of the Common Stock offered hereby
may exceed the net tangible book value per share of the Common Stock. In
addition, the net tangible book value per share of the Common Stock will
decrease upon the exercise of outstanding options and warrants. Accordingly,
purchasers of the Common Stock offered hereby may incur an immediate and
substantial dilution.
SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS; POTENTIAL ADVERSE IMPACT
ON MARKET PRICE FROM SALES OF COMMON STOCK
Sales of substantial amounts of Common Stock in the public market following
the Stock Offerings could adversely affect the market price of the Common Stock
and adversely affect the Company's ability to raise capital at a time and on
terms favorable to the Company.
As of December 31, 1997, after giving effect to the Stock Offerings, there
would have been 48,706,814 shares of Common Stock outstanding, (i) assuming no
exercise of the Underwriters' over-allotment options and (ii) excluding (x)
11,258,886 shares for which outstanding warrants and vested options
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are exercisable, (y) 713,311 shares reserved for issuance upon exercise of a put
right and (z) 7,239,350 shares into which the Bonds are convertible. Of the
48,706,814 outstanding shares, (i) the 11,100,000 shares registered in the Stock
Offerings will be freely tradable without restriction under the Securities Act
(except that any shares purchased in the Stock Offerings by "affiliates" of the
Company may generally be resold only in compliance with applicable provisions of
Rule 144, as described below) and (ii) 9,430,629 additional shares may be resold
under Rule 144 without restriction under the Securities Act (subject to the
lock-up agreements described below). Beginning 90 days after the date of this
Prospectus, an additional 19,650 shares may be resold under Rule 144 without
restriction under the Securities Act and an additional 25,164,324 shares may be
resold under Rule 144 subject to the volume and manner limitations therein (in
each case, subject to the lock-up agreements described in "Underwriting"). In
addition, the Company will cause to become effective this Registration Statement
and a registration statement on Form S-8 covering the resale of shares of Common
Stock issued to employees, officers and directors of the Company pursuant to
employee benefit plans. Holders of approximately 29,623,784 shares of Common
Stock and warrants to purchase 7,777,776 shares of Common Stock, and an
affiliate of the Company with an option with respect to 438,311 shares of Common
Stock, have certain demand and piggy-back registration rights.
Prior to the Stock Offerings, there was no established market for the
Common Stock and no predictions can be made about the effect, if any, that
future sales of Common Stock or the availability of the Common Stock for sale
would have on the market price for the Common Stock. Sales of large numbers of
shares of Common Stock in the public market pursuant to Rule 144 or pursuant to
an effective registration statement under the Securities Act, or the perception
that sales could occur, may have an adverse effect on the market price for the
Common Stock. See "Shares Eligible for Future Sale" and "Description of Capital
Stock -- Prior Purchase Agreements -- Registration Rights."
ABSENCE OF DIVIDENDS
The Company has not paid any dividend on its Common Stock and does not
intend to pay dividends in the foreseeable future. In addition, the indenture
governing the Notes will contain dividend restrictions. In the event that the
Company and/or certain operating companies of the Company enter into future
financings, the terms of such financings may include dividend restrictions. See
"Dividend Policy."
ANTI-TAKEOVER PROVISIONS
The Company is subject to Section 203 of the Delaware General Corporation
Law that contains certain anti-takeover provisions which prohibit a "business
combination" between a corporation and an "interested stockholder" within three
years of the stockholder becoming an "interested stockholder" except in certain
limited circumstances. The business combination provisions of Section 203 of the
Delaware General Corporation Law may have the effect of deterring merger
proposals, tender offers or other attempts to effect changes in control of the
Company that are not negotiated and approved by the Board of Directors.
Accordingly, stockholders of the Company could be prevented from realizing a
premium on their shares in a transaction not approved by the Board of Directors.
In addition, the Company's Certificate of Incorporation and/or By-Laws have
several provisions that could also have the effect of delaying or preventing a
change of control of the Company (although the effectiveness of certain of such
provisions in the By-Laws is subject to final Board approval and the
effectiveness of certain of such provisions in the Certificate of Incorporation
is subject to filing applicable amendments to the Certificate of Incorporation
with the Secretary of State of the State of Delaware). Specifically, the
Company's Certificate of Incorporation and/or By-Laws provide for a classified
Board of Directors serving staggered three-year terms, restrictions on who may
call a special meeting of stockholders, a prohibition on stockholder action by
written consent, restrictions on the removal of directors and supermajority
voting requirements with respect to certain amendments to the Certificate of
Incorporation. The Company's Certificate of Incorporation also grants the Board
of Directors the authority to issue up to 10,000,000 shares of preferred stock
in one or more series and to determine the rights, voting powers, dividend rate,
conversion rights, redemption price, liquidation preference and other terms of
such preferred stock without any further vote or action by the stockholders.
Further, the Company has adopted a stockholders rights plan and in connection
therewith, 200,000 shares of preferred stock have been authorized as Series A
22
<PAGE> 26
Preferred Stock (as defined herein). The foregoing provisions, and any issuance
of preferred stock (including Series A Preferred Stock) with voting or
conversion rights, may adversely affect the voting power of the holders of
Common Stock and may have the effect of delaying or preventing a change of
control of the Company or adversely affect the market price of the Common Stock.
See "Description of Capital Stock -- Certain Charter and By-Law Provisions."
ENFORCEABILITY OF JUDGMENTS
Substantially all of the assets of the Company (including all of the assets
of the Company's operating ventures) are located outside the United States. As a
result, it will be necessary for investors to comply with foreign laws in order
to enforce judgments obtained in a United States court (including those with
respect to federal securities law claims) against the assets of the operating
ventures, including foreclosure upon such assets, and there can be no assurance
that any U.S. judgments would be enforced under any such foreign laws.
NO PRIOR PUBLIC MARKET: VOLATILITY OF STOCK PRICE
Prior to the Stock Offerings, there has been no public market for the
Common Stock, and there can be no assurance that an active public market will
develop or be sustained after the Stock Offerings. The initial public offering
price of the Common Stock has been determined through negotiations between the
Company and the Representatives of the Underwriters (as defined herein) and may
not be indicative of the market prices for the Common Stock after consummation
of the Stock Offerings. See "Underwriting" for a discussion of the factors
considered in determining the initial public offering price. The market price
for the Common Stock could be subject to significant fluctuations in response to
various other factors such as announcements of new contracts, technological
innovations or new products by the Company or its competitors, other
announcements concerning the Company or its competitors, changes in government
regulations, fluctuations in the Company's quarterly and annual operating
results and general market conditions. In addition, the stock markets have in
recent years experienced significant price fluctuations. Those fluctuations
often have been unrelated to the operating performance of the specific companies
whose stock is traded. Market fluctuations, as well as economic conditions, may
adversely affect the market price of the Common Stock.
BENEFITS OF THE OFFERINGS TO CURRENT STOCKHOLDERS
The Company intends to use a portion of the net proceeds of the Offerings
to repay the $70 million (plus accrued interest) of Capital Research Notes and
the Chatterjee Notes, which notes are held by current stockholders of the
Company. Upon completion of the Offerings, certain additional benefits will
accrue to the current stockholders of the Company, including the creation of a
public market for their shares of Common Stock, an increase of $3.70 in the net
tangible book value per share of Common Stock and possibly ownership of Common
Stock in a Company having a lower debt-to-equity ratio than existed prior to the
completion of the Offerings. Additionally, the aggregate unrealized gain to
current stockholders will be approximately $467 million. See "Dilution."
23
<PAGE> 27
USE OF PROCEEDS
The Selling Holders will receive all of the proceeds from the sale of the
Offered Securities and the Company will not receive any proceeds from the sale
thereof.
RATIO OF EARNINGS TO FIXED CHARGES
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------- -----------------
1992 1993 1994 1995 1996 1996 1997
---- ------ ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Pretax Loss......................... (437) (2,440) (11,985) (37,835) (66,631) (47,496) (86,034)
Adjustments: Fixed charges.......... 2 9 100 728 11,122 7,262 21,086
---- ------ ------- ------- ------- ------- -------
Adjusted earnings from continuing
operations..................... (435) (2,431) (11,885) (37,107) (55,509) (40,234) (64,948)
Interest expense from indebtedness,
including amortization of
discount.......................... 2 9 100 728 11,122 7,262 21,086
---- ------ ------- ------- ------- ------- -------
Total fixed charges....... 2 9 100 728 11,122 7,262 21,086
Deficiency of earnings available to
cover fixed charges:.............. (437) (2,440) (11,985) (37,835) (66,631) (47,496) (86,034)
==== ====== ======= ======= ======= ======= =======
</TABLE>
Because of the Company's historic losses, the Company has experienced a
deficiency of earnings available to cover fixed charges throughout its
existence. The deficiency of earnings available to cover fixed charges has been
computed by adding loss from continuing operations before income taxes minus
fixed charges. Fixed charges consist of interest on all indebtedness and
amortization of discount on all indebtedness.
DIVIDEND POLICY
GTS has not paid any dividend on its Common Stock and does not intend to
pay dividends in the foreseeable future. In addition, the indenture governing
the Notes contains restrictions on the payment of dividends.
24
<PAGE> 28
DILUTION
At September 30, 1997, the net tangible book value of the Common Stock was
$12.5 million in the aggregate, or $0.33 per share of Common Stock. "Net
tangible book value per share" represents the amount of total tangible assets of
the Company reduced by the amount of total liabilities and divided by the number
of shares of Common Stock outstanding. After giving effect to the Offerings, the
pro forma net tangible book value of the Common Stock would be $196.2 million in
the aggregate, or $4.03 per share. This represents an increase in net tangible
book value of $3.70 per share of Common Stock to existing shareholders and an
immediate dilution per share of $15.97 to new investors purchasing shares of
Common Stock in the Stock Offerings. "Dilution per share" represents the
difference between the price per share to be paid by new investors and the pro
forma net tangible book value per share after the Stock Offerings. The following
table illustrates the dilution per share as described above:
<TABLE>
<S> <C> <C>
Initial public offering price per share..................... $20.00
Net tangible book value per share at September 30, 1997..... $0.33
Increase in net tangible book value per share attributable
to the Stock Offerings.................................... 3.70
-----
Pro forma net tangible book value per share after the Stock
Offerings................................................. 4.03
------
Dilution per share to new investors in the Stock
Offerings................................................. $15.97
======
</TABLE>
<TABLE>
<CAPTION>
SHARES OF TOTAL
COMMON STOCK CONSIDERATION AVERAGE PRICE
-------------------- ---------------------- PER SHARE OF
NUMBER PERCENT AMOUNT PERCENT COMMON STOCK
---------- ------- ------------ ------- -------------
<S> <C> <C> <C> <C> <C>
Current stockholders........... 37,606,814 77.2% $285,542,000 56.3% $ 7.59
New investors.................. 11,100,000 22.8 222,000,000 43.7% $20.00
---------- ----- ------------ -----
Total................ 48,706,814 100.0% $507,542,000 100.0%
========== ===== ============ =====
</TABLE>
The above computations assume no exercise of any outstanding options or
warrants. At December 31, 1997, there were outstanding options to purchase
7,081,173 shares of Common Stock at a weighted average exercise price of $9.08
per share and warrants to purchase 7,777,776 shares of Common Stock at an
exercise price of $9.33 per share. To the extent outstanding options are
exercised, there will be further dilution to new investors. See "Certain Related
Party Transactions," "Management" and Note 7 to the audited Consolidated
Financial Statements of the Company.
25
<PAGE> 29
CAPITALIZATION
The following table sets forth the consolidated capitalization of the
Company as of September 30, 1997 and as adjusted to give effect to the Offerings
and the application of the net proceeds thereof.
<TABLE>
<CAPTION>
ACTUAL(2) AS ADJUSTED(3)
---------- ---------------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C>
Related party debt maturing within one year......... $ 11,760 $ --
Debt maturing within one year....................... 14,815 14,815
--------- ---------
Current debt.............................. 26,575 14,815
Long-term obligations (net of current portion)
Related party debt, less current portion.......... 64,715 7,656
9 7/8% Senior Notes due 2005...................... -- 105,000
HER Senior Notes due 2007......................... 265,000 265,000
Convertible subordinated notes.................... 141,256 141,256
Capital Leases.................................... 1,452 1,452
Other long-term debt, less current portion........ 3,484 3,484
--------- ---------
Long term debt............................ 475,907 523,848
--------- ---------
Total debt................................ 502,482 538,663
--------- ---------
Minority interest................................... 20,275 20,275
Common stock subject to repurchase.................. 12,489 15,940
Shareholders' equity(1):
Common stock, $0.10 par value (135,000,000 shares
authorized; 37,606,814 shares issued and
outstanding, actual; 48,706,814 shares issued
and outstanding, as adjusted).................. 3,761 4,871
Additional paid-in capital.......................... 274,433 475,028
Accumulated deficit................................. (213,770) (229,064)
Other............................................... (7,021) (7,021)
--------- ---------
Total shareholders' equity................ 57,403 243,814
--------- ---------
Total capitalization................................ $ 592,649 $ 818,692
========= =========
</TABLE>
- - ---------------
(1) Excludes at December 31, 1997 (i) 7,777,776 shares of Common Stock reserved
for issuance upon exercise of outstanding warrants at an exercise price of
$9.33 per share, (ii) 7,081,173 shares of Common Stock reserved for issuance
upon exercise of outstanding stock options at a weighted average exercise
price of $9.08 per share, (iii) 713,311 shares of Common Stock reserved for
issuance upon exercise of a put right associated with a 1996 financing
agreement, as amended, (iv) 7,239,350 shares issuable upon conversion of the
Bonds and (v) 560,820 shares of Common Stock reserved for issuance pursuant
to the TCM business partnership agreement as deferred consideration to TCM's
partners. See "Certain Related Party Transactions."
(2) As a result of the Company's increase in ownership interest and amendment to
the HER shareholders agreement that was completed as of July 16, 1997, the
Company accounts for its ownership interest in HER under the consolidation
method of accounting. Prior to this date, the Company accounted for HER
using the equity method of accounting.
(3) Reflects the repayment of $70.0 million, plus accrued interest of $12.3
million and the write-off of unamortized debt discount and issuance costs of
$15.3 million, of loans from shareholders which bear interest at 10% per
annum and mature on January 19, 2001 and February 2, 2001. Further, amount
also recognizes the accretion of the outstanding common stock that is
subject to repurchase (797,100 shares at September 30, 1997) for the fair
value of the Company's Common Stock at September 30, 1997, from $15.67 per
share, to the $20.00 per share offering price in the Stock Offerings.
26
<PAGE> 30
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The following selected historical consolidated financial data as of and for
the years ended December 31, 1992, 1993, 1994, 1995 and 1996 and as of and for
the nine months ended September 30, 1997 are derived from the Company's audited
Consolidated Financial Statements. The following unaudited selected historical
consolidated financial data as of and for the nine months ended September 30,
1996 are derived from the Company's unaudited Consolidated Financial Statements.
The selected financial data presented below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the audited Consolidated Financial Statements and related notes
thereto appearing elsewhere in this Prospectus.
Under generally accepted accounting principles, most of the Company's
ventures are accounted for by the equity method of accounting. Under this
method, the operating results of the ventures are included in the Company's
Consolidated Statement of Operations as a single line item, "Equity in (losses)
earnings of ventures." The Company recognizes 100% of the losses in ventures
where the Company bears all of the financial risk (which includes all of the
Company's significant ventures except for Sovintel and, historically, HER).
Also, the assets, liabilities and equity of the ventures are included in the
Company's Consolidated Balance Sheets as a single line item "Investments in and
advances to ventures." See Note 2 to the Company's audited Consolidated
Financial Statements and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview." Financial information about
the Company's equity ventures is included below under "Supplemental
Information -- Selected Historical Financial Data -- Combined Equity
Investments."
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
--------------------------------------------- -------------------
1992 1993 1994 1995 1996 1996 1997(1)
------ ------ ------- ------- ------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues, net......................... $1,690 $ 328 $ 2,468 $ 8,412 $24,117 $ 14,639 $ 30,216
Gross margin.......................... 1,690 328 23 16 5,176 1,758 1,864
Operating expenses.................... 1,992 3,340 12,863 41,014 52,928 35,725 52,059
Equity in (losses) earnings of
ventures........................... (134) 472 (135) (7,871) (10,150) (6,999) (18,234)
Other (expense) income................ (2) 100 990 11,034 (8,729) (6,535) (16,902)
Net loss.............................. (437) (2,440) (11,985) (40,400) (67,991) (48,473) (87,872)
Loss per share........................ (0.06) (0.26) (0.69) (1.61) (2.22) (1.69) (2.37)
BALANCE SHEET DATA (AT END OF PERIOD):
Cash and cash equivalents............. $1,597 $3,641 $29,635 $ 9,044 $57,874 $ 86,504 $366,841
Property and equipment,
net................................ 41 829 8,393 29,523 35,463 34,599 69,051
Investments in and advances to
ventures........................... 270 794 13,841 56,153 104,459 83,341 84,068
Total assets.......................... 2,051 5,968 61,957 115,621 237,378 233,879 647,788
Total debt............................ -- 725 2,152 27,454 85,547 76,518 502,482
Minority interest and stock subject to
repurchase......................... -- -- 8 5,273 6,248 6,271 32,764
Shareholders' equity.................. 1,659 4,685 54,684 55,322 113,668 120,979 57,403
</TABLE>
- - ---------------
(1) As a result of the Company's increase in ownership interest and amendment to
the HER Shareholders Agreement that was completed on July 16, 1997, the
Company accounts for its ownership interest in HER under the consolidation
method of accounting. Prior to this date, the Company accounted for HER
under the equity method of accounting.
27
<PAGE> 31
SUPPLEMENTAL INFORMATION -- SELECTED HISTORICAL
FINANCIAL DATA -- COMBINED EQUITY INVESTMENTS
The following unaudited selected historical financial data -- equity
investments for the years ended December 31, 1995 and 1996 and for the nine
months ended September 30, 1996 and 1997, are derived from the Company's
financial records. It is intended to supplement the aforementioned selected
historical consolidated financial data. The financial data set forth below
represents 100% of the results of operations for each of the entities.
The Company believes that this information provides additional insight on
the Company's unconsolidated equity method investments. Generally accepted
accounting principles prescribe inclusion of revenues and expenses for
consolidated interests (generally interests of more than 50%, absent some other
factors), but not for equity interests (generally interests of 20% to 50%) or
cost interests (generally interests of less than 20%). Equity accounting
ordinarily results in the same net income as consolidation; however, the net
operating results are reflected on one line within the income statement.
<TABLE>
<CAPTION>
OWNERSHIP COST OF OPERATING NET
INTEREST(2) REVENUES REVENUES EXPENSES INCOME/(LOSS)
----------- -------- -------- ---------- -------------
(IN THOUSANDS, EXCEPT OWNERSHIP INTEREST)
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1995
Sovintel.................................................. 50% $44,292 $26,247 $ 7,047 $ 7,648
TCM....................................................... 50% 49 -- 57 (7)
TeleRoss.................................................. 50% 176 59 242 (193)
Sovam..................................................... 66.7% 4,434 2,914 3,273 (1,789)
GTS Cellular Companies.................................... 50%(3) 4,574 2,834 2,960 (2,165)
Other..................................................... 50%(3) 526 957 9,379 (9,874)
--- -------- -------- --------- --------
Total............................................... 54,051 33,011 22,958 (6,380)
ADJUSTMENTS FOR INTER-AFFILIATE TRANSACTIONS(1)........... (2,270) (2,215) (6,967)
YEAR ENDED DECEMBER 31, 1996
Sovintel.................................................. 50% $75,040 $43,910 $ 10,411 $ 14,762
TCM....................................................... 50% 16,507 3,330 1,854 8,874
TeleRoss.................................................. 50% 2,413 832 2,293 (841)
Sovam..................................................... 66.7% 11,671 8,236 5,714 (2,138)
GTS Cellular Companies.................................... 50%(3) 25,778 11,883 13,614 (3,406)
Other..................................................... 50%(3) 12,063 12,235 21,132 (22,471)
--- -------- -------- --------- --------
Total............................................... 143,472 80,426 55,018 (5,220)
ADJUSTMENTS FOR INTER-AFFILIATE TRANSACTIONS(1)........... (15,385) (13,562) (8,083)
NINE MONTHS ENDED SEPTEMBER 30, 1996
Sovintel.................................................. 50% $51,977 $30,613 $ 7,311 $ 9,522
TCM....................................................... 50% 12,559 2,267 1,197 6,998
TeleRoss.................................................. 50% 1,265 485 1,527 (753)
Sovam..................................................... 66.7% 8,007 5,895 4,169 (2,048)
GTS Cellular Companies.................................... 50%(3) 16,544 8,216 5,871 (1,362)
Other..................................................... 50%(3) 2,918 3,378 14,099 (18,507)
--- -------- -------- --------- --------
Total............................................... 93,270 50,854 34,174 (6,150)
ADJUSTMENTS FOR INTER-AFFILIATE TRANSACTIONS(1)........... (9,675) (7,596) (7,134)
NINE MONTHS ENDED SEPTEMBER 30, 1997
Sovintel.................................................. 50% $82,029 $51,048 $ 12,324 $ 14,215
TCM....................................................... 50% 20,715 4,733 2,270 9,653
TeleRoss.................................................. 50% 5,113 1,419 2,460 512
Sovam..................................................... 66.7% 12,877 7,867 4,635 (168)
GTS Cellular Companies.................................... 50%(3) 29,412 14,227 13,022 (2,746)
Other..................................................... 50%(3) 8,860 8,400 25,736 (25,146)
--- -------- -------- --------- --------
Total............................................... 159,006 87,694 60,447 (3,680)
ADJUSTMENTS FOR INTER-AFFILIATE TRANSACTIONS(1)........... (17,049) (15,853) (11,105)
</TABLE>
- - ---------------
(1) The adjustment amounts represent the effect of inter-affiliate transactions
between the Company's consolidated and equity method ventures. More detailed
information about inter-affiliate transactions is included under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Accounting Methodology."
(2) The ownership interest column indicates the Company's legal ownership
percentage for the respective equity investments. The information is being
provided to assist an investor or analyst in determining the Company's legal
rights associated with the presented financial data. See Note 3 in the
Company's audited Consolidated Financial Statements for additional
disclosures related to the Company's equity investments.
(3) The Company generally maintains a 50% ownership interest in these equity
investments. See Note 3 in the Company's audited Consolidated Financial
Statements for additional disclosures related to the Company's equity
investments.
28
<PAGE> 32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following is a discussion of the financial condition and results of
operations of the Company as of September 30, 1997 and 1996, December 31, 1996
and 1995 and for the nine months ended September 30, 1997 and 1996 and for the
years ended December 31, 1996, 1995 and 1994. The following discussion should be
read in conjunction with the Company's Consolidated Financial Statements and the
notes related thereto. Certain statements contained in "Management's Discussion
and Analysis of Financial Condition and Results of Operations" including,
without limitation, those concerning (i) projected traffic volume, (ii) future
revenues and costs, (iii) changes in the Company's competitive environment and
(iv) the performance of future equity-method investments, contain
forward-looking statements concerning the Company's operations, economic
performance and financial condition. Because such statements involve risks and
uncertainties, actual results may differ materially from those expressed or
implied by such forward-looking statements.
OVERVIEW
Business. GTS is a provider of a broad range of telecommunications services
to businesses, other telecommunications service providers and consumers in
Russia and the CIS and Central Europe. Through HER, GTS is developing, and
operating the initial segments of, a pan-European high capacity fiber optic
network which is designed to interconnect a majority of the largest Western and
Central European cities and to transport international voice, data and
multimedia/image traffic for other carriers throughout Western and Central
Europe. GTS's strategy to develop its businesses generally has been to establish
joint ventures with a strong local partner or partners while maintaining a
significant degree of operational control. The Company's business activities
consist of the ownership and operation of (i) international long distance
businesses, which operate through international gateways that provide
international switching services and transmission capacity, (ii) local access
networks, which provide local telephone service, (iii) cellular networks, which
provide wireless telecommunications services, (iv) a domestic long distance
business, (v) data networks and (vi) carriers' carrier networks, which provide
high volume transmission capacity to other carriers.
The Company began to acquire interests in numerous telecommunications
ventures beginning in 1994 and continued to acquire such interests throughout
1995 and 1996. Ventures with significant financial results in 1994 included
Sovintel (an international long distance and domestic and local access
telecommunications service provider) and GTS-Hungary (a VSAT network
telecommunications service provider); ventures that incurred start-up costs
associated with building out their business infrastructure in 1994 included
Sovam (a data and internet telecommunications service provider) and EuroHivo (a
paging telecommunications service provider). In 1995, TeleRoss (a domestic long
distance telecommunications service provider) and GTS Cellular (a basic cellular
telecommunications service provider) began operations and expanded into numerous
regions within the CIS by the end of 1996. Telecommunications of Moscow ("TCM")
(a local access telecommunications service provider) began operations in 1996.
HER (a carriers' carrier telecommunications service provider) began its network
build-out in 1995, began limited operations at the end of 1996 and expects to
continue to develop its network during 1998 and beyond. The fact that these
ventures are in various stages of development affects the discussion of
comparative results below.
GTS has invested significantly in its ventures through capital
contributions and loans. In addition, the Company has made a significant
commitment to its businesses and ventures through the provision of management
assistance and training. GTS has also incurred significant expenses in
identifying, negotiating and pursuing new telecommunications opportunities. GTS
and certain of its ventures are experiencing continuing losses and negative
operating cash flow primarily because the businesses are in the developmental
and start-up phases of operations. Management recognizes that the Company must
generate additional capital resources in order to continue its operations and
meet its new development initiatives. The ultimate recoverability of the
Company's investments in and advances to ventures is dependent on many factors
including, but not limited to, the ability of the Company to obtain sufficient
financing to continue to meet its capital and operational commitments, the
economies of the countries in which it does business and the ability of the
Company to maintain the necessary telecommunications licenses.
29
<PAGE> 33
The Company's businesses are developing rapidly. Some of the businesses
operate in countries with emerging economies which have uncertain economic,
political and regulatory environments. The general risks of operating businesses
in the CIS and other developing countries include the possibility for rapid
change in government policies including telecommunications regulations, economic
conditions, the tax regime and foreign currency regulations.
ACCOUNTING METHODOLOGY
Accounting for Business Ventures. Wholly owned subsidiaries and majority
owned ventures where the Company has unilateral operating and financial control
are consolidated. Those ventures where the Company exercises significant
influence, but does not exercise unilateral operating and financial control, are
accounted for by the equity method. The Company has certain majority owned
ventures that are accounted for by the equity method as a result of
super-majority voting conditions or other governmentally imposed uncertainties
so severe that they prevent the Company from obtaining unilateral control of the
venture.
Profit and Loss Accounting. The Company recognizes profits and losses in
accordance with its underlying ownership percentage or allocation percentage as
specified in the agreements with its partners; however, the Company recognizes
100% of the losses in ventures where the Company bears all of the financial risk
(which includes all of the Company's significant ventures except for Sovintel
and, historically, HER). Accordingly, the portion of the losses that would
normally be assigned to the minority interest partner ("Excess Losses") is
recognized by the Company. When such ventures become profitable, the Company
recognizes 100% of the profits until such time as the Excess Losses previously
recognized by the Company have been recovered. As of September 30, 1997, $5.3
million and $9.7 million represents the net unrecovered Excess Losses for the
Company's consolidated and equity method investments, respectively, that is
expected to favorably benefit future period results from operations upon the
Company's existing business ventures becoming profitable. This accounting policy
was adopted prior to 1995; however, 1995 was the first year that the excess loss
amount was deemed material for recognition within the Company's accounting
records. For the period from January 1, 1997, through August 31, 1997, the
Company recognized 100% of HER's losses due to GTS being the financing partner
during this period. As a result of HER's completion of a private placement of
$265.0 million of senior notes (of which $56.6 million was placed in escrow for
the first two years' interest payments) in August 1997, management no longer
considers itself as the financing partner.
Inter-Affiliate Transactions. Several of the Company's ventures have
entered into business arrangements through which they provide integrated
solutions for their customers by leveraging each others' telecommunications
infrastructure. These arrangements have historically been focused primarily
within a region; however, as GTS has increased its geographic coverage and
telecommunication capabilities, these arrangements have expanded between
regions. In accordance with generally accepted accounting principles, all
significant intercompany accounts and transactions are eliminated upon
consolidation.
Turnover Taxes. The Company's ventures within the CIS region incur a 4%
turnover tax that is based on the revenues earned. The Company includes these
taxes as a component of its operating expenses, since these taxes are incidental
to the revenue cycle.
30
<PAGE> 34
The following table summarizes the accounting methodology for the principal
business ventures through which the Company conducts its business.
<TABLE>
<CAPTION>
EFFECTIVE
COUNTRY/REGION GTS ACCOUNTING
COMPANY NAME OF OPERATIONS OWNERSHIP METHODOLOGY
------------ -------------- --------- -----------
<S> <C> <C> <C>
RUSSIA/CIS
Sovintel Russia 50% Equity
TCM Russia 50% Equity
TeleRoss Operating
Company Russia 100%(1) Consolidated
TeleRoss Ventures Russia 50%(2) Equity
Sovam Russia 67%(3) Equity
GTS Cellular CIS 25%-70%(4) Equity
WESTERN EUROPE
HER Western Europe 79% Consolidated(5)
GTS-Monaco Access Monaco 50% Equity
CENTRAL EUROPE
GTS-Hungary Hungary 99% Consolidated
EuroHivo Hungary 70% Equity
CzechNet Czech Republic 100% Consolidated
CzechCom Czech Republic 100% Consolidated
ASIA
V-Tech China 75% Equity
Beijing Tianmu China 47% Equity
CDI India 100% Consolidated
</TABLE>
- - ---------------
(1) The TeleRoss Operating Company is comprised of two wholly owned holding
companies and a 99% owned subsidiary that operates a domestic long distance
network and holds the applicable operating license for TeleRoss and performs
the customer invoicing and collection functions for telecommunications
services. TeleRoss Operating Company is accounted for under the
consolidation method of accounting because GTS has unilateral control over
the operations and management decisions. TeleRoss Operating Company's
operations are further discussed in "-- Results of
Operations -- Consolidated Ventures." A significant portion of TeleRoss
Operating Company's costs of revenue consists of settlement fees paid to the
TeleRoss Ventures, with such fees being recorded as revenue by the TeleRoss
Ventures. In 1996 and for the nine months ended September 30, 1997, all of
the TeleRoss Ventures' revenue was derived from such fees. Any decline in
the business or operations of the TeleRoss Ventures would have a material
adverse effect on the results of TeleRoss Operating Company.
(2) TeleRoss Ventures is comprised of thirteen joint ventures that are 50%
beneficially owned by GTS, which originate traffic and provide local
termination of calls through agency arrangements with TeleRoss Operating
Company. GTS does not exercise unilateral control over the TeleRoss Ventures
and therefore, they are appropriately accounted for under the equity method
of accounting. TeleRoss Ventures' operations are further discussed in
"-- Results of Operations -- Non-Consolidated Ventures (Equity Investees)."
(3) GTS has reached an agreement in principle to purchase its minority partner's
33% interest in Sovam and expects to close the transaction in February 1998,
thereby making Sovam a wholly owned subsidiary of GTS.
(4) GTS conducts its cellular operations through (i) Vostok Mobile, a wholly
owned GTS venture which owns between 50% and 70% of a series of 11 cellular
joint ventures in various regions in Russia, (ii) PrimTelefone, a 50% owned
venture in Vladivostok, Russia and (iii) Bancomsvyaz, an approximately 25%
beneficially owned venture in Kiev, Ukraine.
(5) As of July 16, 1997, HER is accounted for by the consolidation as opposed to
the equity method of accounting.
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RESULTS OF OPERATIONS -- CONSOLIDATED VENTURES
Management's discussion included within "-- Results of
Operations -- Consolidated Ventures" reflects the following significant
operating ventures: TeleRoss Operating Company, GTS-Hungary, CzechNet and
CzechCom (collectively the "Czech Companies") and HER (for fiscal 1997). See
"Results of Operations -- Non-Consolidated Ventures (Equity Investees)" for a
discussion of the operating results of Sovintel, TCM, Sovam, TeleRoss Ventures,
GTS Cellular, HER (prior to fiscal 1997), GTS-Monaco Access, EuroHivo and the
Asia business ventures.
Nine Months Ended September 30, 1997 compared to Nine Months Ended September
30, 1996
Revenue. The Company's consolidated revenue for the nine months ended
September 30, 1997 increased by $15.6 million to $30.2 million, an increase of
over 100% from the comparable period in 1996. TeleRoss Operating Company's
growth accounted for approximately 54.3% of the Company's total revenue over the
nine months ended September 30, 1997.
The CIS region's consolidated revenue was $17.8 million for the nine months
ended September 30, 1997, of which TeleRoss' revenue comprised 92.1%. TeleRoss
Operating Company's revenue increased by $10.3 million to $16.4 million for the
nine months ended September 30, 1997, from the comparable period in 1996.
Service revenue represented approximately 69.5% of the total TeleRoss Operating
Company revenue for the nine months ended September 30, 1997. The remaining
revenue generated by TeleRoss Operating Company was primarily related to
equipment sales and installation revenue of $2.9 million and $1.8 million for
the nine months ended September 30, 1997 and 1996, respectively.
Within the Central Europe region, GTS-Hungary and the Czech Companies
accounted for 100% of the $9.5 million in revenue earned for the nine months
ended September 30, 1997. GTS-Hungary's revenue increased by $1.4 million to
$5.9 million for the nine months ended September 30, 1997, from the comparable
period in 1996, largely due to a 25.0% increase in the number of VSATs installed
since September 1996. Revenue of the Czech Companies, which provide a range of
international telephone, private data and internet access services, increased by
$2.4 million to $3.6 million, for the nine months ended September 30, 1997, from
the comparable period in 1996, primarily due to increased voice and internet
traffic and lease line services.
All of Western Europe's consolidated revenue of $2.3 million for the nine
months ended September 30, 1997 was derived from HER's initial Amsterdam to
Brussels route.
Gross Margin. GTS's consolidated gross margin was $1.9 million and $1.8
million, or 6.3% and 12.3% of total revenue, for the nine months ended September
30, 1997 and 1996, respectively. The decrease in consolidated gross margin as a
percentage of revenue was attributable to the consolidation of HER in fiscal
1997.
TeleRoss Operating Company had a gross margin of $1.0 million and $(1.0)
million for the nine months ended September 30, 1997 and 1996, respectively.
GTS-Hungary had gross margins of $2.7 million and $1.9 million for the nine
months ended September 30, 1997 and 1996, respectively (representing 45.8% and
42.2% of GTS-Hungary's revenue during these periods). The remaining consolidated
gross margin of $(1.8) million and $0.9 million for the nine months ended
September 30, 1997 and 1996, respectively, was primarily attributable to HER,
which generated a negative gross margin of $(3.2) million for the nine months
ended September 30, 1997, and to the Czech Companies, which generated gross
margin of $0.9 million and $0.2 million for the nine months ended September 30,
1997 and 1996, respectively.
Operating Expenses. Consolidated operating costs were $52.1 million and
$35.7 million for the nine months ended September 30, 1997 and 1996,
respectively. The increase in operating costs reflected the growth in
expenditures associated with building business infrastructure, the inclusion of
HER's operating expenses and increasing corporate staff.
Equity in (Losses)/Earnings of Ventures. GTS recognized losses from its
investments in non-consolidated ventures of $18.2 million and $7.0 million for
the nine months ended September 30, 1997 and 1996, respectively. Included in
these losses were $7.3 million and $5.1 million for the nine months ended
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<PAGE> 36
September 30, 1997 and 1996, respectively, that related to GTS's ownership share
of the losses incurred. Also included in the losses for the nine months ended
September 30, 1997 was a write-off of approximately $5.4 million which
represented the net balance of certain investments in and advances to ventures
in Asia (primarily Beijing Tianmu and V-Tech) and Central Europe (Eurohivo)
which were stated in excess of their net realizable value. The Company followed
the authoritative guidance as prescribed by APB No. 18, 'The Equity Method of
Accounting for Investments in Common Stock' ('APB No. 18') for its determination
of the $5.4 million charge. The Company's recoverability analysis was based on
its projected undiscounted cash flows of their equity investees since this is
the lowest level of cash flow information available. The underlying reasons for
the write-down of the Company's investments were the result of the problems that
are more specifically addressed in Results of Operations -- Non-Consolidated
Ventures (Equity Investees) -- Asia. Additionally, included within GTS's
ownership share of the losses incurred and the Excess Losses for the nine months
ended September 30, 1997 is approximately $14.4 million of losses (of the
$14.4 million, approximately $13.5 million related to the write-off of advances
to several Chinese owned operating telecommunications companies to which the
Company provides technical and financial assistance and $0.9 million related to
the write-off of inventories, receivables, and other assets) which represented
the Company's share of asset write-offs recorded by certain of the ventures in
Asia (Beijing Tianmu and V-Tech). See "-- Results of Operations
- - -- Non-Consolidated Ventures (Equity Investees) Asia." The Company would have
recognized earnings from its investments in non-consolidated ventures of $1.6
million for the nine months ended September 30, 1997, had the Company not
recognized the write-downs of investments and assets of approximately $5.4
million and $14.4 million, respectively. The write-down of Central Europe's
investment in EuroHivo was a result of the Company's decision in the third
quarter to recognize the contingent liabilities associated with the expected
liquidation and discontinuation of EuroHivo's operations as of September 30,
1997. In addition, the Company's results were negatively affected by the
recognition of Excess Losses of $5.5 million and $1.9 million for the nine
months ended September 30, 1997 and 1996, respectively. As of September 30,
1997, $9.7 million represents the net unrecovered Excess Losses for the
Company's equity method investments, respectively, that is expected to favorably
benefit future period results from operations upon the Company's existing equity
method business ventures becoming profitable. CIS' ventures, primarily Sovintel
and TCM (with combined earnings to the Company of $11.6 million and $8.3 million
for the nine months ended September 30, 1997 and 1996, respectively), generated
earnings for the Company of approximately $8.2 million and $5.0 million for the
nine months ended September 30, 1997 and 1996, respectively, which partially
offset losses generated by other ventures. See "-- Results of
Operations -- Non-Consolidated Ventures (Equity Investees)." See Footnote 3 in
the Company's Consolidated Financial Statements.
Interest, Net. GTS incurred interest expenses of $21.1 million and $7.3
million for the nine months ended September 30, 1997, and 1996, respectively.
Interest expense is comprised of interest accrued from debt maturing within one
year, long-term debt obligations, amortization of debt discount on the long-term
debt obligations and various other debt instruments. The increase in interest
expense was primarily related to the issuance of $144.8 million in Convertible
Bonds in July 1997 and $265.0 million in senior notes raised in August 1997 by
HER. See "-- Liquidity and Capital Resources."
GTS earned interest income of $5.3 million and $1.5 million for the nine
months ended September 30, 1997 and 1996, respectively, primarily as a result of
investing the proceeds from equity and debt offerings in various highly liquid
investments.
Provision for Income Taxes. The Company's consolidated tax provision was
$1.8 million and $1.0 million for the nine months ended September 30, 1997 and
1996, respectively. The Company's income tax rates are significantly affected by
foreign taxes and the utilization of net operating losses. In addition, the
Company operates worldwide in numerous tax jurisdictions. As a result, losses
incurred in one jurisdiction may not be available to offset income in another.
Year Ended December 31, 1996 compared to Year Ended December 31, 1995 and
compared to Year Ended December 31, 1994
Revenue. The Company's consolidated revenue was $24.1 million, $8.4 million
and $2.5 million for the years ended December 31, 1996, 1995 and 1994,
respectively. The growth in revenue was attributable to the
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<PAGE> 37
commencement in 1995 of commercial operations by TeleRoss Operating Company, as
well as the continued expansion of services and customer base in Central Europe.
TeleRoss Operating Company generated revenue of $9.2 million and $3.8
million, representing 38.2% and 45.2% of the Company's consolidated revenue for
the years ended December 31, 1996 and 1995, respectively. Service revenue
represented 64.1% and 21.1% of TeleRoss Operating Company's revenue for the
years ended December 31, 1996 and 1995, respectively, with the balance of its
revenue in such periods principally represented by equipment sales. The growth
in revenue was a result of increased traffic volume generated by the TeleRoss
Ventures as they expanded to seven new cities during the year ended December 31,
1996, added customers in existing cities and installed several VSATs at customer
locations outside of cities in which they have a presence.
GTS-Hungary and the Czech Companies accounted for $6.9 million and $2.3
million of the Company's consolidated revenue in 1996, respectively, compared to
$4.2 million and $0.3 million in 1995, respectively, and $1.3 million and none
in 1994, respectively. The growth in revenue of GTS-Hungary from 1994 to 1996
was due to the expansion of its customer base and the introduction of microwave
technology services. The Hungary state lottery accounted for 55.3%, 65.0% and
67.2% of GTS-Hungary's revenue in 1996, 1995 and 1994, respectively. The growth
in revenue of the Czech Companies was generated through increases in voice
traffic carried from sixteen buildings at December 31, 1996 as compared to eight
buildings at December 31, 1995.
Gross Margin. GTS's consolidated gross margin was $5.2 million, or 21.6% of
revenue, for the year ended December 31, 1996 and $0.02 million, or 0.0% of
revenue, for the years ended December 31, 1995 and 1994.
TeleRoss Operating Company incurred a negative gross margin of $1.0 million
for both the years ended December 31, 1996 and 1995 which was the result of the
high fixed cost component of its network hub in Moscow. GTS-Hungary had a gross
margin of $3.0 million, $1.7 million and $(0.3) million, representing 43.5%,
40.5% and (23.1)% of GTS-Hungary's revenue for the years ended December 31,
1996, 1995 and 1994, respectively. The favorable gross margin trend reflected
the increased utilization of GTS-Hungary's 1,000 VSAT capacity hub located in
Budapest. The remaining gross margin of $3.2 million for the year ended December
31, 1996 was attributable to the higher margin sales of equipment and consulting
services.
Operating Expenses. Consolidated operating costs were $52.9 million, $41.0
million and $12.9 million for the years ended December 31, 1996, 1995 and 1994,
respectively. The increase in operating costs reflected the growth in
expenditures associated with building business infrastructure for primarily the
TeleRoss Operating Company and GTS-Hungary and increasing corporate staff.
Equity in (Losses)/Earnings of Ventures. GTS recognized losses from its
investments in non-consolidated ventures of $10.2 million, $7.9 million and $0.1
million for the years ended December 31, 1996, 1995 and 1994, respectively.
Included in these losses were $5.7 million, $5.2 million and $0.1 million for
the years ended December 31, 1996, 1995 and 1994, respectively, that related to
GTS's ownership share of the losses. In addition, the Company's results were
negatively affected due to the recognition of Excess Losses of $4.5 million and
$2.7 million for the years ended December 31, 1996 and 1995, respectively. See
"--Overview." The Company would have recognized additional losses of $8.2
million and $3.3 million for the years ended December 31, 1996 and 1995,
respectively, had the Company been considered the financing partner of HER
during those time periods. The Company's losses from its ventures were primarily
the result of most of its ventures being in the early stages of operations.
Sovintel and TCM, however, generated combined earnings of $11.8 million and $3.8
million for the years ended December 31, 1996 and 1995, respectively, which
partially offset losses generated by other ventures.
Other Non-Operating Income. Favorably affecting the 1995 results was the
non-recurring $10.3 million gain the Company recognized as a result of its cash
settlement of certain claims with a third party in 1995.
Interest, Net. GTS incurred interest expense of $11.1 million, $0.7 million
and $0.1 million for the years ended December 31, 1996, 1995 and 1994,
respectively. The increase in interest expense was due to the $60.0 million
increase in debt during 1996. See "--Liquidity and Capital Resources."
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GTS earned interest income of $3.6 million, $2.2 million and $1.2 million
for the years ended December 31, 1996, 1995 and 1994, respectively, primarily as
a result of investing the proceeds from private placements of common stock in
various highly liquid investments.
Provision for Income Taxes. The Company's consolidated tax provision was
$1.4 million and $2.6 million for the years ended December 31, 1996 and 1995,
respectively. These rates were significantly affected by foreign taxes and the
utilization of net operating losses. In addition, the Company operates
world-wide in numerous tax jurisdictions. As a result, losses incurred in one
jurisdiction may not be available to offset income in another. The Company had
no income tax expense for the year ended December 31, 1994.
RESULTS OF OPERATIONS -- NON-CONSOLIDATED VENTURES (EQUITY INVESTEES)
Nine Months Ended September 30, 1997 compared to Nine Months Ended September
30, 1996
RUSSIA -- CIS
Sovintel. Sovintel's revenue increased by 57.7% to $82.0 million for the
nine months ended September 30, 1997, from $52.0 million for the comparable
period in 1996. The increase in revenue was primarily the result of
telecommunications services revenue, which increased to $61.5 million for the
nine months ended September 30, 1997, from $34.9 million for the nine months
ended September 30, 1996, due to the Moscow customer base growth and traffic
from other GTS ventures that generated increased volume of outgoing
international and domestic minutes carried by Sovintel. Incoming international
revenue grew significantly by $3.6 million to $9.9 million for the nine months
ended September 30, 1997, from the comparable period in 1996. Included in
Sovintel's 1997 traffic revenue was $8.7 million for the nine months ended
September 30, 1997, that was related to customers using phone numbers provided
by TCM. This revenue was derived primarily from international/long distance
traffic and local traffic. Sovintel and TCM have an arrangement whereby Sovintel
reimburses TCM 50% of installation charges, monthly fees and local traffic
revenues and approximately 33% of the international/long distance billings from
TCM-supplied phone numbers.
Sovintel's non-traffic related revenue increased to $20.6 million for the
nine months ended September 30, 1997, from $16.7 million for the comparable
period in 1996. In March 1997, Sovintel's historically largest customer for port
sales revenue, MTS, received its own numbering plan. Accordingly, management
expects revenue from port sales to continue to decline.
Sovintel's gross margin percentage decreased to 37.8% for the nine months
ended September 30, 1997, as compared to 41.1% for the comparable period in
1996, in part due to a general price decrease implemented in April 1997.
Operating expenses were $12.3 million and $7.3 million, or 15.0% and 14.0%
of total revenue, for the nine months ended September 30, 1997 and 1996,
respectively. The increase in operating expenses for the nine months ended
September 30, 1997 was related to an increase in turnover taxes associated with
revenues, and also increased personnel, advertising and sales force costs
required to support Sovintel's growth.
Income tax expense was $4.1 million and $3.9 million for the nine months
ended September 30, 1997 and 1996, respectively.
TCM. TCM's revenue grew 64.9% to $20.7 million for the nine months ended
September 30, 1997, from the comparable period in 1996. TCM's gross margin was
$16.0 million and $10.3 million, or 77.3% and 81.7% of total revenue, for the
nine months ended September 30, 1997 and 1996, respectively. The decrease in
gross margin as a percentage of revenue was attributable to higher
infrastructure and settlement costs. Operating expenses were $2.0 million and
$1.2 million, or 9.7% and 9.5% of total revenue, for the nine months ended
September 30, 1997 and 1996, respectively.
Sovam. Sovam's revenue increased by 61.3% to $12.9 million for the nine
months ended September 30, 1997, from the comparable period in 1996. Sovam's
revenue was derived primarily from data services, network capabilities and
application revenues. The increase in revenue is primarily attributable to the
expansion of
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Sovam's network throughout Russia and the CIS and the improvement in the quality
of Internet services due to increased international bandwidth.
Sovam's gross margin was $5.0 million, or 38.8% of total revenue, for the
nine months ended September 30, 1997, up from $2.1 million, or 26.3%, for the
nine months ended September 30, 1996. Operating expenses were $4.6 million and
$4.2 million, or 35.7% and 52.5% of total revenue, for the nine months ended
September 30, 1997 and 1996, respectively.
TeleRoss Ventures. Revenue for the TeleRoss Ventures for the nine months
ended September 30, 1997 and 1996 was $5.1 million and $1.3 million,
respectively. The increase in revenues reflected growth in settlement fees
charged to the TeleRoss Operating Company. The settlement fees are based on
minutes of use by regional customers in the core switched voice services, as
well as installation work and equipment sales.
Gross margin was $3.7 million and $0.8 million, or 72.5% and 61.5% of total
revenue, for the nine months ended September 30, 1997 and 1996, respectively.
Operating expenses of $2.5 million and $1.5 million were incurred for the nine
months ended September 30, 1997 and 1996, respectively.
GTS Cellular. The Company operates three cellular networks through
differing ownership structures; Vostok Mobile, Prim Telefone and Bancomsvyaz.
Revenue for Vostok Mobile increased by 41.5% from $10.6 million to $15.0
million for the nine months ended September 30, 1997, from the comparable period
in 1996, as a result of increased subscribership to approximately 11,000 at
September 30, 1997. Vostok Mobile's gross margin was $7.6 million and $5.3
million, or 50.7% and 50.0% of total revenue, for the nine months ended
September 30, 1997 and 1996, respectively. Operating expenses were $4.8 million
and $5.4 million for the nine months ended September 30, 1997 and 1996,
respectively. The higher operating costs in 1996 was attributed to development
and start-up expenses related to new business ventures.
Revenue for PrimTelefone increased by 43.9% to $8.2 million for the nine
months ended September 30, 1997, from the comparable period in 1996, due to an
increase in subscribership to approximately 4,600 as of September 30, 1997.
PrimTelefone's gross margin was $4.7 million and $3.0 million, or 57.3% and
52.6% of total revenue, for the nine months ended September 30, 1997 and 1996,
respectively. Operating expenses were $2.7 million and $1.5 million, or 32.9%
and 26.3% of total revenue, for the nine months ended September 30, 1997 and
1996, respectively.
Revenues for Bancomsvyaz was $4.0 million for the nine months ended
September 30, 1997, with a gross margin of $1.5 million and operating expenses
of $3.4 million for the nine months ended September 30, 1997, respectively.
WESTERN EUROPE
GTS-Monaco Access. In 1997, GTS-Monaco Access revenue increased
significantly to $7.9 million for the nine months ended September 30, 1997, from
$2.2 million for the same period in 1996. The increase was the result of a
substantially larger traffic base and number of countries covered under the
network. Gross margin for the nine months ended September 30, 1997 and 1996 was
$0.4 million and $(0.3) million, respectively. In January 1998 GTS-Monaco Access
terminated its relationship with a major traffic partner which is expected to
result in a loss of approximately $6.0 million of revenues and a reduction to
gross margin of less than $0.1 million in 1998. See "Business -- Western
Europe -- GTS-Monaco Access."
CENTRAL EUROPE
Eurohivo. Eurohivo's operating results were minimal for the nine months
ended September 30, 1997 and 1996. In September 1997, the Company recorded a
$2.4 million charge in the third quarter to recognize the contingent liabilities
associated with the planned liquidation and discontinuance of Eurohivo's
operations. See Footnote 2 in the Company's condensed consolidated financial
statements for additional disclosures related to Eurohivo.
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ASIA
Most of the Company's ventures within the Asia region were in the start-up
phase and had not commenced operations in 1996. The non-consolidated ventures in
the Asia region had no revenue for the nine months ended September 30, 1997, and
had minimal revenue of $0.5 million for the nine months ended September 30,
1996. During the nine months ended September 30, 1997, the V-Tech and Beijing
Tianmu business ventures (the 'Asia Ventures') determined that a charge of $14.4
million (GTS's portion) was appropriate in the quarter as a result of the
write-off of $13.5 million of advances to several Chinese owned operating
telecommunications companies to which the Asia Ventures provide technical and
financial assistance and $0.9 million related to the write-off of inventories,
receivables and other assets. The Asia Ventures followed the authoritative
guidance as prescribed by SFAS No. 121, 'Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of' for their
determination of the $13.5 million charge as they believed that the advances, as
evidenced by legal agreements between the Asia Ventures and the underlying
operating telecommunications companies, represents long-lived assets. (The Asia
Ventures would have reflected the same charge had they followed the
authoritative accounting guidance as prescribed by APB No. 18 or SFAS No. 5,
"Accounting for Contingencies"). The Asia Ventures recoverability analysis was
based on their projected undiscounted cash flows of their respective operations
since this is the lowest level of cash flow information available. The
underlying reasons for the write-offs were the result of problems dealing with
one of the Asian partners; the inability of the Chinese operating
telecommunications companies to develop markets for their services; and
technical problems, all of which surfaced during the third quarter 1997. See
Footnote 2 in the Company's condensed consolidated financial statements for
additional disclosures related to the Company's Asia operations.
Year Ended December 31, 1996 compared to Year Ended December 31, 1995 and
compared to Year Ended December 31, 1994
RUSSIA -- CIS
Sovintel. Sovintel's revenue for the years ended December 31, 1996, 1995
and 1994 was $75.0 million, $44.3 million, and $20.7 million, respectively.
Sovintel's revenue was derived from telecommunications services, including
international, domestic and local traffic, and other non-traffic related revenue
associated with port and equipment sales, leased line installation and
maintenance. Telecommunications services traffic revenue was $50.8 million,
$26.8 million and $19.5 million, representing 67.7%, 60.5% and 94.2% of
Sovintel's total revenue, for the years ended December 31, 1996, 1995 and 1994,
respectively.
Revenue from outgoing international, domestic long distance and Moscow
local traffic was $44.0 million, $24.6 million and $18.0 million for the years
ended December 31, 1996, 1995 and 1994, respectively. This growth was due to
Sovintel's increased customers in Moscow and traffic from other GTS ventures.
Sovintel began providing Moscow local access services in 1995. Revenue from
incoming international minutes was $6.8 million, $2.2 million and $1.5 million
for the years ended December 31, 1996, 1995 and 1994, respectively. Included in
Sovintel's 1996 traffic revenue was $5.0 million from customers using phone
numbers provided by TCM.
Sovintel's non-traffic related revenue of $24.2 million, $17.5 million and
$1.2 million for the years ended December 31, 1996, 1995 and 1994, respectively,
was primarily attributable to non-recurring port sales revenues of $12.4 million
and $14.4 million for the years ended December 31, 1996 and 1995, respectively.
Included in 1996 non-traffic related revenue was $3.7 million from one-time
installation charges related to TCM-supplied phone numbers. There were no
significant port sales in 1994.
Sovintel's gross margin was $31.1 million, $18.0 million and $8.2 million,
or 41.5%, 40.6% and 39.6% of revenue, for the years ended December 31, 1996,
1995 and 1994, respectively. The gross margin percentage remained relatively
unchanged over the past three years as the decrease in average revenue per
minute for international and intercity calls was partially offset by the
decrease in average settlement cost per minute.
Operating expenses were $10.3 million, $7.1 million and $4.6 million, or
13.7%, 16.0% and 22.2% of total revenue, for the years ended December 31, 1996,
1995 and 1994, respectively. Turnover taxes and personnel
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related costs comprised the majority of the increase in selling, general and
administrative costs. The increase in personnel related costs reflected the
growth in sales and general operations of Sovintel.
Income tax expense was $5.2 million and $2.6 million for the years ended
December 31, 1996 and 1995, respectively. The increase in income tax expense was
attributable to Sovintel's profitable operations. According to Russian
Federation tax holiday provisions, Sovintel was exempt from income taxes for a
two-year period beginning with the first year of taxable income, which was in
1993.
TCM. TCM's total revenue was $16.5 million for the year ended December 31,
1996 and had minimal activities in 1995. TCM had a gross margin of $13.2
million, or 80.0% of total revenue, and operating expenses of $1.9 million, or
11.5% of total revenue, for the year ended December 31, 1996.
Sovam. Sovam's revenue was $11.7 million, $4.4 million and $3.3 million for
the years ended December 31, 1996, 1995 and 1994, respectively. The increase in
revenues is primarily attributable to the wider variety of service offerings,
including the introduction of Russia On Line services.
Gross margin was $3.4 million, $1.5 million and $1.8 million, or 29.1%,
34.1% and 54.5% of total revenue for the years ended December 31 in 1996, 1995
and 1994, respectively. The decline in gross margin as a percentage of revenue
was reflective of the higher cost of sales component in Sovam's recently
introduced products. Operating expenses were $5.7 million, $3.3 million and $2.1
million, or 48.7%, 75.0% and 63.6% of total revenue, for the years ended
December 31, in 1996, 1995 and 1994, respectively.
TeleRoss Ventures. Revenues for TeleRoss Ventures for the years ended
December 31, 1996 and 1995 were $2.4 million and $0.2 million, respectively.
Revenues resulted from settlement fees charged to TeleRoss Operating Company.
The growth in total revenue was the result of steady growth in sales of core
switched voice services in the five cities serviced in 1995 as well as the
addition of seven new cities to the network in 1996.
Gross margin for the years ended December 31, 1996 and 1995 was $1.6
million and $0.1 million, respectively. Operating expenses of $2.3 million and
$0.2 million were incurred for the years ended December 31, 1996 and 1995,
respectively.
GTS Cellular. The Company operates three cellular networks through
differing ownership structures: Vostok Mobile, PrimTelefone and Bancomsvyaz.
Revenue for Vostok Mobile was $16.5 million and $2.0 million for the years
ended December 31, 1996 and 1995, respectively. Vostok Mobile's gross margin was
$9.3 million and $1.1 million, or 56.4% and 55.0% of total revenue, and
operating expenses were $9.2 million and $4.7 million for the year ended
December 31, 1996 and 1995, respectively.
Revenue for PrimTelefone was $8.4 million and $2.2 million for the years
ended December 31, 1996 and 1995, respectively. PrimTelefone's gross margin was
$4.7 million and $0.6 million, or 56.0% and 27.3% of total revenue, and
operating expenses were $3.7 million and $0.7 million for the years ended
December 31, 1996 and 1995, respectively.
Bancomsvyaz did not have significant operations until 1997.
WESTERN EUROPE
HER. HER represents substantially all of GTS's investment in the Western
Europe region. A small operational revenue stream was earned in 1996.
Operating expenses were $16.0 million, $6.7 million and $0.2 million for
the years ended December 31, 1996, 1995 and 1994, respectively. The increase in
selling, general and administrative expenses reflected HER's continued
transition from the start-up phase to the operational phase.
GTS-Monaco Access. Limited international traffic was carried from GTS
subsidiaries through GTS-Monaco Access for termination worldwide during 1995
which resulted in minimal revenues earned. Total revenue was $3.9 million and
gross margin was $(0.4) million for the year ended December 31, 1996.
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CENTRAL EUROPE
EuroHivo. EuroHivo's revenue was $1.0 million and $0.5 million for the
years ended December 31, 1996 and 1995, respectively. Although revenue improved
significantly during 1996, EuroHivo continued to show negative gross margins of
$(0.2) million and $(0.5) million for the years ended December 31, 1996 and
1995, respectively. Furthermore, operating expenses decreased to $1.9 million
for the year ended December 31, 1996 from $2.4 million for the year ended
December 31, 1995 despite a 64.0% increase in personnel during 1996. This was
primarily attributable to management's decision to grow revenue through
alternative measures resulting in significant reductions to advertising
expenditures in 1996.
ASIA
Most of the Company's ventures within the Asia region were in the start-up
phase and had not commenced operations in 1996. The non-consolidated ventures in
the Asia region had revenue of $7.0 million and $0.0 million for the years ended
December 31, 1996 and 1995, respectively. The revenue in 1996 consisted
principally of equipment sales. The Company believes that future revenue will be
derived primarily from providing telecommunications engineering and consulting
services.
LIQUIDITY AND CAPITAL RESOURCES
The telecommunications business is capital intensive. The Company generally
is the primary source of funding for its ventures, both for working capital and
capital expenditures. Under a typical arrangement, GTS's venture partner
contributes the necessary licenses or permits under which the venture will
conduct its business, office space and other equipment. GTS's contribution is
generally cash and equipment, but may consist of other specific assets as
required by the joint venture agreement.
The Company has raised capital through the issuance of equity securities
and through various debt agreements. The issuance of equity securities has
raised $36.5 million, $107.7 million, $42.1 million and $62.1 million in 1997,
1996, 1995 and 1994, respectively, net of placement fees, for a total of $248.4
million. In addition, the Company and HER received $409.8 million, $60.0 million
and $23.3 million in 1997, 1996 and 1995, respectively, for a total of $493.1
million under various debt agreements. Included within the debt proceeds
identified above, the Company received $3.5 million, $60.0 million and $10.0
million in 1997, 1996 and 1995, respectively, from lenders who are affiliated
with, and are considered related parties to, the Company as a result of their
(or their affiliates) ownership of the Company's Common Stock.
The Company had working capital of $353.4 million and $66.5 million as of
September 30, 1997 and 1996, respectively. Approximately $190.0 million of the
$353.4 million of working capital at September 30, 1997, is intended to be used
for the buildout of the HER Network. The Company had an accumulated deficit of
$213.8 million as of September 30, 1997, including a net loss of approximately
$87.9 million and $48.5 million for the nine months ended September 30, 1997 and
1996, respectively. During 1997, the Company has incurred and expects to
continue to incur substantial expenditures to fund the working capital
requirements of its ventures, to provide capital equipment for certain of its
ventures, and to engage in new development and acquisitions.
GTS will require substantial capital investment to execute its business
plans and to fund expected operating losses. Management expects that GTS and its
ventures will incur over $515.0 million of capital expenditures during the next
three fiscal years, of which approximately $235.0 million will be incurred in
1998. The Company has obtained funds in 1997 through a variety of financing
arrangements, including (i) the issuance in September 1997 of $39.2 million of
Common Stock in a private placement of equity with a value of $15.67 per common
share, (ii) the issuance in August 1997 of $265.0 million in gross proceeds (of
which $56.6 million was placed into escrow to fund the first two years' interest
payments) of 11.5% Senior Notes by HER that may be redeemed upon the successful
completion of a complying equity offering or meeting other certain criteria, and
(iii) the issuance in July and August 1997 of $144.8 million in gross proceeds
of the Bonds in the Original Offering.
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The Company believes that the net proceeds from the Offerings, together
with existing cash, will be sufficient to fund its expected capital needs until
at least June 1999. The Company expects that it may require additional capital
to execute its current business plan and to fund expected operating losses, as
well as to consummate future acquisitions and exploit opportunities to expand
and develop its businesses. There can be no assurances that the Company will be
able to consummate additional financing on favorable terms. As a result, the
Company may be subject to additional or more restrictive financial covenants,
its interest obligations may increase significantly and its existing
shareholders may be adversely diluted. Failure to generate sufficient funds in
the future, whether from operations or by raising additional debt or equity
capital, may require the Company to delay or abandon some or all of its
anticipated expenditures, to sell assets, or both, either of which could have a
material adverse effect on the operations of the Company.
HER
Construction of the HER fiber optic network is one of the Company's most
significant business activities. The buildout of the network is expected to
require approximately $290.0 million of capital expenditures during fiscal year
1998 and thereafter, with approximately $35.0 million required for the initial
five country network. As of September 30, 1997, approximately $27.6 million has
been spent on network capital expenditures. In August 1997, HER completed the
issuance of $265.0 million in gross proceeds of 11.5% Senior Notes due in August
2007. The Senior Notes are general unsecured obligations of HER. HER currently
estimates that its capital resources will be sufficient to fund operations and
expected network development through December 1998, at which time it may be
required to obtain additional funds. Sources of capital to fund network
development after 1998 may include internally generated funds, bank debt and
vendor financing. HER is currently in discussion with a number of financial
institutions to obtain debt financing and to negotiate vendor financing with key
suppliers of network equipment. Any failure to obtain necessary financing may
require HER to delay or abandon its plans for deploying the remainder of the
network and would jeopardize the viability of HER, or may require the Company to
make additional capital contributions to HER at the expense of the Company's
other operations, either of which could have a material adverse effect on the
operations of the Company. There can be no assurance that GTS or its partners in
HER would have sufficient capital to make contributions to HER, or that they
would be willing to do so.
Pursuant to the Recapitalization, HER offered to GTS-Hermes, HIT Rail and
the eleven individual members of the HIT Rail consortium the right to subscribe
to additional common stock of the Company. GTS-Hermes and two of the members of
HIT Rail exercised their rights, while HIT Rail and the nine remaining members
of HIT Rail declined to participate.
As a result of the finalization of the Recapitalization, total shareholder
loans of ECU 39.4 million (approximately $48.5 million) from, collectively,
GTS-Hermes, HIT Rail and two of the members of HIT Rail, were converted into
equity. Additionally, GTS-Hermes contributed ECU 46.0 million (approximately
$51.8 million) and one of the members of HIT Rail contributed a ten-year fiber
optic cable lease which was valued at ECU 1.8 million (approximately $2.0
million). The ownership of HER subsequent to the recapitalization was as
follows: GTS-Hermes, 79.08%; HIT Rail, 12.63%; and the two members of HIT Rail
combined, 8.29%. See "Business -- Western Europe -- HER -- HER
Recapitalization."
Liquidity Analysis
The Company had cash and cash equivalents of $366.8 million and $86.5
million as of September 30, 1997 and 1996, respectively. Approximately $190.0
million of the $366.8 million of cash and cash equivalents at September 30,
1997, is intended to be used for the build-out of the HER network. The Company
had restricted cash of $59.8 million and $3.9 million as of September 30, 1997
and 1996, respectively. Restricted cash included amounts held in escrow to pay
the first two years' interest payments on the Senior Notes of HER, amounts held
for equipment purchases under various debt agreements, and cash maintained in
foreign financial institutions that may not be readily convertible into dollars
or easily repatriated.
During the nine months ended September 30, 1997 and 1996, the Company used
$38.9 million and $31.8 million, respectively, of cash for operating activities.
Cash used for investing activities was $73.0 million
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and $48.0 million for the nine months ended September 30, 1997 and 1996,
respectively. The use of cash in operations and for investing activities
reflected primarily the development and buildout of existing telecommunications
networks and the funding of fully operational ventures.
Substantially all of the Company's operations are in foreign countries and
therefore the Company's consolidated financial results are subject to
fluctuations in currency exchange rates. The Company's consolidated operations
transact their business in the following significant currencies: Russian Ruble,
Hungarian Forint, Belgian Franc and the European Currency Unit. For those
operating companies that transact their business in currencies that are not
readily convertible, the Company attempts to minimize its exposure by indexing
its invoices and collections to the applicable dollar/foreign currency exchange
rate to the extent its costs (including interest expense, capital expenditures
and equity) are incurred in U.S. dollars. Although the Company will continue to
attempt to match revenues, costs, borrowing and repayments in terms of their
respective currencies, the Company may experience economic loss and a negative
impact on earnings with respect to holdings solely as a result of foreign
currency exchange rate fluctuations, which include foreign currency devaluations
against the U.S. dollar. Furthermore, certain of the Company's operations have
notes payable and notes receivable which are denominated in a currency other
than their own functional currency or loans linked to the U.S. dollar. The
Company may also experience economic loss and a negative impact on earnings
related to these monetary assets and liabilities.
The Company is in the process of developing risk management policies that
will establish guidelines for managing foreign exchange risk. The Company
expects that these policies will be implemented in the first quarter of 1998,
and anticipates that these policies will allow management to use financial
hedging instruments to manage foreign exchange exposure. Currently, the Company
is considering alternatives to hedge foreign exchange exposure resulting from
the issuance of $265 million in senior notes by HER.
YEAR 2000 COMPLIANCE
The Company is currently in the process of assessing its year 2000
compliance costs and of converting its computer systems to year 2000 compliant
software. This process includes obtaining confirmations from the Company's
primary vendors that plans are being developed or are already in place to
address processing of transactions in the year 2000. The Company does not expect
that the cost of converting such systems will be material to its financial
condition or results of operations. The Company currently believes it will be
able to achieve year 2000 compliance by the end of 1999, and currently does not
anticipate any material disruption in its operations as the result of any
failure by the Company to be in compliance or that year 2000 compliance costs
will have a material effect on the Company's earnings.
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BUSINESS
INTRODUCTION
GTS is a provider of a broad range of telecommunications services to
businesses, other telecommunications service providers and consumers in Russia,
the CIS and Central Europe. Through HER, GTS is developing, and operating the
initial segments of, a pan-European high capacity fiber optic network that is
designed to interconnect a majority of the largest Western and Central European
cities and to transport international voice, data and multimedia/image traffic
for other carriers throughout Western and Central Europe. GTS's strategy to
develop its businesses generally has been to establish joint ventures with a
strong local partner or partners while maintaining a significant degree of
operational control. The Company's business activities consist of the ownership
and operation of (i) international long distance businesses, which operate
through international gateways that provide international switching services and
transmission capacity, (ii) local access networks, which provide local telephone
service, (iii) cellular networks, which provide wireless telecommunications
services, (iv) a domestic long distance business, (v) data networks and (vi)
carriers' carrier networks, which provide high volume transmission capacity to
other carriers.
In Russia and the CIS, GTS's objective is to become the premier alternative
telecommunications operator. To attain its objective, the Company has partnered
with regional telephone companies and with Rostelecom, the national long
distance carrier in Russia. The Company currently operates in 24 oblasts
(regions) and the city of Moscow in Russia, as well as in 11 additional cities
in the CIS, and believes it is well-positioned to become the leading independent
telecommunications service provider in Russia. These businesses include: (i)
Sovintel, which provides Moscow, and recently St. Petersburg, with international
long distance and local telephone services and access to the major domestic long
distance carriers; (ii) TCM, which provides local access services in Moscow;
(iii) TeleRoss, which provides domestic long distance services in fourteen
cities in Russia, including Moscow, as well as VSAT service to customers outside
its primary long distance satellite network; (iv) Sovam, which provides data
services, including high-speed data transmission, electronic mail, Internet
access services, as well as Russia On Line, the first Russian language Internet
service; and (v) GTS Cellular, which operates cellular networks in twelve
regions in Russia and also in Kiev, Ukraine, with licenses covering regions with
an aggregate population of approximately 25 million people at the end of 1996.
Whenever practical, GTS's businesses integrate and co-market their service
offerings in Russia and the CIS, utilizing TeleRoss as the domestic long
distance provider, Sovintel as the international gateway, TCM and GTS Cellular
for local access, and Sovam as the data communications and Internet access
network for business applications and on-line services. Together, GTS's Russian
and CIS ventures carried 202.5 million and 292.0 million minutes of traffic for
the year ended December 31, 1996 and the nine months ended September 30, 1997,
respectively, and had approximately 24,600 customers, including approximately
16,300 cellular subscribers, as of September 30, 1997. See "-- Russia and the
CIS."
In Western Europe, GTS seeks to position itself as the leading independent
carriers' carrier through the development of two ventures, HER and GTS-Monaco
Access. HER's objective is to become the leading pan-European carriers' carrier
by providing centrally managed cross-border telecommunications transmission
capacity to telecommunications companies including traditional PTOs and New
Entrants on an approximately 18,000 kilometer pan-European high capacity fiber
optic network designed to interconnect a majority of the largest Western and
Central European cities. HER is currently operating over an approximately 1,700-
kilometer portion of the network linking Brussels, Antwerp, Rotterdam,
Amsterdam, London and Paris. HER expects the initial five country network to be
placed in operation in the second quarter of 1998. This segment of the network
is expected to deliver managed transport services over approximately 2,900
kilometers of fiber optic cable linking the cities of London, Rotterdam,
Amsterdam, Antwerp, Brussels, Paris, Dusseldorf and Frankfurt. The full 18,000
kilometer network is expected to become fully operational during the year 2000.
HER also plans to lease capacity on a transatlantic cable linking the European
network to North America and is exploring various interconnectivity options to
Russia and Asia. Such intercontinental interconnectivity will help HER to
satisfy the needs of its European customers with respect to outgoing traffic and
to attract additional non-European customers with traffic terminating in Europe.
HER commenced commercial service over the Brussels-Amsterdam portion of the
network in late 1996, and the London-Paris portion in November 1997. GTS-Monaco
Access operates an international gateway in Monaco in partnership with, and
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utilizing the existing gateway infrastructure of, the Principality of Monaco and
provides transit and routing of international calls to other telecommunications
operators. Through its HER and GTS-Monaco Access ventures, GTS is building a new
network for transporting voice, data and multimedia/image traffic for other
carriers throughout Western and Central Europe and for worldwide international
voice, data and multimedia/image traffic that either originates or terminates
in, or transits through, Western and Central Europe. See " -- Western Europe."
In Central Europe, GTS's objective is to become one of the leading
alternative telecommunications providers in the region. GTS currently provides
private data communications services to government and commercial customers in
Hungary and the Czech Republic. In the Czech Republic, the Company provides
outgoing voice services and operates an international gateway and a data
services network. In Hungary, GTS operates a VSAT network, which GTS believes is
the largest VSAT network in Central Europe as measured by number of VSAT sites.
The Company has also signed an agreement to provide international data services
in Poland, subject to the receipt of necessary governmental approvals. GTS's
strategy is to expand its service offerings as the regulatory environment
permits, leverage its existing VSAT and international gateway infrastructure
where possible and provide a broad range of services to its target markets. See
" -- Central Europe."
Although GTS does not currently own or operate significant
telecommunication assets in Asia, GTS's objective is to become an established
and diversified telecommunications provider in China and India. GTS seeks to
leverage its position in these countries to capitalize on opportunities as they
arise. See "-- Asia."
BUSINESS STRATEGY
GTS seeks to develop businesses to meet the rapidly expanding market demand
for telecommunications services. GTS's goal in emerging markets is to establish
itself as the leading alternative to the incumbent telecommunications service
providers and as a premier provider of value-added services. In addition, the
Company seeks to position itself as the leading independent carriers' carrier
within Western and Central Europe through the development of a pan-European
fiber optic network and an international gateway in Monaco.
GTS believes that it will be able to successfully operate its businesses
and develop business opportunities by pursuing the following strategies:
- Identify and Seize Early Market Opportunities. GTS's primary strategy is
to identify less developed markets in which the incumbent operator offers
inadequate service and where liberalization of telecommunications
regulations may be pending. The Company believes entering these less
developed markets quickly is a key competitive advantage in the global
telecommunications market. GTS leverages its management's knowledge of
the markets in which the Company operates to assess and react quickly
when attractive business opportunities arise.
- Establish Joint Ventures with Experienced Local Partners. GTS seeks to
establish and maintain strategic partnerships and relationships with key
telecommunications operators and service providers in the countries in
which it operates. The Company believes that these relationships increase
its ability to anticipate and respond to changes in the regulatory and
legal environment and assist with license renewal and expansion of its
operating companies.
- Retain Significant Operational Control. In general, GTS actively
participates in the management of its ventures by (i) providing most of
the funding for the ventures' operations, (ii) selecting key members of
the local management team, (iii) developing business plans and marketing
strategies together with local management, (iv) monitoring operating
functions, (v) maintaining close working relationships with local
partners and (vi) integrating its networks and businesses in a manner
which is consistent with the Company's overall strategic objectives.
- Build Infrastructure to Provide High Quality Services. GTS continues to
develop and expand its network infrastructure. The Company believes that
its networks offer service, quality and cost advantages over incumbent
providers as a result of the Company's customer support, network
monitoring, management systems and its ability to integrate and co-market
its service offerings.
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- Leverage Management Depth and Experience. GTS's management has
significant experience in the development and operation of
telecommunications businesses outside the United States. The Company
believes that this experience, together with the Company's extensive
operations, has provided its management with the ability to identify,
evaluate and pursue international telecommunications business
opportunities. Additionally, GTS has assembled a management team
comprised of executives with extensive experience managing
telecommunications companies in the respective local markets. GTS
believes that its management team possesses a broad knowledge of relevant
political and regulatory structures, as well as the cultural awareness
and fluency with international and local business practices necessary to
implement the Company's objectives.
- Ability to Access Capital. In general, the Company's financing strategy
is to establish parent level funding to meet general corporate needs and
the costs of start-ups and acquisitions and, when it is possible and
cost-effective, to finance ongoing operations at the venture level. Since
1993, the Company has raised approximately $268 million in equity and
approximately $215 million of debt (of which approximately $74 million
was raised through shareholders). In addition, HER completed a $265
million private placement of senior notes (of which $56.6 million was
placed in escrow for the first two years' interest payments) in 1997. The
Company's principal investors include affiliates of George Soros and Alan
B. Slifka and certain of his affiliates.
In addition to its overall business strategy, GTS has developed specific
market strategies to achieve its goals in emerging markets and Western Europe.
Emerging Markets. The Company pursues its goals in emerging markets through
a three-stage approach of market entry, market expansion and market integration.
- Market Entry. GTS identifies a market as a suitable target for entry
based upon: (i) superior growth prospects for such market, demonstrated
by growing demand for high quality telecommunications services; (ii) the
provision of inadequate services by incumbent providers, typically
resulting from the incumbents' unwillingness to offer high quality
services with reliable customer support at attractive prices; and (iii)
attractive regulatory environments in which emerging alternative
telecommunications providers such as GTS have, or expect to have over a
clearly defined time horizon, the ability to compete on a substantially
equal basis with the incumbent providers in terms of certain services and
the cost of providing those services. Once GTS has identified a market as
suitable for entry, the Company seeks to establish its presence in that
market by establishing a venture with a strong local partner or partners.
In general, GTS maintains a significant degree of operational control in
such ventures. Through such ventures, the Company benefits from its
partners' ability to provide infrastructure, regulatory expertise and
personnel that will provide GTS with a competitive advantage in entering
that market. When entering a new market, GTS's strategy is to provide its
customers with higher quality service as compared to the services offered
by incumbent providers.
- Market Expansion. Having entered a market successfully and established a
limited service offering to its targeted customer base, GTS then seeks to
expand the range of services it offers to existing and potential
customers and to further develop its relationships with local partners.
By broadening its service offerings, GTS anticipates achieving increased
economies of scale through the common use of administrative and operating
functions already in place, increasing the Company's share of its
customers' telecommunications spending and expanding GTS's base of
potential customers through the provision of a bundled service offering.
The Company also seeks to expand its targeted geographic market by
forming new partnerships, installing infrastructure and offering services
in additional geographic regions, allowing the Company to further enhance
its operating leverage and ability to service its customers'
telecommunications needs.
- Market Integration. GTS ultimately intends to integrate and co-market its
service offerings in each of the markets in which it operates. The
Company believes such integration enables it to enhance its operating
efficiency by leveraging its distribution channels, infrastructure and
networks, and management information systems. As customers develop a need
for a broader variety of telecommunications services, the Company
believes GTS's integrated operations will represent an attractive service
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alternative for customers seeking a single provider with the ability to
meet all their telecommunications needs.
Western Europe. The Company seeks to position itself as the leading
independent carriers' carrier within Western Europe through the development of
HER's pan-European fiber optic network and the operation of GTS-Monaco Access's
international gateway in partnership with, and utilizing the gateway
infrastructure of, the Principality of Monaco. The overall strategy of GTS in
Western Europe is to complement and enhance the services provided by PTOs and
New Entrants in a way that helps them to more successfully meet the needs of
their end-user customers. HER seeks to enter the market ahead of competition and
encourage a wide variety of carriers to use its network with service offerings
that meet their needs. To establish itself as the leading carriers' carrier for
international telecommunications within Europe, HER intends to provide its
customers with significantly higher quality transmission and advanced network
capabilities at a competitive price by utilizing advanced, uniform technology
across the region and providing redundant routing for higher levels of
reliability.
RUSSIA AND THE CIS
OVERVIEW
GTS is a leading provider of a broad range of telecommunications services
in Russia. GTS's services include international long distance services, domestic
long distance services, high speed data transmission and Internet access,
cellular services and local access services. GTS was among the first foreign
telecommunications operators in the CIS, where it began offering data links to
the United States in 1986, international long distance services in 1992, local
access to its networks in 1994 and cellular services in 1995. GTS has developed
these businesses into a leading provider of telecommunications service offerings
in Russia by building its own infrastructure, including a fully digital overlay
network and interconnections with its local Russian telecommunications partners.
The Company believes that evolving changes in government policy over the
last several years and the overall inadequacy of basic telecommunications
services throughout Russia have created a significant opportunity. Before 1990,
all international, domestic long distance and local telecommunications in the
Soviet Union were provided by a monopoly state telecommunications company
managed by the Ministry of Posts and Communications. In 1990, the Council of
Ministers established a joint-stock company called Sovtelecom and transferred to
it all of the telecommunications assets and operations of the Soviet Ministry of
Posts and Communications. Following the dissolution of the Soviet Union in 1991,
the name of the company was changed to Intertelecom. In 1992, the Russian
government decided to split Intertelecom into several components to foster
privatization, competition and investment. The international and long-distance
assets and operations were combined into Rostelecom, creating a monopolistic
service provider. The local telecommunications assets and operations were broken
up into 88 independent regional joint-stock companies, seven of which serve
cities, including the Moscow City Telephone Network and the Petersburg Telephone
Network. Most of the regional companies have a telecommunications trunk operator
and provide a domestic long distance service within their service region.
Domestic long distance calls to and from areas outside the companies' service
area, as well as international calls, are switched to and from Rostelecom, which
forwards the calls to and from another regional company or a foreign carrier for
international calls. Exceptions to this rule include the seven city operators.
In Moscow and St. Petersburg, the trunk operators have been isolated into
separate, long distance companies called Moscow MMT and St. Petersburg MMT. All
domestic long distance and international calls originating from or terminating
in Moscow and St. Petersburg are switched through the MMTs, which forward the
calls to and from Rostelecom.
Following the former Soviet Union's transformation from a centralized
economy to a more market-oriented economy, increased demand from emerging
private businesses and from individuals, together with the poor state of the
public telephone network, has led to rapid growth in the telecommunications
sector in Russia and the CIS. In 1991 the MOC was established as the Russian
successor to the Soviet Ministry of Posts and Communications to regulate and
improve the telecommunications industry and to be the government's
representative for its ownership share of the 88 regional operating companies,
the assets currently held by
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\Svyazinvest (then the monopoly international and domestic long distance service
provider) and national radio, television and satellite operating companies. This
enabled the MOC and operating organizations to begin the privatization process,
attract foreign investment and initiate joint ventures with foreign partners.
Although it remains subject to certain restrictions, significant progress
in privatization of the telecommunications industry in Russia and the CIS has
occurred. Under Russian law, state-owned enterprises within the
telecommunications sector were subject to privatization but only pursuant to a
decision of the Russian government in each individual case and with the state
retaining a certain percentage of the stock of the privatized entity for three
years, subject to extension for national security reasons. At present, virtually
all of the former state telecommunications enterprises have been privatized and,
subject to the above restrictions, shares of the newly formed joint stock
companies have been sold to the public. Also, a significant number of private
operators provide a wide variety of telecommunications services pursuant to
licenses from the MOC to a growing number of customers throughout Russia.
According to the MOC, more than 6,000 licenses have been granted to
telecommunications operators in Russia, a large portion of which is assumed to
represent licenses reissued to the same operators as a result of their
reorganization or obligation to hold such licenses on counterfeit-proof paper.
In October 1994, the President authorized the establishment of Svyazinvest
with the stated purpose of fostering greater efficiency and economies of scale
within the industry through competition. As a wholly government-owned company,
Svyazinvest was granted a controlling stake in approximately 85 regional
telecommunications companies in order to compete in these respective markets.
Svyazinvest was also given control of more than 20 million of the 25.5 million
telephone lines in Russia, except in Moscow and St. Petersburg.
In April 1997, President Yeltsin approved the transfer of the federal
government's 51% stake in Rostelecom, as well as similar stakes in Central
Telegraph (the national PTO), the Ekaterinburg City Telephone Network and
Giprosvyaz (a telecommunications research institute), to Svyazinvest. On July
30, 1997, Mustcom Ltd., a Cyprus-based company that represents the interests of
a consortium which includes ICFI Cyprus, Renaissance International Ltd.,
Deutsche Morgan Grenfell, Morgan Stanley, and an affiliate of George Soros,
purchased a 25% stake in Svyazinvest for $1.87 billion. The President has also
authorized the sale of another 24% of Svyazinvest at a future date. This sale is
scheduled to occur in the first half of 1998 and is currently reserved solely
for Russian investors. The Russian government has announced that it will retain
a controlling 51% interest in Svyazinvest.
The Russian government's interest in Svyazinvest is held by the MOC, which
was reclassified as the State Committee on Telecommunications and Informatics
during a recent government reorganization. The MOC remains the central body of
federal authority in the Russian Federation, having responsibility for state
management of the communications industry and supervisory responsibility for the
condition and development of all types of communications.
Despite the recent changes in the Russian telecommunications industry, the
level of telecommunications service generally available from most public
operators in Moscow remains significantly below that available in cities of
Western Europe and the United States, although in recent years, the Moscow local
telephone infrastructure has benefitted from significant capital investment. By
1995, there were approximately 16 lines per 100 persons in Russia and 45 lines
per 100 persons in Moscow. In comparison, there were 60 and 58 lines per 100
persons in the United States and Western Europe, respectively. In addition, the
quality of services, reflected as the percentage of digital switching in local
telephone networks, currently is approximately 12% in Russia compared to 65% and
66% in the United States and Western Europe, respectively.
Outside Moscow (and to a lesser extent St. Petersburg), most standard
Russian telecommunications equipment is obsolete. For example, many of the
telephone exchanges are electromechanical and most telephones still use pulse
dialing. The Russian population is over 145 million, of which approximately two-
thirds is concentrated in urban areas. The telecommunications market in Russia
currently includes a number of operators that compete in different service
offering segments -- local, inter-city, international, data and cellular
services. In large measure, the relative lack of economic development in the
regions accounts for the lack of improvement in local telecommunications
infrastructure. Although the regions still generally rely on an
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outdated infrastructure inherited from the former Soviet Union, they are
starting to resort to sophisticated sources of finance, such as municipal bond
offerings, in order to upgrade it.
Growth in the Russian telecommunications industry has been principally
driven by businesses in Moscow requiring international and domestic long
distance voice and data services and by consumers using mobile telephony. This
growth has been most significant as multinational corporations have established
a presence in Moscow and Russian businesses have begun to expand. The service
sector, which includes operations in distribution, financial services and
professional services and tends to be the most telecommunications-intensive
service sector of the economy, is growing rapidly in Moscow. Since moving to a
more market-oriented economy, the economic conditions in the outlying regions in
Russia have also generally improved. The telecommunications industry in the
outlying regions has experienced recent growth, principally as a result of
growth in the industrial sector as well as the establishment of satellite
offices in the regions by multinational corporations and growing Russian
businesses. The extent of overall market growth will depend in part on the rate
at which the Russian economy expands, although recent revenue growth in the
sector has been significant (in spite of a declining economy in certain regions)
because of increasing traffic from pre-existing customers and the normalization
of tariffs for business services.
The Company believes it is well-positioned to take advantage of market
growth factors due to (i) its early market entry, (ii) its strong infrastructure
position in Moscow, by far the most important regional market, (iii) the local
market experience of its local partners, (iv) the extent of its existing
customer base and (v) its extensive range of international and domestic
telecommunications services. GTS believes it is the only operator in Russia
currently capable of providing a broad range of service offerings and marketing
them as a single end-to-end service offering for its customers.
STRATEGY
GTS's objective is to become the premier alternative carrier in Russia and
other key growth markets of the CIS. To attain this objective, the Company has
developed and implemented the following strategy:
- Develop Strong Local Partnerships. The Company has and continues to
develop its Russian and CIS business through alliances with experienced
local partners, which to date have been primarily regional telephone
companies and Rostelecom. These ventures combine the management,
financial and marketing expertise of GTS together with its partner's
ability to provide infrastructure and local regulatory experience. GTS
believes that these relationships lend it credibility and increase its
ability to anticipate and respond to the evolving regulatory and legal
environment. GTS maintains a significant degree of managerial and
operational control in its joint ventures through its foundation
documents, which enable GTS to develop them in a manner consistent with
its overall strategic objectives.
- Expand Customer Base. The Company continues to expand its customer base
through the provision of basic telephone and digital services in markets
where such services are not currently provided. Once they have
established a presence in a market, the Company's ventures seek for
opportunities to expand further into neighboring regions and cities.
- Increase Range of Digital Services. As its business customers expand
their operations throughout Russia and the CIS and as their
telecommunications needs become more sophisticated, the Company seeks to
increase its revenues by expanding the range of integrated digital
services offered to its customers.
- Offer High Quality Telecommunications Service and Customer Service. The
Company continues to invest in and build sophisticated high-speed digital
networks and other infrastructure through which customers can gain local
access to the Company's services. In addition to providing advanced, high
quality network infrastructure, the Company emphasizes and offers its
customers a level of customer service which the Company believes cannot
be found elsewhere in the market.
To date, GTS has made substantial progress employing this strategy. The
Company provides digital voice, data and local services in Moscow through its
Sovintel, Sovam and TCM ventures and provides these same services to thirteen
additional Russian cities through its TeleRoss long distance network.
47
<PAGE> 51
OPERATIONS
GTS provides a broad range of telecommunications services in Russia,
including international long distance services, domestic long distance services,
cellular services, high speed data transmission, Internet access and local
access services. These services are supported by operator assistance, itemized
call reporting and billing, and other value-added capabilities that leverage
GTS's investment in advanced switching, data collection and processing
equipment. GTS also provides customized systems integration, including PABXs,
key systems, wiring and interconnectivity. GTS's own infrastructure is
supplemented with dedicated and leased capacity to allow GTS to bypass the
severely congested and poorly maintained local, domestic and long distance
circuits of the Russian carriers.
Whenever practical, GTS's business units integrate and co-market their
service offerings, utilizing TeleRoss as the long distance provider, Sovintel as
the international gateway, TCM and GTS Cellular for local access, and Sovam as
the data communications and Internet access network for business applications
and on-line services. Through this integrated marketing approach, GTS is able to
provide comprehensive telecommunications solutions to multinational corporations
operating throughout Russia and the CIS.
The following table sets forth certain operating data related to the
Company's operating ventures in Russia and the CIS.
<TABLE>
<CAPTION>
AT AND FOR THE YEAR
ENDED DECEMBER 31, AT AND FOR THE NINE
------------------------ MONTHS ENDED
1994(1) 1995 1996 SEPTEMBER 30, 1997
------- ---- ----- --------------------
<S> <C> <C> <C> <C>
Cities In Service................................. 5 24 33 40
Total Voice Minutes (millions)(2)
Inter-city...................................... -- (3) 2.3 15.8 33.8
Local........................................... 0.0 22.1 133.0 174.9
International Outgoing.......................... 7.7(3) 10.5 20.5 31.7
Incoming........................................ 2.0 4.5 33.2 50.9
Total Data Customers (thousands).................. 1.9 2.9 6.2 8.3
Total Cellular Subscribers (thousands)............ 0.0 1.6 9.8 16.3
</TABLE>
- - ---------------
(1) In 1994, the Company's interest in ventures operating in Russia consisted of
a ten-percent interest in Baltic Communications Limited, a one-third
interest in Sovam, and Sovintel, in which the Company owned a 12.5% interest
through May 1994 and a 50% interest thereafter.
(2) Amounts include minutes between Company affiliates.
(3) International and inter-city long distance outgoing minutes not segregated
in 1994.
SOVINTEL
GTS owns 50% of Sovintel, a joint venture with Rostelecom, the national
long distance carrier. Sovintel was founded in 1990 by GTS, Rostelecom and GTE
Spacenet, with GTS acquiring GTE Spacenet's interest in 1994. Sovintel markets a
broad range of high quality telecommunications services by (i) directly
providing international direct dial access to over 170 countries and private
line dedicated voice channels and (ii) leveraging the infrastructure and
services of the other GTS ventures, including TeleRoss, TCM and Sovam. In
addition, Sovintel provides and installs for its customers equipment such as
PABXs, key systems and wiring and provides maintenance and other value-added
services. Sovintel customers, which primarily consist of businesses, hotels and
Moscow-based cellular operators, are able to access these telecommunications
services through Sovintel's fully-digital overlay network in Moscow. In
addition, Sovintel has recently commenced construction of a limited network in
St. Petersburg that is interconnected to Sovintel's Moscow network and is
intended to support Sovintel's Moscow clients which have a presence in St.
Petersburg. Sovintel serviced over 40,500 telephone numbers, or "ports," for
business customers and cellular providers and had over 240 employees as of
September 30, 1997.
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<PAGE> 52
Sovintel has constructed and operates a fully-digital overlay network in
and around Moscow which consists of (i) an approximately 600-kilometer fiber
optic ring, (ii) over 250 PABXs linked to the fiber optic ring, (iii) a
fully-digital microwave network, (iv) a wireless local loop and (v) an
international gateway connected to the fiber optic ring. In addition, Sovintel
leases dedicated international long distance channels. Customers are connected
to the Sovintel network via last mile connections to over 250 PABXs that provide
"points-of-presence" in and around Moscow. The PABXs are connected to the
network through a direct fiber connection or a digital microwave network. Some
of Sovintel's new customers are temporarily connected to the network through a
wireless local loop. The wireless local loop provides a significant competitive
advantage because it allows Sovintel to connect customers to its network more
quickly than alternative methods. As these customers are provided permanent
connections to Sovintel's network through direct connections to the PABXs,
additional customers are rolled onto the wireless local loop.
[GTS SOVINTEL MOSCOW NETWORK]
After a customer is connected to the Sovintel network, local telephone
services are provided through the Sovintel fiber optic ring's interconnection
with the switches of either TCM or MTU Inform. These switches provide access to
local telephone service in Moscow through interconnections with the Moscow city
telephone network ("MGTS") and the principal Moscow cellular providers. Sovintel
provides its customers access to domestic long distance service through the
TeleRoss long distance network, or through Rostelecom's network in cities not
currently served by TeleRoss. International service is provided primarily
through the Sovintel international gateway, which transmits international
traffic via dedicated international leased long distance channels. Sovintel's
customers also can receive high speed data services through Sovintel's
interconnection with the Sovam data network. Accordingly, from a customer's
perspective, Sovintel offers a broad range of telecommunication services.
49
<PAGE> 53
The following table sets forth certain operating data related to Sovintel's
operations:
<TABLE>
<CAPTION>
AT AND FOR THE
NINE MONTHS
AT AND FOR THE YEAR ENDED DECEMBER 31, ENDED
-------------------------------------- SEPTEMBER 30,
1994 1995 1996 1997
-------- --------- --------- --------------
<S> <C> <C> <C> <C>
MINUTES OF USE(1)
International Minutes
Number of Minutes.................. 7,681(2) 10,516 20,839 30,628
Average Rate Per Minute............ $ 2.35 $ 2.06 $ 1.55 $ 1.19
Domestic Long Distance Minutes
Number of Minutes.................. --(2) 2,047 10,098 16,946
Average Rate Per Minute............ -- $ 0.86 $ 0.65 $ 0.55
Moscow (Local) Fixed Line Minutes
Number of Minutes.................. -- -- -- 2,302
Average Rate Per Minute............ -- -- -- $ 0.06
Moscow (Local) Cellular Minutes
Number of Minutes.................. -- 21,478 83,673 82,333
Average Rate Per Minute............ -- $ 0.06 $ 0.08 $ 0.08
Incoming Minutes
Number of Minutes.................. 1,967 3,839 24,306 34,571
Average Rate Per Minutes........... $ 0.76 $ 0.58 $ 0.28 $ 0.29
PORTS
Number of Ports (cumulative).......... -- 6,079 29,646 40,563
NUMBER OF PRIVATE LINE CHANNELS
International......................... 1 26 89 162
Inter- and Intra-City................. 1 26 103 184
APPROXIMATE EQUIPMENT SALES
(THOUSANDS)........................... $1,100 $ 1,400 $ 2,200 $ 2,500
</TABLE>
- - ---------------
(1) Minutes in thousands. Amounts include minutes among affiliates.
(2) International and domestic long distance outgoing minutes not segregated in
1994.
Services. Sovintel markets a broad range of high quality telecommunications
services by (i) directly providing international direct dial access to over 170
countries and private line dedicated voice services and (ii) by leveraging the
infrastructure and services of the other GTS ventures. Sovintel's services
include:
- Switched International, Domestic Long Distance and Local
Services. Customers are provided switched international long distance
services directly through Sovintel's international gateway in Moscow and
its leased long distance channels. Domestic long distance services are
marketed by Sovintel and provided either through the TeleRoss long
distance network or, where the call destination is not served by
TeleRoss, through Rostelecom's network. Local call service is provided by
Sovintel indirectly as a result of its interconnection, through TCM or
MTU Inform, with the Moscow city telephone network. Based on its
familiarity with the market, the Company believes that Sovintel's
services are distinguished by a higher level of quality than those of its
competitors, particularly with respect to call completion rates for its
domestic long distance and local call services. In addition, the Company
trains its employees to provide customer service at a level which is
comparable to that provided by Western telecommunications companies. As a
result, the Company believes that customers choose Sovintel over its
competitors because it has earned a reputation for providing high quality
telecommunications services through an experienced and professional
customer service staff.
- Private Line Channels. Private line channels, which are provided over
dedicated leased lines, are principally utilized by customers with
high-volume data traffic needs, such as Sovam and large data providers.
Private line customers have access to intra-city service in Moscow
through Sovintel's fiber optic ring and to inter-city service between
Moscow and St. Petersburg via fiber leased by Sovintel, in
50
<PAGE> 54
each case benefitting from Sovintel's high quality infrastructure.
Private line domestic long distance service is provided through TeleRoss
and, for cities not served by TeleRoss, through Rostelecom. International
private line service is provided through dedicated leased fiber channels
from Rostelecom.
- Equipment Sales, Installation Services and Project Planning and
Management Services. In providing the above services to its customers,
Sovintel installs and maintains equipment on its customers' premises,
including PABXs, key systems and wiring. Sovintel also provides project
planning and management services, including system design and management,
to its customers.
- World Access Service. Customers are able to access Sovintel's
international long distance services through the World Access Card, which
provides customers either direct or calling-card-based portable access to
domestic and international long distance service. The calling card can be
used in 15 Russian cities, including Moscow and St. Petersburg, and 23
countries.
Sovintel complements its service offerings by providing a wide range of
value-added services including operator assistance, maintenance and customer
support and itemized call reporting and billing.
Customers and Pricing. Sovintel's customers consist primarily of
high-volume business and professional customers, such as IBM, Credit Suisse
Group and Reuters, other multinational corporations and Russian enterprises, a
number of premium Moscow hotels and other telecommunications carriers. In
addition, Sovintel is one of the primary providers of domestic and international
long distance service for the major cellular service providers in Moscow,
including VimpelCom, MTS and Moscow Cellular. Sovintel's customers typically
demand a higher level of service than generally available in the market.
Sovintel further provides to its large corporate customers data services such as
frame relay and Internet access contracted from Sovam in order to offer
"one-stop shopping" telecommunications solution to these customers, who
increasingly require this type of service.
The pricing structure for international and domestic long distance calls is
based upon traffic volume and overall market rates, with Sovintel's rates
varying depending on the time and destination of the call. Local calls, other
than calls placed to cellular phones, are completed without charge. Sovintel
expects to continue its practice of not charging to complete local calls unless
and until the MGTS begins to charge for completion of such calls. Sovintel
prices its international long distance services slightly below those of its
principal competitors, and has recently reduced its rates in anticipation of
increased competitive pricing pressures. Sovintel's average revenue per minute
for outgoing international long distance calls has declined from approximately
$2.35 per minute for the year ended December 31, 1994 to approximately $1.19 per
minute for the nine months ended September 30, 1997. Sovintel expects increased
pricing pressure from competitors over time. Sovintel prices domestic long
distance services in line with those of its principal competitors. Prices for
domestic long distance services have increased significantly over the last
several years, although such prices stabilized in the second half of 1996.
Sovintel's private line services are priced competitively. Sovintel provides
private line channels by releasing lines it leases from Rostelecom. The lines
are leased by Sovintel from Rostelecom at wholesale rates and leased by Sovintel
to its customers at prices in line with Rostelecom's retail rate.
Customers are billed monthly with larger-volume customers receiving
discounts of up to 25%. Customers using international services, domestic long
distance or data services are billed in U.S. dollars. To the extent permitted by
law, payment is made either in U.S. dollars or in rubles at the ruble/dollar
exchange rate at the time of payment, plus a conversion charge in order to
minimize the impact of currency fluctuations. Sovintel currently bills on an
invoicing system that was internally developed. Currently, the system is
adequate for Sovintel's present customer base; however, the Company is
evaluating alternatives for upgrading the system in anticipation of future
growth.
Sales and Marketing. Sovintel's sales and marketing strategy targets large
multinational and Russian businesses both directly and through contacts with
real estate developers and business center managers in the greater Moscow area.
These developers and managers typically determine which telecommunications
service provider will service their respective properties. By identifying and
building relationships with these developers and managers at an early stage
(typically up to one year prior to the completion of a new building project),
51
<PAGE> 55
Sovintel seeks to enhance the likelihood of winning the service contract. In
addition to its traditional target market, Sovintel has recently begun to market
its services to smaller businesses. Sovintel utilizes a departmentalized sales
force in order to focus its sale efforts on the different segments within its
target market. The sales force is comprised of 40 sales personnel, including 15
account managers, all of whom specialize in serving specific targeted
industries. Dedicated marketing and customer support personnel provide technical
support, customer service, training, market monitoring and promotional functions
for Sovintel. Sovintel's sales and marketing personnel are paid through a
combination of salary, commissions and incentive bonuses.
Ownership and Control. Sovintel is a joint venture between a wholly owned
entity of GTS and Rostelecom with each having a 50% ownership interest. Under
Sovintel's charter, GTS and Rostelecom each have the right to appoint three of
the six members of Sovintel's managing board. Rostelecom has the right to
nominate the Director General (the highest ranking executive officer at
Sovintel), while GTS has the right to nominate the First Deputy Director General
(the next-highest ranking executive officer at Sovintel). In practice, the
Director General and the First Deputy Director General together perform the role
of a chief executive officer. Certain business decisions, including the adoption
of Sovintel's annual budget and business plan as well as the distribution of
profits and losses require the approval of both GTS and Rostelecom. Neither GTS
nor Rostelecom are obligated to fund Sovintel's operations or capital
expenditures. Losses and profits of Sovintel are allocated to the partners in
accordance with their ownership percentages, in consideration of funds at risk.
As of September 30, 1997, GTS and Rostelecom have each made equity contributions
of $1.0 million to Sovintel. In addition, Sovintel had outstanding loans of $9.0
million to GTS as of September 30, 1997. See "Management's Discussion and
Analysis -- Accounting Methodology -- Profit and Loss Accounting." The Sovintel
joint venture agreement does not have an expiration date. See "Risk
Factors -- Dependence on Certain Local Parties; Absence of Control."
TCM
GTS beneficially owns approximately 50% of TCM, a joint venture founded in
1994 that provides a licensed numbering plan and interconnection to the Moscow
city telephone network for carriers needing basic local access service in
Moscow. GTS's partners in TCM are MTU-Inform and a group of entrepreneurs with
extensive telecommunications experience. TCM is currently licensed to provide
100,000 numbers in Moscow, of which approximately 44,000 have been leased. TCM
has contracted with MGTS to construct up to an additional 100,000 numbers in
several stages over the next five years, and currently plans to construct 10,000
numbers in each of 2000, 2001 and 2002. Any such construction, however, is
subject to TCM obtaining a license covering the additional numbers and the
availability of such numbers in the portion of the MGTS numbering plan in which
TCM plans to construct such numbers. TCM's switching facilities are fully
integrated with the networks of Rostelecom, Sovintel, and MGTS, allowing it to
provide high quality digital service to its customers.
Services. TCM acts as a local gateway by providing numbers and ports to
carriers in Moscow, including Sovintel, VimpelCom, MTS and Moscow Cellular, and
thus providing interconnectivity to the Moscow city telephone network. Access to
the Moscow city telephone network provides customers with the higher quality and
broader range of services available in Moscow, such as the services provided by
Sovintel. Access from outlying regions is typically obtained through a domestic
long distance service provider such as TeleRoss. See "-- Sovintel" and
"-- TeleRoss."
Customers and Pricing. TCM provides its services on the wholesale level to
primary carriers. VimpelCom is TCM's primary customer and accounts for
substantially all of TCM's revenues, hence the loss of VimpelCom as a customer
would have a material adverse effect on the Company. TCM also provides ports to
Sovintel and to other network operators including MTS and Moscow Cellular. TCM's
ports are leased principally to carriers in Moscow. Although local access
services are priced upon the basis of supply and demand factors in the local
market, in general, for each port cellular operators pay an approximately $300
installation fee and a $16 flat monthly fee plus a per minute charge for traffic
while other carriers pay a larger initial fee of approximately $500 and a
monthly fee of approximately $25. Local access services are typically provided
pursuant to five-year contracts that may be renewed upon expiration for
additional one-year periods. TCM has entered into an agreement with Sovintel
pursuant to which billing and collecting functions
52
<PAGE> 56
for TCM-Sovintel joint customers are performed by Sovintel, with Sovintel
remitting such amounts (less applicable settlement charges and administrative
costs) to TCM. The rapid growth of cellular services in markets like Moscow has
placed a premium on new numbers, which has translated into attractive prices for
these numbers. TCM, however, believes these prices will decline over time.
Ownership and Control. GTS's indirect interest in TCM is represented by its
approximately 52% interest in a holding company, which owns 95% of TCM. This
structure provides GTS with 50% beneficial ownership interest in TCM. Decisions
of the holding company regarding TCM require unanimous board approval and
neither GTS nor its partner in the holding company is obligated to fund
operations or capital expenditures of the holding company. In addition, neither
the holding company nor the TCM shareholders are obligated to fund operations or
capital expenditures of TCM. At both the holding company and TCM level, losses
and profits are allocated to the partners in accordance with their ownership
percentages, in consideration of funds at risk. GTS acquired its indirect, 50%
beneficial interest in TCM for approximately $700,000 and certain additional
consideration. As of September 30, 1997, GTS had no outstanding loans relating
to TCM. See "Management's Discussion and Analysis -- Accounting
Methodology -- Profit and Loss Accounting." None of the operative charters and
agreements relating to the holding company or TCM have expiration dates. See
"Risk Factors -- Dependence on Certain Local Parties; Absence of Control."
TELEROSS
TeleRoss, which began operations in 1995, consists of (i) two wholly owned
holding companies and a 99% owned subsidiary of GTS that operates a domestic
long distance network (collectively, the "TeleRoss Operating Company") and (ii)
thirteen joint ventures that are 50% beneficially-owned by GTS that originate
traffic and provide local termination of calls (the "TeleRoss Ventures" and,
together with TeleRoss Operating Company, "TeleRoss"). The TeleRoss domestic
long distance network serves fourteen major Russian cities, including Moscow
and, through VSAT technology, 19 customers located outside these cities.
TeleRoss provides digital domestic long distance services and other value-added
services through its own infrastructure as well as access to Sovintel's
international gateway services and access to the Moscow city telephone network
through TCM's switching facilities. Sovam uses the TeleRoss digital channels to
provide regional data service and has co-located its access facilities with
TeleRoss. As of September 30, 1997, TeleRoss employed approximately 188 persons
of which approximately 90 people were based in Moscow and approximately 98
people were deployed in the regions in which TeleRoss operates.
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<PAGE> 57
TeleRoss's licenses cover the city of Moscow and a total of 39 regions
throughout Russia. Most of the thirteen cities in which TeleRoss primarily
operates are regional capitals, with an aggregate population of approximately
11.5 million. TeleRoss's licenses cover the entire oblast surrounding these
cities, with populations totalling approximately 38.1 million persons, and GTS
intends eventually to extend the reach of the TeleRoss network beyond the
regional capitals to the surrounding areas. The cities in which TeleRoss
currently offers its services are:
<TABLE>
<CAPTION>
1995 POPULATION
---------------------------------------
(IN MILLIONS)
URBAN
CITY(4) CITY(1) OBLAST(2) TOTAL OBLAST(3)
------- ------- --------- ---------------
<S> <C> <C> <C>
Arkhangelsk....................................... 0.6 1.2 1.6
Ekaterinburg...................................... 1.4 4.1 4.7
Irkutsk........................................... 0.6 2.3 2.9
Khabarovsk........................................ 0.6 1.5 1.9
Krasnodar......................................... 0.6 2.6 4.8
Nizhni Novgorod................................... 1.4 2.9 3.7
Novosibirsk....................................... 1.4 2.1 2.8
Syktyvkar......................................... 0.3 0.9 1.3
Tyumen............................................ 0.5 2.4 3.1
Ufa............................................... 1.0 2.6 4.0
Vladivostok....................................... 1.2 1.8 2.2
Volgograd......................................... 0.9 2.0 2.6
Voronezh.......................................... 1.0 1.5 2.5
---- ---- ----
Total................................... 11.5 27.9 38.1
---- ---- ----
</TABLE>
- - ---------------
(1) This column reflects the population residing in cities. Source: GTS estimate
(2) This column reflects the urban population in oblast. Source: Rusline
(3) This column reflects the total population residing in the oblast, including
rural population. Source: Rusline
(4) TeleRoss plans to expand to the city of Samara in February, 1998. The 1995
city population, urban oblast population and total oblast population for
Samara was 1.2 million, 2.7 million and 3.3 million, respectively.
The TeleRoss network architecture involves local city switches connected to
remote earth stations which communicate via satellite to a Moscow-based hub.
This hub consists of the network control center, earth station equipment,
multiplexing equipment and a switch. The earth stations, hub and related
equipment are owned by TeleRoss, which gives TeleRoss the flexibility to
redeploy network assets to other locations as necessary. The hub interconnects
to Sovintel's network providing access to Sovam's data networks, TCM's switching
facilities and Sovintel's international gateway, which transports international
traffic via dedicated international leased satellites and fiber channels and
provides access to Rostelecom's long distance networks. Outside of Moscow,
TeleRoss's local joint venture partners provide interconnection to the local
public telephone networks in each of the cities it serves. In addition to
providing services through its network, TeleRoss currently serves 19 customers
in 18 additional cities through VSAT technology which links the customers via
satellite to the Moscow hub.
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<PAGE> 58
The following table sets forth certain operating data related to TeleRoss's
operations:
<TABLE>
<CAPTION>
AT AND FOR
AT AND FOR THE NINE
THE YEAR MONTHS
ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
<S> <C> <C>
MINUTES OF USE(1)
Domestic Minutes (thousands).............................. 3,478 14,440
Average Rate Per Domestic Minute.......................... $ 0.99 $ 0.66
International Minutes (thousands)......................... 189 486
Average Rate Per International Minute..................... $ 2.76 $ 2.56
NUMBER OF CITIES SERVED..................................... 13 14
WORLD CONNECT DIAL/RUSSIA
Number of Connect Dial Ports.............................. 472 961
Average Revenue Per Port Per Month........................ $ 767 $ 378
MOSCOW CONNECT
Number of Ports........................................... 49 56
Average Revenue Per Port Per Month........................ $1,165 $ 1,513
DEDICATED CIRCUITS
Number of Dedicated Channels.............................. 33 43
Average Price Per Channel................................. $4,553 $ 4,264
WORLD ACCESS SERVICE
Number of World Access Card Users......................... 3,929 4,360
Average Revenue Per Card Per Month........................ $ 52 $ 45
VSAT SERVICES
Number of VSATs........................................... 12 20
</TABLE>
- - ---------------
(1) Includes minutes among affiliates.
Services. Through its network and VSAT offerings, TeleRoss offers the
following services:
- Carriers' Carrier Services. TeleRoss provides services as a "carriers'
carrier," providing domestic long distance carrier services to cellular
operators, Sovintel, the TeleRoss Ventures' regional partners and
competitive bypass operators from the cities in which the TeleRoss
Ventures operate, and to customers in remote cities using VSAT stations.
These services are provided to and from Moscow, and are provided by
TeleRoss at wholesale rates competitive with those offered by Rostelecom.
TeleRoss also provides private line channels to Sovam in cities where the
TeleRoss Ventures operate. In addition, TeleRoss has recently received a
license to provide international private line service.
- World Connect Dial/Russia Connect Dial. Customers in TeleRoss's cities
are provided dedicated local access to the regional TeleRoss switch
through lines leased from the TeleRoss Venture's regional joint venture
partner. These customers then have access to the domestic long distance
service provided by TeleRoss, international long distance service provided
by Sovintel and are fully integrated into the local phone networks
operated by the applicable TeleRoss Venture's partner and to the Moscow
city telephone network through TCM.
- Moscow Connect. Customers are provided with dedicated last mile
connection over lines leased from the regional joint venture partner
which lines are connected to a local TeleRoss switch. The TeleRoss
network and its interconnection to TCM provide customers with a Moscow
dial tone which allows users in remote locations better access to
Moscow's advanced telecommunications infrastructure. In addition, Moscow
Connect service provides better call quality at lower rates for domestic
and international long distance. Moscow Connect also facilitates
communications between users and their
55
<PAGE> 59
Moscow-based associates as calls can be made to and from Moscow without
the use of prefixes and without long distance charges accruing to the
Moscow-based parties.
- Dedicated Circuits. Customers are provided with point-to-point clear
channel circuits within Russia and internationally through the TeleRoss
backbone and its interconnection with Sovintel's international gateway in
Moscow. Dedicated circuits are generally used by news services, banks and
other commercial customers who require high capacity and high quality
service. This service can be used for voice or data, depending on the
user's needs. In providing dedicated circuits, TeleRoss competes against
other alternative communications providers, however, TeleRoss believes
that it has a distinct price advantage over its competitors because of
the use of its own infrastructure and the bulk purchase of satellite
capacity.
- World Access Service. TeleRoss and Sovintel co-market World Access
Service to their customers in each of the cities they serve through two
products: World Access Direct and World Access Card. Through World Access
Direct, TeleRoss customers can access domestic long distance and
international service anywhere within the customer's city through the
local telephone network. The World Access Card is a calling card which
allows TeleRoss customers portable access to domestic long distance and
international service from 15 Russian cities, including Moscow and St.
Petersburg, and 23 countries. This service is provided through Sovintel's
infrastructure.
- VSAT Services. For customers that are located outside the cities serviced
by TeleRoss or that cannot be physically linked to TeleRoss's regional
switches, TeleRoss offers VSAT service which connects these customers
directly to TeleRoss's Moscow-based hub through a VSAT antenna installed
at the customer's location. Both dedicated and switched services are
provided through these VSAT arrangements.
In addition to continuing the development of its core domestic long
distance business, TeleRoss's strategy includes the development of local access
networks to capitalize on demand for local phone service and to capture
additional customers for its long distance and value-added service offerings.
Outside Moscow, TeleRoss has primarily pursued a strategy whereby it develops
its own intra-city trunking network with copper based or fiber optic facilities
leased from the regional joint venture partners. As of September 30, 1997,
TeleRoss, in conjunction with regional joint venture partners, has installed
approximately 25 kilometers of fiber optic cable in 3 cities and plans to
install an aggregate of approximately 100 kilometers of additional fiber optic
cable in up to an additional 6 cities over the next 24 to 30 months. Customers
who obtain local phone numbers from TeleRoss's venture partners are directly
interconnected to the local telephone company and to the Company's long distance
network and Sovintel's international gateway and may obtain a broad range of
value-added services offered by the Company.
Customers and Pricing. TeleRoss's customers include businesses and other
telecommunications service providers such as carriers, PTOs, cellular operators,
Sovintel and Sovam. TeleRoss's business customers consist of large multinational
and Russian businesses in each of the regions it services, as well as medium and
small-sized businesses. Between 1993 and mid-1996, consumer prices in TeleRoss's
industry increased significantly as a result of Rostelecom raising its prices in
an effort to raise capital for investment and development of its network
infrastructure, although prices have stabilized over the past six months. In the
first nine months of 1997, TeleRoss increased sales to carriers, which sales
were made at wholesale rates, resulting in a decrease in the average rate per
minute for TeleRoss. TeleRoss strategically prices its domestic long distance
services at a slight premium over similar services offered by Rostelecom to
account for a higher quality of service, but in line with the prices offered by
regional competitors.
Sales and Marketing. TeleRoss markets its services to carriers and
businesses through direct sales channels. As of September 30, 1997, TeleRoss
employed 27 sales and marketing personnel, approximately half of which are based
in Moscow with the other half deployed regionally to identify and contact
prospective customers. The Moscow-based sales and marketing personnel are
organized into industry groups in order to better identify and serve customer
needs. Each region is typically served by one or two sales representatives.
TeleRoss's sales efforts are supported by market research and promotional
activities carried out at the joint venture level and tailored to the specific
market base of each region. TeleRoss's marketing strategy is to attract
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carrier customers by focusing on those carriers with high volume minutes
operating in regions where TeleRoss has a competitive advantage. Through
cross-marketing agreements with Sovintel and Sovam, TeleRoss markets many of the
other service offerings of GTS's Russian businesses to customers throughout its
service regions. Billing functions and the monitoring of quality control and
technical issues are performed centrally through the Moscow-based hub.
Ownership and Control. TeleRoss consists of the TeleRoss Operating Company,
and the 50% beneficially owned TeleRoss Ventures. GTS controls TeleRoss
Operating Company (which holds the network license) and co-manages the TeleRoss
Ventures under the terms of the applicable TeleRoss Ventures' foundation
agreements and charters. Under some of these charters, GTS generally has the
right to designate the Chairman of the board of directors, and GTS's local
partner has the right to designate the Deputy Chairman, for the first two-year
term (and thereafter GTS and the local partner nominate the Chairman and Deputy
Chairman for approval by the entire board on a rotating basis). The foundation
agreements and charters do not have expiration dates. While GTS has significant
influence within these ventures, decisions, including the decision to declare
and pay dividends, are generally subject to GTS's partner's approval. See "Risk
Factors -- Dependence on Certain Local Parties; Absence of Control." Neither GTS
nor its respective joint venture partners are obligated to fund operations or
capital expenditures of the TeleRoss Ventures. Losses and profits are allocated
to the partners in accordance with their ownership percentages, in consideration
of funds at risk. As of September 30, 1997, GTS and its partners had each made
equity contributions aggregating $1.7 million to the various TeleRoss Ventures.
Contributions made by the partners include contributions of cash and intangible
assets, such as licenses. In addition, the various TeleRoss Ventures had
outstanding loans of $3.3 million to GTS as of September 30, 1997. See
"Management's Discussion and Analysis -- Accounting Methodology -- Profit and
Loss Accounting."
SOVAM
Sovam is a venture owned 66.7% by GTS and 33.3% by the Institute for
Automated Systems ("IAS"). Sovam was founded in 1990 as a venture equally owned
by GTS and IAS. In 1992, Cable & Wireless acquired a 33% ownership interest in
Sovam, which interest was subsequently acquired by GTS in 1994, bringing GTS's
ownership interest to its current 66.7%. GTS has entered into an agreement to
purchase IAS's interest in Sovam and expects to close the transaction in
February 1998, thereby making Sovam a wholly owned subsidiary of GTS. Sovam
provides high-speed data communications services, electronic mail and database
access over a high-speed packet/frame relay network in 30 major Russian and CIS
cities. Sovam also offers Russia On Line, the first Russian language Internet
service, which provides direct access to the Internet as well as access to a
wide range of local and international information services and databases. As of
September 30, 1997, Sovam had approximately 1,667 data service customers and
approximately 3,272 Russia On Line customers. Sovam employed over 100 persons in
Moscow and other regions of the CIS as of September 30, 1997. Sovam provides
equipment and maintains marketing and technical support personnel at each
location either through its own infrastructure or through the infrastructure of
TeleRoss.
In addition to serving the Moscow and St. Petersburg markets, Sovam
co-locates its operations with the TeleRoss Ventures, offering its services in
all TeleRoss cities, and also serves 15 additional cities in Russia and the CIS.
Sovam operates under its own license within Russia while services elsewhere in
the CIS are provided through applicable joint venture or local partner licenses.
The local partners of the TeleRoss Ventures provide facilities, assist in the
provision of leased lines to Sovam customers that allow them to connect with
Sovam's local data switches and also provide technical support. Sovam utilizes
Sovintel's international capabilities and, in TeleRoss-served locations,
TeleRoss's satellite overlay network, to take data through its local data
switches and over the leased lines to its customers. Customers may obtain
virtual private data networks without investing in, acquiring, installing and
maintaining their own network nodes and switches.
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The following table sets forth certain operating data related to Sovam's
operations:
<TABLE>
<CAPTION>
AT AND FOR THE
AT AND FOR THE YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED
--------------------------- SEPTEMBER 30,
1994 1995 1996 1997
------- ------- ------- ----------------
<S> <C> <C> <C> <C>
BASIC DATA SERVICE
Percentage of Total Sovam Revenue..... 96% 91% 79% 80%
Number of Customers................... 1,335 1,587 1,726 1,667
Average Revenue Per Month Per
Customer........................... $ 180 $ 201 $ 446 $ 675
Number of Cities in Service........... 2 11 25 30
EQUIPMENT AND HARDWARE SALES
Percentage of Total Sovam Revenue..... 4% 8% 14% 10%
RUSSIA ON LINE SERVICE
Percentage of Total Sovam Revenue..... -- 1% 7% 10%
Number of Subscribers(1).............. -- 407 1,854 2,606
Average Revenue Per Month Per
Subscriber......................... -- $ 49 $ 52 $ 67
</TABLE>
- - ---------------
(1) In addition to the subscribers included above, Sovam frequently connects
potential Russia On Line subscribers on a complimentary one-month trial
basis. As of September 30, 1997, there were approximately 600 such potential
subscribers.
Services. Sovam's service offerings are comprised of data services,
equipment and hardware sales and its Russia On Line services.
- Data Services. Sovam provided high speed connectivity, electronic mail,
database access and fax services to approximately 1,667 customers as of
September 30, 1997, in Russia and the CIS. Sovam customers can use
electronic mail systems to send and receive messages and data and to
access public and private data networks (including the Internet)
worldwide. Customers may obtain virtual private data networks without
investing in, acquiring, installing and maintaining their own network
nodes and switches. In addition, Sovam offers its customers value-added
data services. For example, Sovam offers "one-stop shopping" for
hardware, software, installation and maintenance support and products
such as "SovamMail," an e-mail service which allows customers to use
Sovam's data network to send telex or facsimile messages to overseas
recipients worldwide. Data services are currently available in 30 cities
throughout Russia and the CIS, including Moscow, St. Petersburg, each of
the cities served by TeleRoss and some cities outside of the TeleRoss
network.
- Equipment and Hardware Sales. Sovam sells communications equipment and
hardware, and provides related installation, maintenance and support
functions, to its customers. Sovam's primary customers in the equipment
and hardware market are banking clients who use the equipment to
interface with Sovam's network.
- Russia On Line. Russia On Line is the first Russian language, as well as
the first dual language, graphical user interface online service for
accessing domestic and international information sources designed to
appeal to a wide commercial audience. This service, which is distributed
via GTS's domestic long distance infrastructure, provides customers with
access to international databases (including the Internet), as well as an
array of proprietary Russian and English language information services,
such as news stories and market updates. Sovam had 2,606 Russia On Line
subscribers as of September 30, 1997. Sovam has developed a modified
version of Netscape's Internet browser, which utilizes the Cyrillic
alphabet, as part of its Russia On Line package. Sovam's enhanced Russian
version of Netscape's browser is provided by Sovam to its customers under
a distribution agreement with Netscape. In addition, Sovam has signed a
letter of intent with Microsoft whereby Microsoft has agreed to include
software access to Russia On Line in its Russian version of Windows 97,
which had not been released as of September 1997. Sovam has also entered
into agreements with equipment
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manufacturers, including Dell, Hewlett-Packard and U.S. Robotics, to
include Russia On Line software with their products.
Customers and Pricing. Sovam's data communications customers consist
primarily of banking and financial services organizations and large
multinational companies, while Sovam's Russia On Line customers consist of a
wide variety of commercial enterprises. Sovam charges customers an installation
fee when service is commenced and a charge for any equipment which is installed.
Thereafter, customers are billed on a monthly basis for leased line fees, port
access charges and charges for data and Russia On Line services rendered during
the month. Data services are priced on a two-tier structure with high volume
users generally negotiating a flat-rate fee and lower volume uses paying a
volume-based fee which on average was $446 and $675 per subscriber in 1996 and
for the nine months ended September 30, 1997, respectively. Russia On Line
customers pay a fixed monthly access charge plus an additional volume-based fee.
Customers are billed in dollars and payment is remitted in rubles and, to the
extent permitted by law, in dollars, with a 5% conversion fee added to
ruble-denominated payments.
Sales and Marketing. Sovam employs a dedicated sales and marketing force
comprised of 23 Russian nationals, 18 of which are based in Moscow with the
remainder deployed in the other Russian and CIS regions. Salespersons are paid a
fixed salary supplemented by sales commissions and performance-based bonuses.
Sovam's sale efforts are focused primarily on the banking and financial
communities and large multinational companies, although small and medium sized
entities are also emerging as potential Sovam customers. Bundled service
packages, which include Sovam's data and Internet service, Sovintel's
international service and TeleRoss's long distance service, are frequently
marketed together in order to offer customers a comprehensive telecommunications
solution. In addition to data communications services, Sovam offers its
customers hardware, installation and maintenance service and is a distributor of
Northern Telecom equipment.
Ownership and Control. GTS owns 66.7% of Sovam and IAS owns the remaining
33.3%. GTS has entered into an agreement to purchase IAS's interest in Sovam and
expects to close the transaction in February 1998, thereby making Sovam a wholly
owned subsidiary of GTS. The Sovam managing board is comprised of three GTS
representatives and two IAS representatives. Decisions of the managing board are
adopted by a majority vote. Changes to the charter and certain business
decisions, including decisions on distribution of profits and losses, obtaining
loans and approving major transactions, require unanimous approval. See "Risk
Factors -- Dependence on Certain Local Parties; Absence of Control." The Sovam
charter does not have an expiration date. Neither GTS nor IAS are obligated to
fund Sovam's operations or capital expenditures. Losses and profits of Sovam are
allocated to the partners in accordance with their ownership percentages, in
consideration of funds at risk. As of September 30, 1997, GTS and its partner
had made equity contributions of $1.3 million and $0.7 million, respectively, to
Sovam. In addition, Sovam had outstanding loans of $10.4 million to GTS as of
September 30, 1997. See "Management's Discussion and Analysis -- Accounting
Methodology -- Profit and Loss Accounting."
GTS CELLULAR
GTS Cellular operates three cellular businesses in Russia and Ukraine. In
Russia, GTS has a wholly owned subsidiary Vostok Mobile, which operates eleven
AMPS cellular companies in Russian regions west of the Urals under the trade
name Unicel. Vostok Mobile owns between 50% and 70% of these cellular joint
ventures (the "Unicel Ventures") in Russia. In addition, GTS intends to enter
into the cellular markets of additional Russian regions through its Vostok
Mobile venture. GTS also participates in PrimTelefone, a 50% owned joint venture
that operates an NMT-450 network in Vladivostok and four other cities in the
Primorsky region of Russia. In Ukraine, GTS has an approximately 25% beneficial
interest in Bancomsvyaz which operates a DCS-1800 cellular network in Kiev, and
an international overlay network in Ukraine. GTS Cellular entities possess
licenses covering major Russian and Ukrainian markets (excluding Moscow and St.
Petersburg) with an aggregate 1995 population of approximately 25 million
people.
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GTS currently offers cellular services in the following regions as of
September 30, 1997:
<TABLE>
<CAPTION>
URBAN
GTS'S POPULATION TOTAL
OPERATING ECONOMIC CITY IN OBLAST NUMBER OF
COMPANY INTEREST(1)(4) CITY POPULATION(3) OBLAST(2) POPULATION(2) SUBSCRIBERS
--------- -------------- ---- ------------- ---------- ------------- -----------
(MILLIONS) (MILLIONS) (MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
RUSSIA
Vostok Mobile(4)
Arkhangelsk Mobile
Networks................ 50.0% Arkhangelsk 0.6 1.2 1.6 499
Astrakhan Mobile.......... 50.0% Astrakhan 0.6 0.7 1.0 1,116
Chuvashi Mobile........... 70.0% Cheboksary 0.5 0.8 1.4 1,052
Lipetsk Mobile............ 70.0% Lipetsk 0.5 0.8 1.2 1,237
Murmanskaya Mobilnaya
Set..................... 50.0% Murmansk 0.6 1.1 1.8 1,170
Penza Mobile.............. 60.0% Penza 0.6 1.0 1.5 603
Saratov Mobile............ 50.0% Saratov 0.2 2.0 2.7 1,599
Parma Mobile.............. 50.0% Syktyvkar 0.3 0.9 1.3 360
Volgograd Mobile.......... 50.0% Volgograd 0.9 2.0 2.6 1,309
Votec Mobile.............. 50.0% Voronezh 1.0 1.5 2.5 1,631
Mar Mobile................ 50.0% Yoshkar-ola 0.4 0.5 0.8 415
PrimTelefone................. 50.0% Vladivostok(5) 1.2 1.8 2.2 3,907
UKRAINE
Bancomsvyaz.................. 24.9% Kiev 2.6 3.7 4.5 1,438
---- ---- ---- ------
Total................ 10.0 18.0 25.1 16,336
---- ---- ---- ------
</TABLE>
- - ---------------
(1) Represents the indirect economic interest of GTS in each entity.
(2) Source: Rusline (1995), except Kiev (from Ukraine Ministry of Statistics
(1995)).
(3) Source: GTS estimate (1995).
(4) Prior to September 26, 1997, GTS owned 62% of Vostok Mobile. On September
26, 1997, GTS acquired the minority interest in Vostok Mobile, making Vostok
Mobile a wholly owned subsidiary of GTS. Vostok Mobile owns between 50% and
70% of a series of 11 cellular joint ventures in various regions in Russia.
In addition, Vostok Mobile has acquired a 50% interest in a cellular joint
venture in the city of Barnaul, is expected to begin commercial service in
February 1998. GTS intends to enter into the cellular markets of additional
Russian regions through its Vostok Mobile venture.
(5) Includes Vladivostok and four other cities in the Primorsky region.
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The following table sets forth certain operating data related to GTS
Cellular's operations:
<TABLE>
<CAPTION>
AT AND FOR THE AT AND FOR THE
YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED
----------------- SEPTEMBER 30,
1995 1996 1997
------ ------- ----------------
<S> <C> <C> <C>
Vostok Mobile
Total Subscribers................................... 850 6,884 10,991
Average Revenue Per Subscriber Per Month............ -- $ 128 $ 138
Minutes of Use(1)(thousands)........................ -- 10,561 18,800
Population Covered by Licenses (thousands).......... 18,400 18,400 18,400
Population Covered by Networks (thousands).......... 4,000 6,500 6,500
Subscriber Penetration of Population Covered by
Networks.......................................... -- 0.11% 0.17%
PrimTelefone
Total Subscribers(2)................................ 792 2,822 3,907
Average Revenue Per Subscriber Per Month............ $ 282 $ 236 $ 230
Minutes of Use(1)(thousands)........................ 725 6,919 10,592
Population Covered by Licenses (thousands).......... 2,200 2,200 2,200
Population Covered by Networks (thousands).......... 500 1,175 1,175
Subscriber Penetration of Population Covered by
Networks.......................................... 0.16% 0.24% 0.39%
Bancomsvyaz
Cellular Network
Total Subscribers................................... -- 121 1,438
Average Revenue Per Subscriber Per Month............ -- $ 62 $ 185
Minutes of Use(1)(thousands)........................ -- 9 2,261
Population Covered by Licenses (thousands).......... -- 4,500 4,500
Population Covered by Networks (thousands).......... -- 1,669 1,669
Subscriber Penetration of Population Covered by
Networks.......................................... -- 0.01% 0.09%
Overlay Network
Minutes of Use(1)(thousands)........................ -- -- 2,232
Number of Ports..................................... -- -- 555
Average Revenue Per Minute.......................... -- -- $ 0.36
</TABLE>
- - ---------------
(1) Includes minutes among affiliates.
(2) Includes active subscribers only.
Vostok Mobile. Through Vostok Mobile, GTS participates in eleven cellular
joint ventures in Russia. Vostok Mobile owns between 50% and 70% interests in
each of the eleven Unicel Ventures with regional telephone companies and, in one
instance, a private Russian company, owning the remaining ownership interest.
The Unicel Ventures each operate an AMPS-based cellular network, which was
chosen principally because of the lower licensing fees and equipment costs
associated with AMPS operations. The Company believes that the Unicel Ventures'
AMPS-based networks can be upgraded to digital AMPS ("D-AMPS") for an
incremental capital investment. Cellular networks which utilize digital
technology, such as D-AMPS, DCS and GSM offer several advantages over analog
technology including improved overall signal and sound quality, improved call
security, potentially lower incremental infrastructure costs for additional
subscribers and the ability to provide enhanced data transmission services, such
as facsimile and e-mail. Digital technology also provides increased system
capacity. The ventures intend to convert to D-AMPS at such time as there exists
sufficient competitive pressures and/or market demand for digital services to
merit the additional investment.
AMPS technology is widely used by other cellular networks throughout
Russia, making roaming commercially feasible. The Unicel Ventures have entered
into roaming agreements with other AMPS-based cellular providers, which allow
their subscribers to manually roam throughout Russia. Manual roaming, as opposed
to automated roaming, requires subscribers to notify their local cellular
providers of their travel plans
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in order to receive roaming capability. Vostok Mobile is currently working with
VimpelCom to develop automated roaming standards which will provide subscribers
with automated roaming capability.
The Unicel Ventures, collectively, are licensed to provide cellular service
to regions with an aggregate population of approximately 18.4 million people and
the cellular networks of these ventures cover populations of approximately 6.5
million people. Over the next five years, Vostok Mobile plans to expand the
coverage of the cellular networks to approximately 9.8 million people.
The Unicel Ventures are the only cellular operators in many of their
respective regions. Each region, however, has the potential for three licensed
operators, including one operator for each of the AMPS, NMT and GSM cellular
standards, and the Company expects competition to increase in the future as the
Russian economy develops and telephony demands increase. Each of the Unicel
Ventures operates independently within uniform guidelines established by Vostok
Mobile. The Unicel Ventures employ local engineering and marketing personnel,
which helps the ventures maximize their presence in their respective markets and
maintain quality control. Vostok Mobile and its ventures employed over 279
persons as of September 30, 1997, with over 240 persons employed regionally.
PrimTelefone. GTS's cellular operations in Vladivostok are conducted
through PrimTelefone, a 50% owned GTS subsidiary, with the local electrosviaz
owning the remaining 50%. PrimTelefone began operations in 1995 and operates an
NMT-450 network in Vladivostok and four other cities in the Primorsky region.
PrimTelefone entered and penetrated the Vladivostok market by leveraging its
network design and full interconnection with the city telephone network. As a
result, PrimTelefone's subscriber base has grown to 3,907 as of September 30,
1997 and PrimTelefone has been able to capture approximately half of the
Vladivostok cellular market. PrimTelefone has also updated its billing system,
which allows it to offer automated roaming. Although PrimTelefone has
experienced significant growth, it does face competition. PrimTelefone's only
current competitor has recently upgraded its network for more complete coverage
and has been fully interconnected to the city telephone network and may prove to
be more competitive in the future. PrimTelefone employs approximately 60 persons
which include dedicated sales, marketing and customer service personnel.
PrimTelefone holds a license to provide cellular service to a region having
a population of approximately 2.2 million people and, as of September 30, 1997,
its cellular network covered an area with a population of approximately 1.2
million people. PrimTelefone plans to expand its network's coverage to
approximately 1.7 million people over the next five years.
Bancomsvyaz. GTS operates in Ukraine through a 60% owned intermediate
holding company which holds an approximately 49% interest in Bancomsvyaz, giving
GTS an indirect approximately 25% economic interest in Bancomsvyaz. The
remaining approximately 51% interest in Bancomsvyaz is owned by Bancomservice, a
private company whose principals include telecommunications industry
participants in Ukraine, and a Ukranian national. Bancomsvyaz is co-managed by
GTS and Bancomservice, with Bancomservice appointing the General Director and
GTS appointing the Chief Operating Officer, Chief Financial Officer and two
Business Line directors. The current General Director has been active in the
development of the telecommunications industry in Ukraine. Through Bancomsvyaz,
GTS participates in the operation of a cellular network and an international
overlay network. With over 85 employees, Bancomsvyaz markets its services and
closely monitors technical and quality-related issues.
Cellular network. Bancomsvyaz operates a cellular network in Kiev utilizing
DCS-1800 cellular technology, and operates under a cellular license that covers
the Kiev oblast. Bancomsvyaz began cellular operations in 1996 by covering the
city center of Kiev and expanded its coverage to include the entire city in
1997. Bamcomsvyaz currently provides automated roaming capability in the U.K.
and has entered into a clearinghouse agreement with a European PTO which
provides Bancomsvyaz customers with automated roaming capability with all GSM
signatories with a roaming agreement with this PTO.
Bancomsvyaz holds a license to provide cellular service to a region having
a population of approximately 4.5 million people and, as of September 30, 1997,
its cellular network covered an area with approximately 1.7 million people.
Bancomsvyaz plans to expand its network's coverage to approximately 3.2 million
people over the next five years.
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Overlay network. Bancomsvyaz provides switched traffic service through its
overlay network in Kiev. Bancomsvyaz owns and operates a partitioned mobile
switch for both its overlay and cellular businesses. Bancomsvyaz has seven
central offices in the city and also provides last mile connections (which are
primarily copper) from the central offices to customers. Local traffic is routed
to the local telephone network through the mobile switch. International traffic
is routed through a government-owned satellite dish to the GTS-Monaco Access
international gateway. Bancomsvyaz emphasizes its high quality service and
markets primarily to multinational companies, real estate developers and hotels.
Bancomsvyaz is also negotiating with Sovintel to provide a link to Moscow and
plans to offer VSAT-based connections to its network in the future.
Sales and Marketing. The GTS Cellular entities have entered into agreements
with local distributors to more effectively reach their target markets.
Particular emphasis is placed on product branding. Vostok Mobile's sales and
marketing efforts are focused on the branding of its trade name, Unicel, which
is marketed and promoted at the local level by each of the Unicel Ventures. By
promoting the Unicel trade name, local ventures can emphasize their
relationships with Vostok Mobile and the other Unicel Ventures, allowing
customers to view the Unicel Ventures as integrated parts of a large cellular
organization rather than as lone, independent operators. Bancomsvyaz operates
under the trade name Golden Telecom.
Customers and Pricing. GTS Cellular's customers are primarily large,
mid-sized and start-up businesses and wealthy individuals. Increases in the
number of customers for GTS Cellular's ventures is typically linked to the
economic health of the region in which such venture operates. Cellular service
is generally a premium service in the cities in which GTS Cellular operates and
is priced as such. Each venture begins with two tariff plans, a "standard"
tariff plan and a "premium" tariff plan, which includes a fixed amount of
airtime at a discounted per-minute rate. Each plan prices late night and weekend
calls at off-peak rates. The Company expects that prices will decrease as
competition increases. Connection fees are minimized in order to reduce license
fees in AMPS regions (which are partially calculated by reference to connection
fees), as well as to keep market entry costs low. GTS Cellular has benefited
from high margins generated by the sale of handsets, which are marked up in line
with other cellular operators in Russia and the CIS. Value-added services, such
as call forwarding and conference calling, when available, are priced nominally
and discounted when sold in packages. Cellular accounts are recorded in dollars
and customers remit payment in rubles at the exchange rate on the date of the
bill and, in instances permitted by law, in dollars. Ruble accounts generally
are charged a two percent conversion fee and payments in rubles are applied at
the rate of exchange on the date of payment. In order to lessen risks to its
receivables, the Company and its cellular ventures require advance payment from
all customers with prepayments averaging approximately $250 per customer or six
to eight weeks of service.
Ownership and Control. GTS Cellular's Russian operations (except for the
Vladivostok operations) are conducted through ventures that are owned between
50% and 70% by Vostok Mobile, a wholly owned subsidiary of GTS. GTS Cellular's
Vladivostok and Ukrainian operations are conducted through ventures which
require partner approval for most decisions. The applicable foundation
agreements and charters do not have expiration dates. See "Risk
Factors -- Dependence on Certain Local Parties; Absence of Control." Neither GTS
nor any of its respective partners in its Vladivostok or Ukrainian operations
are obligated to fund operations or capital expenditures. Losses and profits of
all such ventures are allocated to the partners in accordance with their
ownership percentages, in consideration of funds at risk. As of September 30,
1997, GTS and its partners had made equity contributions aggregating $15.8
million and $15.3 million, respectively, to the various GTS Cellular Ventures.
Contributions made by the partners include contributions of cash and intangible
assets, such as licenses. In addition, the various GTS Cellular Ventures had
outstanding loans of $28.0 million to GTS as of September 30, 1997. See
"Management's Discussion and Analysis -- Accounting Methodology -- Profit and
Loss Accounting."
LICENSES AND REGULATORY ISSUES
Telecommunications operators in Russia are nominally subject to the
regulations of the Regional Communications Committee (the "RCC"). As a practical
matter, national telecommunications authorities of the individual CIS countries
and certain regional and local authorities generally regulate telecommunications
operators in their markets through their power to issue licenses and permits.
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The Communications Law sets out a comprehensive legal and regulatory
framework for the sector. It also sets forth general principles for the right to
carry on telecommunications activities, describes government involvement in
telecommunications regulation and operation, establishes the institutional
framework involved in regulation and administration of telecommunications, and
deals with various operational matters, such as ownership of networks,
protection of fair competition, interconnection, privacy and liability. This
institutional framework is implemented by separate legislation.
Licenses to provide telecommunications services are issued by the MOC on
the basis of a decision by the Licensing Commission at the MOC. No new licensing
regulations have been issued since the enactment of the Communications Law and
in practice the MOC continues to issue licenses based on the Licensing
Regulations. Under the Licensing Regulations, licenses for rendering
telecommunications services may be issued and renewed for periods ranging from 3
to 10 years and several different licenses may be issued to one person. Once the
licenses are received, the licensee is required to register its right to hold
and operate under the license with Gossvyaznadzor, the national authority
responsible for monitoring compliance with regulatory and technical norms.
Renewals may be obtained upon application to the MOC and verification by
appropriate government authorities that the licensee has conducted its
activities in accordance with the licenses. Officials of the MOC have fairly
broad discretion with respect to both the issuance and renewal procedures. Both
the Communications Law and the Licensing Regulations provide that a license may
not be transferred. However, regional authorities are sometimes in a practical
position to limit these national authorities. In August 1995, the Russian
government created Svyazinvest, a holding company, to hold the federal
government's interests in the majority of Russian local telecommunications
operators. Such entities at the oblast and krai levels (administrative regions
within Russia) and two cities -- Moscow and St. Petersburg -- exercise
significant control over their respective local telephone networks.
License procedures for the Company's cellular services include frequency
licensing from the MOC through a two step process. A license must first be
obtained from the MOC for permission to operate mobile cellular services on a
commercial basis in a specific standard and frequency bandwidth. Thereafter, an
approval to use specific frequencies within the band must be received from the
State Radio Frequencies Commission. Once the licenses are received,
Gossvyaznadzor confirms the rights of an operator to offer radio frequency
transmissions on specific frequencies, administers type acceptance procedures
for radio communications equipment and monitors compliance with licensing
constraints. In each instance, the Company is required to obtain additional
licenses and permits with respect to the use of equipment and the provision of
services.
Telecommunications laws and regulations in Ukraine are similar in many
respects to those of Russia but are subject to greater risks and uncertainties.
Regulations currently prohibit foreign entities from owning more than 49% of any
telecommunications operating company. GTS's Ukrainian joint venture agreements
provide it with the option of purchasing an additional one percent of the
cellular network if these rules are liberalized. The Ukrainian government has
proposed substantial frequency permit fees in connection with providing GSM
service in Ukraine. Although the government has not imposed additional fees on
Bancomsvyaz's existing DCS-1800 service, there can be no assurance that such
fees will not be imposed in the future.
GTS's subsidiaries and ventures hold the following licenses in Russia and
Ukraine:
Switched Services. In Russia, the Company holds two licenses. The first
license was reissued to Sovintel in November 1996 and authorizes Sovintel to
operate as an international overlay network with the ability to interconnect
with the Moscow region and St. Petersburg public switched telecommunications
network ("PSTN"). This license ultimately requires Sovintel to provide service
to at least 50,000 subscribers and expires in May 2000. It was amended in
February 1997 to cover the Leningrad region. The second license was reissued to
SFIT, Ltd., a wholly-owned subsidiary of GTS in February 1997, for provision of
intercity services in 39 regions and in Moscow with ability to interconnect with
the PSTN. In Kiev, Ukraine, the company holds a license for provision of overlay
network services, including international services, in the name of its
affiliate, Bancomsvyaz. In addition, Sovintel is an ITU recognized private
operating agency ("RPOA"), which enables it to maintain a separate dialing code
(7-501) that can be directly dialed from over 170 countries. Sovintel's status
as an RPOA also enables it to terminate calls directly with other operators.
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Leased Circuits. In September 1996 the MOC issued to Sovintel a five-year
license to lease local, intercity and international circuits in the territory of
Moscow, Moscow region and St. Petersburg, valid until September 2001. The total
amount of circuits leased is approximately 300 and may be increased up to a
total authorized capacity of 2,500.
Data Services. In August 1996, the MOC reissued to Sovam a 2 1/2-year
license, effective July 1996, to provide data transmission services via a
dedicated network to a number of oblasts and other regions covering a large
portion of Russia. The license permits a network capacity of not less than 5,000
customers, allows it to interconnect with other data transfer networks in
Russia, and expires January 1, 1999.
Local Access Services. In January 1997, the MOC has licensed TCM to provide
local telephone service in Moscow to not less than 100,000 subscriber local
access lines. The license expires in May 2006. TCM has an agreement with MGTS to
provide up to 200,000 lines, which would require an extension to its license,
when its current capacity is reached.
Cellular Services. In connection with cellular operations, Russian law
apportions the responsibility for regulating and licensing cellular businesses
between national and regional regulators. National telecommunications regulators
have been assigned the responsibility of regulating and licensing cellular
businesses utilizing the GSM and NMT-450 cellular standards prevalent in Europe.
These regulators have auctioned licenses to provide these services to a number
of ventures that have included large, well capitalized western
telecommunications providers such as U S WEST and Nokia during the last four
years. Regional telecommunications authorities have been given the rights to
supervise the observance of licenses by cellular businesses utilizing AMPS
cellular standard service, which is prevalent in the United States. However,
AMPS licenses are issued by the MOC. GTS believes that, in many instances,
cellular operators obtaining AMPS standard licenses, particularly those in
second tier cities, pay license fees that are lower than those paid for the GSM
and NMT-450 "national standards". Licenses for cellular providers have a term of
approximately 10 years.
The Company's twelve Russian cellular companies have licenses which expire
between 2005 and 2007. One of the companies initially received an operating
license in 1994, six companies initially received an operating license in 1995
and five companies initially received an operating license in 1996.
Bancomsvyaz holds a license for provision of DCS-1800 mobile services in
the Kiev oblast.
COMPETITION
Overview. GTS faces significant competition in virtually all of its
existing telecommunications businesses in the CIS. Many of the Company's
competitors and potential competitors, which include large multinational
telecommunications companies, have substantially greater financial and technical
resources than the Company and have the ability to operate independently or with
global or local partners and to obtain a dominant position in these markets. The
Company believes that it has a competitive advantage in each of these markets
because of its operating history, its ability to bundle a broad range of
telecommunications services in the region and its ability to make rapid
decisions in pursuing new business opportunities and addressing customer service
needs. The Company also believes that its local partnerships and reliance on
nationals in the management of its businesses and joint ventures provide it with
better knowledge of local political and regulatory structures, cultural
awareness and access to customers.
International Services. Sovintel faces significant competition from more
than ten other existing service providers in Moscow, including Rostelecom and
joint ventures between local parties and multinational telecommunications
providers. Large competitors include the "Combelga" joint venture, an RPOA
operator in which Alcatel and the Belgian PTO participate as foreign investors,
"Comstar", a joint venture between GPT Plessey and MGTS, providing services
similar to those provided by the Company, TelMos, a joint venture between AT&T,
MGTS, Global One, through its Moscow based ventures, and Peterstar, in
Petersburg, which is part of the PLD Telekom group. Several smaller companies,
such as DirectNet, and Aerocom provide high-volume and carrier's carrier
services in Moscow. Bancomsvyaz competes in the switched international traffic
market with the Kiev electrosviaz and UTel, a joint venture that includes
Western partners with substantial capital and technical resources who together
hold a dominant share of the
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Kiev market. The Company expects that market consolidation will take place among
the competitive field in international services.
Domestic Long Distance Services. The Company believes its major competitors
in the Russian domestic long distance market consist of Rostelecom, the
electrosviazs, including those which are partners in the Company's TeleRoss
Ventures, and a variety of ventures that include foreign partners with
substantial financial resources. The most significant of such competitors
include: Global One, through its regional operations; Rustel, a venture that
includes Rostelecom, other Russian partners and International Business
Communication Systems, a Massachusetts telecommunications firm; Belcom, a
private company in which Comsat has a majority interest and which provides VSAT
services primarily to the energy sector; Satcom, a Russian joint venture
licensed to provide local, long distance and international service over private
and public switched networks; Teleport TP, a satellite overlay company jointly
owned by Rostelecom and Petersburg Long Distance that provides satellite
teleports in cities throughout Russia; and Comincom, a Russian private venture.
In the Russian far east, TeleRoss competes with Vostok Telecom, which is owned
by the Japanese companies KDD and NIC and certain Russian partners; and Nakhodka
Telecom, which is owned by Cable & Wireless and certain Russian partners.
GTS both cooperates and competes with Rostelecom. Rostelecom provides only
international and long distance services to international carriers and regional
electrosviazs, and does not provide end-to-end customer services. GTS provides
last mile, account management, and transit services for Rostelecom in Moscow,
and uses Rostelecom channels and switches for both international and long
distance services. GTS provides long distance and international services on an
end-to-end basis, using service elements of Rostelecom, the electrosviazs and
its own resources. However, Rostelecom does compete with Teleross, in that
Teleross provides intercity services to customers, using satellite channels
provided by other state agencies (Intersputnik), and provides transit services
to various electrosviazs, on a traffic overflow basis.
GTS believes that it enjoys a number of competitive advantages in the
Russian domestic long distance market, the most important being the maturity of
its international and data service businesses in Russia. This provides GTS with
access to the services, customers, products, licenses and facilities of its
other businesses. The Company also believes that it has more experienced
management, a more comprehensive strategy to build out a nationwide long
distance network and stronger relationships with many regional telephone
companies and with satellite capacity providers, such as Intersputnik, than most
of its competitors. In addition, the Company believes that it does not have any
significant competitor in the regional inter-city market (i.e., calls between
Russian cities other than Moscow or St. Petersburg).
Data Services. Sovam has several primary competitors in the market for data
services: Global One, which began packet-switched service in Moscow and St.
Petersburg in June 1992, under the Sprint Networks venture; Demos, an Internet
service provider; and Relcom, a cooperative affiliation of computer users that
relies on an older generation of technology that supplies slower and lower-cost
messaging facilities to customers (primarily domestic commodities traders) that
do not require higher levels of service. In addition MCI and Rostelecom have
recently announced their agreement to create a national Internet access network
utilizing Rostelecom's domestic network and MCI's international infrastructure.
Rostelecom has also announced the formation of a new Internet services company
called RTK Internet, with Relcom as its partner. Although Sovam's business has
grown quickly, the Company believes that Global One is the market leader. GTS
believes that other potential competitors, including foreign PSTNs, Infotel,
Infocom and Glasnet, are also active in this market.
Although the Company faces significant competition in this market, it
believes that it enjoys certain competitive advantages, including the ability to
reach a wide area throughout Russia through TeleRoss, innovative service
offerings such as Russia On Line, the maturity of its business in the key
banking services segment, high levels of customer service and support, and high
speed digital channels through TeleRoss.
Local Access Services. The Company believes that its major competition in
the Moscow local access market consists of a number of ventures with Western
partners, including Telmos (which includes AT&T), Comstar (which includes GPT
Plessey), and Combelga. However, since TCM has obtained an allocation of
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up to 100,000 numbers, the Company believes that TCM will account for a
substantial proportion of the new capacity to come onto the market within the
next five years.
Cellular Services. Most Russian cellular markets have the potential for
three licensed operators, including one operator for each of the GSM and NMT-450
cellular standards, which Russia has adopted as national standards, and one
operator using the AMPS cellular standard, which has been set as a regional
standard. Many large Western telecommunications operators, including U S WEST,
Deutsche Telekom, STET, Midcom and Millicom, have participated in auctions for
licenses to provide GSM and NMT-450 cellular service to certain significant
Russian urban centers. In addition, a CDMA auction is likely to occur in the
future which could result in one or more CDMA operators entering the market. In
Ukraine, Bancomsvyaz competes primarily with an NMT operator and a GSM operator
in Kiev. Additional GSM licenses were auctioned off in early 1997 and other GSM
operators may enter other markets in 1998.
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WESTERN EUROPE
OVERVIEW
GTS seeks to position itself as the leading independent carriers' carrier
within Western Europe through the development of two ventures, HER and
GTS-Monaco Access. HER's objective is to become the leading pan-European
carriers' carrier by providing centrally managed cross-border telecommunications
transmission capacity to telecommunications companies including traditional PTOs
and New Entrants on an approximately 18,000 kilometer high capacity fiber optic
network designed to interconnect a majority of the largest Western and Central
European cities. HER is currently operating over an approximately
1,700-kilometer portion of the network linking Brussels, Antwerp, Rotterdam,
Amsterdam, London and Paris. HER expects the initial five country network to be
placed in operation in the second quarter of 1998. This segment of the network
is expected to deliver managed transport services over approximately 3,000
kilometers of fiber optic cable linking the cities of London, Rotterdam,
Amsterdam, Antwerp, Brussels, Paris, Dusseldorf and Frankfurt. The full 18,000
kilometer network is expected to become fully operational during the year 2000.
HER also plans to lease capacity on a transatlantic cable linking the European
network with North America and is exploring various interconnectivity options to
Russia and Asia. Such intercontinental interconnectivity will help HER satisfy
the needs of its European customers with respect to outgoing traffic and attract
additional non-European customers with traffic terminating in Europe. HER
commenced commercial service over the Brussels-Amsterdam portion of the network
in late 1996, and the London-Paris portion in November 1997. GTS-Monaco Access
operates an international gateway in Monaco in partnership with, and utilizing
the existing gateway infrastructure of, the Principality of Monaco and provides
transit and routing of international calls to other telecommunications
operators. Through its HER and GTS-Monaco Access ventures, GTS is building a new
network for transporting voice, data and multimedia/image traffic for other
carriers throughout Western and Central Europe and for worldwide international
voice, data and multimedia/image traffic that either originates or terminates
in, or transits through, Western and Central Europe.
The Company believes that the international segment of the Western and
Central European telecommunications market will be an attractive market for new
telecommunications entrants because of its large size, the high operating costs
and low productivity of current providers, and the barriers to entry created by
the need to control a network and its rights-of-way.
The European telecommunications market has historically been dominated by
monopoly PTOs. This system has ensured the development of broad access to
telecommunications services in Europe, but it has also restricted the growth of
high quality and competitively priced pan-European voice and data services. The
current liberalization occurring in Europe is intended to address these
structural deficiencies by breaking down PTO monopolies, allowing new
telecommunications operators to enter the market and increasing the competition
within the European telecommunications market. In March 1996, the European
Commission adopted a directive (the "Full Competition Directive") requiring the
full liberalization of all telecommunications services in most EU member states
by January 1, 1998. The Company expects that full liberalization in these
European countries will lead to the emergence of New Entrants with new and
competitive service offerings. HER expects this increase in competition will
result in lower prices and a substantial increase in the volume of traffic and
range of telecommunication services provided. HER believes that as a result of
the increased call volume and growth in value added services, participants in
these markets will require significant amounts of new cross-border
telecommunications transport capacity to provide their services.
The Hermes network will offer PTOs and New Entrants an attractive
alternative for the transport of cross-border European telecommunications
traffic. In the traditional system, PTOs own and control circuits only within
their national borders, and as a result, cross-border traffic must be passed
from one PTO to another PTO at the national boundary. No single PTO therefore
owns or controls end-to-end circuits for cross-border calls. The alternative for
carriers of this traffic will be to build their own transport capacity or use
International Private Leased Circuits ("IPLCs") which are provisioned by
combining half-circuits on the networks of two or more PTOs. The Company
believes that there are a number of problems with these options that result in
HER being well-positioned to become the leading independent carriers' carrier in
Western and Central Europe. In particular, building their own transport capacity
is unlikely to be an attractive option for most
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carriers because of the high traffic volumes required to justify the expense,
the need to focus resources on marketing and customer service, the time
commitment and the regulatory and administrative complexities involved,
particularly in obtaining the rights of way across national borders. Likewise,
IPLCs provided by the PTOs also have a number of disadvantages, including high
prices, lack of end-to-end quality control, lack of redundancy, low quality due
to diversity of network systems and equipment, limited availability of bandwidth
and long lead times for provisioning.
HER
HER's objective is to become the leading pan-European carriers' carrier by
providing centrally managed cross-border telecommunications transmission
capacity to telecommunications companies including PTOs and New Entrants. HER
intends to offer these target customers a better transport system than is
currently available in Europe with a higher and more consistent level of
transmission quality, redundancy, network functionality and service across
Europe at lower prices. Development of the HER network is dependent upon, among
other things, HER's continuing ability to obtain the necessary financing,
rights-of-way, licenses and other regulatory approvals in a timely and
cost-effective manner. See "Risk Factors -- HER Network Roll-out."
HER is developing an approximately 18,000 kilometer, pan-European high
capacity fiber optic network designed to interconnect a majority of the largest
Western and Central European cities. Each access point of the network will be
placed in operation as it is linked to the network. HER intends to build the
network using the most accessible and cost-efficient infrastructure base in each
of the regions served, including using rights-of-way and existing infrastructure
of railways, motorways, pipeline companies, waterways and power companies. HER
plans a flexible approach to the network build-out plan and intends to fine-tune
the scope, route and design of the network based upon the evaluation of customer
demand.
HER began initial trials of the Brussels-Amsterdam portion of the network
in the third quarter of 1996 and commenced commercial service in November 1996.
Commercial service connecting Paris to Amsterdam, Brussels and London started in
November 1997.
HER expects to continue to roll-out full telecommunications transport
service on the initial network in the first five countries linking the
additional cities of Dusseldorf and Frankfurt in the second quarter of 1998.
This initial network in the first five countries is expected to consist of 2,900
kilometers of fiber optic cable covering countries which, in 1995, originated
over 60% of all outgoing calls and terminated over 60% of all incoming calls in
the countries to be served by the full network. Network coverage is planned to
be expanded to include Munich, Berlin, Geneva, Zurich, Stockholm, Copenhagen,
and Milan in the third quarter of 1998. By the year 2000, the 18,000 kilometer
HER network is expected to have points of presence in at least 32 cities in 15
European countries, including Southern and Central Europe. HER also plans to
lease capacity on a transatlantic cable linking the European network with North
America and is exploring various interconnectivity options to Russia and Asia.
HER has entered into agreements for the construction and/or lease of fiber
optic routes for the initial network in the first five countries. Contracts have
been concluded with respect to the portion of the network connecting Germany
with each of France, the Netherlands and Switzerland and HER continues to
negotiate rights-of-way and other infrastructure arrangements in five other
Western European countries representing the remainder of the Western European
portion of the rollout. HER will need to negotiate similar agreements to
complete the network in four Central European countries. Buildout of the HER
network is subject to numerous risks and uncertainties that could delay
deployment or increase the costs of the network, or make the network
commercially unfeasible. See "Risk Factors -- HER Network Roll-out."
HER was formed on July 6, 1993 by HIT Rail. HIT Rail was incorporated in
1990 by eleven national railways to carry out telecommunications engineering
activities in order to construct and exploit a data communications network for
railway traffic. GTS-Hermes purchased a 34.4% interest in HER in 1994 and has
increased its interest to 50% in 1995 and to 79% in 1997. GTS-Hermes is a wholly
owned subsidiary of GTS.
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Business and Marketing Strategy
The overall strategy of HER is to offer PTOs and New Entrants pan-European
cross-border telecommunications transport services to help them, in turn, more
successfully meet the needs of their end-user customers. The HER network also
provides a vehicle through which a carrier can compete in markets where it does
not own infrastructure. HER expects to enter the market ahead of similar
competition and encourage a wide variety of carriers to use its network with
service offerings that meet their needs. HER's primary service offerings are
large-capacity circuits for "wholesale" customers such as PTOs and New Entrants.
HER's focus on carriers is designed to complement and not compete with carriers'
own business objectives in providing services to end-users.
To establish HER as the leading carriers' carrier for international
telecommunications within Europe, HER intends to offer its customers
significantly higher quality transmission and extended/advanced network
capabilities at a competitive price by focusing on the following:
High Capacity International Network Facilities. The HER network is
designed to offer its customers access to high capacity network facilities
outside their domestic markets, providing cross-border capabilities without
requiring customers to invest in network infrastructure or being
constrained by a narrow range of capacity offerings. With STM-64 technology
and Wavelength Division Multiplexing ("WDM") upgrades, HER's fiber
deployment plan provides for the equivalent of 128 fiber pairs of capacity
across Europe.
Uniform Network Architecture. The HER network is designed to offer
managed transport services from country to country and across multiple
countries utilizing a single uniform network, in contrast to services
currently available that use multiple providers over several networks with
varying technologies and each under the control of separate, not
necessarily compatible, network control systems. The HER network's uniform
technology enhances service by providing quality and reliability as well as
uniformity of features throughout the network.
Diverse Routing. The HER network architecture includes diverse,
redundant routes that are designed to provide high levels of reliability.
The network is designed to provide availability of over 99.98% for most
routes and to provide customers with a wide range of telecommunications
transmission capacity. To achieve this level of reliability without the use
of a network similar to the HER network, HER believes that carrier
customers would need to purchase additional dedicated circuits to provide
for redundancy.
Rapid Provisioning. HER services provide access to the network, such
that additional capacity can be provided to customers on the HER network on
a rapid basis. This access provides a level of capabilities that HER
believes is unavailable in Europe today. This ability to rapidly provide
service is largely due to HER's development of capacity substantially in
excess of HER's forecasted requirements.
- Flexibility. HER services are focused on providing customers flexibility
across the network through which the customer may minimize risk by
enabling network rerouting, eventually even under customer direct
control.
- Advanced Technology. HER is deploying SDH technology which, by using WDM
techniques and hardware, is upgradeable and will permit significant
expansion of transmission capacity without increasing the number of fiber
pairs in the network. This technology also provides the basis for
structuring advanced operating features, such as virtual private network
service and ATM-based services. Additionally, the SDH technology deployed
by HER may be upgraded.
- Innovative Pricing. Currently the price of E1 equivalent circuits on
transborder European routes is artificially high and not necessarily
related to the cost of such circuits. HER intends to offer competitive
pricing. HER will also offer highly tailored contract terms and volume
discounts, which allow carrier customers to plan more efficiently the
fixed costs of their service portfolio. Customers can select varying
capacity, access, guaranteed availability and contract terms at
competitive prices. Customers sourcing from PTOs are generally limited to
order from a very narrow set of capabilities offered under inflexible
pricing plans.
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Although HER and GTS have relationships with certain PTOs or other access
providers for specific projects, they do not have wide-ranging alliances with
any of the major consortia or large Western telecommunications companies.
Additionally, HER's strategy calls for it to focus on carriers' carrier
services, so that it will limit overlap of target markets with its carrier
customers in end user markets. HER believes that this independence will make it
an attractive service provider for carriers who may otherwise be reluctant to
obtain services from other providers of intra-European transport that also may
be their competitors in the retail market.
SERVICES
HER's primary service is large capacity cross-border European circuits
provided to carriers and service providers over an integrated, managed
pan-European network structure thus providing a service for wholesale customers
such as PTOs and New Entrants. The HER network will be based on SDH technology,
which provides for digital transmission capability upon which a broad range of
advanced functionality may be built and which offers network availability,
flexibility, bandwidth speeds and error performance not otherwise available to
carriers for transport of telecommunications traffic across national borders in
Western and Central Europe. The network is designed to provide customers with a
wide variety of bandwidth speeds, ranging from VC12/E1 Standard (equivalent to
2.048 Mbps) to STM-1/E4 Standard (equivalent to 155 Mbps) and beyond.
HER will provide high quality cross-border transmission services for
licensed or otherwise authorized telecommunications providers. Services are
based on the principle of adding greater value than currently available in the
market while retaining competitive prices.
Point-to-Point Transport Service. The current market for cross-border
transport is served by IPLCs provided by PTOs. IPLCs are formed by combining
half-circuits from two PTOs between customer locations, often with additional
PTOs providing transit segments. Under the IPLC service, overall service quality
guarantees generally are not provided and only a limited range of bandwidth is
available, usually only E1 and in certain instances, E3. The Company believes
that HER's Point-to-Point Transport Service will be a major improvement to the
PTO-based approach because it provides a greater range of bandwidths (from 2
Mbps (E1 or VC-12) to 140/155 Mbps (E4 or VC-4)) and allows customers to choose
a service level agreement with guarantees appropriate for their applications,
including guarantees for on-time service delivery and service availability.
Point-to-Point Transport Service consists of two services, "Integrated" and
"Node-to-Node." The HER "Integrated" service provides an end-to-end service
between customer-specified locations where the customer can request for HER to
arrange for "last mile" services from the HER node location to the customer's
location. The HER "Node-to-Node" service can be selected when the customer
prefers to provides its own services to reach the local HER node location. In
Node-to-Node Service, HER guarantees service only on its portion of the network
between HER nodes. Both services are competitively priced relative to current
service offerings. A premium is charged for the highest guaranteed level of
service which incorporates an end-to-end, fully diverse, protected, "Integrated"
service. The customer can choose flexible contract terms from one to five or
more years' duration, with volume discount schemes designed to ensure that HER
remains a cost-effective solution.
Virtual Infrastructure Service. Carriers and operators that plan to expand
their operations to become pan-European service providers as the European
marketplace is liberalized require a flexible and cost-effective means of
telecommunications transport. To date such service providers obtain
international transport service by leasing IPLCs. Leasing IPLCs requires a
carrier to lease channels on a segment-by-segment basis from multiple PTOs,
linking the target cities under arrangements having fixed capacity and pricing
structure for each segment of the carrier's network. Leasing IPLCs has several
disadvantages, including (i) difficulty in obtaining discount/volume pricing
schemes since there is no single provider of pan-European coverage, (ii) delays
in implementation due to numerous contractual negotiations and having to
interconnect numerous IPLCs, (iii) limited availability of pan-European leased
capacity at high bandwidth and (iv) variability of quality due to multiple
operators and the absence of a single uniform network. Operators could also
construct
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their own network, which is expensive, time-consuming and complex and which may
not be justified by such operators' traffic volume.
HER's Virtual Infrastructure Service will offer a new solution and an
attractive alternative to leasing IPLCs or building infrastructure. This service
will enable HER's customers to obtain a uniform pan-European or cross-border
network under one service agreement by allowing the customer to select any
number of cities along the HER network at a pricing structure based on the
overall amount of leased capacity for the customer's entire network. The key
feature behind Virtual Infrastructure Service is that it gives the customer the
ability to add or reconfigure capacity in 24 hours between locations connected
in the Virtual Infrastructure Service, thereby enabling the customers to respond
almost immediately to changes in traffic. By being able to transfer capacity
among the network routes, HER's customers are able to avoid over- and
under-utilization of leased channels. This service offering provides a customer
with the benefits of ownership (rapid provisioning, freedom to rearrange and
control) with a "pay-as-you-go" managed service offering, without the burdens of
up-front investment and costs required to build a network, and without having to
manage the on-going maintenance and operation of the network.
The service would be delivered through pre-installed physical facilities at
each of the customer locations. These facilities are designed to ensure that
most growth or changes in customer requirements can be addressed purely by
remote logical reconfiguration from the HER Network Operations Center. This
remote network management ability is inherent in SDH technology and allows rapid
provisioning and high quality of service.
Ring Service. Most medium to large carriers and operators purchase network
capacity in excess of actual requirements, and prefer to have physical
configuration control over their networks. The HER Ring Service connects
multiple customer locations with multiple VC-4 paths in a ring configuration.
The customer has direct control over the configuration of the VC-3 and VC-12
paths within the ring, and has exclusive control over the routing. Additional
ring capacity can be added with no service interruption and additional customer
locations may be added to the ring with minimal service interruption. Because
HER is not required to configure 'idle' bandwidth or to manage the 'SDH subnet'
this service can be provided at a very competitive rate vis-a-vis other
point-to-point services.
Sales and marketing of HER's services are conducted through its sales and
marketing department, which includes a director and senior sales managers
responsible for various regions and customer segments. Additionally, HER expects
that its railway shareholders that develop domestic telecommunications
businesses, or other local network access providers, can provide an effective
distribution channel to smaller carrier customers.
PRICING
Currently the price of cross-border pan-European calls are often
significantly higher than the underlying cost of transport and terminating such
calls and higher than the price of intra-country calls or transborder calls to
and from liberalized markets. The low cost of operating the network enables HER
to attractively and competitively price services in the face of declining
overall tariffs for telecommunication services. HER's low-cost basis is due to,
among other things, its use of up-to-date technology without the burden of
legacy networks, which requires fewer employees to operate.
The term of a typical customer agreement currently ranges from 1 to 3
years. The customer agrees to purchase, and HER agrees to provide, cross-border
transmission services. In general the customer agrees to pay certain
non-recurring charges and recurring charges on an annual basis, payable in
twelve monthly installments. If the customer terminates the service order prior
to the end of the contract term, it is generally required to pay HER a
cancellation charge equal to three months service for each of the twelve months
remaining in the contract term. HER guarantees transmission services to a
certain service level. If such levels are not met or HER fails to deliver
service by the committed delivery date, the customer is eligible for a credit
against charges otherwise payable in respect of the relevant link.
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CUSTOMERS
HER's high capacity, SDH-based fiber optic network is designed to enable
PTOs and New Entrants to integrate high quality, cross-border capacity into
their end user offerings. As of November 30, 1997, fifteen customers were under
contract for service on the HER network, including PTOs, a global consortium of
PTOs, Internet service providers, an international carrier, VANs and resellers.
HER provided capacity of approximately 180 E1 equivalent circuits as of November
30, 1997. The type and quality of HER's customers validates the concept of the
HER network, and illustrates the type of customers who will be attracted to the
full network. The success of this limited network also demonstrates the demand
for cross-border transport services. In total, HER is targeting seven major
market segments or customer groups which can be characterized as follows:
- Existing PTOs. This customer segment consists of the traditional
European PTOs that generally participate in the standard bilateral
agreements for cross-border connectivity. Hermes provides a vehicle
for PTOs to compete in non-domestic markets both before and after
January 1, 1998. As of January 1, 1998, both reserved and
non-reserved traffic can be transported by alternative infrastructure
providers, thus vastly expanding the available PTO market for HER.
- Global Consortia of Telecommunications Operators. Many of the
largest PTOs and international carriers have pooled resources and
formed consortia in order to compete more effectively in important
telecommunications markets such as those in Western Europe
particularly outside their home markets. Prior to liberalization of
the provision of switched voice services in Western European markets,
one of the primary objectives of these consortia is to provide
non-reserved pan-European services to multinational business
customers, including X.25/frame relay (high speed data network)
service and closed-user group voice services. Under the current
regulatory framework, consortia would otherwise be required to
purchase leased lines at negotiated retail rates, even within their
home countries. HER believes that it provides an attractive
alternative at better pricing in those environments where such a
consortium does not already own its infrastructure. Furthermore, HER
believes that it is well positioned to provide cross-border
connectivity between different domestic infrastructures of these
alliances.
- International Carriers. This customer segment consists of
non-European carriers with traffic between European and other
international gateways. Such carriers include Teleglobe, GTS-Monaco
Access and eventually the U.S. Regional Bell Operating Companies. HER
can provide these customers a pan-European distribution network to
gather and deliver traffic to and from their own and other hubs.
- Alternative Carriers. This segment consists of second carriers,
cable TV and mobile carriers and competitive access providers. These
new carriers have chosen to compete with the incumbent PTOs in their
respective countries, and the Company believes that they would look
favorably to an alternative such as HER. HER believes that this
segment will sustain the largest growth as competition emerges in
Europe. HER also believes that non-PTO competitors in Europe will
prefer to use a non-PTO alternative like HER to meet their
cross-border telecommunication transport needs.
- Internet Backbone Networks. Internet backbone networks are a fast
emerging segment and are expected to generate significant
requirements for the services HER offers. These require large
capacity international connectivity services between Internet nodes
(point of interconnection between local Internet service providers)
in all local European markets. The Internet segment is experiencing
significant growth in demand for transmission capacity.
- Resellers. Resellers are carriers that do not own transmission
facilities, but obtain communications services from another carrier
for resale to the public. Resellers are also a growing segment of the
market and are expected to increase in conjunction with the
liberalization of the European telecommunications market. In the
U.S., for example, resellers were a significant factor in the
expansion of competition.
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- Value Added Networks ("VANs") and other Service Providers. VANs are
data communications systems in which special service features enhance
the basic data transmission facilities offered to customers. Many of
these networks are targeted to the data transfer requirements of
specific international customer segments such as airlines and
financial institutions. VANs' basic network transmission requirement
is to connect data switches or processors. VANs currently purchase
their own international circuits and build additional resiliency into
their network infrastructure. HER will allow them to meet these needs
cost-effectively, and to extend their services to new markets or
customers without substantial capital investment.
HER expects that additional demand for alternative service providers will
come from increased usage of dedicated circuits for Internet access, private
lines for the deployment of wide-area networks by large corporations, "single
source" local and long distance services by small and medium-sized businesses
and emerging broad band applications such as cable TV programming distribution
(other than broadcast) to the end user.
CURRENT OPERATIONS
HER currently operates an approximately 1,700 kilometer network connecting
the cities of Brussels, Antwerp, Rotterdam, Amsterdam, London and Paris. HER
began initial trials of a 244 kilometer portion of the network between Brussels
and Amsterdam in the third quarter of 1996 and commenced commercial service in
November 1996. Commercial service connecting Paris to Amsterdam, Brussels and
London started in November 1997. HER's Network Operations Center located in
Brussels, Belgium and its backup center located in Antwerp, Belgium are fully
operational and house network management and customer support services which
operate 24 hours a day, seven days a week. Billing and customer service
functions are also operational.
NETWORK DESIGN
Network Architecture. The network architecture is based on a highly meshed
flat topology which covers a wide geographical area with large distances between
individual network nodes. This architecture allows rerouting of traffic at
electronic speeds in the event of a network failure. This approach also lowers
network cost by allowing each node to be sized to match anticipated traffic
volumes rather than to a standard capacity. Individual nodes can be configured
to connect any trunk to any other in the nodes, thus allowing efficient
transmission of traffic. Each node will be connected to at least two other nodes
allowing rerouting of traffic in the event of a network failure. HER believes
that its network will be the first cross border pan-European network with such
redundancy.
The HER network has been designed to be controlled by a single network
management center and supported by advanced operational support systems. A
centralized network center can pinpoint overloaded pathways or malfunctioning
circuitry and reroute traffic much more quickly than networks controlled by
separate network centers operated by PTOs in different countries. HER primarily
uses Alcatel for the supply of transmission equipment and network management
systems. HER's advanced operational support systems allow it to correct network
failures and isolate equipment faults with greater speed and at a lower cost
than is the case with heterogeneous multi-operator networks. Critical elements
of the network, including network maintenance and control systems, are designed
with redundancy in order to ensure a high quality of service. The network design
has several important resilience features including: multiple paths to each
node, built-in hardware redundancy and redundant power supplies. For all network
routings, there will be at least two paths. Should service failure occur on one
route, the network is designed to automatically re-route traffic to another
route. HER believes that these techniques will result in performance of 99.98
percent or better for premium service customers for most routes.
HER expects to operate the entire network and to own substantially all of
the network equipment as well as some segments of the fiber optic cable. A
substantial part of the fiber is leased on a long-term basis. Long-term leases
for fiber are advantageous to HER because they reduce the capital expense burden
of building large quantities of capacity before they can be used. Where HER
leases dark fiber, the infrastructure provider
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will generally be responsible for maintaining such fiber optic cable. HER will
enter into agreements with Alcatel and infrastructure providers and other third
parties to supply and/or maintain the equipment for the HER network. See "Risk
Factors -- HER Network Roll-out."
Network Capacity. The network will consist of Synchronous Digital
Hierarchy ("SDH") STM-16 links managed by equipment and operating centers owned
by HER and running on dark fiber leased from infrastructure providers or built
by HER on leased rights of way. Each line system and multiplexer works initially
at the 2.5 Gbps (STM-16) level. The most important types of equipment used or to
be used in this network are Add-Drop Multiplexors ("ADMs") and regulators and a
variety of optical amplifiers for boosting optical signals. The STM-16 links are
expected, where needed, to be upgraded to STM-64. Furthermore, fibers will be
multiplexed using WDM, also as required. Additional capacity can be achieved by
adding new fiber accesses to a given city over alternative routes, thereby
achieving more meshing and the resulting improved network availability.
Network Agreements. HER has entered into agreements and letters of intent
with various infrastructure providers for construction and/or dark fiber lease
of portions of the HER network. HER's agreements for leases of portions of the
network typically required the infrastructure provider to provide a certain
number of pairs of dark fiber and node and/or regenerator sites along the
network route commencing on certain dates provided by HER. The term of a lease
agreement typically ranges from 10 to 18 years. An agreement typically contains
optical specification standards for the fiber and methods of testing. HER is
allowed to use the cable for the transmission of messages and in other ways,
including increasing capacity. The infrastructure provider also provides space
for the location of equipment and spare parts and guarantees the provision of
power and other utilities together with environmental controls and security to
ensure the proper functioning of the equipment. The infrastructure provider is
typically responsible for maintenance of the cable and the provision of first
line maintenance to equipment and permits HER access to such facilities. Access
arrangements to the nodes are also provided so that connection may be made to
HER customers or to the rest of the network. An agreement also provides for an
annual price for the provision of fiber and for the facilities and maintenance.
The agreements typically provide for termination by the parties only for
material breach, with a 90 day minimum cure period. The agreements typically
contain a transition period after termination of the agreement to allow HER to
continue to serve its customers until it can reach agreement with an alternative
infrastructure provider.
Local Access. Access to the HER network will be provided to clients
through SDH access lines including at the STM-1 or STM-4 level. However,
customers who continue to use the older PDH technology may also access the HER
network. In each city, as a HER point of presence is deployed, HER may contract
with a local access network supplier for "last mile" services to customer
locations. HER will not invest in building local access infrastructure but such
connectivity can be supplied on a case-by-case basis via preferred local access
partner arrangements. Currently Telfort in the Netherlands and Belgacom in
Belgium are providing local access to the operating Amsterdam-Brussels route. In
London and Paris, HER has contracted with local access providers to connect the
HER network to intra-city networks in those cities. Pursuant to this agreement,
HER can offer its carrier customers local connectivity in those cities. Various
Local Access Network Suppliers may also be interested in HER for the purpose of
linking the business centers in which they are active. Therefore, the
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Company believes that the relationships between HER and local access network
suppliers can benefit both parties. Set forth below is an illustration of the
connection between the HER network and local access providers.
[SDH/WDM NETWORK CHART]
Network Routes. The table below sets forth the current planning dates of
the development of routes in the initial network in the first five countries.
<TABLE>
<CAPTION>
ESTIMATED
COMMERCIAL
SERVICE TOTAL ROUTE
AVAILABILITY KILOMETERS OF
FROM TO DATE FIBER
- - ------------ ---------- ------------ --------------
<S> <C> <C> <C>
Amsterdam Brussels Operational 244
Amsterdam London Operational 458
Brussels London Operational 474
Paris Brussels Operational 514
Dusseldorf Amsterdam April 1998 246
Paris Frankfurt June 1998 574
Frankfurt Dusseldorf June 1998 236
</TABLE>
HER is currently operating on an approximately 1,700 kilometer portion of
the network. Under HER's current plan, HER expects to have an aggregate of
approximately 3,200 kilometers completed in the first half of 1998,
approximately 10,200 kilometers completed at the end of 1998 and the entire
18,000 kilometer network completed by the year 2000. Hermes also plans to lease
capacity on a transatlantic cable linking the European network with North
America in 1999.
The Dusseldorf-Amsterdam, Frankfurt-Dusseldorf and Paris-Frankfurt fiber
optic routes are currently under construction. "Under construction" means that
with respect to each of the segments that make up each of these routes, one of
the following is occurring: (i) HER has contracted to build or is contracting to
build the
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fiber optic cable segment, and (ii) HER has leased or will lease such segment of
dark fiber optic cable from a third party who has built or is currently building
such segment. The dates set forth above may be subject to delays due to a
variety of factors, many of which are beyond the control of the Company. See
"Risk Factors -- HER Network Roll-Out."
HER is deploying the network along the rights-of-way of several
shareholders as well as the rights-of-way of a variety of alternative sources,
including motorways, waterways, pipelines and utilities. The rights-of-way of
HER-built portions of the network will be provided pursuant to long-term leases
or other arrangements entered into with railroads, highway commissions, pipeline
owners, utilities or others. HER generally prefers to use the infrastructure of
its rail-based shareholders when such infrastructure is available on a timely
and commercially reasonable basis. In certain cases, however, HER has not been
able to reach agreement with such shareholders for the provision of
rights-of-way along their railways, which has resulted in significant delays to
the network buildout. In all cases, it is the policy of HER to evaluate multiple
alternative infrastructure suppliers in order to maximize flexibility. As a
result of its network development activities to date, HER has gained access to
infrastructure for its network routes which, in certain cases, HER believes will
be difficult for its competitors to duplicate.
Competition
The European and international telecommunications industries are
competitive. HER's success depends upon its ability to compete with a variety of
other telecommunications providers offering or seeking to offer cross-border
services, including (i) the respective PTO in each country in which HER operates
and (ii) global alliances among some of the world's largest telecommunications
carriers. HER expects that some of these potential competitors may also become
its customers. HER believes that the ongoing liberalization of the European
telecommunications market will attract New Entrants to the market and increase
the intensity of competition. Competitors in the market compete primarily on the
basis of price and quality. HER intends to focus on these factors and on service
innovation as well. HER business plan anticipates substantial head-to-head
competition as well as indirect competition.
WorldCom recently announced plans to construct a pan-European fiber
network, the first phase of which is expected to connect London, Amsterdam,
Frankfurt, Brussels and Paris by early 1998. Although the Company believes that
the proposed WorldCom pan-European network is primarily intended to carry
WorldCom traffic, WorldCom has stated that any excess capacity on such network
will be used to provide a competitive carrier's carrier service.
Viatel, Inc. ("Viatel") also recently announced its intention to build a
pan-European fiber optic network connecting select cities in Belgium, France,
the Netherlands and the United Kingdom. Excess capacity would be available for
other carriers. Viatel has stated that, assuming that it obtains necessary
financing, construction would begin in spring 1998 and the network would become
operational in 1999.
HER also competes with respect to its "point-to-point" transborder service
offering against circuits currently provided by PTOs through International
Private Leased Circuits. In addition, the liberalization of the European
telecommunications market is likely to attract additional entrants to both the
"point-to-point" and other telecommunications markets.
If HER's competitors, many of whom possess greater technical, financial and
other resources than HER, devote significant resources to the provision of
pan-European, cross-border telecommunications transport services to carriers,
such action could have a material adverse effect on HER's business, financial
condition and results of operations. There can be no assurance that HER will be
able to compete successfully against such new or existing competitors. See "Risk
Factors -- Competition."
HER RECAPITALIZATION
HER has completed a recapitalization (the "HER Recapitalization"), wherein
HER extended rights to subscribe to additional shares of HER to GTS-Hermes, HIT
Rail and the eleven railways comprising the HIT Rail consortium. Pursuant
thereto, GTS-Hermes and two of the eleven railways that comprise the HIT Rail
consortium have exercised their subscription rights, while HIT Rail and the
other nine railways have declined to
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exercise their subscription rights. HER has issued (i) 150,592 shares to
GTS-Hermes in exchange for the conversion of loans and additional consideration,
(ii) 24,007 shares to HIT Rail in exchange for the conversion of loans, (iii)
11,424 shares to Societe Nationale des Chemins de Fer Belges S.A. de Droit
Public/Nationale Maatschappij der Belgische Spoorwegen N.V. Van Publiek Recht
(the Belgian national railway) ("SNCB/NMBS") and (iv) 4,365 shares to AB Swed
Carrier (a wholly owned subsidiary of SJ, the Swedish national railway). As a
result, GTS-Hermes owns 79.1%, HIT Rail owns approximately 12.6%, SNCB/NMBS owns
6.0% and AB Swed Carrier owns 2.3% of the issued HER shares. Pursuant to the HER
Recapitalization, HER, GTS-Hermes, HIT Rail, SNCB/NMBS and AB Swed Carrier have
executed a new Shareholders Agreement, the principal terms of which are set
forth below.
Under the new Shareholders Agreement, actions to be taken by shareholders
will be adopted by a simple majority vote with the exception of certain actions
which will require at least 85% of the votes cast: (i) purchase by HER of its
own shares and any redemption thereof, (ii) exclusion of preemptive rights in
the case of the issuance of new shares and the transfer of shares held by HER,
except in the event of a public listing of the shares or of new shares or of an
offering of shares or options on new shares (warrants) to professional investors
in order to obtain further funding, (iii) winding up or dissolution of HER, (iv)
any amendment to the articles of association other than those pertaining to
increases in the authorized capital of HER or to convert HER into an N.V.
("Naamloze Vennootschap") to enable a public listing of shares or new shares,
(v) any amendment to the scope of HER's business, (vi) the declaration of
dividends and (vii) the admission of new shareholders to the Shareholders
Agreement. In addition, the Shareholders Agreement provides that (a) if
GTS-Hermes is the owner of at least 50% of the issued shares, then it will have
the right to make a binding nomination for the appointment of half of the
members of the Board of Supervisory Directors or (b) if GTS-Hermes is the owner
of at least two-thirds of the issued shares, then it will have the right to make
a binding nomination for the appointment of half of the members of the Board of
Supervisory Directors plus one member more, appointed pursuant to nominations by
all other shareholders. As long as HIT Rail is the owner of at least one share,
HIT Rail will be entitled to make a binding nomination for the appointment of at
least one member of the Supervisory Board. The Shareholders Agreement also
provides that shareholders who participated in the capital restructuring other
than GTS-Hermes and HIT Rail with a shareholding of at least 6.8% subject to
adjustment in the discretion of the other shareholders will be entitled to make
a binding nomination for the appointment of one member of the Board of
Supervisory Directors. Shareholders who participated in the capital
restructuring other than GTS-Hermes and HIT Rail who hold fewer than 6.8% of the
issued share capital of HER will be entitled on a rotating basis to make one
binding nomination for the appointment of a member of the Board of Supervisory
Directors for two-year periods.
Articles of Association and Shareholders Agreement
Under the Articles of Association and the Shareholders Agreement, both
GTS-Hermes and HIT Rail have preemptive rights in connection with issuances of
ordinary shares and options on shares to be issued in proportion to the total
nominal value of the shares held by each of them. Preemptive rights can be
exercised for four weeks after the date the notice of the offer is received by
the shareholders.
The Shareholders Agreement provides that HER or its designated vendor will
provide fiber capacity in its network for use by the shareholders of HER on fair
commercial terms, use, quantity and price to be negotiated on a bilateral basis.
In the Shareholders Agreement, HIT Rail has covenanted to (i) use its best
efforts to establish such commercial agreements between individual HIT Rail
shareholders and HER, to obtain rights of way from individual HIT Rail
shareholders and to cooperate in obtaining such licenses as may advance the
business of HER, (ii) use its best efforts to ensure that the HIT Rail
shareholders cooperate in obtaining such license in accordance with the business
plan of HER and as may be necessary or advisable in furtherance of HER's
business, (iii) will not, so long as both HIT Rail and GTS-Hermes are
shareholders of HER and for one year after HIT Rail ceases to be a shareholder,
agree with any entity other than GTS-Hermes or HER to assist or cooperate in the
development of any pan-European telecommunications operator and (iv) use its
best efforts to obtain on HER's behalf such materials as may be required and
arrange inspection visits of selected rights of way for the purpose of making
initial cost estimates.
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The foregoing summary of the Shareholders Agreement does not purport to be
complete and is qualified in its entirety by reference to the Shareholders
Agreement.
LICENSES AND REGULATORY ISSUES
A summary discussion of the regulatory framework in the countries of the
network in the first five countries and the next five countries into which HER
expects to develop the network is set forth below. This discussion is intended
to provide a general outline, rather than a comprehensive discussion, of the
more relevant regulations and current regulatory posture of the various
jurisdictions.
National authorities in individual member states of the EU are responsible
for regulating the operation (and in some cases the construction) of
telecommunications infrastructure. HER believes that the adoption of the Full
Competition Directive and the various related Directives adopted by the European
Parliament and the Council of the EU have resulted in the removal of most
regulatory barriers to the operation of telecommunications infrastructure in the
countries of the initial network in the first five countries.
HER requires licenses, authorizations or registrations in all countries to
operate the network. There can be no assurance that HER will be able to obtain
such licenses, authorizations or registrations or that HER's operations will not
become subject to other regulatory, authorization or registration requirements
in the countries in which it plans to operate. Licenses, authorizations or
registrations have been obtained in the United Kingdom, the Netherlands,
Belgium, France and Germany and a trial concession has been granted in
Switzerland. HER intends to file applications in other countries in anticipation
of service launch in accordance with the network roll-out plan.
On June 28, 1990, the European Commission, in an effort to promote
competition and efficiency in the European Union, issued a directive (the "1990
Directive") requiring EU member states to immediately liberalize all
telecommunication services with the exception of voice telephony to the general
public (basic voice services provided over the public switched voice network).
This step liberalized value added services and voice services over corporate
networks and/or "closed user groups," although the exact definitions of the
terms used in the 1990 Directive were not altogether clear.
On July 22, 1993, the Council of EU agreed that all voice telephony
services in EU member states should be liberalized by January 1, 1998 subject to
additional transitional periods of up to five years to allow member states with
less developed networks to achieve the necessary adjustments. It was agreed that
such exemptions would be granted to Spain, Ireland, Greece and Portugal, subject
to formal application and satisfaction of certain requirements. Luxembourg,
because of the small size of its market, would be eligible for a special
transitional period of up to two years.
In April 1995, a communication from the European Commission sought to
clarify the types of services that were liberalized by the 1990 Directive,
stating that the burden of proof as to why a service should be considered
"reserved" and therefore not open to competition should be upon the PTOs and the
regulatory authorities of member states. Along with this statement came the
threat of formal procedures under the Treaty of Rome against member states that
do not implement the 1990 Directive "within a reasonable time." Procedures have
been brought so far against Italy, Greece, Germany and Spain for failing to
apply the requirements of the 1990 Directive.
On March 13, 1996, the European Commission adopted the Full Competition
Directive extending the 1990 Directive to all services, requiring that licensing
procedures for these services be transparent and non-discriminatory, requiring
member states to fully liberalize alternative infrastructure to allow a
competitive market for "non-reserved" services such as data, value added
services and non-public (closed-user group) switched voice services by July 1,
1996 and mandating open competition in all public telecommunications services,
including voice telephony to the general public, by January 1, 1998 (except for
countries to which grace periods were granted in accordance with the 1993
Council Resolution).
On April 10, 1997, the European Parliament and the Council of Ministers
adopted a Directive on a common framework for general authorizations and
individual licenses in the field of telecommunications services, including
networks. Licenses must be awarded through open, non-discriminatory and
transparent procedures and applications will be required to be dealt with in a
timely fashion. The number of licenses may
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only be restricted to the extent required to ensure the efficient use of radio
frequencies or for the time necessary to make available sufficient numbers in
accordance with EC law.
HER believes that many European countries have revised telecommunications
regulations to comply with the 1990 Directive and the Full Competition Directive
and that such changes will enhance HER's ability to obtain other necessary
regulatory approvals for its operations.
As a multinational telecommunications company, HER is subject to varying
degrees of regulation in each of the jurisdictions in which it provides its
services. Local laws and regulations and the interpretation of such laws and
regulations, differ significantly among the jurisdictions in which HER operates.
There can be no assurance that future regulatory, judicial and legislative
changes will not have a material adverse effect on HER, that domestic or
international regulators or third parties will not raise material issues with
regard to HER's compliance or noncompliance with applicable regulations or that
regulatory activities will not have a material adverse effect on HER. See "Risk
Factors -- Government Regulation." The regulatory framework in certain
jurisdictions in which HER provides its services is briefly described below.
United Kingdom
Since the elimination in 1991 of the United Kingdom telecommunications
duopoly consisting of British Telecommunications and Mercury, it has been the
stated goal of Oftel, the United Kingdom telecommunications regulatory
authority, to create a competitive marketplace from which detailed regulation
could eventually be withdrawn. The United Kingdom has already liberalized its
market beyond the requirements of the Full Competition Directive, and most
restrictions on competition have been removed in practice as well as in law. HER
has received a license from the Secretary of State for Trade and Industry which
grants it the right to run a telecommunications system or systems in the United
Kingdom connected to an overseas telecommunications system and to provide
international services over such systems. Like the licenses granted to other
providers of international facilities-based services, the license granted to HER
on December 18, 1996 was for an initial six months' duration and thereafter is
subject to revocation on one month's notice in writing. The short duration of
these initial licenses was adopted for administrative convenience on the
opening-up of the United Kingdom market for international facilities-based
services. The Department of Trade and Industry ("DTI") has confirmed that it
intends to replace the initial licenses with new licenses and that it would not
normally expect to revoke an initial license without replacing it with another
license giving an equivalent authorization. The DTI is currently discussing with
license holders the arrangements to put these new licenses into effect and
although the DTI has indicated that the new licenses are expected to be of 25
years duration, there can be no certainty that this will be the case or that the
new licenses will not contain terms or conditions unfavorable to HER.
The Netherlands
On July 1, 1997 the Dutch government abolished the prohibition on the use
of fixed infrastructure for the provision of public voice telephony, thereby
complying with the requirements of the Full Competition Directive six months
ahead of schedule. On August 1, 1996, HER was granted a license for the
installation, maintenance and use of a fixed telecommunications infrastructure.
An entirely new Telecommunications Bill was introduced to the Second
Chamber (the House of Representatives) of the Parliament on September 15, 1997.
The new Telecommunications Act is intended to confirm the full liberalization of
the telecommunications market according to European Community standards. It is
not expected that the new Telecommunications Act will detrimentally affect the
conduct of business by HER.
Belgium
Belgium has implemented the "alternative infrastructure" provider provision
of the Full Competition Directive. The decision-making process regarding the
adoption of the full package of liberalization legislation (including licensing
regimes for voice telephony and public network infrastructure) is in the final
stages and is anticipated to be completed in early 1998. Given the fact that the
implementation of the EC Directives is late,
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the Belgian authorities have made public that they will work during the first
months of 1998 with a system of provisional licenses. HER has obtained, through
a wholly-owned subsidiary, a license from the Belgian regulatory authority to
provide liberalized services using alternative infrastructure and is currently
operating under its license in Belgium on the Brussels-Amsterdam route. HER also
has authorization to build infrastructure between major Belgian population
centers and the relevant border crossings. The liberalization legislation is
expected to require all previously licensed operators to apply for new licenses
or authorizations. HER expects that, in such event, its existing licenses and
authorizations would be renewed in due course, although there can be no
assurance that this will be the case.
Germany
Germany has approved legislation to implement the Full Competition
Directive and remove all remaining restrictions on competition from January
1998. HER was granted a license by the German regulatory authorities on July 18,
1997. The license permits HER to operate the portions of the network in Germany
connecting Dusseldorf, Frankfurt and Stuttgart; Dusseldorf to the Dutch border;
and Stuttgart to the French and Swiss borders. HER expects to extend its license
in Germany as appropriate in order to enable it to operate the remaining
portions of the network in Germany.
France
A new regulatory agency, the Autorite de Regulation des Telecommunications
("ART"), was established in France effective January 1, 1997. In 1996, France
approved legislation to implement the Full Competition Directive and to remove
all remaining restrictions on competition from January 1998. HER applied for an
authorization to operate its network in specific regions of France, which was
approved on October 22, 1997. In October 1997, HER obtained authorization to
operate its network in specific regions of France. Such authorization requires
prior notification to and approval of the ART of any substantial changes in the
capital of HER or its controlling shareholder.
Switzerland
The Swiss Parliament has recently passed a new Telecommunications Law which
will enter into force on January 1, 1998. Although Switzerland is not a Member
State of the EU, the effect of the law is largely to mirror the EC
telecommunications liberalization Directives and therefore from that date
existing voice telephony monopoly will be abolished and such services will be
fully liberalized. An independent national regulatory authority has previously
been established. HER obtained a trial concession on October 30, 1997, in order
to roll out its network and to provide its services in advance of the full
liberalization coming into effect on January 1, 1998. This concession expired on
December 31, 1997. However, the Swiss regulator has invited HER to submit a new
application for a concession and HER expects to obtain a permanent concession in
due course. No assurance can be given that such new concession will be granted
or granted on terms acceptable to HER.
Italy
Although in the past Italy has been dilatory in implementing EC
liberalization measures, Italy enacted legislation on July 31, 1997 which
substantially completes the liberalization of services in accordance with the
Full Competition Directive. The Parliament has also approved the creation of an
independent national regulatory authority for the telecommunications and
audiovisual sectors. The most recent EC liberalization Directives relating to
licensing and interconnection has been implemented. HER intends to apply for a
license to provide its services in due course.
Spain
Under the Full Competition Directive Spain was granted the right to request
a delay of up to five years in liberalizing fully its telecommunications market.
However, the Spanish government and the European Commission have agreed that
full liberalization should take place on December 1, 1998. In order to ensure
effective liberalization from that date, the Commission Decision granting the
eleven month extension sets out
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a timetable of interim measures leading up to full liberalization. These
measures include the passing of legislation authorizing regional cable operators
to provide telecommunications services and the adoption of a new General
Telecommunications Bill effectively transposing EC Directives into Spanish law.
Further RETEVISION, S.A. has been granted a second national operator's license
to compete with the national PTO and Spain has agreed to grant a third national
operator license in early 1998. HER intends to apply for a license to provide
its services in due course.
Sweden
Full liberalization of the Swedish telecommunications market occurred in
1993. A new Telecommunications Act was passed this year to reinforce the powers
of the national regulatory authority, to ensure conformity with EC Directives
and to supplement the pre-existing licensing regime with a general authorization
regime for services other than telephony services, mobile services and leased
lines. HER intends to register to provide its services in due course.
Denmark
With the liberalization of infrastructure from July 1, 1997 Denmark has
fully liberalized its telecommunications markets in accordance with the
requirements of the relevant EC Directives. An independent national regulatory
authority has been established. According to the Danish rules, HER will not
require any regulatory approval in order to install or operate the network in
Denmark.
GTS-MONACO ACCESS
GTS owns a 50% interest in and manages GTS-Monaco Access, a joint venture
with the Principality of Monaco created to develop Monaco's existing
international telecommunications infrastructure into an international gateway
hub for transport of international traffic to European and overseas
destinations. The Principality has constructed and operates a sophisticated
international gateway infrastructure that includes an international digital
switching center and a satellite earth station to support significant amounts of
carriers' carrier traffic. Through Monaco's network, GTS-Monaco Access is linked
to approximately 170 countries worldwide. GTS believes that this partnership
provides it with the opportunity to build a strong international gateway
operator in lucrative Western European markets.
GTS-Monaco Access offers competitively priced international switching and
transit services, primarily to the "wholesale" international gateway and
carrier-to-carrier portion of the international calling market, as distinguished
from "retail" services offered to end users. Basic service offerings include (i)
international switched traffic; (ii) international private lines; (iii)
facilities management, including billing, customer management and fault
reduction systems; (iv) resale distribution for Internet service providers; and
(v) prepaid calling card platform services.
With the cooperation of Monaco Telecom ("MT"), GTS-Monaco Access is
entitled to exercise the privileges of signatories to international treaties
such as the ITU, and to international satellite agreements, such as Intelsat,
Inmarsat and Eutelsat. Other signatories are generally PTOs and other
quasi-governmental telecommunications entities. GTS-Monaco Access purchases
capacity on international fiber routes at rates available only to recognized
operators which are substantially below the rates charged to other service
providers. These fiber-based facilities are an important element for GTS-Monaco
Access's core network and provide it with capacity that may be leased or resold
to customers. Monaco inaugurated its independent country code, 377, on June 21,
1996, which made it eligible for certain privileges, including special terms
(generally reserved for PTOs) in connection with transmission agreements,
transit agreements, settlements and low-cost accounting rates with select
carriers.
GTS's partner in GTS-Monaco Access is an investment fund designated by the
Principality of Monaco to represent its interests. GTS-Monaco Access functions
in cooperation with MT under a commercial agreement governing, among other
things, the terms of use of existing facilities, access to and acquisition of
new international infrastructure, and sales and marketing. GTS exercises
operational control of the joint venture, and provides managerial and financial
support, international telecommunications expertise and strategic
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planning. Neither GTS nor its partner is obligated to fund operations or capital
expenditures of GTS-Monaco Access. Losses and profits of GTS-Monaco Access are
allocated to the partners in accordance with their ownership percentages, in
consideration of funds at risk. As of September 30, 1997, GTS and its partner
had each made equity contributions of $0.8 million to GTS-Monaco Access. In
addition, GTS-Monaco Access had outstanding loans of $2.9 million to GTS as of
September 30, 1997. See "Management's Discussion and Analysis -- Accounting
Methodology -- Profit and Loss Accounting." The agreement between GTS-Monaco
Access and MT, by its terms, continues in operation until 2020.
BUSINESS AND MARKETING STRATEGY
GTS's strategy for developing GTS-Monaco Access into an international
gateway hub includes the following:
- Develop Advanced Carrier Services Offerings. GTS-Monaco Access may
develop its "advanced carrier services" offerings to include global 0800
services and international free phone services, which GTS believes will
broaden customer relationships, enhance revenues and help to protect it
from price-based competition.
- Develop Relationships to Broaden Service Offerings. GTS-Monaco Access may
develop relationships to broaden its service offerings. GTS-Monaco Access
has entered into agreements with UUNET, one of its gateway customers, to
provide wholesale Internet access to GTS-Monaco Access's carrier
customers in a number of Western European countries. The agreement allows
these services to be "cobranded" with GTS's affiliates.
- Pricing. Price is a critical factor in the market for international
switching as competition increases due to expanding international
capacity, advances in technology and falling regulatory barriers. GTS-
Monaco Access intends to price its services competitively with the
prevailing price for comparable inter-PTO transit and gateway services.
GTS-Monaco Access is not bound by legacy systems, infrastructure and
personnel levels and can, therefore, manage lower cost operations.
- Leverage Non-Aligned Position. Because GTS's Western European activities
are not allied with any of the major consortia or large Western European
telecommunications companies, and generally focus on carriers' carrier
services, GTS-Monaco Access will not compete with its carrier customers
in retail markets. This independence should make GTS-Monaco Access an
attractive service provider for Western European carriers who may
otherwise be reluctant to obtain services from the larger operators of
international gateways that are often their competitors in the retail
market.
- Exploit GTS Synergies. GTS-Monaco Access may ally with other GTS
companies in Europe and the CIS. GTS-Monaco Access is expected to realize
significant reductions in its cost structure through access to low-cost
pan-European transmission capacity through alternative infrastructure
providers such as HER, Sovintel and C-Datacom International, Inc., GTS's
Indian venture, already route international traffic through GTS-Monaco
Access's gateway.
CUSTOMERS
Targeted customers for GTS-Monaco Access include:
- Non-Aligned PTOs. GTS believes that various large American and Western
European PTOs that lack adequate international switching and transport
facilities of their own may be persuaded to purchase international
services from GTS-Monaco Access, rather than from competing PTOs or
consortia.
- Mobile Carriers. GTS believes that some of the non-PTO mobile carriers,
which currently provide only a small percentage of Western European
mobile telecommunications traffic, may prefer the "independent"
international gateway service offerings of GTS-Monaco Access to those of
their PTO competitors.
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- Internet Service Providers. Growth in Internet usage creates a
significant opportunity for a nonaligned Internet access provider such as
GTS-Monaco Access, since many Internet service providers will be in
direct competition with PTO-owned services in large European markets.
- Second Carriers/Resellers. GTS believes that many second carriers will
seek to enter new markets quickly without investing in international
switching capacity.
- Established ("Aligned") PTOs. This customer segment will be a niche
market for GTS-Monaco Access. As markets are deregulated and carriers
become increasingly competitive, traditional friendly correspondent
relations may become strained, and opportunities may emerge to leverage
GTS's non-aligned status to route traffic between rivals or to displace
incumbents for transit relationships.
- Other GTS Companies. GTS-Monaco Access currently provides gateway
services indirectly to Sovintel, CDI and other GTS companies that
aggregate traffic or provide international long distance services. It may
also provide these services to HER.
In January 1998, GTS-Monaco Access terminated its relationship with a major
traffic partner as a result of which GTS expects that the venture will lose
approximately $6 million of revenues in 1998. Although GTS-Monaco Access is
putting in place plans to replace such revenues from other sources, no assurance
can be provided that such revenues will be replaced in the current fiscal year.
NETWORK
GTS has enhanced MT's existing technology platform of digital switching,
fiber optic transmission, satellite and submarine cable facilities by
interconnecting this existing network infrastructure to multiple terrestrial
routes covering Europe and to undersea fiber optic cables connecting the
GTS-Monaco Access network to Asia and the Americas.
The network infrastructure of GTS-Monaco Access is complementary with that
of HER, with each serving the carriers' carrier market from different
perspectives; HER for bandwidth services and GTS-Monaco Access for switched call
terminations and other carrier services.
LICENSES AND REGULATORY ISSUES
Because it operates in coordination with MT, the licensed operator of the
Monaco public network, and in indirect partnership with the government,
GTS-Monaco Access's telecommunications activities in Monaco require no
telecommunications license.
Because the Principality of Monaco is not an EU member state, GTS-Monaco
Access's telecommunications activities in the Principality are not subject to
European law. However, GTS-Monaco Access will have to comply with EU regulation
to the extent it does business in EU member states. The regulatory requirements
established by the EU create general guidelines under which the national
agencies of EU member states regulate. Accordingly, local laws and regulations
may differ significantly among these jurisdictions, and the interpretation and
enforcement of such laws and regulations may vary. Local rules are sometimes
based on the informal views of the local ministries which, in some cases, are
subject to influence by the local PTOs. In certain of the Company's existing and
target markets, there are laws and regulations which affect the number and types
of customers which the Company can address. For instance, certain countries may
and do require licenses for communication companies to interconnect to the
public network to originate traffic.
In addition, one of the services provided by GTS-Monaco Access is a form of
transit service, known in the industry as "re-filing." Re-filing is the practice
of routing traffic through a third country in order to take advantage of
disparities in settlement rates between different countries, allowing traffic to
a potential country to be treated as if it originated in the third country that
enjoys lower settlement rates with the destination country, thereby resulting in
lower overall costs on an end-to-end basis. Re-filing is prevalent in the
industry even though the practice is technically in contravention of ITU
regulations. In practice, because of the widespread non-observance of these
regulations, such a contravention normally does not give rise to specific legal
problems. However, their enforceability essentially depends on the status given
to ITU obligations by
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Member countries' domestic laws. Accordingly, there can be no assurance that
GTS-Monaco Access's re-filing services might not be disrupted or be the subject
of legal process at some time in the future. In such event, within the EU a
defense may be available that the ITU regulations are anti-competitive and
contravene the Treaty of Rome, although there can be no certainty that such a
defense would succeed.
COMPETITION
GTS-Monaco Access faces competition from consortia of telecommunications
operators, large PTOs and other international telephone operators with advanced
network infrastructures, access to large quantities of long-haul capacity and
established customer bases. PTOs currently providing large amounts of
international traffic have already established direct routes, transit
arrangements and correspondent relations and many have excess capacity that they
resell in competition with GTS-Monaco Access.
With the advent of deregulation in the Western European telecommunications
markets in 1998, opportunities for the establishment of international gateways
will likely develop in Europe and as a result competition in the market for
GTS-Monaco Access's services will increase. During the first quarter of 1998,
GTS intends to evaluate various locations in Europe for the establishment of
international hubs based upon prospective costs and the availability of call
routing at these locations. GTS plans to locate these prospective points of
presence in cities served by HER and to allow the termination of traffic through
HER. GTS Monaco Access may benefit from the establishment of these points of
presence by incurring reduced transmission expenses.
While GTS believes that GTS-Monaco Access will be able to compete
effectively in certain identified market segments because most of its targeted
customers are in new and fast growing markets and have not established long-term
relationships with international gateway providers, and because it has equal
access to advanced infrastructure and international fiber routes, potential
access to low cost transport from HER and an "independent" status that allows it
to service a worldwide range of potential customers. GTS intends continually to
review the competitiveness of GTS-Monaco Access with respect to its competitors.
CENTRAL EUROPE
In Central Europe, GTS's objective is to become one of the leading
alternative telecommunications providers in the region. GTS currently provides
private data communications services to government and commercial customers in
Hungary and the Czech Republic. In the Czech Republic, the Company provides
outgoing voice services and operates an international gateway and a data
services network. In Hungary, GTS operates a VSAT network which GTS believes is
the largest VSAT network in Central Europe as measured by number of VSAT sites.
The Company has also signed an agreement to provide international data services
in Poland, subject to receipt of necessary governmental approvals. GTS's
strategy is to expand its service offerings as the regulatory environment
permits, leveraging its existing VSAT and international gateway infrastructure
where possible and providing a broad range of services to its target markets.
Hungary
GTS-Hungary. GTS-Hungary, a 99% owned subsidiary of GTS, is a leading
provider of customized data services offering high quality, reliable virtual
private network services to customers throughout Hungary and, through other GTS
affiliates, other countries in Central Europe. GTS-Hungary provides these
services through VSATs installed at customer sites throughout the country and a
microwave-based high speed overlay network for points in the Budapest
metropolitan area. Along with these data transmission services, GTS-Hungary
provides high quality customer service including (i) significant system
integration support in the initial implementation of the customers' networks and
in on-going expansion and improvements and (ii) a unique maintenance and
technical support service, which include "rapid response" service calls and
24-hour hub service operations support, which can be backed by financial
guarantees when required.
As of September 30, 1997, GTS-Hungary's VSAT network consisted of
approximately 935 owned and operated VSAT sites which the Company believes makes
it the largest VSAT-based network in Central Europe. GTS believes that its
choice of VSAT technology as a way of quickly deploying a full range of
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business services nationwide will allow it to capture key customers and market
segments. Such positioning, the Company believes, will enable GTS-Hungary to
expand its service offerings as the Central European market matures and as
regulatory authorities further privatize and deregulate the telecommunications
industry. GTS-Hungary is undertaking a nationwide expansion of its
microwave-based Budapest overlay network. The expansion will increase
GTS-Hungary's revenue base in the region and provide opportunities to leverage
further its other service offerings. There can be no assurance, however, that
the expansion will be completed on a timely and commercially feasible basis.
The Hungarian state lottery is GTS-Hungary's largest customer, accounting
for more than 54% of GTS-Hungary's VSAT revenue for the nine months ended
September 30, 1997. GTS-Hungary has also targeted its VSAT network services to
business customers in the domestic service industry and other government
organizations. Although GTS-Hungary continues to diversify its revenue and
customer base, the loss of the Hungarian state lottery as a customer would have
a material adverse effect on GTS-Hungary's business.
GTS-Hungary generally charges its data services customers a flat monthly
fee for a fixed amount of usage and usage-based fees for use above the
contractual amount. Customers are billed in Hungarian forints (indexed to U.S.
dollars) on a monthly basis. Pricing is generally determined for an individual
client based upon the size of traffic requirements. In general, GTS-Hungary's
strategy is to minimize the initial customer investment in order to lower the
barriers to purchase, while committing customers to long-term contracts.
GTS-Hungary's major competitors include BankNet, Hungaro-DigiTel and MATAV,
the Hungarian PTO, each of which operates a network with at least 200 VSAT
sites. MATAV offers a broad range of services and has recently targeted the
business sector that GTS serves. GTS believes that, while some of its
competitors have stronger financial resources, GTS-Hungary remains the leading
VSAT service provider in Hungary in terms of number of VSAT sites, the size and
quality of its infrastructure and the quality of its service. GTS also believes
it has distinguished itself from its competition by its superior customer
service.
Currently, all VSAT licenses in Hungary have been granted under temporary
telecommunications regulations. The temporary licenses prohibit connection to
public telecommunications networks or other international or domestic
data-transmitting systems. In December 1993, GTS received a temporary service
permit to provide data-transfer services utilizing a VSAT-based wireless
communications system throughout Hungary. In March 1997 the government issued
new telecommunications regulations which require all operations with temporary
licenses to apply for permanent licenses by the end of April 1997. GTS-Hungary
has submitted applications for the conversion of its temporary licenses to
permanent ones. While no assurances can be given, GTS expects permanent licenses
to be issued in due course. The failure to receive such licenses would have a
material adverse effect on the business of GTS-Hungary.
Neither GTS nor its partner in GTS-Hungary are obligated to fund operations
or capital expenditures of GTS-Hungary. Losses and profits of GTS-Hungary are
allocated to the partners in accordance with their ownership percentages, in
consideration of funds at risk. As of September 30, 1997, GTS had made equity
contributions of $9.5 million to GTS-Hungary, GTS' partner has not made any
equity contributions as of September 30, 1997. In addition, GTS-Hungary had
outstanding loans of $3.4 million to GTS as of September 30, 1997. See
"Management's Discussion and Analysis -- Accounting Methodology -- Profit and
Loss Accounting. Further, the joint venture does not have an expiration date.
EuroHivo. In addition to its network and data services, GTS also provides
nationwide paging services primarily to the retail consumer market through its
70% owned joint venture, EuroHivo. GTS has concluded that EuroHivo is not a core
business and is currently assessing offers to sell its interests in EuroHivo. In
connection with this anticipated divestiture, the Company wrote-off its
investment in EuroHivo in the third quarter of 1997. See "Management's
Discussion and Analysis -- Results of Operations -- Consolidated Ventures."
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Czech Republic
The Czech Companies. The Czech Companies, which consist of two wholly owned
subsidiaries of GTS, offer the only alternative international telephony service
in the Czech Republic, as well as a full range of private data services,
delivered through a combination of a fully digital microwave overlay network and
an international satellite gateway in Prague and GTS-Hungary's VSAT network.
Through an intercompany arrangement with GTS-Hungary, the Czech Companies
provide all of the same VSAT services offered by GTS-Hungary. In addition, the
Czech Companies offer high-speed Internet access service and are among the
leading Internet access providers in the Czech Republic. The Czech Companies
seek to become the second carrier in the Czech Republic and are also targeting
opportunities in Slovakia, based upon the historic relationship between the
Czech and Slovak markets.
The Czech Companies network consist of an earth station linked to
GTS-Monaco Access and to British Telecom, a series of point-to-point and
point-to-multipoint microwave connections providing dedicated access to the
buildings served by the Czech Companies and individual VSATs based on, and
controlled by, GTS-Hungary's hub in Budapest.
The Czech Companies target customers include real estate developers, hotels
and multinational companies which require international voice or data services
or Internet connectivity, where both GTS's own services and the services of GTS
partners are sold. The Czech Companies provide outgoing international voice
services and high-speed Internet access to large commercial buildings in Prague.
As of September 30, 1997, the Czech Companies had concluded agreements with
building owners to convert PABXs in 23 buildings in Prague. International voice
services are offered at prices similar to those of the Czech PTO. The Czech
market for VSAT services is extremely competitive, with prices at approximately
50% of those in Hungary for basic services. The Czech Companies plan to pursue
customers who require value-added services which may be offered at higher prices
and better margins.
The Czech Companies are licensed to provide international satellite and
domestic private voice and data services. They received their operating licenses
in 1994 and 1995 and began offering services in 1995. The licenses grant
permission to install and operate up to 150 earth stations and, upon
application, an additional 150 earth stations. The licenses currently prohibit
the provision of switched voice services and the interconnection to public
voice, telex and data networks and telecommunications networks of other
providers.
The Czech Companies are the only alternative international telephony
provider licensed in the Czech Republic. As such, their only competitor is SPT
Telecom, the Czech PTO. Should SPT decide to compete aggressively with the Czech
Companies, it has the ability to discount prices below those which could be
easily sustained by the Czech Companies. In data services, Telenor, GITY and
Nextel (a subsidiary of SPT Telecom) are the Czech Companies' three major
competitors for data services in the Czech Republic. GTS believes that its
experience in establishing VSAT services in the region and its emphasis on
integrated voice and data services provides the Czech Companies with a
competitive advantage. Additionally, GTS's transmission facilities and
infrastructure in Hungary and Monaco provide them with a relatively low cost
infrastructure and, as a consequence, greater pricing flexibility than their
competitors. With respect to Internet services, GTS believes that, although this
market consists of a large number of small providers and that SPT Telecom will
seek to enter this market, the dedicated, high-speed infrastructure that the
Czech Companies are installing will provide superior services to its customers.
ASIA
Chinese law generally prohibits foreign investment or participation in the
operation of telecommunications services, while Indian law requires foreign
telecommunications operators to conduct certain telecommunications businesses,
including basic switched telephony and cellular services, through joint ventures
that are at least 51% owned by Indian partners. GTS believes that these
restrictive regulations will eventually be liberalized and that its early entry
into these markets and its strong relationships with influential commercial
firms and with local, regional and national-level government entities will
provide it with a strong competitive advantage over competitors that await more
explicit regulatory regimes authorizing direct telecommunications investments.
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China
GTS participates in the nationwide tourist industry VSAT network through
GTS China Investments LLC, a company in which GTS holds a 75% interest and an
affiliate of the Soros Foundations owns a 25% interest. See "Certain Related
Party Transactions." GTS China Investments LLC holds an indirect 63% interest in
Beijing Tianmu Satellite Communications Technology Co. Ltd. ("Beijing Tianmu"),
which provides technical, operational and financial support for the VSAT
network. In addition, through Shanghai V-Tech Telecommunications Systems Co.,
Ltd. ("V-Tech"), a venture in which GTS holds a 75% interest, the Company
provides financing, operational consulting, technical and engineering services
to a Shanghai-based VSAT network operator.
With respect to V-Tech, in addition to the Company's initial equity
contribution of $3.75 million, GTS committed to fund up to an additional $3.0
million (all of which has been funded as of September 30, 1997). The joint
venture expires in April 2015, and profits and losses are allocated according to
ownership interests in consideration of funds at risk. See "Management's
Discussion and Analysis -- Accounting Methodology -- Profit and Loss
Accounting." GTS currently is evaluating adding additional partners to V-Tech
which may reduce GTS's ownership interest in V-Tech.
With respect to Beijing Tianmu, in addition to the Company's initial equity
contribution of $8.75 million, GTS is responsible for arranging additional
financing of up to $14.4 million, subject to the approval of the venture's Board
of Directors, the majority of members of which are elected by GTS. The joint
venture expires in March 2021, and profits and losses are allocated according to
ownership interests, in consideration of funds at risk. See "Management's
Discussion and Analysis -- Accounting Methodology -- Profit and Loss
Accounting."
India
In India, GTS is following the strategy it implemented in Moscow and is
currently pursuing in Central Europe, in which it initially penetrates the
telecommunications market by developing satellite-based international gateway
networks to provide telecommunications services to targeted business customers.
GTS's operations in India are conducted through C-Datacom International, Inc.
("CDI"), a wholly owned subsidiary which provides digital international private
line communications to and from India for multiple applications, including data
and voice. While not permitted to provide telephony services, CDI is currently
in the process of installing an international gateway switch adjacent to
GTS-Monaco Access's international gateway for the purpose of handling
international traffic.
EMPLOYEES
On September 30, 1997, GTS employed a total of 166 persons. On September
30, 1997, the joint ventures in which GTS participates employed approximately
1,400 persons. The Company believes its future success will depend on its
continued ability to attract and retain highly skilled and qualified employees.
The Company believes that its relations with its employees are good.
Although GTS's employees are not unionized, unions represent employees of
the Company's railroad partners in HER. Under the agreements contemplated
between HER and its railroad partners, some of these employees will be required
to construct and maintain certain portions of the HER network. There can be no
assurances that unionized employees of HER's partners will not experience labor
unrest.
PROPERTIES
The Company's physical properties include owned and leased space for
offices, storage and equipment rooms and collocation sites. Additional equipment
rooms will be leased as networks are expanded. GTS maintains regional
headquarters offices in Moscow and Budapest, as well as facilities in McLean,
Virginia and London. HER is headquartered just outside of Brussels, Belgium.
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LITIGATION
In addition to routine legal proceedings incidental to the conduct of its
business, the Company, GTS-Hungaro and GTS-Hungary are named as defendants in an
action captioned USH Ventures and USH Telecom, L.L.C. v. Global TeleSystems
Group, Inc. and GTS-Hungaro, Inc., Civil Action No. 97C-08-86, commenced in
August 1997, which is currently pending in the Superior Court of the State of
Delaware in and for New Castle County. The complaint alleges breach of contract
and interference with a business relationship. While it is not possible at this
time to make a meaningful assessment of the outcome of this litigation, based
upon information currently available and upon consultation with counsel, the
Company does not believe that the outcome of this litigation will have a
material adverse effect upon the financial condition of the Company.
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MANAGEMENT
The directors, executive officers and key employees of the Company, their
positions and their ages are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITIONS
---- --- ---------
<S> <C> <C>
Alan B. Slifka(1)(3)(4)(7).............. 68 Chairman of the Board of Directors
Gerald W. Thames(1)(6).................. 50 President, Chief Executive Officer and Director
Bruno d'Avanzo.......................... 56 Executive Vice President and Chief Operating
Officer
William H. Seippel...................... 41 Executive Vice President of Finance and Chief
Financial Officer
Jan Loeber.............................. 53 Senior Vice President -- HER
Raymond I. Marks........................ 51 Senior Vice President -- Asia
Stewart P. Reich........................ 53 Senior Vice President -- Russia
Louis T. Toth........................... 55 Senior Vice President -- Central Europe
Grier C. Raclin......................... 45 Senior Vice President, General Counsel and
Secretary
Eileen K. Sweeney....................... 46 Senior Vice President -- Human Resources
Kevin Power............................. 44 Managing Director -- GTS-Monaco Access
Gary Gladstein(2)(5).................... 52 Director
Michael A. Greeley(4)(6)................ 34 Director
Bernard McFadden(3)(7).................. 64 Director
Stewart J. Paperin(2)(3)(7)............. 49 Director
W. James Peet(1)(4)(6).................. 42 Director
Jean Salmona(3)(5)...................... 61 Director
Morris A. Sandler(2)(4)(5).............. 51 Director
Joel Schatz(2)(6)....................... 60 Director
Adam Solomon(2)(4)(5)................... 44 Director
</TABLE>
- - ---------------
(1) Member of Executive Committee
(2) Member of Audit Committee
(3) Member of Compensation Committee
(4) Member of Finance Committee
(5) Term expires at annual meeting of stockholders in 1998
(6) Term expires at annual meeting of stockholders in 1999
(7) Term expires at annual meeting of stockholders in 2000
Biographical information on each of the foregoing officers follows:
Alan B. Slifka, Chairman of the Board of Directors. Mr. Slifka has served
as a director of GTS since 1990. Mr. Slifka is a New York investment banker and
the Managing Principal of Halcyon/Alan B. Slifka Management Company LLC, an
equity asset management firm specializing in nontraditional investments,
specifically corporate event investing. Previously, Mr. Slifka was a partner of
L.F. Rothschild, Unterberg, Towbin from 1961 to 1982. He is a director of Pall
Corporation and is active in other business, civic and philanthropic affairs as
founder, director or officer of numerous for-profit and not-for-profit
corporations and foundations. Mr. Slifka served as acting Chief Executive
Officer of GTS during most of 1993.
Gerald W. Thames, President, Chief Executive Officer and Director. Mr.
Thames joined GTS as Chief Executive Officer in February 1994, and has served as
a director of GTS since February 1994. From 1990 to 1994, Mr. Thames was
President and Chief Executive Officer for British Telecom North America and
Syncordia, a joint venture company focused on the international outsourcing
market. Mr. Thames has spent over 18 years in senior positions with
telecommunications companies, where he was responsible for developing start-up
telecommunications companies, including 15 years with AT&T, where he rose to the
position of General Manager of Network Services for the Northeast Region of AT&T
Communications.
Bruno d'Avanzo, Executive Vice President and Chief Operating Officer. Mr.
d'Avanzo joined GTS as Executive Vice President and Chief Operating Officer in
August 1996. From 1994 to 1996, Mr. d'Avanzo was Executive Vice President and
Chief Operating Officer of Intelsat, the largest telecommunications satellite
operator in the world. From 1992 to 1994, Mr. d'Avanzo was a senior executive
with Olivetti Corporation, serving as Vice President and General
Manager -- Europe and as Vice President -- U.S., Canada and South
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America. Mr. d'Avanzo also spent 15 years with Digital Equipment Corporation, a
diversified computer manufacturer where his last position was Vice
President -- European Sales and Marketing.
William H. Seippel, Executive Vice President of Finance and Chief Financial
Officer. Mr. Seippel joined GTS as Executive Vice President of Finance and Chief
Financial Officer in October 1996. From July 1992 to October 1996, Mr. Seippel
was Vice President -- Finance and Chief Financial Officer of Landmark Graphics
Corporation. From August 1990 to July 1992, Mr. Seippel was Director of Finance
for Covia, Inc., an affiliate of United Airlines. From April 1984 to August
1990, Mr. Seippel held the positions of Group Business Controller (1989 to
1990), Group Controller Sales/Marketing (1986 to 1989), and Product Line
Controller (1984 to 1986) with Digital Equipment Corporation, a diversified
computer manufacturer.
Jan Loeber, Senior Vice President -- HER. Mr. Loeber joined GTS in January
1995. From October 1992 to December 1994, Mr. Loeber was a Managing Director of
BT Securities Corporation. From April 1990 to September 1992, Mr. Loeber held
positions as Managing Director of Unitel Ltd. (now One 2 One) in the United
Kingdom, Group President of Nokia North America Inc., Vice President of ITT
Corporation, and Marketing and Product Management Director of ITT Europe. Mr.
Loeber also spent almost 10 years with AT&T, where his last position was
Executive Director, Bell Laboratories. Mr. Loeber has over 22 years of
experience in the telecommunications industry and an additional 9 years of
experience in information technology with the Pentagon, IBM and Chemical Bank of
New York.
Raymond I. Marks, Senior Vice President -- Asia. Mr. Marks joined GTS as
Senior Vice President -- Asia in July 1994. From October 1986 to June 1994, Mr.
Marks served as Vice President and General Manager of GTE Spacenet Corporation,
where he had overall responsibility for strategic planning, domestic and
international business development, creation of joint ventures and international
alliances, as well as the worldwide management of the marketing, sales and
technical support organizations. Mr. Marks has also served as Vice President for
the Digital Information Group for MCI Communications Corporation. Mr. Marks has
28 years of experience in the telecommunications and computer industries.
Stewart P. Reich, Senior Vice President -- Russia. Mr. Reich joined GTS as
President -- GTS Russia in September 1997. From September 1992 to August 1997,
Mr. Reich was President of UTEL, a joint venture of AT&T, Deutsche Telekom, PTT
Telecom (Netherlands), and Ukrtelecom (a Ukrainian telecommunications company)
which provides international and interregional telecommunications services in
Ukraine. From 1982 to 1992, Mr. Reich held various positions at AT&T where his
last position was Financial Manager, AT&T International Communications Switched
Services. Mr. Reich was also employed for 20 years with Western Electric Company
from 1961 to 1981.
Louis T. Toth, Senior Vice President -- Central Europe. Mr. Toth joined GTS
as Senior Vice President -- Central Europe in July 1993. From February 1987 to
July 1991, Mr. Toth served as President of Dynaforce Inc. and as Partner and
General Manager for the pan-European expansion of Andlinger & Company. Mr. Toth,
who is currently based in London, has 23 years of telecommunications experience
with ITT Corporation in Europe, Latin America and Asia.
Grier C. Raclin, Senior Vice President and General Counsel. Mr. Raclin
joined GTS as its Senior Vice President and General Counsel in September, 1997,
and was elected Secretary of the Company in December 1997. Prior to joining GTS,
Mr. Raclin served as Vice-Chairman and a Managing Partner of the Washington,
D.C. office of Gardner, Carton & Douglas, a 250-attorney, corporate law firm
based in Chicago, Illinois, where his practice was concentrated in the area of
international telecommunications. Mr. Raclin received his undergraduate and law
degrees from Northwestern University and attended the University of Chicago
School of Business Executive Program.
Eileen K. Sweeney, Senior Vice President -- Human Resources. Ms. Sweeney
joined GTS as Senior Vice President -- Human Resources in November, 1997. Prior
to joining GTS, Ms. Sweeney was President of Global Resource Associates, a
consulting company specializing in international human resource issues. Prior to
that time, Ms. Sweeney spent 10 years with ITT Corporation in a variety of human
resource management positions, including eight years based in Europe and in the
Middle East. Ms. Sweeney holds a Master's Degree in Business Administration from
Simmons Graduate School of Management in Boston.
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<PAGE> 95
Kevin Power, Managing Director -- GTS Monaco Access. Prior to joining GTS
Monaco Access in October 1995, Mr. Power was Vice President, Carrier Relations
for the Company beginning in November 1994, where he was responsible for
assisting and coordinating the carrier activities of the GTS group of companies.
In 1988, Mr. Power was one of a group of five people who started the commercial
operations of Orion Network Systems and he stayed with the company until the
launch of its first satellite in 1994. His last position there was Vice
President of Carrier Services. Prior to that, he held positions with INTELSAT,
National Economic Research Associates (NERA) and the U.S. Department of
Commerce.
Biographical data on each of the directors, other than Mr. Thames, are as
follows:
Gary Gladstein, Director. Mr. Gladstein has served as a director of GTS
since December 1990. Mr. Gladstein is a Managing Director of Soros Fund
Management, an investment advisory firm with which he has been associated since
1985. Mr. Gladstein is also a director of Crystal Oil, Jos. A. Bank Clothier,
Inversiones y Representaciones S.A., Cresud S.A., Emerging Dolphin Fund and
Argentina High Yield and Capital Appreciation Fund Ltd.
Michael A. Greeley, Director. Mr. Greeley has served as a director of GTS
since September 1996. Mr. Greeley is the Senior Vice President of GCC
Investments, Inc., the investment group of GC Companies, Inc. From June 1989 to
July 1994, Mr. Greeley was a Vice President at Wasserstein Perella & Co., Inc.,
an international investment bank, specializing in mergers and acquisitions and
corporate finance transactions. Mr. Greeley is also a director of Teletrac,
Inc., Crescent Communications and American Capital Access Holdings, LLC. By
contractual arrangement, GCC Investments, Inc. has the right to designate one
person for nomination to the Board of Directors as long as it holds not less
than two and one-half percent of the issued and outstanding shares of the Common
Stock on a fully diluted basis. Mr. Greeley is the designee of GCC Investments,
Inc. to the Board of Directors.
Bernard McFadden, Director. Mr. McFadden has served as a director of GTS
since February 1994. Mr. McFadden currently serves as an independent consultant
for GTS and is a GTS representative on the supervisory board of HER. Mr.
McFadden's career in international telecommunications includes 32 years with ITT
Corporation, where he served as President and Chief Executive Officer of ITT's
Telecom International Group, and a four and one-half year assignment as
President and Chief Operating Officer of Alcatel Trade International, S.A.
Stewart J. Paperin, Director. Mr. Paperin has served as a director of GTS
since March 1997. Mr. Paperin serves as Executive Vice President of The Open
Society Institute, a charitable foundation associated with George Soros. In
addition, he has served as the President of Capital Resource East since October
1993. Prior to that, Mr. Paperin was President of Brooke Group International,
from 1990 to 1993 where he was responsible for investments in the former Soviet
Union. Mr. Paperin also served as Chief Financial Officer of Western Union
Corporation from 1989 to 1990. Mr. Paperin serves as a director of the Board of
Penn Octane Corporation.
W. James Peet, Director. Mr. Peet has served as a director of GTS since
January 1996. Mr. Peet has been affiliated with The Chatterjee Group, an
investment firm, since 1991. Mr. Peet is a director of three public companies:
Viatel Global Communications, Phoenix Information Systems, and Primus
Telecommunications, Inc. and several private companies. Immediately prior to
joining The Chatterjee Group, Mr. Peet spent six years with McKinsey & Company.
By contractual arrangement, The Chatterjee Group has the right to designate one
person for nomination to the Board of Directors to serve a term of five years.
Mr. Peet is the designee of The Chatterjee Group to the Board of Directors.
Jean Salmona, Director. Mr. Salmona has served as a director of GTS since
March 1996. Since 1989, Mr. Salmona has been Chairman and Chief Executive
Officer of CESIA Consulting Group ("CESIA"), a consulting concern based in
France that specializes in information and communications systems and
technologies. Mr. Salmona is also Chairman and Director General, Data for
Development International Association, a nongovernmental organization with
consultative status to the United Nations Economic and Social Council; and a
member of the board of directors of CESYS, a joint venture between CESIA and
COGEMA, the French State company which processes nuclear waste.
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<PAGE> 96
Morris A. Sandler, Director. Mr. Sandler has served as a director of GTS
since 1990. Mr. Sandler has been a consultant to GTS since November 1995. Prior
to that, Mr. Sandler was Executive Vice President of GTS from February 1994 to
November 1995, and acting Chief Operating Officer from April 1993 to February
1994. From August 1990 to April, 1993, Mr. Sandler was an employee of Alan B.
Slifka and Company. Since November 1995, Mr. Sandler has been a principal of
Pennwood Capital Corporation, a venture capital investment and management firm.
He has served as director of Baltic International USA, Inc. since 1995.
Joel Schatz, Director. Mr. Schatz has served as a director of GTS since the
inception of the Company. Mr. Schatz was a founder of the Company and served as
its President from 1985 to 1991. Mr. Schatz is presently the Chairman and Chief
Executive Officer of Datafusion, Inc., a company developing software to
accelerate knowledge synthesis.
Adam Solomon, Director. Mr. Solomon has served as a director of the Company
since June 1995. Mr. Solomon is also Chairman of Shaker Investments, Inc., a
growth equity investment firm and Chairman of Signature International, L.P., a
venture/development firm whose initial focus is redeveloping existing
residential/golf communities, and a member of the board of directors of MetaSolv
Software, Inc. Prior to that, Mr. Solomon spent eleven years with E.M. Warburg,
Pincus & Co., Inc., where he was Managing Director from 1988 to 1992. While at
E.M. Warburg, Pincus & Co., Inc., Mr. Solomon served as a member of the board of
directors of LCI International, Inc., a regional long-distance carrier.
EXECUTIVE COMPENSATION AND OTHER INFORMATION
COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS
Prior to the completion of the Offerings, each director of GTS received an
annual director's fee of $10,000. In addition, each director of GTS who attended
any meetings of the Board of Directors was entitled to receive a director's fee
of $1,000 for each such meeting, and each director of GTS who attended a
committee meeting was entitled to a directors' fee of $750 for each such
committee meeting.
Upon completion of the Offerings, each director of GTS will receive an
annual directors' fee of $15,000. In addition, the fee for attending any meeting
of the Board of Directors will increase to $1,500 per meeting, except for
telephonic Board of Directors meetings of two hours or less, where the fee will
be decreased to $750 for each such meeting. Similarly, upon the completion of
the Offerings, each director who attends a committee meeting will be entitled to
a directors' fee of $1,000 per meeting, except for telephonic committee meetings
of a duration of two hours or less, for which a fee of $500 will be paid.
For the year ended December 31, 1996, the aggregate compensation paid by
the Company to its directors and executive officers for services in all
capacities was approximately $3.1 million.
GTS maintains the Global TeleSystems Group, Inc. Non-Employee Directors'
Stock Option Plan that permits directors to share in the growth of the value of
GTS through the grant and exercise of nonqualified stock options. See "-- Global
TeleSystems Group, Inc. Non-Employee Directors' Stock Option Plan."
GLOBAL TELESYSTEMS GROUP, INC. NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN
The purpose of the Global TeleSystems Group, Inc. Non-Employee Directors'
Stock Option Plan (the "Directors' Plan") is to permit eligible non-employee
directors of GTS (each a "Non-Employee Director") to share in the growth of the
value of GTS through the grant and exercise of nonqualified stock options.
The total number of shares of Common Stock presently reserved and available
for delivery under the Directors' Plan is 375,000, subject to adjustment upon
certain changes in capitalization. Upon completion of the Offerings, an
additional 900,000 shares of Common Stock, totalling 1,275,000 shares, will be
reserved and available under the Directors' Plan. The Directors' Plan is
administered by the compensation committee of the Board of Directors (the
"Committee"). Only directors of GTS who are not employees of GTS or any
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<PAGE> 97
subsidiary of GTS on the date on which an option is to be granted are eligible
to participate in the Directors' Plan on such date.
An option (a "Directors' Option") to purchase shares of Common Stock was
granted to each Non-Employee Director on the effective date of the Directors'
Plan and a Director's Option is granted to each new Non-Employee Director when
he or she is first elected or appointed to serve as a director of GTS. One-half
of the Directors' Options vests six months after the date of grant. An
additional one quarter become exercisable on the date six months following the
first annual meeting of GTS's shareholders to occur after such date of grant,
and the remaining one quarter shares become exercisable on the date six months
following the second annual meeting of GTS's shareholders to occur after such
date of grant. Prior to the completion of the Offerings, initial Directors'
Options represented 18,000 shares of Common Stock. After the completion of the
Offerings, an initial Directors' Option will represent 22,250 shares of Common
Stock. On the date of the third annual meeting of GTS's shareholders following
the grant of the initial Directors' Options to any Non-Employee Director,
provided that such Non-Employee Director remains an incumbent on such date, an
additional Directors' Option to purchase 13,500 shares of Common Stock is
granted to such Non-Employee Director. The second Directors' Options become
exercisable with respect to 4,500 shares on the date six months after the date
of grant, with respect to an additional 4,500 shares on the date six months
following the first annual meeting of GTS's shareholders to occur after such
date of grant, and with respect to the final 4,500 shares on the date six months
following the second annual meeting of GTS's shareholders to occur after such
date of grant. After the completion of the Offerings, on the date of each annual
meeting of GTS's shareholders, an additional Directors' Option to purchase 9,000
shares will be granted each year on the date of the Company's annual meeting to
the individuals who will serve as elected Non-employee Directors of the Company
during the next year.
Directors' Options are nonqualified stock options which are subject to
certain terms and conditions including those summarized below. The exercise
price per share of Common Stock purchasable under a Directors' Option will be
equal to 100% of the fair market value of Common Stock on the date of grant.
Each Directors' Option will expire upon the earliest of (a) the tenth
anniversary of the date of grant, (b) one year after the Non-Employee Director
ceases to serve as a director of GTS due to death or disability, (except that,
in the case of disability, if the Non-Employee Director dies within that
one-year period, the Directors' Option is exercisable for a period of one year
from the date of death), (c) three months after the Non-Employee Director ceases
to serve as a director of GTS for any reason other than death or disability,
(except that, if the Non-Employee Director dies within that three-month period,
his or her Directors' Options are exercisable for a period of one year from the
date of such death), and (d) three months after the Non-Employee Director ceases
to be employed by GTS if such Non-Employee Director had become an employee of
GTS (except that, if the Non-Employee Director dies within that three-month
period, his or her Directors' Options are exercisable for a period of one year
from the date of such death). Each Directors' Option may be exercised in whole
or in part by giving written notice of exercise to GTS specifying the Directors'
Option to be exercised and the number of shares to be purchased. Such notice
must be accompanied by payment in full of the exercise price in cash or by
surrender of shares of Common Stock or a combination thereof. Directors' Options
granted under the Directors' Plan may not be sold, pledged, assigned or
otherwise disposed of in any manner other than by will or by the laws of descent
and distribution.
At the time of grant, the Board of Directors may provide in connection with
any grant made under the Directors' Plan that the shares of Common Stock
received as a result of such grant are subject to a right of first refusal by
GTS.
The Board of Directors may amend, alter, suspend, discontinue or terminate
the Directors' Plan at any time, except that any such action will be subject to
the approval of GTS shareholders at the next annual meeting following such Board
of Directors' action if such shareholder approval is required by any federal or
state law or regulation or the rules of any stock exchange or automated
quotation system on which Common Stock may then be listed or quoted, or if the
Board of Directors determines in its discretion to seek such shareholder
approval.
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<PAGE> 98
EXECUTIVE COMPENSATION
The following table sets forth each component of compensation paid or
awarded to, or earned by, the chief executive officer and the four most highly
compensated executive officers other than the chief executive officer serving as
of December 31, 1996 (collectively, the "Named Executive Officers") for the year
ended December 31, 1996.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
-----------------------
ANNUAL COMPENSATION AWARDS
----------------------- -----------------------
RESTRICTED SECURITIES
PAID OTHER ANNUAL STOCK UNDERLYING ALL OTHER
NAME AND PRINCIPAL SALARY BONUS COMPENSATION AWARD(S) OPTIONS COMPENSATION
POSITION ($) ($) ($) ($) (#) ($)(7)
------------------ -------- -------- ------------ ---------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C>
Gerald W. Thames,.......... $325,000 $113,750 (1) -0- 112,500(5) 9,954
President and Chief
Executive Officer
Jan Loeber,................ 235,000 78,608 74,642(4) 30,000(8) 3.5(6) 12,986
Senior Vice President --
HER
Raymond I. Marks,.......... 230,091 46,200 (1) -0- 55,500(5) 13,788
Senior Vice President --
Asia
Henry A. Radzikowski,...... 208,750 42,000 226,060(2) -0- 55,500(5) 12,986
Senior Vice President and
Chief Executive
Officer -- CIS Operations
Louis T. Toth,............. 203,937 40,950 33,602(3) -0- 43,500(5) 13,004
Senior Vice President --
Central Europe
</TABLE>
- - ---------------
(1) Perquisites and other personal benefits paid to the Named Executive Officer
during fiscal year 1996 were less than the lesser of $50,000 and 10 percent
of the total of annual salary and bonus reported for the Named Executive
Officer.
(2) Mr. Radzikowski received a cost of living allowance totalling $96,000 during
fiscal year 1996. In addition, GTS paid approximately $122,376 in housing
expenses on behalf of Mr. Radzikowski. Mr. Radzikowski's successor as Chief
Executive Officer -- CIS and Eastern Europe Operations was Mr. Reich. Mr.
Radzikowski resigned in the second quarter of 1997.
(3) These amounts represent a cost of living allowance of $27,500 and paid home
leave of $6,102 paid to Mr. Toth during fiscal year 1996.
(4) Mr. Loeber received a cost of living allowance and paid home leave during
fiscal year 1996. HER provided Mr. Loeber with a tax equalization that
compensates him for the higher taxes he pays because he resides in Belgium
instead of the United States. Furthermore, HER provided Mr. Loeber with a
housing allowance equal to $31,836 per year (converted from Belgian Francs
to U.S. Dollars at an exchange rate of BF32.0392 = $1.00). In addition, HER
provides Mr. Loeber with the use of a company car.
(5) Stock options awarded under the 1992 Stock Option Plan.
(6) Stock options awarded under the GTS-Hermes Plan.
(7) Amounts hereunder represent premiums paid by GTS for $1,000,000 in term life
insurance for each Named Executive Officer and contributions by GTS under
the 401(k) Plan to each Named Executive Officer's account.
(8) Shares of restricted stock that vest in an amount of one-third each year for
three years beginning on January 2, 1997.
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<PAGE> 99
THE GTS 401(k) PLAN
The GTS 401(k) Plan (the "401(k) Plan") is a defined contribution
retirement benefit plan that is qualified for favorable tax treatment under
Section 401 of the Code. All employees of GTS, including the Named Executive
Officers, who are at least 21 years of age and have completed the minimum
service requirement are eligible to participate in the 401(k) Plan. The 401(k)
Plan participants may defer pre-tax income by contributing to the plan up to the
maximum amount permitted by law. After-tax contributions are also permitted
under the 401(k) Plan. GTS matches 50% of each participant's pre-tax
contribution to the 401(k) Plan up to 5% of the participant's total
compensation. In addition, GTS may, in its sole discretion and in a
nondiscriminatory manner, contribute additional amounts as profit sharing to
each participant's account. The amounts that are deposited into each
participant's account are invested among various investment options according to
the direction of the participant. Each participant's pre-tax and after-tax
contributions are immediately vested and nonforfeitable. GTS's matching
contribution and profit sharing allocations to each participant's account do not
vest until the participant has completed three years of service with GTS, at
which time the matching contribution and profit sharing allocations become 100%
vested. Each participant is eligible to begin receiving benefits under the
401(k) Plan on the first day of the month coincident with or following the
attainment of normal retirement age. There is no provision for early retirement
benefits under the 401(k) Plan.
THE SFMT, INC. EQUITY COMPENSATION PLAN
The purpose of the SFMT, Inc. Equity Compensation Plan (the "Equity
Compensation Plan") is to attract, retain and motivate key employees, officers
and eligible independent contractors of GTS and to enable such individuals to
own Common Stock and to have a mutuality of interest with other shareholders of
GTS through the grant of restricted stock and other equity-based awards.
The total number of shares of Common Stock that may be issued or
transferred under the Equity Compensation Plan is four percent of the total
number of shares of Common Stock outstanding at the beginning of the calendar
year, subject to certain adjustments, which are described below. This threshold
number may be increased by the number of shares (a) that were issued under the
Equity Compensation Plan with respect to which no dividends were paid and (b)
that were subsequently forfeited, in accordance with the terms of the Equity
Compensation Plan.
The Equity Compensation Plan is administered by the Committee. The chief
executive officer of GTS has the authority to recommend the individuals to whom
awards will be granted, subject to approval by the Committee. The Committee has
full and binding authority to determine the fair market value of the Common
Stock and the number of shares included in any awards, to establish terms and
conditions of any award, to interpret the Equity Compensation Plan, to prescribe
rules relating to the Equity Compensation Plan and to make all other
determinations necessary to administer the Equity Compensation Plan. The
Committee may condition the vesting of restricted stock upon the attainment of
specified performance goals or such other factors as the Committee may determine
in its sole discretion. In the event that the Committee determines, in its sole
discretion, that an award of restricted stock would not be appropriate with
respect to any individual who has been recommended for an award by the chief
executive officer, the Committee has the authority to grant to any such
individual any other variety of equity-based compensation award, including, but
not limited to, phantom stock, phantom units, stock appreciation rights,
performance shares and performance units. The Committee does not, however, have
the authority to grant stock options pursuant to the Equity Compensation Plan.
Grants under the Equity Compensation Plan are determined by the Committee
in its sole discretion. For this reason, it is not possible to determine the
benefits or amounts that will be received by any individual employee or group of
employees in the future. The Equity Compensation Plan will remain effective
until November 14, 2004, unless earlier terminated by GTS. No restricted stock
may be granted under the Equity Compensation Plan on or after November 14, 2000.
During a specified period set by the Committee commencing with the date of
any restricted stock award, the participant is not permitted to sell, transfer,
pledge or otherwise encumber shares of restricted stock.
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Within these limits, the Committee, in its sole discretion, may provide for the
lapse of such restrictions or may accelerate or waive such restrictions in whole
or in part, based on service, performance and such other factors. Unless the
Committee specifically determines otherwise, a restricted stock award granted
under the Equity Compensation Plan vests one-third on the second anniversary of
the date of grant, one-third on the third anniversary of the date of grant and
one-third on the fourth anniversary of the date of grant.
The Committee may impose such other restrictions on shares of Common Stock
issued under the Equity Compensation Plan, including a right of first refusal by
GTS that requires the participant to offer GTS any shares that the participant
wishes to sell.
The Equity Compensation Plan provides that, in the event of a change to the
Common Stock (whether by reason of merger, consolidation, reorganization,
recapitalization, stock dividend, stock split, combination or exchange of
shares, or other change in the capital structure made without receipt of
consideration), the Board of Directors will preserve the value of outstanding
awards by making certain equitable adjustments in its discretion.
The Board of Directors may amend, alter, suspend, discontinue or terminate
the Equity Compensation Plan at any time, except that any such action will be
subject to the approval of GTS shareholders at the first annual meeting
following such action if such shareholder approval is required by any federal or
state law or regulation or the rules of any stock exchange or automated
quotation system on which Common Stock may then be listed or quoted, or if the
Board of Directors determines in its discretion to seek such shareholder
approval.
THE AMENDED AND RESTATED 1992 STOCK OPTION PLAN OF GLOBAL TELESYSTEMS GROUP,
INC.
In 1992, the Board of Directors approved the adoption of the 1992 Stock
Option Plan of Global TeleSystems Group, Inc. (the "1992 Option Plan") for key
employees of GTS. The purpose of the 1992 Option Plan is to enable GTS to
attract and retain the best personnel for positions of substantial
responsibility, to provide additional incentives to employees of GTS and its
subsidiaries and to promote the success of the business of GTS and its
subsidiaries by providing certain employees with an ownership interest in the
Company.
The total number of shares of Common Stock that may be subject to options
granted under the 1992 Option Plan (the "1992 Options") is generally 18.5% of
the total number of shares of Common Stock outstanding at the beginning of the
calendar year.
The 1992 Option Plan is administered by the Committee, which must be
composed of not less than two members of the Board of Directors who are
"non-employee directors" within the meaning of Rule 16b-3 of the Exchange Act.
The Committee has full and binding authority to determine the fair market value
of the Common Stock, the exercise price of options to be granted, the persons to
whom and the times at which options will be granted and the number of shares to
be represented by each option. The Committee also has full and binding authority
to interpret the 1992 Option Plan, to prescribe rules relating to the 1992
Option Plan, to establish terms and conditions of each 1992 Option and to make
all other determinations necessary to administer the 1992 Option Plan.
The 1992 Option Plan will remain effective until November 14, 2004, unless
earlier terminated by GTS. Grants under the 1992 Option Plan are determined by
the Committee in its sole discretion. For this reason, it is not possible to
determine the benefits or amounts that will be received by any individual
employee or group of employees in the future.
The 1992 Option Plan authorizes the grant of both nonqualified options,
which are not qualified for special tax treatment, and incentive stock options
("ISOs"), which qualify for special federal income tax treatment under Section
422 of the Code. The exercise price per share of Common Stock issuable pursuant
to an ISO may not be less than 100% of the fair market value of Common Stock on
the date of grant. Unless otherwise specified in any respective option
agreement, a nonqualified 1992 Option will expire ten years and one day after
the date of grant and an ISO will expire ten years from the date of grant. Each
person granted 1992 Options shall be provided with an option agreement setting
forth the terms of each grant pursuant to the
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<PAGE> 101
1992 Option Plan. Unless the Committee specifically determines otherwise, each
1992 Option vests one-third on each of the first three anniversaries of the date
of grant. The full purchase price of the shares must be paid, either in cash, by
delivery of previously owned shares, or by withholding of shares having a fair
market value equal to the 1992 Option exercise price or by such other method
approved by the Committee. Each 1992 Option expires (a) 30 days after the option
holder ceases to be an employee of GTS for any reason other than death,
disability or retirement, (b) one year from the date of death or disability of
an employee, or (c) 90 days following retirement of the employee. 1992 Options
may not be sold, pledged, assigned or otherwise disposed of in any manner other
than by will or by the laws of descent and distribution.
The Committee may impose such other restrictions on shares of Common Stock
issued under the 1992 Option Plan, including a right of first refusal by GTS. In
addition, if the amount of any payment under the 1992 Option Plan, either
separately or in combination with any other payment by GTS, would constitute an
excess parachute payment within the meaning of Section 280G of the Code, the
total payments payable under the 1992 Option Plan will be reduced in order to
maximize the amount received by the participant under the 1992 Option Plan in
combination with other payments by GTS.
The 1992 Option Plan provides that, in the event of a change to the Common
Stock (whether by reason of merger, consolidation, reorganization,
recapitalization, stock dividend, stock split, combination of shares or exchange
of shares, or other change in the capital structure made without receipt of
consideration), the Board of Directors will, in its discretion, preserve the
value of outstanding 1992 Option Plan awards by making certain equitable
adjustments.
The Board of Directors may amend, alter, suspend, discontinue, or terminate
the 1992 Option Plan at any time, except that any such action will be subject to
the approval of GTS shareholders at the first annual meeting following such
Board of Directors action if such shareholder approval is required by any
federal or state law or regulation or the rules of any stock exchange or
automated quotation system on which Common Stock may then be listed or quoted,
or if the Board of Directors determines in its discretion to seek such
shareholder approval.
THE GTS 1996 TOP TALENT RETENTION PROGRAM
GTS implemented the GTS 1996 Top Talent Retention Program (the "Program")
which, for 1996 only, alters the terms offered to certain employees under the
1992 Option Plan. Employees who are offered participation in the Program must
sign a "retention agreement," the terms of which are described below, in order
to receive any 1992 Options during 1996. The Program has been offered to
approximately 28 employees, and it provides that any 1992 Options granted to
such participants will vest as follows: (i) one-half of any 1992 Option granted
under the Program will vest at a rate of 25% per year beginning on the first
anniversary of the initial date of grant and (ii) the remaining portion of any
1992 Option granted under the Program will vest one-quarter according to the
achievement of performance revenue levels, and one-quarter according to the
achievement of price levels of Common Stock, provided that all options will vest
on the fifth anniversary of the date of grant regardless of whether such
performance revenue and pricing levels are attained.
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OPTION GRANTS IN THE LAST FISCAL YEAR -- 1992 STOCK OPTION PLAN
<TABLE>
<CAPTION>
NUMBER OF % OF TOTAL
SECURITIES OPTIONS
UNDERLYING GRANTED TO EXERCISE OR GRANT DATE
OPTIONS EMPLOYEES IN BASE EXPIRATION PRESENT
NAME GRANTED(#) FISCAL YEAR PRICE($/SH.) DATE VALUE($)
---- ---------- ------------ ------------ ---------- ----------
<S> <C> <C> <C> <C> <C>
Gerald W. Thames........................ 112,500(1) 7.3 $10.27 3-30-06 $1,155,000
Henry A. Radzikowski.................... 55,500(1) 3.6 10.27 3-30-06 569,800
Louis T. Toth........................... 43,500(1) 2.8 10.27 3-30-06 446,400
Raymond I. Marks........................ 55,500(1) 3.6 10.27 3-30-06 569,800
Jan Loeber.............................. -- -- -- -- --
</TABLE>
- - ---------------
(1) Stock options were awarded under the 1992 Stock Option Plan. Each option
vests one-third on each of the first three anniversaries of the date of
grant.
AGGREGATED OPTION EXERCISES IN THE LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION VALUES -- 1992 STOCK OPTION PLAN
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FY-END(#)(1) AT FY-END($)(2)
----------------------- ---------------------
EXERCISABLE/ EXERCISABLE/
NAME UNEXERCISABLE UNEXERCISABLE
---- ------------- -------------
<S> <C> <C>
Gerald W. Thames........................ 575,000/287,501 $5,538,540/$1,103,336
Henry A. Radzikowski.................... 89,801/310,100 857,883/ 2,679,717
Louis T. Toth........................... 186,549/122,601 1,883,386/ 788,677
Raymond I. Marks........................ 144,996/195,504 1,301,667/ 1,186,033
Jan Loeber.............................. -- --
</TABLE>
- - ---------------
(1) No options were exercised during the year ended December 31, 1996.
(2) Based on $13.33 per share value of Common Stock as of December 31, 1996 less
the exercise price.
GTS-HERMES, INC. 1994 STOCK OPTION PLAN
The GTS-Hermes, Inc. 1994 Stock Option Plan (the "GTS Hermes Plan") was
adopted by the board of directors of GTS-Hermes, Inc. ("GTS-Hermes") in 1994 to
enable employees of GTS-Hermes and its subsidiaries, including HER, and
affiliates to participate in ownership of GTS-Hermes and to attract and retain
key employees of particular merit. The GTS-Hermes Plan provides for the award of
incentive stock options, nonqualified stock options and stock appreciation
rights. All employees of GTS-Hermes and its subsidiaries, including HER, and
affiliates are eligible to participate in the GTS-Hermes Plan.
The maximum number of shares authorized with respect to grants of awards
under the GTS-Hermes Plan in each calendar year is 6.5% of the shares of common
stock, par value $0.01 per share, of GTS-Hermes issued and outstanding, and the
aggregate number of shares of stock subject to the GTS-Hermes Plan is 13% of the
total shares of stock issued and outstanding. The GTS-Hermes Plan is
administered by a committee appointed by the board of directors of GTS-Hermes,
which has broad discretion to determine who shall receive awards under the
GTS-Hermes Plan and the characteristics of any award thereunder, including the
price, term and vesting of such award, and to interpret the terms of the
GTS-Hermes Plan and awards granted under the GTS-Hermes Plan. Stock appreciation
rights may not be awarded alone and may only be awarded in tandem with an option
grant.
The GTS-Hermes Plan provides that in the event of a change in control, as
defined under the GTS-Hermes Plan, any stock appreciation rights outstanding for
at least six months and any stock options awarded under the GTS-Hermes Plan not
previously exercisable and vested which have been held for at least six months
from the date of grant will become fully vested and exercisable at an adjusted
price to be determined
99
<PAGE> 103
according to the highest sales price per share paid in any transaction reported
or offer made at any time during the preceding 60 days as determined by the
committee.
The board of directors of GTS-Hermes may amend, alter or discontinue the
GTS-Hermes Plan at any time, provided that the rights of participants are not
impaired, except that shareholder approval is necessary for certain material
modifications.
In the fourth quarter of 1997, HER established a stock option plan (the
"New Plan") to replace the GTS-Hermes Plan for the purpose of incentivizing HER
key employees, in substantially similar form to the GTS-Hermes Plan. The
aggregate number of shares of HER stock subject to the New Plan is approximately
13% of the total shares of HER stock issued and outstanding including options.
HER issued 10,166 options in replacement of those outstanding under the
GTS-Hermes Plan as well as additional options to certain employees. The issuance
of these options will result in a non-cash charge of $3.7 million of which $2.6
million is expected to be recorded during the fourth quarter and the remaining
$1.1 million will be recognized principally ratably over fiscal 1998. The
GTS-Hermes Plan is intended to be terminated.
OPTION GRANTS IN THE LAST FISCAL YEAR -- GTS-HERMES PLAN(1)
<TABLE>
<CAPTION>
POTENTIAL
REALIZABLE VALUE AT
ASSUMED ANNUAL
NUMBER OF % OF TOTAL RATES OF STOCK
SECURITIES OPTIONS PRICE APPRECIATION
UNDERLYING GRANTED IN EXERCISE OR FOR OPTION TERM(2)
OPTIONS EMPLOYEES IN BASE EXPIRATION -------------------
NAME GRANTED(#) FISCAL YEAR PRICE($/SH.) DATE 5% ($) 10% ($)
---- ---------- ------------ ------------ ---------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
Jan Loeber(3)........................... 3.5 53.8 $57,148.86 2007 N/A N/A
</TABLE>
- - ---------------
(1) Stock options are for GTS-Hermes stock pursuant to the GTS-Hermes Plan. Each
stock option vests one-third on each of the first three anniversaries of the
date of grant. HER established the New Plan to replace the GTS-Hermes Plan
during the fourth quarter of 1997. The New Plan, known as the Key Employee
Stock Option Plan of Hermes Europe Railtel B.V., is substantially similar to
the GTS-Hermes Plan. The options outstanding under the GTS-Hermes Plan were
cancelled and replaced by options under the New Plan.
(2) Due to the high exercise price of the options granted under the GTS-Hermes
Plan and the relatively low value of GTS-Hermes shares, GTS and GTS-Hermes
have agreed that it is reasonable to set the potential realizable value of
the options at zero with respect to the assumed annual rates of stock price
appreciation of 5% and 10% for the term of the options.
(3) In 1995, Jan Loeber was granted 3.5 shares.
AGGREGATED OPTION EXERCISES IN THE LAST FISCAL YEAR AND
FISCAL YEAR-ENDED OPTION VALUES -- GTS-HERMES PLAN
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FY-END(#) AT FY-END($)(1)
------------------------- -------------------------
NAME EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- ------------------------- -------------------------
<S> <C> <C>
Jan Loeber.............................. 1.167/5.833 N/A
</TABLE>
- - ---------------
(1) Due to the high exercise price of the options granted under the GTS-Hermes
Plan and the relatively low value of GTS-Hermes shares, GTS and GTS-Hermes
have agreed that it is reasonable to set the potential realizable value of
the options at zero with respect to the assumed annual rates of stock price
appreciation of 5% and 10% for the term of the options.
100
<PAGE> 104
EMPLOYMENT AGREEMENTS
GTS has executed employment agreements (together, the "Employment
Agreements") with all the Named Executive Officers. The agreements with Messrs.
Thames, Radzikowski and Marks include a three-year term of employment commencing
on April 1, 1996. Mr. Radzikowski resigned from the Company in the second
quarter of 1997. The agreements with Mr. Toth and Mr. Loeber include a two-year
term of employment commencing on April 1, 1996 and January 3, 1995,
respectively. All the Employment Agreements provide for the automatic renewal of
the term for additional one-year periods after the initial term unless written
notice of intent to terminate is provided by either party within a stated period
of between 120 days and six months prior to the renewal date. The salary of each
Named Executive Officer is reviewed yearly and may be increased at the sole
discretion of the Board of Directors. In addition to salary, each Named
Executive Officer is eligible for a performance-based annual bonus, to
participate in the GTS 1992 Stock Option Plan (with the exception of Mr. Loeber
whose employment agreement provides him with an option grant under the
GTS-Hermes Plan), to receive standard health and insurance benefits that are
provided to executives of GTS, to receive certain other fringe benefits and to
be reimbursed for all reasonable expenditures incurred in the execution of each
Named Executive Officer's respective duties. In addition, Mr. Loeber's
employment agreement provides him with 30,000 shares of restricted stock that
vest in an amount of one-third each year for three years beginning on January 2,
1997.
The performance-related bonuses are discretionary annual bonuses. Mr.
Loeber's bonus is based on a comparison of the projected to the actual
performance of HER during any given fiscal year. The maximum amount of Mr.
Loeber's bonus is a percentage of his salary that is determined by the Board of
Directors in its sole discretion. The bonus awards for Messrs. Thames, Marks and
Toth are based on the achievement of performance goals by a combination of both
GTS and the pertinent named Executive Officer and are determined each year by
the compensation committee. The amount of the performance-based bonuses awarded
to Messrs. Marks and Toth may equal up to 30% of the executive's salary for the
year. Mr. Thames may receive a performance-based bonus of up to 100% of his
salary for the year.
Each Employment Agreement may be terminated by GTS by giving notice of
intent to not extend the term of employment, for cause or as a result of the
Named Executive Officer's permanent disability. In the event that the employment
relationship is terminated due to the employee's disability or death or if GTS
provides notice of its intent not to renew the term of employment, GTS shall pay
to the Named Executive Officer or to the Named Executive Officer's estate, as
the case may be, the salary and bonus for the remaining portion of the fiscal
year in which the termination of employment occurs. In addition, if the Company
provides notice of its intent not to extend the term of employment, each Named
Executive Officer will receive assurances in an amount equal to his salary for
the greater of (a) the number of months or days in the notice period and (b) the
period during which the Named Executive Officer remains subject to the
restrictive covenants described below. If the Named Executive Officer is
terminated for cause or if he quits other than for the reasons stated above, he
shall not be entitled to any salary bonus or severance (other than accrued
salary).
Each Employment Agreement includes noncompetition and nonsolicitation
clauses that are effective during the term of employment and for a period of
from four months to one year thereafter. In addition, the Employment Agreements
include an unlimited covenant of confidentiality and nondisclosure. Any dispute
arising under an employment agreement must be resolved through arbitration,
except that each agreement also provides for specific performance and for a
court injunction in the event of a breach by the Named Executive Officer.
101
<PAGE> 105
CERTAIN RELATED PARTY TRANSACTIONS
Alan B. Slifka, the Chairman of the Board of Directors, owns an interest in
an office building in New York in which GTS leased office space until the
corporate headquarters were moved to McLean, Virginia on March 1, 1995. GTS
retains a small office space in New York City that is leased from Mr. Slifka on
a monthly basis, and the annual expense for 1996 was $40,600. Mr. Slifka also
has a consulting agreement with GTS pursuant to which he is paid consulting fees
of $100,000 per year.
Halcyon/Alan B. Slifka Management Company LLC (formerly Alan B. Slifka and
Company), a company principally owned by Mr. Slifka, holds 225,000 stock options
to purchase Common Stock that were granted in 1991 pursuant to a stock option
agreement that is not subject to any stock option plan. The options have an
exercise price of $0.533 per share and are fully vested. Any of the stock
options that remain unexercised after November 30, 2001 shall lapse and become
void. Generally, in the event that Mr. Slifka ceases to be an employee or
nonemployee director of GTS, any of such unexercised stock options shall lapse
thirty days after such termination.
In addition, Joel Schatz, a director of GTS, and Ms. Sandler, the wife of
Morris A. Sandler, a director of GTS were granted in 1991 stock options to
purchase Common Stock pursuant to stock option agreements that are not subject
to any stock option plan. Mr. Schatz holds 50,250 of such stock options to
purchase Common Stock with an exercise price of $0.533 per share. Mr. Schatz's
options are fully vested and any unexercised options he holds after November 4,
2001 shall lapse and become void. Generally, in the event that Mr. Schatz ceases
to be an employee or nonemployee director of GTS any of his unexercised stock
options shall lapse thirty days after such termination. The stock options held
by the spouse of Mr. Sandler were granted to Mr. Sandler in November 1991 and,
with the approval of the Board, were immediately assigned to his spouse, whom
the stand-alone stock option agreement names as the optionee. Pursuant to such
stock option agreement, the spouse of Mr. Sandler was granted 225,000 stock
options to purchase Common Stock at an exercise price of $.533 per share. The
options are fully vested and any unexercised options held after November 4, 2001
shall lapse and become void. Generally, in the event that Mr. Sandler ceases to
be an employee or nonemployee director of GTS, any of such unexercised stock
options shall lapse thirty days after such termination.
Bernard McFadden, Director, has a consulting agreement with GTS pursuant to
which he is paid $100,000 in consulting fees each year.
In August and September 1997, affiliates of George Soros and Mr. Slifka
purchased 319,149 and 57,015 shares of Common Stock, respectively, at a price of
$15.67 per share in the Company's private stock offering. In addition,
affiliates of Mr. Slifka purchased $2.9 million of Convertible Bonds in
September 1997. Pursuant to the terms of the indenture related to the
Convertible Bonds, the Convertible Bonds will be convertible into such shares of
Common Stock as is equal to the principal amount of such Convertible Bonds
divided by the applicable conversion price, which conversion price shall be
equal to the public offering price of the Common Stock in the Offerings. See
"Selling Holders."
Affiliates of Soros Fund Management purchased $40 million of notes from GTS
in 1996, which notes bear interest at 10% per annum, in partial consideration of
which (i) W. James Peet was appointed to the Board of Directors and (ii) the
affiliates received warrants to purchase 4,444,443 shares of Common Stock.
Together with their prior equity interests in GTS, these affiliates currently
hold, on a fully diluted basis (excluding shares underlying stock options), in
excess of 20.3% of the Company's Common Stock. In accordance with the terms of
the warrant agreement, the exercise price of the warrants was reduced from
$10.27 per share to $9.33 per share as the outstanding debt had not been repaid
prior to December 31, 1996. In addition, these affiliates collect a monitoring
fee of $40,000 per month, which they will continue to collect until the
consummation of the Offerings, at which point it will be reduced to $25,000.
Under certain agreements, these affiliates have the right to co-invest with GTS
in all of its new ventures throughout Asia, excluding countries in the former
Soviet Union, and pursuant to this right, one of these affiliates holds a 25%
interest in GTS China Investments LLC. See "Business -- Asia."
102
<PAGE> 106
Affiliates of Capital Research International purchased $30 million of notes
from GTS in 1996, which notes bear interest at 10% per annum, in partial
consideration of which it received warrants to purchase 3,333,333 shares of
Common Stock. In accordance with the terms of the warrant agreement, the
exercise price of the warrants was reduced from $10.27 per share to $9.33 per
share as the outstanding debt had not been repaid prior to December 31, 1996.
Jean Salmona, a director of GTS, is the Chairman and Chief Executive
Officer of CESIA. CESIA also provides consultancy services for CDI and for HER.
The Company paid $123,685 in 1996 and $0 in both 1995 and 1994 to CESIA for
consulting services related to CDI. In addition, HER paid $84,270 in 1996 and $0
in both 1995 and 1994 to CESIA for consulting services. Further, the Company
paid $2,314 and $5,843 to CESIA in 1996 and 1997, respectively, pursuant to the
purchase agreement with CESIA related to the CDI business.
Pursuant to a 1995 purchase agreement, the Company received its interest in
GTS-Vox Limited, the intermediate holding company of TCM, in exchange for a note
in the principal amount of $693,380 issued to the sellers and certain additional
consideration to its partners payable in the form of either cash or Common Stock
based upon its financial performance. The Company paid the note in 1996. On
January 17, 1997, the agreement was amended such that the consideration would
only be in the form of the issuance of Common Stock and as such, GTS is
obligated under these arrangements to issue up to a maximum of 1,121,640 shares
of Common Stock. In the first quarter of 1997, pursuant to this agreement the
Company issued 504,600 common shares, which was valued at the Company's current
fair market value of $13.33 per share. In addition, the Company was credited
37,480 shares of Common Stock under the amended agreement, for purposes of
applying against the 1,121,640 maximum number of shares of Common Stock, for the
Company's payment of its note to the sellers in 1996. Common Stock issued
pursuant to the agreement must be held for a minimum holding period. In certain
circumstances, if GTS's partners are unable to sell their shares of Common
Stock, GTS is obligated to assist in locating a purchaser for the Common Stock,
and, if unable to do so, to repurchase these shares. GTS's repurchase
obligations are at the following prices: (i) if shares of Common Stock are then
being publicly traded, at the average trading price of such shares for the 10
trading days preceding such repurchase or (ii) if shares of Common Stock are not
then publicly traded, at the price shares of Common Stock were most recently
offered to individual investors in a private placement, or, if no such private
placement has occurred within the three months preceding the repurchase of such
shares, at a price determined by an independent financial institution to be
agreed upon by GTS and the seller. As a result of their receipt of shares of
Common Stock in 1997, the sellers became shareholders of GTS.
GTS purchased its interest in PrimTelefone, the Company's cellular
operations in the Primorsky region of Russia, from Commstruct International,
B.V. ("CIBV") for $500,000 cash and 400,000 shares of Common Stock of the
Company, as a result of which CIBV became a stockholder of the Company. Pursuant
to the asset purchase agreement relating to the purchase by GTS of its interest
in PrimTelefone, CIBV has the right to have some or all of its shares of Common
Stock repurchased, which right will terminate on the date when the Company first
sells shares of Common Stock to the public pursuant to an effective registration
statement under the Securities Act, by GTS over a five-year period at the
current fair market value of such shares at the time of such repurchase.
Affiliates of Baring International Investment Management Limited
("Barings"), which affiliates consist primarily of investment funds and trusts,
are shareholders of the Company and Barings may designate a non-voting observer
to attend meetings of the Board of Directors of the Company. Barings' observer
status terminates upon the consummation of an initial public offering of the
Company's Common Stock. In April 1996, GTS entered into an agreement with First
NIS Regional Fund SICAF, an affiliate of Barings, to organize GTS Ukrainian
TeleSystems, L.L.C. (the "LLC"), a Delaware limited liability company 60% owned
by GTS, which in turn entered into a stock purchase agreement to acquire 49% of
all the ownership interests in Bancomsvyaz, a Ukrainian limited liability
company. See "Business -- Russia and the CIS." Such acquisition closed in May
1996. By contractual arrangement, Barings designates one member of the board of
directors of Bancomsvyaz. Barings funded $4.5 million to be applied towards the
LLC's purchase of the interest in Bancomsvyaz and for the LLC's $1.5 million
contribution to the registered capital of Bancomsvyaz. Prior to March 1, 1999,
Barings may put its initial investment to GTS for $4.5 million, plus accrued
interest at
103
<PAGE> 107
13.5% per annum, or, if GTS has consummated an initial public offering of its
Common Stock, may exercise an option to convert such investment into 438,311
shares of Common Stock at an exercise price of $10.27. In June 1997 the
agreement was amended, such that Barings funded an additional $4.1 million to be
applied toward Bancomsvyaz's capital expenditure and operating capital
requirements. On September 30, 2000, Barings may put that portion of its LLC
interest represented by the additional Barings investment to GTS for $4.1
million, or if GTS has consummated an initial public offering of its Common
Stock, may exercise an option to convert such additional investment into 275,000
Shares of Common Stock at an exercise price of $15.00.
104
<PAGE> 108
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding ownership of
the Common Stock and rights to acquire Common Stock by (i) stockholders that
manage or own, either beneficially or of record, five percent or more of the
Common Stock of the Company, (ii) each of the Company's directors, (iii) each of
the Named Officers and (iv) all directors and executive officers of the Company
as a group as of December 31, 1997. For the purposes of this table, a person or
group of persons is deemed to have "beneficial ownership" of any shares which
such has the right to acquire within 60 days after such date, but such shares
are not deemed to be outstanding for the purpose of computing the percentage
ownership of any other person.
<TABLE>
<CAPTION>
SHARES OF COMMON STOCK SHARES OF COMMON STOCK TO
BENEFICIALLY OWNED PRIOR TO BE BENEFICIALLY OWNED AFTER
THE STOCK OFFERINGS THE STOCK OFFERINGS
---------------------------- ----------------------------
NUMBER OF NUMBER OF
SHARES PERCENTAGE SHARES PERCENTAGE
BENEFICIALLY BENEFICIALLY BENEFICIALLY BENEFICIALLY
NAME OF BENEFICIAL OWNER OWNED(1)(2) OWNED(1) OWNED(1)(2) OWNED(1)
------------------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
George Soros affiliates..................... 10,837,791(3) 25.8% 10,837,791(3) 20.4%
c/o Soros Fund Management
888 Seventh Avenue, 31st Floor
New York, NY 10106
Alan B. Slifka and affiliates............... 5,492,981(4) 14.5% 5,492,981(4) 11.2%
c/o Halcyon/Alan B. Slifka Management
Company LLC
477 Madison Avenue, 8th Floor
New York, NY 10022
Capital Research International.............. 5,347,620(5) 13.1% 5,347,620(5) 10.3%
c/o Capital Research International
25 Bedford Street
London WC2E England
Emerging Markets Management................. 2,767,046(6) 7.4% 2,767,046(6) 5.7%
1001 19th Street North, 16th Floor
Arlington, VA 22209
Morgan Stanley Asset Management............. 2,243,316(7) 6.0% 2,243,316(7) 4.6%
1221 Avenue of the Americas, 21st Floor
New York, NY 10020
Gary Gladstein.............................. 45,000(8) * 45,000(8) *
Bernard McFadden............................ 37,500 * 37,500 *
Michael A. Greeley.......................... 13,500(9) * 13,500(9) *
Stewart J. Paperin.......................... 9,000(8) * 9,000(8) *
W. James Peet............................... 13,500(8) * 13,500(8) *
Jean Salmona................................ 13,500 * 13,500 *
Morris A. Sandler........................... 351,000 * 351,000 *
Joel Schatz................................. 500,250 1.3% 500,250 1.0%
Adam Solomon................................ 25,500(10) * 25,500(10) *
Gerald W. Thames............................ 676,562 1.8% 676,562 1.4%
Jan Loeber.................................. 30,000(11) * 30,000(11) *
Raymond I. Marks............................ 246,940 * 246,940 *
Henry A. Radzikowski........................ 186,539 * 186,539 *
Louis T. Toth............................... 256,538 * 256,538 *
Other officers.............................. 197,051 * 197,051 *
All Directors and Executive Officers as a
group (21 persons)..................... 2,602,380 6.5% 2,602,380 5.1%
Total of above.............................. 29,291,134 29,291,134
Total shares on a fully diluted basis:...... 45,384,590 56,484,590
</TABLE>
105
<PAGE> 109
- - ---------------
* Less than 1%
(1) The percentage of ownership is based upon 45,384,590 shares, comprised of
37,606,814 shares of Common Stock issued and outstanding, and warrants to
purchase 7,777,776 shares of Common Stock. Excluded from the calculation
are: 195,528 treasury shares; 6,322,173 shares of Common Stock issued to
employees under the Company's 1992 Option Plan, of which 2,796,111 are
vested at December 31, 1997; 759,000 options to purchase shares of Common
Stock issued to employees prior to the adoption of the Company's 1992
Option Plan and options issued pursuant to the Directors' Plan and Equity
Compensation Plan; and an option to convert a debt put right to 713,311
shares of Common Stock.
(2) Includes shares of Common Stock issuable upon the exercise of stock options
and stock warrants within 60 days of December 31, 1997.
(3) Comprised of 3,074,199 shares of Common Stock held by the Soros
Foundation-Hungary; 1,125,000 shares of Common Stock held by the Soros
Charitable Foundation; 319,149 shares of Common Stock held by Soros
Humanitarian Foundation; 1,125,000 shares and warrants to purchase
3,333,333 shares of Common Stock held by The Open Society Institute;
500,000 and 250,001 shares of Common Stock held by Winston Partners II LDC
and Winston Partners II LLC, respectively; warrants to purchase 370,371,
185,184 and 555,555 shares of Common Stock held by Winston Partners II LDC,
Winston Partners II LLC and Chatterjee Fund Management, respectively, all
of which are affiliates of George Soros. Information in the above table
excludes the 45,000, 9,000 and 13,500 shares of, and options for the
purchase of, Common Stock held by Gary Gladstein, Stewart J. Paperin and W.
James Peet, respectively, over which the George Soros affiliates disclaim
ownership.
(4) Includes 2,788,784 shares of Common Stock owned by Mr. Slifka, shares of
Common Stock held in trust for a minor child and options to purchase
225,000 shares of Common Stock; 2,563,041 shares of Common Stock owned by
various Halcyon Partnerships which are managed by Halcyon/Alan B. Slifka
Management Company LLC, of which Mr. Slifka is the Managing Principal and
over which Mr. Slifka disclaims beneficial ownership; 67,500 shares of
Common Stock held by GTS 1995 Partners, LP; 4,500 shares of Common Stock
held by Kevah Konner, a Principal of Halcyon/Alan B. Slifka Management
Company LLC; 19,656 shares of Common Stock held by John M. Bader, a
Principal of Halcyon/Alan B. Slifka Management Company LLC; and 49,500
shares of Common Stock owned by Randolph Slifka, Mr. Slifka's son, over all
of which Mr. Slifka disclaims beneficial ownership.
(5) Includes 2,014,287 shares of Common Stock and warrants to purchase
3,333,333 shares of Common Stock held by funds managed by affiliates of
Capital Research International.
(6) Shares of Common Stock held by funds managed by Emerging Markets
Management.
(7) Shares of Common Stock held by funds managed by Morgan Stanley Asset
Management.
(8) Excludes the shares of Common Stock held by the George Soros affiliates
over which Gary Gladstein, Stewart J. Paperin and W. James Peet disclaim
ownership.
(9) Excludes the 1,819,149 shares of Common Stock owned by Chestnut Hill
Telecom Inc., an affiliate of Michael A. Greeley, over which Mr. Greeley
disclaims ownership.
(10) Excludes 31,914 shares of Common Stock held in trust for a relative over
which Adam Solomon disclaims ownership.
(11) Includes 30,000 restricted shares of Common Stock.
106
<PAGE> 110
DESCRIPTION OF CERTAIN INDEBTEDNESS
SENIOR NOTES DUE 2005
Concurrently with the Stock Offerings, the Company is offering, pursuant to
a separate prospectus, $105 million of Notes. The Notes will be issued pursuant
to an indenture (the "Notes due 2005 Indenture") between the Company and The
Bank of New York as trustee, dated on or about February 10, 1998. The Notes are
expected to have the following terms when issued. The Notes will mature in 2005
and will bear interest, payable semi-annually, at 9 7/8% per annum. The Notes
due 2005 Indenture will not provide for a sinking fund. The Notes will be
subject to redemption at any time on or after February 15, 2002, at the option
of the Company, in whole or in part, in integral multiples of $1,000 principal
amount at declining redemption prices set forth in the Notes due 2005 Indenture.
Notwithstanding the foregoing, during the first three years after the date of
the Notes due 2005 Indenture, the Company will be permitted to redeem up to
33 1/3% of the aggregate principal amount of the Notes with the net proceeds of
any Public Equity Offerings (as defined in the Notes due 2005 Indenture) or
Strategic Equity Investments (as defined in the Notes due 2005 Indenture) at
109.875% of the principal amount thereof. The Company will place net proceeds
from the offering of the Notes representing funds that, together with the
proceeds from the investment thereof, will be sufficient to pay the first four
scheduled interest payments (but not additional interest) on the Notes, into an
escrow account (the "Escrow Account") to be held by the Trustee for the benefit
of the holders of the Notes. The Company will grant to the Trustee for the
benefit of the holders of the Notes, a first priority and exclusive security
interest in the Escrow Account and the proceeds thereof. Funds will be disbursed
from the Escrow Account for interest payments (but not additional interest) on
the Notes. Pending such disbursement, all funds contained in the Escrow Account
will be invested in Cash Equivalents (as defined in the Notes due 2005
Indenture).
Upon a Change of Control (as defined in the Notes due 2005 Indenture) of
the Company, or in the event of Asset Sales (as defined in the Notes due 2005
Indenture) in certain circumstances, the Company will be required by the terms
of the Notes due 2005 Indenture to make an offer to purchase the outstanding
Notes at a purchase price equal to 101% and 100%, respectively, of the principal
amount thereof.
The indebtedness of the Company evidenced by the Notes will rank pari passu
in right of payment with all other existing and future unsubordinated
indebtedness of the Company and senior in right of payment to all existing and
future obligations of the Company expressly subordinated in right of payment to
the Notes. The Notes due 2005 Indenture will contain a number of covenants
restricting the operations of the Company and its Restricted Group Members (as
defined in the Notes due 2005 Indenture), including those restricting: the
incurrence of indebtedness; the making of restricted payments (in the form of
the declaration or payment of certain dividends or distributions, the purchase,
redemption or other acquisition of any capital stock of the Company, the
voluntary prepayment of pari passu or subordinated indebtedness and the making
of certain investments, loans and advances) unless no Default or Event of
Default (each, as defined in the Notes due 2005 Indenture) exists, its leverage
ratio does not exceed 6.0 to 1.0 and such restricted payments do not exceed the
Basket (as defined in the Notes due 2005 Indenture); transactions with
stockholders and affiliates; the incurrence of liens; sale-leaseback
transactions; issuances and sales of capital stock of subsidiaries; the
incurrence of guarantees by subsidiaries; dividend and other payment
restrictions affecting subsidiaries; consolidation, merger or sale of
substantially all of the Company's assets; and requiring the purchase of Notes,
at the option of the holder, upon the occurrence of a Change of Control and
certain Asset Sales.
The events of default under the Notes due 2005 Indenture will include
provisions that are typical of senior debt financings, including a
cross-acceleration to a default by the Company or any Restricted Group Member on
any indebtedness that has an aggregate principal amount in excess of certain
levels. Upon the occurrence of such an event of default, the trustee or the
holders of not less than 25% in principal amount at maturity of the outstanding
Notes may immediately accelerate the maturity of all the Notes as provided in
the Notes due 2005 Indenture.
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CHATTERJEE NOTES AND CAPITAL RESEARCH NOTES
In 1996, the Company issued $40 million of notes (the "Chatterjee Notes")
to the Chatterjee Group, an affiliate of George Soros. In connection with the
issuance of the Chatterjee Notes, the Chatterjee Group received warrants (the
"Chatterjee Warrants") to purchase 4,444,443 shares of Common Stock. The
Chatterjee Warrants were initially issued with an exercise price of $10.27 per
share, which exercise price was subsequently reduced to $9.33 per share in
accordance with the terms of the warrant agreement. In addition, The Chatterjee
Group was granted the right to appoint, and has appointed, one member to the
Board of Directors and collects a monitoring fee of $40,000 per month, which it
will continue to collect until the Company completes the Offering. The
Chatterjee Group also has the right to co-invest with GTS in all of its new
ventures throughout Asia, excluding countries in the former Soviet Union, and
pursuant to this right has invested and holds a 25% interest in GTS China
Investments LLC. See "Business -- Asia." The Chatterjee Notes bear interest at
10% per annum and the principal is payable in 12 quarterly installments
commencing April 1, 1998.
In 1996, the Company also issued $30 million of notes (the "Capital
Research Notes") to affiliates of Capital Research International. In connection
with the issuance of the Capital Research Notes, Capital Research International
received warrants (the "Capital Research Warrants") to purchase 3,333,333 shares
of Common Stock. The Capital Research Warrants were initially issued with an
exercise price of $10.27 per share, which exercise price was subsequently
reduced to $9.33 per share in accordance with of the warrant agreement. The
Capital Research Notes bear interest at 10% per annum and the principal is
payable in 12 quarterly installments commencing April 1, 1998.
Both the Chatterjee Notes and the Capital Research Notes impose significant
covenants on the Company which covenants, among other things, limit the ability
of the Company and its subsidiaries to incur debt and pay dividends and require
the Company to maintain certain financial ratios.
The Company intends to use a portion of the net proceeds of the Offerings
to repay the Chatterjee Notes and the Capital Research Notes.
HER NOTES
HER sold $265 million aggregate principal amount of 11 1/2% Senior Notes
due 2007 ("HER Notes") in August, 1997. The HER Notes have a ten year maturity
and are unsecured, senior obligations of HER. HER placed approximately $56.6
million of the net proceeds in escrow for the first two years' interest payments
on the HER Notes. The HER Notes were issued pursuant to an indenture containing
certain covenants for the benefit of the holders of HER Notes, including, among
other things, covenants limiting the incurrence of indebtedness, restricted
payments, liens, payment restrictions affecting certain subsidiaries and joint
ventures, transactions with affiliates, assets sales and mergers. The HER Notes
are redeemable in whole or part, at the option of HER at any time on or after
August 15, 2002 at a price ranging from 105.75 percent to 100.0 percent of the
principal amount.
A portion of the HER Notes are also redeemable at any time or from time to
time prior to August 15, 2000 at a redemption price equal to 111.5% of the
principal amount of the HER Notes so redeemed, plus accrued and unpaid interest
thereon, if any, to the date of redemption with the net cash proceeds of one or
more public equity offerings or strategic equity investments resulting in
aggregate gross cash proceeds to HER of at least $75 million. In the event of a
change of control of HER, holders of the HER Notes have the right to require HER
to purchase such holder's HER Notes at a price equal to 101% of the aggregate
principal amount.
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DESCRIPTION OF THE BONDS
The following terms and conditions (subject to attachment and except for
the sentences in italics) will be endorsed on the Certificates issued in respect
of the Bonds.
GENERAL
The Senior Subordinated Convertible Bonds due 2000 (the "Bonds") of Global
TeleSystems Group, Inc. (the "Company") were initially issued under an indenture
(the "Indenture") dated as of July 14, 1997 (the "Closing Date") between the
Company, The Bank of New York, as trustee (the "Trustee"), registrar (the
"Registrar") and paying, conversion and transfer agent (the "Principal Paying
Agent"). The issue of the Bonds was authorized by a resolution of the Board of
Directors of the Company on June 18, 1997. Certain statements herein are
summaries of, and are subject to, the detailed provisions of the Indenture,
which contains the forms of Bonds. Copies of the Indenture are available for
inspection at the registered office of the Trustee, being at the date hereof at
One Wall Street, New York, New York, 10286 and at the specified offices of each
of the Paying Agents. The Bondholders are entitled to the benefit of, are bound
by, and are deemed to have notice of all the provisions of the Indenture. The
Bonds mature on June 30, 2000.
The Bonds are limited in aggregate original principal amount to
U.S.$155,250,000; provided, however, that an additional $18,000,000 principal
amount of Bonds may be issued under the Indenture to satisfy any preemptive
rights of the Company's existing shareholders. Pursuant to such preemptive
rights, certain of the Company's existing shareholders acquired approximately
$3.5 million in aggregate principal amount of Bonds on August 29, 1997.
STATUS, FORM, DENOMINATION AND TITLE
(A) STATUS
The Bonds are direct, unsecured, senior subordinated obligations of the
Company and will rank pari passu with each other and with all other present and
future unsecured, senior subordinated indebtedness of the Company.
(B) FORM AND DENOMINATION
The Bonds are issued in registered form in the minimum denomination of
U.S.$10,000 and integral multiples of $1,000 in excess thereof.
(C) TITLE
Title to the Bonds passes only by registration in the register of
Bondholders (the "Register") maintained by the Registrar. The registered holder
of any Bond will (except as otherwise required by law) be treated as its
absolute owner for all purposes (whether or not such Bond is overdue and
regardless of any notice of ownership, trust or any interest in it or any
writing on, or the theft or loss of, the certificate issued in respect of it)
and no person will be liable for so treating the holder. As used herein,
"Bondholder" and (in relation to a Bond) "holder", mean the person in whose name
a Bond is registered.
INTEREST
The Bonds bear interest payable at the rate of 8.75 per cent. per annum
from and including the date of their issuance. Interest on each Bond will cease
to accrue from the Redemption Date or Conversion Date thereof unless, upon due
presentation of such Bond, payment of principal is improperly withheld or
refused or conversion is not consummated, as the case may be. In such event,
interest will continue to accrue on such Bond up to and including (a) the date
on which payment in full of the principal thereof (plus accrued interest) is
made or (if earlier) the date on which the funds for the payment in full of the
principal thereof (plus accrued interest) have been received in New York City by
the Trustee or (b) the Bonds are converted to shares of Common Stock. Interest
shall be computed on the basis of a 360 day year consisting of twelve (12)
months of 30 days each and, in the case of an incomplete month, the number of
days elapsed.
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Interest is payable semiannually in arrears on July 15 and January 15 of
each year commencing January 15, 1998 (each, an "Interest Payment Date"), to the
person in whose name a Bond (or any predecessor Bond) is registered at the close
of business on the preceding June 30 or December 31, as the case may be. Each
Bond will carry a right to interest in respect of all periods from the date of
issue thereof, or the date from which interest has been paid to, whichever is
later, up to but excluding the relevant Redemption Date or Conversion Date.
The Luxembourg Stock Exchange will be informed of each change in the
interest rate of the Bonds on the date of such change.
TRANSFERS OF BONDS; ISSUE OF CERTIFICATES
(A) TRANSFERS
A Bond may be transferred by depositing the certificate issued in respect
of that Bond, with the form of transfer on the back duly completed and signed,
at the specified office of the Registrar or any of the Transfer Agents.
Except as set forth below, the Global Certificates may be transferred in
whole, but not in part, solely to another nominee of DTC or to a successor of
DTC or its nominee.
(B) DEFINITIVE BONDS
Bonds represented by interests in Global Certificates are exchangeable for
certificated physical Bonds in registered form only if (i) DTC is at any time
unwilling or unable to continue as a depositary and a successor depositary is
not appointed by the Company within 90 days of notice of such fact, or (ii) the
Trustee has instituted or been directed to institute any judicial proceeding in
a court to enforce the rights of the Bondholders under the Bonds and has been
advised by counsel that it is necessary or appropriate to obtain possession of
certificated physical Bonds.
(C) REPLACEMENTS OF BONDS
In case any certificate representing a Bond shall become mutilated,
defaced, destroyed, lost or stolen, the Company will execute and, upon the
Company's request, the Trustee will authenticate and deliver a new certificate
of like tenor (including the same date of issuance) and equal principal amount,
registered in the same manner, dated the date of its authentication and bearing
interest from the date to which interest has been paid on such Bond, in exchange
and substitution for such certificate (upon surrender and cancellation thereof
in the case of mutilated or defaced certificates) or in lieu of and substitution
for such certificate. In case such certificate is destroyed, lost or stolen, the
applicant for a substitute certificate shall furnish to the Company satisfactory
evidence of the destruction, loss or theft of such certificate and of the
ownership thereof. Upon the issuance of any substituted certificate, the Company
may require the payment by the registered holder thereof of a sum sufficient to
cover fees and expenses connected therewith, together with such indemnity as the
Company and Trustee shall require.
(D) FORMALITIES FREE OF CHARGE
Registration of transfer of Bonds will be effected without charge but only
upon payment (or the giving of such indemnity as the Company, the Trustee or any
of the Paying Agents may require) in respect of any tax or other governmental
charges which may be imposed in relation to it.
(E) CLOSED PERIODS
No Bondholder may require the transfer of a Bond to be registered during
the period of 15 days ending on the due date for any payment of principal of or
interest on or Additional Amounts, if any, on that Bond or after a Conversion
Notice (as defined below) has been delivered with respect thereto.
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(F) REGULATIONS
All transfers of Bonds and entries on the Register will be made subject to
the detailed regulations concerning transfer of Bonds set forth in the
Indenture. The regulations may be changed by the Company, with the prior written
approval of the Trustee. A copy of the current regulations will be mailed (at
the Company's expense) by the Trustee to any Bondholder who asks for one.
(G) PAYMENTS
The principal of, and premium, if any, on the Bonds will be paid against
surrender thereof at the main office of the Paying Agent in New York City or,
subject to applicable laws and regulations, at the offices of the paying agent
in Luxembourg by U.S. dollar check drawn on a bank in the City of New York, or
by a wire transfer to a U.S. dollar account maintained by the payee with a bank
in the City of New York. The Company will at all times maintain a Principal
Paying Agent and Conversion Agent in New York City, and, so long as the Bonds
are listed on the Luxembourg Stock Exchange and the rules of the Luxembourg
Stock Exchange so requires, a Paying Agent, Conversion Agent and Transfer Agent
in Luxembourg.
Payment in respect of interest on any Interest Payment Date with respect to
any Bond will be made to the person in whose name such Bond is registered at the
close of business on the June 30 or December 31, as the case may be, preceding
such Interest Payment Date by U.S. dollar check drawn on a bank in the City of
New York mailed to such person at the address specified in the Register on such
day or, under certain circumstances, by wire transfer to a U.S. dollar account
maintained by the payee with a bank in the City of New York, provided that a
written request from such holder to such effect designating such account is
received by the relevant Paying Agent no later than fifteen days before the
relevant Interest Payment Date. Unless such designation is revoked, any such
designation made by such person with respect to such Bond will remain in effect
with respect to any future payments with respect to such Bond payable to such
person.
If any payment on a Bond is due on a day that is, at any place of payment,
a day on which banking institutions are authorized or obligated by law or
executive order to close, then, at each place of payment, such payment need not
be made on such day but may be made on the next succeeding day that is not, at
such place of payment, a day on which banking institutions are authorized or
obligated by law or executive order to close (a "Business Day"), with the same
force and effect as if made on the originally scheduled date of such payment,
and no interest will accrue for the period from and after such date.
ADDITIONAL AMOUNTS
All payments of principal, premium, if any, and interest with respect to
the Bonds will be made without withholding or deduction at source for, or on
account of, any present or future taxes, fees, duties, assessments or
governmental charges of whatever nature imposed or levied by the United States
or any political subdivision or taxing authority thereof or therein, unless such
withholding or deduction is required by (i) the laws (or any regulations or
rulings promulgated thereunder) of the United States or any political
subdivision or taxing authority thereof or therein or (ii) an official position
regarding the application, administration, interpretation or enforcement of any
such laws, regulations or rulings (including, without limitation, a holding by a
court of competent jurisdiction or by a taxing authority in the United States or
any political subdivision thereof). If a withholding or deduction at source is
required, the Company will, subject to certain limitations and exceptions (set
forth below), pay to a holder of Bonds who is a Non-U.S. Holder (as defined
herein) such additional amounts ("Additional Amounts") as may be necessary so
that every net payment of principal, premium, if any, or interest with respect
to such Bonds after such withholding or deduction, will not be less than the
amount provided for in the Bonds. However, the Company shall not be required to
make any payment of Additional Amounts for or on account of:
(a) any tax, fee, duty, assessment or other governmental charge which
would not have been imposed but for (i) the existence of any present or
former connection between such Bondholder (or between a fiduciary, settlor,
beneficiary, member or shareholder of, or possessor of a power over, such
Bondholder, if such Bondholder is an estate, trust, partnership or
corporation) and the United States, including without limitation, such
Bondholder (or such fiduciary, settlor, beneficiary, member, share-
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holder or possessor) being or having been a citizen or resident thereof or
being or having been present or engaged in trade or business therein or
having or having had a permanent establishment therein, or (ii) the
presentation of a Bond for payment on a date more than 15 days after the
date on which such payment became due and payable or the date on which
payment thereof is duly provided for whichever occurs later;
(b) any estate, inheritance, gift, sales, transfer, personal property
or similar tax, assessment or other governmental charge;
(c) any tax, fee, duty, or future assessment or other governmental
charge imposed by reason of such Bondholder's past or present status as a
personal holding company, foreign personal holding company, passive foreign
investment company or controlled foreign corporation with respect to the
United States or as a corporation which accumulates earnings to avoid
United States federal income tax;
(d) any tax, fee, duty, assessment or other governmental charge which
is payable otherwise than by withholding from payments of principal or
interest with respect to the Bonds;
(e) any tax, fee, duty, assessment of other governmental charge
imposed on any interest received (x) by a holder or beneficial owner of
Bonds that for U.S. federal income tax purposes is treated as actually or
constructively owning 10% or more of the voting power of the Company's
stock, (y) on an extension of credit made pursuant to a loan agreement
entered into in the ordinary course of business by a holder or beneficial
owner of Bonds that is a bank and (z) by a holder or beneficial owner of
Bonds that is a controlled foreign corporation and with respect to which
the Company is a related person;
(f) any tax, fee, duty, assessment or other governmental charge
required to be withheld by any paying agent from any payment of principal,
premium, if any, or interest with respect to any Bond, if such payment can
be made without such withholding by any other paying agent with respect to
the Bonds;
(g) any tax, fee, duty, assessment or other governmental charge which
would not have been imposed but for the failure to comply with
certification, identification, documentation, information or other
reporting requirements concerning the nationality, residence, identity or
connection with the United States of the Bondholder or of the beneficial
owner of such Bond, if such compliance is required by a present or future
statute, treaty, regulation, ruling or administrative practice as a
precondition to a reduction of or relief or exemption from such tax,
assessment or other governmental charge; or
(h) any combination of items (a), (b), (c), (d), (e), (f) and (g);
nor shall Additional Amounts be paid to any holder of a Bond who is a fiduciary
or partnership or other than the sole beneficial owner of the Bond to the extent
a beneficiary or settlor with respect to such fiduciary or a member of such
partnership or a beneficial owner of the Bond would not have been entitled to
payment of the Additional Amounts had such beneficiary, settlor, member or
beneficial owner been the holder of the Bond.
The term "Non-U.S. Holder" means any corporation, individual, fiduciary or
partnership that for United States federal income tax purposes is a foreign
corporation, nonresident alien individual, nonresident alien fiduciary of a
foreign estate or trust, or foreign partnership one or more members of which is
a foreign corporation, nonresident alien individual or nonresident alien
fiduciary of a foreign estate or trust.
REDEMPTION FOR TAX RESOURCES
The Company may redeem any Bond in whole but not in part at any time at a
redemption price equal to the principal amount thereof together, if appropriate,
with accrued interest to but excluding the date fixed for redemption, if the
Company shall determine, based upon a written opinion of independent counsel
selected by the Company, that as a result of any change in or amendment to the
laws (or any regulations or rulings promulgated thereunder) of (i) the United
States or any political subdivision or tax authority thereof affecting taxation
or (ii) the relevant taxing jurisdiction or any political subdivision or taxing
authority thereof or therein affecting taxation, or any change in application or
official interpretation of such laws, regulations or rulings, which amendment or
change is effective on or after the original Issue Date, the Company would be
required to pay Additional Amounts on the occasion of the next payment due with
respect to such Bond.
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Notice of intention to redeem Bonds will be given not less than 30 days nor
more than 60 days prior to the date fixed for redemption, provided that no such
notice of redemption shall be given earlier than 90 days prior to the effective
date of such change or amendment and that at the time notice of such redemption
is given, such obligation to pay such Additional Amounts remains in effect and
cannot be avoided by the Company's taking reasonable measures available to it.
From and after any redemption date, if monies for the redemption of Bonds shall
have been made available for redemption on such redemption date, such Bonds
shall cease to bear interest and the only right of the holders of such Bonds
appertaining thereto shall be to receive payment of the principal amount
thereof, premium if any, and, if appropriate, all unpaid interest accrued to
such redemption date.
SUBORDINATION
The indebtedness evidenced by the Bonds will, to the extent set forth in
the Indenture, be subordinated in right of payment to the prior payment in full
in cash or Cash Equivalents of all existing and future Senior Indebtedness. In
the event of any insolvency or bankruptcy case or proceeding, or any
receivership, liquidation, reorganization or other similar case or proceeding in
connection therewith, relating to the Company or its assets, or any liquidation,
dissolution or other winding-up of the Company, whether voluntary or
involuntary, or any assignment for the benefit of creditors or other marshalling
of assets or liabilities of the Company, all Senior Indebtedness will be
entitled to be paid in full before any payment or distribution is made on
account of the principal of (including upon redemption), premium, if any, or
interest on the Bonds or Additional Amounts. Notwithstanding the foregoing,
Bondholders may receive shares of stock and any debt securities that are
subordinated at least to the same extent as the Bonds to Senior Indebtedness and
any securities issued in exchange for Senior Indebtedness.
During the continuance of any default in the payment of principal, premium,
if any, or interest on any Designated Senior Indebtedness, when the same becomes
due and such default is continuing beyond any applicable grace periods, and
after receipt by the Trustee and the Company from the representative of holders
of such Designated Senior Indebtedness of written notice of such default, no
direct or indirect payment by or on behalf of the Company of any kind or
character may be made on account of the principal of (including redemption
amount), premium, if any, or interest or Additional Amounts on, or the purchase,
redemption, or other acquisition of, the Bonds unless and until such default has
been cured or waived or has ceased to exist or such Designated Senior
Indebtedness shall have been discharged or paid in full.
In addition, upon the occurrence and during the continuance of any other
default with respect to any Designated Senior Indebtedness pursuant to which the
maturity thereof may be accelerated as a result of such default (a "Non-payment
Default") and upon receipt by the Trustee and the Company from the
representatives of holders of such Designated Senior Indebtedness of written
notice of such Non-payment Default, no payment of any kind or character may be
made by the Company on account of the principal of, premium, if any, or interest
or Additional Amounts on, or the purchase, redemption or other acquisition of,
the Bonds for the period specified below (the "Payment Blockage Period").
The Payment Blockage Period shall commence upon receipt of written notice
of a Non-payment Default by the Trustee from the representatives of holders of
Designated Senior Indebtedness and shall end on the earliest to occur of the
following events: (i) 179 days has elapsed since the receipt of such notice
(provided such Designated Senior Indebtedness shall not theretofore have been
accelerated), (ii) such default is cured or waived or ceases to exist or such
Designated Senior Indebtedness is discharged or paid in full, or (iii) such
Payment Blockage Period shall have been terminated by written notice to the
Company or the Trustee from the representative of holders of Designated Senior
Indebtedness initiating such Payment Blockage Period, after which the Company
shall promptly resume making any and all required payments in respect of the
Bonds, including any missed payments. Only one Payment Blockage Period with
respect to the Bonds may be commenced within any 365 consecutive day period. No
Non-payment Default that existed or was continuing on the date of the
commencement of any Payment Blockage Period will be, or can be, made the basis
for the commencement of a second Payment Blockage Period, whether or not within
a period of 365 consecutive days, unless such default has been cured or waived
for a period of not less than 90 consecutive days. In no event will a Payment
Blockage Period extend beyond 179 days from the receipt by the Trustee of the
notice initiating
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such Payment Blockage Period and there must be a 186 consecutive day period in
any 365 day period during which no Payment Blockage Period is in effect.
Notwithstanding the foregoing, no further notice may be given in respect of any
Non-payment Default unless and until all scheduled payments of principal,
premium, if any, and interest not paid on the Bonds during any such Payment
Blockage Period as a result of any notice or acceleration shall have been paid
in full in cash.
If the Company fails to make any payment on the Bonds when due after giving
effect to any applicable grace period, whether or not on account of the payment
blockage provisions referred to above, such failure would constitute an Event of
Default under the Indenture and would enable the holders of the Bonds to
accelerate the maturity thereof. The Company will promptly notify holders of
Senior Indebtedness if payment of the Bonds is accelerated because of an Event
of Default. See "-- Events of Default."
By reason of such subordination, in the event of any insolvency or
bankruptcy case or proceeding, or any receivership, liquidation, reorganization
or similar case or proceeding of the Company, creditors of the Company who are
holders of Senior Indebtedness may recover more, ratably, than the holders of
the bonds and funds which would be otherwise payable to the holders of the Bonds
will be paid to the holders of the Senior Indebtedness to the extent necessary
to pay the Senior Indebtedness in full, and the Company may be unable to meet
its obligations fully with respect to the Bonds.
At September 30, 1997 the Company had $357.7 million of Senior Indebtedness
outstanding. The Indenture limits, but does not prohibit, the incurrence by the
Company of additional Indebtedness (including Indebtedness which is senior to
the Bonds). See "Risk Factors -- Ranking: Unsecured Status of the Bonds."
CONVERSION
(A) CONVERSION RIGHT
Subject to and upon compliance with the provisions of the Indenture, any
Bondholder shall have the right (the "Conversion Right"), at its option, at any
time and from time to time on or after the occurrence of a Complying Public
Equity Offering and under the other circumstances specified in paragraph (B)(i)
below and prior to the close of business on June 30, 2000, to convert the
principal amount of any such Bond, or any portion of such principal amount
(subject to minimum authorized denominations of the Bonds), into that number of
fully paid and non-assessable shares of Common Stock (as such shares shall then
be constituted) obtained by dividing the principal amount of the bond or portion
thereof surrendered for conversion by the Conversion Price in effect at such
time, by surrender of the Bond so to be converted in whole or in part in the
manner provided in paragraph (B)(i) below. A Bondholder is not entitled to any
rights of a holder of shares of Common Stock until such holder has converted its
Bonds to shares of Common Stock, and only to the extent such Bonds are deemed to
have been converted to shares of Common Stock under the Indenture.
(B) EXERCISE OF CONVERSION RIGHT; ISSUANCE OF SHARES OF COMMON STOCK ON
CONVERSION
(i) Exercise of Conversion Right
Bondholders have a Conversion Right which is exercisable in whole or in
part at any time and from time to time (a) in the case of subparagraph (ii)
below, subsequent to the Conversion Date but not later than the Maturity of the
Bond (as such Maturity may be extended pursuant to the other provisions of this
paragraph (B)(i), (b) if a notice of redemption of the Bonds pursuant to the
Indenture has been given, after the date of such notice and prior to the date of
redemption specified in such notice, (c) if the Bonds are subject to
acceleration as a result of an Event of Default, following the date notice
thereof is given to Bondholders until the Bonds are paid in full upon such
acceleration, or (d) if any Non-Complying Equity Offering occurs, within the 60
day period prior to the Maturity of the Bonds (provided, however, that such
Conversion Right may be exercised prior to the 60th day prior to Maturity of the
Bonds if a Change of Control shall have occurred, upon delivery of a Conversion
Notice by the Bondholder pursuant to this subparagraph at any time on or after
the time the Change of Control Offer is made pursuant to the terms of the
Indenture, until the Maturity of the Bonds). In order to exercise its Conversion
Right, a Bondholder shall complete a notice in the then current form obtainable
from the Trustee or a specified office of a Conversion Agent (a "Conversion
Notice") (which may be accompanied by a share transfer form, or other instrument
which may
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be required, signed by the Bondholder or may include an authorization signed by
the Bondholder, authorizing the Bondholder's nominee to become the registered
transferee and to execute any requisite transfer form or other instrument which
may be required, on behalf of the Bondholder) and deliver such Conversion Notice
and where appropriate, an executed share transfer form, or other instrument
which may be required, to the Trustee or a specified office of any Conversion
Agent (together with the relevant Bond or Bonds if in definitive form) and any
payment required by paragraph (D) below. Once given, a Conversion Notice shall
be irrevocable and may not be withdrawn without the consent in writing of the
Company.
(ii) Complying Public Equity Offering
If a Complying Public Equity Offering occurs prior to the Maturity of the
Bonds on June 30, 2000, then the Company shall, no earlier than twenty Business
Days and no later than fifteen Business Days prior to the anticipated completion
of such offering, cause notice to be given to the Trustee, the Bondholders and
the Luxembourg Stock Exchange to the effect that a Complying Public Equity
Offering is expected to occur on a specified date and that on and after the
Conversion Date the Bondholders may from time to time until Maturity of the
Bonds by delivery of a notice pursuant to paragraph (B)(i) above, elect to
exercise their Conversion Right, in whole or in part. Following the completion
of such Complying Public Equity Offering, the Company shall promptly cause a
Notice of Offering to be given to the Trustee, the Bondholders and the
Luxembourg Stock Exchange stating that the Complying Public Equity Offering has
been completed and confirming the Conversion Date. The Company shall also
provide in the Notice of Offering all information concerning the Complying
Public Equity Offering and all prior offerings since the Issue Date that may be
relevant to a Conversion Price determination or requested by the Trustee in
relation thereto.
(iii) Non-Complying Equity Offering
If any Non-Complying Equity Offering occurs prior to the Maturity of the
Bonds on June 30, 2000, then the Company shall no later than ten Business Days
after the completion of such offering cause a Notice of Offering to be given to
the Trustee, the Bondholders and the Luxembourg Stock Exchange of such fact and
that at any time and from time to time, in whole or in part (but not earlier
than the 60th day prior to the Maturity of the Bonds, subject to the provisions
of paragraph (B)(i)(d) above) the Bondholders may by delivery of notice pursuant
to paragraph (B)(i) above elect to exercise their Conversion Right. The Company
shall also provide in the Notice of Offering all information concerning all
offerings since the Issue Date that may be relevant to a Conversion Price
determination or requested by the Trustee in relation thereto;
(iv) Delayed Closing Date
If a Complying Public Equity Offering or a Non-Complying Equity Offering
occurs within the 60 day period prior to and ending at the original Maturity of
the Bonds, then for purposes of exercise of the Conversion Right by Bondholders,
the Maturity for all Bonds shall be postponed to the 60th day following the date
of the Notice of Offering and the Bonds will continue to accrue interest to the
date the Bonds are converted, provided that, in no event will interest accrue
for a period longer than 60 days from June 30, 2000.
(v) Conversion Right Termination
The Conversion Right of any Bondholder in respect of a Bond becoming
redeemable pursuant to the Indenture and in respect of which the conditions
required for conversion have not been satisfied by the relevant Bondholder by
the end of the second Business Day prior to any date for redemption thereof
shall, except as provided below, thereupon terminate. Notwithstanding the
foregoing, if these is a default in making full payment when due of the
redemption monies in respect of any Bond, the Conversion Right in respect
thereof shall extend up to and including the date on which payment has been
received by a Paying Agent or the Trustee. The Conversion Right of a Bondholder
in respect of a Bond becoming due and payable as a result of the acceleration of
the Maturity thereof following an Event of Default shall terminate on the date
that payment with respect to such Bonds has been received by a Paying Agent or
the Trustee.
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(vi) General
In the event where Bondholders have elected to convert their Bonds pursuant
to paragraph (ii) or (iii) above by giving notice thereof to the Company in
accordance with the terms of the Indenture, then any subsequent redemption of
the Bonds shall not affect the right of the holders of such Bonds to receive
shares of Common Stock and such Bonds shall not be so redeemed. No earlier than
60 days and no later than 30 days prior to the Maturity of the Bonds, the
Company shall deliver a notice to the Trustee, the Bondholder and the Luxembourg
Stock Exchange of the status of the Conversion Rights, if any, of the
Bondholders.
(C) CONVERSION PRICE
Each Bond will be converted into such number of shares of Common Stock as
is equal to the principal amount of such Bond divided by the applicable
Conversion Price.
The applicable Conversion Price of the Bonds shall be determined as
follows:
(i) where a Complying Public Equity Offering has not been preceded,
since the Issue Date, by a Non-Complying Equity Offering, the Conversion
Price shall be equal to the per share price to the public in the Complying
Public Equity Offering multiplied by (A) 100 per cent. if the Complying
Public Equity Offering occurs on or before June 30, 1998, (B) 93 per cent.
if the Complying Public Equity Offering occurs on or before June 30, 1999
and after June 30, 1998, or (C) 85 per cent. if the Complying Public Equity
Offering occurs after June 30, 1999;
(ii) where a Complying Public Equity Offering has been preceded by one
or more Non-Complying Equity Offerings since the Issue Date, the Conversion
Price shall be equal to the lower of (a) the dollar-weighted average
conversion price for all of such Non-Complying Equity Offerings and the
Complying Public Equity Offering (as calculated for each such offering by
multiplying the gross per share offering price for the applicable offering
by (A) 100 per cent. if the closing date of such offering occurs on or
before June 30, 1998, (B) 93 per cent. if the closing date of such offering
occurs on or before June 30, 1999 and after June 30, 1998, or (C) 85 per
cent. if the closing date of such offering occurs after June 30, 1999) and
(b) the conversion price for the Complying Public Equity Offering alone (as
calculated in clause (i) above);
(iii) where a Non-Complying Public Equity Offering has an offering
size of at least $50,000,000 and (A) no Complying Public Equity Offering
has occurred since the issuance of the Bonds, and (B) there has been one or
more Non-Complying Equity Offerings, the Conversion Price shall be equal to
the lower of (a) the dollar-weighted average conversion price for all of
such Non-Complying Equity Offerings and the Non-Complying Public Equity
Offering (as calculated for each such offering by multiplying the gross per
share offering price by (A) 100 per cent. if the closing date of such
offering occurs on or before June 30, 1998, (B) 93 per cent. if the closing
date of such offering occurs on or before June 30, 1999 and after June 30,
1998, or (C) 85 per cent. if the closing date of such offering occurs after
June 30, 1999) and (b) the conversion price for the Non-Complying Public
Equity Offering (as calculated in (a) above); or
(iv) in the case of any other Non-Complying Equity Offering not
provided for in clause (iii) above, where no Complying Public Equity
Offering has occurred since the Issue Date, the applicable Conversion Price
shall be equal to the lowest conversion price calculated for each such
offering that has occurred since the Issue Date, where each such conversion
price will be determined by multiplying the gross per share offering price
for each such offering by (A) 100 per cent. if the closing date of such
offering occurs on or before June 30, 1998, (B) 93 per cent. if the closing
date of such offering occurs on or before June 30, 1999 and after June 30,
1998, or (C) 85 per cent. if the closing date of such offering occurs after
June 30, 1999.
There shall be excluded from the calculation of the applicable Conversion
Price any Private Equity Offerings aggregating no more than $100 million in
gross proceeds if such offering or offerings (i) are consummated on or prior to
December 31, 1997 and (ii) any Strategic Equity Offering that occurs from the
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Issue Date so long as there has occurred a Complying Public Equity Offering or a
Non-Complying Equity Offering.
The Company will publish the Conversion Price in the Luxemburger Wort and
will notify the Luxembourg Stock Exchange of the Conversion Price when
determined for so long as the Bonds are listed on the Luxembourg Stock Exchange.
(D) STAMP AND OTHER DUTIES AND EXCHANGE COSTS
Payment of all stamp, transfer and registration duties (if any) and any
brokers' commission and stock exchange transaction charges and any other tax
thereon arising on exercise of Conversion Rights and/or on the transfer or
delivery of shares of Common Stock by the Company (or the Trustee pursuant to
the Indenture) to or to the order of the Trustee or the relevant Bondholder in
connection therewith, payable in or imposed by the United States, any state or
other political sub-division thereof and any other jurisdiction in which the
register in respect of any securities is located will be made or procured by the
Company. If the Company shall fail to pay any such duties or costs, the relevant
Bondholder shall be entitled to tender and pay the same. The Company has in the
Indenture covenanted to reimburse each such Bondholder in respect of the payment
of such duties or costs and any penalties paid in respect thereof. A Bondholder
exercising Conversion Rights must pay to the relevant Conversion Agent any such
duties or costs arising in any other circumstances.
(E) CASH PAYMENT INSTRUCTIONS
Upon the exercise of Conversion Rights, a Bondholder shall, when delivering
the relevant Conversion Notice, give directions to the relevant Conversion Agent
for payment of any cash sum which such Bondholder is entitled to receive
pursuant to the Indenture and which shall be paid by way of U.S. dollar check
drawn on a bank in the City of New York or by wire transfer to a U.S. dollar
account maintained by the payee with a bank in the City of New York.
(F) FRACTIONS ARISING ON CONVERSION
No fraction of a share of Common Stock shall be delivered on exercise of
Conversion Rights but a cash payment shall be made by the Company to the
relevant Bondholder, pursuant to directions given to the relevant Conversion
Agent by the Bondholder as provided in (E) above, not later than 21 days after
the Conversion Date, of an amount equal to the value of such fraction (such
amount to be rounded up to the nearest U.S.$0.01).
REDEMPTION AND PURCHASE
(A) FINAL REDEMPTION AT MATURITY
Unless previously redeemed or converted or to be converted or purchased and
cancelled, on June 30, 2000 outstanding Bonds will be redeemed by the Company at
their principal amount plus accrued interest, if any. However, in the event that
a Complying Public Equity Offering has not occurred prior to June 30, 2000,
outstanding Bonds will be redeemed at Maturity at 121.0 per cent. of their
principal amount, plus accrued interest, if any.
(B) ACCELERATION FOLLOWING AN EVENT OF DEFAULT
If the Bonds are accelerated following the occurrence of an Event of
Default, the Bonds will be repaid at their principal amount multiplied by 106.5
per cent. plus accrued interest to the date of acceleration, if the date of
acceleration occurs on or before June 30, 1998; 113.5 per cent. plus accrued
interest to the date of acceleration if the date of acceleration occurs after
such date but on or before June 30, 1999; and 121.0 per cent. if the date of
acceleration occurs thereafter; provided that notwithstanding the foregoing,
each Bondholder shall have the option to exercise his Conversion Right, if any.
The payment of the premium referred to above upon the occurrence of an
Event of Default may not be enforceable under U.S. federal or New York Law.
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(C) CANCELLATION
All Bonds redeemed pursuant to the Indenture or purchased by the Company in
the open market will be forthwith cancelled and may not be reissued or sold. The
Company will not permit its Subsidiaries and will to the fullest extent of the
rights available to it under the relevant contractual or organizational
documents not permit its Significant Joint Ventures to purchase any of the
Bonds.
(D) LIMITED OPTIONAL REDEMPTION
The Bonds are redeemable at the option of the Company, in whole but not in
part on or after the second anniversary of a Complying Public Enquiry Offering,
on not less than 90 nor more than 120 days' prior notice (which notice shall
provide the Trustee and the Bondholders information concerning the right of
Bondholders to convert prior to the Redemption Date and information pertinent to
the Conversion Price) at the principal amount thereof plus accrued interest to
the Redemption Date, provided that the shares of Common Stock into which Bonds
are convertible would not be at the time of redemption "restricted securities"
in the hands of any Bondholder not affiliated with the Company, within the
meaning of the Securities Act, and provided further, that the average Closing
Price of the shares of Common Stock for the 20 consecutive Trading Days prior to
the date of the Company's notice of redemption is greater than 130 per cent of
the Conversion Price determined in conjunction with such Complying Public Equity
Offering.
The redemption of the Bonds at the option of the Company under the
Indenture may be prohibited by the terms of or result in an event of default
under or require the consents of holders of Senior Indebtedness of the Company.
The Company's obligations under its Senior Indebtedness represent obligations
senior in right of payment to the Bonds. Consequently, the purchase of the Bonds
by the Company pursuant to an optional redemption will be precluded, absent any
required consent of the lenders under Senior Indebtedness or repayment of all
amounts outstanding thereunder or the waiver of any event of default caused
thereunder.
EVENTS OF DEFAULT
The following are "Events of Default" under the Indenture:
(a) the Company fails to pay the principal of or any premium (if any)
or interest (including Additional Amounts) on any of the Bonds when due
(upon Maturity, acceleration, redemption, required purchase or otherwise
and whether or not prohibited by the subordination provisions) and, in the
case of interest only, such failure continues for a period of 30 days; or
(b) the Company does not perform or comply with any one or more of its
other obligations in the Bonds or the Indenture (other than a default under
(a) above) for a period of 60 days after written notice of such default
shall have been given to the Company by the Trustee or to the Company and
the Trustee by holders of at least 25 per cent in aggregate principal
amount of Bonds then outstanding; or
(c) (i) one or more defaults in the payment of principal of or
premium, if any, on Indebtedness of the Company or any Material Subsidiary
or any Significant Joint Venture aggregating U.S.$10 million (or the
foreign currency equivalent thereof) or more, when the same becomes due and
payable at the Maturity thereof, and such default or defaults shall have
continued after any applicable grace period and shall not have been cured
or waived or (ii) Indebtedness of the Company or any Material Subsidiary or
any Significant Joint Venture aggregating U.S.$10 million (or the foreign
currency equivalent thereof) or more shall have been accelerated or
otherwise declared due and payable, or required to be prepaid or
repurchased (other than by regularly scheduled required prepayment) prior
to the Maturity thereof, or
(d) any holder or holders of Indebtedness aggregating U.S.$10 million
(or the foreign currency equivalent thereof) or more of the Company or any
Material Subsidiary or any Significant Joint Venture shall notify the
Company or the Trustee of the intended sale or disposition of any assets of
the Company or any such Material Subsidiary or Significant Joint Venture
that have been pledged to or for the benefit of such person to secure such
Indebtedness, or shall commence proceedings, or take action (including by
way of set-off) to retain in satisfaction of any such Indebtedness, or to
collect on, seize, dispose of or apply, any such assets of the Company or
any Material Subsidiary or any Significant Joint Venture
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pursuant to the terms of any agreement or instrument evidencing any such
Indebtedness or in accordance with applicable law; or
(e) one or more final judgments (or judgments which can no longer be
appealed) or orders or similar judicial or administrative action shall be
rendered against the Company or any Material Subsidiary or Significant
Joint Venture for the payment of money, either individually or in an
aggregate amount, in excess of U.S.$10 million (or the foreign currency
equivalent thereof) and which shall not have been discharged and either (i)
an enforcement proceeding shall have been commenced by any creditor upon
such judgement or order or similar judicial or administrative action or
(ii) there shall have been a period of 60 consecutive days during which a
stay of enforcement of such judgment or order, by reason of a pending
appeal or otherwise, was not in effect; or
(f) the Company or any Material Subsidiary or Material Joint Venture,
pursuant to or under or within any applicable bankruptcy, insolvency,
reorganization, moratorium, liquidation or like law; (i) commences a
voluntary case or proceeding; (ii) consents to the entry of an order for
relief against it in an involuntary case or proceeding; (iii) makes a
general assignment for the benefit of its creditors; (iv) or shall
generally not pay its debts when such debts become due or shall admit in
writing its inability to pay its debts generally; (v) or a court of
competent jurisdiction (or like entity) shall enter an order or decree
under any applicable law described above that is for relief against the
Company or any Material Subsidiary or Material Joint Venture, as applicable
in an involuntary case or proceeding, appoints a custodian for the Company
or such other entity for all or substantially all its properties or orders
the liquidation of the Company or such other entity, as applicable and in
each such case in this clause (v), the order or decree remains unstayed and
in effect for 60 days; (vi) or the Company or such other entity shall take
any corporate action regarding any of the foregoing; or
(g) excluding the events referred to in paragraph (f) above, any
seizure, compulsory acquisition, expropriation or nationalization of any
assets of the Company, any Subsidiary or Significant Joint Venture for
which there is not paid Fair Market Value and where the seizure, compulsory
acquisition, expropriation or nationalization (whether by an outright
taking or by confiscatory tax or other policies), individually or in the
aggregate, could reasonably be expected to result in a material adverse
effect on the business, (including without limitation the ability to
generate cash flow over the life of the Bonds) the condition (financial or
other), the properties or the results of operations of the Company, its
Subsidiaries, and Significant Joint Ventures on a combined basis (a
"Material Adverse Effect").
If an Event of Default (other than as specified in subparagraph (f) above)
shall occur and be continuing, the Trustee, by notice to the Company, or the
holders of at least 25 per cent. in aggregate principal amount of the Bonds then
outstanding by notice to the Trustee and the Company, may declare the principal
of, premium, if any, and accrued and unpaid interest on all of the outstanding
Bonds due and payable immediately upon which declaration, all amounts payable in
respect of the outstanding Bonds shall be due and payable immediately. If an
Event of Default specified in subparagraph (f) above occurs and is continuing,
then the principal of, premium, if any, and accrued and unpaid interest, on all
of the outstanding Bonds shall ipso facto become and be immediately due and
payable without any declaration or other act on the part of the Trustee or any
holders of Bonds.
After a declaration of acceleration under the Indenture, but before a
judgment or decree for payment of the money due has been obtained by the
Trustee, the holders of a majority in aggregate principal amount of the
outstanding Bonds, by written notice to the Company and the Trustee, may rescind
such declaration if (a) the Company has paid or deposited with the Trustee a sum
sufficient to pay (i) all sums paid or advanced by the Trustee under the
Indenture and the reasonable compensation, expenses, disbursements and advances
of the Trustee, its agents and counsel, (ii) all overdue interest on all Bonds,
(iii) the unpaid principal of and premium, if any, on any outstanding Bonds
which have become due otherwise than by such declaration of acceleration and
interest thereon at the rate borne by the Bonds, and (iv) to the extent that
payment of such interest is lawful, interest upon overdue interest and overdue
principal at the rate borne by the Bonds which has become due otherwise than by
such declaration of acceleration; (b) the rescission would not conflict with
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any judgment or decree of a court of competent jurisdiction; and (c) all Events
of Default, other than the non-payment of principal of, premium, if any, and
interest on the Bonds that have become due solely by such declaration of
acceleration, have been cured or waived.
The holders of not less than a majority in aggregate principal amount of
the outstanding Bonds may on behalf of the holders of all the Bonds waive any
past defects under the Indenture, existing Default or Event of Default, except a
Default or Event of Default in the payment of the principal of, premium, if any,
or interest on any Bond, or in respect of a covenant or provision which under
the Indenture cannot be modified or amended without the consent of the holder of
each Bond outstanding.
No holder of any of the Bonds has any right to institute any proceeding
with respect to the Indenture or the Bonds or any remedy thereunder, unless the
holders of at least 25% in aggregate principal amount of outstanding Bonds have
made written requests, and offered reasonable indemnity, to the Trustee to
institute such proceeding as Trustee under the Bonds and the Indenture, and the
Trustee has failed to institute such proceeding within 30 days after receipt of
such notice and the Trustee, within such 30-day period, has not received
directions inconsistent with such written request by holders of a majority in
aggregate principal amount of the outstanding Bonds. Such limitations do not
apply, however, to a suit instituted by a holder of a Bond for the enforcement
of the payment of the principal of, premium, if any, or interest on such Bond on
or after the respective due dates expressed in such Bonds.
During the existence of an Event of Default, the Trustee is required to
exercise such rights and powers vested in it under the Indenture and use the
same degree of care and skill in its exercise thereof as a prudent person would
exercise under the circumstances in the conduct of such person's own affairs.
Subject to the provisions of the Indenture relating to the duties of the
Trustee, whether or not an Event of Default shall occur and be continuing, the
Trustee under the Indenture is not under any obligation to exercise any of its
rights or powers under the Indenture at the request or direction of any of the
holders unless such holders shall have offered to the Trustee reasonable
security or indemnity. Subject to certain provisions concerning the rights of
the Trustee, the holders of not less than a majority in aggregate principal
amount of the outstanding Bonds have the right to direct the time, method and
place of conducting any proceeding for any remedy available to the Trustee, or
exercising any trust or power conferred on the Trustee under the Indenture.
If a Default or an Event of Default occurs and is continuing and is known
to the Trustee, the Trustee shall mail to each holder of the Bonds, and to the
Luxembourg Stock Exchange for so long as the Bonds are listed thereon, notice of
the Default or Event of Default within 30 days after obtaining knowledge
thereof. Except in the case of a Default or an Event of Default in payment of
principal or premium, if any, or interest on any Bonds, the Trustee may withhold
the notice to the holders of such Bonds if a committee of its trust officers in
good faith determines that withholding the notice is in the interest of the
holders of the Bonds.
REPORTING REQUIREMENTS
For the fiscal quarters ending June 30, 1997 and September 30, 1997 and for
the fiscal year ended December 31, 1997 the Company will (i) transmit by mail to
all Bondholders, as their names and addresses appear in the Register, without
cost to such Bondholders, and (ii) file with the Trustee copies of the quarterly
and audited annual financial reports of the Company (including the condensed,
combining financial data in the form and scope set forth in the condensed,
consolidated financial statements of the Company for the first quarter of 1997
and for the fiscal year ending December 31, 1996, respectively) that are
generally distributed to its shareholders at the time such reports are so
distributed.
Beginning with the financial statements of the Company for the quarter
ending March 31, 1998 and thereafter, whether or not the Company is subject to
Section 13(a) or 15(d) of the Exchange Act, or any successor provision thereto,
the Company shall prepare the annual and quarterly reports which the Company
would have been required to file with the Securities and Exchange Commission
pursuant to such Section 13(a) or 15(d) or any successor provision thereto
(including, until such time as the Company is required to file reports with the
Commission pursuant to Section 13(a) or 15(d) of the Exchange Act, the
condensed, combining financial data in the form and scope set forth in the
condensed, consolidated financial statements described above) on or prior to the
respective dates (the "Required Filing Dates") by which the Company
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would have been required so to file such documents. The Company shall also in
any event within 15 days of each Required Filing Date (i) transmit by mail to
all Bondholders, as their names and addresses appear in the Register, without
cost to such Bondholders, and (ii) file with the Trustee, copies of such annual
and quarterly reports.
The Company is required to furnish to the Trustee annual and quarterly
statements as to the performance by the Company of its obligations under the
Indenture and as to any default in such performance. The Company is also
required to notify the Trustee within thirty (30) days after the Company has
knowledge of any event which is, or after notice or lapse of time or both would
become, an Event of Default.
NEGATIVE PLEDGE AND COVENANTS
So long as any Bond remains outstanding or any amount remains unpaid with
respect to any of the Bonds or up to and including the date of (a) the Complying
Public Equity Offering or (b) a Covenant Defeasance, the Company, its
Subsidiaries and Significant Joint Ventures will be subject to the following
Negative Pledge and Covenants:
(A) NEGATIVE PLEDGE
The Company will not, and will not permit any of its Subsidiaries to, and
will to the fullest extent of the rights available to it under the relevant
contractual or organizational documents not permit its Significant Joint
Ventures to, directly or indirectly create, incur, assume or suffer to exist any
Lien that secures obligations under any Pari Passu Indebtedness or Subordinated
Indebtedness on any asset or property of the Company or such Subsidiary or such
Significant Joint Venture, or any income or profits therefrom, or assign or
convey any right to receive income therefrom, unless the Bonds are equally and
ratably secured with the obligations so secured (provided that any Lien securing
Subordinated Indebtedness shall be subordinate and junior to the Lien securing
the Bonds with the same relative priority as such Subordinated Indebtedness
shall have with respect to the Bonds) until such time as such obligations are no
longer secured by such Lien.
(B) COVENANTS
(a) Limitation on Indebtedness. The Company will not, and will not permit
any of its Subsidiaries to, and will to the fullest extent of the rights
available to it under the relevant contractual or organizational documents not
permit its Significant Joint Ventures to, directly or indirectly, create, incur,
issue, assume, guarantee or in any manner become directly or indirectly liable,
contingently or otherwise, for the payment of (in each case, to "incur") any
Indebtedness (including any Acquired Indebtedness); provided, however, that the
Company, any Subsidiary or any Significant Joint Venture will be permitted to
incur Indebtedness (including Acquired Indebtedness) if (a) at the time of such
incurrence, no Default or Event of Default under the Indenture has occurred and
is continuing, (b) at the time of such incurrence the Fixed Charge Coverage
Ratio for the four full fiscal quarters immediately preceding the incurrence of
such Indebtedness, taken as one period (and after giving pro forma effect to (i)
the incurrence of such Indebtedness and (if applicable) the application of the
net proceeds therefrom, including to refinance other Indebtedness, as if such
Indebtedness was incurred, and the application of such proceeds occurred, on the
first day of such four-quarter period, (ii) the incurrence, repayment or
retirement of any other Indebtedness by the Company, its Subsidiaries and its
Significant Joint Ventures since the first day of such four-quarter period
(except that, in making such computation, the amount of Indebtedness under any
revolving credit facility shall be computed based upon the average daily balance
of such Indebtedness during such four-quarter period) and (iii) the acquisition
(whether by purchase, merger or otherwise) or disposition (whether by sale,
merger or otherwise) of any company, entity or business acquired or disposed of
by the Company, or its Subsidiaries or its Significant Joint Ventures, as the
case may be, since the first day of such four-quarter period), would have been
at least equal to 2:1 and (c) in the case of the incurrence of Subordinated
Indebtedness or Pari Passu Indebtedness, such Indebtedness has no scheduled
principal payment prior to the 91st day after the Maturity of the Bonds.
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Notwithstanding the foregoing, the Company and its Subsidiaries and
Significant Joint Ventures may, to the event specifically set forth below, incur
each and all of the following:
(a) Indebtedness of the Company evidenced by the Bonds;
(b) Indebtedness of the Company, any Subsidiary or any Significant
Joint Venture outstanding on the Issue Date;
(c) Indebtedness of the Company, any Subsidiary and any Significant
Subsidiary in an aggregate principal amount at any one time outstanding not
to exceed U.S.$75,000,000 (or the foreign currency equivalent thereof);
(d)(i) Interest Rate Protection Obligations of the Company or any
Subsidiary or any Significant Joint Venture covering Indebtedness of the
Company, such Subsidiary or such Significant Joint Venture; provided,
however, that, (x) any Indebtedness to which any such Interest Rate
Protection Obligations relate bears interest at fluctuating interest rates
and is otherwise permitted to be incurred under this covenant and (y) the
notional principal amount of any such Interest Rate Protection Obligations
does not exceed the principal amount of the Indebtedness to which such
Interest Rate Protection Obligations relate;
(e) Indebtedness of any Subsidiary or Significant Joint Venture owed
to and held by the Company, another Subsidiary or Significant Joint
Venture, in each case which is not subordinated in right of payment to any
Indebtedness of such Subsidiary or Significant Joint Venture, except that
(i) any transfer of such Indebtedness by the Company or a Subsidiary or a
Significant Joint Venture (other than to the Company or to another
Subsidiary or Significant Joint Venture) and (ii) the sale, transfer or
other disposition by the Company or any Subsidiary or Significant Joint
Venture of the Capital Stock of any Subsidiary or ownership interest in any
Significant Joint Venture which is owned Indebtedness from another
Subsidiary or Significant Joint Venture such that the first such Subsidiary
or Significant Joint Venture ceases to be a Subsidiary or Significant Joint
Venture shall, in each case in (i) and (ii), be an incurrence of
Indebtedness by the second such Subsidiary or Significant Joint Venture, as
the case may be, subject to the other provisions of this covenant;
(f) Indebtedness of the Company owed to and held by any Subsidiary or
any Significant Joint Venture which is unsecured and subordinated in right
of payment to the payment and performance of the Company's obligations
under the Indenture and the Bonds provided that any subsequent issuance or
transfer of Capital Stock or other ownership interest or any other event
which results in any such Subsidiary or Significant Joint Venture ceasing
to be a Subsidiary or Significant Joint Venture, as the case may be, or any
subsequent transfer of any such Indebtedness (except to the Company or
another Subsidiary or another Significant Joint Venture) shall be deemed,
in each case, be an incurrence of Indebtedness by the Company, subject to
the other provisions of this covenant;
(g) Indebtedness under Currency Agreements, provided that in the case
of Currency Agreements which relate to Indebtedness, such Currency
Agreements do not increase the outstanding Indebtedness of the Company or
any Subsidiary or any Significant Joint Venture other than as a result of
fluctuations in foreign currency exchange rates or by reason of fees,
indemnities and compensation payable thereunder;
(h) Indebtedness of the Company or any of its Subsidiaries or any of
its Significant Join Ventures in an aggregate amount on the date of
incurrence, not in excess of 80 per cent of the average of the outstanding
accounts receivable balances of the Company, its Subsidiaries and
Significant Joint Ventures on a combined basis at each of the three
preceding quarterly balance sheet dates;
(i) Indebtedness of Hermes as to which the Company or any other
Subsidiary or any Significant Joint Venture is not directly or indirectly
liable by virtue of being the primary obligor on, guarantor of or otherwise
liable with respect to, such Indebtedness;
(j) Indebtedness of the Company or any Subsidiary or any Significant
Joint Venture represented by letters of credit for the account of the
Company or such Subsidiary or such Significant Joint Venture, as
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the case may be, in order to provide security for workers' compensation
claims, payment obligations in connection with self-insurance or similar
requirements in the ordinary course of business;
(k) Indebtedness and Acquired Indebtedness incurred by the Company or
any Subsidiary or Significant Joint Venture in order to finance the
construction, acquisition, installation or improvement of
Telecommunications Assets to be used in Europe and/or Asia (including
Russian and the CIS) by the Company, any Subsidiary or any Significant
Joint Venture;
(l)(i) Indebtedness of the Company the proceeds of which are used
solely to refinance (whether by amendment, renewal, extension or refunding)
Indebtedness of the Company or any Subsidiary or any Significant Joint
Venture and (ii) Indebtedness of any Subsidiary or Significant Joint
Venture, the proceeds of which are used solely to refinance (whether by
amendment, renewal, extension or refunding) Indebtedness of such Subsidiary
or such Significant Joint Venture, in each case other than the Indebtedness
incurred under the preceding clauses (c) through (g) and (i) through (k) of
this covenant; provided, however, that (x) the principal amount of
Indebtedness incurred pursuant to this clause (l) (or, if such Indebtedness
provides for an amount less than the principal amount thereof to be due and
payable upon a declaration of acceleration of the maturity thereof, the
original issue price of such Indebtedness) shall not exceed the sum of the
outstanding principal amount of Indebtedness so refinanced, plus the amount
of any premium required to be paid in connection with such refinancing
pursuant to the terms of such Indebtedness or the amount of any premium
reasonably determined by the Board of Directors of the Company as necessary
to accomplish such refinancing by means of a tender offer or privately
negotiated purchase, plus the amount of expenses in connection therewith,
(y) in the case of Indebtedness incurred by the Company pursuant to this
clause (J) to refinance Subordinated Indebtedness, such Indebtedness (A)
has no scheduled principal payment prior to the 91st day after the Maturity
of the Bonds, (B) has an Average Life to Stated Maturity greater than the
remaining Average Life to Stated Maturity of the Bonds, and (C) is
subordinated to the Bonds in the same manner and to the same extent that
the Subordinated Indebtedness being refinanced is subordinated to the Bonds
and (z) in the case of Indebtedness incurred by the Company pursuant to
this clause (l) to refinance Pari Passu Indebtedness, such Indebtedness (A)
has no scheduled principal payment prior to the 91st day after the Maturity
of the Bonds, (B) has an Average Life to Stated Maturity greater than the
remaining Average Life to Stated Maturity of the Bonds and (C) constitutes
Pari Passu Indebtedness or Subordinated Indebtedness.
(b) Limitation on Restricted Payments. The Company will not, and will not
permit any of its Subsidiaries to, and will to the fullest extent of the rights
available to it under the relevant contractual or organizational documents not
permit its Significant Joint Ventures to, directly or indirectly:
(i) declare or pay any dividend or make any other distribution or
payment on or in respect of Capital Stock of the Company or any Subsidiary
or any Significant Joint Venture or any payment to the direct or indirect
holders (in their capacities as such) of Capital Stock of the Company or
any Subsidiary or any Significant Joint Venture (other than (x) dividends
or distributions payable solely in Capital Stock of the Company, such
Subsidiary or such Significant joint Venture (other than, in each case,
Redeemable Capital Stock) or in options, warrants of other rights to
purchase Capital Stock of the Company (other than, in each case, Redeemable
Capital Stock), (y) the declaration or payment of dividends or other
distributions to the extent declared or paid to the Company or any
Subsidiary or any Significant Joint Venture and (z) the declaration or
payment of dividends or other distributions by any such entity to all
holders of equity or similar economic interests of such entity on a pro
rata basis).
(ii) purchase, redeem, defense or otherwise acquire or retire for
value any Capital Stock or other ownership interest of the Company or any
subsidiary or any Significant Joint Venture (other than any such Capital
Stock or other ownership interest owned by a Wholly-Owned Subsidiary),
(iii) make any principal payment on, or purchase, defease, repurchase,
redeem or otherwise acquire or retire for value, prior to any scheduled
maturity, scheduled repayment, scheduled sinking fund payment or other
Maturity, any Subordinated Indebtedness (other than any such Indebtedness
owned by the Company or a Wholly-Owned subsidiary), or
(iv) make any Investment (other than any Permitted Investment) in any
person
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(such payments or Investments described in the preceding clauses (i), (ii),
(iii) and (iv) are collectively referred to as "Restricted Payments") unless, at
the time of and after giving effect to the proposed Restricted Payment (the
amount of any such Restricted Payment, if other than cash, shall be the Fair
Market Value on the date of such Restricted Payment of the assets(s) proposed to
be transferred by the Company or the relevant entity described above, as the
case may be, pursuant to such Restricted Payment, (A) no Default or Event of
Default under the Indenture shall have occurred and be continuing, (B)
immediately prior to and after giving effect to such Restricted Payment, the
Company would be able to incur $1.00 of additional Indebtedness pursuant to the
first paragraph of the covenant described under "-- Limitation on Indebtedness"
above (assuming a market rate of interest with respect to such additional
Indebtedness) and (C) the aggregate amount of all Restricted Payments declared
or made from and after the Issue Date would not exceed the sum of (1) 50 per
cent of the aggregate Pro rata Combined Adjusted Net Income accrued on a
cumulative basis during the period beginning on the first day of the fiscal
quarter of the Company during which the Issue Date occurs and ending on the last
day of the fiscal quarter of the Company immediately preceding the date of such
proposed Restricted Payment, which period shall be treated as a single
accounting period (or, if such aggregate cumulative Pro rata Combined Adjusted
Net Income for such period shall be a deficit, minus 100 per cent of such
deficit) plus (2) the aggregate net cash proceeds received by the Company, a
Subsidiary or Significant Joint Venture either (x) as capital contributions
after the Issue Date from any person (other than a Subsidiary or Significant
Joint Venture) or (y) from the issuance or sale of Capital Stock (excluding
Redeemable Capital Stock, but including Capital Stock issued upon the conversion
of convertible Indebtedness or from the exercise of options, warrants or rights
to purchase Capital Stock (other than Redeemable Capital Stock) of such entity
to any person (other than to a Wholly-Owned Subsidiary) after the Issue Date
plus (3) in the case of the disposition or repayment of any Investment
constituting a Restricted Payment made after the Issue Date (excluding any
Investment described in clause (v) of the following paragraph), an amount equal
to the lesser of the return of capital with respect to such Investment and the
cost of such Investment, in either case, less the cost of the disposition of
such Investment. For purpose of the preceding clause (C)(2), the value of the
aggregate net proceeds received by the Company upon the issuance of Capital
Stock upon the conversion of convertible Indebtedness or upon the exercise of
options, warrants or rights will be the net cash proceeds received upon the
issuance of such Indebtedness, options, warrants or rights plus the incremental
cash amount received by the Company upon the conversion or exercise thereof.
None of the foregoing provisions will prohibit (i) the payment of any
dividend within 60 days after the date of its declaration, if at the date of
declaration such payment would be permitted by the foregoing paragraph; (ii) the
redemption, repurchase or other acquisition or retirement of any shares of any
shares of any class of Capital Stock of the Company or any Subsidiary in
exchange for, or out of the net cash proceeds of, a substantially concurrent (x)
capital contributions to the Company from any person (other than a Subsidiary or
Joint Venture) or (y) issue and sale of other shares of Capital Stock (other
than Redeemable Capital Stock) of the Company to any person (other than to a
Subsidiary or Joint Venture); provided however, that the amount of any such net
cash proceeds that are utilized for any such redemption, repurchase or other
acquisition or retirement shall be excluded from clause (C)(2)of preceding
paragraph; (iii) any redemption, repurchase or other acquisition or retirement
of Subordinated Indebtedness by exchange for, or out of the net cash proceeds
of, a substantially concurrent (x) capital contribution to the Company from any
person (other than Subsidiary or Joint Venture) or (y)(1) issue and sale of
Capital Stock (other than Redeemable Capital Stock) of the Company to any person
(other than to a Subsidiary or Joint Venture); provided however, that the amount
of any such net cash proceeds that are utilized for any such redemption,
repurchase or other acquisition or retirement shall be excluded from clause
(C)(2) of the proceeding paragraph or (2) Indebtedness of the Company issued to
any person (other than a Subsidiary or Joint Venture), so long as such
Indebtedness is Subordinated Indebtedness which (A) has no Subsidiary or Joint
Venture), so long as such Indebtedness which (A) has no Maturity earlier than
the 91st day after the Maturity of the Bonds, (B) has an Average Life to Stated
Maturity equal to or greater than the remaining Average Life to Stated Maturity
of the Bonds and (C) is subordinated to the Bonds in the same manner and at
least to the same extent as the Subordinated Indebtedness so purchased,
exchanged, redeemed, acquired or
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retired; (iv) so long as no Default or Event of Default shall have occurred and
be continuing, any redemption, repurchase or other acquisition of retirement of
Pari Passu Indebtedness by exchange for, or out of the net cash proceeds of, a
substantially concurrent (x) capital contribution to the Company from any person
(other than a subsidiary or Joint Venture) or (y)(1) issue and sale of Capital
Stock (other than Redeemable Capital Stock) of the Company to any person (other
than to a Subsidiary or Joint Venture); provided, however, that the amount of
any such net cash proceeds that are utilized for any such redemption, repurchase
or other acquisition or retirement is excluded from clause (C)(2) of the
preceding paragraph or (2) Indebtedness of the Company issued to any person
(other than a Subsidiary), so long as such Indebtedness is Subordinated
Indebtedness or Pari Passu Indebtedness which (A) has no Maturity earlier than
the 91st day after the Maturity of the Bonds and (B) has an Average Life to
Stated maturity equal to or greater than the remaining Average Life to Stated
Maturity of the Bonds; (v) Investments constituting Restricted Payments made as
a result of the receipt of non-cash consideration from any Asset Sale made
pursuant to and in compliance with the covenant described under " -- Disposition
of Proceeds of Asset Sales" below; (vi) payments or other actions described in
clauses (i) through (iv) in the next preceding paragraph above that would
otherwise be Restricted Payments in an aggregate amount not to exceed U.S. $10
million (or the foreign currency equivalent thereof); and (vii) so long as no
Default or Event of Default has occurred and is continuing, repurchases by the
Company of Common Stock of the Company from employees of the Company or any of
its Subsidiaries or their authorized representatives upon the death, disability
or termination of employment of such employees, in an aggregate amount not
exceeding U.S. $10 million (or the foreign currency equivalent thereof) in any
calendar year. In computing the amount of Restricted Payments previously made
for purposes of clause (C) of the preceding paragraph, Restricted Payments made
under the preceding clauses (vi), and (vii) shall be included and clauses (i),
(ii), (iii), (iv) and (v) shall not be so included.
(c) Change of Control. Upon the occurrence of a Change of Control, the
Company shall be obligated to make an offer to purchase (a "Change of Control
Offer") all of the outstanding Bonds at a purchase price (the 'Change of Control
Purchase Price') equal to 106.5 per cent, (if the date of such purchase occurs
on or before June 30, 1998), 113.5 per cent , (if the date of such purchase
occurs after June 30, 1998 but on or before June 30, 1999) or 121.0 per cent,
(if the date of such purchase occurs after June 30, 1999), as applicable, of the
principal amount thereof plus accrued and unpaid interest, if any, to the
purchase date which shall be no earlier than 60 days and no later than 90 days
from the date the notice of the Change of Control Offer is distributed to the
Bondholders and the Trustee (the "Change of Control Purchase Date"). The Company
shall be required to purchase all Bonds properly tendered (or the portions
thereof equal to U.S. $10,000 or increments of U.S.$1,000 in excess thereof that
are so tendered by a Bondholder in the case of a partial tender) in the Change
of Control Offer and not withdrawn on the Change of Control Purchase Date. The
Change of Control Offer is required to remain open for at least 20 Business Days
and until the close of business on the second Business Day preceding the Change
of Control Purchase Date.
In order to effect such Change of Control Offer, the Company shall, not
later than the 30th day after the occurrence of the Change of Control, give to
each holder of Bonds notice of the Change of Control Offer, which notice shall
govern the terms of the change of Control Offer and shall state, among other
things, the procedures that holders of Bonds must follow to accept the Change of
Control Offer.
The occurrence of the events constituting a Change of Control under the
Indenture may be prohibited by the terms of or result in an event of default
under or require the consents of holders of Senior Indebtedness of the Company.
The Company's obligations under its Senior Indebtedness represent obligations
senior in right of payment to the Bonds. Consequently, the subordination
provisions of the Indenture will have the effect of precluding the purchase of
the Bonds by the Company in the event of a Change of Control, absent any
required consent of the lenders under Senior Indebtedness or repayment of all
amounts outstanding thereunder or the waiver of any event of default caused
thereunder by such Change of Control (although the failure by the Company to
comply with its obligations in the event of a Change of Control will constitute
a Default under the Bonds). There can be no assurance that the Company will have
adequate resources to repay or refinance all Indebtedness owing under the Senior
Indebtedness or to fund the purchase of the Bonds upon a Change of Control.
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The Company shall not be required to make a Change of Control Offer upon a
Change of Control if a third party makes the Change of Control Offer in the
manner, at the times and otherwise in compliance with the requirements
applicable to a Change of Control Offer made by the Company and purchases all
Bonds validly tendered and not withdrawn under such Change of Control Offer.
The Company will comply with Rule 14c-1 under the Exchange Act and any
other securities laws and regulations there under to the extent such laws and
regulations are applicable, in the event that a Change of Control occurs and the
Company is required to purchase Bonds as described above.
(d) Disposition of Proceeds of Asset Sales. The Company will not, and will
not permit any of its Subsidiaries to, and will to the fullest extent of the
rights available to it under the relevant contractual organizational documents
not permit its Significant Joint Ventures to, make any Asset Sale unless (a) the
Company or such entity, as the case may be, receives consideration at the time
of such Asset Sale at least equal to the Fair Market Value of the shares or
assets sold or otherwise disposed of and (b) at least 75 per cent of such
consideration consists of cash or Cash Equivalents or the assumption of
Indebtedness of the Company or such Subsidiary or such Significant Joint Venture
or other obligations relating to such assets and release from all liability on
the Indebtedness or other obligations assumed, or such consideration consists of
(x) property or assets that will be owned by the Company, or a Subsidiary or a
Significant Joint Venture and are to be used in a telecommunications business or
in related activities or services that thereafter will be conducted by the
Company or such Subsidiary or such Significant Joint Venture or (y) Capital
Stock or other securities issued by a party to the transaction or an Affiliate
thereof, which Capital Stock or other securities are freely tradeable and which
are sold for cash within 90 days of the consummation of the Asset Sale in
connection with which they were acquired. To the extent the Net Cash Proceeds of
any Asset Sale are not required to be applied to repay, and permanently reduce
the commitments under, Senior Indebtedness or Indebtedness of a Subsidiary or
Indebtedness of a Significant Joint Venture or are not so applied, the Company
or such entity, as the case may be, within 360 days of such Asset Sale, will
apply such Net Cash Proceeds to an investment in properties and assets that
replace the properties and assets that were the subject of such Asset Sale or in
properties and assets that will be used in the business of the Company and such
entities existing on the Issue Date or in businesses reasonably related thereto
("Replacement Assets"). Any Net Cash Proceeds from any Asset Sale that are
neither used to repay, and permanently reduce the commitments under Senior
Indebtedness or Indebtedness of a Subsidiary or Indebtedness of a Significant
Joint Venture, nor invested in Replacement Assets within the 360-day period
described above constitute "Excess Proceeds" subject to disposition as provided
below.
When the aggregate amount of Excess Proceeds equals or exceeds U.S. $10
million, the Company shall make an offer to purchase (an "Asset Sale Offer"),
from all holders of the Bonds, on a date not more than 40 Business Days
thereafter, an aggregate principal amount of Bonds equal to such Excess
Proceeds, at a price in cash equal to 100 per cent. of the outstanding principal
amount thereof plus accrued and unpaid interest, if any, to the purchase date.
To the extent that the aggregate principal amount of Bonds tendered pursuant to
an Asset Sale Offer is less than the Excess Proceeds, the Company may use such
excess for general corporate purposes. If the aggregate principal amount of
Bonds validly tendered and not withdrawn by holders thereof is greater than the
Excess Proceeds, Bonds to be purchased will be selected on a pro rata basis.
Upon completion of such Asset Sale Offer, the amount of Excess Proceeds shall be
reset to zero.
The making of any Asset Sale Offer under the Indenture may be prohibited by
the terms of or results in an event of default under or require the consents of
holders of Senior Indebtedness of the Company. The Company's obligations under
its Senior Indebtedness represent obligations senior in right of payment to the
Bonds. Consequently, the purchase of the Bonds by the Company pursuant to an
Asset Sale Offer will be precluded, absent any required consent of the lenders
under Senior Indebtedness or repayment of all amounts outstanding thereunder.
There can be no assurance that the Company will have adequate resources to repay
or refinance all Indebtedness owing under the Senior Indebtedness or to fund the
purchase of the Bonds pursuant to an Asset Sale Offer.
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The Company will comply with Rule 14e-1 under the Exchange Act and any
other securities laws and regulations thereunder to the extent such laws and
regulations are applicable, in the event that an Asset Sale occurs and the
Company is required to purchase Bonds as described above.
(e) Limitation on Transactions with Interested Persons. The Company will
not, and will not permit any of its Subsidiaries to, and will to the fullest
extent of the rights available to it under the relevant contractual or
organizational documents not permit its Significant Joint Ventures to, directly
or indirectly, enter into or suffer to exist any transaction or series of
related transactions (including, without limitation, the sale, transfer,
disposition, purchase, exchange or lease of assets, property or services) with,
or for the benefit of, any Affiliate of the Company, any Subsidiary or
Significant Joint Venture or any beneficial owner (determined in accordance with
the Indenture) of 5 per cent. or more of the Capital Stock or other ownership
interest of any of the foregoing entities at any time outstanding (each of the
foregoing being "Interested Persons"), unless (a) such transaction or series of
related transactions is on terms that are no less favorable to the Company or
such Subsidiary or Significant Joint Venture, as the case may be, than those
which could have been obtained in a comparable transaction at such time from
persons who are not Affiliates of the Company or Interested Persons, (b) with
respect to a transaction or series of transactions involving aggregate payments
or value equal to or greater than U.S. $20,000,000 (or the foreign currency
equivalent thereof), the Company has obtained a written opinion from an
Independent Financial Advisor stating that the terms of such transaction or
series of transactions are fair to the Company or such Subsidiary or such
Significant Joint Venture, as the case may be, from a financial point of view
and (c) with respect to a transaction or series of transactions involving
aggregate payments of equal value to or greater than U.S. $10,000,000 (or the
foreign currency equivalent thereof), the Company shall have delivered an
officer's certificate to the Trustee certifying that such transaction or series
of transactions complies with the preceding clause (a) and, if applicable,
certifying that the opinion referred to in the preceding clause (b) has been
delivered and that such transaction or series of transactions has been approved
by a majority of the disinterested members of the Board of Directors of the
Company; provided, however, that this covenant will not restrict the Company
from (i) paying dividends in respect of its Capital Stock permitted under the
covenant described under "-- Limitation on Restricted Payments" above, (ii)
paying reasonable and customary fees to directors of the Company who are not
employees of the Company, (iii) making loans or advances to officers or
employees of the Company and its Subsidiaries or Significant Joint Ventures
(including travel and moving expenses) in the ordinary course of business for
bona fide business purposes of the Company or such Subsidiary or Significant
Joint Venture not in excess of U.S. $5,000,000 (or the foreign currency
equivalent thereof), in the aggregate at any one time outstanding, (iv) engaging
in any transaction involving the provision of telecommunications services or
related activities between or among the Company, any Subsidiary or any
Significant Joint Venture and, provided that such transaction is in the ordinary
course of business and consistent with commercially reasonable practice, any
Joint Venture of the Company that is not a Significant Joint Venture or between
any of them or (v) any agreement as in effect as of the Issue Date or any
amendment thereto or any transaction contemplated thereby, as listed in a
schedule to the Indenture (including pursuant to any amendment thereto so long
as any such amendment in the judgment of the Board of Directors voting to
approve the amendment does not have a material adverse effect on the
Bondholders).
(f) Limitation on Dividends and Other Payment Restrictions Affecting
Subsidiaries and Significant Joint Ventures. The Company will not, and will not
permit any of its Subsidiaries to, and will to the fullest extent of the rights
available to it under the relevant contractual or organizational documents not
permit its Significant Joint Ventures to, directly or indirectly, create or
otherwise cause or suffer to exist or become effective any encumbrance or
restriction on the ability of any such Subsidiary or Significant Joint Venture
to (a) pay dividends, in cash or otherwise, or make any other distributions on
or in respect of its Capital Stock or any other interest or participation in, or
measured by, its profits to the Company or any Subsidiary or any Significant
Joint Venture, (b) pay any Indebtedness owed to the Company or any other
Subsidiary or Significant Joint Venture, (c) make loans or advances to, or any
investment in, the Company or any other Subsidiary Joint Venture, (d) transfer
any of its properties or assets to the Company or any other Subsidiary or
Significant Joint Venture or (e) guarantee any Indebtedness of the Company or
any Subsidiary or Significant Joint Venture, except for such encumbrances or
restrictions existing under or by reason of (i) applicable law, (ii) customary
non-assignment provisions of any contract or any lease governing a
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leasehold interest of the Company or any Subsidiary or Significant Joint
Venture, (iii) customary restrictions on transfers of property subject to a Lien
permitted under the Indenture which could not materially adversely affect the
Company's ability to satisfy its obligations under the Indenture and the Bonds,
(iv) any agreement or other instrument of a person acquired by the Company or
any Subsidiary or Significant Joint Venture (or a Subsidiary of such person) in
existence at the time of such acquisition (but not created in contemplation
thereof), which encumbrance or restriction is not applicable to any person, or
the properties or assets of any person, other than the person, or the properties
or assets of the person, so acquired, (v) provisions contained in agreements or
instruments relating to Indebtedness which prohibit the transfer of all or
substantially all of the assets of the obligor thereunder unless the transferee
shall assume the obligations of the obligor under such agreement or instrument,
(vi) encumbrances and restrictions under Indebtedness in effect on the Issue
Date and encumbrances and restrictions in permitted refinancings or replacements
thereof which are no less favorable to the holders of the Bonds than those
contained in the Indebtedness so refinanced or replaced, (vii) any agreement in
existence at the Issue Date, (viii) encumbrances and restrictions in connection
with Subsidiaries acquired after the Issue Date and Significant Joint Ventures
entered into after the Issue Date, including with respect to any financing
thereof, that are no more adverse to the Company than those referred to in (vii)
above), (ix) in the case of clause (d) of this covenant above, arising or agreed
to in the ordinary course of business, not relating to any Indebtedness and that
do not individually, or together with all such encumbrances or restrictions,
detract from the value of the property or assets of the Company or any
Subsidiary or any Significant Joint Venture in any manner material to the
Company or any Subsidiary or any Significant Joint Venture, (x) contained in the
terms of any Indebtedness incurred by Hermes or any agreement pursuant to which
such Indebtedness was issued if the encumbrance or restriction is not materially
more disadvantageous to the Bondholders than is customary in comparable
financings (as determined by the Company) and the Company determines that any
such encumbrance or restriction will not materially affect the Company's ability
to make principal payments on the Bonds, (xi) contained in any stockholders or
similar agreement, so long as such encumbrance or restriction is not more
disadvantageous to the Bondholders than the encumbrances and restrictions
contained in comparable agreements entered into the past by the Company, any of
its Subsidiaries or Significant Joint Ventures, or (xii) contained in any
agreement entered into after the Issue Date, so long as such encumbrance or
restriction is not materially more disadvantageous to the Bondholders than the
encumbrances and restrictions contained in agreements in existence on the Issue
Date.
(g) Limitation on Sale-Leaseback Transactions. The Company will not, and
will not permit any of its Subsidiaries to, and will to the fullest extent of
the rights available to it under the relevant contractual or organizational
documents not permit its Significant Joint Ventures to, enter into any
Sale-Leaseback Transaction with respect to any property of the Company or any of
its Subsidiaries or Significant Joint Ventures other than a Sale-Leaseback
Transaction between the Company, a Subsidiary or Significant Joint Venture or
between any of them. Notwithstanding the foregoing, the Company and its
Subsidiaries or Significant Joint Ventures may enter into Sale-Leaseback
Transactions involving Telecommunications Assets; provided that (i) the Company,
or such Subsidiary or Significant Joint Venture, as the case may be, would be
entitled to create or incur a Lien to secure Indebtedness pursuant to the
provisions of the "Negative Pledge" covenant equal in amount to the Attributable
Value of the Sale-Leaseback Transaction without equally and ratably securing the
Bonds and (ii) the Sale-Leaseback Transaction is treated as an Asset Sale and
the provisions of the "Disposition of Proceeds of Asset Sales" covenant are
satisfied with respect to such Sale-Leaseback Transaction.
(h) Limitation on Guarantees by Subsidiaries. The Company will not permit
any Subsidiary to, and will to the fullest extent of the rights available to it
under the relevant contractual and organizational documents not permit its
Significant Joint Ventures to, directly or indirectly, assume, guarantee or in
any other manner become liable with respect to any Indebtedness of the Company
which is Subordinated Indebtedness or Pari Passu Indebtedness unless such
Subsidiary or Significant Joint Venture, as the case may be, simultaneously
executes and delivers a supplemental indenture to the Indenture, pursuant to
provisions in form and substance satisfactory to the Trustee, providing for a
guarantee of payment of the Bonds by such subsidiary or Significant Joint
Venture and (A) if any such assumption, guarantee or other liability is
subordinated, the guarantee under such supplemental indenture shall be
subordinated to the same extent as the Bonds are subordinated to Senior
Indebtedness of the Company under the Indenture and (B) any such assumption,
guarantee or other
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liability of such Subsidiary or Significant Joint Venture with respect to
Subordinated Indebtedness shall be subordinated to such Subsidiary's or
Significant Joint Venture's, as applicable assumption, guarantee or other
liability with respect to the Bonds to the same extent as such Subordinated
Indebtedness is subordinated or junior to the Bonds under the Indenture.
(i) Merger, Sale of Assets, Etc. The Company will not, in any transaction
or series of transactions, merge or consolidate with or into, or sell, assign,
convey, transfer, lease or otherwise dispose of all or substantially all of its
properties and assets as an entirety to, any person or persons, and the Company
will not permit any of its Subsidiaries to, and will to the fullest extent of
the rights available to it under the relevant contractual or organizational
documents not permit its Significant Joint Ventures to, enter into any such
transaction or series of transactions if such transaction or series of
transactions, in the aggregate, would result in a sale, assignment, conveyance,
transfer, lease or other disposition of all or substantially all of the
respective properties and assets of the Company and its Subsidiaries and
Significant Joint Ventures on a combined basis, to any other person or persons,
unless at the time of and after giving effect thereto (a) either (i) if the
transaction or series of transactions is a merger or consolidation, the Company
shall be the surviving person of such merger or consolidation, or (ii) the
person formed by such consolidation or into which the Company or such Subsidiary
or Significant Joint Venture is merged or to which the properties and assets of
the Company and its Subsidiaries and Significant Joint Ventures are transferred
(any such surviving person or transferee person being the "surviving Entity")
shall be a corporation organized and existing under the laws of the United
States of America, any state thereof or the District of Columbia or the United
Kingdom, the Federal Republic of Germany, France or Italy and shall expressly
assume by a supplemental indenture executed and delivered to the Trustee, in
form reasonably satisfactory to the Trustee, all the obligations of the Company
under the Bonds and the Indenture, and in each case, the Indenture shall remain
in full force and effect; (b) immediately before and immediately after giving
effect to such transaction or series of transactions on a pro forma basis
(including, without limitation, any Indebtedness incurred or anticipated to be
incurred in connection with or in respect of such transaction or series of
transactions), no Default or Event of Default shall have occurred and be
continuing and the Company or the Surviving Entity, as the case may be, after
giving effect to such transaction or series of transactions on a pro forma basis
(including, without limitation, any Indebtedness incurred or anticipated to be
incurred in connection with or in respect of such transaction or series of
transactions), could incur $1.00 of additional Indebtedness pursuant to the
first paragraph of the covenant described under "-- Limitation on Indebtedness"
above (assuming a market rate of interest with respect to such additional
Indebtedness); (c) immediately after giving effect to such transaction or series
of transactions on a pro forma basis (including, without limitation, any
Indebtedness incurred or anticipated to be incurred in connection with or in
respect of such transaction or series of transactions), the Consolidated Net
Worth of the Company or the Surviving Entity, as the case may be, is at least
equal to the Consolidated Net Worth of the Company immediately before such
transaction or series of transactions; (d) such consolidation, merger,
conveyance, transfer, lease or other disposition does not adversely affect the
validity or enforceability of the Bonds; and (e) if the Surviving Entity is
organized in a jurisdiction other than the United States of America, any state
thereof or the District of Columbia, such entity appoints CT Corporation System,
New York, New York, as its agent for service of process in any suit, action or
proceeding with respect to the Indenture or the bonds issued thereunder and for
actions brought under federal or state securities laws brought in any federal or
state court located in the Borough of Manhattan in The City of New York and
submits to such jurisdiction, waives forum non conveniens, waives or is not
subject to immunity from suit and any judgments brought against such entity in
respect of the Indenture and the Bonds may be recognized and enforced in such
jurisdiction of its organization.
In connection with any consolidation, merger, transfer, lease, assignment
or other disposition contemplated hereby, the Company shall deliver, or cause to
be delivered, to the Trustee, in form and substance reasonably satisfactory to
the Trustee, an officer's certificate and an opinion of counsel, each stating
that such consolidation, merger, transfer, lease, assignment or other
disposition and the supplemental indenture in respect thereof comply with the
foregoing requirements; provided, however, that solely for purposes of computing
amounts described in subclause (C) of the covenant described under
"-- Limitation on Restricted Payments" above, any such successor person shall
only be deemed to have succeeded to and be substituted for
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the Company with respect to periods subsequent to the effective time of such
merger, consolidation or transfer of assets.
Upon any consolidation or merger or any transfer of all or substantially
all of the assets of the Company in accordance with the foregoing, in which the
Company is not the continuing corporation, the successor corporation formed by
such a consolidation or into which the Company is merged or to which such
transfer is made shall succeed to, and be substituted for, and may exercise
every right and power of, the Company under the Indenture with the same effect
as if such successor corporation had been named as the Company therein.
(j) Limitation on Other Subordinated Indebtedness. The Company will not
create, incur, assume, guarantee or in any other manner become liable with
respect to any Indebtedness that is subordinate in right of payment to any
Senior Indebtedness unless such Indebtedness is also pari passu with, or
subordinate in right of payment to, the Bonds.
REGISTRATION RIGHTS
The Company has filed a Registration Statement, of which this Prospectus
forms a part (the "Registration Statement") pursuant to the terms of a
registration rights agreement with the Trustee, amongst others, for the benefit
of the holders of the Bonds (the "Registration Rights Agreement"). Under the
Registration Rights Agreement, the Company, at its expense, agreed to cause a
shelf registration statement covering the issuance, or issuance and resale as
the case may be, and resale of a sufficient number of shares of Common Stock
that may be issuable upon conversion of the Bonds to be declared effective under
the Securities Act prior to the first date on which any of such shares of Common
Stock may be issued upon such conversion. The Company agreed to use its best
efforts to maintain the effectiveness of such shelf registration statement until
the earliest of (i) the expiration of the time period referred to in Rule 144(k)
under the Securities Act with respect to all beneficial holders of shares of
Common Stock that are not affiliates of the Company within the meaning of the
Securities Act, and (ii) such time as all the shares of Common Stock covered by
such registration statement have been sold pursuant to such registration
statement. The Company will provide to each Bondholder, each holder of shares of
Common Stock into which Bonds are converted, and the Paying Agent, Conversion
Agent and Transfer Agent in Luxembourg copies of the prospectus that is part of
such registration statement, notify such holders of the effectiveness of such
registration statement and take all other action required to permit unrestricted
resales of such shares of Common Stock. A holder who sells the shares of Common
Stock pursuant to the shelf registration statement generally will be required to
be named as a selling stockholder in the related prospectus and to deliver a
prospectus to purchasers and will be bound by the provisions of the Registration
Rights Agreement which are applicable to such holder (including certain
indemnification provisions).
Each holder must notify the Company not later than three Business Days
prior to any proposed sale by such holder of shares of Common Stock pursuant to
the shelf registration statement, which notice shall be effective for five
Business Days. The Company may, upon written notice to such holder, suspend such
holder's use of the prospectus (which is part of the shelf registration
statement) for up to two periods not to exceed 45 consecutive days but not more
than 60 days in any 365-day period if the Company in its reasonable judgment
believes it may possess material non-public information the disclosure of which
would have an adverse effect on the Company or any of its Subsidiaries or any
Significant Joint Venture. Each holder, by its acceptance of a Bond, agrees to
hold any communication by the Company in response to a notice of a proposed sale
under the shelf registration statement in confidence.
If the Registration Statement of which this Prospectus is a part does not
remain effective with the Commission as required by the Registration Rights
Agreement (a "Registration Default"), additional interest ("Liquidated Damages")
will accrue on the Bonds from and including the day following such Registration
Default to but excluding the day on which such Registration Default has been
cured. Liquidated Damages will be paid semi-annually in arrears, with the first
semi-annual payment due on the first Interest Payment Date, as applicable,
following the date on which such Liquidated Damages begin to accrue and will
accrue at a rate per annum of one quarter of one per cent (.25%) of the
principal amount, to and including the 90th day following such Registration
Default and at a rate per annum of one half of one cent (.5%) thereof from and
after the
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91st day following such Registration Default. In no event will Liquidated
Damages accrue at a rate per annum exceeding one half of one per cent (.5%).
The specific provisions relating to the registrations described above will
be contained in the Registration Rights Agreement which is filed as an exhibit
hereto.
RESERVATION OF SHARES OF COMMON STOCK
The Company shall at all times reserve and keep available out of its
authorized common stock, solely for the purpose of issuance or delivery upon
conversion of the Bonds, the number of shares of Common Stock that it reasonably
believes will be required to be delivered in connection with such conversion
pursuant to the terms of the Indenture.
GOVERNING LAW
The Indenture and the Bonds will be governed by the laws of the State of
New York.
CERTAIN DEFINITIONS
"Acquired Indebtedness" means, with respect to any specified person, (i)
Indebtedness of any other person at the time such other person merged with or
into or became a Subsidiary or Significant Joint Venture of any specified
person, and (ii) Indebtedness encumbering any asset acquired by any specified
person.
"Affiliate" means, with respect to any specified person, any other person
directly or indirectly controlling or controlled by or under direct or indirect
common control with such specified person.
"Asset Sale" means any sale, issuance, conveyance, transfer, lease or other
disposition to any person other than the Company or a Wholly-Owned Subsidiary of
the Company, in one or a series of related transactions, of (a) any Capital
Stock of any Subsidiary or Significant Joint Venture (other than in respect of
director's qualifying shares or investments by foreign nationals mandated by
applicable law); (b) all or substantially all of the properties and assets of
any division or line of business of the Company or any Subsidiary or Significant
Joint Venture; or (c) any other properties or assets of the Company or any
Subsidiary or Significant Joint Venture other than in the ordinary course of
business. For the purposes of this definition, the term "Asset Sale" shall not
include (i) any sale, transfer or other disposition of equipment, tools or other
assets (including Capital Stock or other equity of any Subsidiary or Significant
Joint Venture) by the Company or any of its Subsidiaries or Significant Joint
Ventures in one or a series of related transactions in respect of which the
Company or such Subsidiary or Significant Joint Venture receives cash or
property with an aggregate Fair Market Value of U.S.$10,000,000 (or the foreign
currency equivalent thereof) or less; (ii) any sale, issuance, conveyance,
transfer, lease or other disposition of properties or assets that is governed by
the provisions described under "-- Merger, Sale of Assets, Etc." above and (iii)
any direct or indirect sale, transfer or other disposition of shares of Capital
Stock of Hermes so long as after such sale, transfer or other disposition the
Company owns or controls at least 51 per cent. of the Voting Stock of Hermes.
"Average Life to Stated Maturity" means, with respect to any Indebtedness,
as at any date of determination, the quotient obtained by dividing (i) the sum
of the products of (a) the number of years (or any fraction thereof) from such
date to the date or dates of each successive scheduled principal payment
(including, without limitation, any sinking fund requirements) of such
Indebtedness multiplied by (b) the amount of each such principal payment by (ii)
the sum of all such principal payments.
"Capital Research Notes" means the aggregate $30 million of notes issued
pursuant to (i) the Senior Note Purchase Agreement, dated as of February 2,
1996, as amended, between GTS and Emerging Markets Growth Fund, Inc. and (ii)
the Senior Note Purchase Agreement, dated as of February 2, 1996, as amended,
between GTS and Capital International Emerging Markets Funds.
"Capital Stock" means, with respect to any person, any and all shares,
interests, participations, rights in or other equivalents (however designated)
of such person's capital stock, and any rights (other than debt
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securities convertible into capital stock), warrants or options exchangeable for
or convertible into such capital stock.
"Capitalized Lease Obligation" means any obligation under a lease of (or
other agreement conveying the right to use) any property (whether real, personal
or mixed) that is required to be classified and accounted for as a capital lease
obligation under GAAP, and the amount of such obligation at any date shall be
the capitalized amount thereof at such date, determined in accordance with GAAP.
"Cash Equivalents" means, at any time, (a) any evidence of Indebtedness
with a maturity of 180 days or less issued or directly and fully guaranteed or
insured by the United States of America or any agency or instrumentality thereof
(provided that the full faith and credit of the United States of America is
pledged in support thereof); (b) certificates of deposit or acceptances with a
maturity of 180 days or less of any financial institution that is a member of
the Federal Reserve System having combined capital and surplus and undivided
profits of not less than U.S.$500,000,000 (or the foreign currency equivalent
thereof); (c) certificates of deposit with a maturity of 180 days or less of any
financial institution that is not organized under the laws of the United States,
any state thereof or the District of Columbia that are rated at least A-1 by S&P
or at least P-1 by Moody's or at least an equivalent rating category of another
nationally recognized securities rating agency; and (d) repurchase agreements
and reverse repurchase agreements relating to marketable direct obligations
issued or unconditionally guaranteed by the government of the United States of
America or issued by any agency thereof and backed by the full faith and credit
of the United States of America, in each case maturing within 180 days from the
date of acquisition; provided that the terms of such agreements comply with the
guidelines set forth in the Federal Financial Agreements of Depository
Institutions With Securities Dealers and Others, as adopted by the Comptroller
of the Currency on October 31, 1985.
"Change of Control" means the occurrence of any of the following events:
(a) any "person" or "group" (as such terms are used in Sections 13(d) and 14(d)
of the Exchange Act), other than the Permitted Holders, is or becomes the
"beneficial owner" (as defined in Rules 13d-3 and 13d-5 under the Exchange Act,
except that a person shall be deemed to have "beneficial ownership" of all
securities that such person has the right to acquire, whether such right is
exercisable immediately or only after the passage of time, upon the happening of
an event or otherwise), directly or indirectly, of more than 40 per cent of the
total Voting Stock of the Company (50.1 per cent, in the case of a Strategic
Investor); (b) the Company consolidates with, or merges with or into, another
person or sells, assigns, conveys, transfers, leases or otherwise disposes of
all or substantially all of its assets to any person, or any person consolidates
with, or merges with or into, the Company, in any such event pursuant to a
transaction in which the outstanding Voting Stock of the Company is converted
into or exchanged for cash, securities or other property, other than any such
transaction where (i) the outstanding Voting Stock of the Company is converted
into or exchanged for (1) Voting Stock (other than Redeemable Capital Stock) of
the surviving or transferee corporation or (2) cash, securities and other
property in an amount which could then be paid by the Company as a Restricted
Payment under the Indenture, or a combination thereof, and (ii) immediately
after such transaction no "person" or "group" (as such terms are used in
Sections 13(d) and 14(d) of the Exchange Act), excluding Permitted Holders is
the "beneficial owner" (as defined in Rules 13d-3 and 13d-5 under the Exchange
Act, except that a person shall be deemed to have "beneficial ownership" of all
securities that such person has the right to acquire, whether such right is
exercisable immediately or only after the passage of time, upon the happening of
an event or otherwise), directly or indirectly, of more than 50 per cent of the
total Voting Stock of the surviving or transferee corporation; (c) at any time
during any consecutive two-year period, individuals who at the beginning of such
period constituted the Board of Directors of the Company (together with any new
directors whose election by such Board of Directors or whose nomination for
election by the stockholders of the Company was approved by a vote of 66 2/3 per
cent of the directors than still in office who were either directors at the
beginning of such period of whose election or nomination for election was
previously so approved) cease for any reason to constitute a majority of the
Board of Directors of the Company then in office; or (d) the Company is
liquidated or dissolved or adopts a plan of liquidation.
"Chatterjee Notes" means the aggregate $40 million of notes issued pursuant
to (a) the Senior Note Purchase Agreement, dated as of January 19, 1996, as
amended, among GTS, The Open Society Institute and
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Chatterjee Fund Managements, L.P. and (b) the Senior Note Purchase Agreement,
dated as of June 6, 1996, as amended, among the Company, The Open Society
Institute, Winston Partners II LDC and Winston Partners II LLC.
"Closing Price" means the closing price of the shares of Common Stock on a
Qualifying Stock Exchange or if the shares of Common Stock are listed on more
than one such exchange the average of such closing prices on all such exchanges.
"Common Stock" means, with respect to any person, any and all shares,
interests or other participations in, and other equivalents (however designated
and whether voting or nonvoting) of, such person's common stock, whether
outstanding at the Issue Date or issued after the Issue Date, and includes,
without limitation, all series and classes of such common stock.
"Complying Public Equity Conditions" means all of the following: (a) the
Company has made public sales of shares of Common Stock with a cumulative public
offering price of at least U.S.$100,000,000 to an aggregate of not less than 50
purchasers; (b) the shares of Common Stock have been listed or shall be listed
in connection with the offering on either the New York Stock Exchange, the
London Stock Exchange, the American Stock Exchange or the Nasdaq National
Market; and (c) the Company shall have registered additional shares of Common
Stock from Private Equity Offerings with a market value of at least
U.S.$100,000,000 calculated using the offering price in the Complying Public
Equity Offering.
"Complying Public Equity Offering" means a public offering of shares of
Common Stock where, immediately following completion thereof, (a) the Complying
Public Equity Conditions have been met and (b) the aggregate number of shares of
Common Stock sold thereby, together with any shares of Common Stock sold in any
prior public offerings plus the number of shares of Common Stock into which the
Bonds may be converted (calculated as if such conversion were to be effected at
the time of such public offering) does not exceed 50 per cent of the total
shares of Common Stock outstanding on a fully diluted basis.
"Consolidated Net Worth" means, with respect to any person at any date, the
consolidated stockholders' equity of such person less the amount of such
stockholders' equity attributable to Redeemable Capital Stock of such person and
its subsidiaries, as determined in accordance with GAAP.
"Conversion Agent" means the office or agency (which shall be located in
the Borough of Manhattan, the City of New York, State of New York) where Bonds
may be presented for conversion.
"Conversion Date" means the earliest date possible after the listings of
the shares of Common Stock on the New York Stock Exchange, the American Stock
Exchange or the Nasdaq National Market that the Company may deliver shares of
Common Stock to converting Bondholders.
"Covenant Defeasance" means the 123rd day after (i) the Company has
irrevocably deposited with the Trustee, in trust, for the benefit of the
Bondholders, cash in U.S. dollars, non-callable U.S. Government Obligations, or
a combination thereof, in such amounts as will be sufficient, in the opinions of
a nationally recognized firm of independent public accountants selected by the
Company, to pay the principal of and premium, if any, on the outstanding Bonds
at their Maturity or on the applicable optional redemption date, as the case may
be, of such principal or installment of principal of, or premium, if any, on the
outstanding Bonds; (ii) the Company must have delivered to the Trustee an
opinion of counsel in the United States reasonably acceptable to the Trustee
confirming that the holders of the outstanding Bonds will not recognize income,
gain or loss for federal income tax purposes as a result of such Covenant
Defeasance and will be subject to federal income tax on the same amounts, in the
same manner and at the same times as would have been the case if such Covenant
Defeasance had not occurred; (iii) no Default or Event of Default shall have
occurred and be continuing on the date of such deposit or insofar as Events of
Default from bankruptcy or insolvency events are concerned, at any time in the
period ending on the 91st day after the date of deposit; (iv) such Covenant
Defeasance will not result in a breach or violation of, or constitute a default
under any material agreement or instrument (other than the Indenture) to which
the Company or any of its Subsidiaries or Significant Joint Ventures is a party
or by which the Company or any of its Subsidiaries or Significant Joint Ventures
is bound; (v) the Company must have delivered to the Trustee an opinion of
counsel to the effect that after the 123rd day (or such other applicable date)
following the deposit of the instruments referred to in (i), the trust funds
will not be subject to the effect of any applicable bankruptcy, insolvency,
reorganization or similar laws
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affecting creditors' rights generally and the creation of the defeasance trust
does not violate the Investment Company Act of 1940, as amended; (vi) the
Company must have delivered to the Trustee an Officers' Certificate of the
Company stating that the deposit was not made by the Company with the intent of
preferring the Bondholders over the other creditors of the Company with the
intent of defeating, hindering, delaying or defrauding creditors of the Company
or others; and (vii) the Company must have delivered to the Trustee an Officers'
Certificate of the Company and an opinion of counsel in the United States
acceptable to the Trustee, each stating that all conditions precedent provided
for relating to the Covenant Defeasance have been complied with.
"Currency Agreement" means any foreign exchange contract, currency swap
agreement or other similar agreement or arrangement designed to protect the
Company or any Subsidiary or any Significant Joint Venture against fluctuations
in currency values.
"Default" means any event that is, or after notice or passage of time or
both would be, an Event of Default.
"Designated Senior Indebtedness" means Senior Indebtedness permitted under
the Indenture, the principal amount of which is $30 million (or the foreign
currency equivalent) or more and has been designated by the Company as
Designated Senior Indebtedness (which includes the Chatterjee Notes and the
Capital Research Notes).
"Eligible Joint Venture" means a Joint Venture (other than a Subsidiary)
(a) that is formed with respect to the construction, development, acquisition,
servicing, ownership, improvement, operation or management of a
telecommunications business, (b) in which the Company, directly or indirectly,
owns at least 25 per cent. of the Capital Stock or other ownership interest
therein and (c) in respect of which the Company, directly or indirectly, either
(i) controls, by voting power, membership on the board of directors or
management committee or other similar governing body, or through the provisions
of any applicable partnership, joint venture, shareholder or other similar
agreement or under an operating, maintenance or management agreement or
otherwise, the management and operation of the Joint Venture and any
telecommunications project of such Joint Venture or (ii) otherwise has the right
to control or veto material acts and decisions with respect to the management or
operation of the Joint Venture that, taken as a whole, are substantially similar
to the rights of the Company with respect to the Existing Joint ventures as of
the Issue Date.
"Event of Default" has the meaning set forth under "Events of Default"
herein.
"Existing Joint Venture" means each of the PrymTelefon, Bancomsvyaz,
TeleCommunications of Moscow, Hermes Europe Railtel B.V., LvNet-Telport, GTS
Monaco Access S.A.M., Sovam Teleport Kiev Division L.L.C., EDN Sovintel, all the
entities in which SFMT-Rusnet, Inc. currently has an interest, all the entities
in which Vostok Mobile b.v. currently has an interest and their respective
successors.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Fair Market Value" means, with respect to any asset, the price, as
determined by the Board of Directors of the Company, acting in good faith, which
could be negotiated in an arm's-length free market transaction, for cash,
between a willing seller and a willing buyer, neither of which is under pressure
or compulsion to complete the transaction; provided, however, that, with respect
to any transaction or related series of transactions which involved an asset or
assets in excess of U.S.$10,000,000 (or the foreign currency equivalent
thereof), in the aggregate, such determination shall be evidenced by a
resolution of the majority of disinterested members of the Board of Directors of
the Company delivered to the Trustee.
"Fixed Charge Coverage Ratio" of the Company means, for any period, the
ratio of (a) the sum of Pro rata Combined Adjusted Net Income, Pro rata Combined
Interest Expense, Pro rata Combined Income Tax Expense and Pro rata Combined
Non-cash Charges deducted in computing Pro rata Combined Adjusted Net Income, in
each case, for such period to (b) Pro rata Combined Interest Expense for such
period.
"GAAP" means generally accepted accounting principles set forth in the
opinions and pronouncements of the Accounting Principles board of the American
Institute of Certified Public Accountants and statements and pronouncements of
the Financial Accounting Standards Board or in such other statements by such
other
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entity as may be approved by a significant segment of the accounting profession
of the United States of America, which are applicable from time to time and are
consistently applied.
"Indebtedness" means, with respect to any person, without duplication, (a)
all liabilities of such person for borrowed money or for the deferred purchase
price of property or services, excluding any (i) trade account payables arising
in the ordinary course of business and (ii) other accrued current liabilities
incurred in the ordinary course of business, including, without limitation, all
obligations, contingent or otherwise, of such person in connection with any
letters of credit, banker's acceptance or other similar credit transaction; (b)
all obligations of such person evidenced by bonds, debentures or other similar
instruments; (c) all indebtedness created or arising under any conditional sale
or other title retention agreement with respect to property acquired by such
person (even if the rights and remedies of the seller or lender under such
agreement in the event of default are limited to repossession or sale of such
property), but excluding trade accounts payable arising in the ordinary course
of business; (d) all Capitalized Lease Obligations of such person; (e) all
Indebtedness referred to in the preceding clauses of other persons and all
dividends of other persons, the payment of which is secured by (or for which the
holder of such Indebtedness has an existing right, contingent or otherwise, to
be secured by) any Lien upon property (including, without limitation, accounts
and contract rights) owned by such person, event though such person has not
assumed or become liable for the payment of such Indebtedness (the amount of
such obligation being deemed to be the lesser of the value of such property or
asset or the amount of the obligation so secured); (f) all guarantees of
Indebtedness referred to in this definition by such person; (g) all Redeemable
Capital Stock of such person valued at the greater of its voluntary or
involuntary maximum fixed repurchase price plus accrued dividends; (h) all
obligations under or in respect of Currency Agreements and Interest Rate
Protection Obligations of such person; (i) any Preferred Stock of such person
that provides for payments of liquidation value by way of a sinking fund, or by
way of a mandatory redemption, defeasance, retirement, repurchase or otherwise,
or allows the holder the option to redeem, in each case prior to the 91st day
prior to the Maturity of the Bonds (valued at the sum of (without duplication)
(A) the liquidation preference thereof, (B) any mandatory redemption payment
obligations in respect thereof (C) accrued dividends thereon); and (j) any
amendment, supplement, modification, deferral, renewal, extension or refunding
of any liability of the types referred to in clauses (a) through (i) above. For
purposes hereof, the "maximum fixed repurchase price" of any Redeemable Capital
Stock which does not have a fixed repurchase price shall be calculated in
accordance with the terms of such Redeemable Capital Stock as if such Redeemable
Capital Stock were purchased on any date on which Indebtedness shall be required
to be determined pursuant to the Indenture, and if such price is based upon, or
measured by, the fair market value of such Redeemable Capital Stock, such fair
market value shall be determined in good faith by the board of directors of the
issuer of such Redeemable Capital Stock.
"Independent Financial Advisor" means a firm (i) which does not, and whose
directors, officers and employees or Affiliates do not, have a material direct
or indirect financial interest in the Company, any Subsidiary or Significant
Joint Venture and (ii) which, in the judgement of the Board of Directors of the
Company, is otherwise independent and qualified to perform the task for which it
is to be engaged.
"Interest Rate Protection Agreement" mens any arrangement with any other
person whereby, directly or indirectly, such person is entitled to receive from
time to time periodic payments calculated by applying either a floating or a
fixed rate of interest on a stated notional amount in exchange for periodic
payments made by such person calculated by applying a fixed or a floating rate
of interest on the same notional amount and shall include without limitation,
interest rate swaps, caps, floors, collars and similar agreements.
"Interest Rate Protection Obligations" means the obligations of any person
pursuant to an Interest Rate Protection Agreement.
"Investment" means, with respect to any person, any direct or indirect loan
or other extension of credit or capital contribution to (by means of any
transfer of cash or other property to others or any payment for property or
services for the account or use of others), or any purchase or acquisition by
such person of any Capital Stock, bonds, debentures or other securities or
evidences of Indebtedness issued by, any other person. "Investments" shall
exclude extension of trade credit in the ordinary course of business in
accordance with normal trade practices.
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"Issue Date" means the closing date for the sale and issuance of the Bonds
under the Indenture.
"Joint Venture" means joint venture, partnership or other similar
arrangement, whether corporation, partnership or other legal form where the
Company or one or more Subsidiaries has, directly or indirectly, less than a
majority of the Voting Stock or other ownership interest.
"Lien" means any mortgage, charge, pledge, lien (statutory or other),
security interest, hypothecation, assignment for security, claim, or preference
or priority or other encumbrance upon or with respect to any property of any
kind; provided that in no event shall an operating lease be deemed to constitute
a Lien. A person shall be deemed to own subject to a Lien any property which
such person has acquired or holds subject to the interest of a vendor or lessor
under any conditional sale agreement, capital lease or other title retention
agreement.
"Material Joint Venture" means a Joint Venture that, as of the end of the
most recent four-quarter period, had (i) total assets which exceeded 10 per
cent. of the total combined assets of the Company at the end of such period or
(ii) total revenues which exceeded 15 per cent. of the total combined revenues
of the Company for such period.
"Material Subsidiary" means a Subsidiary that, as of the end of the most
recent four-quarter period, had (i) total assets which exceeded 10 per cent. of
the total combined assets of the Company at the end of such period or (ii) total
revenues which exceeded 15 per cent. of the total combined revenues of the
Company for such period.
"Maturity" means, (i) when used with respect to the Bonds, June 30, 2000
and (ii) when used with respect to any Indebtedness other than the Bonds, the
date specified in the instrument governing such Indebtedness as the fixed date
on which the principal of such Indebtedness, or any installment of interest
thereon, is due and payable.
"Moody's" means Moody's Investors Service, Inc. and its successors.
"Net Cash Proceeds" means, with respect to any Asset Sale, the proceeds
thereof in the form of cash or Cash Equivalents including payments in respect of
deferred payment obligations when received in the form of cash or Cash
Equivalents (except to the extent that such obligations are financed or sold
with recourse) net of (i) brokerage commissions and other fees and expenses
(including, without limitation, fees and expenses of legal counsel and
investment bankers) related to such Asset Sale, (ii) provisions for all taxes
payable as a result of such Asset Sale, (iii) amounts required to be paid to any
person (other than the Company or any Subsidiary or Significant Joint Venture)
owning a beneficial interest in the assets subject to the Asset Sale and (iv)
appropriate amounts to be provided by the Company or any Subsidiary or
Significant Joint Venture, as the case may be, as a reserve required in
accordance with GAAP against any liabilities associated with such Asset Sale and
retained by the Company or any Subsidiary or Significant Joint Venture, as the
case may be, after such Asset Sale, including, without limitation, pension and
other post-employment benefit liabilities, liabilities related to environmental
matters and liabilities under any indemnification obligations associated with
such Asset Sale, all as reflected in an officers' certificate delivered to the
Trustee.
"Non-Complying Equity Offering" means (i) a Private Equity Offering or (ii)
a public offering of shares of Common Stock that is not a Complying Public
Equity Offering.
"Non-Complying Public Equity Offering" means a public equity offering of
shares of Common Stock that satisfies all the Complying Public Equity
Conditions, except that the cumulative public offering price is less than
U.S.$100,000,000.
"Notice of Offering" means a notice given to the Trustee or the Bondholders
and, if required by the Indenture, the Luxembourg Stock Exchange, that a
Complying Public Equity Offering or a Non-Complying Equity Offering has
occurred.
"Pari Passu Indebtedness" means Indebtedness of the Company which ranks
pari passu in right of payment with the Bonds.
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"Paying Agent" means the office or agency (which shall be located in the
Borough of Manhattan, the City of New York, State of New York) where Bonds may
be presented for payment of principal, premium, if any, and interest.
"Permitted Holder" means (A) Alan B. Slifka and any entity controlled by
him, (B) one or more of George Soros, Soros Fund Management LLC, Purnendu
Chatterjee or Chatterjee Management Company or affiliates of any of the
foregoing, and any person or entity for which any such person or entity acts as
investment advisor or investment manager and (C) any person that acquires the
capital stock of the Company in a Strategic Equity Offering.
"Permitted Investments" means any of the following: (i) Investments in any
Subsidiary or Significant Joint Venture; (ii) Investments in any person that is
merged or consolidated with or into, or transfers or conveys all or
substantially all of its assets to, the Company or any Subsidiary or Significant
Joint Venture of the Company at the time such Investment is made; (iii)
Investments in cash or Cash Equivalents; (iv) Investments in deposits with
respect to leases or utilities provided to third parties in the ordinary course
of business; (v) Investments in the Bonds; (vi) Investments in Currency
Agreements on commercially reasonable terms entered into by the Company or any
of its Subsidiaries or Significant Joint Ventures in the ordinary course of
business in connection with the operations of the business of the Company or its
Subsidiaries or Significant Joint Ventures to hedge against fluctuations in
foreign exchange rates; (vii) loans or advances to officers or employees of the
Company and its Subsidiaries or Significant Joint Ventures in the ordinary
course of business for bona fide business purposes of the Company and its
Subsidiaries or Significant Joint Ventures (including travel and moving
expenses) not in excess of U.S.$5,000,000 (or the foreign currency equivalent)
in the aggregate at any one time outstanding; (viii) Investments in evidences of
Indebtedness, securities or other property received from another person by the
Company or any of its Subsidiaries or Significant Joint Ventures in connection
with any bankruptcy proceeding or by reason of a composition or readjustment of
debt or a reorganization of such person or as a result of foreclosure,
perfection or enforcement of any Lien in exchange for evidences of Indebtedness,
securities or other property of such person held by the Company or any of its
Subsidiaries or Significant Joint Ventures, or for other liabilities or
obligations of such other person to the Company or any of its Subsidiaries or
Significant Joint Ventures that were created, in accordance with the terms of
the Indenture; (ix) Investments in Interest Rate Protection Agreements on
commercially reasonably terms entered into by the Company or any of its
Subsidiaries or Significant Joint Ventures in the ordinary course of business in
connection with the operations of the business of the Company or its
Subsidiaries or Significant Joint Ventures to hedge against fluctuations in
interest rates; and (x) Investments in entities that are not Subsidiaries or
Significant Joint Ventures, to finance the construction, installation,
improvement, acquisition or operation of Telecommunications Assets, provided
that such Investments do not exceed in the aggregate, the greater of
U.S.$25,000,000 (or the foreign currency equivalent) or 10 per cent. of the pro
rata combined assets of the Company or, individually, the greater of
U.S.$5,000,000 (or the foreign currency equivalent) or 2 per cent. of the pro
rata combined assets of the Company.
"person" means any individual, corporation, limited liability company
partnership, joint venture, association, joint-stock company, trust, charitable
foundation, unincorporated organization, government or any agency or political
subdivision thereof or any other entity.
"PORTAL" means the PORTAL trading system of the NASD.
"Preferred Stock" of any person means capital stock of such person of any
class or classes (however designated) that ranks prior, as to the payment of
dividends or as to the distribution of assets upon any voluntary or involuntary
liquidation, dissolution or winding up of such person, to shares of capital
stock of any other class of such person.
"Private Equity Offering" means a private offering of shares of Common
Stock pursuant to an exemption from registration under the Securities Act.
"Pro rata Combined Adjusted Net Income" means, for any period, the pro rata
combined net income (or loss) of the Company and its Subsidiaries and
Significant Joint Ventures for such period, adjusted by
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excluding, without duplication, (a) any net after-tax extraordinary gains or
losses (less all fees and expenses relating thereto), (b) any net after-tax
gains or losses (less all fees and expenses relating thereto) attributable to
asset dispositions other than in the ordinary course of business, and (c) the
portion of net income (or loss) of any person (other than the Company or a
Subsidiary or Significant Joint Venture), in which the Company or any such
Subsidiary or Significant Joint Venture has an ownership interest, except to the
extent of the amount of dividends or other distributions actually paid to the
Company or any Subsidiary or any Significant Joint Venture in cash dividends or
distributions during such period.
"Pro rata Combined Interest Expense" means, for any period, without
duplication, the sum of (a) the pro rata combined interest expense of the
Company and its Subsidiaries and its Significant Joint Ventures for such period,
including, without limitation, (i) amortization of debt discount, (ii) the net
cost of Interest Rate Protection Agreements (including amortization of
discounts), (iii) the interest portion of any deferred payment obligation and
(iv) amortization of debt issuance costs, plus (b) the pro rata combined
interest component of Capitalized Lease Obligations of the Company, its
Subsidiaries and Significant Joint Ventures during such period, less (c) pro
rata interest income of the Company, its Subsidiaries and Significant Joint
Ventures; provided that (x) the Pro rata Combined Interest Expense attributable
to interest on any Indebtedness computed on a pro forma basis and (A) bearing a
floating interest rate shall be computed as if the rate in effect on the date of
computation had been the applicable rate for the entire period and (B) which was
not outstanding during the period for which the computation is being made but
which bears, at the option of the Company, a Subsidiary or Significant Joint
Venture as the case may be, a fixed or floating rate of interest, shall be
computed by applying at the option of the Company, either the fixed or floating
rate, and (y) in making such computation, the Pro rata Combined Interest Expense
attributable to interest on any Indebtedness under a revolving credit facility
computed on a pro forma basis shall be computed based upon the average daily
balance of such Indebtedness during the applicable period; provided further
that, notwithstanding the foregoing, the interest rate with respect to any
Indebtedness covered by any Interest Rate Protection Agreement shall be deemed
to be the effective interest rate with respect to such Indebtedness after taking
into account such Interest Rate Protection Agreement.
"Pro rata Combined Income Tax Expense" means, for any period the provision
for federal, state, local and foreign income taxes of the Company, its
Subsidiaries and Significant Joint Ventures for such period as determined on a
pro rata combined basis.
"Pro rata Combined Non-cash Charges" means, for any period, the aggregate
depreciation, amortization and other non-cash expenses of the Company and its
Subsidiaries and Significant Joint Ventures reducing Pro rata Combined Adjusted
Net Income for such period, determined on a pro rata combined basis (excluding
any such non-cash charge that requires an accrual of or reserve for cash charges
for any future period).
"Qualifying Stock Exchange" means the New York Stock Exchange, the American
Stock Exchange, the London Stock Exchange or the Nasdaq National Market.
"Redeemable Capital Stock" means any shares of any class or series of
Capital Stock that, either by the terms thereof, by the terms of any security
into which it is convertible or exchangeable or by contract or otherwise, is or
upon the happening of an event or passage of time would be, required to be
redeemed prior to the Maturity with respect to the principal of the Bonds or is
redeemable at the option of the holder thereof at any time prior to any such
Maturity, or is convertible into or exchangeable for debt securities at any time
prior to any such Maturity.
"Redemption Date" means with respect to any Bonds to be redeemed, the date
fixed by the Company for such redemption pursuant to the Indenture and the
Bonds.
"Sale-Leaseback Transaction" of any person means an arrangement with any
lender or investor or to which such lender or investor is a party providing for
the leasing by such person of any property or asset of such person which has
been or is being sold or transferred by such person after the acquisition
thereof or the completion of construction or commencement of operation thereof
to such lender or investor or to any person to whom funds have been or are to be
advanced by such lender or investor on the security of such property or asset.
The stated maturity of such arrangement shall be the date of the last payment of
rent or any other
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amount due under such arrangement prior to the first date on which such
arrangement may be terminated by the lessee without payment of a penalty.
"Senior Indebtedness" means the principal of, premium, if any, interest,
and other amounts payable on or in respect of any Indebtedness of the Company,
whether outstanding on the Issue Date or thereafter created, incurred or
assumed, unless, in the case of any particular Indebtedness, the instrument
creating or evidencing the same or pursuant to which the same is outstanding
expressly provides that such Indebtedness shall not be senior in right of
payment to the Bonds. Notwithstanding the foregoing, "Senior Indebtedness" shall
not include (a) Indebtedness evidenced by the Bonds, (b) Indebtedness that is
pursuant to the instrument creating such Indebtedness expressly subordinate or
junior in right of payment to any Indebtedness of the Company, (c) Indebtedness
which, when incurred and without respect to any election under Section 1111(b)
of Title 11, United States Code, is without recourse to the Company, (d)
Indebtedness which is represented by Redeemable Capital Stock, (e) Indebtedness
for goods, materials or services purchased in the ordinary course of business or
Indebtedness consisting of trade account payables or other current liabilities
incurred in the ordinary course of business, (f) Indebtedness of or amounts owed
by the Company for compensation to employees or for services rendered to the
Company, (g) any liability for federal, state, local or other taxes owed or
owing by the Company, (h) other than the Chatterjee Notes and the Capital
Research Notes, Indebtedness of the Company to a Wholly-Owned Subsidiary or any
other Affiliate of the Company or any of such Affiliate's Wholly-Owned
Subsidiaries, (i) that portion of any Indebtedness which is incurred by the
Company in violation of the Indenture and (j) amounts owing under leases (other
than Capitalized Lease Obligations).
"Significant Joint Venture" means any Existing Joint Venture or any
Eligible Joint Venture.
"S&P" means Standard & Poor's Ratings Group, and its successors.
"Strategic Equity Offering" means a private sale of more than 10 per cent.
and less than 30 per cent. (calculated on a fully-diluted basis after giving
effect to such offering) of shares of Common Stock to a Strategic Investor.
"Strategic Investor" means an entity that has a total market capitalization
of at least $3,000,000,000 or a rating of at least BBB- from S&P and/or a rating
of Baa3 from Moody's, and is engaged in the business of providing
telecommunications services or in the manufacture and sale of telecommunications
equipment, or any subsidiary of such person.
"Subordinated Indebtedness" means Indebtedness of the Company which is by
its terms subordinated in right of payment to the Bonds.
"Subsidiary" means, with respect to the Company, (i) a corporation a
majority of whose Voting Stock is at the time, directly or indirectly, owned by
the Company, by one or more Subsidiaries of the Company or by the Company and
one or more Subsidiaries and (ii) any other person (other than a corporation),
including, without limitation, a joint venture, in which the Company, one or
more Subsidiaries of the Company or the Company and one or more Subsidiaries,
directly or indirectly, at the date of determination thereof, has at least
majority ownership interest entitled to vote in the election of directors,
managers or trustees thereof (or other person performing similar functions). For
purposes of this definition, any directors' qualifying shares or investments by
foreign nationals mandated by applicable law shall be disregarded in determining
the ownership of a Subsidiary.
"Telecommunications Assets" means, with respect to any person, any tangible
or intangible asset (including the capital stock of another person) that is
utilized by such person, directly or indirectly, for the design, development,
installation, integration, management or provision of telecommunications systems
and/or services, including, without limitation, any business or services in
which the Company, or any Subsidiary or any Significant Joint Venture of the
Company is engaged at the Issue Date.
"Trading Days" means, with respect to a securities exchange or automated
quotation system, a day on which such exchange or system is open for a full day
of trading.
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"Transfer Agent" means the office or agency (which shall be located in the
Borough of Manhattan, the city of New York, state of New York) where Bonds may
be presented for registration of transfer or for exchange.
"U.S. Government Obligations" means securities that are (a) direct
obligations of the United States of America for the timely payment of which its
full faith and credit is pledged or (b) obligations of a person controlled or
supervised by and acting as an agency or instrumentally of the United States of
America the timely payment of which is unconditionally guaranteed as a full
faith and credit obligation by the United States of America, which, in either
case, are not callable or redeemable at the option of the issuer thereof, and
shall also include a depository receipt issued by a bank (as defined in Section
3(a)(2) of the Securities Act), as custodian with respect to any such U.S.
Government Obligations or a specific payment of the principal of or interest on
any such U.S. Government Obligations held by such custodian for the account of
the holder of such depository receipt; provided that (except as required by law)
such custodian is not authorized to make any deduction from the amount payable
to the holder of such depository receipt from any amount received by the
custodian in respect of the U.S. Government Obligations or the specific payment
of principal of or interest on the U.S. Government Obligations evidenced by such
depository receipt.
"Voting Stock" means any class or classes of Capital Stock pursuant to
which the holders thereof under ordinary circumstances have the power to vote in
the election of the board of directors, managers or trustees of any person
(irrespective of whether or not, at the time, Capital Stock of any other class
or classes shall have, or might have, voting power by reason of the happening of
any contingency).
"Wholly-Owned Subsidiary" means any Subsidiary of the Company of which 100
per cent of the outstanding Capital Stock is owned by the Company or by one or
more Wholly-Owned Subsidiaries of the Company or by the Company and one or more
Wholly-Owned Subsidiaries of the Company. For purposes of this definition, any
directors' qualifying shares or investments by foreign nationals mandated by
applicable law shall be disregarded in determining the ownership of a
Subsidiary.
ENFORCEMENT
At any time after the Bonds shall have become due and payable, the Trustee
may, at its discretion and without further notice, take such proceedings against
the Company as it may think fit to enforce repayment of the Bonds together with
premium (if any) and accrued interest and to enforce the provisions of the
Indenture, but it shall not be bound to take any such proceedings unless (a) it
shall have been so directed in writing by the holders of at least 25 per cent.
in principal amount of the Bonds then outstanding, and (b) it shall have been
indemnified to its satisfaction. No Bondholder shall be entitled to proceed
directly against the Company unless the Trustee, having become bound so to
proceed, fails to do so within 30 days after the receipt of the request and
offer, such request has not been rescinded pursuant to the terms of the
Indenture, and such failure to proceed shall be continuing.
NOTICES
Notices to Bondholders shall be validly given if (i) mailed to them at
their respective addresses in the register and (ii) published in an English
language newspaper of general circulation in Europe approved by the Trustee,
currently expected to be the Financial Times, and, so long as the Bonds are
listed on the Luxembourg Stock Exchange, published in a daily newspaper of
general circulation in Luxembourg approved by the Trustee, currently expected to
be the Luxemburger Wort. Any such notice shall be deemed to have been given on
the first date on which both conditions shall have been met.
MEETINGS OF BONDHOLDERS, MODIFICATION AND WAIVER
The Indenture contains provisions for convening meetings of Bondholders to
consider any matter affecting their interests, including any modification of, or
arrangement in respect of, the terms and conditions of the Bonds or of the
provisions of the Indenture Certain special quorum provisions apply for meetings
of Bondholders convened for the purpose of amending certain terms concerning,
inter alia, the amounts payable
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on and the currency of payment of the Bonds and the Conversion Rights. Any
resolution duly passed at any such meeting will be binding on all Bondholders,
whether present or not.
SATISFACTION AND DISCHARGE
The Indenture will be discharged and will cease to be of further effect
(except as to surviving rights or registration of transfer or exchange of the
Bonds, as expressly provided for in the Indenture) as to all outstanding Bonds
when either (a) all the Bonds theretofore authenticated and delivered (except
lost, stolen or destroyed Bonds which have been replaced or repaid and Bonds for
whose payment money has theretofore been deposited with the Trustee or any
Paying Agent in trust or segregated and held in trust by the Company and
thereafter repaid to the Company or discharged from such trust) have been
delivered to the Trustee for cancellation and the Company has paid all other
sums payable by it under the Indenture or (b)(i) the Company has distributed to
the Trustee and each holder of Bonds notice of redemption or all Bonds have
otherwise become due and payable; (ii) all Bonds not theretofore delivered to
the Trustee for cancellation (except lost, stolen or destroyed Bonds which have
been replaced or paid) have been called for redemption pursuant to the terms of
the Bonds or have otherwise become due and payable and the Company has
irrevocably deposited or caused to be deposited with the Trustee funds in an
amount sufficient to pay and discharge the entire Indebtedness on the Bonds not
theretofore delivered to the Trustee for cancellation, for principal of,
premium, if any, and interest on the Bonds to the date of deposit together with
irrevocable instructions from the Company directing the Trustee to apply such
funds to the payment thereof at maturity or redemption, as the case may be;
(iii) the Company shall have irrevocably deposited or caused to be deposited
with the Trustee or a trustee reasonably satisfactory to the Trustee, under the
terms of an irrevocable trust agreement in form and substance satisfactory to
the Trustee, as trust funds in trust solely for the benefit of the Holders for
that purpose, money in such amount as is sufficient without consideration of
reinvestment of such interest, to pay principal of, premium, if any, and
interest on the outstanding Bonds to Maturity or redemption, as certified in a
certificate of a nationally recognized firm of independent public accountants,
provided that the Trustee shall have been irrevocably instructed to apply such
money to the payment of said principal, premium, if any, and interest with
respect to the Bonds and, provided, further, that from and after the time of
deposit, the money deposited shall not be subject to the rights of holders of
Senior Indebtedness' pursuant to the provisions of Article Ten; (iv) there
exists no Default or Event of Default under the Indenture; (v) the Company shall
have paid all other sums payable under the Indenture by the Company; and (vi)
the Company has delivered to the Trustee an officers' certificate and an opinion
of counsel stating that all conditions precedent under the Indenture relating to
the termination of the Company's obligations under the Bonds and the Indenture
have been complied with.
AMENDMENTS AND WAIVERS
From time to time, the Company, when authorized by a resolution of its
Board of Directors, and the Trustee may, without the consent of the holders of
any outstanding Bonds, amend, waive or supplement the Indenture or the Bonds for
certain specified purposes, including, among other things, (a) curing
ambiguities, defects or inconsistencies, (b) qualifying, or maintaining the
qualification of, the Indenture under the Trust Indenture Act of 1939, (c)
evidencing the succession of another Person to the Company or any other obligor
on the Bonds, and the assumption by any such successor of the covenants of the
Company or such obligor in the Indenture and in the Bonds in accordance with the
"Merger, Sale of Assets, Etc." covenant; (d) adding to the covenants of the
Company or any other obligor upon the Bonds for the benefit of the holders of
the Bonds or surrendering any right or power conferred upon the Company or any
other obligor upon the Bonds, as applicable, in the Indenture or in the Bonds;
(e) evidencing the replacement of the Trustee by a trustee that is appointed to
so act pursuant to the terms of the Indenture; and (f) evidencing or making any
other change that does not adversely affect the rights of any holder of Bonds;
provided, however, that such change does not adversely affect the rights of any
holder of Bonds and the Company has delivered to the Trustee an opinion of
counsel to such effect.
Other amendments and modifications of the Indenture or the Bonds may be
made by the Company and the Trustee with the consent of the holders of not less
than a majority of the aggregate principal amount of the
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outstanding Bonds; provided, however, that no such modification or amendment
may, without the consent of the holder of each outstanding Bond affected
thereby, (i) reduce the principal amount of, extend the fixed maturity of or
alter the redemption provisions of, the Bonds, (ii) change the currency in which
any Bonds or any premium or the interest thereon is payable or make the
principal of, premium, if any, or interest on any Bond payable in money other
than that stated in the Bond, (iii) reduce the percentage in principal amount of
outstanding Bond that must consent to an amendment, supplement or waiver or
consent to take any action under the Indenture or the Bonds, (iv) impair the
right to institute suit for the enforcement of any payment on or with respect to
the Bonds, (v) waive a default in payment with respect to the Bonds, (v) amend,
change or modify the obligations of the Company to make and consummate a Change
of Control Offer in the event of a Change of Control or make and consummate the
offer with respect to any Asset Sale or modify any of the provisions or
definitions with respect thereto, (vii) reduce or change the rate or time for
payment of interest on the Bonds, (viii) modify or change any provision of the
Indenture affecting the subordination or ranking of the Bonds in manner adverse
to the holders of the Bonds, or (ix) take any other action otherwise prohibited
by the Indenture or be taken without the consent of each Bondholder affected
thereby.
THE TRUSTEE
The Indenture provides that, except during the continuance of an Event of
Default, the Trustee thereunder will perform only such duties as are
specifically set forth in the Indenture. If an Event of Default has occurred and
is continuing, the Trustee will exercise such rights and powers vested in it
under the Indenture and use the same degree of care and skill in its exercise as
a prudent person would exercise under the circumstances in the conduct of such
person's own affairs.
The Trustee may, without the consent of the Bondholders:
(i) agree to any modification of the provisions of the Indenture or
the Bonds which, in the opinion of the Trustee, is of a formal, minor or
technical nature, is made to correct a manifest error or to comply with
mandatory provisions of law or is not materially prejudicial to the
interests of the Bondholders;
(ii) waive or authorize any breach or proposed breach by the Company
of the provisions of the Indenture or the Bonds, or determine that the
occurrence of any Event of Default shall not be treated as such, which, in
the opinion of the Trustee, is not materially prejudicial to the interests
of the Bondholders.
Any such modification, waiver or authorization shall be binding on the
Bondholders and , if the Trustee so requires, such modification shall be
notified by the Company to the Bondholders as soon as possible.
INDEMNIFICATION OF THE TRUSTEE
The Indenture contains provisions for the indemnification of the Trustee
and for its relief from responsibility, including provisions relieving it from
taking proceedings to enforce repayment or taking steps to enforce the
Conversion Rights unless indemnified to its satisfaction. The Trustee is
entitled to enter into business transactions with the Company or any entity
related to it without accounting for any profit.
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DESCRIPTION OF CAPITAL STOCK
The Company's authorized capital stock consists of 135,000,000 shares of
Common Stock, par value $0.10 per share, of which 37,606,814 shares were issued
and outstanding as of December 31, 1997, and 10,000,000 shares of preferred
stock, par value $0.0001 per share (the "Preferred Stock"), none of which is
outstanding. The following summary of the rights, privileges, restrictions and
conditions of each of the classes of shares issued by the Company does not
purport to be complete and is subject to the detailed provisions of, and
qualified in its entirety by reference to, the Certificate of Incorporation and
By-laws, and to the applicable provisions of the General Corporation Law of the
State of Delaware (the "DGCL").
COMMON STOCK
Holders of Common Stock are entitled to one vote for one share held of
record on all matters upon which shareholders have the right to vote. There are
no cumulative voting rights. All issued and outstanding shares of Common Stock
are, and the Offered Shares, when issued and paid for, will be, validly issued,
fully paid and non-assessable. Holders of Common Stock are entitled to such
dividends as may be declared from time to time by the Board of Directors out of
funds legally available for that purpose. See "Dividend Policy." Upon
dissolution, holders of Common Stock are entitled to share pro rata in the
assets of the Company remaining after payment in full of all of its liabilities
and obligations, including payment of the liquidation preference, if any, of any
Preferred Stock then outstanding.
PREFERRED STOCK
The Board of Directors may authorize the issuance of one or more series of
Preferred Stock having such rights, including voting, conversion and redemption
rights, and such preferences, including dividend and liquidation preferences, as
the Board may determine, without further action by the stockholders of the
Company.
The issuance of Preferred Stock by the Board of Directors could adversely
affect the rights of holders of Common Stock. For example, the issuance of
Preferred Stock could result in a series of securities outstanding that would
have preferences over the Common Stock with respect to dividends and in
liquidation and that could, upon conversion or otherwise, enjoy all the rights
appurtenant to the Common Stock. As of the date of the Offerings, the Company
has authorized 200,000 shares of Series A Junior Participating Preferred Stock,
par value $.0001 per share (the "Series A Preferred Stock"). No other series of
Preferred Stock has been authorized. There are no issued and outstanding shares
of Series A Preferred Stock and no such shares are being offered hereby. A Right
(as defined below) to purchase shares of Series A Preferred Stock, however, is
attached to each share of Common Stock pursuant to the Rights Agreement
discussed below. The Company has authorized 200,000 shares of Series A Preferred
Stock initially for issuance upon exercise of such Rights.
The Units (as defined herein) of Series A Preferred Stock that may be
acquired upon exercise of the Rights will be nonredeemable and subordinate to
any other shares of preferred stock that may be issued by the Company. Each Unit
of Series A Preferred Stock will have a minimum preferential quarterly dividend
of $.01 per Unit or any higher per share dividend declared on the Common Stock.
In the event of liquidation, the holder of a Unit of Series A Preferred Stock
will receive a preferred liquidation payment equal to the greater of $.01 per
Unit and the per share amount paid in respect of a share of Common Stock.
Each Unit of Series A Preferred Stock will have one vote, voting together
with the Common Stock. The holders of Units of Series A Preferred Stock, voting
as a separate class, shall be entitled to elect two directors if dividends on
the Series A Preferred Stock are in arrears for six fiscal quarters.
In the event of any merger, consolidation or other transaction in which
shares of Common Stock are exchanged, each Unit of Series A Preferred Stock will
be entitled to receive the per share amount paid in respect of each share of
Common Stock. The rights of holders of the Series A Preferred Stock to
dividends, liquidation and voting, and in the event of mergers and
consolidations, are protected by customary antidilution provisions. Because of
the nature of the Series A Preferred Stock's dividend, liquidation and voting
rights, the economic value of one Unit of Series A Preferred Stock that may be
acquired upon the exercise of each Right is expected to approximate the economic
value of one share of Common Stock.
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PRIOR PURCHASE AGREEMENTS
The Company and certain investors ("Prior Shareholders") have previously
entered into stock purchase agreements on (i) April 23, 1993 (the "1993 Stock
Purchase Agreement"), (ii) April 22, 1994 and June 17, 1994 (collectively, the
"1994 Stock Purchase Agreements"), (iii) a series of dates in 1995 (the "1995
Stock Purchase Agreements"), (iv) a series of dates in 1996 (the "1996 Stock
Purchase Agreements"), (v) a series of dates in 1997 (the "1997 Stock Purchase
Agreements" and, together with the 1993 Stock Purchase Agreement, the 1994 Stock
Purchase Agreements, the 1995 Stock Purchase Agreements and the 1996 Stock
Purchase Agreements, the "Prior Purchase Agreements"). The Prior Purchase
Agreements contain, among other things, certain registration and other rights
granted by the Company with respect to such Common Stock described below.
Registration Rights. Pursuant to the terms of the Prior Purchase
Agreements, Prior Shareholders holding an aggregate of 29,623,784 shares of
Common Stock are entitled to certain demand registration rights with respect to
the Common Stock held by them ("Demand Registration Rights") following the
consummation of the Offerings. In addition to the Demand Registration Rights,
Prior Shareholders are, subject to certain limitations, entitled to register
shares of Common Stock in connection with a registration statement prepared by
the Company to register its equity securities. Holders who purchased pursuant to
the 1993 Stock Purchase Agreement may also register their shares of Common Stock
in connection with a registered sale of Common Stock by a Major Shareholder (as
that term is defined in the 1993 Stock Purchase Agreement). All of the
registration rights of the Prior Shareholders are subject to certain conditions
and limitations described in the Prior Purchase Agreements.
Rights of First Refusal and Tag-Along Rights. Under the Prior Purchase
Agreements, Prior Shareholders have certain rights of first refusal to purchase
pro rata any issue of New Securities (as that term is defined in the Prior
Purchase Agreements) which the Company thereafter may from time to time propose
to issue and sell, other than in connection with certain types of transactions
and to certain types of excluded purchasers. Termination of such rights will
occur upon the earlier of the closing of an initial public offering pursuant to
an effective registration statement under the Act or, as to any Prior
Shareholder, when such Prior Shareholder no longer owns all the shares it
originally purchased.
The Prior Purchase Agreements further provide that, in the case of a sale
by the Major Shareholders as a group of all their Major Shareholders' Shares (as
those terms are defined in the Prior Purchase Agreements), holders under the
Prior Purchase Agreements may elect to participate in that sale as well.
SECTION 145 OF DGCL AND CERTAIN CHARTER PROVISIONS
Section 145 of the DGCL provides that a corporation may indemnify any
person who was or is a party or is threatened to be made a party to any
threatened, pending or completed action, suit or proceeding whether civil,
criminal or investigative (other than an action by or in the right of the
corporation) by reason of the fact that he is or was a director, officer,
employee or agent of the corporation, or is or was serving at the request of the
corporation as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, against expenses
(including attorneys' fees), judgments, fines and amounts paid in settlement
actually and reasonably incurred by him in connection with such action, suit or
proceeding if he acted in good faith and in a manner he reasonably believed to
be in or not opposed to the best interests of the corporation, and, with respect
to any criminal action or proceeding, had no reasonable cause to believe his
conduct was unlawful. Section 145 further provides that a corporation similarly
may indemnify any such person serving in any such capacity who was or is a party
or is threatened to be made a party to any threatened, pending or completed
action or suit by or in the right of the corporation to procure a judgment in
its favor, against expenses (including attorneys' fees) actually and reasonably
incurred in connection with the defense or settlement of such action or suit if
he acted in good faith and in a manner he reasonably believed to be in or not
opposed to the best interests of the corporation and except that no
indemnification shall be made in respect of any claim, issue or matter as to
which such person shall have been adjudged to be liable to the corporation
unless and only to the extent that the Delaware Court of Chancery or such other
court in which such action or suit was brought shall determine upon application
that, despite the adjudication of liability but in view of all
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the circumstances of the case, such person is fairly and reasonably entitled to
indemnity for such expenses which the Court of Chancery or such other court
shall deem proper.
Section 102(b)(7) of the DGCL permits a corporation to include in its
certificate of incorporation a provision eliminating or limiting the personal
liability of a director to the corporation or its stockholders for monetary
damages for breach of fiduciary duty as a director, provided that such provision
shall not eliminate or limit the liability of a director (i) for any breach of
the director's duty of loyalty to the corporation or its stockholders, (ii) for
acts or omission not in good faith or which involve intentional misconduct or a
knowing violation of law, (iii) under Section 174 of the DGCL (relating to
unlawful payment of dividends and unlawful stock purchase and redemption) or
(iv) for any transaction from which the director derived an improper personal
benefit.
The Company's Certificate of Incorporation provides that the Company's
Directors shall not be liable to the Company or its stockholders for monetary
damages for breach of fiduciary duty as a director provided, however, that such
exculpation from liabilities is not permitted with respect to liability arising
from items described in clauses (i) through (iv) in the preceding paragraph. The
Certificate and the Company's By-Laws further provide that the Company shall
indemnify its directors and officers to the fullest extent permitted by the
DGCL.
The directors and officers of the Company are covered under directors' and
officers' liability insurance policies maintained by the Company.
CERTAIN CHARTER AND BY-LAW PROVISIONS
Shareholders' rights and related matters are governed by the DGCL, the
Certificate of Incorporation and By-laws. Certain provisions of the Certificate
of Incorporation and the By-laws, which are summarized below, may discourage or
make more difficult a takeover attempt that a shareholder might consider in its
best interest, although certain of such provisions in the By-laws are subject to
final approval by the Company's Board of Directors. Such provisions may also
adversely affect prevailing market prices for the Common Stock. See "Risk
Factors -- Anti-takeover Provisions."
Classified Board of Directors and Related Provisions. The Certificate of
Incorporation provides that the Board of Directors of the Company be divided
into three classes of directors serving staggered three-year terms. The classes
of directors (designated Class I, Class II and Class III) shall be, as nearly as
possible, equal in number. Accordingly, one-third of the Company's Board of
Directors will be elected each year. The terms of the Initial Class I directors
shall terminate on the date of the 1998 annual meeting of stockholders; the term
of the initial Class II directors shall terminate on the date of the 1999 annual
meeting of stockholders; and the term of the initial Class III directors shall
terminate on the date of the 2000 annual meeting of stockholders. At each annual
meeting of stockholders beginning in 1998, successors to the class of directors
whose term expires at that annual meeting shall be elected for a three-year
term. The classified board provision may prevent a party who acquires control of
a majority of the outstanding voting stock of the Company from obtaining control
of the Board of Directors until the second annual shareholders meeting following
the date such party obtains the controlling interest.
Subject to the rights of the holders of any series of Preferred Stock or
any other class of capital stock of the Company (other than the Common Stock)
then outstanding, directors may only be removed for cause by a majority vote of
the holders of capital stock of the Company issued and outstanding and entitled
to vote generally in the election of directors, voting together as a single
class.
No Shareholder Action by Written Consent; Special Meetings. Subject to
filing applicable amendments to the Certificate of Incorporation with the
Secretary of State of Delaware, the Certificate of Incorporation prohibits
shareholders from taking action by written consent in lieu of an annual or
special meeting, and thus shareholders may take action at an annual or special
meeting called in accordance with the By-laws. The Certificate of Incorporation
and By-laws provide that special meetings of shareholders may only be called
only by the Chairman of the Board of Directors, the Chief Executive Officer or a
majority of the Board of
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Directors. Special meetings may not be called by the shareholders, except as
permitted by the Shareholder Rights By-law described below.
Amendments to the Certificate of Incorporation. The provisions of the
Certificate of Incorporation described above may not be amended, altered,
changed or repealed without the affirmative vote of the holders of at least 75%
of the shares of capital stock of the Company issued and outstanding and
entitled to vote.
SECTION 203 OF DELAWARE GENERAL CORPORATION LAW AND CERTAIN PROVISIONS OF THE
CERTIFICATE OF INCORPORATION
Section 203 of the DGCL prohibits certain transactions between a Delaware
corporation and an "interested stockholder", which is defined as a person who,
together with any affiliates or associates of such person, beneficially owns,
directly or indirectly, 15% or more of the outstanding voting shares of a
Delaware corporation. This provision prohibits certain business combinations
(defined broadly to include mergers, consolidations, sales or other dispositions
of assets having an aggregate value in excess of 10% of the consolidated assets
of the corporation, and certain transactions that would increase the interested
stockholder's proportionate share ownership in the corporation) between an
interested stockholder and a corporation for a period of three years after the
date the interested stockholder becomes an interested stockholder, unless (i)
the business combination is approved by the corporation's board of directors
prior to the date the interested stockholder becomes an interested stockholder,
(ii) the interested stockholder acquired at least 85% of the voting stock of the
corporation (other than stock held by directors who are also officers or by
certain employee stock plans) in the transaction in which it becomes an
interested stockholder or (iii) the business combination is approved by a
majority of the board of directors and by the affirmative vote of 66 2/3% of the
outstanding voting stock that is not owned by the interested stockholder.
In addition, the Company's Certificate of Incorporation grants the Board of
Directors of the Company the authority to issue up to 10,000,000 shares of
preferred stock in one or more series and to determine the rights, voting
powers, dividend rate, conversion rights, redemption price, liquidation
preference and other terms of such preferred stock without any further vote or
action by the stockholders. The foregoing provisions of Section 203 of the DGCL
and the Company's Certificate of Incorporation, and any issuance of preferred
stock with voting or conversion rights, may adversely affect the voting power of
the holders of Common Stock and may have the effect of delaying or preventing a
change of control of the Company or adversely affect the market price of the
Company's Common Stock.
SHAREHOLDER RIGHTS AGREEMENT AND SHAREHOLDER RIGHTS BY-LAW
Shareholder Rights Plan. The Company is planning to enter into a Rights
Agreement (the "Rights Agreement") immediately prior to the closings of the
Stock Offerings. In connection with the Rights Agreement, the Board of Directors
of the Company will declare a distribution of one right (a "Right") for each
outstanding share of Common Stock, each share of Common Stock offered hereby and
each share of Common Stock issued (including shares distributed from treasury)
by the Company thereafter and prior to the Distribution Date (as defined below).
Each Right will entitle the registered holder, subject to the terms of the
Rights Agreement, to purchase from the Company one one-thousandth of a share (a
"Unit") of Series A Preferred Stock at a purchase price of $75 per Unit, subject
to adjustment.
Initially, the Rights will attach to all certificates representing shares
of outstanding Common Stock, and no separate Rights Certificates will be
distributed. The Rights will separate from the Common Stock and the
"Distribution Date" will occur upon the earlier of (i) 10 days following a
public announcement (the date of such announcement being the "Stock Acquisition
Date") that a person or group of affiliated or associated persons (other than
the Company, any subsidiary of the Company or any employee benefit plan of the
Company or such subsidiary) (an "Acquiring Person") has acquired, obtained the
right to acquire, or otherwise obtained beneficial ownership of 15% or more of
the then outstanding shares of Common Stock and (ii) 10 business days (or such
later date as may be determined by action of the Board of Directors prior to
such time as any person becomes an Acquiring Person) following the commencement
of a tender offer or exchange offer that would result in a person or group
beneficially owning 15% or more of the then outstanding shares of Common Stock.
George Soros and his affiliates and Alan B. Slifka and his affiliates are
excluded
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from the definition of "Acquiring Person" under the Rights Agreement unless such
persons increase the aggregate percentage of their ownership interest in the
Company to 20%.
Until the Distribution Date, (i) the Rights will be evidenced by Common
Stock certificates and will be transferred with and only with such Common Stock
certificates, (ii) new Common Stock certificates issued after date of
consummation of the Offerings (also including shares distributed from treasury)
will contain a notation incorporating the Rights Agreement by reference and
(iii) the surrender for transfer of any certificates representing outstanding
Common Stock will also constitute the transfer of the Rights associated with the
Common Stock represented by such certificates.
The Rights will not be exercisable until the Distribution Date and will
expire at the close of business on the tenth anniversary of the Rights Agreement
unless earlier redeemed by the Company as described below.
In the event that (i) the Company is the surviving corporation in a merger
with an Acquiring Person and shares of Common Stock shall remain outstanding,
(ii) a Person becomes an Acquiring Persons, (iii) an Acquiring Person engages in
one or more "self-dealing" transactions as set forth in the Rights Agreement or
(iv) during such time as there is an Acquiring Person, an event occurs which
results in such Acquiring Person's ownership interest being increased by more
than 1% (e.g., by means of a recapitalization), then, in each such case, each
holder of a Right (other than such Acquiring Person) will thereafter have the
right to receive, upon exercise, Units of Series A Preferred Stock (or, in
certain circumstances, Common Stock, cash, property or other securities of the
Company) having a value equal to two times the exercise price of the Right. The
exercise price is the Purchase Price multiplied by the number of Units of Series
A Preferred Stock issuable upon exercise of a Right prior to the events
described in this paragraph.
In the event that, at any time following the Stock Acquisition Date, (i)
the Company is acquired in a merger or other business combination transaction
and the Company is not the surviving corporation (other than a merger described
in the preceding paragraph), (ii) any Person consolidates or merges with the
Company and all or part of the Common Stock is converted or exchanged for
securities, cash or property of any other Person or (iii) 50% or more of the
Company's assets or earning power is sold or transferred, each holder of a Right
(other than an Acquiring Person) shall thereafter have the right to receive,
upon exercise, common stock of the ultimate parent of the Acquiring Person
having a value equal to two times the exercise price of the Right.
The Purchase Price payable, and the number of Units of Series A Preferred
Stock issuable, upon exercise of the Rights are subject to adjustment from time
to time to prevent dilution (i) in the event of a stock dividend on, or a
subdivision, combination or reclassification of, the Series A Preferred Stock,
(ii) if holders of the Series A Preferred Stock are granted certain rights or
warrants to subscribe for Series A Preferred Stock or convertible securities at
less than the current market price of the Series A Preferred Stock or (iii) upon
the distribution to the holder of the Series A Preferred Stock of evidences of
indebtedness, cash or assets (excluding regular quarterly cash dividends) or of
subscription rights or warrants (other than those referred to above).
At any time until ten business days following the Stock Acquisition Date,
either (i) 75% of the Company's Board of Directors or (ii) a majority of the
Company's Board of Directors and a majority of the Continuing Directors (as
defined below), may redeem the Rights in whole, but not in part, at a nominal
price. Immediately upon the action of a majority of the Company's Board of
Directors ordering the redemption of the Rights, the Rights will terminate and
the only right of the holders of Rights will be to receive such redemption
price. As used in the Rights Agreement, a Continuing Director means any person
(other than an Acquiring Person or an affiliate or associate of an Acquiring
Person or a representative of an Acquiring Person or of any such affiliate or
associate) who was a director prior to the date of the Rights Agreement and any
person (other than an Acquiring Person or an affiliate or associate of an
Acquiring Person or a representative of an Acquiring Person or of any such
affiliate or associate) nominated for selection or elected to the Board of
Directors pursuant to the approval of a majority of the Continuing Directors.
At its option, either (i) 75% of the Company's Board of Directors or (ii) a
majority of the Company's Board of Directors and a majority of the Continuing
Directors, may exchange each Right for (i) one Unit of
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Series A Preferred Stock or (ii) such number of Units of Series A Preferred
Stock as will equal the spread between the market price of each Unit to be
issued and the purchase price of such Unit set forth in the Rights Agreement.
Any of the provisions of the Rights Agreement may be amended without the
approval of either (i) 75% of the Company's Board of Directors or (ii) a
majority of the Company's Board of Directors and a majority of Continuing
Directors in order to cure any ambiguity, defect or inconsistency, to make
changes which do not adversely affect the interests of holders of Rights
(excluding the interests of any Acquiring Person), or to shorten or lengthen any
time period under the Rights Agreement; provided, however, that no amendment to
adjust the time period governing redemption shall be made at such time as the
Rights are not redeemable.
Shareholder Rights By-Law. If a fully financed tender offer is made
publicly to purchase all the Company's outstanding shares of Common Stock for
cash or Marketable Securities (as defined below) at a price that is at least 40
percent greater than the average closing price of such shares on the principal
exchange on which such shares are listed during the 30 days prior to the date on
which such offer is first published or sent to security holders (the "Offer
Date") and the Board of Directors opposes such offer, the holders of more than
50% of the outstanding shares of Common Stock may, at any time subsequent to the
date that is nine calendar months after the Offer Date, call a special meeting
of the stockholders, notwithstanding the provisions described in "-- Certain
Charter and By-Law Provisions -- No Shareholder Action by Written Consent;
Special Meetings," at which meeting stockholders may be asked to vote upon a
proposal to request that the Board of Directors amend the Rights Agreement to
exempt such offer from the terms of the Rights Agreement; provided, however, if
prior to the expiration of such nine-month period, the Board of Directors
determines that it is in the best interests of the shareholders to undertake
efforts to sell the Company, such period shall be extended as long as the Board
of Directors continues its efforts to solicit, evaluate and negotiate
alternative bids to acquire the Company. If the proposal to amend the Rights
Agreement is approved by a vote of 70% of the votes cast for or against such
proposal at such meeting of stockholders at which a quorum is present, the Board
of Directors shall amend the Rights Agreement to exempt such offer from its
terms no later than 60 days after the date of such stockholders' meeting. The
foregoing provisions of the By-Laws have been approved in principle by the Board
of Directors and, once formally adopted, may only be amended or repealed by a
stockholder vote.
"Marketable Securities" means any securities that are traded on a
nationally recognized exchange and, in the opinion of an independent investment
bank, provide sufficient value and liquidity so that they would be treated as
substantially equivalent to cash consideration.
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SHARES ELIGIBLE FOR FUTURE SALE
As of December 31, 1997, after giving effect to the Stock Offerings, there
would have been 48,706,814 shares of Common Stock outstanding, (i) assuming no
exercise of the Underwriters' over-allotment options and (ii) excluding (x)
11,258,886 shares for which outstanding warrants and vested options are
exercisable, (y) 713,311 shares reserved for issuance upon exercise of a put
right and (z) the 7,239,350 shares into which the Bonds are convertible.
Of the 48,706,814 outstanding shares, (i) the 11,100,000 shares registered
in the Stock Offerings will be freely tradable without restriction under the
Securities Act (except that any shares purchased in the Stock Offerings by
"affiliates" of the Company may generally be resold only in compliance with
applicable provisions of Rule 144, as described below) and (ii) 9,430,629
additional shares may be resold under Rule 144 without restriction under the
Securities Act (subject to the lock-up agreements described below). Beginning 90
days after the date of this Prospectus, an additional 19,650 shares may be
resold under Rule 144 without restriction under the Securities Act and an
additional 25,164,324 shares may be resold under Rule 144 subject to the volume
and manner limitations therein (in each case, subject to the lock-up agreements
described below).
In addition, the Company will cause to become effective, (i) this
Registration Statement and (ii) a registration statement on Form S-8 covering
the resale of shares of Common Stock issued to employees, officers and directors
of the Company pursuant to employee benefit plans. Holders of approximately
29,623,784 shares of Common Stock and warrants to purchase 7,777,776 shares of
Common Stock, and an affiliate of the Company with an option with respect to
438,311 shares of Common Stock, have certain demand and piggy-back registration
rights.
Prior to the Stock Offerings, there was no established market for the
Common Stock and no predictions can be made about the effect, if any, that
future sales of Common Stock or the availability of the Common Stock for sale
would have on the market price for the Common Stock. Sales of large numbers of
shares of Common Stock in the public market pursuant to Rule 144 or pursuant to
an effective registration statement under the Securities Act, or the perception
that sales could occur, may have an adverse effect on the market price for the
Common Stock.
The Company and its directors, executive officers and certain stockholders
have agreed, subject to certain exceptions, not to (i) grant any option to
purchase or otherwise transfer or dispose of any Common Stock or securities
convertible into or exercisable or exchangeable for Common Stock or (ii) enter
into any swap or other agreement or transaction that transfers, in whole or in
part, the economic consequences of ownership of the Common Stock without the
prior written consent of Merrill Lynch, on behalf of the Underwriters, for a
period of 180 days after February 4. See "Underwriting." The lock-up agreements
cover more than 93% of the shares of Common Stock outstanding as of December 31,
1997.
In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this Prospectus, a person (or persons whose shares of the Company
are required to be aggregated) who has been deemed to have owned shares of an
issuer for at least one year, including an "affiliate," is entitled to sell,
within any three-month period, a number of shares that does not exceed the
greater of 1% of the then outstanding number of shares of such class or the
average weekly trading volume in composite trading in all national securities
exchanges during the four calendar weeks preceding the filing of the required
notice of such sale. A person (or persons whose shares of the Company are
required to be aggregated) who is not deemed an affiliate of an issuer at the
time of the sale and for at least three months prior to the sale and who has
owned shares for at least two years is entitled to sell such shares under Rule
144 without regard to the volume limitations described above. Affiliates
continue to be subject to such limitations. As defined in Rule 144, an
"affiliate" of an issuer is a person that directly or indirectly, through one or
more intermediaries, controls or is controlled by, or is under common control
with, such issuer.
The Stock Offerings constitute a Complying Public Equity Offering under the
terms of the Bonds. As a result, 7,239,350 shares of Common Stock are issuable
upon conversion of the Common Stock.
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CERTAIN U.S. TAX CONSIDERATIONS
The following is a summary of the principal U.S. federal income tax
considerations relevant to ownership, disposition and conversion of the Bonds.
This summary is based on the Internal Revenue Code of 1986, as amended (the
"Code"), existing and proposed Treasury regulations, revenue rulings,
administrative interpretations and judicial decisions (all as currently in
effect and all of which are subject to change, possibly with retroactive
effect). Except as specifically set forth herein, this summary deals only with
Bonds purchased by a U.S. Holder (as defined below) at original issue and held
as capital assets within the meaning of Section 1221 of the Code. This summary
does not discuss all of the tax consequences that may be relevant to holders in
light of their particular circumstances or to holders subject to special tax
rules, such as insurance companies, dealers in securities or foreign currencies,
tax-exempt investors, persons holding the Bonds as part of a hedging
transaction, "straddle," conversion transaction, or other integrated
transaction, or U.S. Holders whose functional currency (as defined in Section
985 of the Code) is not the U.S. dollar. Persons considering the purchase of the
Bonds should consult with their own tax advisors with regard to the application
of the U.S. federal income tax laws to their particular situations as well as
any tax consequences arising under the laws of any state, local or foreign
jurisdiction.
As used herein the term "U.S. Holder" means a beneficial owner of a Bond
who or that is for U.S. federal income tax purposes (i) a citizen or resident of
the United States, (ii) a corporation, partnership or other entity created or
organized in or under the laws of the United States or any political subdivision
thereof, (iii) an estate the income of which is subject to U.S. federal income
taxation regardless of its source, or (iv) a trust if both: (A) a U.S. court is
able to exercise primary supervision over the administration of the trust, and
(B) one or more U.S. persons have the authority to control all substantial
decisions of the trust. A Non-U.S. Holder means a holder of Bonds who or that is
not, for U.S. federal income tax purposes, a U.S. Holder.
THE BONDS
Based on currently applicable authorities, the Company will treat the Bonds
as indebtedness for U.S. federal income tax purposes. However, since the Bonds
have certain equity characteristics, it is possible that the IRS will contend
that the Bonds should be treated as an equity interest in, rather than
indebtedness of the Company. In the event the Bonds are treated as equity,
distributions received on a Bond would first be taxable to the holder as
dividend income to the extent of the Company's accumulated earnings and profits,
and next would be treated as a return of capital to the extent of the holder's
tax basis in the Bond, with any remaining amount treated as gain from the sale
of a Bond. Further, payments on Bonds treated as equity to Non-U.S. Holders
would not be eligible for the portfolio interest exception from U.S. withholding
tax, and those payments would be subject to U.S. withholding tax at a flat rate
of 30% unless reduced under an applicable tax treaty or unless the Company
qualifies as an "80/20 Company," as discussed below. Moreover, in the event of
equity treatment, the Company would never be entitled to deduct interest or
original issue discount on such Bonds for U.S. federal income tax purposes.
Except as otherwise noted, the remainder of this discussion assumes that the
Bonds will constitute indebtedness for U.S. tax purposes.
Investors should also be aware that recently enacted legislation disallows
deductions for interest paid or accrued on debt instruments issued after June 8,
1997 by a corporation if either (i) a substantial amount of the principal or
interest is required to be paid in or converted into equity of the issuer, (ii)
a substantial amount of the principal or interest is required to be determined,
or at the option of the issuer or a related party is determined, by reference to
the value of such equity, or (iii) the indebtedness is part of an arrangement
that is reasonably expected to result in a transaction described in either (i)
or (ii). For these purposes, principal or interest shall be required to be so
paid, converted, or determined if it may be required at the option of the holder
and there is a substantial certainty the option will be exercised.
TAX CONSEQUENCES TO U.S. HOLDERS
Payments of Interest and Original Issue Discount on the Bonds
Except as otherwise provided below, U.S. Holders will include payments of
stated interest on the Bonds to the extent of the lowest fixed rate provided by
the Bonds throughout their term as ordinary interest income
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when accrued or received in accordance with their respective method of tax
accounting. Unless de minimis in amount, stated interest on the Bonds in excess
of such rate will be taxable to U.S. holders on the economic accrual basis as
original issue discount ("OID") under the rules described below.
A debt instrument is issued with OID if its "stated redemption price at
maturity" exceeds its issue price by more than a de minimis amount. In general
terms, U.S. Holders are required to include OID gross income as ordinary
interest income on the economic accrual basis in advance of the cash
attributable to that income. Under Treasury regulations, the stated redemption
price at maturity of a debt instrument is equal to the sum of all payments to be
made thereon other than qualified stated interest. Qualified stated interest is
stated interest which is unconditionally payable at least annually at a single
fixed rate throughout the term of the debt instrument. The Treasury regulations
further provide that, for purposes of the OID rules, if (i) a debt instrument
provides for alternative payment schedules based on the occurrence of a
contingency (or contingencies), (ii) the timing and amounts of the payments that
comprise each payment schedule are known as of the issue date, and (iii) as of
the issue date, based on all the facts and circumstances, a single payment
schedule is significantly more likely than not to occur, then the yield and
maturity of the debt instrument for purposes of computing OID are computed based
on that payment schedule. When a debt instrument provides for alternative
payment schedules upon the occurrence of one or more contingencies, the debt
instrument provides for qualified stated interest to the extent of the lowest
fixed rate of interest that would be payable under any payment schedule.
The rate of stated interest payable on the Bonds will increase on June 30,
1998 and June 30, 1999 if the Company has not made a Complying Equity Offering
by those dates. Further, absent such an Offering during the term of the Bonds,
the Bonds will be retired at maturity for 121% of their stated principal amount.
If a Complying Equity Offering occurs by June 1998, however, the rate of
interest payable on the Bonds will remain constant, and the Bonds will be
retired at maturity for their stated principal amount. As such, different
payment schedules for the Bonds will result depending on the timing or
occurrence of a Complying Equity Offering. For each of these schedules, the
timing and amount of the payments will be known as of the issue date. As of the
issue date, the Company took the position that it was significantly more likely
than not that a Complying Equity Offering would occur after June 30, 1998 and
before July 1, 1999. As such, the payment schedule under which the Bonds bore
interest with one interest rate increase, and under which the Bonds would be
retired at their stated principal amount, was considered significantly more
likely than not to occur. Under this approach, the stated redemption price at
maturity of the Bonds included a portion of the excess interest payable at the
rate in effect after June 30, 1998, but not the 21% retirement premium payable
at maturity of the Bonds. The amount of such excess interest represented OID
taxable to U.S. Holders on the accrual basis prior to the receipt of cash
attributable to that interest.
Because a Complying Equity Offering occurred before June 30, 1998, solely
for purposes of the OID rules, the Bonds will be treated as retired and reissued
on the date of such occurrence for their adjusted issue price on such date,
which generally will equal the Bonds' stated principal amount increased by the
total amount of OID required to be included in income in respect of the Bonds by
U.S. Holders prior to that date. As a result of the deemed reissuance, (i) all
stated interest on the Bonds should be treated as qualified stated interest and
a U.S. Holder should include such interest in income as it accrues or is
received, in accordance with its method of tax accounting, (ii) except as
provided below, the Bonds should not be treated as bearing OID upon reissuance,
and (iii) a U.S. Holder that included OID in income on the Bonds based on the
payment schedule treated by the Company as significantly more likely than not to
occur as described above should be treated as reacquiring the Bonds with
"amortizable bond premium," as described below in "-- Market Discount and
Premium," to the extent that such Holder's adjusted tax basis in the Bonds
exceeds their principal amount.
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If a shelf registration statement does not remain effective with the
Commission as described in the Registration Rights Agreement (a "Registration
Default"), additional interest will accrue on the Bonds in the manner described
therein. According to Treasury Regulations, the possibility of a change in the
interest rate will not affect the amount of interest income recognized by a U.S.
Holder (or the timing of such recognition) if the likelihood of the change, as
of the date the Bonds are issued, is remote. The Company believes that the
likelihood of a change in the interest on the Bonds due to a Registration
Default is remote and does not intend to treat the possibility of such a change
in the interest rate as affecting the yield to maturity of any Bond. In the
unlikely event that the interest rate on the Bonds is increased, then such
increased interest may be treated as additional OID, includible by a holder in
income as such interest accrues, in advance of receipt of any cash payment
thereof.
U.S. Holders are permitted to elect to include all interest on a Bond using
the constant yield method. For this purpose, interest includes stated interest,
acquisition discount, OID, de minimis OID, market discount, de minimis market
discount, and unstated interest, as adjusted by any amortizable bond premium or
acquisition premium. Special rules apply to elections made with respect to Bonds
with amortizable bond premium or market discount and U.S. Holders considering
such an election should consult their own tax advisors. The election cannot be
revoked without the approval of the Internal Revenue Service.
Contingent Payment Debt Instrument Regulations
Certain Treasury Regulations provide for special tax treatment of
"contingent payment debt instruments" (the "contingent debt regulations"). These
regulations apply to debt instruments with contingent interest that do not fall
within the scope of the rules described above for debt instruments providing for
alternative payment schedules, each of which can be determined (as to timing and
amount) as of the issue date. By their terms, however, the contingent debt
regulations do not apply where the contingency is remote or incidental or
because the holder of the debt instrument has an option to convert the
instrument into stock of the issuer. In general, if a debt instrument is subject
to the contingent debt regulations, a U.S. Holder must accrue contingent
interest income as OID over the term of the debt instrument and in advance of
the cash payments attributable thereto based upon a projected payment schedule
(subject to later adjustments) provided by the issuer. Further, any gain and
(subject to certain limitations) loss recognized by a holder with respect to the
sale or other disposition of such an instrument will be ordinary, rather than
capital, in nature.
The application of the contingent debt regulations to instruments such as
the Bonds is uncertain. In particular, the Bonds provide for (i) the payment of
additional amounts in the event U.S. withholding tax is imposed and (ii)
depending on certain contingencies, for (A) the payment of additional interest
and retirement premium and (B) periodic decreases over the term of the Bonds in
the price at which Bonds may be converted into shares of Common Stock. The
Company is taking the position that the contingent debt regulations should not
apply to the Bonds because the Company believes the Bonds had, at the time of
issuance, a payment schedule that was significantly more likely than not to
occur. However, since the scope of the contingent debt regulations is not clear,
it is possible that the Internal Revenue Service will take the position that the
Bonds are subject to the contingent debt regulations. If the Bonds are
ultimately found to be subject to the contingent debt regulations, U.S. Holders,
including U.S. Holders using the cash method of tax accounting, would be
required to accrue interest income as "original issue discount" over the term of
the debt instrument based upon a projected payment schedule (subject to later
adjustments) that could include projected values for the retirement premium and
conversion price adjustments, and any gain and (subject to certain limitations)
loss recognized by a holder on a sale or other taxable disposition with respect
to such instrument would be ordinary, rather than capital, in nature. In
addition, all or a portion of the gain or loss recognized on sale or other
taxable disposition of shares of Common Stock received in exchange for Bonds
might be ordinary, rather than capital, in nature.
Market Discount and Premium
If a U.S. Holder purchases a Bond for an amount that is less than its
stated redemption price at maturity or its adjusted issue price for Bonds
purchased prior to their deemed reissuance as described above the amount
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of the difference will be treated as "market discount" for U.S. federal income
tax purposes, unless such difference is less than a specified de minimis amount.
Under the market discount rules of the Code, a U.S. Holder will be required
to treat any partial principal payment on, or any gain realized on the sale,
exchange, retirement or other disposition of, a Bond as ordinary income to the
extent of the lesser of (i) the amount of such payment or realized gain or (ii)
the market discount that has not previously been included in income and is
treated as having accrued on such Bond at the time of such payment or
disposition. If such Bond is disposed of in a nontaxable transaction (other than
a nonrecognition transaction described in Code Section 1276(c)), the amount of
gain realized on such disposition for purposes of the market discount rules
shall be determined as if such holder had sold the Bond at its then fair market
value. Market discount will be considered to accrue ratably during the period
from the date of acquisition to the maturity date of the Bond, unless the U.S.
Holder elects to accrue on the basis of a constant interest rate.
A U.S. Holder may be required to defer the deduction of all or a portion of
the interest paid or accrued on any indebtedness incurred or maintained to
purchase or carry such Bond until the maturity of the Bond or its earlier
disposition (except for certain nonrecognition transactions). A U.S. Holder may
elect to include market discount in income currently as it accrues (on either a
ratable or a constant interest rate basis), in which case the rules described
above regarding the treatment as ordinary income of gain upon the disposition of
the Bond and upon the receipt of certain cash payments and regarding the
deferral of interest deductions will not apply.
If a U.S. Holder's tax basis in a Bond (either (i) its purchase price or
(ii) in the case of a U.S. Holder that included OID in income prior to the
deemed reissuance discussed above in "Payments of Interest and Original Issue
Discount on the Bonds," the sum of the purchase price and the amount of OID
included by such holder) reduced by the portion of the tax basis attributable to
the Bond's conversion feature exceeds the amount payable at maturity (or on the
earlier call date, in the case of a Bond that is redeemable at the option of the
Company), such holder will be considered to have purchased such Bond with
"amortizable bond premium" equal in amount to such excess, and may elect (in
accordance with applicable Code provisions) to amortize such premium, using a
constant yield method over the remaining term of the Bond and to offset interest
otherwise required to be included in income in respect of such Bond during any
taxable year by the amortized amount of such excess for such taxable year.
However, if such Bond may be optionally redeemed after the U.S. Holder acquires
it at a price in excess of its stated redemption price at maturity, special
rules would apply which could result in a deferral of the amortization of some
bond premium until later in the term of such Bond.
Adjustment to Conversion Ratio
The Conversion Price applicable to the Bonds is subject to adjustments
under certain circumstances. Under Section 305 of the Code and the Treasury
Regulations promulgated thereunder, holders of the Bonds may be treated as
having received a constructive distribution, resulting in ordinary income to the
extent of the Company's current and accumulated earnings and profits, if, and to
the extent that, adjustments in the Conversion Price occur within thirty-six
months of certain taxable distributions on shares of Common Stock and increase
the proportionate interest of a holder of a Bond in the earnings and profits of
the Company. As such, under certain circumstances that may or may not occur,
such an adjustment may be treated as a taxable distribution to holders of the
Bonds, without regard to whether such holders receive any cash or other
property. Further, in the event the Bonds were treated as equity interests in,
rather than indebtedness of, the Company, any change in the Conversion Price
that increased the ratio at which Bonds could be converted into shares of Common
Stock would be treated as a taxable distribution with respect to the Bonds under
section 305 of the Code.
Sale or Other Disposition
In general, a U.S. Holder of Bonds will recognize gain or loss upon the
sale, exchange, redemption, or other taxable disposition of such Bonds measured
by the difference between (i) the amount of cash and the
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fair market value of property received (except to the extent attributable to
accrued interest on the Bonds previously taken into account) and (ii) the U.S.
Holder's tax basis in the Bonds (as increased by any accrued OID (net of all
amortized acquisition premiums) and market discount previously includible in
income by the U.S. Holder and decreased by amortizable bond premiums, if any,
deducted over the term of the Bonds.) Subject to the market discount rules
discussed above and except if the Bonds are subject to the contingent debt
regulations described above, any such gain or loss generally will be capital
gain or loss and will be long-term capital gain or loss if the Bonds have been
held for more than one year.
No gain or loss will be recognized for U.S. federal income tax purposes by
holders of the Bonds upon the conversion thereof in exchange for shares of
Common Stock (except to the extent of cash, if any, received in lieu of the
issuance of fractional shares of Common Stock and for shares of Common Stock
received on accrual of accrued interest, OID or retirement premium). A U.S.
Holder's tax basis in the shares of Common Stock will equal the sum of the
adjusted tax basis in the Bonds reduced by the portion of adjusted tax basis
allocated to any fractional shares of Common Stock exchanged for cash. The
holding period of the shares of Common Stock received on the conversion of the
Bonds will include the period during which the Bonds were held by such U.S.
Holder, except that the holding period of shares of Common Stock allocable to
accrued original issue discount may commence on a later date. If any cash is
received in lieu of fractional shares, the U.S. Holder will recognize gain or
loss, and the character and the amount of such gain or loss will be determined
as if the U.S. Holder had received such fractional shares and then immediately
sold them for cash.
THE SHARES OF COMMON STOCK
Dividends
The Company does not presently intend to pay dividends on shares of Common
Stock in the foreseeable future. If the Company should pay a dividend on shares
of Common Stock, the dividend will be taxable as ordinary income to the extent
of the Company's current and accumulated earnings and profit. If there are no
such earnings and profits, such dividend would be treated first as a return of
capital to the extent of the U.S. Holder's tax basis in the shares of Common
Stock, and then, if the amount of the dividend exceeds such tax basis, as
capital gain to the extent of such excess. As a result, until such time as the
Company has current or accumulated earnings and profits, cash distributions on
shares of Common Stock will be a nontaxable return of capital and will be
applied against and reduce the adjusted tax basis of any shares of Common Stock
(but not below zero) in the hands of its holder. The Company believes that it
does not presently have accumulated earnings and profits for tax purposes.
However, the Company cannot predict whether it will have earnings and profits
for future taxable years. See "Risk Factors."
Sale of Shares of Common Stock
Gain or loss will generally be recognized upon a sale or other taxable
disposition of the shares of Common Stock in an amount equal to the difference
between the amount realized on the transfer and the holder's adjusted tax basis
in the shares of Common Stock. Except as provided below, such gain or loss will
be capital gain or loss, provided the shares of Common Stock are held as a
capital assets and will be long-term capital gain or loss with respect to shares
of Common Stock held for more than one year. If the Bonds converted into shares
of Common Stock are subject to the contingent debt regulations, a portion of
such gain or loss might be ordinary rather than capital.
Backup Withholding
"Backup withholding" at a rate of 31% may apply to payments of interest on
the Bonds, dividends on the shares of Common Stock and to payments of the
proceeds of a sale or exchange of the Bonds or shares of Common Stock that are
made to a non-corporate U.S. Holder if such holder fails to provide a correct
taxpayer identification number or otherwise comply with applicable requirements
of the backup withholding rules. The backup withholding tax is not an additional
tax and may be credited against a U.S. Holder's U.S. federal income tax
liability, provided that correct information is provided to the Internal Revenue
Service.
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TAX CONSEQUENCES TO NON-U.S. HOLDERS
The Bonds
Under present U.S. federal income tax law, and subject to the discussion
below concerning backup withholding:
(a) payments of principal, interest and premium, if any, on the Bonds
by the Company or any paying agent to any Non-U.S. Holder will not be
subject to U.S. withholding tax, provided that, in the case of interest,
either (i) the Company is an "80/20 company," as described below, or, (ii)
if the Company is not an 80/20 company, the requirements for the "Portfolio
Interest Exemption" are satisfied; and
(b) a Non-U.S. Holder of a Bond will not be subject to U.S. federal
income tax on gain realized on the sale, exchange or other disposition of
such Bond, unless (i) such Holder is an individual who is present in the
United States for 183 days or more in the taxable year of disposition and
certain other conditions are met, or (ii) such gain is effectively
connected with the conduct by such Holder of a trade or business in the
United States.
U.S. withholding tax will not be imposed on interest paid by a U.S.
corporation if at least 80% of the gross income derived by such corporation
(either directly or through its subsidiaries) during the applicable testing
period is "active foreign business income," as defined in section 861 of the
Code (an "80/20 company"). At present, the Company believes that it qualifies as
an 80/20 company. However, the 80% test for active foreign business income is
applied on a periodic basis, and operations and business plans of the Company
may change in subsequent taxable years. Therefore, while at present it appears
that this exception from withholding is available, no assurances can be made
regarding its future availability.
If the Company is not an 80/20 company, a Non-U.S. Holder will be exempt
from U.S. withholding tax under the Portfolio Interest Exemption, provided that
(A) such Holder does not own, actually or constructively, 10 percent or more of
the total combined voting power of all classes of stock of the Company entitled
to vote, is not a controlled foreign corporation related, directly or
indirectly, to the Company through stock ownership, and is not a bank receiving
interest described in section 881(c)(3)(A) of the Code and (B) the certification
requirement set forth in section 871(h) or section 881(c) of the Code has been
fulfilled with respect to the beneficial owner. Such requirement will be
fulfilled if the beneficial owner of a Bond certifies on IRS Form W-8, under
penalties of perjury, that it is not a U.S. person and provides its name and
address, and (i) such beneficial owner files such Form W-8 with the withholding
agent or (ii) in the case of a Bond held by a securities clearing organization,
bank or other financial institution that holds customers' securities in the
ordinary course of its trade or business, such financial institution files with
the withholding agent a statement that it has received such a statement from the
Holder and furnishes the withholding agent with a copy thereof. Certain
pass-through entities may be required to comply with additional certification
requirements.
If a Non-U.S. Holder of a Bond is engaged in a trade or business in the
United States, and if interest on the Bond is effectively connected with the
conduct of such trade or business, the Non-U.S. Holder, although exempt from the
withholding tax discussed in the preceding paragraph, generally will be subject
to regular U.S. federal income tax on interest and on gain realized on the sale,
exchange or other disposition of a Bond in the same manner as if it were a U.S.
Holder. See "U.S. Holders" above. In lieu of the certificate described in the
preceding paragraph, such a Holder will be required to provide to the Company a
properly executed IRS Form 4224 in order to claim an exemption from withholding
tax on stated interest paid on the Bonds on or before December 31, 1998 and
payments made on or before such date of proceeds from a sale or exchange of a
Bond. Under recently finalized Treasury regulations (the "Final Regulations"),
such a Non-U.S. Holder will be required to provide a Form W-8 to the withholding
agent on which such Holder provides its name, address and TIN and states, under
penalty of perjury, that the interest paid on a Bond and the gain on the sale or
exchange of a Bond is effectively connected with such Holder's U.S. trade or
business in order to obtain an exemption from withholding tax on payments made
after December 31, 1998. In addition, if such Non-U.S. Holder is a foreign
corporation, it may be subject to a branch profits tax equal to 30% (or such
lower rate
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provided by an applicable treaty) of its effectively connected earnings and
profits for the taxable year, subject to certain adjustments.
The Shares of Common Stock
Dividends
Dividends that are paid by a U.S. corporation to a Non-U.S. Holder and that
are not effectively connected with a trade or business carried on by such
Non-U.S. Holder in the United States (or, if one or more of certain tax treaties
apply, are attributable to a permanent establishment in the United States
maintained by the Non-U.S. Holder) generally are subject to a 30% U.S.
withholding tax. An exemption from such withholding exists with respect to
dividends paid to Non-U.S. Holders by an 80/20 company. See "Non-U.S. Holders --
The Bonds." Under the provisions of the Code applicable to 80/20 companies, the
proportion of an 80/20 company's dividends equal to such company's total gross
income from foreign sources over its total gross income is exempt from U.S.
withholding tax. At present, the Company believes that it qualifies as an 80/20
company. However, the 80% active foreign business income test is applied on a
periodic basis, and operations and business plans of the Company may change in
subsequent taxable years. Therefore, no assurances can be made regarding the
Company's future status as an 80/20 company. If, for any period or periods, the
Company fails to satisfy the requirements applicable to an 80/20 company, the
withholding agent generally would be required to withhold tax from dividends
paid on shares of Common Stock. If withholding tax is collected on distributions
that do not constitute dividends because the Company lacks earnings and profits,
a Non-U.S. Holder may obtain a refund of the excess amounts withheld by timely
filing a claim for refund with the Internal Revenue Service. The rate of
withholding may be reduced to the extent provided by a tax treaty between the
United States and the country of which the Non-U.S. Holder is a resident for tax
purposes.
In order to claim the benefit of an applicable tax treaty rate, a Non-U.S.
Holder may have to file with the Company or its dividend paying agent an
exemption or reduced treaty rate certificate or letter in accordance with the
terms of such treaty. Under Treasury regulations currently in effect, for
purposes of determining whether tax is to be withheld at a 30% rate or at a
reduced rate as specified by an income tax treaty, the Company ordinarily will
presume that dividends paid to the address in a foreign country are paid to a
resident of such country absent knowledge that such presumption is not
warranted. However, under the Final Regulations, a non-U.S. Holder seeking a
reduced rate of withholding under an income tax treaty generally would be
required to provide to the Company a valid Internal Revenue Service Form W-8
certifying that such Non-U.S. Holder is entitled to benefits under an income tax
treaty. The Final Regulations also provide special rules for determining
whether, for purposes of assessing the applicability of an income tax treaty,
dividends paid to a Non-U.S Holder that is an entity should be treated as being
paid to the entity itself or to the persons holding an interest in that entity.
A Non-U.S. Holder that is eligible for a reduced withholding rate may obtain a
refund of any excess amounts withheld by filing an appropriate claim for a
refund with the Internal Revenue Service.
In the case of dividends that are effectively connected with the Non-U.S.
Holder's conduct of a trade or business within the United States or, if an
income tax treaty applies, attributable to a U.S. permanent establishment of the
Non-U.S. Holder, the Non-U.S. Holder will generally be subject to regular U.S.
income tax in the same manner as if the Non-U.S. Holder were a U.S. resident,
and will be exempt from U.S. withholding tax provided that the Non-U.S. Holder
complies with the requirements for the exemption from withholding for
effectively connected interest described above. A Non-U.S. corporation receiving
effectively connected dividends also may be subject to an additional "branch
profits tax" which is imposed, under certain circumstances, at a rate of 30% (or
such lower rate as may be specified by an applicable treaty) of the Non-U.S.
corporation's "effectively connected earnings and profits," subject to certain
adjustments.
Gain on Disposition of Shares of Common Stock
A Non-U.S. Holder generally will not be subject to U.S. federal income tax
with respect to gain realized on a sale or other disposition of shares of Common
Stock unless (i) the gain is effectively connected with a
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trade or business of such Non-U.S. Holder in the U.S., (ii) in the case of
certain Non-U.S. Holders who are non-resident alien individuals and hold shares
of Common Stock as capital assets, such individuals are present in the U.S. for
183 or more days in the taxable year of the disposition and either (a) such
individuals have a "tax home" (as defined for U.S. federal income tax purposes)
in the United States or (b) the gain is attributable to an office or other fixed
place of business maintained by such individuals in the United States, (iii) the
Non-U.S. Holder is subject to tax, pursuant to the provisions of the U.S. tax
law applicable to certain U.S. expatriates whose loss of U.S. citizenship has as
one of its principal purposes of avoidance of U.S. taxes, or (iv) under certain
circumstances if the Company is or has been during certain time periods a
"United States real property holding corporation" within the meaning of Section
897(c)(2) of the Code and, assuming that the shares of Common Stock are
regularly traded on an established securities market for tax purposes, the
Non-U.S. Holder held, directly or indirectly, at any time within the five-year
period preceding such disposition more than 5% of the outstanding shares of
Common Stock. The Company is not, and does not anticipate becoming, a United
States real property holding corporation.
Information Reporting Requirements and Backup Withholding
Under the Treasury regulations, the Company must report annually to the
Internal Revenue Service and to each Non-U.S. Holder the amount of interest and
dividends paid to such holder and any tax withheld with respect to such
dividends. These information reporting requirements apply regardless of whether
withholding is required because the dividends were effectively connected with a
trade or business in the United States of the Non-U.S. Holder or withholding was
reduced or eliminated by an applicable income tax treaty. Copies of the
information returns reporting such dividends and withholding may also be made
available to the tax authorities in the country in which the Non-U.S. Holder is
a resident under the provisions of an applicable income tax treaty or agreement.
U.S. backup withholding (which generally is a withholding tax imposed at
the rate of 31% on certain payments to persons that fail to furnish certain
information under the U.S. information reporting requirements) generally will
not apply to (i) payments on Bonds received by Non-U.S. Holders if the
certifications required by sections 871(h) and 881(c), discussed above, are
received, provided in each case that the Company or such paying agent, as the
case may be, does not have actual knowledge that the payee is a United States
person, (ii) dividends paid to Non-U.S. Holders that are subject to the 30%
withholding discussed above (or that are not so subject because a tax treaty
applies that reduces or eliminates such 30% withholding) or (iii) under current
law, dividends paid to a Non-U.S. Holder at an address outside of the United
States. However, under the Final Regulations, effective as of January 1, 1999, a
Non-U.S. Holder generally will be subject to backup withholding tax on dividends
unless certain certification procedures (or, in the case of payments made
outside the United States with respect to an offshore account, certain
documentary evidence procedures) are satisfied, directly or through a foreign
intermediary. Backup withholding and information reporting generally will apply
to dividends paid to addresses inside the United States on shares of Common
Stock to beneficial owners that are not "exempt recipients" and that fail to
provide in the manner required certain identifying information.
Non-U.S. Holders should consult their tax advisers regarding the
application of information reporting and backup withholding in their particular
situations, the availability of an exemption therefrom, and the procedure for
obtaining such an exemption, if available. Any amounts withheld from a payment
to a Non-U.S. Holder under the backup withholding rules will be allowed as a
credit against such Holder's U.S. federal income tax liability and may entitle
such Holder to a refund, provided that the required information is furnished to
the Internal Revenue Service.
THE FOREGOING DISCUSSION IS INCLUDED FOR GENERAL INFORMATION ONLY.
ACCORDINGLY, EACH PROSPECTIVE PURCHASER IS URGED TO CONSULT HIS TAX ADVISOR WITH
RESPECT TO THE U.S. FEDERAL INCOME TAX CONSEQUENCES OF THE OWNERSHIP AND
DISPOSITION OF THE BONDS AND SHARES OF COMMON STOCK, INCLUDING THE APPLICATION
AND EFFECT OF THE LAWS OF ANY STATE, LOCAL, FOREIGN, OR OTHER TAX JURISDICTION.
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SELLING HOLDERS
The Bonds were originally issued by the Company and sold to certain
Accredited Investors and by UBS Securities, Donaldson, Lufkin & Jenrette
Securities Corporation and Merrill Lynch, Pierce, Fenner & Smith (the
"Managers"), in a transaction exempt from the registration requirements of the
Securities Act, to persons reasonably believed by such Managers to be "qualified
institutional buyers" (as defined in Rule 144A under the Securities Act), or
outside the United States to non-U.S. persons in offshore transactions in
reliance on Regulation S under the Securities Act. The Selling Holders may from
time to time offer and sell pursuant to this Prospectus any or all of the Bonds
and Conversion Shares issued upon conversion of the Bonds. The term Selling
Holder includes the record holders listed below and the beneficial owners of the
Bonds and their transferees, pledges, donors or other successors.
The following table sets forth information with respect to certain record
holders of the Bonds as of January 14, 1998.
<TABLE>
<CAPTION>
PRINCIPAL AMOUNT
SELLING HOLDER OF BONDS
-------------- ----------------
<S> <C> <C>
1. Cede & Co. ................................................. $141,295,000
2. Kevah Konner................................................ 20,000
------------
Total....................................................... $141,315,000
============
</TABLE>
Kevah Konner is a Principal of Halcyon/Alan B. Slifka Management Company
LLC, an affiliate of Alan B. Slifka, the Chairman of the Board of Directors.
Alan B. Slifka and affiliates beneficially owned 5,492,981 shares of Common
Stock, representing 14.5% of the outstanding Common Stock and warrants to
purchase Common Stock prior to the Stock Offerings and 11.2% of the outstanding
Common Stock and warrants to purchase Common Stock after the Stock Offerings.
Such number of shares of Common Stock includes 2,788,784 shares of Common Stock
owned by Mr. Slifka, shares of Common Stock held in trust for a minor child and
options to purchase 225,000 shares of Common Stock; 2,563,041 shares of Common
Stock owned by various Halcyon Partnerships which are managed by Halcyon/Alan B.
Slifka Management Company LLC, of which Mr. Slifka is the Managing Principal and
over which Mr. Slifka disclaims beneficial ownership; 67,500 shares of Common
Stock held by GTS 1995 Partners, LP; 4,500 shares of Common Stock held by Mr.
Konner; 19,656 shares of Common Stock held by John M. Bader, a Principal of
Halcyon/Alan B. Slifka Management Company LLC; and 49,500 shares of Common Stock
owned by Randolph Slifka, Mr. Slifka's son, over all of which Mr. Slifka
disclaims beneficial ownership.
Because the Selling Holders may, pursuant to this Prospectus, offer all or
some portion of the Bonds or the Common Stock issuable upon conversion of the
Bonds, no estimate can be given as to the amount of the Bonds or the Common
Stock issuable upon conversion of the Bonds that will be held by the Selling
Holders upon termination of any such sales. Pursuant to the terms of a lock-up
agreement entered into in connection with the Stock Offerings, Mr. Konner has
agreed not to offer, pledge or sell Bonds or Common Stock for 180 days after
February 4, 1998. In addition, the Selling Holders identified above may have
sold, transferred or otherwise disposed of all or a portion of their Bonds since
the date on which they provided the information regarding their Bonds, in
transactions exempt from the registration requirements of the Securities Act.
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PLAN OF DISTRIBUTION
The Offered Securities may be sold from time to time to purchasers directly
by the Selling Holders. Alternatively, the Selling Holders may from time to time
offer the Offered Securities to or through underwriters, broker/dealers or
agents, who may receive compensation in the form of underwriting discounts,
concessions or commissions from the Selling Holders or the purchasers of such
securities for whom they may act as agents. The Selling Holders and any
underwriters, broker/dealers or agents that participate in the distribution of
Offered Securities may be deemed to be "underwriters" within the meaning of the
Securities Act and any profit on the sale of such securities and any discounts,
commissions, concessions or other compensation received by any such underwriter,
broker/dealers or agents may be deemed to be underwriting discounts and
commissions under the Securities Act.
The Offered Securities may be sold from time to time in one or more
transactions at fixed prices, at prevailing market prices at the time of sale,
at varying prices determined at the time of sale or at negotiated prices. The
sale of Offered Securities may be effected in transactions (which may involve
crosses or block transactions) (i) on any national securities exchange or
quotation service on which the Offered Securities may be listed or quoted at the
time of sale, (ii) in the over-the-counter markets, (iii) in transactions
otherwise than on such exchange or in the over-the-counter market or (iv)
through the writing of options. At the time a particular offering of the Offered
Securities is made, a Prospectus Supplement, if required, will be distributed
which will set forth the aggregate amount and type of Offered Securities being
offered and the terms of the offering, including the name or names of any
underwriter, broker/dealers or agents, any discounts, commissions and other
terms constituting compensation from the Selling Holders and any discounts,
commissions or concessions allowed or reallowed or paid to broker/dealers.
To comply with the securities laws of certain jurisdictions, if applicable,
the Offered Securities will be offered or sold in such jurisdictions only
through registered or licensed brokers or dealers. In addition, in certain
jurisdictions the Offered Securities may not be offered or sold unless they have
been registered or qualified for sale in such jurisdictions or any exemption
from registration or qualification is available and is complied with.
The Selling Holders will be subject to applicable provision of the Exchange
Act and the rules and regulations thereunder, which provision may limit the
timing of purchases and sales of any of the Offered Securities by the Selling
Holders. The foregoing may affect the marketability of such securities.
Pursuant to the Registration Rights Agreement, all expenses of the
registration of the Offered Securities will be paid by the Company, including
without limitation, Commission filing fees and expense of compliance with state
securities or "blue sky" laws; provided, however, that the Selling Holders will
pay all underwriting discounts and selling commissions, if any. The Selling
Holders will be indemnified by the Company against certain civil liabilities,
including certain liabilities under the Securities Act, or will be entitled to
contribution in connection therewith. The Company will be indemnified by the
Selling Holders severally against certain civil liabilities including certain
liabilities under the Securities Act, or will be entitled to contribution in
connection therewith.
LEGAL MATTERS
The validity of the Offered Securities offered hereby will be passed upon
for the Company by Shearman & Sterling, New York, New York.
EXPERTS
The consolidated financial statements of Global TeleSystems Group, Inc. as
of December 31, 1996 and 1995 and September 30, 1997, and for each of the three
years in the period ended December 31, 1996 and the nine months ended September
30, 1997, appearing in this Prospectus and Registration Statement, have been
audited by Ernst & Young, LLP, independent auditors, as set forth in their
report appearing elsewhere herein
159
<PAGE> 163
and are included in reliance upon such report given upon the authority of such
firm as experts in accounting and auditing.
The consolidated financial statements of EDN Sovintel as of December 31,
1996 and 1995, and for each of the three years in the period ended December 31,
1996, appearing in this Prospectus and Registration Statement, have been audited
by Ernst & Young (CIS) Ltd., independent auditors as set forth in their report
appearing elsewhere herein and are included in reliance upon such report given
upon the authority of such firm as experts in accounting and auditing.
The consolidated financial statements of Hermes Europe Railtel B.V. as of
December 31, 1996 and 1995 and September 30, 1997, and for each of the three
years in the period ended December 31, 1996 and the nine months ended September
30, 1997, appearing in this Prospectus and Registration Statement, have been
audited by Ernst & Young Reviseurs d'Entreprises S.C.C., independent auditors,
as set forth in their report appearing elsewhere herein and are included in
reliance upon such report given upon the authority of such firm as experts in
accounting and auditing.
160
<PAGE> 164
INDEX TO FINANCIAL STATEMENTS
GLOBAL TELESYSTEMS GROUP, INC.
YEAR END AND NINE MONTH 1997 FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Ernst & Young LLP, Independent Auditors........... F-2
Consolidated Balance Sheets as of December 31, 1995 and 1996
and September 30, 1997.................................... F-3
Consolidated Statements of Operations for the years ended
December 31, 1994, 1995, and 1996 and for the nine months
ended September 30, 1996 and 1997......................... F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 1994, 1995, and 1996 and for the nine months
ended September 30, 1996 and 1997......................... F-5
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1994, 1995, and 1996 and for the
nine months ended September 30, 1996 and 1997............. F-6
Notes to Consolidated Financial Statements.................. F-7
EDN SOVINTEL
YEAR END FINANCIAL STATEMENTS
Report of Ernst & Young (CIS) Limited, Independent
Auditors.................................................. F-27
Balance Sheets as of December 31, 1996 and 1995............. F-28
Statements of Income and Retained Earnings for the years
ended December 31, 1996, 1995, and 1994................... F-29
Statements of Cash Flows for the years ended December 31,
1996, 1995, and 1994...................................... F-30
Notes to Financial Statements............................... F-31
THIRD QUARTER FINANCIAL STATEMENTS
Condensed Balance Sheets as of December 31, 1996 and
September 30, 1997........................................ F-40
Condensed Statements of Operations for the nine months ended
September 30, 1996 and 1997............................... F-41
Condensed Statements of Cash Flows for the nine months ended
September 30, 1996 and 1997............................... F-42
Notes to Condensed Financial Statements..................... F-43
HERMES EUROPE RAILTEL B.V.
YEAR END AND NINE MONTH 1997 FINANCIAL STATEMENTS
Report of Ernst & Young Reviseurs d'Entreprises S.C.C.,
Independent Auditors...................................... F-46
Consolidated Balance Sheets as of December 31, 1995 and 1996
and September 30, 1997.................................... F-47
Consolidated Statements of Operations for the years ended
December 31, 1994, 1995 and 1996 and for the nine months
ended September 30, 1996 and 1997......................... F-48
Consolidated Statements of Cash Flows for the years ended
December 31, 1994, 1995 and 1996 and for the nine months
ended September 30, 1996 and 1997......................... F-49
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1994, 1995 and 1996 and for the
nine months ended September 30, 1996 and 1997............. F-50
Notes to Consolidated Financial Statements.................. F-51
</TABLE>
F-1
<PAGE> 165
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors
Global TeleSystems Group, Inc.
We have audited the accompanying consolidated balance sheets of Global
TeleSystems Group, Inc. as of December 31, 1995 and 1996 and September 30, 1997,
and the related consolidated statements of operations, cash flows, and
shareholders' equity for each of the three years in the period ended December
31, 1996 and for the nine months ended September 30, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these 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 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Global
TeleSystems Group, Inc. at December 31, 1995 and 1996 and September 30, 1997,
and the consolidated results of its operations and its cash flows for each of
the three years in the period ended December 31, 1996 and for the nine months
ended September 30, 1997, in conformity with generally accepted accounting
principles.
Ernst & Young LLP
Washington, DC
December 16, 1997
F-2
<PAGE> 166
GLOBAL TELESYSTEMS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------- SEPTEMBER 30,
1995 1996 1997
-------- --------- -------------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C>
Current assets
Cash and cash equivalents................................. $ 9,044 $ 57,874 $ 366,841
Accounts receivable, less allowance for doubtful accounts
of $30, $782 and $2,588 at December 31, 1995, December
31, 1996 and September 30, 1997, respectively........... 2,972 8,920 13,498
Restricted cash........................................... -- 13,627 30,404
Prepaid expenses.......................................... 1,932 2,537 3,324
Other assets.............................................. 4,189 2,187 6,118
-------- --------- ---------
Total current assets................................ 18,137 85,145 420,185
Notes receivable............................................ 84 209 238
Property and equipment, net................................. 29,523 35,463 69,051
Investments in and advances to ventures..................... 56,153 104,459 84,068
Goodwill and intangible assets, net of accumulated
amortization of $1,983, $3,916, and $7,672 at December 31,
1995 and 1996 and September 30, 1997, respectively........ 8,681 9,548 44,864
Restricted cash............................................. 3,043 2,554 29,382
-------- --------- ---------
Total Assets........................................ $115,621 $ 237,378 $ 647,788
======== ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable.......................................... $ 8,705 $ 6,761 $ 10,883
Accrued compensation...................................... 2,339 3,151 5,070
Interest payable.......................................... -- 213 6,557
Other accrued expenses.................................... 6,029 5,086 12,000
Related party debt maturing within one year............... 9,481 4,947 11,760
Debt maturing within one year............................. 5,099 16,261 14,815
Other current liabilities................................. 957 2,040 5,731
-------- --------- ---------
Total current liabilities........................... 32,610 38,459 66,816
Related party long-term debt, less current portion.......... -- 59,079 64,715
Long-term debt, less current portion........................ 12,874 5,260 411,192
Taxes and other non-current liabilities..................... 9,542 14,664 14,898
-------- --------- ---------
Total Liabilities................................... 55,026 117,462 557,621
Commitments and contingencies
Minority interest........................................... 1,936 1,915 20,275
Common stock, subject to repurchase (325,000 shares
outstanding at December 31, 1995 and 1996 and 797,100
shares outstanding at September 30, 1997)................. 3,337 4,333 12,489
Shareholders' Equity
Preferred stock, $0.0001 par value (10,000,000 shares
authorized; none issued and outstanding)................ -- -- --
Common stock, $0.10 par value (135,000,000, shares
authorized; 26,204,759, 34,589,106, and 37,606,814
shares issued and outstanding, net of 75,000, 116,639
and 195,528 shares of treasury stock at December 31,
1995 and 1996 and September 30, 1997, respectively)..... 2,620 3,459 3,761
Additional paid-in capital................................ 112,144 238,268 274,433
Cumulative translation adjustment......................... (1,535) (2,161) (7,021)
Accumulated deficit....................................... (57,907) (125,898) (213,770)
-------- --------- ---------
Total Shareholders' Equity.......................... 55,322 113,668 57,403
-------- --------- ---------
Total Liabilities and Shareholders' Equity.......... $115,621 $ 237,378 $ 647,788
======== ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE> 167
GLOBAL TELESYSTEMS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
--------------------------------------- -----------------------------
1994 1995 1996 1996 1997
----------- ----------- ----------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues, net:
Telecommunication and other
services....................... $ 1,295 $ 5,979 $ 19,210 $ 12,474 $ 26,547
Equipment sales................... 1,173 2,433 4,907 2,165 3,669
-------- -------- -------- -------- --------
2,468 8,412 24,117 14,639 30,216
Operating costs and expenses:
Cost of revenues:
Telecommunication and other
services..................... 1,474 8,150 14,741 11,231 25,169
Equipment sales................ 971 246 4,200 1,650 3,183
Selling, general and
administrative................. 12,228 37,291 47,940 31,552 46,203
Depreciation and amortization..... 658 3,491 4,165 3,661 4,404
Non-income taxes.................. -- 234 850 512 1,452
-------- -------- -------- -------- --------
15,331 49,412 71,896 48,606 80,411
Write-off of venture-related
assets......................... -- -- -- 1,673
Equity in losses of ventures...... 135 7,871 10,150 6,999 18,234
-------- -------- -------- -------- --------
Loss from operations................ (12,998) (48,871) (57,929) (40,966) (70,102)
Other income/(expense):
Other non-operating income........ -- 10,270 -- --
Interest income................... 1,189 2,177 3,569 1,546 5,278
Interest expense.................. (100) (728) (11,122) (7,262) (21,086)
Foreign currency losses........... (99) (685) (1,176) (819) (1,094)
-------- -------- -------- -------- --------
990 11,034 (8,729) (6,535) (16,902)
-------- -------- -------- -------- --------
Net loss before income taxes and
minority interest................. (12,008) (37,837) (66,658) (47,501) (87,004)
Income taxes........................ -- 2,565 1,360 977 1,838
-------- -------- -------- -------- --------
Net loss before minority interest... (12,008) (40,402) (68,018) (48,478) (88,842)
Minority interest................... 23 2 27 5 970
-------- -------- -------- -------- --------
Net loss............................ $(11,985) $(40,400) $(67,991) $(48,473) $(87,872)
======== ======== ======== ======== ========
Net loss per share.................. $ (0.69) $ (1.61) $ (2.22) $ (1.69) $ (2.37)
======== ======== ======== ======== ========
Weighted average common shares
outstanding....................... 17,263 25,128 30,578 28,736 37,144
======== ======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE> 168
GLOBAL TELESYSTEMS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------ -----------------------------
1994 1995 1996 1996 1997
-------- -------- -------- ------------- -------------
(IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Operating Activities
Net loss.................................. $(11,985) $(40,400) $(67,991) $(48,473) $(87,872)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization........... 576 3,721 7,444 6,094 9,173
Amortization of discount on note
payable............................... -- -- 3,598 2,502 3,665
Equity in losses of ventures, net of
dividends received.................... 135 7,871 11,123 6,999 18,234
Deferred interest....................... -- -- 6,583 4,386 8,142
Write-off of venture-related assets..... -- -- -- -- 1,673
Non-cash compensation................... -- -- -- -- 3,390
Minority interest....................... (23) (2) (27) (970)
Other................................... 115 2,577 1,342 1,047 2,325
Changes in assets and liabilities,
excluding effects of acquisitions and
ventures:
Accounts receivable................... (36) (1,557) (6,996) (3,965) (5,723)
Prepaid expenses...................... -- (438) (605) (960) 4,387
Accounts payable and accrued
expenses........................... 4,224 12,820 (1,694) (2,062) 7,386
Other changes in assets and
liabilities........................ (7,615) 9,474 8,207 2,608 (2,743)
-------- -------- -------- -------- --------
Net cash used in operating activities....... (14,609) (5,934) (39,016) (31,824) (38,933)
Investing Activities
Investments in and advances to ventures... (14,213) (45,102) (54,932) (34,187) (2,157)
Purchases of property and equipment....... (6,580) (24,324) (12,195) (10,088) (13,861)
Restricted cash........................... (500) (2,543) (13,138) (853) (55,813)
Acquisitions, net of cash acquired........ -- (1,871) -- 1,050
Goodwill and other intangibles............ -- (6,181) (487) (1,807) (2,196)
Other investing activities................ -- 2,069 (125) (1,104) (30)
-------- -------- -------- -------- --------
Net cash used in investing activities....... (21,293) (77,952) (80,877) (48,039) (73,007)
Financing Activities
Proceeds from debt........................ -- 23,325 63,599 62,360 415,986
Payment of debt issue costs............... -- (779) (2,777) (582) (24,178)
Net proceeds from issuance of common
stock................................... 62,108 42,175 107,775 95,002 36,527
Other financing activities................ (190) (750) -- 118 (557)
-------- -------- -------- -------- --------
Net cash provided by financing activities... 61,918 63,971 168,597 156,898 427,778
Effect of exchange rate changes on cash and
cash equivalents.......................... (22) (676) 126 425 (6,871)
-------- -------- -------- -------- --------
Net increase (decrease) in cash and cash
equivalents............................... 25,994 (20,591) 48,830 77,460 308,967
Cash and cash equivalents at beginning of
period.................................... 3,641 29,635 9,044 9,044 57,874
-------- -------- -------- -------- --------
Cash and cash equivalents at end of
period.................................... $ 29,635 $ 9,044 $ 57,874 $ 86,504 $366,841
======== ======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE> 169
GLOBAL TELESYSTEMS GROUP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996 AND
THE NINE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL CUMULATIVE TOTAL
---------------- PAID-IN TRANSLATION ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT CAPITAL ADJUSTMENT DEFICIT EQUITY
------- ------ ---------- ----------- ----------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1993........................ 9,230 $ 923 $ 9,406 $ (122) $ (5,522) $ 4,685
Proceeds from the sale of
common stock, net of
expenses of $3,649....... 11,501 1,150 60,932 -- -- 62,082
Translation adjustment...... -- -- -- (124) -- (124)
Net loss.................... -- -- -- -- (11,985) (11,985)
Other....................... 50 5 21 -- -- 26
------- ------ -------- ------- --------- --------
Balance at December 31,
1994........................ 20,781 2,078 70,359 (246) (17,507) 54,684
Proceeds from the sale of
common stock, net of
expenses of $3,680....... 5,091 509 41,629 -- -- 42,138
Translation adjustment...... -- -- -- (1,289) -- (1,289)
Net loss.................... -- -- -- -- (40,400) (40,400)
Other....................... 333 33 156 -- -- 189
------- ------ -------- ------- --------- --------
Balance at December 31,
1995........................ 26,205 2,620 112,144 (1,535) (57,907) 55,322
Proceeds from the sale of
common stock, net of
expenses of $3,567....... 8,349 835 106,909 -- -- 107,744
Issuance of 7,223 warrants
in connection with debt
financing................ -- -- 20,184 -- -- 20,184
Translation adjustment...... -- -- -- (626) -- (626)
Net loss.................... -- -- -- -- (67,991) (67,991)
Other....................... 35 4 (969) -- -- (965)
------- ------ -------- ------- --------- --------
Balance at December 31,
1996........................ 34,589 3,459 238,268 (2,161) (125,898) 113,668
Proceeds from the sale of
common stock, net of
expenses of $2,683....... 2,503 250 36,277 -- -- 36,527
Translation adjustment...... -- -- -- (4,860) -- (4,860)
Net loss.................... -- -- -- -- (87,872) (87,872)
Other....................... 515 52 (112) -- -- (60)
------- ------ -------- ------- --------- --------
Balance at September 30,
1997........................ 37,607 $3,761 $274,433 $(7,021) $(213,770) $57,403
======= ====== ======== ======= ========= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE> 170
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: NATURE OF BUSINESS OPERATIONS
Global TeleSystems Group, Inc. ("GTS" or the "Company"), is a provider of a
broad range of telecommunications services to businesses, other
telecommunications service providers and consumers through its operation of
voice and data networks, international gateways, local access and cellular
networks and the provision of various value-added services in the Commonwealth
of Independent States ("CIS"), primarily Russia, Central Europe, and India and
China ("Asia"). The Company, through two of its ventures, is also building a new
infrastructure for transporting international voice, data and video traffic for
other carriers throughout Western Europe and for worldwide international voice,
data and video traffic that either originates or terminates in, or transits
through, Western Europe. See further discussion of the Company's business
operations within Note 3, "Investments In and Advances to Ventures," and Note
14, "Segment Information and Certain Geographical Data."
Certain of the Company's ventures are in the early stages of operations in
the telecommunications industry. The Company's businesses are developing
rapidly; some are in countries with an emerging economy, which by nature have an
uncertain economic, political and regulatory environment. The general risks of
operating businesses in the CIS and other developing countries include the
possibility for rapid change in government policies, economic conditions, the
tax regime and foreign currency regulations.
The ultimate recoverability of the Company's investments in and advances to
ventures is dependent on many factors including, but not limited to, the
economies of the countries in which it does business; the ability of the Company
to maintain the necessary telecommunications licenses; and the ability of the
Company to obtain sufficient financing to continue to meet its capital and
operational commitments.
Management recognizes that the Company must generate additional capital
resources in order to continue its operations and meet its new development
initiatives. The Company is currently pursuing various equity and debt financing
sources and has entered into substantive negotiations with financial
institutions in order to obtain further debt and equity financing. The Company
has also retained independent consultants to assist it in identifying other
entities interested in entering into strategic partnerships relative to its
telecommunications properties and new development initiatives. If the Company is
not successful in closing debt or equity financing, the Company may be required
to curtail new development initiatives, sell certain assets or a combination of
these actions.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
Wholly-owned subsidiaries and majority owned ventures where the Company has
unilateral operating and financial control are consolidated. Those ventures
where the Company exercises significant influence, but does not exercise
unilateral operating and financial control are accounted for by the equity
method. The Company has certain majority-owned ventures that are accounted for
by the equity method as a result of super majority voting conditions or other
governmentally imposed uncertainties so severe that they prevent the Company
from obtaining unilateral control of the venture. If the Company has little
ability to exercise significant influence over a venture, the venture is
accounted for by the cost method. All significant intercompany accounts and
transactions are eliminated upon consolidation.
The Company recognizes profits and losses in accordance with its underlying
ownership percentage or allocation percentage as specified in the agreements
with its partners; however, the Company recognizes 100% of the losses in
ventures where the Company bears all of the financial risk. When such ventures
become profitable, the Company recognizes 100% of the profits until such time as
the excess losses previously recognized have been recovered.
F-7
<PAGE> 171
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The accompanying unaudited, consolidated financial data presented in the
Statements of Operations and the Statements of Cash Flows for the nine months
ended September 30, 1996 have been derived from the Company's financial records
and contain all adjustments (consisting only of normal recurring accruals)
necessary to present fairly the results of operations and cash flows for the
period indicated.
Reclassifications
Certain reclassifications have been made to the 1994, 1995 and 1996
consolidated financial statements in order to conform to the 1997 presentation.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of
three months or less at the time of purchase to be cash equivalents. The Company
had $3.0 million, $16.2 million and $59.8 million of restricted cash at December
31, 1995 and 1996, and September 30, 1997, respectively. The restricted cash is
primarily related to cash held in escrow for interest payments.
Property and Equipment
Property and equipment is stated at cost. Depreciation is calculated on a
straight-line basis over the estimated lives ranging from five to fifteen years
for telecommunications equipment and three to five years for furniture, fixtures
and equipment and other property. Construction in process reflects amounts
incurred for the configuration and build-out of telecommunications equipment and
telecommunications equipment not yet placed into service. Maintenance and
repairs are charged to expense as incurred.
Goodwill and Intangible Assets
Goodwill represents the excess of acquisition costs over the fair market
value of the net assets of acquired businesses and is being amortized on a
straight-line basis over their estimated useful lives ranging from three to ten
years. Intangible assets, principally telecommunications service contracts,
licenses and deferred financing costs, are amortized on a straight-line basis
over the lesser of their estimated useful lives, generally three to fifteen
years, or their contractual term. In accordance with APB 17, "Intangible
Assets," the Company continues to evaluate the amortization period to determine
whether events or circumstances warrant revised amortization periods.
Additionally, the Company considers whether the carrying value of such assets
should be reduced based on the future benefits of its intangible assets.
Long-Lived Assets
Effective January 1, 1995, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." In accordance
with SFAS No. 121, long-lived assets to be held and used by the Company are
reviewed to determine whether any events or changes in circumstances indicate
that the carrying amount of the asset may not be recoverable. For long-lived
assets to be held and used, the Company bases its evaluation on such impairment
indicators as the nature of the assets, the future economic benefit of the
assets, any historical or future profitability measurements, as well as other
external market conditions or factors that may be present. If such impairment
indicators are present or other factors exist that indicate that the carrying
amount of the asset may not be recoverable, the Company determines whether an
impairment has occurred through the use of an undiscounted cash flows analysis
of assets at the lowest level for which identifiable cash flows exist. If an
impairment has occurred, the Company recognizes a loss for the difference
between the carrying amount and the estimated value of the asset. The fair value
of the asset is measured using quoted market prices or, in the absence of quoted
market prices, fair value is based on an estimate of discounted cash flow
analysis. During the years ended December 31, 1995 and 1996, the Company's
analyses indicated that
F-8
<PAGE> 172
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
there was not an impairment of its long-lived assets. During the nine months
ended September 30, 1997, the Company's analyses indicated that there was an
impairment of its long-lived assets. Accordingly, the Company recorded a
write-down of long-lived assets associated with the investment in the Asia and
Central Europe regions (see Note 3, "Investments in and Advances to Ventures").
Income Taxes
The Company uses the liability method of accounting for income taxes.
Deferred income taxes result from temporary differences between the tax basis of
assets and liabilities and the basis as reported in the consolidated financial
statements. The Company does not provide for deferred taxes on the undistributed
earnings of its foreign companies, as such earnings are intended to be
permanently reinvested in those operations.
Foreign Currency Translation
The Company follows a translation policy in accordance with SFAS No. 52,
"Foreign Currency Translation." In most instances, the local currency is
considered the functional currency for the Company's subsidiaries and ventures,
except for operations in the CIS where the U.S. dollar has been designated as
the functional currency. Assets and liabilities of these subsidiaries and
ventures are translated at the rates of exchange at the balance sheet date.
Income and expense accounts are translated at average monthly rates of exchange.
The resultant translation adjustments are included in the cumulative translation
adjustment, a separate component of shareholders' equity. Gains and losses from
foreign currency transactions of these subsidiaries and ventures are included in
the operations of the subsidiary or venture.
For those ventures operating in the CIS, the temporal method for
translating assets and liabilities is used. Accordingly, monetary assets and
liabilities are translated at current exchange rates while non-monetary assets
and liabilities are translated at their historical rates. Income and expense
accounts are translated at average monthly rates of exchange. The resultant
translation adjustments are included in the operations of the subsidiaries and
ventures.
Revenue Recognition
The Company records as revenue the amount of telecommunications services
rendered, as measured primarily by the minutes of traffic processed, after
deducting an estimate of the traffic that will be neither billed nor collected.
Revenue from service or consulting contracts is accounted for when the services
are provided. Equipment sales revenue is generally recognized upon shipment of
the equipment. Billings received in advance of service being performed are
deferred and recognized as revenue as the service is performed.
Net Loss Per Share
The Company's net loss per share calculations are based upon the weighted
average number of shares of common stock outstanding. Pursuant to the
requirements of the Securities and Exchange Commission Staff Accounting Bulletin
No. 83, common stock, common stock options and common stock warrants issued at
prices below the initial offering price during the twelve months immediately
preceding the contemplated initial filing of the registration statement relating
to the initial public offering ("IPO") have been included in the computation of
net loss per share as if they were outstanding for all periods presented (using
the treasury method assuming repurchase of common stock at the estimated IPO
price). Other shares issuable upon the exercise of common stock options and
warrants have been excluded from the computation because the effect of their
inclusion would be anti-dilutive. Subsequent to the Company's IPO, common stock
options and warrants under the treasury stock method will be included to the
extent they are dilutive.
F-9
<PAGE> 173
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128, "Earnings per Share. SFAS No. 128 establishes a different method of
computing net income (loss) per share than is currently required under the
provisions of Accounting Principles Board Opinion No. 15. Under SFAS No. 128,
the Company will be required to present both basic net income (loss) per share
and diluted net income (loss) per share. The impact of SFAS No. 128 on the
calculation of net income (loss) per share is not expected to be material. The
Company plans to adopt SFAS No. 128 in its year ended December 31, 1997, and at
that time all historical net income (loss) per share data presented will be
restated to conform to the provisions of SFAS No. 128.
Fair Value of Financial Instruments
The Company believes that the carrying amount of its assets and liabilities
reported in the balance sheets approximates their fair value.
Off Balance Sheet Risk and Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of cash and cash equivalents and accounts and
notes receivable. The Company maintains most of its cash and cash equivalents in
one high-quality U.S. financial institution. The Company extends credit to
various customers and establishes an allowance for doubtful accounts for
specific customers that it determines to have significant credit risk. The
Company provides allowances for potential credit losses when necessary.
The Company does not now hedge against foreign currency fluctuations,
although the Company may implement such practices in the future. Under current
practices, the Company's results from operations could be adversely affected by
fluctuations in foreign currency exchange rates.
Stock Based Compensation
SFAS No. 123, "Accounting for Stock-Based Compensation," ("SFAS No. 123")
establishes a fair value method of accounting for employee stock options and
similar equity instruments. The fair value method requires compensation cost to
be measured at the grant date based on the value of the award and is recognized
over the service period. SFAS No. 123 allows companies to either account for
stock-based compensation under the new provisions of SFAS No. 123 or under the
provisions of APB No. 25, "Accounting for Stock Issued to Employees" ("APB No.
25"). The Company has elected to account for its stock-based compensation in
accordance with the provisions of APB No. 25 and will present pro forma
disclosures of net loss as if the fair value method had been adopted.
Uses of Estimates in Preparation of Financial Statements
The preparation of these consolidated financial statements, in conformity
with generally accepted accounting principles, requires management to make
estimates and assumptions that affect amounts in the financial statements and
accompanying notes and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
F-10
<PAGE> 174
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3: INVESTMENTS IN AND ADVANCES TO VENTURES
The Company has various investments in ventures that are accounted for by
the equity method. The Company's ownership percentages in its equity method
investments range from 49% to 80%. The Company has no investments in ventures
that are accounted for by the cost method.
The components of the Company's investments in and advances to ventures are
as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------- SEPTEMBER 30,
1995 1996 1997
------- -------- -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Equity in net assets acquired..................... $18,664 $41,105 $30,954
Excess of investment cost over equity in net
assets acquired net of amortization of $1.7
million, $4.3 million and $4.1 million at
December 31, 1995 and 1996, and September 30,
1997, respectively.............................. 8,577 11,288 8,285
Accumulated (losses) earnings recognized.......... (6,267) (13,840) 10,321
Dividends......................................... -- (973) (2,793)
Cash advances and other........................... 35,179 66,879 37,301
------- -------- -------
Total investments in and advances to ventures..... $56,153 $104,459 $84,068
======= ======== =======
</TABLE>
In applying the equity method of accounting, the Company's policy is to
amortize the excess of investment cost over equity in net assets acquired based
upon an assignment of the excess to the fair value of the venture's identifiable
tangible and intangible assets, with any unassigned amounts designated as
goodwill. The Company then amortizes the allocated costs in accordance with its
policies defined in Note 2, "Summary of Significant Accounting Policies."
The Company has financed the operating and investing cash flow requirements
of several of its ventures, in the form of cash advances. The Company
anticipates that these ventures will generate sufficient cash inflows for the
repayment of the cash advances, as their businesses mature. Also, due to the
long-term nature of the anticipated repayment period and the potential risk
associated with the repatriation of the cash advances, the Company has
aggregated its investments in and cash advances to the ventures.
The Company's share of the ventures' foreign currency translation
adjustments is reflected in the investment accounts.
Investment Recoverability
The Company periodically evaluates the recoverability of their equity
investments, in accordance with APB No. 18 "The Equity Method of Accounting for
Investments in Common Stock," and if circumstances arise where a loss in value
is considered to be other than temporary, the Company will record a write-down
of excess investment cost. The Company's recoverability analysis is based on the
projected undiscounted cash flows of the operating ventures which is the lowest
level of cash flow information available. As of September 30, 1997, the Company
recorded a write-off of approximately $5.4 million which represented the net
balance of certain investments in and advances to ventures located in Asia
(primarily Beijing Tianmu and V-Tech) and Central Europe (Eurohivo) which were
stated in excess of their net realizable value. The entire net balance of these
investments in and advances to ventures was written-off based on the fact that
these ventures project overall negative cash flows for the foreseeable future.
The ventures projected future operations deteriorated during 1997 as a result of
problems dealing with one of its partners, the inability of the ventures to
develop markets for its services, and technical problems. The components of the
charge, which was classified as equity in losses of ventures, were as follows:
<TABLE>
<S> <C>
Equity in net assets acquired............................... $ 17,093
Excess of investment cost over equity in net assets
acquired.................................................. 593
Accumulated (losses) recognized............................. (23,253)
Dividends................................................... --
Cash advances and other..................................... 10,921
--------
Net write-off as of September 30, 1997...................... $ 5,354
========
</TABLE>
F-11
<PAGE> 175
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Prior to the write-off detailed above the Company included in its
accumulated (losses) approximately $14.4 million of losses (of the
$14.4 million, approximately $13.5 million related to the write-off of advances
to several Chinese owned operating telecommunications companies to which the
Company provides technical and financial assistance and $0.9 million related to
the write-off of inventories, receivables, and other assets) which represented
the Company's share of asset write-offs recorded by certain of the Company's
equity method investments in Asia during the nine months ended September 30,
1997. Such write-offs, for the same reasons mentioned in the previous paragraph,
were recorded by the Company's equity method investments pursuant to SFAS No.
121. This amount is included in the $(23.3) million accumulated (losses)
detailed above. Additionally, during the nine months ended September 30, 1997
the Company recorded a charge of $1.7 million in order to write-off certain
holding company assets associated with the ventures located in Asia and Central
Europe. This charge has been included as a separate line item in the Company's
statement of operations.
Hermes Europe Railtel B.V. ("HER") Recapitalization
During the nine months ended September 30, 1997, HER recapitalized its
equity structure and amended its existing shareholder agreement. In connection
with the HER recapitalization the Company contributed approximately $51.8
million and converted existing note receivables of approximately $28.4 million
in exchange for an additional 29% equity interest in HER. As a result of the
recapitalization and amended shareholder agreement, the Company obtained
unilateral control over HER. As such, HER has been consolidated into the
Company's financial statements effective July 6, 1997, the effective date of the
recapitalization. The Company recognized approximately $8.7 of goodwill in
connection with the recapitalization. As a result of the Company's loss
recognition policy, the consolidation of HER did not have a material impact on
the Company's historical financial position or operating results and thus no pro
forma information is disclosed herein.
As of September 30, 1997, the consolidation of HER resulted in reductions
of $72.9 million, $10 million, and $4.6 million in the equity in net assets
acquired, excess of investment cost over equity in net assets acquired, and cash
advances and other, respectively. Additionally, as of September 30, 1997 the
consolidation of HER had a $21.4 million favorable impact on the accumulated
(losses) earnings recognized.
Changes in the Investments in and Advances to Ventures
The changes in the investments in and advances to ventures are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------- SEPTEMBER 30,
1995 1996 1997
------- -------- -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Balance, at beginning of period................... $13,841 $ 56,153 $104,459
Equity in net assets acquired..................... 13,888 22,441 79,825
Excess of investment cost over equity in net
assets acquired................................. 5,646 5,288 10,187
Dividends......................................... -- (973) (1,820)
Cash advances (repayments) and other.............. 30,649 31,700 (14,024)
Effect of consolidating equity method company..... -- -- (76,325)
------- -------- --------
50,183 58,456 (2,157)
Equity ownership in losses........................ (4,224) (3,122) (10,066)
Excess losses recognized over amount attributable
to ownership interest........................... (2,709) (4,451) (10,434)
Amortization of excess of investment cost over
equity in net assets acquired................... (938) (2,577) (2,610)
Loss in value that is other than temporary........ -- -- (5,354)
Effect of consolidating equity method company..... -- -- 10,230
------- -------- --------
(7,871) (10,150) (18,234)
------- -------- --------
Balance, at end of period......................... $56,153 $104,459 $ 84,068
======= ======== ========
</TABLE>
F-12
<PAGE> 176
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As of September 30, 1997, the significant investments accounted for under
the equity method and the percentage interest owned consist of the following:
<TABLE>
<CAPTION>
EQUITY OWNED SUBSIDIARIES OWNERSHIP %
------------------------- -----------
<S> <C>
EDN Sovintel................................................ 50%
Sovam Teleport.............................................. 67%
GTS Ukrainian TeleSystems, L.L.C. (holds a 49% interest in
Bancomsvyaz).............................................. 60%
GTS Vox Limited............................................. 52.64%
TeleRoss Ventures - 13 joint ventures in various regions in
the CIS................................................... 50%
Vostok Ventures - 11 joint ventures in various regions in
the CIS................................................... 50-70%
PrimTelefone................................................ 50%
GTS Monaco Access S.A.M..................................... 50%
</TABLE>
In connection with a purchase of a venture during 1995, the Company is
required to pay additional consideration through 1998, either in cash or shares
of the Company's common stock, based on the actual earnings of the venture.
During the first quarter of 1997, the purchase agreement related to acquiring
this venture was amended and notes payable of $5.2 million were replaced and
additional consideration was paid by the issuance of 504,600 shares of the
Company's common stock valued at $13.33 per share. Further, the agreement was
modified such that the remaining consideration would only be in the form of the
issuance of the Company's common stock. The Company's maximum obligation
pursuant to this agreement is to issue 1,121,640 shares of common stock. The
Company will recognize any additional consideration paid under this agreement as
goodwill.
During 1996 and 1997, the Company, in connection with a venture investment,
entered into two financing agreements with a shareholder of the Company for a
total of approximately $8.6 million. Subject to certain conditions, the
shareholder has the right to require the repayment of this amount in cash or
713,311 shares of the Company's common stock. This amount has been included in
"Other financing agreements" (see Note 5, "Debt Obligations").
The following tables present condensed financial information of the
Company's ventures that are accounted for by the equity method of accounting as
of December 31, 1995 and 1996 and September 30, 1997.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995
--------------------------------------------------------
MAJORITY OWNED 50% OR LESS OWNED TOTAL EQUITY METHOD
EQUITY METHOD ENTITIES VENTURES VENTURES VENTURES
---------------------- -------------- ----------------- -------------------
(IN THOUSANDS)
<S> <C> <C> <C>
Revenue............................... $ 4,966 $49,085 $54,051
Gross margin.......................... 1,096 19,944 21,040
Net loss.............................. (5,156) (1,224) (6,380)
Equity in net losses.................. (5,136) (1,797) (6,933)
Current assets........................ 5,188 27,074 32,262
Total assets.......................... 17,343 79,486 96,829
Current liabilities................... 9,214 38,411 47,625
Total liabilities..................... 14,395 54,734 69,129
Net assets............................ 2,948 24,752 27,700
Ownership interest in equity in net
assets.............................. 2,595 12,511 15,106
</TABLE>
F-13
<PAGE> 177
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
--------------------------------------------------------
MAJORITY OWNED 50% OR LESS OWNED TOTAL EQUITY METHOD
EQUITY METHOD ENTITIES VENTURES VENTURES VENTURES
---------------------- -------------- ----------------- -------------------
(IN THOUSANDS)
<S> <C> <C> <C>
Revenue............................... $36,202 $107,270 $143,472
Gross margin.......................... 17,109 45,937 63,046
Net income (loss)..................... 3,240 (8,460) (5,220)
Equity in net losses.................. (1,091) (6,482) (7,573)
Current assets........................ 27,293 50,689 77,982
Total assets.......................... 48,174 146,483 194,657
Current liabilities................... 19,416 68,474 87,890
Total liabilities..................... 24,987 102,332 127,319
Net assets............................ 23,187 44,151 67,338
Ownership interest in equity in net
assets.............................. 14,912 19,513 34,425
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1997
--------------------------------------------------------
MAJORITY OWNED 50% OR LESS OWNED TOTAL EQUITY METHOD
EQUITY METHOD ENTITIES VENTURES VENTURES VENTURES
---------------------- -------------- ----------------- -------------------
(IN THOUSANDS)
<S> <C> <C> <C>
Revenue............................... $34,421 $124,585 $159,006
Gross margin.......................... 21,004 50,307 71,311
Net (loss) income..................... (13,373) 9,693 (3,680)
Equity in net losses.................. (13,275) 2,702 (10,573)
Current assets........................ 20,562 56,056 76,618
Total assets.......................... 33,977 156,001 189,978
Current liabilities................... 15,233 61,052 76,285
Total liabilities..................... 27,940 87,843 115,783
Net assets............................ 6,037 68,158 74,195
Ownership interest in equity in net
assets.............................. 7,475 42,848 50,323
</TABLE>
NOTE 4: SUPPLEMENTAL BALANCE SHEET INFORMATION
<TABLE>
<CAPTION>
DECEMBER 31,
------------------ SEPTEMBER 30,
1995 1996 1997
------- ------- -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Accounts receivable consists of:
Trade accounts receivable........................ $ 1,026 $ 6,769 $11,851
Value added taxes receivable..................... 1,082 1,971 3,230
Other receivables................................ 894 962 1,005
------- ------- -------
3,002 9,702 16,086
Less: allowance for doubtful accounts......... 30 782 2,588
------- ------- -------
Total accounts receivable, net........... $ 2,972 $ 8,920 $13,498
======= ======= =======
Property and equipment consists of:
Telecommunications equipment..................... $ 9,296 $28,302 $42,360
Furniture, fixtures and equipment................ 4,111 5,877 9,947
Other property................................... 658 837 1,791
Construction in process.......................... 17,555 7,009 28,087
------- ------- -------
31,620 42,025 82,185
Less: accumulated depreciation................ 2,097 6,562 13,134
------- ------- -------
Total property and equipment, net........ $29,523 $35,463 $69,051
======= ======= =======
</TABLE>
F-14
<PAGE> 178
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5: DEBT OBLIGATIONS
Company debt consists of:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------ SEPTEMBER 30,
1995 1996 1997
------- ------- -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Senior notes of HER, due August 15, 2007 at 11.5%
interest payable semiannually.................... $ -- $ -- $265,000
Senior subordinated convertible bonds, due June 30,
2000 at an effective interest rate of 15%, and a
stated rate of 8.75% - 9.75% payable
semiannually..................................... -- -- 144,787
Related party debt obligations, with principal
payments beginning April 1, 1998 and maturing on
March 31, 2001 at 10% interest, net of
unamortized discount for 7,778 warrants issued... -- 59,079 68,820
Other financing agreements......................... 27,454 26,468 23,875
------- ------- --------
27,454 85,547 502,482
Less: debt maturing within one year.............. 14,580 21,208 26,575
------- ------- --------
Total long-term debt..................... $12,874 $64,339 $475,907
======= ======= ========
</TABLE>
In the third quarter of 1997, HER issued aggregate principal amount $265.0
million of senior notes due August 15, 2007 (the "Senior Notes"). The Senior
Notes are general unsecured obligations of the subsidiary with interest payable
semiannually at a rate of 11.5%. Approximately $56.6 million of the net proceeds
of the offering of the Senior Notes is being held in escrow for the first four
semiannual interest payments commencing in 1998. HER may redeem the Senior
Notes, in whole or in part, any time on or after August 15, 2007 at specific
redemption prices. HER may also redeem the Senior Notes at a price equal to
111.5% of the principal amount prior to August 15, 2000 with net cash proceeds
of a public equity offering of HER with gross proceeds of at least $75 million
or in certain other circumstances specified in the indenture for the Senior
Notes, provided, however, that at least two-thirds of the principal amount of
the Senior Notes originally issued remain outstanding after each such
redemption. Pursuant to the covenants in the offering, HER has filed a Form S-4
registration statement with the Securities and Exchange Commission to exchange
registered senior notes, with the same terms and conditions as the Senior Notes,
for the Senior Notes.
In July 1997, the Company issued aggregate principal amount $144.8 million
of senior subordinated convertible bonds (the "Bonds") due June 30, 2000. The
Bonds constitute direct, unsecured senior subordinated indebtedness after
existing debt of $82.7 million. Upon completion of a complying public equity
offering as defined in the Bond agreement (an "Offering") or in certain other
circumstances as defined in the Bond agreement, the Bonds may be converted at
the option of the holders from time to time, in whole or in part, prior to the
close of business on June 30, 2000, into shares of the Company's common stock,
par value $0.10 per share. The Bonds will be convertible into such number of
shares of the Company's common stock as is equal to the principal amount of such
Bonds divided by the applicable conversion price, which conversion price shall
be equal to the public offering price of the Company's common stock in the
Offering. The Bonds bear interest payable semiannually at a stated rate of 8.75%
for the first year, 9.25% for the second year and 9.75% for the final year. In
the event of an Offering, the interest rate will remain at the interest rate
prevailing at the time of the Offering until maturity. In the event that an
Offering has not occurred by the maturity date, the Bonds will be redeemed at
121% of their principal amount. As a result of the redemption factor, interest
expense is being accreted at an annual effective rate of 15%.
F-15
<PAGE> 179
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In 1996, the Company entered into long-term obligations ("Debt
Obligations"), totaling $70.0 million, with lenders (the "Lenders"). The Lenders
are affiliated with and are considered related parties to the Company, as a
result of their ownership of the Company's common stock (see Note 12, "Related
Party Transactions"). The Debt Obligations require principal payments beginning
in the third year, to maturity in the fifth year. The Debt Obligations bear an
interest rate of 10.0% and require interest payments beginning in the first
fiscal quarter subsequent to the date of issuance. At the Company's discretion,
the initial interest accrued until the first principal payment can be deferred
until maturity. Upon commencement of principal payments, the Company is
obligated to make concurrent interest payments. Further, in connection with the
Debt Obligations, the Company issued 7,777,776 warrants, valued at $20.7
million, to purchase the Company's common stock. The initial valuation of the
warrants considered the probable reduction of the exercise price. In accordance
with the terms of the warrant agreement, the exercise price of the warrants was
reduced from $10.27 per share to $9.33 per share, as the outstanding debt had
not been repaid prior to December 31, 1996. The warrants may be exercised up to
six years after the date of the relevant agreements. Upon the consummation of
these Debt Obligations, the Company repaid in full the outstanding $9.5 million
interim financing ("Interim Financing") balance outstanding at December 31,
1995, and the 555,555 warrants associated with the interim financing were
canceled. The Company entered into the $10.0 million Interim Financing in
December 1995 in order to provide the Company sufficient working capital to meet
its contractual obligations, until a larger dollar amount and longer-term
maturity debt could be finalized between the Company and the Lenders. The
Company is subject to certain restrictive covenants pursuant to these Debt
Obligations, including restrictions on the payment of dividends and indebtedness
to affiliated ventures.
Certain of the Company's consolidated ventures maintain credit facilities
for their local operations. Borrowings under such credit facilities bear
interest at prevailing negotiated market rates.
Aggregate maturities of long-term debt, as of September 30, 1997, are as
follows: 1998 -- $26.6 million, 1999 -- $25.8 million, 2000 -- $173.9 million,
2001 -- $24.4 million and $265.2 million thereafter.
The Company paid interest of $0.1 million, $0.7 million, $0.2 million and
$0.8 million in 1994, 1995, 1996, and the nine months ended September 30, 1997,
respectively. The Company incurred interest expense of $11.1 million and $21.1
million in 1996 and the nine months ended September 30, 1997, respectively, and
would have recorded $56.2 million and $33.0 million in additional interest
expense in 1996 and the nine months ended September 30, 1997, had the Senior
Notes and Bonds been outstanding on January 1, 1996.
NOTE 6: SHAREHOLDERS' EQUITY
Common Stock
The following table summarizes the Company's equity private placements for
the periods ending:
<TABLE>
<CAPTION>
SHARES ISSUED SHARE PRICE NET PROCEEDS
------------- ------------ ------------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C>
December 31, 1994............................. 11,499,869 $4.67 - 6.67 $ 62,082
December 31, 1995............................. 5,090,876 9.00 42,138
December 31, 1996............................. 8,348,532 13.33 107,744
September 30, 1997............................ 2,502,686 15.67 36,527
</TABLE>
During 1995, the Company issued 400,000 shares of common stock to an
independent third party in connection with the purchase of an interest in a
venture within the CIS region. At the discretion of the holder of these shares,
the Company is obligated to repurchase these shares at the prevailing fair
market value of the Company's common stock on the date of repurchase. During
1995, the Company repurchased 75,000 shares at $10.00 per share and the
repurchased shares became treasury stock. In March 1997, the Company repurchased
32,500 shares at $13.33 per share, and these shares became treasury stock. The
Company will be required to repurchase the remaining shares on an equal basis
over the next three years. During 1997, the
F-16
<PAGE> 180
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Company issued 504,600 shares of common stock pursuant to a purchase agreement
with a seller for a portion of their interest in a venture within the CIS
region. Pursuant to the purchase agreement, the Company is obligated to assist
the seller in locating a purchaser for the common stock, and if unable to do so,
to repurchase the issued common stock. Additionally, the Company has accreted
the value of the outstanding common stock subject to repurchase (325,000 shares
on December 31, 1995 and 1996 and 797,100 shares at September 30, 1997), to the
fair value of the Company's common stock as of December 31, 1995 and 1996 and
September 30, 1997 ($10.27, 13.33 and $15.67 per share, respectively).
During 1996, the Company entered into the Debt Obligations totaling $70.0
million with the Lenders. In connection with the Debt Obligations, the Company
issued 7,777,776 warrants to purchase common stock at $10.27 per share. The
exercise price of the warrants was automatically reduced to $9.33 per share as
of December 31, 1996, because the Debt Obligations remained outstanding. The
initial valuation of the warrants considered the probable reduction of the
exercise price. The warrants expire during the first and second quarters of
2002.
The Company does not intend to pay dividends on common stock in the
foreseeable future. In addition, certain of the Company's financing agreements
include covenant restrictions precluding the payment of dividends by the
Company.
The Company has reserved 14,819,867 shares of common stock for issuance
upon conversion of the exercise of outstanding and future stock options,
warrants and common stock put rights.
Preferred Stock
As of December 31, 1995 and 1996 and September 30, 1997, there were
10,000,000 shares of $0.0001 par value preferred stock authorized, with rights
and preferences to be determined by the Board of Directors. As of December 31,
1995 and 1996 and September 30, 1997, no shares of preferred stock had been
issued.
NOTE 7: STOCK OPTION PLANS
The Company applies the provisions of APB No. 25 in accounting for its
stock option incentive plans. The effect of applying SFAS No. 123 on the net
loss as reported is not representative of the effects on reported net loss for
future years due to the vesting period of the stock options and the fair value
of additional stock options in future years. Had compensation expense been
determined in accordance with the methodology of SFAS No. 123, the Company's net
loss for the years ended December 31, 1995 and 1996 and for the nine months
ended September 30, 1997 would have been approximately $40.9 million, $69.4
million, and $91.3 million, respectively. The fair value of options granted
during 1995 and 1996 are estimated as $2.19 and $2.93 per share, respectively,
on the date of grant using the minimum value option pricing model with the
following assumptions: dividend yield 0%, risk free interest rate of 5.50% for
1995 and 6.13% for 1996, and an expected life of five years. The fair value of
options granted during the nine months ended September 30, 1997 are estimated as
$7.02 per share, on the date of grant using the Black Scholes option valuation
model with the following assumptions: dividend yield 0%, risk free interest rate
of 5.74%, an expected life of five years, and an expected volatility of .50. The
Company determined its volatility factor with assistance of an investment
banker, based on peer group public companies.
The Company maintains the 1992 Stock Option Plan, the Non-Employee
Directors Stock Option Plan and the GTS Equity Compensation Plan (the "Option
Plans"). As of September 30, 1997, the maximum number of shares of common stock
available for grant under the Option Plans was 8,157,549. All options granted
under the Option Plans are at exercise prices that are at least equal to the
fair market value of common stock at the date of grant. Generally, all options
granted under the Option Plans vest over a three-year period from the date of
grant and expire ten years from the date of grant.
F-17
<PAGE> 181
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ADDITIONAL INFORMATION WITH RESPECT TO STOCK OPTION ACTIVITY IS SUMMARIZED AS
FOLLOWS:
<TABLE>
<CAPTION>
YEARS ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
------------------------------------------------------------------ --------------------
1994 1995 1996 1997
-------------------- -------------------- -------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE SHARES PRICE
--------- -------- --------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of year.... 417,000 $2.25 2,431,800 $3.65 3,422,399 $ 5.56 4,869,360 $ 7.31
Options granted........ 2,014,800 3.94 1,210,800 9.04 1,612,962 11.10 1,407,996 13.85
Options exercised...... - - (28,001) 4.46 (56,498) 6.70 (89,312) 6.34
Options canceled or
expired.............. - - (192,200) 3.57 (109,503) 8.73 (378,264) 6.65
--------- ----- --------- ----- --------- ------ --------- ------
Outstanding at end of
year................. 2,431,800 $3.65 3,422,399 $5.56 4,869,360 $ 7.31 5,809,780 $ 8.95
========= ===== ========= ===== ========= ====== ========= ======
Options exercisable at
year-end............. 353,965 $2.54 995,617 $3.59 1,992,236 $ 4.65 2,759,906 $ 5.78
</TABLE>
The following table summarizes information about stock options outstanding:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------------------
WEIGHTED OPTIONS EXERCISABLE
AVERAGE ----------------------
REMAINING WEIGHTED WEIGHTED
CONTRACTUAL AVERAGE AVERAGE
NUMBER LIFE EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICE OUTSTANDING (IN YEARS) PRICE EXERCISABLE PRICE
----------------------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
At September 30, 1997:
$1.42 to $2.75........................ 1,446,000 6 $ 2.69 1,371,000 $ 2.68
$4.67 to $9.00........................ 1,270,650 7 7.88 888,527 7.77
$10.00 to $15.67...................... 3,093,130 8 12.32 500,379 10.71
--------- ---------
5,809,780 7 $ 8.95 2,759,906 $ 5.78
========= =========
</TABLE>
In addition, prior to the establishment of the Option Plans, certain
options were granted in 1991 to certain key employees and former employees to
purchase 1,172,250 shares of the Company's common stock at an exercise price of
$0.53 per share. All options were granted at an exercise price equal to the fair
value of the underlying common stock at the date of grant. The options vested in
equal increments over a three-year period. During 1993, 603,000 of the options
were canceled and in 1994, 50,250 options were exercised, leaving 519,000 fully
vested options outstanding at December 31, 1995 and 1996 and September 30, 1997.
Certain of the Company's subsidiaries and ventures have stock option plans,
or similar agreements, in place or in the process of being implemented for key
officers and employees. The ownership dilution caused by such plans is not
expected to be significant. During the fourth quarter of 1997, one of the
Company's consolidated subsidiaries issued options that will result in a
non-cash charge of approximately $3.7 million of which $2.6 million is expected
to be recorded during the fourth quarter and the remaining $1.1 million will be
recognized principally ratably over fiscal 1998.
NOTE 8: EMPLOYEE BENEFIT PLAN
The Company has a 401(k) retirement savings plan (the "Savings Plan")
covering all U.S. citizen employees. The Savings Plan qualifies under section
401(k) of the Internal Revenue Code and as such, participants may defer pretax
income in accordance with federal income tax limitations. The Company provides a
50.0% matching contribution on the first 5.0% contributed by the employee. The
Company may also, at its discretion, make non-matching contributions. Both
matching and non-matching contributions by the Company vest 100% after three
years of service. The Company's expense under the Savings Plan was less
F-18
<PAGE> 182
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
than $0.1 million, $0.1 million, $0.2 million and $0.2 million for the years
ended December 31, 1994, 1995 and 1996, and the nine months ended September 30,
1997, respectively. The Company made no discretionary (non-matching)
contributions in 1994, 1995, 1996 or in the nine months ended September 30,
1997.
HER established a pension plan in 1995 that covers all HER employees upon
twenty-five years of age and at least one year of service. HER has entered into
an insurance arrangement (an annuity contract) whereby an insurance provider has
undertaken a legal obligation to provide specific benefits to participants in
return for a fixed premium. As such, HER no longer bears any financial risk for
its pension plan.
NOTE 9: OTHER NON-OPERATING INCOME
Favorably affecting the 1995 results was the non-recurring $10.3 million
gain the Company recognized as a result of its cash settlement of certain claims
with a third party in 1995.
NOTE 10: INCOME TAXES
The components of loss before income taxes and minority interest were as
follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
PERIOD ENDED, 1994 1995 1996 1997
------------- ------------ ------------ ------------ -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Pretax loss:
Domestic......................... $ (8,996) $(22,398) $(41,554) $(41,991)
Foreign.......................... (2,989) (15,437) (25,077) (45,013)
-------- -------- -------- --------
$(11,985) $(37,835) $(66,631) $(87,004)
======== ======== ======== ========
</TABLE>
For the years ended December 31, 1995 and 1996 and the nine months ended
September 30, 1997, the Company recorded $2.6 million, $1.4 million and $1.8
million, respectively, in income tax expense that related exclusively to its
current provision for foreign taxes. The Company did not have income tax expense
for 1994.
The reconciliation of the U.S. statutory federal tax rate of 34.0% to the
Company's effective tax rate is as follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
1995 1996 1997
------------------ ------------------ ------------------
PERIOD ENDED, AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------------- -------- ------- -------- ------- -------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Taxes at U.S. statutory
rates..................... $(12,865) 34.0% $(22,655) 34.0% $(29,581) 34.0%
Foreign operating losses
generating no tax
benefit................... 6,550 (17.3) 8,526 (12.8) 15,304 (17.6)
Domestic operating losses
generating no tax
benefit................... 6,315 (16.7) 14,129 (21.2) 14,277 (16.4)
Other -- net................ 2,565 (6.8) 1,360 (2.1) 1,838 (2.1)
-------- ----- -------- ----- -------- -----
$ 2,565 (6.8)% $ 1,360 (2.1)% $ 1,838 (2.1)%
======== ===== ======== ===== ======== =====
</TABLE>
F-19
<PAGE> 183
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Deferred tax assets and liabilities are recorded based on temporary
differences between earnings as reported in the financial statements and
earnings for income tax purposes. The following table summarizes major
components of the Company's deferred tax assets and liabilities:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
1995 1996 1997
------------ ------------ -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carryforwards............. $ 10,106 $ 20,720 $ 31,440
Other deferred tax assets.................... 245 1,326 3,304
-------- -------- --------
Total deferred tax asset....................... 10,351 22,046 34,744
Deferred tax liability......................... 724 1,161 2,267
-------- -------- --------
Net deferred tax asset......................... 9,627 20,885 32,477
Less: valuation allowance.................... (9,627) (20,885) (32,477)
-------- -------- --------
Total................................ $ -- $ -- $ --
======== ======== ========
</TABLE>
As of September 30, 1997, the Company had net operating loss carryforwards
for U.S. federal income tax purposes of approximately $92.5 million expiring in
fiscal years 2003 through 2012. Because of the "change in ownership" provisions
of the Tax Reform Act of 1986, the utilization of the Company's net operating
loss carryforwards will be subject to an annual limitation.
The Company's investment in EDN Sovintel is treated for U.S. tax purposes
as a partnership and, therefore, the Company's share of EDN Sovintel's income or
loss flows through to the Company's consolidated federal income tax return on a
current basis. Undistributed earnings of the Company's other foreign investments
are considered to be indefinitely reinvested and, accordingly, no provision for
U.S. federal and state income taxes, or foreign withholding taxes has been made.
Upon distribution of those earnings, the Company would be subject to foreign
withholding taxes and U.S. income taxes (subject to reduction for foreign tax
credits).
Certain ventures in the CIS and Hungary are operating under tax holidays
granted by the local governments. Tax holidays are for periods ranging from up
to five years to several years after achieving profitability under local tax
regulations. In addition to these tax holidays, certain of the Company's foreign
ventures have foreign tax loss carryforwards in excess of $50.0 million. The
Company's financial statements do not reflect any provision for benefits that
might be associated with such loss carryforwards.
NOTE 11: COMMITMENTS AND CONTINGENCIES
Operating Leases
Operating lease commitments are primarily for office space and equipment.
Rental expense aggregated $0.7 million, $2.0 million, $2.2 million and $2.3
million for the years ended December 31, 1994, 1995, and 1996, and the nine
months ended September 30, 1997, respectively.
Future minimum lease payments under these non-cancelable operating leases
with terms of one year or more, as of September 30, 1997, are as follows:
1998 -- $3.5 million, 1999 -- $2.7 million, 2000 -- $1.5 million, 2001 -- $1.0
million, 2002 -- $0.4 million and thereafter -- $1.0 million.
Other Commitments and Contingencies
As of September 30, 1997, the Company purchased the remaining interest in
one of its subsidiaries within the CIS region for $5.2 million, which was paid
in October 1997. Furthermore, the Company is required to pay additional
consideration of a minimum of $2.4 million if certain revenue levels are met,
certain other
F-20
<PAGE> 184
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
events occur or if neither has occurred, on April 1, 1999. The purchase price
and consideration have been allocated to net assets based on the fair value at
the date of acquisition. The excess of the purchase price over the fair value of
the net assets acquired was $5.9 million, which has been recorded as goodwill
and is being amortized on a straight-line basis over five years.
The Company had no significant commitments to its ventures for future
contract obligations as of September 30, 1997.
In the ordinary course of business, the Company has issued financial
guarantees on debt and equities for the benefit of certain of its
non-consolidated ventures. The total amount guaranteed at September 30, 1997 was
approximately $15.3 million. In addition, certain ventures are currently
negotiating other financing instruments in which the Company will guarantee upon
perfection of the obligations.
Major Customers
In 1995, the Company had one major customer, a foreign governmental agency
in Central Europe, representing $2.7 million, or 32.1%, of total revenue. In
1996, the Company had two major customers, a foreign governmental agency in
Central Europe and a customer in the CIS, representing $3.8 million, or 15.8%,
of total revenue and $2.6 million, or 10.8%, of total revenue, respectively. For
the nine months ended September 30, 1997, the Company had one major customer, a
foreign governmental agency in Central Europe, representing $3.1 million, or
10.3%, of total revenue.
Tax Matters
The taxation system in Russia ("Russian Taxes") is evolving as the central
government transforms itself from a command to a market oriented economy. The
Russian Federation has introduced and continues to introduce new tax and royalty
laws and related regulations. These laws and regulations are not always clearly
written and their interpretation is subject to the opinions of the local tax
inspectors, Central Bank officials and the Ministry of Finance. Instances of
inconsistent opinions between local, regional and federal tax authorities and
between the Central Bank and Ministry of Finance are not unusual.
The Company's policy is to accrue for contingencies in the accounting
period in which a liability is deemed probable and the amount is reasonably
determinable. In this regard, because of the uncertainties associated with the
Russian Taxes, the Company's Russian Taxes may be in excess of the estimated
amount expensed to date and accrued at December 31, 1995 and 1996 and September
30, 1997. It is the opinion of management that the ultimate resolution of the
Company's Russian Tax liability, to the extent not previously provided for, will
not have a material effect on the financial condition of the Company. However,
depending on the amount and timing of an unfavorable resolution of this
contingency, it is possible that the Company's future results of operations or
cash flows could be materially affected in a particular period.
In various foreign jurisdictions, the Company is obligated to pay value
added taxes ("VAT") on the purchase or importation of assets, and for certain
other transactions. In many instances, VAT can be offset against VAT the Company
collects and otherwise would remit to the tax authorities, or may be refundable.
Because the law in some jurisdictions is unclear, the local tax authorities
could assert that the Company is obligated to pay additional amounts of VAT. In
the opinion of management, any additional VAT the Company may be obligated to
pay would not be material.
Other Matters
In the ordinary course of business, the Company may be party to various
legal and tax proceedings, and subject to claims, certain of which relate to the
developing markets and evolving fiscal and regulatory environments in which the
Company operates. In the opinion of management, the Company's liability, if any,
F-21
<PAGE> 185
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
in all pending litigation, other legal proceeding or other matter other than
what is discussed above, will not have a material effect upon the financial
condition, results of operations or liquidity of the Company.
NOTE 12: RELATED PARTY TRANSACTIONS
As discussed within Note 5, "Debt Obligations," the Company entered into an
Interim Financing agreement and Debt Obligations during 1995 and 1996,
respectively, with the Lenders. The Lenders are shareholders of the Company. As
part of these transactions, the Company provided one of the Lenders with the
opportunity, at its discretion, to co-invest with the Company in all of the
Company's new ventures within the Asia region.
During 1996 and 1997, the Company, in connection with a venture investment,
entered into two financing agreements with a shareholder of the Company for a
total of approximately $8.6 million. Subject to certain conditions, the
shareholder has the right to require the repayment of this amount in cash or
713,310 shares of the Company's common stock. This amount has been included in
"Other financing agreements" (see Note 5, "Debt Obligations").
The Company has entered into certain consulting agreements with directors
of the Company and paid $0.1 million, $0.2 million, $0.2 million and $0.3
million in 1994, 1995, 1996, and the nine months ended September 30, 1997,
respectively, pursuant to those agreements.
The Company had notes receivable due from employees aggregating $0.2
million, $0.1 million and less than $0.1 million as of December 31, 1995 and
1996, and September 30, 1997, respectively, with no single amount due from any
individual in excess of $0.1 million.
The Company derived revenue from affiliates of $3.3 million and $3.1
million in 1996 and the nine months ended September 30, 1997, respectively.
There was no significant revenue earned from affiliate sales in 1995 and 1994.
F-22
<PAGE> 186
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 13: SUPPLEMENTAL CASH FLOW INFORMATION
The Company paid interest of $0.1 million, $0.7 million, $0.2 million and
$0.8 million in 1994, 1995, 1996 and the nine months ended September 30, 1997,
respectively. The following table summarizes non-cash investing and financing
activities for the Company:
<TABLE>
<CAPTION>
PERIOD ENDED
-----------------------------
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
(IN THOUSANDS)
<S> <C> <C>
Purchase of additional interest in Western Europe region
subsidiary with conversion of debt to equity............. $ -- $9,139
Line of credit issued as payment on note payable and
reclassification of restricted cash...................... -- 7,887
Purchase of the remaining interest of a CIS region
subsidiary with a note payable........................... -- 5,249
Conversion of a note payable to stock as additional
consideration in relation to purchase of interest in a
CIS region subsidiary.................................... 4,497 4,250
Note payable issued for additional capital infusion in CIS
region subsidiary........................................ 4,500 4,125
Additional consideration due in relation to purchase of the
remaining interest in a CIS region subsidiary............ -- 2,443
Contribution of fixed asset for the stock of a Western
Europe region subsidiary................................. -- 1,989
Compensatory stock options................................. -- 3,390
Accretion of stock......................................... 996 1,860
Additional consideration due in relation to purchase of
interest in a CIS region subsidiary...................... -- 1,528
</TABLE>
No significant non-cash investing activities were incurred for the years
ended December 31, 1994 and 1995.
F-23
<PAGE> 187
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 14: SEGMENT INFORMATION AND CERTAIN GEOGRAPHICAL DATA
The Company operates predominantly in a single industry segment, the
telecommunications industry. The industry consists of a wide range of
telecommunications services to international business customers, including long
distance voice and data services and electronic messaging services. The
following tables present consolidated financial information by geographic area
for 1994, 1995, 1996 and the nine months ended September 30, 1997. Transfers
between geographic areas were not considered material for disclosure purposes.
<TABLE>
<CAPTION>
CORPORATE
WESTERN CENTRAL OFFICE &
EUROPE CIS EUROPE ASIA ELIMINATIONS TOTAL
-------- -------- -------- -------- ------------ --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Year Ended December 31, 1994
Total revenue.................. $ -- $ -- $ 1,295 $ -- $ 1,173 $ 2,468
Gross margin................... -- -- (179) -- 202 23
Operating loss................. (546) (1,802) (1,122) -- (9,528) (12,998)
Net loss....................... (423) (939) (1,661) -- (8,962) (11,985)
Identifiable assets............ 2,173 15,423 9,297 -- 35,064 61,957
Liabilities.................... -- 3,921 6,501 -- (3,157) 7,265
Net assets..................... 2,173 11,502 2,796 -- 38,221 54,692
Year Ended December 31, 1995
Total revenue.................. $ 179 $ 3,838 $ 4,361 $ 140 $ (106) $ 8,412
Gross margin................... (318) (949) 1,380 9 (106) 16
Operating loss................. (5,469) (16,681) (6,312) (4,831) (15,578) (48,871)
Net loss....................... (5,452) (19,415) (7,091) (4,771) (3,671) (40,400)
Identifiable assets............ 5,898 73,816 15,639 9,167 11,101 115,621
Liabilities.................... 11,766 78,440 26,834 13,936 (75,950) 55,026
Net (liabilities)/assets....... (5,868) (4,624) (11,195) (4,769) 87,051 60,595
Year Ended December 31, 1996
Total revenue.................. $ -- $ 12,696 $ 9,355 $ 1,561 $ 505 $ 24,117
Gross margin................... -- 811 3,292 652 421 5,176
Operating loss................. (10,679) (14,608) (4,651) (5,057) (22,934) (57,929)
Net loss....................... (10,700) (15,572) (5,295) (4,951) (31,473) (67,991)
Identifiable assets............ 19,607 96,773 17,339 14,973 88,686 237,378
Liabilities.................... 35,728 116,961 33,826 24,753 (93,806) 117,462
Net (liabilities)/assets....... (16,121) (20,188) (16,487) (9,780) 182,492 119,916
Nine Months Ended September 30,
1997
Total revenue.................. $ 2,262 $ 17,786 $ 9,460 $ 556 $ 152 $ 30,216
Gross margin................... (3,231) 1,325 3,724 (105) 151 1,864
Operating loss................. (16,382) (6,198) (5,042) (25,456) (17,024) (70,102)
Net loss....................... (17,329) (7,853) (6,776) (25,400) (30,514) (87,872)
Identifiable assets............ 359,499 101,976 16,637 (6,919) 176,595 647,788
Liabilities.................... 333,906 128,360 41,067 16,984 37,304 557,621
Net (liabilities)/assets....... 25,593 (26,384) (24,430) (23,903) 139,291 90,167
</TABLE>
NOTE 15: SUBSEQUENT EVENTS
Financing Transactions
In connection with the purchase of certain equipment and services for
certain cellular ventures within the CIS region, the Company entered into a
credit agreement with a bank totaling up to $30.7 million in 1996.
F-24
<PAGE> 188
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Subsequent to September 30, 1997, certain conditions precedent were finalized
which allowed funding under the facility. Initial loans of $7.5 million were
incurred at an initial interest rate based on the Eurodollar rate, with
principal and interest payments due semiannually beginning June 15, 1998 through
December 15, 2002. The initial interest rate was 6.04%, which is reset
semiannually.
Contractual Commitments
Subsequent to September 30, 1997, a subsidiary of the Company entered into
contractual commitments to lease fiber pairs, including facilities and
maintenance and utilizing the partial routes for laying fiber optic cable. Based
on the contract provisions, these commitments are currently estimated to
aggregate approximately $98.0 million. The commitments have expected lease terms
of three to twenty years with options for renewal rights of five additional
years. As of September 30, 1997, the subsidiary made prepayments of
approximately $6.4 million related to the above leases.
Equity Transactions
On December 1, 1997, the Company filed an amendment to its Certificate of
Incorporation to reflect an increase in the authorized common shares from
60,000,000 to 135,000,000; a 3 for 2 common share stock split, 1 1/2 common
shares for every common share issued and outstanding; and an increase in the par
value of its authorized common shares from $0.0001 to $.10, on a post-split
basis. Accordingly, the Company has presented share and per share data on a
restated basis to give effect to the increase in authorized common shares, the
stock split and the increase in par value for its capital stock.
F-25
<PAGE> 189
EDN SOVINTEL
FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
F-26
<PAGE> 190
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Owners
EDN Sovintel
We have audited the accompanying balance sheets of EDN Sovintel as of
December 31, 1996 and 1995, and the related statements of income and retained
earnings, and cash flows for each of the three years in the period ended
December 31, 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of EDN Sovintel at December 31,
1996 and 1995, and the results of its operations and its cash flows for each of
the three years in period ended December 31, 1996, in conformity with accounting
principles generally accepted in the United States of America.
We have also audited the financial statements of the Company at December
31, 1996, 1995 and 1994 and for each of the three years ended December 31, 1996,
not presented herewith, prepared in compliance with the regulations for
bookkeeping and accounting for income tax and statutory reporting purposes in
the Russian Federation on which we expect to report separately for the 1996
audited financial statements and have reported separately for the 1995 and 1994
financial statements. The significant differences between the accounting
principles applied for preparing the statutory financial statements and
accounting principles generally accepted in the United States of America are
summarized in Note 2, "Basis of Presentation."
Ernst & Young (CIS) Ltd.
Moscow, Russia
February 21, 1997
F-27
<PAGE> 191
EDN SOVINTEL
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1995
------- -------
(IN THOUSANDS OF
US DOLLARS)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 3,606 $ 3,094
Cash deposit with related party........................... 476
Accounts receivable, net of allowances.................... 15,329 7,400
Due from affiliates....................................... 1,879 1,196
Inventories............................................... 1,749 938
Prepaid expenses and other assets......................... 2,328 1,540
------- -------
Total current assets.............................. 25,367 14,168
Property and equipment, net................................. 27,709 21,349
Deferred expenses........................................... 1,080 1,215
------- -------
Total assets...................................... $54,156 $36,732
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Note due shareholder...................................... $ 5,700 $ 5,500
Trade payables............................................ 8,382 8,761
Accrued liabilities and other payables.................... 1,130 701
Taxes accrued or payable.................................. 1,086 1,019
Amounts due to shareholder and affiliates................. 5,703 2,664
Current portion of amount due to partner in commercial
venture................................................ 1,350
Current portion of long-term debt......................... 694
------- -------
Total current liabilities......................... 23,351 19,339
Amount due to partner in commercial venture................. 1,350
Commitments and contingencies
Shareholders' equity:
Capital contributions..................................... 2,000 2,000
Retained earnings......................................... 28,805 14,043
------- -------
Total shareholders' equity........................ 30,805 16,043
------- -------
Total liabilities and shareholders' equity........ $54,156 $36,732
======= =======
</TABLE>
See accompanying notes.
F-28
<PAGE> 192
EDN SOVINTEL
STATEMENTS OF INCOME AND RETAINED EARNINGS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1996 1995 1994
------- ------- -------
(IN THOUSANDS OF US DOLLARS)
<S> <C> <C> <C>
Revenues, net:
Service revenues.......................................... $63,488 $29,920 $19,674
Installation revenues..................................... 9,312 12,981
Product sales............................................. 2,240 1,391 1,054
------- ------- -------
75,040 44,292 20,728
------- ------- -------
Cost of revenues:
Service costs............................................. 37,884 18,545 11,814
Cost of installation...................................... 4,656 6,491
Cost of products.......................................... 1,370 1,211 705
------- ------- -------
43,910 26,247 12,519
------- ------- -------
Gross profit................................................ 31,130 18,045 8,209
Selling, general and administrative expenses................ 10,291 7,145 4,644
Interest expense............................................ 638 703 612
Interest income............................................. (87) (59) (24)
Other loss (income)......................................... 120 (98) (113)
Foreign exchange loss on net monetary items................. 252 112 467
------- ------- -------
Income before taxes......................................... 19,916 10,242 2,623
Income taxes................................................ 5,154 2,594
------- ------- -------
Net income.................................................. 14,762 7,648 2,623
Retained earnings, beginning of year........................ 14,043 6,395 3,772
------- ------- -------
Retained earnings, end of year.............................. $28,805 $14,043 $ 6,395
======= ======= =======
</TABLE>
See accompanying notes.
F-29
<PAGE> 193
EDN SOVINTEL
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1996 1995 1994
-------- ------- -------
(IN THOUSANDS OF US DOLLARS)
<S> <C> <C> <C>
Operating activities
Net income................................................ $ 14,762 $ 7,648 $ 2,623
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 3,638 2,448 1,929
Provision for doubtful accounts........................ 678 132 303
Write-off of accounts receivable....................... (147) (492)
Write-down of network equipment and inventories........ 100 196 170
Foreign exchange loss.................................. 252 112 467
Changes in operating assets and liabilities:
Accounts receivable, net of allowances................. (8,460) (2,759) (358)
Due from affiliates.................................... (683) (1,011) (172)
Inventories............................................ (911) (309) 77
Advances to related party.............................. (376)
Prepaid expenses and other assets...................... (1,054) (307) (712)
Trade payables......................................... (193) 2,983 2,176
Accrued liabilities and other payables................. 429 586 (591)
Taxes accrued or payable............................... 207 876
Amounts due to shareholder and affiliates.............. 3,039 2,165 499
Other.................................................. (132)
-------- ------- -------
Net cash provided by operating activities......... 11,657 12,268 5,903
Investing activities -- Purchases of and advances for
property and equipment.................................... (9,863) (9,259) (5,729)
Financing activities
Borrowings from shareholder............................... 11,300 11,888 2,883
Repayments to shareholder................................. (11,100) (9,271)
Repayments of long-term debt.............................. (694) (3,979) (3,979)
Increase in cash deposited with related party............. (476)
-------- ------- -------
Net cash used in financing activities............. (970) (1,362) (1,096)
Effect of exchange rate changes on cash and cash
equivalents............................................... (312) (220)
-------- ------- -------
Net increase (decrease) in cash and cash equivalents........ 512 1,647 (1,142)
Cash and cash equivalents at beginning of year.............. 3,094 1,447 2,589
-------- ------- -------
Cash and cash equivalents at end of year.................... $ 3,606 $ 3,094 $ 1,447
======== ======= =======
</TABLE>
See accompanying notes.
F-30
<PAGE> 194
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS
(US DOLLAR AMOUNTS IN TABLES EXPRESSED IN THOUSANDS)
1. DESCRIPTION OF BUSINESS
EDN Sovintel (the "Company") was created in August 1990 to design,
construct, and operate a telecommunications network in Moscow. This network
provides worldwide communications services, principally to major hotels,
business offices and mobile communication companies. Telecommunications services
are subject to local licensing. The Company's license for international,
intercity and local calls was most recently renewed on November 4, 1996 and is
valid until January 5, 2000. The Company received a license for leased lines on
September 20, 1996 valid for 5 years. The Company began operating in December
1991, providing services under long-term contracts payable in US dollars.
The Company initially registered as a limited liability Russian-American
joint venture. The venture re-registered as a limited liability Russian company
in October 1992. The Company is fifty-percent owned by Open Joint Stock Company
"Rostelecom", an intercity and long-distance carrier which is 51% owned by the
Russian Government, and fifty-percent owned by Sovinet, a US general
partnership, owned by two wholly-owned Global TeleSystems Group, Inc. ("GTS")
subsidiaries.
2. BASIS OF PRESENTATION
The Company maintains its records and prepares its financial statements in
Russian roubles in accordance with the requirements of Russian accounting and
tax legislation. The accompanying financial statements differ from the financial
statements used for statutory purposes in Russia in that they reflect certain
adjustments, not recorded on the Company's books, which are appropriate to
present the financial position, results of operations and cash flows in
accordance with generally accepted accounting principles in the United States of
America ("US GAAP"). The principal adjustments are related to foreign currency
translation, and depreciation and valuation of property and equipment.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements, in conformity with US GAAP,
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates.
Foreign Currency Translation
The Company's functional currency is the US dollar because the majority of
its revenues, costs, property and equipment purchased, and debt and trade
liabilities are either priced, incurred, payable or otherwise measured in US
dollars. Accordingly, transactions and balances not already measured in US
dollars (primarily Russian roubles) have been remeasured into US dollars in
accordance with the relevant provisions of US Financial Accounting Standard
("FAS") No. 52, "Foreign Currency Translation".
Under FAS No. 52, revenues, costs, capital and non-monetary assets and
liabilities are translated at historical exchange rates prevailing on the
transaction dates. Monetary assets and liabilities are translated at exchange
rates prevailing on the balance sheet date. Exchange gains and losses arising
from remeasurement of monetary assets and liabilities that are not denominated
in US dollars are credited or charged to operations.
The rouble is not a convertible currency outside the territory of Russia.
Within Russia its official exchange rates were determined principally through
trading on Moscow Interbank Currency Exchange ("MICEX") until May 17, 1996.
Although MICEX rates did occasionally diverge from market rates, they were
generally considered to be a reasonable approximation. Beginning May 17, 1996,
official exchange rates
F-31
<PAGE> 195
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
were determined daily by the Central Bank of Russia ("CBR") and are generally
considered to be a reasonable approximation of market rates. The translation of
rouble denominated assets and liabilities into US dollars for the purpose of
these financial statements does not indicate that the Company could realize or
settle in US dollars the reported values of the assets and liabilities.
Likewise, it does not indicate that the Company could return or distribute the
reported US dollar values of capital and retained earnings to its shareholders.
The exchange rate used for translation purposes is the CBR rate as of
December 31, 1996 and the MICEX rate as of December 31, 1995 and 1994. The rates
at December 31, 1996, 1995 and 1994 for one US dollar were RUR 5,560, RUR 4,640
and RUR 3,550, respectively. At February 21, 1997, the CBR rate had changed to
RUR 5,665. The effect of this devaluation of the rouble on monetary assets and
liabilities has not been determined.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash on hand and in the bank.
Accounts Receivable
Accounts receivable are shown at their net realizable value which
approximates their fair value. Accounts receivable are shown in the balance
sheet net of an allowance for uncollectible accounts of $900,000 and $369,000 at
December 31, 1996 and 1995, respectively.
Inventories
Inventories consist of telecommunications equipment held for resale and are
stated at the lower of cost or market. Cost is computed on a weighted average
basis.
Property and Equipment
Property and equipment are recorded at their historical cost. Depreciation
and amortization are provided on the straight-line method over the following
estimated useful lives:
<TABLE>
<S> <C>
Network equipment....................................... 10 years
Other property and equipment............................ 3-5 years
</TABLE>
There is no depreciation charge for construction-in-progress. Depreciation
commences upon completion of the related project.
Deferred Expenses
Deferred expenses represent the Company's interest in the historical cost
of network equipment owned by MTU Inform, a partner in a commercial venture
(Note 8). These expenses are amortized over the equipment's useful life of 10
years.
Revenue Recognition and Taxes on Revenue
Service revenues from telecommunication traffic and periodic fixed fees are
recognized in the period in which the traffic occurs or the fixed fee earned.
Installation revenues represent connection fees and are recognized in the period
of installation. Product sales are recognized in the period in which the
products are shipped to customers. Revenues are stated net of any value-added
taxes ("VAT") charged to customers. Certain other taxes on revenues were charged
at rates ranging from 1.5% to 4.0% over the three year period ending December
31, 1996 and amounted to $2,792,000, $1,166,000 and $336,000 in 1996, 1995 and
1994, respectively, and are charged to selling, general and administrative
expenses.
F-32
<PAGE> 196
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
Advertising
The Company expenses the cost of advertising as incurred. Advertising
expenses for the years ended December 31, 1996, 1995 and 1994 were $512,000,
$395,000 and $270,000, respectively, and are included in selling, general and
administrative expenses.
Investment Incentive Deductions
Russian legislation allows for certain additional tax deductions related to
new asset investments. These deductions are accounted for as a reduction to
current income taxes in the year in which they arise.
Income Taxes
The Company computes and records income taxes in accordance with FAS No.
109, "Accounting for Income Taxes".
Government Pension Funds
The Company contributes to the Russian Federation state pension fund,
social fund, medical insurance fund, unemployment charters and transport fund on
behalf of all its Russian employees. Contributions were 40.5%, 41.0% and 40.0%
for 1996, 1995 and 1994, respectively.
Fair Value of Financial Instruments
The fair value of financial instruments included in current assets and
liabilities is considered to be the carrying value.
Comparative figures
Certain of the 1995 comparative figures have been reclassified to conform
to the presentation adopted in the current year.
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following as of December 31:
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
Network equipment........................................... $31,251 $20,875
Other property and equipment................................ 3,108 2,740
------- -------
34,359 23,615
Accumulated depreciation and amortization................... (9,380) (5,877)
Construction-in-progress.................................... 1,796 1,539
Network equipment and advances for network equipment not yet
in service................................................ 934 2,072
------- -------
Net book value.............................................. $27,709 $21,349
======= =======
</TABLE>
Total depreciation and amortization expense on property and equipment for
1996, 1995 and 1994 was $3,503,000, $2,253,000 and $1,720,000, respectively.
F-33
<PAGE> 197
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. INCOME TAXES
The Russian Federation was the only tax jurisdiction in which the Company's
income was taxed. The income tax expense reported in the accompanying statements
of operations for the years ended December 31, 1996, 1995 and 1994 represents
the provision for taxes currently payable.
The following is a reconciliation of the tax basis and book basis of the
taxable income reported in the Russian statutory financial statements to the
income before taxes reported in the accompanying financial statements presented
in accordance with US GAAP for the years ended December 31:
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- ------
<S> <C> <C> <C>
Taxable income (loss) reported for
Russian tax purposes.................. $14,726 $ 7,411 $
Investment incentive deductions....... 9,030 7,220
Tax loss carry-forwards utilized...... 113
Net permanent difference related to
revenues and expenses incurred in
the ordinary course of business
which are not assessable or
deductible for Russian tax
purposes........................... (1,174) (2,595) (948)
------- ------- ------
Russian income (loss) before taxes...... 22,695 12,036 (948)
Adjustments to present financial
statements in accordance with US GAAP:
Reversal of excess depreciation due to
statutory revaluations............. (1,497) (293) (285)
Depreciation rate differences......... (424) (236) (98)
Allowances for uncollectible
accounts........................... 369 (132) (129)
Inventory allowance................... (100) (249) (29)
Accrual of deductible expenses........ (2,437) (1,339) (659)
Accrual of revenue.................... 1,093 19
Foreign exchange differences.......... 280 1,425 5,665
Other non-deductible accruals......... (63) (989) (894)
------- ------- ------
Income before taxes under US GAAP....... $19,916 $10,242 $2,623
======= ======= ======
</TABLE>
The Company operated under a two-year income tax holiday in 1994 and 1993.
As such, no Russian tax calculations or tax filings were made or reported.
A reconciliation between the statutory rate and the effective income tax
rate is as follows for the years ended December 31:
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Income tax expense computed on financial
income taxes at statutory tax rate of
35% for 1996 and 1995 and 38% for
1994.................................. $ 6,970 $ 3,585 $ 997
Tax effect of permanent differences:
Investment incentive deductions....... (3,161) (2,594)
Tax loss carryforwards utilized....... (40)
Other permanent differences........... 411 805 360
Adjustments made to compute income
before taxes for US GAAP financial
reporting.......................... 813 555 (1,548)
Temporary differences not recognised as
measured by the change in the
valuation allowance................... 161 243 191
------- ------- -------
Income tax expense reported in the
financial statements.................. $ 5,154 $ 2,594 $
======= ======= =======
</TABLE>
F-34
<PAGE> 198
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. INCOME TAXES -- (CONTINUED)
The deferred tax balances are calculated by applying the statutory tax
rates in effect at the respective balance sheet dates to the temporary
differences between the tax basis of assets and liabilities and the amount
reported in the accompanying financial statements, and consist of the following
at December 31:
<TABLE>
<CAPTION>
1996 1995 1994
------- ----- -----
<S> <C> <C> <C>
Deferred tax assets (liabilities):
Depreciation............................................. $ 300 $ 151 $ 74
Inventory write-downs and allowances..................... 235 147 11
Accrual of expenses...................................... 898 469 284
Accrual of revenue....................................... (383) (7)
Allowance for uncollectible accounts..................... 129 277
------- ----- -----
Deferred tax assets........................................ 1,050 889 646
Valuation allowance for deferred tax assets................ (1,050) (889) (646)
------- ----- -----
Net deferred tax assets.................................... $ -- $ -- $ --
======= ===== =====
</TABLE>
For financial reporting purposes, a valuation allowance has been recognised
to reflect management's estimate of the deferred tax assets that are less likely
than not to be realized. Management's estimate of the recoverability of the
deferred tax assets is based on the Company's limited history of profitable
operations as well as the uncertainties surrounding the tax and legal systems in
Russia (see Note 11).
Unexpired tax loss carryforwards at December 31, 1996 amount to $113,000
and is available in and expires in 1997.
The Company paid Russian profits tax of $5,849,000 and $2,660,000 in 1996
and 1995, respectively, and no taxes in 1994.
6. NOTE DUE TO SHAREHOLDER AND LONG-TERM DEBT
In October 1995, the Company entered into a $5,000,000 credit facility with
Sovinet, one of the Company's shareholders. It was subsequently increased to
$7,000,000. In January of 1997, this facility was repaid and on January 16,
1997, a new six-month facility was established with GTS Finance, Inc. for
$7,000,000. The loan bears interest at a rate equal to the then current six
month LIBOR rate (5.6% as of December 31, 1996) plus 5.0 percent per annum. As
of December 31, 1996 and 1995, the outstanding borrowings under this agreement
were $5,700,000 and $5,500,000, respectively.
In April 1991, the Company entered into a $5,300,000 credit facility with
Barclays Bank PLC and International Moscow Bank. This loan was fully repaid
during 1996.
The Company believes that the carrying value of the above loans approximate
their fair values.
The Company paid interest of $403,000, $576,000 and $472,000 in 1996, 1995
and 1994, respectively.
F-35
<PAGE> 199
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
7. SHAREHOLDERS' EQUITY
The Company's capital structure as specified in its charter capital
document as of December 31 is as follows:
<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <C> <C>
Registered capital in Russian roubles:
Rostelecom............................ 600,000 600,000
Sovinet............................... 600,000 600,000
---------- ----------
1,200,000 1,200,000
========== ==========
Historical value of the Company's
capital in US dollars................. $ 2,000 $ 2,000
========== ==========
</TABLE>
As a Russian limited liability company, the Company has no capital stock;
rather, it has only contributed and locally registered capital in accordance
with its charter. As such, no earnings per share data are presented in these
financial statements.
Retained earnings available for distribution at December 31, 1996 amounted
to 84 billion roubles or approximately $15,108,000 at applicable year-end
exchange rates.
8. RELATED PARTY TRANSACTIONS
Transactions and balances with Rostelecom (one of the Company's
shareholders) and its affiliates were, as of and for the years ending December
31, as follows:
<TABLE>
<CAPTION>
1996 1995 1994
------ ------ ----
<S> <C> <C> <C>
Sales................................... $1,525 $ 62
Telecommunication lease and traffic
costs................................. 4,586 1,506 $410
Amounts due to shareholder and
affiliates............................ 656 460
Cash deposit with related party......... 476
</TABLE>
At the request of Rostelecom, a shareholder, the Company placed a deposit
of 2.65 billion roubles in August 1996 with a Russian bank related to this
shareholder. The bank deposit agreement states a deposit term of one year. The
deposit earns interest quarterly at a rate of 15% per annum plus any devaluation
losses against the US dollar up to a maximum of 4.8% per quarter. Management is
aware that the deposited amount collateralizes certain obligations of the
shareholder.
Transactions and balances with Sovinet (one of the Company's shareholders),
GTS and affiliates were, as of and for the years ending December 31, as follows:
<TABLE>
<CAPTION>
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Sales................................... $3,115 $1,041 $ 172
Management service fees and
reimbursements of expenses of
expatriate staff...................... 927 2,062 499
Balances due under credit facility...... 5,700 5,500 2,883
Interest expense........................ 626 461 65
Amounts due from affiliates............. 1,879 1,196 185
Amounts due to shareholder and
affiliates............................ 5,047 2,204 499
</TABLE>
F-36
<PAGE> 200
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
8. RELATED PARTY TRANSACTIONS -- (CONTINUED)
Transactions and balances with MTU Inform, an entity with which the Company
entered into a commercial agreement to co-develop and operate a "258" phone
exchange were, as of and for the years ending December 31, as follows:
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- ----
<S> <C> <C> <C>
Telecommunication settlement and rent
expense............................... $15,889 $10,491
Balances in trade payables.............. 1,237 2,184
Balance of amount due to partner in
commercial venture.................... 1,350 1,350
Balances in prepaid expenses and other
assets................................ $376
</TABLE>
The Company also has an interest in the cost of the related network
equipment owned by MTU Inform, which is reflected in the balance sheet as
deferred expenses.
9. CONCENTRATIONS OF CREDIT RISK AND MAJOR CUSTOMERS
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of temporary cash deposits and trade accounts
receivables. The Company deposits its available cash with several Russian
financial institutions. The Company's sales and accounts receivable are made to
and due from a variety of international and Russian business customers. As of
December 31, 1996, two customers accounted for 17% and 16% of revenues and 25%
and 10% of accounts receivable, respectively. As of December 31, 1995, these
same two customers accounted for 1% and 14% of revenues and 10% and 11% of
accounts receivable, respectively. The Company did not have significant
activities with these customers during 1994. However, during 1994, a different
customer accounted for 14% of revenues. The Company has no other significant
concentrations of credit risk.
10. COMMITMENTS
The Company has several cancelable operating leases for office and
warehouse space and telecommunications lines with terms ranging from one to five
years.
Total rent expense for 1996, 1995 and 1994 was $2,123,000, $1,068,000 and
$1,058,000, respectively.
11. CONTINGENCIES
The tax and legal systems in Russia are evolving as Russia and its central
government transform from a command to a market oriented economy. The Russian
Federation has and continues to introduce laws, decrees and related regulations.
These laws, decrees and regulations are not always clearly written and are, at
times, conflicting. In addition, their interpretation is subject to the opinions
of a variety of local, regional and federal tax inspectors, Central Bank
officials and the Ministry of Finance. Instances of inconsistent opinions among
and between these authorities are not unusual.
The Company's policy is to accrue contingencies in the accounting period in
which a loss is deemed probable and the amount is reasonably determinable. In
this regard, because of the uncertainties associated with the Russian tax and
legal systems, the ultimate taxes as well as penalties and interest, if any,
assessed may be in excess of the amount expensed to date and accrued at December
31, 1996. It is the opinion of management, that the ultimate resolution of the
Company's Russian tax liability and potential loss contingencies, to the extent
not previously provided for, will not have a material effect on the financial
condition of the Company. However, depending on the amount and timing of an
unfavorable resolution of this contingency, it is possible that the Company's
future results of operations or cash flows could be materially affected in a
particular period.
F-37
<PAGE> 201
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
11. CONTINGENCIES -- (CONTINUED)
The Company's operations and financial position will continue to be
affected by Russian political developments including the application of existing
and future legislation, tax regulations, cancellations or non-renewal of license
rights, and expropriation of property. The Company does not believe that these
contingencies, as related to its operations, are any more significant than those
of similar enterprises in Russia.
F-38
<PAGE> 202
EDN SOVINTEL
CONDENSED FINANCIAL STATEMENTS
FOR THE THIRD QUARTER OF 1997
(UNAUDITED)
F-39
<PAGE> 203
EDN SOVINTEL
CONDENSED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
ASSETS
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
(IN THOUSANDS)
<S> <C> <C>
Current assets
Cash and cash equivalents................................. $ 3,606 $ 6,041
Accounts receivable, less allowance for doubtful accounts
of $900 and $1,477 at December 31, 1996 and September
30, 1997............................................... 15,329 14,779
Restricted cash........................................... 476 492
Due from affiliated companies............................. 1,879 2,267
Inventory................................................. 1,749 2,836
Deferred tax asset........................................ -- 665
Prepaid expenses and other assets......................... 2,328 4,544
------- -------
Total current assets.............................. 25,367 31,624
Property and equipment, net of accumulated depreciation of
$9,380 and $13,197 at December 31, 1996 and September 30,
1997...................................................... 27,709 35,344
Deferred expenses........................................... 1,080 958
------- -------
TOTAL ASSETS...................................... $54,156 $67,926
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable.......................................... $ 8,382 $ 8,492
Accrued expenses.......................................... 2,216 4,043
Due to affiliated companies............................... 5,703 5,572
Note payable to shareholder............................... 5,700 3,449
Taxes and other liabilities............................... 1,350 1,350
------- -------
TOTAL LIABILITIES................................. 23,351 22,906
Commitments and contingencies
SHAREHOLDERS' EQUITY
Contributed capital......................................... 2,000 2,000
Retained earnings........................................... 28,805 43,020
------- -------
TOTAL SHAREHOLDERS' EQUITY........................ 30,805 45,020
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $54,156 $67,926
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-40
<PAGE> 204
EDN SOVINTEL
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------
1996 1997
------- -------
(IN THOUSANDS)
<S> <C> <C>
Revenues, net:.............................................. 51,977 82,029
Cost of revenues:........................................... 30,613 51,048
------- -------
Gross margin.............................................. 21,364 30,981
Operating expenses:
Selling, general and administrative....................... 4,619 8,175
Depreciation and amortization............................. 320 452
Non-income taxes.......................................... 2,372 3,697
------- -------
Total operating expenses.......................... 7,311 12,324
Income from operations...................................... 14,053 18,657
Other (expense) income:
Interest income........................................... 36 176
Interest expense.......................................... (481) (447)
Foreign currency losses................................... (170) (87)
------- -------
(615) (358)
Net income before taxes..................................... 13,438 18,299
Income taxes................................................ 3,916 4,084
------- -------
Net income.................................................. $ 9,522 $14,215
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-41
<PAGE> 205
EDN SOVINTEL
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------
1996 1997
------- --------
(IN THOUSANDS)
<S> <C> <C>
OPERATING ACTIVITIES
Net income.................................................. $ 9,522 $ 14,215
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................. 2,397 3,817
Provision for doubtful accounts........................... (550) (577)
Income tax benefit........................................ -- (665)
Changes in assets and liabilities:
Accounts receivable.................................... (5,991) 1,126
Inventory.............................................. (507) (1,087)
Prepaid expenses and other assets...................... (1,352) (2,216)
Accounts payable and accrued expenses.................. 3,620 1,937
------- --------
Net cash provided by operating activities................... 7,139 16,550
INVESTING ACTIVITIES
Purchases of property and equipment....................... (6,938) (11,329)
Restricted cash........................................... (40) (16)
------- --------
Net cash used in investing activities....................... (6,978) (11,345)
FINANCING ACTIVITIES
Borrowing on (repayment of) shareholder note, net......... 278 (2,251)
Repayment of debt......................................... (694) --
Due to affiliated companies, net.......................... 832 (519)
------- --------
Net cash provided by (used in) financing activities......... 416 (2,770)
------- --------
Net increase in cash and cash equivalents................... 577 2,435
Cash and cash equivalents at beginning of period............ 3,094 3,606
------- --------
Cash and cash equivalents at end of period.................. $ 3,671 $ 6,041
======= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-42
<PAGE> 206
EDN SOVINTEL
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. FINANCIAL PRESENTATION AND DISCLOSURES
In the opinion of management, the accompanying unaudited condensed
financial statements of EDN Sovintel (the "Company") contain all adjustments
(consisting only of normal recurring accruals) necessary to present fairly the
Company's financial position as of December 31, 1996 and September 30, 1997, and
the results of operations and cash flows for the periods indicated.
The Company was established in August 1990 to design, construct and operate
a telecommunications network in Moscow. This network provides worldwide
communications services, principally to major hotels, business offices and
mobile communication companies. Telecommunications services are subject to local
licensing. The Company's license for international, intercity and local calls
was most recently renewed on November 4, 1996 and is valid until January 5,
2000. The Company began operating in December 1991, providing services under
long-term contracts payable in U.S. dollars.
The Company initially registered as a limited liability Russian-American
joint venture. The venture re-registered as a limited liability Russian company
in October 1992. The Company is 50.0% owned by Sovinet, a U.S. general
partnership that is owned by two wholly-owned subsidiaries of Global TeleSystems
Group, Inc. ("GTS"); and the Company is 50.0% owned by Open Joint Stock Company
"Rostelecom," an intercity and long-distance carrier that is 51.0% owned by the
Russian Government.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. Material accruals have been recorded; however,
other adjustments may have been required had an audit been performed. It is
suggested that these financial statements be read in conjunction with the
Company's 1996 audited financial statements and the notes related thereto. The
results of operations for the nine months ended September 30, 1997 may not be
indicative of the operating results for the full year.
The Company maintains its records and prepares its financial statements in
Russian roubles in accordance with the requirements of Russian accounting and
tax legislation. The accompanying financial statements differ from the financial
statements used for statutory purposes in Russia in that they reflect certain
adjustments, not recorded on the Company's books, which are appropriate to
present the financial position, results of operations and cash flows in
accordance with generally accepted accounting principles in the United States of
America. The principal adjustments are related to foreign currency translation,
and depreciation and valuation of property and equipment.
2. DEBT OBLIGATIONS
In October 1995, the Company entered into a $5.0 million credit facility
with Sovinet, one of the Company's shareholders. It was subsequently increased
to $7.0 million. In January 1997, this facility was repaid, and on January 16,
1997 a new six-month facility was established with GTS Finance, Inc., a wholly-
owned subsidiary of GTS, for $7.0 million, of which $5.8 million was drawn upon.
The new facility was subsequently repaid in June 1997, and on June 23, 1997, a
new six-month facility was established with GTS Finance, Inc. for $7.0 million,
with a remaining balance of $3.4 million at September 30, 1997. The loan bears
interest at a rate equal to the then current six-month LIBOR rate, approximately
5.6%, plus 5.0% per annum.
3. CONTINGENCIES
The tax and legal system in Russia are evolving as Russia and its central
government transform from a command to a market-oriented economy. The Russian
Federation has and continues to introduce laws, decrees and related regulations.
These laws, decrees and regulations are not always clearly written and are, at
times, conflicting. In addition, their interpretation is subject to the opinions
of a variety of local, regional and
F-43
<PAGE> 207
EDN SOVINTEL
NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
federal tax inspectors, Central Bank officials and the Ministry of Finance.
Instances of inconsistent opinions among and between these authorities are not
unusual.
The Company's policy is to accrue contingencies in the accounting period in
which a loss is deemed probable and the amount is reasonably determinable. In
this regard, because of the uncertainties associated with the Russian tax and
legal systems, the ultimate taxes as well as penalties and interest, if any,
assessed may be in excess of the amount expensed to date and accrued at
September 30, 1997. It is the opinion of management that the ultimate resolution
of the Company's Russian tax liability and potential loss contingencies, to the
extent not previously provided for, will not have a material effect on the
financial condition of the Company. However, depending on the amount and timing
of an unfavorable resolution of this contingency, it is possible that the
Company's future results of operations or cash flows could be materially
affected in a particular period.
The Company's operations and financial position will continue to be
affected by Russian political developments, including the application of
existing and future legislation, tax regulations, cancellations or non-renewal
of license rights, and expropriation of property. The Company does not believe
that these contingencies, as related to its operations, are any more significant
than those of similar enterprises in Russia.
F-44
<PAGE> 208
HERMES EUROPE RAILTEL B.V.
FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996 AND 1995
AND NINE MONTHS ENDED SEPTEMBER 30, 1997
F-45
<PAGE> 209
REPORT OF ERNST & YOUNG REVISEURS D'ENTREPRISES S.C.C.,
INDEPENDENT AUDITORS
To the Board of Directors and the Shareholders of
Hermes Europe Railtel B.V.
We have audited the accompanying consolidated balance sheets of Hermes
Europe Railtel B.V. as of December 31, 1995 and 1996 and September 30, 1997 and
the related consolidated statements of operations, cash flows, and shareholders'
equity for each of the three years in the period ended December 31, 1996 and for
the nine months ended September 30, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Hermes Europe
Railtel B.V. at December 31, 1995 and 1996 and September 30, 1997, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 1996, and for the nine months ended
September 30, 1997, in conformity with generally accepted accounting principles
in the United States.
Ernst & Young Reviseurs d'Entreprises
S.C.C.
Represented by
L. SWOLFS
Partner
Brussels, Belgium
December 23, 1997
F-46
<PAGE> 210
HERMES EUROPE RAILTEL B.V.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
1995 1996 1997
------------ ------------ -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
ASSETS
Current assets
Cash and cash equivalents........................... $ 5,784 $ 2,013 $237,541
Restricted cash..................................... -- 3,840 29,155
Accounts receivable................................. -- 84 479
Due from affiliated companies....................... 67 491 672
Other assets........................................ 579 1,100 1,843
-------- -------- --------
Total current assets............................. 6,430 7,528 269,690
Property and equipment, net........................... 4,671 20,303 36,593
Deferred financing costs, net......................... -- -- 12,842
Restricted cash....................................... -- -- 27,877
-------- -------- --------
Total Assets..................................... $ 11,101 $ 27,831 $347,002
======== ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued expenses............... $ 4,659 $ 8,476 $ 15,138
Due to affiliated companies......................... 2,117 3,344 1,251
Deferred income..................................... -- 24 1,577
Other current liabilities........................... -- 8 599
Debt maturing within one year....................... 9 63 52
-------- -------- --------
Total current liabilities........................ 6,785 11,915 18,617
Long-term debt, less current portion.................. 10 499 265,401
-------- -------- --------
Total Liabilities................................ 6,795 12,414 284,018
Commitments and contingencies
Shareholders' loans................................... 8,353 34,863 --
SHAREHOLDERS' EQUITY
Common stock, 1,000 guilders par value (305 shares
authorized and 80 shares issued and outstanding
at December 31, 1995 and 1996; 297,000 shares
authorized and 190,468 shares issued and
outstanding at September 30, 1997)............... 45 45 96,757
Additional paid-in capital.......................... 2,884 2,884 7,513
Cumulative translation adjustment................... (254) 316 (2,920)
Accumulated deficit................................. (6,722) (22,691) (38,366)
-------- -------- --------
Total Shareholders' Equity....................... (4,047) (19,446) 62,984
-------- -------- --------
Total Liabilities and Shareholders' Equity....... $ 11,101 $ 27,831 $347,002
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-47
<PAGE> 211
HERMES EUROPE RAILTEL B.V.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
------------------------------------------ -----------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
1994 1995 1996 1996 1997
------------ ------------ ------------ ------------- -------------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Revenues....................... $ -- $ -- $ 48 $ -- $ 2,262
----- ------- -------- -------- --------
Operating costs and expenses:
Cost of revenues............. -- -- 4,694 3,442 5,989
Selling, general and
administrative............ 183 6,637 10,552 7,329 10,177
----- ------- -------- -------- --------
183 6,637 15,246 10,771 16,166
----- ------- -------- -------- --------
Loss from operations........... (183) (6,637) (15,198) (10,771) (13,904)
Other income/(expense):
Interest income.............. 18 125 508 428 2,729
Interest expense............. -- (9) (153) (5) (4,593)
Foreign currency (losses)
gains..................... (55) 19 (1,126) (774) 93
----- ------- -------- -------- --------
(37) 135 (771) (351) (1,771)
----- ------- -------- -------- --------
Net loss before income taxes... (220) (6,502) (15,969) (11,122) (15,675)
Income taxes................... -- -- -- -- --
----- ------- -------- -------- --------
Net loss....................... $(220) $(6,502) $(15,969) $(11,122) $(15,675)
===== ======= ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-48
<PAGE> 212
HERMES EUROPE RAILTEL B.V.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
------------------------------------------ -----------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
1994 1995 1996 1996 1997
------------ ------------ ------------ ------------- -------------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss......................... $ (220) $ (6,502) $(15,969) (11,122) $(15,675)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Depreciation and
amortization................ 5 11 683 387 1,862
Deferred interest............. -- -- 130 -- --
Changes in assets and
liabilities:
Accounts receivable......... -- -- (87) -- (414)
Deposits.................... -- (16) (627) (628) 319
Accounts payable and accrued
expenses................. 89 4,364 4,336 4,625 7,871
Other changes in assets and
liabilities.............. (41) (512) (6) (1,705) 234
-------- -------- -------- -------- --------
Net cash used in operating
activities....................... (167) (2,655) (11,540) (8,443) (5,803)
INVESTING ACTIVITIES
Purchases of property and
equipment..................... (52) (4,405) (16,807) (12,834) (19,316)
Restricted cash.................. -- -- (3,974) (6,883) (54,860)
-------- -------- -------- -------- --------
Net cash used in investing
activities....................... (52) (4,405) (20,781) (19,717) (74,176)
FINANCING ACTIVITIES
Proceeds from debt............... -- 19 564 583 270,849
Payment of debt issue costs...... -- -- -- -- (13,238)
Net proceeds from issuance of
common stock.................. 1,028 1,732 -- -- 52,015
Proceeds from shareholders'
loans......................... -- 7,942 27,358 25,305 13,311
Due to affiliated companies,
net........................... -- 1,951 1,002 351 (1,964)
-------- -------- -------- -------- --------
Net cash provided by financing
activities....................... 1,028 11,644 28,924 26,239 320,973
Effect of exchange rate changes on
cash and cash equivalents........ 58 333 (374) (404) (5,466)
-------- -------- -------- -------- --------
Net increase (decrease) in cash and
cash equivalents................. 867 4,917 (3,771) (2,325) 235,528
Cash and cash equivalents at
beginning of period.............. -- 867 5,784 5,784 2,013
-------- -------- -------- -------- --------
Cash and cash equivalents at end of
period........................... $ 867 $ 5,784 $ 2,013 $ 3,459 $237,541
======== ======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-49
<PAGE> 213
HERMES EUROPE RAILTEL B.V.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended December 31, 1994, 1995 and 1996 and the nine months ended
September 30, 1997:
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL CUMULATIVE TOTAL
----------------- PAID-IN TRANSLATION ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT CAPITAL ADJUSTMENT DEFICIT EQUITY
------- ------- ---------- ----------- ------------ -------------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1993............ 40 $ 21 $ -- $ -- $ -- $ 21
Proceeds from the sale of common
stock................................. 21 11 996 -- -- 1,007
Translation adjustment.................. -- -- -- 58 -- 58
Net loss................................ -- -- -- -- (220) (220)
------- ------- ------ ------- -------- --------
BALANCE AT DECEMBER 31, 1994............ 61 32 996 58 (220) 866
Proceeds from the sale of common
stock................................. 19 13 1,886 -- -- 1,901
Translation adjustment.................. -- -- -- (312) -- (312)
Net loss................................ -- -- -- -- (6,502) (6,502)
------- ------- ------ ------- -------- --------
BALANCE AT DECEMBER 31, 1995............ 80 45 2,884 (254) (6,722) (4,047)
Translation adjustment.................. -- -- -- 570 -- 570
Net loss................................ -- -- -- -- (15,969) (15,969)
------- ------- ------ ------- -------- --------
BALANCE AT DECEMBER 31, 1996............ 80 45 2,884 316 (22,691) (19,446)
Recapitalization, net of tax............ 190,388 96,712 4,629 -- -- 101,341
Translation adjustment.................. -- -- -- (3,236) -- (3,236)
Net loss................................ -- -- -- -- (15,675) (15,675)
------- ------- ------ ------- -------- --------
BALANCE AT SEPTEMBER 30, 1997........... 190,468 $96,757 $7,513 $(2,920) $(38,366) $ 62,984
======= ======= ====== ======= ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-50
<PAGE> 214
HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF BUSINESS OPERATIONS
Hermes Europe Railtel B.V. (the "Company") intends to become the leading
pan-European carriers' carrier by constructing and operating a managed,
seamless, fiber optic, pan-European network, and providing high quality
trans-border transmission services to telecommunications carriers across Europe.
In an effort to generate sufficient capital resources to continue its
buildout of the network and sustain working capital requirements, the Company
undertook a recapitalization (the "Recapitalization") during the first quarter
of 1997, which was completed in September 1997. Prior to the recapitalization,
the Company was 50% owned by HIT Rail B.V. ("HIT Rail"), a consortium of eleven
European railway companies, and 50% owned by GTS-Hermes, Inc. ("GTS-Hermes"), a
U.S. holding company that is a wholly-owned subsidiary of Global TeleSystems
Group, Inc., a provider of a broad range of telecommunications services to
businesses, other telecommunications service providers and consumers through its
operations of voice and data networks, international gateways, local access and
cellular networks and the provision of various value-added services, in markets
outside the United States.
Pursuant to the Recapitalization, the Company offered to GTS-Hermes, HIT
Rail and the eleven individual members of the HIT Rail consortium the right to
subscribe to additional common stock of the Company. GTS-Hermes and two of the
members of HIT Rail, Societe Nationale des Chemins de Fer Belges S.A. de Droit
Public/Nationale Maatschappij der Belgische Spoorwegen N.V. ("NMBS") and AB Swed
Carrier ("Swed Carrier"), exercised their rights, while HIT Rail and the nine
remaining members of HIT Rail declined to participate.
As a result of the finalization of the Recapitalization, total shareholder
loans of ECU 39.4 million (approximately $48.5 million) from, collectively,
GTS-Hermes, HIT Rail, NMBS and Swed Carrier were transferred into equity.
Additionally, GTS-Hermes contributed ECU 46.0 million (approximately $51.8
million) and NMBS contributed a ten-year fiber optic cable lease with a fair
value of ECU 1.8 million (approximately $2.0 million).
The ownership of the Company as a result of the Recapitalization is as
follows:
<TABLE>
<CAPTION>
SHARES OWNERSHIP %
------ -----------
<S> <C> <C>
GTS-Hermes.............................................. 150,632 79.1%
HIT Rail................................................ 24,047 12.6
NMBS.................................................... 11,424 6.0
Swed Carrier............................................ 4,365 2.3
------- ------
Total.............................................. 190,468 100.0%
======= ======
</TABLE>
In an additional effort to obtain capital resources, the Company completed
a debt offering in August 1997 that raised $265.0 million (see Note 4, "Debt
Obligations").
The Company was a development stage enterprise through December 31, 1996.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The financial statements include the accounts of Hermes Europe Railtel
B.V., its Belgian branch and of Hermes Europe Railtel N.V. All significant
intercompany accounts and transactions are eliminated upon consolidation.
The accompanying unaudited, consolidated financial data presented in the
Statements of Operations and the Statements of Cash Flows for the nine months
ended September 30, 1996 have been derived from the
F-51
<PAGE> 215
HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Company's financial records and contain all adjustments (consisting only of
normal recurring accruals) necessary to present fairly the results of operations
and cash flows for the period indicated.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1995 and 1996 consolidated
financial statements in order to conform to the 1997 presentation.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of
three months or less at the time of purchase to be cash equivalents. The Company
had $3.8 million and $57.0 million of restricted cash at December 31, 1996, and
September 30, 1997, respectively. The restricted cash is primarily related to
cash held in escrow for interest payments (see Note 4, "Debt Obligations").
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is calculated on a
straight-line basis over the estimated lives ranging from ten to fifteen years
for fiber optic cable, five years for telecommunications equipment and five to
ten years for furniture, fixtures and equipment and other property. A
substantial part of the costs includes construction in process, which is
currently related to the configuration and buildout of the network, and these
costs primarily consist of labor. These costs are transferred to
telecommunications equipment in service as construction is completed and/or
equipment is placed in service. Depreciation is recorded commencing with the
first full month that assets are placed into service. Maintenance and repairs
are charged to expense as incurred.
DEFERRED FINANCING COSTS
Deferred financing costs are amortized on a straight-line basis over the
lesser of their estimated useful lives or their contractual term, generally ten
years. In accordance with APB 17, "Intangible Assets," the Company continues to
evaluate the amortization period to determine whether events or circumstances
warrant revised amortization periods. Additionally, the Company considers
whether the carrying value of such assets should be reduced based on the future
benefits of its deferred financing costs.
LONG-LIVED ASSETS
Effective January 1, 1995, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." In accordance
with SFAS No. 121, long-lived assets to be held and used by the Company are
reviewed to determine whether any events or changes in circumstances indicate
that the carrying amount of the asset may not be recoverable. For long-lived
assets to be held and used, the Company bases its evaluation on such impairment
indicators as the nature of the assets, the future economic benefit of the
assets, any historical or future profitability measurements, as well as other
external market conditions or factors that may be present. If such impairment
indicators are present or other factors exist that indicate that the carrying
amount of the asset may not be recoverable, the Company determines whether an
impairment has occurred through the use of an undiscounted cash flow analysis of
assets at the lowest level for which identifiable cash flows exist. If an
impairment has occurred, the Company recognizes a loss for the difference
between the carrying amount and the estimated value of the asset. The fair value
of the asset is measured using quoted market prices or, in the absence of quoted
market prices, fair value is based on an estimate of discounted cash flow
analysis. Based on its analyses for the years ended December 31, 1995 and 1996,
and the nine months ended September 30, 1997, the Company determined that there
was not an impairment of its long-lived assets.
F-52
<PAGE> 216
HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
The Company uses the liability method of accounting for income taxes.
Deferred income taxes result from temporary differences between the tax basis of
assets and liabilities and the basis as reported in the consolidated financial
statements.
FOREIGN CURRENCY TRANSLATION
The accounting records of the Dutch B.V. company are maintained in Dutch
guilders. The accounting records of the Belgian branch and the Belgian N.V.
company are maintained in Belgian francs. The functional currency for the
Company has been determined to be the Belgian franc. Therefore, the Dutch
guilder statements have been remeasured into Belgian franc equivalents,
consolidated with the Belgian branch and Belgian N.V. statements and then
translated into U.S. dollar equivalents for the purpose of preparing the
accompanying financial statement in accordance with accounting principles
generally accepted in the United States.
The Company follows a translation policy in accordance with SFAS No. 52,
"Foreign Currency Translation." Assets and liabilities are translated at the
rates of exchange at the balance sheet date. Income and expense accounts are
translated at average monthly rates of exchange. The resultant translation
adjustments are included in the cumulative translation adjustment, a separate
component of shareholders' equity. Gains and losses from foreign currency
transactions are included in the operations.
REVENUE RECOGNITION
The Company's revenue is associated with its customers' right to use the
network and is recognized on a straight-line basis over the terms of the
customer contracts. Amounts billed in advance are deferred and recognized as the
service is performed.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company believes that the carrying amount of its assets and liabilities
reported in the balance sheets approximates their fair value.
OFF BALANCE SHEET RISK AND CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of cash and cash equivalents and accounts
receivable. At December 31, 1995 and 1996, the Company maintained most of its
cash and cash equivalents in high quality European financial institutions. At
September 30, 1997, the Company maintained most of its cash and cash equivalents
in high quality U.S. financial institutions. The Company extends credit to
various customers and establishes an allowance for doubtful accounts for
specific customers that it determines to have significant credit risk.
The Company does not now hedge against foreign currency fluctuations,
although the Company may implement such practices in the future. Under current
practices, the Company's results from operations could be adversely affected by
fluctuations in foreign currency exchange rates.
USES OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of these consolidated financial statements, in conformity
with generally accepted accounting principles, requires management to make
estimates and assumptions that affect amounts in the financial statements and
accompanying notes and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
F-53
<PAGE> 217
HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3. SUPPLEMENTAL BALANCE SHEET INFORMATION
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
1995 1996 1997
------------ ------------ -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Other assets consist of:
Deposits................................. $ 17 $ 606 $ 219
VAT receivable........................... 272 402 871
Interest receivable...................... -- -- 412
Other assets............................. 290 92 341
----------- ------------- ---------------
Total other assets......................... $ 579 $ 1,100 $ 1,843
=========== ============= ===============
Property and equipment, net consists of:
Construction in process.................. $ 3,879 $ 12,981 $ 25,541
Telecommunications equipment in
service............................... -- 4,947 7,790
Fiber.................................... -- -- 2,363
Furniture, fixtures and equipment........ 807 2,507 2,503
Leasehold improvements................... 2 543 703
----------- ------------- ---------------
4,688 20,978 38,900
Less: accumulated depreciation....... 17 675 2,307
----------- ------------- ---------------
Total property and equipment, net.......... $ 4,671 $ 20,303 $ 36,593
=========== ============= ===============
Accounts payable and accrued expenses
consist of:
Trade accounts payable................... $ 2,225 $ 5,445 $ 6,594
Accrued interest......................... -- 10 3,785
Accrued salaries and bonuses............. 668 1,150 1,941
Accrued consulting expense............... 471 152 996
Accrued vacation expense................. 110 774 901
Other.................................... 1,185 945 921
----------- ------------- ---------------
Total accounts payable and accrued
expenses................................. $ 4,659 $ 8,476 15,138
=========== ============= ===============
</TABLE>
NOTE 4. DEBT OBLIGATIONS
Company debt consists of:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
1995 1996 1997
------------ ------------ -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Senior notes, due August 15, 2007 at 11.5%
interest payable semiannually............ $ -- $ -- $ 265,000
Other financing agreements................. 19 562 453
----------- ------------- ---------------
Total debt outstanding..................... 19 562 265,453
Less: debt maturing within one year...... 9 63 52
----------- ------------- ---------------
Total long-term debt....................... $ 10 $ 499 $ 265,401
=========== ============= ===============
</TABLE>
F-54
<PAGE> 218
HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4. DEBT OBLIGATIONS (CONTINUED)
On August 15, 1997, the Company issued aggregate principal amount $265.0
million of senior notes due August 15, 2007 (the "Senior Notes"). The Senior
Notes are general unsecured obligations of the Company, with interest payable
semiannually at a rate of 11.5%. Approximately $56.6 million of the net proceeds
of the offering are being held in escrow for the first four semiannual interest
payments commencing on February 15, 1998. The Company may redeem the Senior
Notes, in whole or in part, any time on or after August 15, 2002 at specific
redemption prices. The Company may also redeem the Senior Notes at a price equal
to 111.5% of the principal amount prior to August 15, 2000 with net cash
proceeds of a public equity offering with gross proceeds of at least
$75.0 million or in certain other circumstances specified in the indenture for
the Senior Notes, provided, however, that at least two-thirds of the principal
amount of the Senior Notes originally issued remain outstanding after each such
redemption. Pursuant to the covenants in the offering, the Company has filed an
S-4 registration statement with the Securities Exchange Commission to exchange
registered senior notes, with the same terms and conditions as the Senior Notes,
for the Senior Notes.
On a pro forma basis, assuming the Senior Notes had been outstanding as of
January 1, 1996, the Company's net loss would have been $47.7 million and $35.9
million for 1996 and for the nine months ended September 30, 1997, respectively,
as a result of interest expense of $30.5 million and $19.3 million and
amortization expense of $1.3 million and $1.0 million related to amortizing
$12.9 million of deferred financing fees over the term of the Senior Notes, for
1996 and for the nine months ended September 30, 1997, respectively.
Aggregate maturities of long-term debt, as of September 30, 1997, are as
follows: 1998 -- $0.05 million, 1999 -- $0.05 million, 2000 -- $0.06 million,
2001 -- $0.06 million, 2002 -- $0.07 million, and $265.2 million thereafter.
NOTE 5. EMPLOYEE BENEFITS
The Company established a pension plan in 1995 that covers substantially
all of its employees upon twenty-five years of age and at least one year of
service. The benefits are based on years of service and the employee's
compensation. The Company has entered into an arrangement, an annuity contract,
with an insurance company for the provision of a group insurance policy (the
"Policy"). Under the Policy, the insurance provider has undertaken a legal
obligation to provide specified benefits to participants in return for a fixed
premium; accordingly, the Company no longer bears any financial risk. Premium
payments for the Policy are partly paid by the employee, based on specified
terms that consider the employee's annual salary, with the remaining premium
paid by the employer. Premiums are intended to provide not only for benefits
attributed to service to date but also for those expected to be earned in the
future.
The Company's pension costs for 1995, 1996 and the nine months ended
September 30, 1997 were $0.05 million, $0.4 million and $0.2 million,
respectively.
NOTE 6. STOCK OPTION PLANS
GTS - HERMES
The Company's parent company, GTS - Hermes, maintained the GTS - Hermes,
Inc. 1994 Stock Option Plan (the GTS - Hermes Plan) for the sole benefit of the
employees of the Company and GTS - Hermes, Inc., through September 30, 1997. As
of September 30, 1997, 12.0 options were outstanding with a weighted average
exercise price of $197,752 and 4.5 of the options were exercisable. The
accounting for the GTS - Hermes Plan resulted in an insignificant amount of
compensation expense in FY 1995, 1996 and the nine months ended September 30,
1997.
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HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6. STOCK OPTION PLANS (CONTINUED)
HERMES EUROPE RAILTEL B.V.
Subsequent to the third quarter of 1997, the Company finalized the
establishment of a stock option plan (the "Plan"). The maximum number of shares
of common stock available for grant under the Plan is 24,760. The terms and
conditions of the Plan are substantially similar to the existing stock option
plan maintained by the Company's parent, GTS - Hermes as described above. The
Company intends to account for the Plan in accordance with APB No. 25.
During the fourth quarter of 1997, in connection with the adoption of the
Plan, the Company issued 10,166 options in replacement of those outstanding
under the GTS - Hermes Plan as well as additional options to certain employees.
The options that were granted have exercise prices ranging from $83 to $2,888
per share of HER common stock. All options granted vest no later than 3 years
after the grant date; however, 6,244 options will be vested at December 31,
1997. Further, the issuance of these options will result in a non-cash charge of
approximately $3.7 million of which $2.6 million is expected to be recorded
during the fourth quarter and the remaining $1.1 million will be recognized
principally ratably over fiscal 1998.
NOTE 7. INCOME TAXES
The components of loss before income taxes were as follows:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
--------------------------------------------- ---------------
1994 1995 1996 1997
---- ---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Pretax loss:
Domestic (the Netherlands)... $ (95) $ (422) $ (608) $ (209)
Foreign...................... (125) (6,080) (15,361) (15,466)
--------- ------------- --------------- ---------------
$ (220) $ (6,502) $ (15,969) $ (15,675)
========= ============= =============== ===============
</TABLE>
No current income taxes are due, as the Company incurred losses due to the
start-up activities in the Belgian branch and the Company.
A deferred tax asset is recorded on temporary differences between earnings
as reported in the financial statements and earnings for income tax purposes.
The following table summarizes major components of the Company's deferred tax
assets:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
1995 1996 1997
------------ ------------ -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carryforwards.... $ 3,919 $ 11,729 $ 16,700
--------------- --------------- ---------------
Total deferred tax asset................. 3,919 11,729 16,700
Less: valuation allowance.......... (3,919) (11,729) (16,700)
--------------- --------------- ---------------
Total.................................... $ -- $ -- $ --
=============== =============== ===============
</TABLE>
As of September 30, 1997, the Company had net operating loss carryforwards
for Belgian and Dutch income tax purposes of approximately $41.6 million, which
are recoverable from profits for an unlimited period of time,
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HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8. SUPPLEMENTAL CASH FLOW INFORMATION
The following table summarizes non-cash investing and financing activities
related to the Recapitalization for the nine months ended September 30, 1997:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, 1997
------------------
(IN THOUSANDS)
<S> <C>
Transfer of shareholders' loans to equity............. $ 48,491
Contribution of fiber optic cable lease............... 1,989
Unpaid capital duty tax............................... 591
</TABLE>
There were no significant non-cash activities in 1994, 1995 or 1996.
The Company paid interest of $0.02 million, $0.01 million and $0.7 million
in 1996, 1995 and for the nine months ended September 30, 1997, respectively.
The Company did not pay interest in 1994.
NOTE 9. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
Operating lease commitments are primarily for office space and car rental.
The office lease has a term of nine years, expiring on June 30, 2005, with an
option to cancel January 1, 2002 upon the payment of certain penalties. In
addition, the Company received a reduction in annual expense during the first
three years of the lease. This reduction is being amortized over the first six
years of the lease, using a straight-line method. On April 29, 1997, the Company
entered into a lease for a second office building, with annual payments of
0.4 million beginning in October 1997 and expiring on June 30, 2005.
Rental expense aggregated approximately $0.5 million, $0.7 million and $0.7
million for the years ended December 31, 1996 and 1995, and the nine months
ended September 30, 1997, respectively. The Company did not have rent expense in
1994.
Future minimum lease payments under these non-cancelable operating leases
with terms of one year or more, as of September 30, 1997, are as follows:
1998 -- $1.4 million, 1999 -- $1.4 million, 2000 -- $1.2 million, 2001 -- $0.9
million, 2002 -- $0.4 million and $1.0 million thereafter.
OTHER MATTERS
In the ordinary course of business, the Company may be party to various
legal and tax proceedings, and subject to claims, certain of which relate to the
regulatory environments in which the Company currently operates or intends to
operate. In the opinion of management, the Company's liability, if any, in all
pending litigation, or other legal proceeding or other matter other than what is
discussed above, will not have a material effect upon the financial condition,
results of operations or liquidity of the Company.
NOTE 10. RELATED PARTY TRANSACTIONS
The Company received financing through shareholders' loan transactions
provided by Hit Rail, GTS-Hermes, NMBS, and Swed Carrier. The components of the
Company's shareholders' loans are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1995 1996
------------ ------------
(IN THOUSANDS)
<S> <C> <C>
Hit Rail.......................................... $6,425 $13,999
GTS-Hermes........................................ 1,928 20,864
------ -------
Total shareholders' loans.................... $8,353 $34,863
====== =======
</TABLE>
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<PAGE> 221
HERMES EUROPE RAILTEL B.V.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. RELATED PARTY TRANSACTIONS (CONTINUED)
All shareholder loans outstanding were converted into equity prior to
September 30, 1997 (See Note 1, "Nature of Business Operations").
NOTE 11. SUBSEQUENT EVENTS
Subsequent to September 30, 1997, the Company entered into contractual
commitments to lease fiber pairs, including facilities and maintenance and
utilizing the partial routes for laying fiber optic cable. Based on the contract
provisions, these commitments are currently estimated to aggregate approximately
$98.0 million. The commitments have expected lease terms of three to twenty
years with options for renewal rights of five additional years. As of September
30, 1997, the Company made prepayments of approximately $6.4 million related to
the above leases.
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<PAGE> 222
EXHIBIT A
GLOSSARY OF TELECOMMUNICATIONS INDUSTRY TERMS
Accounting Rate Mechanism (ARM) -- The current system of bilateral
settlement agreements between PTOs under which tariffs for cross-border
pan-European-switched voice traffic are determined.
Add-drop multiplexer (ADM) -- A multiplexer which controls cross connect
between individual circuits by software, permitting dynamic cross connect of
individual 64 kbps circuits within an E-1 line.
AMPS -- Advanced Mobile Phone System; the cellular mobile telephone system
based on analog technology that is now used in U.S. systems. Each AMPS cell can
handle 832 simultaneous conversations.
Asynchronous Transfer Mode (ATM) -- A switching and transmission technology
that is one of general class of packet technologies that relay traffic by way of
an address contained within the first five bits of a switching and transmission
of mixed voice, data, and video at varying rates. The ATM format can be used by
many different information systems, including LANs.
Bps -- Bits per second; the basic measuring unit of speed in a digital
transmission system; the number of bits that a transmission facility can convey
between a sending location and a receiving location in one second.
Backbone -- The through-portions of a transmission network, as opposed to
spurs which branch off the through-portions.
Bandwidth -- The information-carrying capability of a transmission medium
is measured by its bandwidth, which is the relative range of frequencies that
can be passed without distortion by such medium. Bandwidth is measured in Hertz,
but may also be expressed as the number of bits that can be transmitted per
second.
Capacity -- Refers to transmission.
Carrier -- A provider of communications transmission services by fiber,
wire, or radio.
CCIT -- International Telegraph and Telephone Consultative Committee.
Closed User Group -- A group of customers with some affiliation with one
another and which are treated for regulatory purposes as not being the public.
Competitive Local Telecommunications Provider -- A company that provides
its customers with an alternative to the local telephone company for local
transport of private line, special access and transport of switched access
telecommunications services. Competitive Local Telecommunications Providers are
also referred to in the industry as alternative local telecommunications service
providers (ALTS), Competitive Access Providers (CAPs) and Competitive Local
Exchange Carriers (CLECs).
Dark Fiber -- Fiber that lacks the requisite electronic and optronic
equipment necessary to use the fiber for transmission.
Dedicated -- Refers to telecommunications lines dedicated to or reserved
for use by particular customers along predetermined routes (in contrast to
telecommunications lines within the local telephone company's public switched
network).
Digital -- Describes a method of storing, processing and transmitting
information through the use of distinct electronic or optical pulses that
represent the binary digits 0 and 1. Digital transmission/switching technologies
employ a sequence of discrete, distinct pulses to represent information, as
opposed to the continuously variable analog signal.
E1 -- Data transmission rate of approximately 2 Mbps.
E3 -- Data transmission rate of approximately 34 Mbps.
Electrosviaz -- regional telephone company.
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Enhanced Network Services -- Telecommunications services providing digital
connectivity, primarily for data applications, via frame relay, ATM, or digital
interexchange private line facilities. Enhanced network services also include
applications on such networks, including Internet access and other Internet
services.
ERMES -- A standard for a pan-European radio message system sponsored by
the EC.
Eutelsat -- European Telecommunications Satellite Organization; an
international satellite organization in which members of the European Union hold
an 88% combined investment.
Frame Relay -- A wide area transport technology that organizes data into
units called frames instead of providing fixed bandwidth as with private lines.
A high-speed, data-packet switching service used to transmit data between
computers. Frame Relay supports data units of variable lengths at access speeds
ranging from 56 kilobits per second to 1.5 megabits per second. This service is
well-suited for connecting local area networks, but is not presently well-suited
for voice and video applications due to the variable delays which can occur.
Frame Relay was designed to operate at high speeds on modern fiber optic
networks.
Gbps -- Gigabits per second, which is a measurement of speed for digital
signal transmission expressed in billions of bits per second.
Gateway -- A network element interconnecting two otherwise incompatible
networks, network nodes, subnetworks or devices; performs a protocol conversion
operation across a wide spectrum of communications functions.
GSM -- Global System for Mobile Communications, formerly known as Groupe
Speciale Mobile. GSM began as a pan-European standard for digital cellular
systems. The name was changed to reflect the fact that the standard has been
adopted by several countries in Asia.
Hertz -- The unit for measuring the frequency with which an electromagnetic
signal cycles through the zero-value state between lowest and highest states.
One Hz (Hertz) equals one cycle per second. kHz (kilohertz) stands for thousands
of Hertz; MHz (megahertz) stands for millions of Hertz.
Inmarsat -- The International Maritime Satellite service, which provides
mobile communications to ships at sea, aircraft in flight and vehicles on the
road.
Intelsat -- International Telecommunications Satellite Organization; a
worldwide consortium of national satellite communications organizations.
Interconnect -- Connection of a telecommunications device of service to the
PSTN.
Interconnection -- Connection of a piece of telephone equipment to the
telephone network, or a data terminal to a data communications network. Also
refers to the connection of one communications network to another so that users
of one network can communicate with users of another network.
International Simple Resale -- Refers to the wholesale purchase of IPLCs
from facilities-based carriers and the reselling of such capacity to customers
for switched telephone service.
IPLC -- International Private Leased Circuits.
ISDN (Integrated Services Digital Network) -- ISDN is an internationally
agreed standard which, through special equipment, allows two-way, simultaneous
voice and data transmission in digital formats over the same transmission line.
ISDN permits video conferencing over a single line, for example, and also
supports a multitude of value-added switched service applications. ISDN's
combined voice and data networking capabilities reduce costs for end users and
result in more efficient use of available facilities. ISDN combines standards
for highly flexible customer to network signaling with both voice and data
within a common facility.
ITU -- International Telecommunications Union; a United Nations treaty
organization whose purpose is to accredit international telecommunications
standards. ITU signatories can turn ITU-approved standards into law through
international treaties such as the treaties governing use of the radio spectrum
for international satellite telecommunications and broadcasting.
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<PAGE> 224
Kbps -- Kilobits per second, which is a measurement of speed for digital
signal transmission expressed in thousands of bits per second.
Local Area Network (LAN) -- The interconnection of computers for the
purpose of sharing files, programs and peripheral devices such as printers and
high-speed modems. LANs may include dedicated computers or file servers that
provide a centralized source of shared files and programs. LANs are generally
confined to a single customer's premises and may be extended or interconnected
to other locations through the use of bridges and routers.
Local Loop -- The local loop is that portion of the local telephone network
that connects the customer's premises to the local exchange provider's central
office or switching center. This includes all the facilities starting from the
customer premise interface which connects to the inside wiring and equipment at
the customer premise to a terminating point within the switching wire center.
Mbps -- Megabits per second, which is a measurement of speed for digital
signal transmission expressed in millions of bits per second.
MGTS -- Moscow city telephone network.
Multiplexing -- The use of some means to inter-leave narrow-band or
slow-speed data from multiple sources in order to make use of a wide-band or
high-speed channel.
NMT -- Acronym for Nordic Mobile Telephone System, a cellular standard
widely used in Northern Europe.
Nodes -- Locations within the network housing electronic equipment and/or
switches which serve as intermediate connection points to send and receive
transmission signals.
PBX/PABX (private branch exchange/private automatic branch exchange) -- A
customer operated switch on customer premises, typically used by large
businesses with multiple telephone lines.
Plesiochronous Digital Hierarchy (PDH) -- A method of controlling the
timing between transmission and switching systems that is not synchronized but
rather relies on highly accurate clocks to minimize the slip rates between
switching nodes.
POCSAG (Postal Office Code Standard Advisory Group) -- A lower-cost paging
technology which can be transmitted on ERMES frequency.
Points of Presence (POPs) -- Locations where a carrier has installed
transmission equipment in a service area that serves as, or relays calls to, a
network switching center of that carrier.
PSTN -- Public switched telecommunications network.
PTT/PTO -- Postal, Telegraph and Telephone agency/Public Telephony
Operators; a government authority or agency that operates the public
telecommunications network, and sets standards and policies. PTTs/PTOs are
agencies in charge of telecommunications services in many countries, under
direct supervision of the national government.
Redundant Electronics -- Describes a telecommunications facility using two
separate electronic devices to transmit the telecommunications signal so that if
one device malfunctions, the signal may continue without interruption.
Regeneration/amplifier -- Devices which automatically re-transmit or boost
signals on an out-bound circuit.
Route Kilometers -- The number of kilometers along which fiber optic cables
are installed.
Route Mile -- The number of miles along which fiber optic cables are
installed.
SDH -- Synchronous Digital Hierarchy; the international standard for
ultra-high-speed broadband fiber-optic, digital transmission networks that use
equipment from many different manufacturers and carry a variety
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of services. The basic communications channel of SDH is a 155.52 Mbps
transmission channel that is multiplexed upward.
STM-1 -- Data transmission rate of approximately 155 Mbps.
STM-4 -- Data transmission rate of approximately 622 Mbps.
STM-16 -- Data transmission of approximately 2,488 Mbps.
STM-64 -- Data transmission rate of approximately 9,952 Mbps.
Switch -- A mechanical or electronic device that opens or closes circuits
or selects the paths or circuits to be used for the transmission of information.
Switching is a process of linking different circuits to create a temporary
transmission path between users.
Synchronous Digital Hierarchy (SDH) -- SDH is a set of standards for
optical communications transmission systems that define optical rates and
formats, signal characteristics, performance, management and maintenance
information to be embedded within the signals and the multiplexing techniques to
be employed in optical communications transmission systems. SDH facilitates the
interoperability of dissimilar vendors' equipment and benefits customers by
minimizing the equipment necessary for telecommunications applications. SDH also
improves the reliability of the local loop connecting customers' premises to the
local exchange provider, historically one of the weakest links in the service
delivery.
TCP/IP -- Transmission Control Protocol/Internet Protocol; an "open"
standard operating and interface protocol for federal government local area
networks that use devices from multiple vendors. TCP/IP, first developed by the
U.S. Defense Department, has been adopted by some academic and business
institutions who deal regularly with the federal government.
Trunk -- A telephone circuit with a switch at both ends. A trunk may
connect two central office switches, or two PBXs, or a PBX and a central office
switch.
VSAT -- Very Small Aperture Terminal; a satellite communications technology
that employs frequencies in the Ku band or C band and very small receiving
dishes. VSAT systems employ satellite transponders; the receiving dishes may be
leased or owned by the VSAT user.
Wavelength Division Multiplexing (WDM) -- A multiplexing technique allowing
multiple different signals to be carried simultaneously on a fiber by allocating
resources according to frequency on non-overlapping frequency bands.
X.25 -- A CCITT standard governing the interface between data terminals and
data circuit termination equipment for terminals on packet-switched data
networks.
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EXHIBIT B
SUPPLEMENTAL EASDAQ INFORMATION
APPROVAL BY THE BELGIAN COMMISSION FOR BANKING AND FINANCE
This Prospectus will be submitted for approval by the Belgian Banking and
Finance Commission ("Commissie voor bet Banken Financiewezen/Commission Bancaire
et Financiere") ("BFC") in accordance with Article 29ter. sec. 1. par.1 of Royal
Decree No. 185 of July 9, 1935 and Article 11 of the Royal Degree of 31 October,
1991 on the publication of prospectuses in connection with public issues of
securities. The approval of this Prospectus by the BFC does not imply any
judgement as to the appropriateness of the quality of this Offering or the Offer
Shares nor of the situation of the Company.
On December 22, 1997, an application was made for the admission of the
Common Stock to trading on EASDAQ under the symbol "GTSG." Admission to EASDAQ
is subject to certain adequacy and liquidity requirements determined by the
EASDAQ Market Authority. Companies applying for admission to trading on EASDAQ
are required to publish relevant financial and other information regularly and
to keep the public informed of all events likely to affect the market price of
their securities. Price sensitive information is made available to investors in
Europe through the EASDAQ Reuters Regulatory Company Reporting System and
international information vendors.
The documents referred to above will also be made available to Belgian
investors upon prior written request addressed to the principal executive office
of the Company.
PERSONS RESPONSIBLE FOR THE PROSPECTUS AND DECLARATION
The Company, represented by Mr. William H. Seippel, Chief Financial
Officer, takes responsibility for the contents of this Prospectus.
The Company, having made all reasonable inquiries, accepts responsibility
for, and confirms that this Prospectus contains all information with regard to
the Company and the Common Stock that is material in the context of the offering
and sale of the Common Stock, that the information contained in this Prospectus
is true and correct in all material respects and is not misleading, that the
opinions and intentions of the Company expressed herein are honestly held and
that there are no other facts the omission of which makes this Prospectus as a
whole or any of such information or the expression of any such opinions or
intentions materially misleading.
Global TeleSystems Group, Inc.
by William H. Seippel
Chief Financial Officer
THE CLEARING SYSTEMS
INTERSETTLE
Transactions executed on EASDAQ will be settled by delivery through
INTERSETTLE. INTERSETTLE holds securities for its direct participants, which
include banks, securities brokers and dealers, other professional intermediaries
and foreign depositories, and facilitates the clearance and settlement of
securities transactions between INTERSETTLE participants through electronic
book-entry changes in the accounts of INTERSETTLE participants. Book-entry
settlement is mandatory for all financial instruments traded on EASDAQ. Physical
certificates cannot be used to settle a market transaction. Investors must hold
a securities account with a financial institution which directly or indirectly
has access to INTERSETTLE's clearing and settlement system. INTERSETTLE conducts
a real-time gross payment system in connection with its clearance operation,
payments being made simultaneously with the book-entry transfers between
securities accounts.
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<PAGE> 227
DTC
DTC is a limited-purpose trust company organized under the laws of the
State of New York, a member of the Federal Reserve System, a "clearing
corporation" within the meaning of the New York Uniform Commercial Code, and a
"clearing agency" registered pursuant to the provisions of Section 17A of the
Securities Exchange Act of 1934. DTC was created to hold securities of its
participants and to facilitate the clearance and settlement of securities
transactions among its participants in such securities through electronic
book-entry changes in accounts of the participants, thereby eliminating the need
for physical movement of securities certificates. DTC participants include
securities brokers and dealers, banks, trust companies, clearing corporations
and certain other organization, some of whom (and/or their representatives) own
DTC. Access to the DTC book-entry system is also available to others, such as
banks, brokers, dealers and trust companies that clear through or maintain a
custodial relationship with a participant, either directly or indirectly. DTC
agrees with and represents to its participants that it will administer its
book-entry system in accordance with its rules and by-laws and requirements of
law.
TRANSFERS BETWEEN INTERSETTLE AND DTC PARTICIPANTS
Common Stock will be held through DTC. Common Stock held directly or
indirectly by INTERSETTLE participants will be registered on the books of DTC in
the name of the nominee company of Brown Brothers Harriman, acting as custodian
for INTERSETTLE.
Transfers of Common Stock will be effected in the following manner:
(i) transfers of Common Stock between INTERSETTLE participants will be
effected in accordance with procedures established for this purpose by
INTERSETTLE;
(ii) transfer of Common Stock between DTC participants will be effected in
accordance with procedures established for the purpose by DTC; and
(iii) transfers of Common Stock between INTERSETTLE participants and DTC
participants will be effected by an increase or a reduction of the
quantity of Common Stock held in INTERSETTLE's account at Brown
Brothers Harriman and a corresponding reduction or increase of the
quantity of Common Stock held by the other relevant DTC participant
or participants.
Investors should inquire with the financial intermediary with whom the
investor has opened a securities account for the purpose of holding and trading
Common Stock, as to the cost of such trading as well as the terms and conditions
on which the financial service of the Common Stock will be delivered by such
financial intermediary.
The Common Stock has the following identification number:
CUSIP 379 36 U104, ISIN US379 36 U1043
The clearing costs, if any, will be at the cost of the investors. Investors
are requested to inform themselves about such costs.
POSSIBILITY OF SHARE REPURCHASES
The Company is not prohibited by its Certificate of Incorporation, By-laws
or Delaware General Corporation Law from repurchasing or otherwise acquiring
outstanding shares of Common Stock and, accordingly, the Company may exercise
its right to repurchase Common Stock.
AUTHORIZATION OF INCREASE IN AUTHORIZED CAPITAL OF THE COMPANY; AUTHORIZATION OF
THE ISSUANCE OF COMMON STOCK IN THE STOCK OFFERINGS
Effective December 1, 1997, the Board of Directors and stockholders of the
Company approved amendments to the Certificate of Incorporation which (i)
increased the authorized number of shares of capital stock to 145,000,000 (of
which 135,000,000 shares are Common Stock and 10,000,000 shares are preferred
stock) and (ii) effected a 3-for-2 stock split of all then-outstanding shares of
the Company's Common Stock.
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<PAGE> 228
In addition, the Board of Directors of the Company has adopted a resolution
approving the offering and issuance of 11,100,000 shares of Common Stock in the
Stock Offerings.
TAXATION OF BELGIAN INVESTORS
The following generally summarizes the material Belgian tax consequences of
the sequisition, ownership and disposition of Common Stock. It is based on the
tax laws applicable in Belgium and France as in effect at the date of this
Prospectus, and is subject to changes in Belgium and French law, including
changes that could have retroactive effect. The following summary does not take
into account or discuss the tax laws of any country other than Belgium and
France nor does it take into account the individual circumstances of each
investor. The summary uses the term "Eligible Belgian Holders" to refer to
beneficial owners of Common Stock who hold directly less than 10% of the share
capital of the Company and whose ownership of such Common Stock is not
attributable to a permanent establishment or a fixed base in France, are
considered residents of Belgium for purposes of the income tax convention
between Belgium and France dated March 10, 1964 (the "Belgian-French Treaty")
and are fully entitled to benefits under the Belgian-French Treaty.
There are currently no procedures available for Holders of Common Stock
that are not U.S. residents to claim or receive from the French tax authorities
any tax treaty benefits in respect of dividends (including payment of avoir
fiscal and availability of a reduced withholding tax rate) that a Holder may be
entitled to receive pursuant to the Belgian-French Treaty.
Prospective Belgian Investors in Common Stock are advised to consult their
own tax advisers as to the Belgian and other tax consequences of the
acquisition, ownership and disposition of Common Stock.
TAXATION OF DIVIDENDS ON COMMON STOCK
French tax considerations
Dividends paid to non-residents of France generally are subject to French
withholding tax at a 25% rate and are not eligible for the benefit of the avoir
fiscal (a tax credit available to French residents equal to 50% of the amount of
dividends received from French companies such as the Company). However, under
the Belgian-French Treaty, Eligible Belgian Holders can claim the benefit of a
reduced withholding tax rate on dividends of 15%.
An individual Eligible Belgian Holder generally will also be entitled to
receive a payment of the avoir fiscal, after deduction of withholding tax of
15%. This payment will not be made available to such individual Eligible Belgian
Holder until after the close of the calendar year in which the dividend was paid
and only upon receipt by the French tax authorities of a claim made by the
individual Eligible Belgian Holder for such payment in accordance with the
procedure set forth below.
A Belgian company that is an Eligible Belgian Holder under the
Belgian-French Treaty (a "Belgian Resident Company") will not benefit from the
refund of the avoir fiscal but will be entitled to obtain from the French tax
authorities a refund of any precompte paid in cash in respect of such dividends
less the 15% French withholding tax. Amounts distributed as dividends by French
companies out of profits which have been taxed at the ordinary corporate income
tax rate or which have been earned and taxed more than five years before the
distribution and which give rise to the avoir fiscal are subject to a
"precompte" or prepayment by such companies. The precompte is paid by the
distributing company to the French tax authorities and is equal to one-half of
the nominal dividend distributed.
Dividends paid to an individual Eligible Belgian Holder will be subject to
the reduced withholding tax rate of 15% at the time the dividend is paid if (i)
such holder duly completes and provides the French tax authorities with French
Treasury Form 5200 RFI Belgique (the "Form") duly certified by the Belgian tax
authorities before the date of payment of the relevant dividend, or (ii) if
completion of the Form is not possible prior to the payment of dividends, such
holder duly completes and provides the French tax authorities with a simplified
certificate (the "Certificate") duly certified by the Belgian tax authorities
stating that (a) such holder is a Belgian resident as defined pursuant to the
provisions of the Belgian-French Treaty,
B-3
<PAGE> 229
(b) such holder's ownership of the Common Stock is not effectively connected
with a permanent establishment or fixed base in France, and (c) such holder
meets all the requirements of the Belgian-French Treaty for obtaining the
benefit of the reduced rate of withholding tax and the right to payment of the
French avoir fiscal. For example, the Company pays a dividend of 100, an
individual Eligible Belgian Holder will initially receive 85, but will be
entitled to an additional payment of 42.50, consisting of the avoir fiscal of
50, less a 15% withholding tax on that amount (equal to 7.5). Dividends paid to
an individual Eligible Belgian Holder that has not filed a completed Form or
Certificate before the dividend payment date will be subject to French
withholding tax at the rate of 25%. Such a holder may claim a refund of the
excess withholding tax and the avoir fiscal by completing and providing the
French tax authorities with the Form before December 31st of the calendar year
following the year during which the dividend is paid.
Dividends paid to a Belgian Resident Company will be subject to the reduced
withholding tax rate of 15% at the time the dividend is paid if such holder duly
completes and provides the French tax authorities with French Treasury 5207 RF2
Belgique form before the date of payment of the relevant dividend duly certified
by the Belgian tax authorities. Dividends paid to such Belgian Resident Company
that has not filed a completed form before the dividend payment date will be
subject to French withholding tax at the rate of 25%. Such a holder may claim a
refund of the excess withholding tax by completing and providing the French tax
authorities with such 5207 RF2 Belgique form before December 31st of the
calendar year following the year during which the dividend is paid. The claim
for refund of the precompte is made on the form RF 5207 RF2 Belgique referred to
above.
Belgian withholding tax
Dividends distributed on Common Stock are subject in Belgium to a
withholding tax at the rate of 25%, when paid or attributed through a
professional intermediary in Belgium. However, no dividend withholding tax is
due if the Eligible Belgian Holder is a company subject to Belgian corporate
income tax.
In a case where dividends are paid outside Belgium without any intervention
of a paying agent in Belgium, no dividend withholding tax is, in principle, due.
However, where the Eligible Belgian Holder is a Belgian resident entity subject
to the legal entities tax (e.g. a pension fund), the Holder itself has to pay
the dividend withholding tax at the rate of 25%.
In certain cases the above-mentioned 25% rate of dividend withholding tax
will be reduced to 15%. The reduced rate applies in particular to (i) dividends
distributed on shares publicly issued after January 1, 1994 and (ii) dividends
distributed on shares that have been privately issued after January 1, 1994 in
exchange for cash contributions, provided the shares are registered or bearer
shares placed in open custody to a financial institution in Belgium as of the
date of their issuance. This reduced rate should in principle also apply to
dividends on shares issued by the Company. The Company may however irrevocably
reject the application of the reduced withholding tax rate.
Income tax for Belgian resident individuals
In the hands of an Eligible Belgian Holder who is an individual holding
Common Stock as a private investment, the Belgian dividend withholding tax is a
final tax and the dividends need not be reported in the individual's annual
income tax return. If no withholding tax has been levied (i.e. in case of
payment or attribution outside Belgium), the individual has to report the
dividends in his tax return. Such Holder will be taxed at the separate rate of
25%, to be increased with a municipal surcharge (varying, as a rule, from 6% to
9%).
In the hands of an individual Eligible Belgian Holder whose holding of
Common Stock is effectively connected with a business, the dividends are taxable
at the ordinary rates for business income (i.e. varying from 25% to 55% to be
increased with the municipal surcharge and a crisis contribution of 3% of the
tax due). Any Belgium withholding tax is creditable against the final income tax
due, provided that the Holder has the full ownership of the Common Stock at the
time of payment of the dividends.
B-4
<PAGE> 230
Income tax for Belgian Resident Companies
Dividends received by Belgian Resident Companies are, in principle, subject
to corporate income tax at the rate of 40.17% (i.e. the standard rate of 39%
increased by the additional tax of 3% of the corporate income tax due).
However, provided that the dividends benefit from the so-called
"dividend-received deduction", only 5% of the dividends received will be
taxable. In order to benefit from the deduction, the Company must not fall
within one of the categories which are expressly excluded from the "dividend
received deduction" (e.g. tax haven companies) and the beneficiary should hold,
at the time of payment of the dividends, a participation of at least 5% in the
Company or a participation which has a acquisition value of at least BEF 50
million.
Any Belgian dividend withholding tax can, in principle, be credited against
the company's final income tax, provided that the company has the full ownership
of the shares at the time of payment or attribution of the dividends and
provided that the dividend distribution does not entail a reduction in value or
capital loss on the Shares.
Income tax for Belgian resident entities subject to the Belgian legal entities
tax (pension funds, etc.)
The Belgian dividend withholding tax is a final tax.
CAPITAL GAINS TAXATION
French tax considerations
In general, a Belgian holder who is a resident of Belgium under the
Belgian-French Treaty will not be subject to French tax on any capital gain
derived from the sale or exchange of Common Stock, unless the gain is
attributable to a permanent establishment or fixed place of business maintained
by the holder in France.
Belgian tax considerations
Individual Eligible Belgian Holders holding the Common Stock as a private
investment and entities subject to legal entities tax are not subject to the
Belgian capital gains taxation on the disposal of the Common Stock.
Individual Eligible Belgian Holders may, however, be subject to a 33% tax
(to be increased with the municipal surcharge and the crisis contribution) if
the capital gain is deemed to be "speculative."
Individual Eligible Belgian Holders whose holding of Common Stock is
effectively connected with a business are taxable at the ordinary rates on any
capital gains realized on the disposal of Common Stock.
Belgian resident companies are not subject to capital gains taxation
provided that the dividends received on the shares qualify for the "dividend
received deduction" (except for the minimum holding requirement).
FRENCH ESTATE AND GIFT TAX
Under the estate tax convention between Belgium and France, a transfer of
Common Stock by reason of the death of an individual Eligible Belgian Holder
entitled to benefits under that convention will not be subject to French
inheritance tax, unless the decedent was domiciled in France at the time of his
or her death.
FRENCH WEALTH TAX
The French wealth tax (impot de solidare sur la fortune) does not apply to
an Eligible Belgian Holder.
BELGIAN INDIRECT TAXES
Stamp tax on securities transactions
In principle, a stamp tax is levied upon the subscription of shares of
Common Stock and the purchase and sale in Belgium of Common Stock through a
professional intermediary. The rate applicable to subscriptions of
B-5
<PAGE> 231
new shares of Common Stock is 0.35% but there is a limit of BEF 10,000 per
transaction. The rate applicable for secondary sales and purchases in Belgium of
Common Stock through a professional intermediary is 0.17% but there is a limit
of BEF 10,000 per transaction.
An exemption is available to professional intermediaries (e.g. credit
institutions), insurance companies, pension funds and collective investment
vehicles who are acting for their own account. A non-resident holder of Common
Stock who is acting for his own account will also be entitled to an exemption
from this stamp tax, provided that he delivers to the issuer or the professional
intermediary in Belgium, as the case may be, an affidavit confirming his
non-resident status in Belgium.
Tax on delivery of bearer securities
A tax is levied upon the physical delivery of Common Stock pursuant to
their subscription or their acquisition for consideration through a professional
intermediary. This tax is also due upon the delivery of Common Stock pursuant to
a withdrawal of these Common Stock from "open custody."
The tax is due, at the rate of 0.2%, on the sums payable by the subscriber
or the acquiror in case of subscription or acquisition or the sales value of the
Common Stock, as estimated by the custodian in case of withdrawal from "open
custody."
However, an exemption is available for deliveries to recognized
professional intermediaries (such as credit institutions) acting for their own
account. An exemption is also available for delivery of Common Stock, which are
held in "open custody", to a non-resident.
B-6
<PAGE> 232
======================================================
NO DEALER, SALESPERSON OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFERING COVERED BY THIS PROSPECTUS. IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, THE SECURITIES IN ANY
JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS UNLAWFUL TO MAKE SUCH OFFER
OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT THERE HAS
NOT BEEN ANY CHANGE IN THE FACTS SET FORTH IN THIS PROSPECTUS OR IN THE AFFAIRS
OF THE COMPANY SINCE THE DATE HEREOF.
-----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary..................... 1
Risk Factors........................... 9
Use of Proceeds........................ 24
Ratio of Earnings to Fixed Charges..... 24
Dividend Policy........................ 24
Dilution............................... 25
Capitalization......................... 26
Selected Historical Consolidated
Financial Data....................... 27
Supplemental Information -- Selected
Historical Financial Data............ 28
Management's Discussion and Analysis of
Financial Condition and Results of
Operations........................... 29
Business............................... 42
Management............................. 90
Executive Compensation and Other
Information.......................... 93
Certain Related Party Transactions..... 102
Principal Stockholders................. 105
Description of Certain Indebtedness.... 107
Description of the Bonds............... 109
Description of Capital Stock........... 143
Shares Eligible for Future Sale........ 149
Certain U.S. Tax Considerations........ 150
Selling Holders........................ 158
Plan of Distribution................... 159
Legal Matters.......................... 159
Experts................................ 159
Index to Financial Statements.......... F-1
Exhibit A -- Glossary of
Telecommunications Industry Terms.... A-1
Exhibit B -- Supplemental EASDAQ
Information.......................... B-1
</TABLE>
======================================================
======================================================
$144,787,000
8.75% SENIOR SUBORDINATED CONVERTIBLE BONDS DUE 2000
7,239,350 SHARES
OF COMMON STOCK OF
[GLOBAL TELESYSTEMS GROUP, INC. LOGO]
GLOBAL TELESYSTEMS GROUP, INC.
-------------------
PROSPECTUS
-------------------
FEBRUARY 27, 1998
======================================================
