<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 8, 1998.
REGISTRATION NO. 333-
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM S-4
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
---------------------
GLOBAL TELESYSTEMS GROUP, INC.
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 4813 94-3068423
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code No.) Identification No.)
</TABLE>
1751 PINNACLE DRIVE
NORTH TOWER -- 12TH FLOOR
MCLEAN, VA 22102
(703) 918-4500
(Address, including Zip Code, and telephone number, including area code,
of Registrant's principal executive offices)
---------------------
GRIER C. RACLIN
1751 PINNACLE DRIVE
NORTH TOWER -- 12TH FLOOR
MCLEAN, VA 22102
(703) 918-4573
(Name, address, including Zip Code, and telephone number, including area code,
of agent for service)
---------------------
Copies to:
<TABLE>
<S> <C>
ALFRED J. ROSS, JR. WILLIAM R. DOUGHERTY, ESQ.
SHEARMAN & STERLING SIMPSON, THACHER & BARTLETT
599 LEXINGTON AVENUE 99 BISHOPSGATE
NEW YORK, NY 10022-6069 LONDON, ECZM 3YH, ENGLAND
(212) 848-7056 (44) 171-422-4000
</TABLE>
---------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF THE SECURITIES TO THE
PUBLIC: As soon as practicable from time to time after the effective date of
this Registration Statement.
If the securities being registered on this Form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
---------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF
TITLE OF EACH CLASS OF SECURITIES AMOUNT TO OFFERING PRICE AGGREGATE REGISTRATION
TO BE REGISTERED BE REGISTERED(1) PER SHARE(2) OFFERING PRICE(2 AND 3) FEE
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, par value
$.10 per share................ 15,973,158 $31.04 $495,796,037 $137,832
- -------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Assumes that all Ordinary Shares (the "Esprit Shares") of Esprit Telecom
Group plc ("Esprit") are exchanged for shares of Common Stock (the "GTS
Common Stock") of Global TeleSystems Group, Inc. ("GTS") and that all ADSs
of Esprit (as defined herein (the "Esprit ADSs")) are exchanged for shares
of GTS Common Stock, each pursuant to the terms of the Offer described
herein. This Registration Statement relates to an Offer (the "Offer") by GTS
of 15,973,158 shares of GTS Common Stock for Esprit Shares and outstanding
Esprit ADSs evidenced by American Depositary Receipts. Each Esprit ADS
represents seven Esprit Shares. The number of shares of GTS Common Stock to
be registered hereby was determined by multiplying (i) 17,947,368 Esprit
ADSs by (ii) the exchange ratio for the Offer (i.e., 0.89 shares of GTS
Common Stock per Esprit ADS).
(2) Calculated pursuant to Rule 457(f) based on the value of the estimated
maximum number of Esprit Shares and Esprit ADSs to be acquired by GTS in the
Offer. The Esprit ADSs are traded on the NASDAQ National Market and on
EASDAQ. The proposed maximum aggregate offering price was determined as
follows: (i) the market value per share of the Esprit Shares (determined as
one-seventh of the market value per Esprit ADS) multiplied by the maximum
number of Esprit Shares which may be exchanged in the Offer described herein
for shares of GTS Common Stock, plus (ii) the market value per Esprit ADS,
multiplied by the number of Esprit ADSs which may be exchanged in the Offer
described herein for shares of GTS Common Stock. Pursuant to Rule 457(c),
the market value per Esprit ADS is based on the average of the bid and asked
price on the NASDAQ National Market on December 3, 1998.
(3) Estimated solely for the purposes of computing the registration fee in
accordance with Rule 457(f) under the Securities Act of 1933.
---------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
SUBJECT TO COMPLETION DATED DECEMBER 8, 1998
PRELIMINARY OFFER TO PURCHASE/PROSPECTUS
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of the securities to be issued in
connection with the acquisition offer or determined if this prospectus is
truthful or complete. Any representation to the contrary is a criminal offense.
The information in this prospectus is incomplete and may be changed. These
securities may not be sold until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus is not an offer
to sell these securities and it is not soliciting an offer to buy these
securities in any state where the offer or sale is not permitted.
There follows the text of the announcement released on December 8, 1998:
2
<PAGE> 3
08 DECEMBER 1998
NOT FOR RELEASE, PUBLICATION OR DISTRIBUTION IN WHOLE OR IN
PART IN OR INTO CANADA, AUSTRALIA OR JAPAN
- --------------------------------------------------------------------------------
GLOBAL TELESYSTEMS GROUP, INC. ("GTS")
PROPOSED RECOMMENDED OFFER FOR ESPRIT TELECOM GROUP PLC
("ESPRIT TELECOM")
o The Boards of GTS and Esprit Telecom announce that agreement has been
reached on the terms of a proposed recommended offer (the "Offer") to be
made by Bear Stearns, on behalf of GTS, to acquire all the issued and to be
issued share capital of Esprit Telecom including those shares represented
by Esprit Telecom ADSs.
o Subject to the satisfaction or, to the extent permitted, waiver of the
pre-conditions referred to below, the Offer will be made on the following
basis:
FOR EVERY ESPRIT TELECOM SHARE, 0.1271 NEW GTS SHARE
FOR EVERY ESPRIT TELECOM ADS, 0.89 NEW GTS SHARE
Based on the NASDAQ closing price of $41.75 per GTS Share on 07
December 1998, the Offer values each Esprit Telecom Share at $5.31
((pound)3.21) and each Esprit Telecom ADS at $37.16 ((pound)22.48)1.
o The Offer represents a premium of approximately 22.8% over the middle
market price of an Esprit Telecom ADS on NASDAQ at the close of business on
07 December 1998, being the last dealing day before the announcement of the
Offer.
o The Offer values the entire issued share capital of Esprit Telecom, fully
diluted for the exercise of all outstanding options, at approximately
$757.3 million ((pound)458.2 million).
o The New GTS Shares to be issued under the Offer will be validly issued and
fully paid and non-assessable and will rank pari passu in all respects with
the existing issued GTS Shares.
- -------------
(1) Exchange rate of (pound)1=$1.6530 based on the 07 December 1998 Noon Buying
Rate.
3
<PAGE> 4
o The Board of Esprit Telecom intends unanimously to recommend the Offer.
o Founded in 1992, Esprit Telecom is a facilities-based provider of
international and national telecommunications services with network and
sales office infrastructure in 30 cities in eight countries in Europe
generating a run rate of over one billion minutes of traffic per annum.
Esprit Telecom Networks Limited, an independent operations subsidiary of
Esprit Telecom, is currently building a 9,000 route kilometre SDH and DWDM
fibre optic network through six European countries. Esprit Telecom also has
links to Washington and New York via a transatlantic circuit owned by other
carriers.
o GTS is a leading independent owner and operator of telecommunications
companies throughout Europe. GTS has five primary lines of business: GTS
Carrier Services, which provides cross-border transport in Europe to other
telecommunications companies; GTS Access Services, which provides
facilities-based access services to businesses throughout Europe; GTS
Business Services - Western Europe, which offers voice, data, Internet and
other telecommunications services to businesses; GTS Business Services -
CIS, where GTS is an alternative provider of high quality
telecommunications services in Moscow, Kiev, St. Petersburg and other
cities in Russia and the CIS; and GTS Mobile Services - CIS, which operates
cellular businesses in Russia and Ukraine. Headquartered in the
metropolitan Washington DC area, GTS's affiliates have offices in London,
Brussels, Moscow, Budapest, Kiev, Prague and Paris.
o The combination of GTS and Esprit Telecom will assist both companies in
their mutual goals of becoming the pre-eminent providers of carriers'
carrier and business communications services throughout Europe. Together,
GTS and Esprit Telecom will have the largest independent cross border
carriers' carrier network in Europe and will have an extensive sales force
in 11 countries in Western Europe.
o The combined group is expected to have:
- A market capitalisation of approximately $4.1 billion2
- Latest quarter annualised consolidated revenues of approximately $482
million
- Approximately 3,000 employees
- Over 35,000 business customers in Western Europe
- A network with 9,200 route kilometres of high capacity, broadband
fibre-transmission facilities in service today
- A broad portfolio of business telecommunications services
- Operations in 11 countries in Western Europe
- -------------
(2) Market capitalisation assumes full conversion of all options, warrants, "in
the money" convertible debt and committed future share issues in respect of
certain acquisitions
4
<PAGE> 5
o The combined group will have (i) presence in 19 countries throughout
Europe; (ii) increased network capacity and resilience; (iii) 500 person
sales force, one of the largest among independent telecommunications
companies in Europe; (iv) ability to provide a wide array of service
offerings; and (v) increased management depth. Furthermore, the combined
group expects to benefit from reduced network operations costs, reduced
administrative costs, and capital expenditure savings.
o Esprit Telecom has operations in seven countries and nine major switch
sites. Together with NetSource Europe ASA, recently acquired by GTS, this
will give the combined group presence in Europe in the UK, Germany, France,
Italy, Spain, the Netherlands, Belgium, Ireland, Denmark, Sweden, Norway,
Austria, Switzerland, the Czech Republic, Hungary, Poland, Slovakia,
Ukraine and Russia. This pan-European presence provides an immediate
critical mass to GTS's existing GTS Business Services - Western Europe
unit, as well as providing an effective platform for entry and a built-in
potential customer base for GTS's CLEC business, GTS Access Services.
o GTS believes this combination should strengthen its position as the most
developed pan-European carriers' carrier, with a presence in 12 countries
and 20 cities throughout Europe and an operational 9,200 route kilometre
network. By the end of 1999, the Hermes Europe Railtel B.V. network is
planned to be deployed in 16 countries and 45 cities, totalling 18,000
route kilometres.
o Certain Esprit Telecom Securityholders have entered into irrevocable
undertakings to accept the Offer in respect of 65% of the issued share
capital of Esprit Telecom. These irrevocable undertakings will continue to
be binding even if a higher competing offer is made. The irrevocable
undertakings will lapse if there are certain material adverse changes in
the value of the GTS Group or in the event that specified deadlines in the
Offer timetable are not met. Further details of the irrevocable
undertakings are set out in Appendix 2.
o The posting of the Offer Document to Esprit Telecom Securityholders is
pre-conditional on:
- GTS obtaining requisite consents from Esprit Telecom Bondholders to the
change in control of Esprit Telecom resulting from the Offer; and
- the necessary registration statement with respect to the Offer becoming
effective under US Securities Law and the relevant approvals being
obtained from EASDAQ and the Commission Banque et Financier in Belgium.
Details regarding the proposals for satisfaction of the first pre-condition
set out above will be contained in documents to be sent to Esprit Telecom
Bondholders in due course.
5
<PAGE> 6
o A further announcement will be made as soon as practicable following the
satisfaction or, to the extent permitted, waiver by GTS of these
pre-conditions, or the determination by GTS that the pre-conditions will
not be satisfied or waived and accordingly that the Offer will not proceed.
o The Offer will be conditional, inter alia, on the approval of GTS's
shareholders and the announcement by NASDAQ and EASDAQ of their decision to
admit the New GTS Shares for quotation.
o The full conditions and certain terms of the Offer are set out in the
attached announcement together with further information on Esprit Telecom
and on GTS. Appendix 4 of the attached announcement contains definitions of
certain expressions used in this announcement.
This summary should be read in conjunction with and is subject to the full text
of the attached announcement.
ENQUIRIES
GTS Telephone: 001 (703) 918 4548
Robert Capozzi
Bear, Stearns International Limited Telephone: +44 (0)171 516 6937
Richard Strang
Esprit Telecom Telephone: +44 (0)118 951 4010
Glenn Manoff
Lehman Brothers International (Europe) Telephone: +44 (0)171 601 0011
Brian Robertson
Simon Costa
There will be an analysts' conference call at 2.30pm (London time) today.
Bear Stearns, which is regulated by The Securities and Futures Authority Limited
in the conduct of its investment business in the United Kingdom, is acting
exclusively for GTS and is acting for no one else in connection with the Offer
and will not be responsible to anyone other than GTS for providing the
protections afforded to customers of Bear Stearns nor for providing advice in
relation to the Offer.
Lehman Brothers, which is regulated by The Securities and Futures Authority
Limited in the conduct of its investment business in the United Kingdom, is
acting exclusively for Esprit Telecom and is acting for no one else in
connection with the Offer and will not be responsible to anyone other than
Esprit Telecom for providing the protections afforded to customers of Lehman
Brothers nor for providing advice in relation to the Offer.
6
<PAGE> 7
Copies of this announcement are not being and must not be, mailed or otherwise
distributed or sent in or into Canada, Australia or Japan and persons receiving
this announcement (including custodians, nominees and trustees) must not
distribute or send it in or into Canada, Australia or Japan.
7
<PAGE> 8
08 DECEMBER 1998
NOT FOR RELEASE, PUBLICATION OR DISTRIBUTION IN WHOLE OR IN
PART IN OR INTO CANADA, AUSTRALIA OR JAPAN
- --------------------------------------------------------------------------------
GLOBAL TELESYSTEMS GROUP, INC. ("GTS")
PROPOSED RECOMMENDED OFFER FOR ESPRIT TELECOM GROUP PLC
("ESPRIT TELECOM")
INTRODUCTION
The Boards of GTS and Esprit Telecom announce that agreement has been reached on
the terms of a proposed recommended offer ( the "Offer") to be made by Bear
Stearns, on behalf of GTS, to acquire all the issued and to be issued share
capital of Esprit Telecom including those shares represented by ADSs.
THE OFFER
Subject to the satisfaction or waiver of the pre-conditions referred to below,
the Offer will be made on the following basis:
FOR EVERY ESPRIT TELECOM SHARE, 0.1271 NEW GTS SHARE
FOR EVERY ESPRIT TELECOM ADS, 0.89 NEW GTS SHARE
Based on the NASDAQ closing price of $41.75 per GTS Share on 07 December 1998,
the Offer values each Esprit Telecom Share at $5.31 ((pound)3.21), each Esprit
Telecom ADS at $37.16 ((pound)22.48) and the entire issued share capital of
Esprit Telecom at approximately $757.3 million ((pound)458.2 million). This
represents a premium of approximately 22.8% over the middle market price of an
Esprit Telecom ADS on NASDAQ at the close of business on 07 December 1998, being
the last dealing day before the announcement of the Offer.2
The New GTS Shares to be issued in respect of the Offer will be validly issued
and fully paid and non-assessable and will rank pari passu in all respects with
the existing issued GTS Shares.
- -------------
(2) Exchange rate of (pound)1=$1.6530 based on the 07 December 1998 Noon Buying
Rate.
8
<PAGE> 9
Application will be made to NASDAQ and EASDAQ for the New GTS Shares issued
pursuant to the Offer to be admitted to NASDAQ and EASDAQ for quotation. Further
details on settlement, listing and dealing will be included in the Offer
Document to be sent to Esprit Telecom Securityholders and GTS Shareholders in
due course, following the satisfaction or, to the extent permitted, waiver of
the pre-conditions.
Full acceptance of the Offer, assuming exercise of options under the Esprit
Telecom Share Option Schemes while the Offer remains open for acceptance (and
upon the exercise of options rolled over into options over GTS Shares and
committed future share issues in respect of certain acquisitions), will result
in the issue of approximately 18.1 million New GTS Shares (which share capital
is taken to include conversions of options, warrants and "in the money"
convertible debt), representing 18.4% of the enlarged GTS share capital.
The Esprit Telecom Securities will be acquired by GTS fully paid and free from
all liens, equities, charges, encumbrances and other interests and together with
all rights now or hereafter attaching thereto, including the right to receive
and retain all dividends and other distributions declared, made or paid
hereafter.
PRE-CONDITIONS
The posting of the Offer Document to Esprit Telecom Securityholders is
pre-conditional on:
- - GTS obtaining requisite appropriate consents from Esprit Telecom
Bondholders to the change in control of Esprit Telecom resulting from the
Offer; and
- - the necessary registration statement with respect to the Offer becoming
effective under US Securities Law and the relevant approvals being obtained
from EASDAQ and the Commission Banque et Financier in Belgium.
Details regarding the proposals for satisfaction of the first pre-condition set
out above will be contained in documents to be sent to Esprit Telecom
Bondholders in due course.
Subject to satisfaction or, to the extent permitted, waiver of the
pre-conditions, the Offer will be made on the terms and subject to the
conditions set out in paragraph 2 of Appendix 1 and the further terms which will
be set out in full in the Offer Document.
IRREVOCABLE UNDERTAKINGS
Certain Esprit Telecom Securityholders have entered into irrevocable
undertakings to accept the Offer in respect of, in aggregate, 81,968,270 Esprit
Telecom Shares (including those represented by Esprit Telecom ADSs) beneficially
owned by them. Together, these represent 65% of the issued share capital of
Esprit Telecom. These irrevocable undertakings will continue to be binding even
if a higher competing offer is made. The irrevocable undertakings will lapse if
there are certain material adverse changes in the value of the GTS Group or in
the event that specified deadlines in the Offer timetable are not met. Further
details of the irrevocable undertakings are set out in Appendix 2.
9
<PAGE> 10
Save for the irrevocable undertakings referred to above, no member of the GTS
Group nor, so far as GTS is aware, any party acting in concert (as defined in
the City Code) with GTS owns or controls any Esprit Telecom Securities or holds
any options to purchase Esprit Telecom Securities or has received any
irrevocable commitments to accept the Offer or has entered into any derivative
contracts referenced to Esprit Telecom Securities which remain outstanding. In
the interest of secrecy, GTS has not made any enquiries in this respect of
certain parties who may be deemed by the Panel to be acting in concert with it
for the purposes of the Offer.
SHARE OPTION SCHEMES
The Offer will extend to any Esprit Telecom Securities unconditionally allotted
or issued whilst the Offer remains open for acceptance (or prior to such earlier
date, not being earlier than the Initial Closing Date, as GTS may, subject to
the City Code, decide) pursuant to the exercise of options under the Esprit
Telecom Share Option Schemes or otherwise.
GTS will give holders of options under the Esprit Telecom Share Option Schemes
the ability to roll over their options into options over GTS Shares. Esprit
Telecom has agreed that (subject to there being no adverse tax consequences for
Esprit Telecom optionholders or GTS giving a satisfactory indemnity) no further
amendments will be made to the Esprit Telecom Share Option Schemes which would
cause options to be exercised at a date earlier than the date they would
otherwise become exercisable.
MANAGEMENT AND EMPLOYEES
Existing employment rights, including pension rights, of the management and
employees of the members of the Esprit Telecom Group will be fully safeguarded.
David Oertle, CEO of Esprit Telecom, will remain with Esprit Telecom through the
transition. He will continue to work with Esprit Telecom towards its successful
integration within the GTS Group. At the same time, Mr Oertle will assume a
senior advisory role working directly with Gerald W. Thames, GTS's President and
CEO, as a key contributor to the development of the corporation's strategic
vision and goals. Roy Merritt, CFO of Esprit Telecom, Hans-Peter Kohlhammer,
Group Managing Director of Sales and Marketing, Jim Reynolds, Chief Operations
Officer, Michael Potter, Chief of Staff and David Reibel, General Counsel and
Director of Corporate Affairs, will continue in their current roles within
Esprit Telecom. Walter Anderson, the former Chairman of Esprit Telecom, has
agreed to serve as a special consultant to the GTS board of directors.
BACKGROUND TO AND REASONS FOR THE OFFER
The boards of GTS and Esprit Telecom believe their businesses are complementary
and that a range of economic, strategic and operational benefits will arise from
combining them. The combination of GTS and Esprit Telecom will assist both
companies in their mutual goals of becoming the pre-eminent providers of
carriers' carrier and business communications services throughout Europe.
Together, GTS and Esprit Telecom will have the largest independent cross border
carriers' carrier network in Europe and will have an extensive sales force in 11
countries in Western Europe.
10
<PAGE> 11
The combined group is expected to have:
o A market capitalisation of approximately $4.1 billion1
o Latest quarter annualised consolidated revenues of approximately $482
million
o Approximately 3,000 employees
o Over 35,000 business customers in Western Europe
o A network with 9,200 route kilometres of high capacity, broadband
fibre-transmission facilities in service today
o A broad portfolio of business telecommunications services
o Operations in 11 countries in Western Europe
GTS is dedicated to serving three large telecommunications market segments
within Western Europe: business telecommunications services, carriers' carrier
services, and CLEC services providing voice, data and Internet Protocol (IP)
based services. Esprit Telecom, one of the leading independent providers of
business and carriers' carrier telecommunications services in Europe, will
greatly enhance the combined company's position as a leader in the first two
rapidly growing European markets. GTS has also recently acquired several other
companies including Ebone A/S (an internet transport provider) and NetSource
Europe ASA (a long distance provider) to augment its presence in Europe.
The combined entity will have (i) presence in 19 countries throughout Europe;
(ii) increased network capacity and resilience; (iii) 500 person sales force,
one of the largest among independent telecommunications companies in Europe;
(iv) ability to provide a wide array of service offerings; and (v) increased
management depth. Furthermore, the companies expect to benefit from reduced
network operations costs, reduced administrative costs, and capital expenditure
savings.
Esprit Telecom has operations in seven countries and nine major switch sites.
Together with NetSource Europe ASA, recently acquired by GTS, this will give the
combined group a presence in Europe in the UK, Germany, France, Italy, Spain,
the Netherlands, Belgium, Ireland, Denmark, Sweden, Norway, Austria,
Switzerland, the Czech Republic, Hungary, Poland, Slovakia, Ukraine, and Russia.
This pan-European presence provides an immediate critical mass to GTS's existing
GTS Business Services - Western Europe unit, as well as providing an effective
platform for entry and a built-in potential customer base for GTS's CLEC
business, GTS Access Services. Both GTS Business Services Western Europe and GTS
Access Services intend to lease transport capacity from Hermes Europe Railtel
B.V. under terms no more favourable than those offered to unaffiliated
telecommunications providers.
- -------------
(1) Market capitalisation assumes full conversion of all options, warrants,
"in the money" convertible debt and committed share issues in respect of
certain acquisitions
11
<PAGE> 12
GTS believes this combination should strengthen its position as the most
developed pan-European carriers' carrier, with a presence in 12 countries and 20
cities throughout Europe and an operational 9,200 route kilometre network. By
the end of 1999, the Hermes Europe Railtel B.V. network is planned to be
deployed in 16 countries and 45 cities, totalling 18,000 route kilometres.
INFORMATION ON ESPRIT TELECOM
Founded in 1992, Esprit Telecom is a facilities-based provider of international
and national telecommunications services with network and sales office
infrastructure in 30 cities in eight countries in Europe generating a run rate
of over one billion minutes of traffic per annum. Esprit Telecom Networks
Limited, an independent operations subsidiary of Esprit Telecom, is currently
building a 9,000 route kilometre SDH and DWDM fibre optic network through six
European countries. Esprit Telecom also has links to Washington and New York via
a transatlantic circuit owned by other carriers.
Esprit Telecom currently offers telecommunications services and products in four
areas: (i) retail telecommunications services for corporate customers for global
destinations either directly, via dedicated leased lines linked to the Esprit
Telecom network, or indirectly on a switched basis. This includes enhanced
services such as toll free services, calling cards, and switched data services
such as ISDN; (ii) carrier's carrier services based on the Esprit Telecom
Networks business (iii) wholesale services, primarily consisting of long
distance traffic termination services for other telecommunications carriers; and
(iv) network management, access and termination services to service providers,
such as calling card companies, and to resellers.
As of December 1998, Esprit Telecom provided telecommunications services in the
UK, Germany, The Netherlands, France, Spain, Belgium and Italy. The company was
awarded one of the first operating licences in Spain on 03 December 1998
allowing for provision of services in the regions in which it currently
operates. Esprit Telecom now has operator licences in the UK, Belgium, The
Netherlands, France, Spain and Germany. Esprit Telecom acquired the business of
PLUSNET Gesellschaft Fur Netzwerk GmbH, a major switch-based German
telecommunications services provider, in May 1998.
Formed in November 1998, Esprit Telecom Networks is an independent business unit
of Esprit Telecom. Esprit Networks builds, manages and sells carrier services
along Esprit Telecom's pan-European broadband fibre network. The super-high
capacity optical fibre network will run at speeds of 2.5 Gbits/second (STM-16)
to 10 Gbits/second (STM-64) and uses advance SDH transmission and DWDM equipment
supplied by Nortel Networks. The London-Paris network, measuring 1,275 route
kilometres, became operational in April.
The France-Belgium-Netherlands-UK network, measuring 1,230 route kilometres, was
completed in October 1998 and is expected to be operational in January 1999. The
Netherlands-Germany-France network, the French national network, and the Spanish
national network, measuring a combined 7,220 route kilometres, are expected to
be completed by mid-1999.
12
<PAGE> 13
On 20 November 1998, Esprit Telecom announced preliminary results for the year
ended 30 September 1998. These results showed that the Esprit Telecom Group
achieved turnover of (pound)82.6 million (1997: (pound)45.5 million) and losses
before tax and exceptional items of (pound)42.1 million (1997: (pound)10.9
million). Reported loss per share was (pound)0.34 in 1998 (1997: (pound)0.10).
Net liabilities as at 30 September 1998 were (pound)7.6 million (1997: net
assets of (pound)31.4 million). Esprit Telecom had 7,657 customers as of 30
September 1998 and recorded 262 million minutes of traffic in the three months
ended 30 September 1998.
INFORMATION ON GTS
Through Hermes Europe Railtel B.V., GTS is developing and operating the initial
segments of a pan-European high-capacity fibre optic network that is designed to
interconnect a majority of the largest Western and Central European cities. As
of April 30, 1998, Hermes Europe Railtel B.V.'s network linked Brussels,
Antwerp, Rotterdam, Amsterdam, London, Paris, Frankfurt, Strasbourg, Zurich, and
Geneva. The full 18,000 kilometre network is expected to be fully operational
during the year 2000.
GTS is a leading independent owner and operator of telecommunications companies
throughout Europe. GTS has five primary lines of business: GTS Carrier Services,
which provides cross-border transport in Europe to other telecommunications
companies; GTS Access Services, which provides facilities-based access services
to businesses throughout Europe; GTS Business Services - Western Europe, which
offers voice, data, Internet and other telecommunications services to
businesses; GTS Business Services - CIS, where GTS is an alternative provider of
high quality telecommunications services in Moscow, Kiev, St. Petersburg and
other cities in Russia and the CIS; and GTS Mobile Services - CIS, which
operates cellular businesses in Russia and Ukraine. Headquartered in the
metropolitan Washington DC area, GTS's affiliates have offices in London,
Brussels, Moscow, Budapest, Kiev, Prague and Paris.
In the financial year ended 31 December 1997, the GTS Group achieved net
revenues of $47.1 million (1996: $24.1 million), and losses before tax and
exceptional items of $114.5 million (1996: $66.6 million). Reported losses per
share were $3.26 in 1997 (1996: $2.33). Shareholders' equity as at 31 December
1997 was $27.0 million (1996: $113.7 million).
In the nine months ended 30 September 1998, GTS achieved net revenues of $117.3
million and losses before tax and exceptional items of $86.0 million.
SPECIAL MEETING OF GTS SHAREHOLDERS
The acquisition of Esprit Telecom requires, inter alia, the approval of the
holders of a majority of the GTS Shares and a special meeting of GTS will be
held for this purpose. A proxy statement will be sent to GTS Shareholders
convening the special meeting in due course.
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<PAGE> 14
FINANCIAL EFFECTS OF ACCEPTANCE
The financial effects of acceptance of the Offer are set out in Appendix 3.
OFFER DOCUMENT
Subject to the satisfaction or, to the extent permitted, waiver of the
pre-conditions referred to above, Bear Stearns, on behalf of GTS, will despatch
the Offer Document in due course.
RECOMMENDATIONS
The Directors of Esprit Telecom, who have been so advised by Lehman Brothers,
consider that the terms of the Offer are fair and reasonable. In providing
advice to the Directors of Esprit Telecom, Lehman Brothers has taken into
account the Directors' commercial assessment of the Offer. Accordingly, the
Directors of Esprit Telecom intend unanimously to recommend Esprit Telecom
Securityholders to accept the Offer.
In the opinion of the Directors of GTS, the Offer is in the best interests of
GTS Shareholders as a whole. Accordingly, they intend unanimously to recommend
GTS Shareholders to vote in favour of the resolutions to be proposed at the
special meeting of GTS in connection with the Offer which will be convened in
due course.
GENERAL
Fractions of New GTS Shares will not be allotted or issued to persons accepting
the Offer but will be aggregated and sold in the market and the net proceeds of
sale will be paid to the persons entitled thereto except that individual cash
entitlements in amounts of less than $2 will not be paid but will be retained
for the benefit of the combined group.
The Esprit Telecom Securities which are the subject of the Offer will be
acquired fully paid and free from all liens, charges, equitable interests,
encumbrances, rights of pre-emption and other third party rights or interests of
any nature whatsoever created by GTS and together with all rights now or
hereafter attached thereto, including the right to receive and retain all
dividends and other distributions declared, made or paid hereafter.
The New GTS Shares issued pursuant to the Offer will be credited as fully paid
and will rank pari passu in all respects with the existing GTS Shares, including
the right to receive all dividends and other distributions declared, made or
paid after the Offer becomes wholly unconditional.
This announcement does not constitute an offer or invitation to purchase or sell
any securities.
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<PAGE> 15
Bear Stearns, which is regulated by The Securities and Futures Authority Limited
in the conduct of its investment business in the United Kingdom, is acting
exclusively for GTS and is acting for no one else in connection with the Offer
and will not be responsible to anyone other than GTS for providing the
protections afforded to customers of Bear Stearns nor for providing advice in
relation to the Offer.
Lehman Brothers, which is regulated by The Securities and Futures Authority
Limited in the conduct of its investment business in the United Kingdom, is
acting exclusively for Esprit Telecom and is acting for no one else in
connection with the Offer and will not be responsible to anyone other than
Esprit Telecom for providing the protections afforded to customers of Lehman
Brothers nor for providing advice in relation to the Offer.
The availability of the Offer to persons not resident in the UK or US may be
affected by the laws of the relevant jurisdiction. Persons who are not resident
in the UK or US should inform themselves about and observe any applicable
requirements. Further details in relation to overseas shareholders will be
contained in the Offer Document.
The Offer will not be made, directly or indirectly in, nor is the Offer capable
of acceptance from, Canada, Australia or Japan or by use of the mails of, or by
any means or instrumentality of inter-state or foreign commerce of, or any
facilities of a national securities exchange of, Canada, Australia or Japan and
cannot be accepted by any such use, means or instrumentality or otherwise from
within Canada, Japan or Australia. This includes, but is not limited to, the
post, facsimile transmission, telex and telephones. Accordingly, copies of this
announcement are not being, and must not be, mailed or otherwise distributed or
sent in or into, Canada, Japan or Australia. Furthermore, the relevant
clearances have not been obtained and will not be obtained, in relation to the
New GTS Shares from the Securities Commission of any province in Canada; no
prospectus in relation to the New GTS Shares has been, or will be, lodged with
or registered by the Australian Securities Commission; nor have any steps been
taken to enable the New GTS Shares to be offered in Japan in compliance with
applicable securities laws of Japan. Accordingly, the New GTS Shares may not be
offered, sold, resold or delivered, directly or indirectly, into Canada,
Australia or Japan. Persons receiving this announcement, (including custodians,
nominees and trustees) must not distribute or send it in, into, or from Canada,
Japan or Australia. Notwithstanding the restrictions in the previous two
paragraphs, GTS will retain the right to permit the Offer to be accepted and any
sale of securities to be completed if, in its sole discretion, it is satisfied
that the transaction in question is exempt from or not subject to the
legislation or regulation giving rise to the restrictions in question.
Appendix 4 contains definitions of the terms used in this announcement.
This announcement includes forward-looking statements that involve risk and
uncertainty. Although each of GTS and Esprit Telecom believes their respective
expectations reflected in such forward-looking statements are based on
reasonable assumptions, no assurance can be given that such projections will be
fulfilled. Any such forward-looking statement must be considered along with
knowledge that actual events or results may vary materially from such
predictions due to, among other things, political, economic or legal changes in
the
15
<PAGE> 16
markets in which GTS or Esprit Telecom, as the case may be, does business,
competitive developments or risks inherent in each company's business plan.
Readers are referred to the documents filed by GTS and Esprit Telecom with the
SEC, specifically the most recent reports filed under the Securities Act of 1933
and the Securities Exchange Act of 1934, which identify important risk factors.
The Panel wishes to draw to the attention of member firms of NASDAQ and EASDAQ
certain UK dealing disclosure requirements following the announcement of GTS's
intention to make an offer for Esprit Telecom. This announcement commenced an
offer period for the purposes of the City Code, which is published and
administered by the Panel. An offer period is deemed to commence at the time
when an announcement is made of a proposed or possible offer, with or without
terms. Esprit Telecom and GTS have equity securities traded on NASDAQ and
EASDAQ.
The above disclosure requirements are set out in Rule 8 of the City Code. In
particular, Rule 8.3 requires public disclosure of dealings during an offer
period by persons who own or control, or who would as a result of any
transaction own or control, 1% or more of any class of relevant securities of
GTS or Esprit Telecom. In the case of the offer for Esprit Telecom, this
requirement will apply until the offer becomes or is declared wholly
unconditional or lapses.
Disclosure should be made on an appropriate form before 12 noon (London time) on
the business day following the date of the dealing transaction. These
disclosures should be sent to the Panel (fax number: +44(0)-171-256 9386).
Copies of appropriate disclosure forms may be obtained on request by faxing Bear
Stearns on +44(0)171-516 6937 (Richard Strang).
The Panel requests that member firms advise those of their clients who wish to
deal in the securities of GTS and/or Esprit Telecom, in the US and Belgium, that
they may be affected by these requirements. If there is any doubt as to their
application, the Panel should be consulted (telephone number: +44(0)-171-382
9026, fax number: +44(0)-171-638 1554).
The attention of the Esprit Telecom Securityholders not resident in the UK or
the US is drawn to the relevant provisions of the formal Offer Document which,
subject to the satisfaction or waiver of the pre-conditions referred to above,
will be despatched on behalf of GTS in due course.
16
<PAGE> 17
APPENDIX 1
PRE-CONDITIONS AND CONDITIONS TO THE OFFER
1. PRE-CONDITIONS
The posting of the Offer Document will be conditional upon:
(A) on or prior to 29 January 1998, valid consents to amendments to Section
4.15 of the Indenture dated as of 18 December 1997, between the Company and
The Bank of New York (and the corresponding provisions of the global and
definitive dollar and deutschmark notes related thereto) and Section 4.15
of the Indenture dated as of 24 June 1998 between the Company and The Bank
of New York (and the corresponding provisions of the global and definitive
dollar and deutschmark notes related thereto) shall have been obtained from
holders of the requisite percentage of each series of notes issued
thereunder to provide that the provisions thereof would not apply to any
"Change of Control" (as defined therein) resulting from the transactions
contemplated by the Offer, subject to the terms and conditions specified in
such amendment, such amendment to be effective following the Offer becoming
wholly unconditional; and
(B) on or prior to 15 April 1999, a registration statement with respect to
the New GTS Shares having been declared and remaining effective under the
US Securities Law and no stop order suspending the effectiveness of such
registration statement having been issued and no proceeding for that
purpose having been initiated or threatened by the SEC; and
(C) on or prior to 15 April 1999, the relevant approvals being obtained
from EASDAQ and the Commission Banque et Financier in Belgium.
GTS reserves the right to waive, in whole only, pre-condition (A) above on or
prior to 29 January 1998.
2. CONDITIONS
The Offer will comply with the US federal securities laws (except to the extent
that any exemptive relief has been granted by the SEC) and the applicable rules
and regulations of the NASDAQ and EASDAQ markets and any other relevant
regulatory bodies and the City Code (except to the extent of any dispensation,
waiver or exemption granted by the appropriate body or (as the case may be) the
Panel). The Offer will be governed by English law and will be subject to the
jurisdiction of the courts of England and to the terms and conditions set out
below, in the Offer Document and the related acceptance forms.
17
<PAGE> 18
The Offer will be subject to the following conditions:
(A) valid acceptances being received (and not, where permitted, withdrawn) by
not later than the Initial Closing Date in respect of not less than 90% (or
such lesser percentage as GTS may decide) in nominal value of Esprit
Telecom Securities to which the Offer relates, provided that this condition
will not be satisfied unless GTS (and/or any of its wholly-owned
subsidiaries) shall have acquired, or agreed to acquire, whether pursuant
to the Offer or otherwise, Esprit Telecom Securities carrying, in
aggregate, more than 50% of the voting rights then normally exercisable at
general meetings of Esprit Telecom and provided further that this condition
may only be treated as satisfied at a time when all of the conditions (B)
to (K) have either been satisfied or, to the extent permitted, waived.
For the purposes of this condition:
(i) Esprit Telecom Securities which have been unconditionally
allotted shall be deemed to carry the voting rights they will carry
upon being entered in the register of members of Esprit Telecom;
and
(ii) the expression "Esprit Telecom Securities to which the Offer
relates" means (i) Esprit Telecom Securities unconditionally
allotted or issued on or before the date the Offer is made and (ii)
Esprit Telecom Securities unconditionally allotted or issued after
that date but before the time at which the Offer ceases to be open
for acceptance (or such earlier date, not being earlier than the
date on which the Offer becomes unconditional as to acceptances or,
if later, the Initial Closing Date, as GTS may, subject to the City
Code, decide) but excluding any Esprit Telecom Securities which, on
the date the Offer is made, are held or (otherwise than under such
a contract as is described in s.428(5) Companies Act 1985)
contracted to be acquired by GTS and/or its associates (within the
meaning of s.430 E Companies Act 1985);
(B) the approval by holders of a majority of GTS Shares of such resolution(s)
as may be necessary or desirable to approve, effect and implement the issue
of New GTS Shares for the purposes of the Offer and the acquisition by GTS
of Esprit Telecom;
(C) the New GTS Shares to be issued pursuant to the Offer having been approved
for listing on NASDAQ and EASDAQ subject to official notice of issuance of
such New GTS Shares;
(D) no stop order suspending the effectiveness of the registration statement
with respect to the New GTS Shares having been issued and no proceeding for
that purpose having been initiated or threatened by the SEC;
18
<PAGE> 19
(E) no Relevant Authority having decided to take, institute, implement or
threaten any action, proceedings, suit, investigation, enquiry or
reference, or made, proposed or enacted any statute, regulation, order or
decision, or taken any other steps which would or could reasonably be
expected to:
(i) make the Offer, or its implementation, or the proposed
acquisition of any Esprit Telecom Securities by any member of the
Wider GTS Group or any matter arising therefrom or relating
thereto, void, illegal or unenforceable under the laws of any
relevant jurisdiction or otherwise materially, directly or
indirectly, restrain, prohibit, restrict or delay the Offer, its
implementation or such proposed acquisition by any member of the
Wider GTS Group or any matter arising therefrom or relating thereto
or impose additional conditions or obligations with respect
thereto, or otherwise challenge or interfere therewith in any such
case to a materially adverse extent;
(ii) result in a material delay in the ability of any member of the
Wider GTS Group, or render any member of the Wider GTS Group
unable, to acquire all or some of the Esprit Telecom Securities or
other securities in Esprit Telecom or require, prevent or
materially delay a divestiture by any member of the Wider GTS Group
of any such shares or securities;
(iii) require the divestiture by GTS or any member of the Wider GTS
Group or any member of the Wider Esprit Telecom Group of all or any
material portion of their respective businesses, assets or
properties or impose any material limitation on the ability of any
of them to conduct all or any material portion of their respective
businesses or own all or any material portion of their respective
assets or properties;
(iv) impose any material limitation on the ability of GTS or any
other member of the Wider GTS Group or of the Wider Esprit Telecom
Group to acquire, or to hold or exercise effectively, directly or
indirectly, any rights of ownership in respect of shares or other
securities in any member of the Wider Esprit Telecom Group or to
exercise management control over Esprit Telecom or any other member
of the Wider Esprit Telecom Group which in any case is material in
the context of the Esprit Telecom Group taken as a whole;
(v) otherwise materially adversely affect the business, profits or
prospects of any member of the Wider Esprit Telecom Group or, as a
consequence of the Offer, any members of the Wider GTS Group;
(vi) require any member of the Wider GTS Group or any member of the
Wider Esprit Telecom Group to acquire or offer to acquire any
shares or other securities in any member of the Wider Esprit
Telecom Group owned by any third party where any such acquisition
or offer is material in the context of the Esprit Telecom Group
taken as a whole;
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<PAGE> 20
(vii) to an extent which is material in the context of the Esprit
Telecom Group taken as a whole result in any member of the Wider
Esprit Telecom Group ceasing to be able to carry on business under
the name which it presently does so; or
(viii) to an extent which is material in the context of the Esprit Telecom
Group taken as a whole, result in any member of the Wider GTS Group
having to dispose of any shares or other securities in any member
of the Wider Esprit Telecom Group or the Wider GTS Group;
and all applicable waiting and other time periods during which any Relevant
Authority could decide to take, institute, implement or threaten any such
action, proceeding, suit, investigation, enquiry or reference or otherwise
intervene having expired, lapsed or been terminated;
(F) in each case with such exceptions as would not be material in the
context of the Esprit Telecom Group taken as a whole or the Offer, all
Authorisations reasonably deemed necessary or appropriate for or in respect
of the Offer and the proposed acquisition of any Esprit Telecom Securities
or other securities in, or control of, Esprit Telecom by the Wider GTS
Group, or which are necessary for any member of the Wider Esprit Telecom
Group to carry on its business, having been obtained in terms and in a form
satisfactory to GTS from all appropriate Relevant Authorities or other
bodies whom any member of the Wider GTS Group or the Wider Esprit Telecom
Group has entered into contractual arrangements and all such Authorisations
remaining in full force and effect at the time at which the Offer becomes
otherwise unconditional and all appropriate waiting periods (including
extensions thereof) under any applicable legislation and regulations of any
jurisdiction having expired, lapsed or been terminated and there being no
intimation or notice of an intention to revoke or not to renew any of the
same having been received, in each case as may be necessary in connection
with the Offer under the laws or regulations of any jurisdiction and all
necessary statutory or regulatory obligations in connection with the Offer
and its implementation in any relevant jurisdiction having been complied
with;
(G) save as disclosed in the annual report and accounts of Esprit Telecom
for the financial year ended 30 September 1997 or in any SEC registration,
submission or filing or in the preliminary results of Esprit Telecom for
the year ended 30 September 1998 announced on 20 November 1998 or announced
at or before 8.00am (London time) on 08 December 1998 through EASDAQ (or at
or before 4.00pm (New York time) on 07 December 1998 through NASDAQ) or as
disclosed in writing to GTS specifically for the purposes of these
conditions at or before 8.00am (London time) on 08 December 1998 (such
information being "Disclosed") there being no provision of any arrangement,
agreement, licence, permit, franchise
20
<PAGE> 21
or other instrument to which any member of the Wider Esprit Telecom Group
is a party or by or to which any such member or any of their assets is or
are or may be bound, entitled or subject or any circumstance which, as a
consequence of the making of the Offer or the acquisition or proposed
acquisition by any member of the Wider GTS Group of some or all of the
share capital or other securities in Esprit Telecom or because of change in
control or management of Esprit Telecom or otherwise, might reasonably
result in, to an extent which is material in the context of the Esprit
Telecom Group, taken as a whole:
(i) any monies borrowed by or other indebtedness (actual or contingent)
of any member of the Wider Esprit Telecom Group which is not
already repayable on demand being or becoming repayable or being
capable of being declared repayable immediately or prior to the
stated maturity date or repayment date or the ability of any such
member to borrow monies or incur any indebtedness being withdrawn
or inhibited;
(ii) the creation of any mortgage, charge or other security interest
over the whole or any material part of the business, property or
assets of any member of the Wider Esprit Telecom Group or any such
security (whenever arising or having arisen) becoming enforceable;
(iii) any such arrangement, agreement, licence, permit, franchise or
other instrument, or the rights, liabilities, obligations or
interests or business of any member of the Wider Esprit Telecom
Group under any such arrangement, agreement, licence, permit,
franchise or other instrument, being terminated or adversely
modified or adversely affected or any material action being taken
or any onerous obligation arising thereunder;
(iv) otherwise than in the ordinary course of business, any assets or
interest of any member of the Wider Esprit Telecom Group being or
falling to be disposed of or charged or any right arising under
which any such asset or interest could be required to be disposed
of or charged;
(v) the interest or business of any member of the Wider GTS Group or
the Wider Esprit Telecom Group in or with any person, firm, company
or body (or any arrangement or arrangements relating to such
interest or business) being terminated or adversely modified or
affected;
(vi) any member of the Wider Esprit Telecom Group ceasing to be able to
carry on business under any name under which it presently does so;
(vii) the value of or the financial or trading position or prospects of
any member of the Wider Esprit Telecom Group being materially
prejudiced or adversely affected; or
21
<PAGE> 22
(viii) any material restriction on any member of the Wider Esprit
Telecom Group or the Wider GTS Group being able to carry on
business as it presently does so or to deal with any person, firm,
company or body;
(H) save as Disclosed (as defined in condition (G) above) no member of the
Wider Esprit Telecom Group having since 31 March 1998:
(i) issued, agreed or authorised or proposed the issue of
additional shares of any class, or securities convertible into, or
rights, warrants or options to subscribe for or acquire, any such
shares or convertible securities (save for the exercise of options
under the Esprit Telecom Share Option Schemes);
(ii) recommended, declared, paid or made or proposed to
recommend, declare pay or make any bonus, dividend or other
distribution;
(iii) otherwise than in the ordinary course of business merged with
any body corporate or acquired or disposed of, or transferred,
mortgaged or charged or created any security interest over, any
assets or any right, title or interest in any asset (including
shares and trade investments), or authorised, proposed or announced
any intention to propose any merger, demerger, acquisition,
disposal, transfer, mortgage, charge or security interest but only
if, in the case of a member of the Wider Esprit Telecom Group which
is not a member of the Esprit Telecom Group in each such case to
the extent material;
(iv) issued, authorised or proposed the issue of any debentures or
incurred or increased any indebtedness or contingent liability in
any case to an extent which is material in the context of the
Esprit Telecom Group, taken as a whole and not in the ordinary
course of business as presently carried on;
(v) purchased, redeemed or repaid or announced any proposal to
purchase, redeem or repay any of its own shares or other securities
or redeemed or reduced or made any other change to any part of its
share capital in any case to an extent which is material in the
context of the Esprit Telecom Group, taken as a whole;
(vi) entered into, or varied, or authorised, proposed or announced
its intention to enter into or vary any contract, transaction,
arrangement or commitment (whether in respect of capital
expenditure or otherwise) which is of a long-term, onerous or
unusual nature or magnitude and not in the ordinary course of
business as presently carried on, or which involves or could
involve an obligation of a nature or magnitude which, in any case,
is material in the context of the Esprit Telecom Group, taken as a
whole;
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<PAGE> 23
(vii) implemented, authorised, proposed or announced its intention
to implement or enter into any reconstruction, amalgamation,
commitment, scheme or other transaction or arrangement otherwise
than in the ordinary course of business;
(viii) entered into or made an offer (which remains open for
acceptance) to enter into or vary the terms of any service
agreement or any other agreement or arrangement with any directors
or senior executives or any connected person of any of such person
(within the meaning of s.346 Companies Act 1985);
(ix) waived or compromised any claim which is material in the
context of the Esprit Telecom Group other than in the ordinary
course of business;
(x) proposed any voluntary winding up;
(xi) made or authorised or proposed or announced an intention to
propose any change in its share or loan capital to an extent which
is material in the context of the Esprit Telecom Group, taken as a
whole;
(xii) entered into any contract, transaction or arrangement which
is or is likely to be restrictive in a material respect on the
business of any member of the Wider GTS Group or the Wider Esprit
Telecom Group;
(xiii) made any material alteration to its Memorandum or Articles
of Association or other incorporation documents; or
(xiv) entered into or made an offer (which remains open for
acceptance) to enter into an agreement or commitment or passed any
resolution or announced or made any proposal with respect to any of
the transactions or events referred to in this condition (H);
(I) prior to the date when the Offer would otherwise become unconditional:
(i) there having been no adverse change in the business, assets,
financial or trading position or profits or prospects of any member
of the Wider Esprit Telecom Group to an extent which is material in
the context of the Esprit Telecom Group taken as a whole;
(ii) there not having been instituted or remaining outstanding any
litigation, arbitration proceedings, prosecution or other legal
proceedings to which any member of the Wider Esprit Telecom Group
is a party (whether as plaintiff or defendant or otherwise) and no
such proceedings having been announced or threatened against any
such member and no investigation by any government or governmental,
quasi-governmental, supranational, statutory, regulatory or
investigative body, authority or court (including
23
<PAGE> 24
any anti-trust or merger control authority) against or in respect
of any such member or the business carried on by any such member
having been threatened, announced, instituted or remaining
outstanding by, against or in respect of any such member and the
effect of which is or is likely to be material in the context of
the Esprit Telecom Group, taken as a whole;
(iii) there having been no receiver, administrative receiver or
other similar officer appointed over any of the assets of any
member of the Wider Esprit Telecom Group or any analogous
proceedings or steps having taken place under the laws of any
jurisdiction and there having been no petition presented for the
administration of any member of the Wider Esprit Telecom Group or
any analogous proceedings or steps taken place under the laws of
any jurisdiction; and
(iv) no contingent or other liability having arisen or having been
incurred which would or might reasonably be expected adversely to
affect any member of the Wider Esprit Telecom Group to an extent
which is material in the context of the Esprit Telecom Group, taken
as a whole;
(J) neither GTS nor its advisers having discovered prior to the date when the
Offer would otherwise become unconditional that:
(i) any financial, business or other information concerning Esprit
Telecom or the Wider Esprit Telecom Group publicly disclosed at any
time is misleading in any material respect, contains a material
misrepresentation of fact or omits to state a fact necessary to
make the information contained therein not materially misleading;
or
(ii) any member of the Wider Esprit Telecom Group is subject to any
liability, contingent (for the purposes of UK GAAP) or otherwise
which is not disclosed in the audited accounts of Esprit Telecom
for the financial year ended on that date and is material in the
context of the Esprit Telecom Group taken as a whole and which
should have been so disclosed in accordance with UK GAAP;
(iii) any member of the Wider Esprit Telecom Group has not complied with
all applicable legislation or regulation of any jurisdiction which
has an impact which is material in the context of the Esprit
Telecom Group; and
(K) GTS not having discovered prior to the date when the Offer would otherwise
become unconditional that:
(i) any member of the Wider Esprit Telecom Group has not complied with
all applicable legislation or regulations of any jurisdiction
relating to environmental matters, or that there has been any
disposal, discharge, spillage, leak, or emission from any land or
other asset now or previously
24
<PAGE> 25
owned, occupied or made use of by any past or present member of the
Wider Esprit Telecom Group which would be likely to give rise to
any material liability (whether actual or contingent) on the part
of any member of the Wider Esprit Telecom Group which is material
in the context of the Esprit Telecom Group taken as a whole;
(ii) there is, or is reasonably expected to be, any material liability
taken in the context of the Esprit Telecom Group taken as a whole
(whether actual or contingent) to make good, repair, reinstate or
clean up any property now or previously owned, occupied or made use
of by any past or present member of the Wider Esprit Telecom Group
or in which any such member may now or previously had an interest.
GTS reserves the right to waive, in whole or in part, all or any of conditions
(E) to (K) inclusive.
GTS also reserves the right, subject to the consent of the Panel, to extend the
time allowed under the City Code for satisfaction of condition (A) until such
time as conditions (E) to (K) inclusive have been satisfied or, to the extent
permitted, waived. GTS shall be under no obligation to waive or treat as
satisfied any of conditions (E) to (K) (inclusive) by a date earlier than the
latest date specified above for the satisfaction thereof notwithstanding that
the other conditions of the Offer may at such earlier date have been waived or
fulfilled or satisfied and that there are at such earlier date no circumstances
indicating that any of such conditions may not be capable of fulfilment or
satisfaction.
If GTS is required by the Panel to make an offer for Esprit Telecom Securities
under the provisions of Rule 9 of the City Code, GTS may make such alterations
to the terms and conditions of the Offer, including condition (A), as are
necessary to comply with the provisions of that Rule.
The Offer will lapse if the proposed acquisition of Esprit Telecom by GTS, or
any matter arising therefrom, is referred to the Monopolies and Mergers
Commission before the Initial Closing Date.
3. CERTAIN FURTHER TERMS OF THE OFFER
A registration statement relating to the New GTS Shares to be offered in the
Offer will be filed with the US Securities and Exchange Commission and such
securities may not be offered or sold nor may the Offer be accepted in the
United States or by US persons prior to the time such registration statement
becomes effective. The Offer will be made only by means of formal offer
documentation, which in the US will include a prospectus.
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<PAGE> 26
APPENDIX 2
IRREVOCABLE UNDERTAKINGS
Irrevocable undertakings have been given by certain Esprit Telecom
Securityholders in respect of 47,736,275 Esprit Telecom Shares and 4,890,285
Esprit Telecom ADSs. Together these represent a total of 81,968,270 Esprit
Telecom Shares (including those represented by Esprit Telecom ADSs),
representing 65% of the issued share capital of Esprit Telecom.
<TABLE>
<CAPTION>
NAME BENEFICIAL HOLDING OF ESPRIT BENEFICIAL
TELECOM ADSS HOLDINGS OF ESPRIT TELECOM
SHARES
<S> <C> <C>
Gold & Appel Transfer S.A. 4,662,555 (i.e. 32,637,885 16
Esprit Telecom Shares)
Walter Anderson 47,230 (i.e. 330,610 9
Esprit Telecom Shares)
Apax Funds Nominees Ltd. 180,500 (i.e. 1,263,500 32,294,100
Esprit Telecom Shares)
Warburg Pincus Ventures L.P. - 15,442,150
</TABLE>
The irrevocable undertakings continue to be binding in the event of a higher
offer. However, they will lapse if : pre-condition (A) to the Offer set out in
Appendix 1 (relating to the Esprit Telecom Bonds) is not satisfied or waived by
29 January 1999; if GTS announces that the pre-conditions will not be met or
waived; if the Offer Document is not despatched by 15 April 1999 (as extended in
certain limited circumstances); if there is a material adverse change in the
value of the GTS Group (as defined in the irrevocable undertakings) before the
17th US Business Day after posting of the Offer Document or if the Offer is not
declared wholly unconditional by the 60th day after posting (as extended in
certain limited circumstances).
26
<PAGE> 27
APPENDIX 3
FINANCIAL EFFECTS OF ACCEPTANCE
The following tables show, for illustrative purposes only and on the bases and
assumptions set out in the notes below, the financial effects of acceptance on
capital value for a Esprit Telecom Shareholder and a Esprit Telecom ADS Holder
accepting the terms of the Offer, if the Offer becomes or is declared
unconditional in all respects:
<TABLE>
<CAPTION>
ESPRIT TELECOM ADSS Notes
<S> <C> <C>
Market Value of 0.89 New GTS Shares (i) $37.1575
Market Value of one Esprit Telecom ADS (ii) $30.2500
--------
Increase $ 6.9075
--------
This represents an increase of 22.8%
--------
ESPRIT TELECOM SHARES
Market Value of 0.1271 New GTS Shares (i) $ 5.3082
Value of one Esprit Telecom Share (iii) $ 4.3214
--------
Increase $ 0.9868
--------
This represents an increase of 22.8%
--------
</TABLE>
Notes
(i) The market value of New GTS Shares is based on the closing price of
$41.75 on NASDAQ for a GTS Share on 07 December 1998, the last dealing
day prior to the announcement of the Offer.
(ii) The market value of Esprit Telecom ADSs is based on the closing price of
$30.25 on NASDAQ for a Esprit Telecom ADS on 07 December 1998, the last
dealing day prior to the announcement of the Offer.
(iii) The value of Esprit Telecom Shares is based upon one seventh of the
market value of a Esprit Telecom ADS.
(iv) No account has been taken of any liability to taxation.
27
<PAGE> 28
APPENDIX 4
DEFINITIONS
The following definitions apply throughout this document, unless the context
requires otherwise:
"Australia" the Commonwealth of Australia, its territories
and its possessions
"Authorisations" all filings, applications, authorisations,
orders, recognitions, grants, consents, licences,
confirmations, clearances, permissions and
approvals under any applicable legislation or
regulations of any jurisdiction
"Bear Stearns" Bear, Stearns International Limited and, to the
extent that the Offer relates to the United
States, Bear, Stearns & Co. Inc.
"CIS" Commonwealth of Independent States
"City Code" the City Code on Takeovers and Mergers
"CLEC" competitive local exchange carrier
"DWDM" Dense Wave Division Multiplexing technology
"EASDAQ" the computerised pan-European quotation system
sponsored by the European Association of
Securities Dealers and Automated Quotations
"Esprit Telecom" Esprit Telecom Group plc
"Esprit Telecom ADSs" American Depository Shares of Esprit Telecom,
each representing seven Esprit Telecom Shares
"Esprit Telecom ADS Holders" holders of Esprit Telecom ADSs
"Esprit Telecom Bond Offer" the proposed offer to be made to holders of
Esprit Telecom Bonds
"Esprit Telecom Bonds" the $230,000,000 11.5% Senior Notes due 2007, the
$150,000,000 10.875% Senior Notes due 2008, the
DEM 125,000,000 11.5% Senior Notes due 2007 and
the DEM 150,000,000 11.0% Senior Notes due 2008
"Esprit Telecom Bondholders" holders of Esprit Telecom Bonds
"Esprit Telecom Group" Esprit Telecom and its subsidiary undertakings
(as such term is defined in the Companies Act
1985)
28
<PAGE> 29
"Esprit Telecom Securities" collectively the Esprit Telecom ADSs and the
Esprit Telecom Shares
"Esprit Telecom
Securityholders" collectively the Esprit Telecom Shareholders and
the Esprit Telecom ADS Holders
"Esprit Telecom Shares" or
"Shares" the existing issued and fully paid ordinary
shares of 1p each in the capital of Esprit
Telecom and any further such shares which are
unconditionally allotted or issued while the
Offer remains open for acceptance (or prior to
such earlier date, not being earlier than the
Initial Closing Date, as GTS may decide
"Esprit Telecom Shareholders" holders of Esprit Telecom Shares
"Esprit Telecom Share
Option Schemes" the Esprit Telecom Employee Share Option
Programme Number 1, the Esprit Telecom Management
Share Option Plan, the Esprit Telecom Company
Share Option Plan, the Esprit Telecom Executive
and Employee Share Option Scheme 1997 and the
Esprit Telecom Savings-Related Share Option
Scheme
"GTS" Global TeleSystems Group, Inc.
"GTS Group" GTS and its subsidiary undertakings (as such term
is defined in the Companies Act 1985)
"GTS Shareholders" holders of GTS Shares
"GTS Shares" shares of common stock, par value $.10 each in
GTS
"Initial Closing Date" 3.00pm (London time), 10.00am (New York time) on
the day following the 20th US Business Day from
the date of the Offer Document, unless GTS, in
its discretion, shall have extended the Offer, in
which case the term "Initial Closing Date" shall
mean the latest time and date at which the Offer,
as so extended by GTS, will expire or, if
earlier, the time at which the conditions of the
Offer set out in paragraph 2 of Appendix 1 are
satisfied or, to the extent permitted, waived
"Initial Offer Period" the period from the date of the Offer Document
to and including the Initial Closing Date
"Lehman Brothers" Lehman Brothers International (Europe)
29
<PAGE> 30
"Majority Shareholders
Undertakings" the irrevocable undertakings to accept the
Offer provided by Gold & Appel Transfer S.A.,
Walter Anderson, Apax Partners Funds Nominees
Ltd, and Warburg, Pincus Ventures L.P.
"NASDAQ" the computerised quotation system sponsored by
the National Association of Securities Dealers
"New GTS Shares" the new GTS Shares proposed to be issued,
credited as fully paid, pursuant to the Offer
"Noon Buying Rate" the noon buying rate for cable transfer in New
York City in pounds sterling as certified by the
New York Federal Reserve Bank for customs
purposes
"Offer" the proposed offer to be made by Bear Stearns, on
behalf of GTS on the terms and subject to the
conditions to be set out in the Offer Document to
acquire the Esprit Telecom Shares and, where the
context admits, any subsequent revision,
variation, extension or renewal thereof
"Offer Document" the formal offer document proposed to be sent to
holders of Esprit Telecom Shares and ADSs
containing, inter alia, the terms and conditions
and further details of the Offer and such other
information as required by the City Code and US
Securities Law
"Overseas Shareholders" holders of Esprit Telecom Shares resident in or
nationals or citizens of, jurisdictions outside
the United Kingdom and the United States or who
are nominees of, or custodians, trustees or
guardians for, citizens or nationals of other
countries
"Panel" The Panel on Takeovers and Mergers
"Relevant Authority" any government or governmental or
quasi-governmental authority (whether,
supra-national, national, regional, local or
otherwise) or statutory or regulatory or
investigative body or other authority (including
any anti-trust or merger control authority),
court, trade agency, association, institution or
professional or environmental body or (without
prejudice to the generality of all the foregoing)
any other person or body in any jurisdiction
30
<PAGE> 31
"Rollover Offer" the proposal for GTS to allow holders of options
under the Esprit Telecom Share Option Schemes to
rollover their options into options over GTS
Shares
"SDH" synchronous digital hierarchy transmission
"SEC" the US Securities and Exchange Commission
"UK GAAP" generally accepted accounting principles as
applied in the UK
"US Business Day" any day other than Saturday, Sunday or a Federal
holiday in the US, and consists of the time
period from 12.01 am to 12.00 midnight, New York
City time
"US Person" a US person as defined in Regulation S of the US
Securities Act 1933, as amended
"US Securities Law" the Securities Act of 1933, the Securities
Exchange Act of 1934 and the rules and
regulations promulgated thereunder
"United States" or "US" the United States of America, its territories and
possessions, any state of the United States of
America and the District of Columbia
"Wider GTS Group" GTS or any of its subsidiaries or subsidiary
undertakings or any joint venture, partnership,
firm or company in which any of them has a
substantial interest
"Wider Esprit Telecom Group" Esprit Telecom or any of its subsidiaries or
subsidiary undertakings or any joint venture,
partnership, firm or company in which any of them
has a substantial interest
$ United States dollars
L. United Kingdom pounds sterling
31
<PAGE> 32
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law ("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 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 directors 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 (the "Certificate") 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.
II-1
<PAGE> 33
ITEM 21. EXHIBITS
(a) Exhibits.
The following is a list of exhibits filed as a part of this registration
statement.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
1.1+++ -- Form of Dealer Manager Agreement between the Registrant and
Bear, Stearns & Co. Inc. ...................................
2.1* -- Offer Agreement dated as of December 8, 1998 between the
Registrant and Esprit Telecom Group plc.....................
2.2* -- Irrevocable Undertaking by Walter Anderson dated as of
December 8, 1998............................................
2.3* -- Irrevocable Undertaking by Apax Funds Nominees Limited dated
as of December 8, 1998......................................
2.4* -- Irrevocable Undertaking by Gold & Appel Transfer S.A. dated
as of December 8, 1998......................................
2.5* -- Irrevocable Undertaking by Warburg, Pincus Ventures, L.P.
dated as of December 8, 1998................................
2.6* -- Irrevocable Undertaking by Sir Robin Biggam dated as of
December 8, 1998............................................
2.7* -- Irrevocable Undertaking by John McMonigall dated as of
December 8, 1998............................................
2.8* -- Irrevocable Undertaking by Roy Merritt dated as of December
8, 1998.....................................................
2.9* -- Irrevocable Undertaking by David Oertle dated as of December
8, 1998.....................................................
2.10* -- Irrevocable Undertaking by Michael Potter dated as of
December 8, 1998............................................
2.11* -- Irrevocable Undertaking by Dominic Shorthouse dated as of
December 8, 1998............................................
3.1** -- Certificate of Incorporation of SFMT, Inc. .................
3.2** -- Certificate of Correction to the Certificate of
Incorporation of SFMT, Inc., filed with the Delaware
Secretary of State on October 8, 1993.......................
3.3** -- Certificate of Ownership and Merger Merging San
Francisco/Moscow Teleport, Inc. into SFMT, Inc., filed with
the Delaware Secretary of State on November 3, 1993.........
3.4** -- Certificate of Amendment to the Certificate of Incorporation
of SFMT, Inc., filed with the Delaware Secretary of State on
January 12, 1995 ...........................................
3.5** -- Certificate of Amendment to the Certificate of Incorporation
of SFMT, Inc., filed with the Delaware Secretary of State on
February 22, 1995 ..........................................
3.6** -- Certificate of Amendment to the Certificate of Incorporation
of Global TeleSystems Group, Inc., filed with the Delaware
Secretary of State on October 16, 1996......................
3.7** -- By-laws of SFMT, Inc. ......................................
3.8** -- Certificate of Amendment to the Certificate of Incorporation
of Global TeleSystems Group, Inc., filed with the Delaware
Secretary of State on December 1, 1997......................
3.9** -- Form of Amended and Restated By-laws of Global TeleSystems
Group, Inc. (supersedes By-laws of SFMT, Inc. filed as
Exhibit 3.7)................................................
3.10+ -- Certificate of Amendment to the Certificate of Incorporation
of Global TeleSystems Group, Inc. filed with the Delaware
Secretary of State on January 29, 1998......................
</TABLE>
II-2
<PAGE> 34
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
3.11+ -- Certificate of Amendment to the Certificate of Incorporation
of Global TeleSystems Group, Inc. filed with the Delaware
Secretary of State on February 9, 1998......................
3.12+ -- Certificate of Designation of the Series A Preferred Stock
of the Company..............................................
4.1** -- Form of Specimen Stock Certificate for Common Stock of the
Registrant .................................................
4.2** -- Indenture dated as of July 14, 1997 between the Company and
The Bank of New York (including the form of Senior
Subordinated Convertible Bond due 2000 as an exhibit
thereto) ...................................................
4.3** -- Registration Rights Agreement, dated as of July 14, 1997,
between Global TeleSystems Group, Inc. and UBS Securities
LLC. .......................................................
4.4** -- Indenture dated as of August 19, 1997 between Hermes Europe
Railtel B.V. and The Bank of New York (including the form of
11 1/2% Senior Note due 2007 as an exhibit thereto) ........
4.5** -- Registration Rights Agreement dated as of August 19, 1997
between Hermes Europe Railtel B.V. and Donaldson, Lufkin &
Jenrette Securities Corporation, UBS Securities LLC, and
Lehman Brothers, Inc. ......................................
4.6** -- Form of Rights Agreement between Global TeleSystems Group,
Inc. and The Bank of New York, as Rights Agent..............
4.7+ -- Indenture dated as of February 10, 1998 between Global
TeleSystems Group, Inc. and The Bank of New York (including
the form of 9 7/8% Senior Notes due 2005 as an exhibit
thereto)....................................................
4.8++ -- Indenture dated as of July 8, 1998 between Global
TeleSystems Group, Inc. and The Bank of New York relating to
the Company's 5 3/4% Convertible Senior Debentures due
2010........................................................
4.9* -- Registration Rights Agreement dated as of December 8, 1998
by and among the Registrant, Apax Funds Nominees Limited and
Warburg, Pincus Ventures, L.P...............................
5.1+++ -- Opinion of Shearman & Sterling respecting the Securities
registered hereby...........................................
10.1** -- Senior Note Purchase Agreement, dated as of January 19,
1996, among Global TeleSystems Group, Inc., The Open Society
Institute and Chatterjee Fund Management, L.P. .............
10.1(a)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated June 6, 1996..........................................
10.1(b)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated June 6, 1996..........................................
10.1(c)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated July 23, 1996.........................................
10.1(d)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated September 16, 1996 ...................................
10.1(e)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated July 11, 1997.........................................
</TABLE>
II-3
<PAGE> 35
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
10.1(f)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated July 29, 1997.........................................
10.1(g)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated September 29, 1997....................................
10.2** -- Registration Rights Letter Agreement, dated as of January
19, 1996, among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P. .....
10.3** -- Warrant Agreement, dated as of January 19, 1996, among
Global TeleSystems Group, Inc., The Open Society Institute
and Chatterjee Fund Management, L.P. .......................
10.4** -- Joint Venture Letter Agreement, dated January 19, 1996,
among Global TeleSystems Group, Inc., The Open Society
Institute and Chatterjee Fund Management, L.P. .............
10.5 -- Intentionally Omitted
10.6** -- Registration Rights Letter Agreement, dated June 6, 1996,
among the Company, The Open Society Institute, Winston
Partners II LDC and Winston Partners II LLC.................
10.7** -- Warrant Agreement, dated as of June 6, 1996, between Global
TeleSystems Group, Inc., The Open Society Institute, Winston
Partners II LDC and Winston Partners II LLC.................
10.8** -- Senior Note Purchase Agreement, dated as of February 2,
1996, between Global TeleSystems Group, Inc. and Emerging
Markets Growth Fund, Inc. ..................................
10.8(a)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated June 6, 1996 (see
Exhibit No. 10.1(b))........................................
10.8(b)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated June 6, 1996......
10.8(c)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated July 25, 1996.....
10.8(d)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated September 10,
1996........................................................
10.8(e)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated September 16,
1996........................................................
10.8(f)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated December 30,
1996........................................................
10.8(g)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated May 13, 1997......
</TABLE>
II-4
<PAGE> 36
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
10.8(h)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated June 20, 1997.....
10.8(i)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated July 11, 1997.....
10.8(j)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated July 21, 1997.....
10.8(k)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated August 14, 1997...
10.8(l)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated September 29,
1997........................................................
10.9** -- Registration Rights Letter Agreement, dated as February 2,
1996, between Global TeleSystems Group, Inc. and Emerging
Markets Growth Fund, Inc. ..................................
10.10** -- Warrant Agreement, dated as of February 2, 1996, between
Global TeleSystems Group, Inc. and Emerging Markets Growth
Fund, Inc. .................................................
10.11 -- Intentionally Omitted
10.12** -- Registration Rights Letter Agreement, dated as February 2,
1996, between Global TeleSystems Group, Inc. and Capital
International Emerging Markets Funds........................
10.13** -- Warrant Agreement, dated as of February 2, 1996, between
Global TeleSystems Group, Inc. and Capital International
Emerging Markets Funds......................................
10.14+ -- Restated and Amended Global TeleSystems Group, Inc.
Non-Employee Directors' Stock Option Plan...................
10.15+ -- Restated and Amended GTS-Hermes, Inc. 1994 Stock Option
Plan........................................................
10.16** -- Restricted Stock Grant letter, dated as of January 1,
1995........................................................
10.17** -- Employment Agreement dated as of January 1995 between SFMT,
Inc. and Jan Loeber.........................................
10.18** -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Louis Toth..................................
10.19** -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Gerald W. Thames............................
10.20** -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Raymond J. Marks............................
10.21** -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Henry Radzikowski...........................
10.22** -- SFMT, Inc. Equity Compensation Plan.........................
10.23** -- Form of Non-Statutory Stock Option Agreement................
10.24+ -- Third Amended and Restated 1992 Stock Option Plan of Global
TeleSystems Group Inc. dated as of September 25, 1997.......
10.25** -- GTS-Hermes 1994 Stock Option Grant, Non-Qualified Stock
Option Grant................................................
10.26** -- Agreement on the Creation and Functions of the Joint Venture
of EDN Sovintel, dated June 18, 1990........................
</TABLE>
II-5
<PAGE> 37
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
10.27** -- Stock Purchase Agreement among Global Telesystems Group,
Inc, Kompaniya "Invest-Project," Swinton Limited, GTS-Vox
Limited, and MTU-Inform, dated September 6, 1995............
10.28** -- Certificate of Registration of Revised and Amended
Foundation Document in the State Registration of Commercial
Organizations, dated May 30, 1996...........................
10.29** -- Agreement on the Creation and Functions of the Joint Venture
Sovam Teleport, dated May 26, 1992..........................
10.30** -- Amended and Restated Joint Venture Agreement between GTS
Cellular, Tricor B.V., Gerard Essing, Ivan Laska, and Erik
Jennes, dated July 6, 1995..................................
10.31** -- Amended and Restated Shareholders' Agreement between HIT
Rail B.V., GTS-Hermes, Inc., Nationale Maatschappij Der
Belgische Spoorwegen, Teleport B.V., AB Swed Carrier, and
Hermes Europe Railtel B.V., dated July, 1997................
10.31(a)** -- Shareholders' Agreement among the Hermes Europe Railtel,
B.V., GTS-Hermes Inc., HIT Rail B.V., SNCB/NMBS and AB Swed
Carrier (incorporated by reference to Exhibit 10.1 to the
Hermes Europe Railtel B.V.'s Registration Statement on Form
S-4 (File No. 333-37719) filed on December 11, 1997)
(supersedes the Amended and Restated Shareholders' Agreement
incorporated by reference as Exhibit 10.31 to this
Registration Statement).....................................
10.32** -- Company Agreement between The Societe National de
Financement, GTS S.A.M. and The Principality of Monaco,
dated September 27, 1995....................................
10.33** -- Joint Venture Agreement between SFMT-Hungaro Inc. and
Montana Holding Vagyonkezelo Kft., dated December 23,
1993........................................................
10.34** -- Joint Venture and Shareholders' Agreement among Gerard
Aircraft Sales and Leasing Company, SFMT-Hungaro Inc., and
Microsystem Telecom Rt., dated August 5, 1994...............
10.35** -- Agreement on the Establishment of Limited Liability Company
between SFMT-Czech, Inc. and B&H s.r.o., dated July 12,
1994........................................................
10.36** -- Formation of the Equity Joint Venture between GTS and SSTIC,
dated April 12, 1995........................................
10.37** -- Contract to Establish the Sino-foreign Cooperative Joint
Venture Beijing Tianmu Satellite Communications Technology
Co., Ltd, amended, by and between China International Travel
Service Telecom Co., Ltd. and American China Investment
Corporation, dated March 27, 1996...........................
10.38** -- Joint Venture Contract between GTS TransPacific Ventures
Limited and Shanghai Intelligence Engineering, Inc., dated
March 28, 1996..............................................
10.39** -- Agreement between Global TeleSystems Group, Inc. and Cesia
S.A., dated June 21, 1997...................................
10.40** -- Consulting Agreement between SFMT, Inc. and Alan B. Slifka,
dated March 1, 1994.........................................
10.41** -- Consulting Agreement between Global TeleSystems Group, Inc.
and Bernard J. McFadden, dated August 15, 1996..............
10.42** -- Consulting Agreement between CESIA S.A. and Hermes Europe
Railtel B.V., dated June 20, 1997...........................
10.43++ -- Master Agreement, dated June , 1998 between Ebone Holding
Association, Ebone A/S, Hermes Europe Railtel Holdings B.V.
and Hermes Europe Railtel (Ireland) Limited.................
</TABLE>
II-6
<PAGE> 38
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
21.1+ -- List of Subsidiaries of the Registrant .....................
23.1+++ -- Consent of Shearman & Sterling (included in its opinion
delivered under Exhibit No. 5.1) ...........................
23.2* -- Consent of Ernst & Young LLP ...............................
23.3* -- Consent of Ernst & Young (CIS) Ltd..........................
24.1* -- Powers of Attorney (included on signature page to this
registration statement).....................................
27.1+ -- Financial Data Schedule extracted from 12/31/97 audited
financial statements........................................
27.2* -- Financial Data Schedule extracted from 9/30/98 unaudited
financial statements........................................
</TABLE>
- ---------------
* Filed herewith.
** Incorporated by reference to the corresponding exhibit to the Company's
Registration Statement on Form S-1 (File No. 333-36555) filed on September
26, 1997.
+ Incorporated by reference to the corresponding exhibit to the Company's
Annual Report on Form 10-K for the year ended December 31, 1997.
++ Incorporated by reference to the corresponding exhibit to the Company's
Registration Statement on Form S-1 (File No. 333-52733) filed on May 14,
1998.
+++ To be filed by amendment.
(b) Financial Statement Schedules.
II-7
<PAGE> 39
ITEM 22. UNDERTAKINGS
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the provisions described under "Item
20 -- Indemnification of Directors and Officers" hereof, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
The undersigned registrant hereby undertakes that
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the forms of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained in
forms of prospectus filed by the registrant pursuant to Rule 424 (b) (I) or
(4) or 497 (h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be to be the initial bona fide offering thereof.
(3) The undersigned registrant hereby undertakes to supply by means of
a post-effective amendment all information concerning a transaction, and
the company being acquired involved therein, that was not the subject of
and included in the registration statement when it became effective.
The undersigned registrant hereby undertakes to provide to the underwriters
at the closing specified in the underwriting agreements certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
II-8
<PAGE> 40
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant certifies that it has duly caused this Registration Statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of McLean, Commonwealth of Virginia, on this 8th day of December, 1998.
GLOBAL TELESYSTEMS GROUP, INC.
By: /s/ GRIER RACLIN
----------------------------------
Name: Grier Raclin
Title: Senior Vice President
and General Counsel
We, the undersigned officers and directors of Global TeleSystems Group,
Inc. hereby severally constitute and appoint, Gerald W. Thames, William H.
Seippel, Grier Raclin and Alan Krenek, and each of them, with full power of
substitution, our true and lawful attorney with full power to him singly to sign
for us and in our names in the capacities indicated below the Registration
Statement on Form S-4 filed herewith and any and all pre-effective and
post-effective amendments to said Registration Statement, and, in connection
with any registration of additional securities pursuant to Rule 462(b) under the
Securities Act of 1933, as amended, to sign any abbreviated registration
statement and any and all amendments thereto, and to file the same, with all
exhibits thereto and other documents in connection therewith, in each case, with
the Securities and Exchange Commission, and generally to do all such things in
our names and on our behalf in our capacities as officers and directors to
enable Global TeleSystems Group, Inc. to comply with the provisions of the
Securities Act of 1933, as amended, and all requirements of the Securities and
Exchange Commission, hereby ratifying and confirming our signatures as they may
be signed by our said attorney to said Registration Statement and any and all
amendments thereto.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities indicated on the 8th day of December, 1998.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ GERALD W. THAMES President, Chief Executive December 8, 1998
- ----------------------------------------------------- Officer and Director
Gerald W. Thames (principal executive
officer)
/s/ WILLIAM H. SEIPPEL Executive Vice President of December 8, 1998
- ----------------------------------------------------- Finance and Chief Financial
William H. Seippel Officer (principal
financial and accounting
officer)
/s/ ALAN B. SLIFKA Chairman of the Board of December 8, 1998
- ----------------------------------------------------- Directors
Alan B. Slifka
Director December 8, 1998
- -----------------------------------------------------
Michael Greeley
/s/ BERNARD MCFADDEN Director December 8, 1998
- -----------------------------------------------------
Bernard McFadden
</TABLE>
II-9
<PAGE> 41
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ STEWART J. PAPERIN Director December 8, 1998
- -----------------------------------------------------
Steward J. Paperin
Director December 8, 1998
- -----------------------------------------------------
W. James Peet
/s/ JEAN SALMONA Director December 8, 1998
- -----------------------------------------------------
Jean Salmona
/s/ JOEL SCHATZ Director December 8, 1998
- -----------------------------------------------------
Joel Schatz
/s/ ADAM SOLOMON Director December 8, 1998
- -----------------------------------------------------
Adam Solomon
/s/ DAVID DEY Director December 8, 1998
- -----------------------------------------------------
David Dey
/s/ ROGER W. HALE Director December 8, 1998
- -----------------------------------------------------
Roger W. Hale
Director December 8, 1998
- -----------------------------------------------------
Robert Amman
</TABLE>
II-10
<PAGE> 42
ANNEX A
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTIONS 13 OR 15(D) OF THE SECURITY
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER:
GLOBAL TELESYSTEMS GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 94-3068423
(State of incorporation) (I.R.S. Employer Identification Nos.)
</TABLE>
1751 PINNACLE DRIVE, NORTH TOWER, 12TH FLOOR
MCLEAN, VIRGINIA 22102
(Address of principal executive offices)
(703) 918-4500
(Registrant's telephone number)
Securities registered pursuant to Section 12(g) of the Act:
TITLE OF EACH CLASS
Common Stock, par value $0.10 per share and Rights associated with Common Stock,
par value $0.10 per share.
Indicate by check mark whether the registrants (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) have been subject to such
filing requirements for the past 90 days. Yes [ ] No [X]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained in this Form 10-K, and will not be
contained, to the best of the registrants' knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [X]
The aggregate market value of the voting stock of Global TeleSystems Group,
Inc. held by non-affiliates on February 27, 1998 was approximately
$1,182,668,000. On February 27, 1998, there were outstanding approximately
50,904,000 shares of Common Stock of Global TeleSystems Group, Inc.
<TABLE>
<CAPTION>
ITEM OF FORM 10-K DOCUMENT INCORPORATED BY REFERENCE
----------------- ----------------------------------
<S> <C>
Part III, Item 10, 11, 12 and 13 Proxy Statement* (excluding therefrom the
subsections entitled "Report of the
Compensation Committee of the Board of
Directors" and "Performance Graph")
Part IV, Item 14(c) Exhibits
</TABLE>
- ---------------
* Refers to the definitive Proxy Statement of Global TeleSystems Group, Inc., to
be filed pursuant to Regulation 14A, relating to the Annual Meeting of
Stockholders of Global TeleSystems Group, Inc. to be held on May 20, 1998.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 43
GLOBAL TELESYSTEMS GROUP, INC.
FORM 10-K
YEAR ENDED DECEMBER 31, 1997
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I
ITEM 1. Business.................................................... 3
Introduction........................................................ 3
Business Strategy................................................... 6
Russia and the CIS.................................................. 8
Sovintel......................................................... 12
TCM.............................................................. 15
TeleRoss......................................................... 16
Sovam............................................................ 19
GTS Cellular..................................................... 21
Certain Considerations Applicable to the Company's Operations in 29
Russia and the CIS..............................................
Western Europe...................................................... 32
HER.............................................................. 34
GTS Monaco Access................................................ 47
Central Europe...................................................... 50
Asia................................................................ 52
Certain Considerations Generally Applicable to the Company's 53
Operations.......................................................
Glossary of Telecommunications Industry Terms....................... 59
ITEM 2. Properties.................................................. 63
ITEM 3. Legal Proceedings........................................... 63
ITEM 4. Submission of Matters to a Vote of Security Holders......... 63
PART II
ITEM 5. Market for the Company's Common Equity and Related
Stockholder Matters....................................... 64
ITEM 6. Selected Financial Data..................................... 67
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 69
ITEM 8. Consolidated Financial Statements and Supplementary
Information for the Company............................... 80
ITEM 9. Changes In and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 120
PART III
ITEM 10. Directors and Executive Officers of the Company............. 120
ITEM 11. Executive Compensation...................................... 121
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 121
ITEM 13. Certain Relationships and Related Transactions.............. 121
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K....................................................... 122
SIGNATURES............................................................ 128
</TABLE>
2
<PAGE> 44
PART I
ITEM 1. BUSINESS
To aid the reader, a "Glossary of Telecommunications Industry Terms," which
defines certain terms used in this "Business" section and elsewhere in this
Report, follows commencing on page 59.
INTRODUCTION
The predecessor to Global TeleSystems Group, Inc. (the "Company" or "GTS")
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.
The Company 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
below), 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 operates cellular networks in
thirteen 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 1997. 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 442 million minutes of traffic for the year ended
December 31, 1997 and had approximately 33,300 customers, including
approximately 23,400 cellular subscribers, as of December 31, 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 S.A.M. ("GTS-Monaco Access"). HER's
3
<PAGE> 45
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 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 pan-European high capacity
fiber optic network designed to interconnect a majority of the largest Western
and Central European cities. As of April 1, 1998, HER's network will link
Brussels, Antwerp, Rotterdam, Amsterdam, London, Paris, and Frankfurt. HER
expects the initial five country network and Switzerland 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 3,800 kilometers of
fiber optic cable linking, in addition to the cities discussed above, the cities
of Zurich, Geneva, Dusseldorf, Stuttgart, and Munich. 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 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."
4
<PAGE> 46
The following table sets forth certain information, as of December 31,
1997, for the principal ventures through which the Company conducts its
business:
<TABLE>
<CAPTION>
COUNTRY/REGION GTS PRINCIPAL
COMPANY NAME OF OPERATIONS OWNERSHIP PARTNERS BUSINESS
------------ -------------- --------- -------- ---------
<S> <C> <C> <C> <C>
CIS
Sovintel............ Russia 50% Rostelecom International Long
Distance; Local
Access and Local
Access Lines
TCM................. Russia 50%(1) MTU Inform and Local Access Lines
others
TeleRoss............ Russia 50%(2) Various local PTOs Domestic Long
Distance Data and
Internet
Sovam............... Russia 67%(3) Institute for
Automated Systems
GTS Cellular........ CIS 25-70%(4) Primarily various Basic Cellular
local PTOs
WESTERN EUROPE
HER................. Western Europe 79%(5) Various Carriers' Carrier
Carriers' Carrier;
GTS-Monaco Access... Monaco 50% Principality of International Gateway
Monaco
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
5
<PAGE> 47
ventures that are 50% beneficially-owned by GTS (the "TeleRoss Ventures").
See "-- Russia and the CIS -- TeleRoss."
(3) GTS purchased its minority partner's 33.3% interest 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 12 operational 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 "-- Russia and the CIS -- GTS Cellular."
(5) As a result of the sale of shares by one of the other shareholders of HER in
March 1998, GTS currently owns approximately 89% of HER. See "Western
Europe -- HER -- HER Recapitalization." 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 HER stock option plan established in the
fourth quarter of 1997. See "Executive Compensation and Other
Information -- Key Employee Stock Option Plan of Hermes Europe Railtel B.V."
in the Company's Proxy Statement for its 1998 Annual Meeting.
(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.
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
6
<PAGE> 48
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. From
1993 through 1997, the Company raised privately 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. On February 10, 1998, the Company completed an initial
public offering of its common stock. The Company sold 12,765,000 shares
in the offering, including 1,665,000 shares sold as a result of the
exercise of over-allotment options granted to the underwriters of the
offering and realized net proceeds of $238.7 million from the offering
after the payment of underwriting fees but, before payment of other
expenses associated with the offering. On the same date, the Company also
sold $105 million aggregate principal amount of 9 7/8% Senior Notes due
2005 ("the Senior Notes"), and realized net proceeds of $82.3 million,
after the payment of underwriting fees and the deposit of $19.6 million
in escrow to cover the first four scheduled payments of interest on the
Senior Notes, but before expenses associated with the sale of the Senior
Notes.
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
7
<PAGE> 49
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.
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
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<PAGE> 50
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 Ministry of Communications (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 (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 second 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
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privatization of Svyazinvest, or the evolution of government policy regarding
Svyazinvest and Rostelecom, will not have a material adverse effect on the
Company or its ventures.
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 benefited 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 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
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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.
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. Several of the TeleRoss Ventures and
the cellular joint ventures were not operational, or had just commenced
operating, in 1995. As a result, TeleRoss and GTS Cellular did not generate
significant revenues in 1995.
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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,
--------------
1996 1997
----- -----
<S> <C> <C>
Cities In Service........................................... 33 40
Total Voice Minutes (millions)(1)
Inter-city................................................ 15.8 57.1
Local..................................................... 133.0 269.1
International Outgoing.................................... 20.5 46.0
Incoming.................................................. 33.2 69.9
Total Data Customers (thousands)............................ 6.2 9.9
Total Cellular Subscribers (thousands)...................... 9.8 23.4
</TABLE>
- ---------------
(1) Amounts include minutes between Company affiliates.
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 43,900 telephone numbers, or "ports," for
business customers and cellular providers and had over 275 employees as of
December 31, 1997.
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.
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
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<PAGE> 54
with the Sovam data network. Accordingly, from a customer's perspective,
Sovintel offers a broad range of telecommunication services.
The following table sets forth certain operating data related to Sovintel's
operations:
<TABLE>
<CAPTION>
AT AND FOR THE YEAR ENDED DECEMBER 31.
---------------------------------------
1995 1996 1997
---------- ---------- -----------
<S> <C> <C> <C>
MINUTES OF USE(1)
International Minutes
Number of Minutes............................... 10,516 20,839 43,664
Average Rate Per Minute......................... $ 2.06 $ 1.55 $ 1.12
Domestic Long Distance Minutes
Number of Minutes............................... 2,047 10,098 26,606
Average Rate Per Minute......................... $ 0.86 $ 0.65 $ 0.52
Moscow (Local) Fixed Line Minutes
Number of Minutes............................... -- -- 3,501
Average Rate Per Minute......................... -- -- $ 0.05
Moscow (Local) Cellular Minutes Number of
Minutes......................................... 21,478 83,673 118,447
Average Rate Per Minute......................... $ 0.06 $ 0.08 $ 0.08
Incoming Minutes Number of Minutes................. 3,839 24,306 43,626
Average Rate Per Minutes........................ $ 0.58 $ 0.28 $ 0.30
PORTS
Number of Ports (cumulative)....................... 6,079 29,646 43,976
NUMBER OF PRIVATE LINE CHANNELS
International...................................... 26 89 201
Inter- and Intra-City.............................. 26 103 243
APPROXIMATE EQUIPMENT SALES (THOUSANDS).............. $ 1,400 $ 2,200 $ 3,400
</TABLE>
- ---------------
(1) Minutes in thousands. Amounts include minutes among affiliates.
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 each case
benefiting from Sovintel's high quality infrastructure. Private line
domestic long distance
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<PAGE> 55
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 $1.12 per
minute for the year ended December 31, 1997. Sovintel expects increased pricing
pressure from competitors over time. Sovintel prices domestic long distance
services in line with those of its principal competitors, however, due to its
obligations under certain agreements with affiliated entities, Sovintel's
margins for these services are declining. 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),
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<PAGE> 56
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 December 31, 1997, GTS and Rostelecom have each made equity contributions
of $1.0 million to Sovintel. The Sovintel joint venture agreement does not have
an expiration date. See "-- Certain Considerations Generally Applicable to the
Company's Operations -- Dependence on Certain Local Parties; Absence of Control"
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations Accounting Methodology Profit and Loss Accounting."
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 50,000 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. 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 for TCM-Sovintel joint customers are performed by
15
<PAGE> 57
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 December 31, 1997, GTS had no outstanding loans relating to
TCM. None of the operative charters and agreements relating to the holding
company or TCM have expiration dates. See "Certain Considerations Generally
Applicable to the Company's Operations -- Dependence on Certain Local Parties;
Absence of Control" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations Accounting Methodology Profit and Loss
Accounting."
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, 24 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 December 31, 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.
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 12
million. TeleRoss's licenses cover the entire oblast surrounding these cities,
with populations totaling approximately 38 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: Arkhangelsk, Ekaterinburg, Irkutsk, Khabarovsk, Krasnodar,
Nizhni Novgorod, Novosibirsk, Syktyvkar, Tyumen, Ufa, Vladivostok, Volgograd and
Voronezh. The Company has formed an additional TeleRoss Venture in the city of
Samara. As of March 1998, this venture was not operational.
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 24 customers
in 24 additional cities through VSAT technology which links the customers via
satellite to the Moscow hub.
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The following table sets forth certain operating data related to TeleRoss's
operations:
<TABLE>
<CAPTION>
AT AND FOR THE YEAR
ENDED DECEMBER 31,
-------------------
1996 1997
------- --------
<S> <C> <C>
MINUTES OF USE(1)
Domestic Minutes (thousands).............................. 4,035 23,233
Average Rate Per Domestic Minute.......................... $ 0.99 $ 0.63
International Minutes (thousands)......................... 272 744
Average Rate Per International Minute..................... $ 2.76 $ 2.47
NUMBER OF CITIES SERVED(2).................................. 13 14
WORLD CONNECT DIAL/RUSSIA
Number of Connect Dial Ports.............................. 472 1,112
Average Revenue Per Port Per Month........................ $ 767 $ 370
MOSCOW CONNECT
Number of Ports........................................... 49 78
Average Revenue Per Port Per Month........................ $1,165 $ 1,358
DEDICATED CIRCUITS
Number of Dedicated Channels.............................. 33 60
Average Price Per Channel................................. $4,553 $ 4,140
WORLD ACCESS SERVICE
Number of World Access Card Users......................... 3,929 4,595
Average Revenue Per Card Per Month........................ $ 52 $ 48
VSAT SERVICES
Number of VSATs........................................... 12 24
</TABLE>
- ---------------
(1) Includes minutes among affiliates.
(2) Includes connection to Moscow.
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 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.
17
<PAGE> 59
- 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 December 31, 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. During
the year ended December 31, 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 December 31, 1997, TeleRoss
employed 31 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 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
18
<PAGE> 60
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
"-- Certain Considerations Generally Applicable to the Company's
Operations -- 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 December 31, 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 $3.4 million to GTS as of December 31, 1997.
In addition, as of December 31, 1997, GTS had made equity contributions of $5.8
million to the TeleRoss Operating Company and the TeleRoss Operating Company had
outstanding loans of $37.4 million to GTS. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Accounting
Methodology -- Profit and Loss Accounting."
SOVAM
Sovam is a venture that is wholly owned by GTS. Sovam was founded in 1990
as a venture equally owned by GTS and the Institute for Automated Systems
("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 66.7%. GTS purchased IAS's interest in Sovam 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. (Russia On
Line(TM) is a trademark of the Company.) As of December 31, 1997, Sovam had
approximately 1,571 data service customers and approximately 3,960 Russia On
Line customers. Sovam employed over 110 persons in Moscow and other regions of
the CIS as of December 31, 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 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.
19
<PAGE> 61
The following table sets forth certain operating data related to Sovam's
operations:
<TABLE>
<CAPTION>
AT AND FOR THE YEAR ENDED
DECEMBER 31
--------------------------
1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
BASIC DATA SERVICE
Percentage of Total Sovam Revenue...................... 91% 79% 81%
Number of Customers.................................... 1,587 1,726 1,571
Average Revenue Per Month Per Customer................. $ 201 $ 446 $ 728
Number of Cities in Service............................ 11 25 30
EQUIPMENT AND HARDWARE SALES
Percentage of Total Sovam Revenue...................... 8% 14% 8%
RUSSIA ON LINE SERVICE
Percentage of Total Sovam Revenue...................... 1% 7% 11%
Number of Subscribers(1)............................... 407 1,854 3,159
Average Revenue Per Month Per Subscriber............... $ 49 $ 52 $ 64
</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 December 31, 1997, there were approximately 800 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 1,571 customers as of
December 31, 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 3,960 Russia On Line
subscribers (which includes approximately 800 trial subscribers) as of
December 31, 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 also entered into
agreements with equipment manufacturers, including Dell, Motorola and
Acer, to include Russia On Line software with their products.
20
<PAGE> 62
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 $728 per subscriber in 1996 and
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. At December 31, 1997, GTS owned 66.7% of Sovam and
IAS owned the remaining 33.3%. GTS purchased IAS's interest in Sovam in February
1998, thereby making Sovam a wholly owned subsidiary of GTS. As of December 31,
1997, neither GTS nor IAS were obligated to fund Sovam's operations or capital
expenditures. Losses and profits of Sovam were allocated to the partners in
accordance with their ownership percentages, in consideration of funds at risk.
As of December 31, 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 $5.7 million to GTS as of December 31, 1997. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operation -- 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 is organized in
The Netherlands), which currently operates twelve 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 1997 population of approximately 25 million
people.
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<PAGE> 63
GTS currently offers cellular services in the following regions as of
December 31, 1997:
<TABLE>
<CAPTION>
GTS'S
OPERATING ECONOMIC NUMBER OF
COMPANY INTEREST(1)(2) CITY SUBSCRIBERS
--------- -------------- ---- -----------
<S> <C> <C> <C>
RUSSIA
Vostok Mobile(2)
Arkhangelsk Mobile................... 50.0% Arkhangelsk 602
Networks
Astrakhan Mobile..................... 50.0% Astrakhan 1,264
Barnaul Mobile(3).................... 50.0% Barnaul --
Chuvashi Mobile...................... 70.0% Cheboksary 1,201
Lipetsk Mobile....................... 70.0% Lipetsk 461
Murmanskaya Mobilnaya Set............ 50.0% Murmansk 1,457
Penza Mobile......................... 60.0% Penza 519
Saratov Mobile....................... 50.0% Saratov 1,456
Parma Mobile......................... 50.0% Syktyvkar 750
Volgograd Mobile..................... 50.0% Volgograd 2,065
Votec Mobile......................... 50.0% Voronezh 1,725
Mar Mobile........................... 50.0% Yoshkar-ola 2,061
PrimTelefone............................ 50.0% Vladivostok(4) 6,152
UKRAINE
Bancomsvyaz............................. 24.9% Kiev 3,664
------
Total........................... 23,377
------
</TABLE>
- ---------------
(1) Represents the indirect economic interest of GTS in each entity.
(2) 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 12 operational cellular joint ventures in various regions
in Russia. In the second half of 1997, the Company formed three additional
ventures in the cities of Bryansk, Kostroma and Ufa. As of March 1998, these
additional ventures were not operational. Moreover, GTS intends to enter
into the cellular markets of additional Russian regions through its Vostok
Mobile venture.
(3) Joint venture acquired in October 1997; operations commenced in February
1998.
(4) Includes Vladivostok and four other cities in the Primorsky region.
22
<PAGE> 64
The following table sets forth certain operating data related to GTS
Cellular's operations:
<TABLE>
<CAPTION>
AT AND FOR THE
YEAR ENDED
DECEMBER 31,
------------------
1996 1997
------- -------
<S> <C> <C>
Vostok Mobile
Total Subscribers......................................... 6,884 13,561
Average Revenue Per Subscriber Per Month.................. $ 128 $ 146
Minutes of Use(1)(thousands).............................. 10,561 27,771
Population Covered by Licenses (thousands)................ 18,400 18,400
Population Covered by Networks (thousands)................ 6,500 6,500
Subscriber Penetration of Population Covered by
Networks............................................... 0.11% 0.21%
PrimTelefone
Total Subscribers......................................... 2,822 6,152
Average Revenue Per Subscriber Per Month(2)............... $ 236 $ 188
Minutes of Use(1)(thousands).............................. 6,919 14,270
Population Covered by Licenses (thousands)................ 2,200 2,270
Population Covered by Networks (thousands)................ 1,175 1,175
Subscriber Penetration of Population Covered by
Networks(2)............................................ 0.24% 0.52%
Bancomsvyaz
Cellular Network Total Subscribers........................ 121 3,664
Average Revenue Per Subscriber Per Month.................. $ 62 $ 160
Minutes of Use(1)(thousands).............................. 9 5,085
Population Covered by Licenses (thousands)................ 4,500 4,536
Population Covered by Networks (thousands)................ 1,669 2,507
Subscriber Penetration of Population Covered by
Networks............................................... 0.01% 0.15%
Overlay Network Minutes of Use(1)(thousands).............. -- 4,909
Number of Ports........................................... -- 751
Average Revenue Per Minute................................ -- $ 0.34
</TABLE>
- ---------------
(1) Includes minutes among affiliates.
(2) 1997 operating data calculated using 5,212 active subscribers.
Vostok Mobile. Through Vostok Mobile, GTS currently operates twelve
cellular joint ventures in Russia. Vostok Mobile owns between 50% and 70%
interests in each of the twelve 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 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.
23
<PAGE> 65
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 330
persons as of December 31, 1997, with over 290 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 total subscriber base has grown to 6,152 (including 5,212
active subscribers) as of December 31, 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 December 31, 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 owns a 50% economic interest in an 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 approximately 100 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 December 31, 1997,
its cellular network covered an area with approximately 2.5 million people.
Bancomsvyaz plans to expand its network's coverage to approximately 3.2 million
people over the next five years.
24
<PAGE> 66
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 "-- Certain
Considerations Generally Applicable to the Company's Operations -- 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 December 31, 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 $25.0
million to GTS as of December 31, 1997. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- 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
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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.
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 directly 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, and has notified Bancomsvyaz that it has levied a $2.9
million frequency license fee on Bancomsvyaz's cellular license. At this time,
the Company is formulating its response to the government's action and expects
that the authorities will grant a ninety-day extension for payment of such fee.
The Company does not believe the outcome will have a material adverse effect on
the Company. There can be no assurance that additional 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
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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. 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
number of circuits leased is approximately 444 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. The Company's purchase of
IAS's 33.3% interest in Sovam requires that Sovam re-register its license.
The Company expects that the license will be re-registered.
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
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telecommunications providers. Large competitors include the "Combellga" 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 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.
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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 Combellga. However, since TCM has obtained an allocation of 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.
CERTAIN CONSIDERATIONS APPLICABLE TO THE COMPANY'S OPERATIONS IN 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. In March 1998, President Yeltsin
dismissed his entire cabinet, including Prime Minister Victor Chernomyrdin,
citing, among other things, a need for more dynamism and initiative in the
Russian government. It was unclear, however, how the change will affect
governmental policy and constitutional issues, including the identity of
President Yeltsin's successor if he were not to survive his term of office. In
addition, it was uncertain whether the resolution of these and other issues
could 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.
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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.
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 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. As of March 1998, there had not been any readings of
the draft legislation beyond the first reading. 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 "-- Russia and the CIS -- Licenses and Regulatory Issues."
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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 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.
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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.
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.
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. In addition, since November 1997,
Russian monetary authorities have pegged the ruble/U.S. dollar exchange rate to
fluctuate within a certain narrow range. It is uncertain whether the Russian
authorities will be able to maintain this exchange rate and there can be no
assurance that there will not be a significant and sudden decline in the value
of the ruble. Such a devaluation of the ruble could have a material adverse
effect on the Company and its results of operations and on the Russian economy
generally.
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, particularly in Russia and
the CIS. 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, there can be no assurance as to what effect
such personnel changes will have on the Company's operations in Russia and the
CIS.
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
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18,000 kilometer high capacity fiber optic network designed to interconnect a
majority of the largest Western and Central European cities. As of April 1,
1998, HER's network will link Brussels, Antwerp, Rotterdam, Amsterdam,
London,Paris, and Frankfurt. HER expects the initial five country network and
Switzerland 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 3,800 kilometers of fiber optic cable linking the cities of
London, Rotterdam, Amsterdam, Antwerp, Brussels, Paris, Dusseldorf, Frankfurt,
Stuttgart, Munich, Geneva and Zurich. 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 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.
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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.
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. 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 and Switzerland in the second quarter of 1998, as discussed
below, 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.
HER expects to continue to roll-out full telecommunications transport
service on the initial network in the first five countries and Switzerland
linking the additional cities of Dusseldorf, Stuttgart, Munich, Zurich and
Geneva by June 30, 1998. This initial network is expected to consist of
approximately 3,800 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. 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 coverage is planned to
be expanded to include the cities Berlin, 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 33 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. Additional contracts have
been concluded in Switzerland, Denmark, Sweden, Spain and Italy. HER continues
to negotiate rights-of-way and other infrastructure arrangements in order to
extend its network in Western Europe. 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.
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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 may need to 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 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. 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.
HER was formed on July 6, 1993 by HIT Rail B.V. ("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, Inc., a Delaware corporation
("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. In March 1998, GTS-Hermes increased
its ownership of HER to 89% by purchasing a portion of Hit Rail's ownership
interest in HER. GTS-Hermes is a wholly owned subsidiary of GTS.
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 offers 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
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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 high-bandwidth E1 equivalent
circuits on transborder European routes is artificially high and not
necessarily related to the cost of such circuits. HER offers competitive
pricing. HER also offers 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.
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
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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 provide 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 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
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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 certain of its railway shareholders and/or railway or other infrastructure
providers 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 upfront 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.
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 January 1998, twenty customers were under
contract for service on the HER network, including PTOs, a global consortium of
PTOs, Internet service providers, an international carrier, value added networks
("VANs") and resellers. HER provided capacity of approximately 446 E1 equivalent
circuits as of January 1998. 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
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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.
- 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.
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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 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.
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 regenerators 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
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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 Company
believes that the relationships between HER and local access network suppliers
can benefit both parties.
Network Routes. HER's current planning dates for operation in certain
cities and kilometers covered by the initial network in the first five countries
and Switzerland are set forth below.
Expected to be operational by:
April 30, 1998 -- Brussels, Antwerp, Rotterdam, Amsterdam, London,
Paris, Strasbourg, Frankfurt, Zurich and Geneva -- covering approximately
3,000 kilometers.
June 30, 1998 -- Above cities and Dusseldorf, Stuttgart and
Munich -- covering approximately 3,800 kilometers.
HER expects to have an aggregate of approximately 10,000 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 routes planned to be operational in the second quarter of 1998 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 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.
HER is deploying the network along the rights-of-way of a variety of
alternative sources, including railways, 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
railways, highway commissions, pipeline owners, utilities or others. 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
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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, Inc. ("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.
In addition, Exprit Telecom Group plc ("Esprit") also recently announced
plans to construct an SDH fiber optic ring network that will connect the United
Kingdom, France, the Netherlands and Belgium.
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
"-- Certain Considerations Generally Applicable to the Company's
Operations -- Competition."
HER RECAPITALIZATION
During 1997, HER 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 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. In March 1998, Hit Rail sold
all of its shares in HER to GTS-Hermes, SNCB/NMBS and AB Swed Carrier. As a
result of such sale, GTS-Hermes, SNCB/NMBS and AB Swed Carrier currently own
170,307, 13,610, and 6,551 shares of HER, repectively, or 89.4%, 7.2%, and 3.4%,
respectively of HER.
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
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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. As a result of the
March 1998 sale by Hit Rail of all its shares in HER, Hit Rail no longer has any
rights or obligations, except as set forth below, under the Shareholders
Agreement and GTS-Hermes, acting alone, can approve all the matters described
above which require an 85% HER shareholder vote.
Articles of Association and Shareholders Agreement
Under the Articles of Association and the Shareholders Agreement, HER's
shareholders 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 it. 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.
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, which is an Exhibit to this Report.
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.
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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 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 -- "Certain Considerations Generally Applicable to the Company's
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Operations -- 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 by mid -- 1998.] Given the fact that
the implementation of the EC Directives is late, 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.
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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. HER has notified the ART of the
initial public offering of the Company's common stock and intends to notify the
ART of the March 1998 increase to approximately 89% of GTS-Hermes' ownership
interest in HER.
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. HER has filed an application for a concession for the
operation of a telecommunications infrastructure and was granted a provisional
concession on March 16, 1998. The provisional concession takes retroactive
effect as of January 1, 1998 and HER expects that the Swiss regulatory authority
will grant HER a final concession by the end of the third quarter 1998. However,
no assurance can be given that such final 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 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.
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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.
In addition, to the discussion above, 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 HER's 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 and the Company.
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
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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
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 December 31, 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 $2.8 million to GTS as of
December 31, 1997. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- 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 competitive 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 "indepen-
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dent" international gateway service offerings of GTS-Monaco Access to
those of their PTO competitors.
- 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
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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 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. GTS intends to evaluate additional
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.
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As of December 31, 1997, GTS-Hungary's VSAT network consisted of
approximately 968 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 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 50% of GTS-Hungary's total revenue for the year ended December 31,
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 December 31, 1997, GTS had made equity
contributions of $12.5 million to GTS-Hungary, GTS' partner has not made any
equity contributions as of December 31, 1997. In addition, GTS-Hungary had
outstanding loans of $2.8 million to GTS as of December 31, 1997. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- 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 of Financial Condition and Results of
Operations -- 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 December 31, 1997, the Czech Companies had concluded agreements with
building owners to convert PABXs in 25 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 a shareholder of the Company owns a 25% interest. See "Certain
Related Party Transactions" in the Company's Proxy Statement for its 1998 Annual
Meeting. 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 by the end of the third quarter of 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 of Financial Condition and Results of
Operations -- 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 of Financial Condition and Results of Operations --
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 December 31, 1997, GTS and its consolidated subsidiaries employed a
total of 387 persons. On December 31, 1997, the joint ventures in which GTS
participates employed approximately 1,195 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.
CERTAIN CONSIDERATIONS GENERALLY APPLICABLE TO THE COMPANY'S OPERATIONS
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
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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 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.
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
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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, the Company or its ventures
could be exposed, among other things, to significant fines, risk of prosecution
and loss of its licenses.
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 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.
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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 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.
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 EU telecommunications market on
January 1, 1998 under existing European Community
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("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 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.
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. See
also "Western Europe -- HER -- Competition" for a discussion of the plans of
WorldCom, Viatel and Esprit to build fiber optic networks in Western Europe.
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
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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."
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.
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.
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.
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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.
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.
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).
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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.
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.
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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.
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.
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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 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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ITEM 2. PROPERTIES
The Company leases, under long-term leases, office space to serve as sales
office and/or administrative facilities, including its 15,000 square-foot
headquarters in McLean, Virginia with a five year lease expiring December, 2000.
The Company maintains regional headquarters offices in Moscow and Budapest, as
well as facilities in London. HER is headquartered just outside of Brussels,
Belgium.
HER leases, under long-term leases, portions of railroad, utility and other
rights-of-way for its fiber-optic routes. HER is creating a fiber optic network
consisting of optical fiber pairs, which are leased under long-term leases, and
technical sites leased under long-term leases. See "Business -- Western
Europe -- HER."
ITEM 3. LEGAL PROCEEDINGS
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.
On March 27, 1998, V-Tech brought a claim for approximately $1.1 million
against Gilat Satellite Networks, Ltd. ("Gilat"), the vendor of a Ku-band VSAT
hub and system which V-Tech purchased in 1996, in an arbitration proceeding
under the Rules of Arbitration of the ICC International Court of Arbitration. V-
Tech has demanded in the request for arbitration that Gilat accept return of the
equipment, which V-Tech has not accepted or commissioned because it has failed
to meet contract specifications, and refund purchase amounts already paid under
the contract, plus other sums. Gilat has previously asserted that the equipment
meets specifications and demanded that V-Tech pay the balance due under the
contract, approximately $400,000. It is not possible at this time to make an
assessment of the outcome of the arbitration proceeding.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
During the fourth quarter of 1997 and first quarter of 1998, the Company,
in lieu of calling stockholders meetings, solicited written consents from its
common stockholders with respect to the following three proposed actions:
1) The Company solicited written consents from its common stockholders
of record on November 14, 1997, regarding a proposal to amend the Company's
Certificate of Incorporation, as amended (the "Charter"), to:
a) change the par value per share of the Company's common stock
from $0.0001 to $0.10;
b) effect a 3-for-2 split of the Company's common stock; and
c) increase the authorized common stock from 60 million to 135
million shares.
As of December 1, 1997, holders representing 17,847,036 shares of the
Company's common stock, or 71% of the outstanding shares of common stock,
submitted written consents approving such proposed amendment of the
Charter. The Company did not receive any responses "against," or
abstentions with respect to, the proposed amendment.
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2) The Company solicited written consents from its common stockholders
of record on December 10, 1997 regarding a proposal to amend its Charter
to:
a) classify its Board of Directors into three classes and stagger
the election of each such class for three-year terms commencing at the
annual stockholders meetings to be held in 1998, 1999 and 2000;
b) eliminate the ability of the stockholders to act by written
consent; and
c) provide that the provisions of the charter set forth in (a) and
(b) above can be amended only by an affirmative vote of 75% of the
shares present and eligible to vote (the "Locking Provision").
As of January 29, 1998, holders representing 20,627,807 shares of the
Company's common stock, or 55% of the outstanding shares of common stock,
submitted written consents approving such proposed amendments of the
Charter. The Company received 2,014,287 votes, or 5% of the outstanding
common stock, against the proposed amendment. The Company did not receive
any abstentions with respect to the proposed amendment.
3) The Company solicited written consents from its common stockholders
of record on January 12, 1998 regarding a proposal to amend the Charter to
require an affirmative vote of 75% of the shares present and eligible to
vote to amend the Locking Provision. As of January 29, 1998 holders
representing 23,595,352 shares of the Company's common stock, or 63% of the
outstanding shares of common stock, submitted written consents approving
such proposed amendment of the Charter. The Company did not receive any
responses "against," or abstentions with respect to, the proposed
amendment.
PART II
ITEM 5.MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The listing of the Company's common stock on the NASDAQ National Market
commenced on February 5, 1997. The high and low sale prices of the Company's
common stock as reported by the NASDAQ National Market from February 5, 1998
through February 27, 1998 were:
High $38.75; Low $25
As of February 27, 1997, the Company's common stock was held by 179 holders
of record.
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 Company's 9-7/8% Senior Notes due 2005 contains restrictions on
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
such 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 such indenture).
Moreover, GTS is a holding company which has no significant business operations
or assets other than its interests in joint ventures and its subsidiaries.
Accordingly, GTS must rely entirely upon distributions from the joint ventures
and its subsidiaries and investments to generate the funds necessary to pay any
dividends. The joint ventures and the Company's subsidiaries are separate and
distinct legal entities which have no obligation, contingent or otherwise, to
pay any amount to the Company, whether by dividends, loans or other payments,
except for payments under certain intercompany indebtedness. See "Business." In
addition, should the Company receive dividends or other distributions from its
joint ventures, subsidiaries or investments, the ability of the Company to
repatriate such profits and capital is dependent upon the provisions of the
applicable foreign investment and exchange laws and availability of foreign
exchange in sufficient quantities in those countries. The amount of such
dividends and other distributions from these entities will be
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affected by the current tax systems in these jurisdictions, primarily the
provisions relating to corporate profits and withholding taxes. Furthermore,
because consent is required of the venture partners in some of the Company's
joint ventures for distributions from such joint ventures, the Company's ability
to receive dividends and other distributions is to some degree dependent on
cooperation from its joint venture partners. Thus, there can be no assurance
that the Company will be able to realize benefits from its joint ventures,
subsidiaries and investments through the receipt of dividends or other
distributions at such times and amounts it desires. In addition, the Company and
certain operating subsidiaries of the Company may enter into future financings,
the terms of which may include dividend restrictions.
The foregoing reflects a 3-for-2 common stock split and an increase in the
par value per share of common stock to $0.10 effective December 1, 1997.
During the year ended December 31, 1997 the Company issued securities which
were not registered under the Securities Act of 1933, as amended (the
"Securities Act") as follows:
On July 14, 1997 and July 31, 1997, the Company issued an aggregate
$141,295,000 of its Senior Subordinated Convertible Bonds due 2000, convertible
into the common stock, par value $0.10 per share, at a purchase price of 100%,
pursuant to a subscription agreement. UBS Securities LLC, Donaldson, Lufkin &
Jenrette Securities Corporation and Merrill Lynch & Co. acted as managers in the
offering and the aggregate discount was $5,651,800. The securities were sold to
a limited number of qualified institutional buyers as defined in Rule 144A under
the Securities Act and to non-U.S. persons outside the United States. Exemption
from registration was claimed under Rule 144A and Regulation S of the Securities
Act. On February 10, 1998, the Company completed a "Complying Public Equity
Offering," as defined in the indenture for such Bonds, and, as a result, such
Bonds became convertible into the common stock at a conversion price of $20 per
share.
On August 15, 1997, August 29, 1997 and September 5, 1997, the Company
issued an aggregate 2,502,686 shares of common stock, par value $0.10 per share,
at a purchase price of $15.67 per share, for an aggregate offering price of
$39.2 million, pursuant to a stock purchase agreement. In addition to (i)
certain investment funds and (ii) certain individual private investors, these
shares were issued to certain members of management and various entities
affiliated with certain members of management. Exemption from registration was
claimed under Section 4(2) of the Securities Act regarding transactions by an
issuer not involving any public offering.
On August 29, 1997, the Company issued $3.5 million of its Senior
Subordinated Convertible Bonds due 2000, convertible into the common stock, par
value $0.10 per share, at a purchase price of 100%. In addition to (i) certain
investment funds and (ii) certain individual private investors, these shares
were issued to certain members of management and various entities affiliated
with certain members of management. Exemption from registration was claimed
under Section 4(2) of the Securities Act regarding transactions by an issuer not
involving any public offering. See the discussion above concering the terms of
conversion of these Bonds.
On September 26, 1997, the Company filed a registration statement
(Commission file no. 333-36555) (the "Stock Registration Statement") with the
Securities and Exchange Commission (the "Commission") to offer and sell to the
public, in an underwritten offering, 11,100,000 shares of its common stock, par
value $0.10 per share (the "Stock Offering"). Merrill Lynch & Co., Donaldson,
Lufkin & Jenrette Securities Corporation, UBS Securities LLC, Lehman Brothers
Inc. and Furman Selz LLC acted as the managers of the U.S. portion (7,400,000
shares) of the Stock Offering. Merrill Lynch International, UBS Limited,
Donaldson, Lufkin and Jenrette International, Lehman Brothers International
(Europe) and Baring Brothers Limited (as agent for ING Bank N.V.) acted as the
managers of the international portion (3,700,000 shares) of the Stock Offering.
The Stock Registration Statement was declared effective by the Commission on
February 5, 1998. In connection with the Stock Offering, the managing
underwriters exercised an overallotment option of 1, 665,000 shares. The Stock
Offering has terminated. The Company realized from the sale of a total of
12,765,000 common shares at $20 per share net proceeds from the Stock Offering,
including shares issued pursuant to exercise of the overallotment option, of
$238,705,500, after payment of $16,594,500 in underwriting discounts. On
December 23, 1997, the Company also filed a registration statement (Commission
file no. 333-43155) (the "Debt Registration Statement") to offer and sell to the
public, in an underwritten offering,
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senior notes due 2005 of the Company (the "Debt Offering"). Donaldson, Lufkin &
Jenrette Securities Corporation, Merrill Lynch & Co. and UBS Securities acted as
managers of this offering. The Debt Registration Statement was declared
effective by the Commission on February 5, 1998. The Debt Offering has
terminated and the Company issued $105 million aggregate principal amount of
9 7/8% Senior Notes due 2005 (the "Senior Notes"). The Company realized from the
sale of the Senior Notes net proceeds of $82.3 million, after payment of
underwriting discounts and commissions of $3,150,000, and the deposit of $19.6
million in escrow to cover the first four scheduled payments of interest on the
Senior Notes. In February 1998, the Company applied a portion of the net
proceeds of the Offerings, approximately $85.2 million, to repay the outstanding
principal of, and accrued interest on, certain loans from related parties. See
Note 5 Debt Obligations the Company's audited consolidated financial statements
for a description of such related party loans. The Company will disclose
additional information regarding expenses incurred in connection with, and
application of net proceeds of, the Offerings in its quarterly report on Form
10-Q for the quarter ended March 31, 1998.
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ITEM 6. SELECTED FINANCIAL DATA
Selected financial data for the Company is presented below.
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The following selected historical consolidated financial data as of and for
the years ended December 31, 1993, 1994, 1995, 1996 and 1997 are derived from
the Company's audited 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, many 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 3 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>
YEARS ENDED DECEMBER 31,
----------------------------------------------------
1993 1994 1995 1996 1997(1) 1997
------- -------- -------- -------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
PRO FORMA
(2)
---------
<CAPTION>
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues, net....................................... $ 328 $ 2,468 $ 8,412 $ 24,117 $ 47,098 47,098
Gross margin........................................ 328 23 16 5,176 4,379 4,379
Operating expenses.................................. 3,340 12,863 41,014 52,955 78,410 78,410
Equity in earnings (losses) of ventures............. 472 (135) (7,871) (10,150) (14,599) (14,599)
Other income (expense).............................. 100 990 11,034 (8,729) (29,551) (29,551)
Loss before extraordinary loss...................... (2,440) (11,985) (40,400) (67,991) (116,986) (116,986)
Extraordinary loss.................................. -- -- -- -- -- (13,213)
Net loss............................................ (2,440) (11,985) (40,400) (67,991) (116,986) (130,199)
Loss per share before extraordinary loss............ (0.26) (0.69) (1.61) (2.22) (3.26) (3.26)
Extraordinary loss per share........................ -- -- -- -- -- (0.27)
Net loss per share.................................. (0.26) (0.69) (1.61) (2.22) (3.26) (2.68)
BALANCE SHEET DATA (AT END OF PERIOD):
Cash and cash equivalents........................... $ 3,641 $ 29,635 $ 9,044 $ 57,874 $ 318,766 551,641
Property and equipment, net......................... 829 8,393 29,523 35,463 236,897 236,897
Investments in and advances to ventures............. 794 13,841 56,153 104,459 76,730 76,730
Total assets........................................ 5,968 61,957 115,621 237,378 780,461 1,036,400
Total debt.......................................... 725 2,152 27,454 85,547 639,359 672,219
Minority interest and stock subject to repurchase... -- 8 5,273 6,248 31,255 18,766
Shareholders' equity................................ 4,685 54,684 55,322 113,668 26,967 266,706
</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.
(2) The above unaudited pro forma information gives effect to the underwritten
public offerings by the Company of common stock and debt securities
consummated in February 1998, as though the transactions had occurred on
December 31, 1997. The adjustments include the raising of $255.3 million
from the sale of 12.8 million shares of common stock at an issue price of
$20.00 per share. In addition, the Company issued $105.0 million in senior
notes. Approximately $85.2 million of the net proceeds were used to repay
the related party debt obligations. See Note 15, Audited Financial
Statements of the Company.
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<PAGE> 109
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, 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)
YEAR ENDED DECEMBER 31, 1997
Sovintel............................................. 50% $113,962 $72,629 $17,020 $18,464
TCM.................................................. 50% 29,308 7,169 3,286 12,512
TeleRoss............................................. 50% 6,794 2,138 3,612 71
Sovam................................................ 66.7% 17,808 10,684 5,653 780
GTS Cellular Companies............................... 50%(3) 44,275 21,355 17,678 (906)
Other................................................ 50%(3) 14,013 13,757 27,596 (26,591)
-------- -------- ------- -------
Total.......................................... 226,160 127,732 74,845 4,330
ADJUSTMENTS FOR INTER-AFFILIATE TRANSACTIONS(1)...... (24,927) (23,250) (8,357)
</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.
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<PAGE> 110
ITEM 7.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 December 31, 1997, 1996 and 1995 and for the
years ended December 31, 1997, 1996, 1995. The following discussion should be
read in conjunction with the Company's Consolidated Financial Statements and the
notes related thereto.
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
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.
In addition, 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 Report. 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
"Business," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and elsewhere in this Report.
The factors described in this Report 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 may 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.
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, Central Europe and Asia. In Western Europe, through HER, GTS
is developing and operating the initial segment 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
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<PAGE> 111
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. See "Business."
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.
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. See
"Business -- Certain Considerations Applicable to the Company's Operations in
Russia and the CIS" and "-- Certain Considerations Generally Applicable to the
Company's Operations."
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 minority
shareholder rights, 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 December 31, 1997, $5.3
million and $10.0 million represent the net unrecovered Excess Losses for the
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<PAGE> 112
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 issuance of $265 million aggregate
principal amount of senior notes (of which $56.6 million was placed in escrow
for the first two years' interest payments) in August 1997, the Company 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.
The following table summarizes the accounting methodology for the principal
business ventures through which the Company conducts its business.
<TABLE>
<CAPTION>
COUNTRY/REGION EFFECTIVE GTS ACCOUNTING
COMPANY NAME OF OPERATIONS OWNERSHIP METHODOLOGY
------------ -------------- ------------- ------------
<S> <C> <C> <C>
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" and "Business -- Russia and the
CIS -- TeleRoss." 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 1997, all of the TeleRoss
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<PAGE> 113
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 operating 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."
(3) GTS purchased the remaining 33% interest in Sovam in February 1998.
(4) GTS conducts its cellular operations through (i) Vostok Mobile, a wholly
owned GTS venture that owns between 50% and 70% of a series of 12 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.
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, the Czech Companies
and HER (for 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 1997), GTS-Monaco Access,
EuroHivo and the Asia business ventures.
Revenue. The Company's consolidated revenue was $47.1 million, $24.1
million and $8.4 million for the years ended December 31, 1997, 1996, and 1995,
respectively. The growth in revenue was attributable to the commencement in 1995
of commercial operations by TeleRoss Operating Company, as well as the continued
expansion of services and customer base in Central Europe, and HER's initial
Amsterdam to Brussels route and further expansion to London and Paris during
1997.
The CIS region's consolidated revenue was $27.1 million, $12.7 million, and
$3.8 million for the years ended December 31, 1997, 1996 and 1995 respectively.
TeleRoss Operating Company generated revenue of $24.7 million, $9.2 million and
$3.8 million, representing 91.1%, 72.4% and 100% of the region's consolidated
revenue for the years ended December 31, 1997, 1996 and 1995, respectively.
Service revenue represented 81.8%, 64.1% and 21.1% of TeleRoss Operating
Company's revenue for the years ended December 31, 1997, 1996 and 1995,
respectively, with the balance of its revenue in such periods principally
represented by installation and equipment sales. The growth in revenue was a
result of increased traffic volume generated by the TeleRoss Ventures as they
expanded to 13 cities for the year ended December 31, 1997, added customers in
existing cities and installed several VSATs at customer locations outside of
cities in which they have a presence.
Within the Central Europe region, GTS-Hungary and the Czech Companies
accounted for 100% of the revenue earned, of which GTS-Hungary and the Czech
Companies provided $8.5 million and $5.1 million of the Company's consolidated
revenue in 1997, respectively, compared to $6.9 million and $2.3 million in
1996, respectively, and $4.2 million and $0.3 million in 1995, respectively. The
growth in revenue of GTS-Hungary from 1995 to 1997 was due to the expansion of
its customer base and the introduction of microwave technology services. The
Hungary state lottery accounted for 50.6%, 55.3% and 65.0% of GTS-Hungary's
revenue in 1997, 1996 and 1995, respectively. The growth in revenue of the Czech
Companies was generated through increases in voice traffic carried from
twenty-five buildings at December 31, 1997, as compared to sixteen buildings at
December 31, 1996.
All of Western Europe's consolidated revenue of $5.4 million for the year
ended December 31, 1997 was derived from HER.
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<PAGE> 114
Gross Margin. GTS's consolidated gross margin was $4.4 million, or 9.3% of
revenue, for the year ended December 31, 1997, $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 year ended December 31, 1995.
The CIS region had a gross margin of $4.0 million, $0.8 million and $(0.9)
million for the years ended December 31, 1997, 1996 and 1995, respectively.
TeleRoss Operating Company had a gross margin of $3.5 million, or 14.2% of
revenues, for the year ended December 31, 1997 and a negative gross margin of
$(1.0) million for each of 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 and the Czech Companies comprised 100% of the Central Europe
region's gross margin. GTS-Hungary had a gross margin of $3.5 million, $3.0
million, and $1.7 million, representing 41.2%, 43.4%, and 40.5% of GTS-Hungary's
revenue for the years ended December 31, 1997, 1996 and 1995, respectively. The
favorable gross margin trend reflected the increased utilization of
GTS-Hungary's 1,000 VSAT capacity hub located in Budapest. The Czech Companies
had a gross margin of $1.5 million, $0.3 million and $(0.1) million for the
years ended December 31, 1997, 1996 and 1995, respectively. HER incurred a
negative gross margin of $(4.6) million for the year ended December 31, 1997,
which was primarily due to the initial cost structure of the new routes and
minimal revenue generated.
Operating Expenses. Consolidated operating costs were $76.7 million, $52.9
million, and $41.0 million for the years ended December 31, 1997, 1996 and 1995,
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, the inclusion of HER's operating
expenses in 1997 and increasing corporate staff.
Equity in (Losses)/Earnings of Ventures. GTS recognized losses from its
investments in non-consolidated ventures of $14.6 million, $10.2 million and
$7.9 million for the years ended December 31, 1997, 1996 and 1995, respectively.
Included in these losses were $3.6 million, $5.7 million and $5.2 million for
the years ended December 31, 1997, 1996 and 1995, respectively, that related to
GTS's ownership share of the losses. Also included in the losses for the year
ended December 31, 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) that
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," 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," "Business -- Central Europe" and
"Business -- Asia." Additionally, included within GTS's ownership share of the
losses incurred and the Excess Losses for the year ended December 31, 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 $5.2 million for the year ended
December 31, 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 due to the recognition of Excess Losses of $5.6 million,
$4.5 million and $2.7 million for the years ended December 31, 1997, 1996 and
1995, respectively. See "-- Overview." 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 $15.5
million, $11.8 million and $3.8 million for the years ended December 31, 1997,
1996 and 1995, respectively, which partially offset losses generated by other
ventures.
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<PAGE> 115
Other Non-Operating Income. Favorably affecting the 1995 results was the
non-recurring $10.3 million gain that 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 $39.1 million, $11.1
million and $0.7 million for the years ended December 31, 1997, 1996 and 1995,
respectively. Interest expense is comprised of interest incurred from debt
maturing within one year, long-term debt obligations, capital lease obligations,
amortization of debt discount on the long-term debt obligations and various
other debt obligations. The significant increase in interest expense was due to
the $409.8 million increase in debt raised in 1997. See "-- Liquidity and
Capital Resources."
GTS earned interest income of $11.4 million, $3.6 million and $2.2 million
for the years ended December 31, 1997, 1996 and 1995, 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
$2.5 million, $1.4 million and $2.6 million for the years ended December 31,
1997, 1996 and 1995, respectively. 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 non-U.S. loss
carryforwards will be allowed, in part or in full, by local tax authorities
against future income.
RESULTS OF OPERATIONS -- NON-CONSOLIDATED VENTURES (EQUITY INVESTEES)
Russia -- CIS
Sovintel. Sovintel's revenue for the years ended December 31, 1997, 1996
and 1995 was $114.0 million, $75.0 million and $44.3 million, respectively. The
increase in revenue was primarily the result of telecommunications service
revenue, which increased to $85.4 million for the year ended December 31, 1997
from $50.8 million and $26.8 million for the years ended December 31, 1996 and
1995, respectively, 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. Revenue from incoming international
minutes also increased to $13.1 million for the year ended December 31, 1997,
from $6.8 million and $2.2 million for the years ended December 31, 1996 and
1995, respectively. Included in Sovintel's traffic revenue for 1997 and 1996 was
$12.4 million and $5.0 million, respectively, 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 international/long
distance billings from TCM-supplied phone numbers.
Sovintel's non-traffic-related revenue of $28.6 million, $24.2 million and
$17.5 million for the years ended December 31, 1997, 1996 and 1995,
respectively, was primarily attributable to port sales and monthly port fees
revenues.
Sovintel's gross margin was $41.3 million, $31.1 million and $18.0 million,
or 36.2%, 41.5% and 40.6% of revenue, for the years ended December 31, 1997,
1996 and 1995, respectively. The decrease in gross margin percentage was
attributable to a general price decrease in international and domestic revenues
due to competitive pressures and a higher percentage of domestic minutes, which
yield a lower margin.
Operating expenses were $17.0 million, $10.3 million and $7.1 million, or
14.9%, 13.7% and 16.0% of total revenue, for the years ended December 31, 1997,
1996 and 1995, respectively. The increase in operating expenses was related to
increases 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 $5.7 million, $5.2 million and $2.6 million for the
years ended December 31, 1997, 1996 and 1995, respectively. The increase in
income tax expense was attributable to Sovintel's profitable operations.
TCM. TCM's revenue was $29.3 million and $16.5 million for the years ended
December 31, 1997 and 1996, respectively. TCM had minimal activities in 1995.
TCM had a gross margin of $22.1 million and
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<PAGE> 116
$13.2 million, or 75.4% and 80.0% of total revenue. The decrease in gross margin
as a percentage of revenue was attributable to higher infrastructure and
settlement costs. TCM had operating expenses of $3.3 million and $1.9 million,
or 11.3% and 11.5% of total revenue, for the years ended December 31, 1997 and
1996, respectively.
Sovam. Sovam's revenue was $17.8 million, $11.7 million and $4.4 million
for the years ended December 31, 1997, 1996 and 1995, respectively. The increase
in revenues is primarily attributable to the expansion of Sovam's network
throughout Russia and the CIS and the wider variety of service offerings,
including the introduction of Russia On Line services.
Gross margin was $7.1 million, $3.4 million and $1.5 million, or 39.9%,
29.1% and 34.1% of total revenue for the years ended December 31 in 1997, 1996
and 1995, respectively. Operating expenses were $5.7 million, $5.7 million and
$3.3 million, or 32.0%, 48.7% and 75.0% of total revenue, for the years ended
December 31, 1997, 1996 and 1995, respectively.
TeleRoss Ventures. Revenue for the TeleRoss Ventures for the years ended
December 31, 1997, 1996 and 1995 was $6.8 million, $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, an additional seven new cities in the network in 1996 and an additional
city in 1997.
Gross margin for the years ended December 31, 1997, 1996 and 1995 was $4.7
million, $1.6 million and $0.1 million, respectively. Operating expenses of $3.6
million, $2.3 million and $0.2 million were incurred for the years ended
December 31, 1997, 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 $25.8 million, $16.5 million and $2.0 million
for the years ended December 31, 1997, 1996 and 1995, respectively. Vostok
Mobile's gross margin was $13.6 million, $9.3 million and $1.1 million, or
52.7%, 56.4% and 55.0% of total revenue, and operating expenses were $10.1
million, $9.2 million and $4.7 million for the years ended December 31, 1997,
1996 and 1995, respectively.
Revenue for PrimTelefone was $12.1 million, $8.4 million and $2.2 million
for the years ended December 31, 1997, 1996 and 1995, respectively.
PrimTelefone's gross margin was $6.6 million, $4.7 million and $0.6 million, or
54.5%, 56.0% and 27.3% of total revenue, and operating expenses were $3.6
million, $3.7 million and $0.7 million for the years ended December 31, 1997,
1996 and 1995, respectively.
Bancomsvyaz did not have significant operations until 1997. Revenue for
Bancomsvyaz was $7.2 million and gross margin was $2.8 million, or 38.9% of
total revenue, for the year ended December 31, 1997. Operating expenses were
$4.9 million for the year ended December 31, 1997.
Western Europe
HER. HER earned a small revenue stream in 1996 and no revenue in 1995.
Operating expenses were $16.0 million and $6.7 million for the years ended
December 31, 1996 and 1995, respectively. The increase in selling, general and
administrative expenses reflected HER's continued transition from the start-up
phase to the operational phase. In 1997, HER was included in the consolidated
results of the Company.
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 $13.0 million and
$3.9 million and gross margin was $0.2 million and $(0.4) million for the years
ended December 31, 1997 and 1996, respectively.
Central Europe
EuroHivo. EuroHivo's operating results were minimal for the years ended
December 31, 1997, 1996 and 1995. In September 1997, the Company recorded a $2.4
million charge to recognize the liabilities associated
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<PAGE> 117
with the planned liquidation and discontinuance of EuroHivo's operations. See
Footnote 3 in the Company's audited financial statements for additional
disclosures related to EuroHivo.
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 for the year ended December 31,
1996, and had minimal revenues in 1997 and 1995. 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.
During the year ended December 31, 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 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 of 1997. See Footnote 3 in the Company's
audited financial statements for additional disclosures related to the Company's
Asia operations and "Business -- Asia."
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 $36.4 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 $248.3
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 $285.3 million and $46.9 million as of
December 31, 1997 and 1996, respectively. Approximately $190.5 million of
working capital at December 31, 1997 is intended to be used for the buildout of
the HER Network. The Company had an accumulated deficit of $242.9 million as of
December 31, 1997, including net losses of approximately $117.0 million, $68.0
million and $40.4 million for the years ended December 31, 1997, 1996 and 1995,
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
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<PAGE> 118
expenditures and investments in ventures during the next three 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 due in August 2007 by HER that may be redeemed upon the successful
completion of a complying equity offering by HER or meeting other certain
criteria, and (iii) the issuance in July and August 1997 of $144.8 million in
gross proceeds of the Convertible Bonds by GTS that are convertible into Common
Stock upon the Company's completion of a complying equity offering.
The Company effected a three-for-two split of its common stock effective
December 31, 1997, and the information presented in this "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
reflects that action.
Subsequent to December 31, 1997, the Company raised approximately $255.3
million in gross proceeds from an initial public stock offering of 12.8 million
common shares at $20.00 per share. Such initial public offering constituted a
"complying public equity offering" under the Company's Convertible Bonds. As a
result, the conversion price of the Bonds is $20 per share. In addition, the
Company issued $105.0 million in gross proceeds of 9.875% senior notes due
February 15, 2005, of which $19.6 million was placed in escrow to fund the first
two years' interest payments. The Company believes that the net proceeds from
these 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.
The actual amount and timing of the Company's future capital requirements
may differ materially from management's estimates. In particular, the accuracy
of management's estimates is 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 Convertible
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 "Business."
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.
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<PAGE> 119
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, with approximately
$35 million required for the initial five country network. See
"Business -- Western Europe -- HER." As of December 31, 1997, approximately
$34.3 million has been spent on network capital expenditure. 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 discussions 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 HER Recapitalization, in 1997, 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 HER. 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 HER 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 HER
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." In March 1998, Hit Rail sold a portion
of its ownership interest to GTS-Hermes for ECU 13.5 million (approximately
$14.6 million) and, as a result, GTS-Hermes increased its ownership of HER to
89.42%. See "Business -- Western Europe -- HER -- HER Recapitalization."
LIQUIDITY ANALYSIS
The Company had cash and cash equivalents of $318.8 million and $57.9
million as of December 31, 1997 and 1996, respectively. Approximately $190.5
million of the $319.0 million of cash and cash equivalents at December 31, 1997,
is intended to be used for the build-out of the HER network. The Company had
restricted cash of $66.9 million and $16.2 million as of December 31, 1997 and
1996, respectively. Restricted cash included $29.0 million 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 years ended December 31, 1997 and 1996, the Company used $48.6
million and $39.0 million, respectively, of cash for operating activities. Cash
used for investing activities was $103.4 million and $80.9 million for the years
ended December 31, 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. 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.
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
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<PAGE> 120
consolidated operations transact their business in the following significant
currencies: Russian Ruble, Hungarian Florint, Belgium Franc and the European
Currency Equivalent. 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 is attempting 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.
See "Business -- Russia and the CIS -- Certain Considerations Applicable to the
Company's Operations in Russia and the CIS -- Exchange Controls and Risks
Relating to Russian Securities" and "Business -- Certain Considerations
Generally Applicable to the Company's Operations -- Currency and Exchange
Risks."
The Company has developed risk management policies that establish
guidelines for managing foreign exchange risk. The Company is currently
evaluating the materiality of foreign exchange exposures in different countries
and the financial instruments available to mitigate this exposure. The Company's
ability to hedge its exposure is limited since certain of its operations are
located in countries whose currencies are not easily convertible. Financial
hedge instruments for these countries are nonexistent or limited and also
pricing of these instruments is often volatile and not always efficient. The
Company is designing reporting processes to monitor the potential exposure on an
ongoing basis and expects to implement this process before the end of 1998. The
Company will use the output of this process to execute financial hedges to cover
foreign exchange exposure when practical and economically justified.
The Company is considering alternatives to hedge the foreign exchange
exposure resulting from the issuance of $265 million senior notes by HER. It
expects to have a transaction which eliminates this risk consummated by the end
of April 1998.
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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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
GLOBAL TELESYSTEMS GROUP, INC.
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
YEAR END FINANCIAL STATEMENTS
Report of Ernst & Young LLP, Independent Auditors......... 81
Consolidated Balance Sheets as of December 31, 1996 and
1997................................................... 82
Consolidated Statements of Operations for the years ended
December 31, 1995, 1996,
and 1997............................................... 83
Consolidated Statements of Cash Flows for the years ended
December 31, 1995, 1996,
and 1997............................................... 84
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1995,
1996, and 1997......................................... 85
Notes to Consolidated Financial Statements................ 86
</TABLE>
EDN SOVINTEL
YEAR END FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Ernst & Young (CIS) Limited, Independent
Auditors.................................................. 108
Balance Sheets as of December 31, 1997 and 1996............. 109
Statements of Income and Retained Earnings for the years
ended December 31, 1997, 1996,
and 1995.................................................. 110
Statements of Cash Flows for the years ended December 31,
1997, 1996, and 1995...................................... 111
Notes to Financial Statements............................... 112
</TABLE>
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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, 1996 and 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, 1997. Our audits also
included the financial statement schedules listed in the Index at Item 14(a).
These financial statements and schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedules 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, 1996 and 1997, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedules,
when considered in relation to the basic financial statements taken as a whole,
present fairly in all material respects the information set forth therein.
Ernst & Young LLP
Vienna, Virginia
February 26, 1998
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<PAGE> 123
GLOBAL TELESYSTEMS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1996 1997
--------- ---------
(IN THOUSANDS,
EXCEPT SHARE DATA)
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents................................. $ 57,874 $ 318,766
Accounts receivable, net.................................. 8,920 17,079
Restricted cash........................................... 13,627 30,486
Prepaid expenses.......................................... 2,537 14,101
Other assets.............................................. 2,396 6,707
--------- ---------
TOTAL CURRENT ASSETS.............................. 85,354 387,139
Property and equipment, net................................. 35,463 236,897
Investments in and advances to ventures..................... 104,459 76,730
Goodwill and intangible assets, net of accumulated
amortization of $3,916 and $10,184 at December 31, 1996
and 1997, respectively.................................... 9,548 43,284
Restricted cash............................................. 2,554 36,411
--------- ---------
TOTAL ASSETS...................................... $ 237,378 $ 780,461
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses..................... $ 15,211 $ 61,984
Debt maturing within one year............................. 16,261 6,390
Current portion of capital lease obligations.............. -- 21,490
Related party debt maturing within one year............... 4,947 5,708
Other current liabilities................................. 2,040 6,301
--------- ---------
TOTAL CURRENT LIABILITIES......................... 38,459 101,873
Long-term debt, less current portion........................ 5,260 408,330
Long-term portion of capital lease obligations.............. -- 117,645
Related party long-term debt, less current portion.......... 59,079 79,796
Taxes and other non-current liabilities..................... 14,664 14,595
--------- ---------
TOTAL LIABILITIES................................. 117,462 722,239
COMMITMENTS AND CONTINGENCIES
Minority interest......................................... 1,915 18,766
Common stock, subject to repurchase (325,000 shares and
797,100 shares outstanding at December 31, 1996 and 1997,
respectively)............................................. 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; 34,589,106, and 37,606,814 shares issued
and outstanding, net of 116,639 and 195,528 shares of
treasury stock at December 31, 1996 and 1997,
respectively).......................................... 3,459 3,761
Additional paid-in capital................................ 238,268 274,359
Cumulative translation adjustment......................... (2,161) (8,269)
Accumulated deficit....................................... (125,898) (242,884)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY........................ 113,668 26,967
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $ 237,378 $ 780,461
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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<PAGE> 124
GLOBAL TELESYSTEMS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1995 1996 1997
---------- ---------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
REVENUES, NET:
Telecommunication and other services.................... $ 5,979 $ 19,210 $ 41,300
Equipment sales......................................... 2,433 4,907 5,798
-------- -------- ---------
8,412 24,117 47,098
-------- -------- ---------
OPERATING COSTS AND EXPENSES
Cost of revenues:
Telecommunication and other services................. 8,150 14,741 37,206
Equipment sales...................................... 246 4,200 5,513
Selling, general and administrative..................... 37,291 47,940 68,425
Depreciation and amortization........................... 3,491 4,165 6,227
Non-income taxes........................................ 234 850 2,085
-------- -------- ---------
49,412 71,896 119,456
Write-off of venture-related assets..................... -- -- 1,673
Equity in losses of ventures............................ 7,871 10,150 14,599
-------- -------- ---------
Loss from operations...................................... (48,871) (57,929) (88,630)
OTHER INCOME/(EXPENSE):
Other non-operating income.............................. 10,270 -- --
Interest income......................................... 2,177 3,569 11,361
Interest expense........................................ (728) (11,122) (39,086)
Foreign currency losses................................. (685) (1,176) (1,826)
-------- -------- ---------
11,034 (8,729) (29,551)
-------- -------- ---------
Net loss before income taxes and minority interest........ (37,837) (66,658) (118,181)
Income taxes.............................................. 2,565 1,360 2,482
-------- -------- ---------
Net loss before minority interest......................... (40,402) (68,018) (120,663)
Minority interest......................................... 2 27 3,677
-------- -------- ---------
Net loss.................................................. $(40,400) $(67,991) $(116,986)
======== ======== =========
Net loss per share........................................ $ (1.70) $ (2.33) $ (3.26)
======== ======== =========
Weighted average common shares outstanding................ 23,707 29,157 35,833
======== ======== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
83
<PAGE> 125
GLOBAL TELESYSTEMS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1995 1996 1997
-------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss................................................ $(40,400) $(67,991) $(116,986)
ADJUSTMENTS TO RECONCILE NET LOSS TO NET CASH USED IN
OPERATING ACTIVITIES:
Depreciation and amortization........................... 3,721 7,444 14,843
Amortization of discount on note payable................ -- 3,598 5,023
Equity in losses of ventures, net of dividends
received............................................. 7,871 11,123 17,474
Deferred interest....................................... -- 6,583 12,970
Write-off of venture related assets..................... -- -- 1,673
Non-cash compensation................................... -- -- 4,571
Minority interest....................................... (2) (27) (3,677)
Other................................................... 2,577 1,342 2,985
Changes in assets and liabilities, excluding effects of
acquisitions and ventures:
Accounts receivable.................................. (1,557) (6,996) (10,900)
Prepaid expenses..................................... (438) (605) (7,522)
Accounts payable and accrued expenses................ 12,820 (1,694) 34,925
Other changes in assets and liabilities.............. 9,474 8,207 (3,984)
-------- -------- ---------
NET CASH USED IN OPERATING ACTIVITIES........... (5,934) (39,016) (48,605)
INVESTING ACTIVITIES Investments in and advances to
ventures, net of repayments............................. (45,102) (54,932) 5,943
Purchases of property and equipment..................... (24,324) (12,195) (45,148)
Restricted cash......................................... (2,543) (13,138) (62,924)
Acquisitions, net of cash acquired...................... (1,871) -- 1,050
Goodwill and other intangibles.......................... (6,181) (487) (2,196)
Other investing activities.............................. 2,069 (125) (149)
-------- -------- ---------
NET CASH USED IN INVESTING ACTIVITIES........... (77,952) (80,877) (103,424)
FINANCING ACTIVITIES
Proceeds from debt...................................... 23,325 63,599 409,817
Payment of debt issue costs............................. (779) (2,777) (24,927)
Net proceeds from issuance of common stock.............. 42,175 107,775 36,432
Other financing activities.............................. (750) -- (536)
-------- -------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES....... 63,971 168,597 420,786
Effect of exchange rate changes on cash and cash
equivalents............................................. (676) 126 (7,865)
-------- -------- ---------
Net (decrease) increase in cash and cash equivalents...... (20,591) 48,830 260,892
Cash and cash equivalents at beginning of year............ 29,635 9,044 57,874
-------- -------- ---------
CASH AND CASH EQUIVALENTS AT END OF YEAR.................. $ 9,044 $ 57,874 $ 318,766
======== ======== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
84
<PAGE> 126
GLOBAL TELESYSTEMS GROUP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996, AND 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, 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 $2,777.......................... 2,503 250 36,182 -- -- 36,432
Translation adjustment........................ -- -- -- (6,108) -- (6,108)
Net loss...................................... -- -- -- -- (116,986) (116,986)
Other......................................... 515 52 (91) -- -- (39)
------ ------ -------- ------- --------- ---------
BALANCE AT DECEMBER 31, 1997.................... 37,607 $3,761 $274,359 $(8,269) $(242,884) $ 26,967
====== ====== ======== ======= ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
85
<PAGE> 127
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.
On December 1, 1997, the Company filed an amendment to its Certificate of
Incorporation to effect 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 $0.10 on a post-split
basis. Accordingly, the Company has presented share and per share data for
issued and outstanding shares as well as options and warrants 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.
Subsequent to year end, the Company completed an initial public offering of
12.8 million shares of common stock at $20 per common share (the "Stock
Offering"). The Company also issued aggregate principal amount $105.0 million of
9.875% senior notes due 2005 (the "Notes Offering" and together with the Stock
Offering, the "Offerings"). See Note 15, "Subsequent Events."
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 minority shareholder rights, 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
86
<PAGE> 128
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
profitable, the Company recognizes 100% of the profits until such time as the
excess losses previously recognized have been recovered.
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 $16.2 million and $66.9 million of restricted cash at December 31, 1996 and
1997, respectively. The restricted cash is primarily related to cash held in
escrow for interest payments associated with the Company's debt obligations.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation, which includes the
amortization of assets recorded under capital leases, is calculated on a
straight-line basis over the lesser of the estimated lives, ranging from five to
ten years for telecommunications equipment and three to five years for
furniture, fixtures and equipment and other property, or their contractual term.
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.
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
34, "Capitalization of Interest Costs," the Company intends to capitalize
material interest costs associated with the construction of capital assets for
business operations and amortize the costs over the assets' useful lives. The
Company has not capitalized any interest costs through December 31, 1997.
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 Accounting Principles Board
("APB") Opinion No. 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
In accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," 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
87
<PAGE> 129
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 year ended December 31, 1996, the Company's analyses
indicated that there was not an impairment of its long-lived assets. During the
year ended December 31, 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 its investments 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
During 1997, the Company adopted SFAS No. 128, "Earnings Per Share," which
requires the Company to present basic and fully diluted earnings per share for
all years presented. The Company's net loss per share calculation (basic and
fully diluted) is based upon the weighted average common shares issued. There
are no reconciling items in the numerator or denominator of the Company's net
loss per share calculation. Employee stock options, warrants, and convertible
debt instruments have been excluded from the net loss per share calculation
because their effect would be anti-dilutive (see Note 5, "Debt Obligations,"
Note 6, Shareholders' Equity and Note 7, "Stock Option Plans").
88
<PAGE> 130
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company believes that the carrying amount of its financial instruments
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 currently hedge against foreign currency fluctuations,
although the Company may implement such practices in the future. Under current
practices, the Company's results of operations could be adversely affected by
fluctuations in foreign currency exchange rates.
STOCK BASED COMPENSATION
SFAS No. 123, "Accounting for Stock-Based Compensation," 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." The Company has elected
to account for its stock-based compensation in accordance with the provisions of
APB No. 25 and presents 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.
NEW ACCOUNTING STANDARDS
The Financial Accounting Standards Board has issued two new standards which
become effective for reporting periods beginning after December 15, 1997. SFAS
No. 130, "Reporting Comprehensive Income," requires additional disclosures with
respect to certain changes in assets and liabilities that previously were not
required to be reported as results of operations for the period. The Company
will begin making the additional disclosures required by SFAS No. 130 in the
first quarter of 1998. SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," requires financial and descriptive
information with respect to "operating segments" of an entity based on the way
management disaggregates the entity for making internal operating decisions. The
Company will begin making the disclosures required by SFAS No. 131 with
financial statements for the period ending December 31, 1998.
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.
89
<PAGE> 131
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of the Company's investments in and advances to ventures are
as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1997
-------- -------
(IN THOUSANDS)
<S> <C> <C>
Equity in net assets acquired............................... $ 41,105 $31,183
Excess of investment cost over equity in net assets acquired
net of amortization of $4,347 and $4,851 at December 31,
1996 and 1997, respectively............................... 11,288 7,582
Accumulated (losses) earnings recognized.................... (13,840) 14,659
Dividends................................................... (973) (3,848)
Cash advances and other..................................... 66,879 27,154
-------- -------
Total investments in and advances to ventures..... $104,459 $76,730
======== =======
</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 its 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 December 31, 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
90
<PAGE> 132
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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) earnings recognized.................... (23,253)
Dividends................................................... --
Cash advances and other..................................... 10,921
--------
Net write-off as of December 31, 1997....................... $ 5,354
========
</TABLE>
Prior to the write-off detailed above, the Company included approximately
$14.4 million in its accumulated 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 year ended December 31, 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 and are included in
the $(23.3) million accumulated (losses) detailed above. Additionally, during
the year ended December 31, 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 year ended December 31, 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 million of goodwill
in connection with the recapitalization. As a result of the Company's loss
recognition policy, the consolidation of HER would 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 December 31, 1997, the consolidation of HER resulted in reductions of
$72.9 million, $10.0 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 December 31, 1997 the
consolidation of HER had a $21.4 million favorable impact on the accumulated
(losses) earnings recognized.
91
<PAGE> 133
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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,
--------------------
1996 1997
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Balance, at beginning of period............................. $ 56,153 $104,459
Equity in net assets acquired............................... 22,441 80,054
Excess of investment cost over equity in net assets
acquired.................................................. 5,288 10,187
Dividends................................................... (973) (2,875)
Cash advances (repayments) and other........................ 31,700 (24,171)
Effect of consolidating equity method company............... -- (76,325)
-------- --------
58,456 (13,130)
Equity ownership in losses.................................. (3,122) (5,552)
Excess losses recognized over amount attributable to
ownership
interest.................................................. (4,451) (10,610)
Amortization of excess of investment cost over equity in net
assets acquired........................................... (2,577) (3,313)
Loss in value that is other than temporary.................. -- (5,354)
Effect of consolidating equity method company............... -- 10,230
-------- --------
(10,150) (14,599)
-------- --------
Balance, at end of period................................... $104,459 $ 76,730
======== ========
</TABLE>
As of December 31, 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 (holds a 95% interest in TeleCommunications
of Moscow)................................................ 52.64%
TeleRoss Ventures -- 13 joint ventures in various regions in
the CIS................................................... 50%
Vostok Ventures -- 12 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, in shares of the
Company's common stock, based on the actual earnings of the venture. 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 the first quarter of 1998, the
Company will issue additional shares based on the venture's 1997 earnings (see
Note 15, "Subsequent Events").
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 by
exchange for 713,311 shares of the Company's common stock. Subsequent to the
Stock Offering, repayment of this financing is due on demand and must be in
exchange for the Company's common stock. This amount has been included in "Other
financing agreements" (see Note 5, "Debt Obligations").
92
<PAGE> 134
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Subsequent to year end, the Company purchased the remaining interest in
Sovam Teleport, one of its equity method investments in the CIS.
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, 1996 and 1997.
YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
MAJORITY OWNED 50% OR LESS TOTAL EQUITY
EQUITY METHOD ENTITIES VENTURES OWNED VENTURES METHOD 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>
YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
MAJORITY OWNED 50% OR LESS TOTAL EQUITY
EQUITY METHOD ENTITIES VENTURES OWNED VENTURES METHOD VENTURES
---------------------- -------------- -------------- ---------------
(IN THOUSANDS)
<S> <C> <C> <C>
Revenue.......................................... $47,986 $178,174 $226,160
Gross margin..................................... 29,292 69,136 98,428
Net (loss) income................................ (10,370) 14,700 4,330
Equity in net (losses) earnings.................. (11,538) 5,131 (6,407)
Current assets................................... 20,841 59,959 80,800
Total assets..................................... 35,090 176,117 211,207
Current liabilities.............................. 18,719 68,503 87,222
Total liabilities................................ 27,653 102,758 130,411
Net assets....................................... 7,438 73,359 80,797
Ownership interest in equity in net assets....... 9,541 45,638 55,179
</TABLE>
93
<PAGE> 135
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4: SUPPLEMENTAL BALANCE SHEET INFORMATION
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1997
------- --------
(IN THOUSANDS)
<S> <C> <C>
Accounts Receivable Consists Of:
Trade accounts receivable................................. $ 6,769 $ 15,725
Value added taxes receivable.............................. 1,971 3,350
Other receivables......................................... 962 2,089
------- --------
9,702 21,164
Less: allowance for doubtful accounts................... 782 4,085
------- --------
Total accounts receivable, net...................... $ 8,920 $ 17,079
======= ========
Property And Equipment Consists Of:
Telecommunications equipment.............................. $28,302 $231,996
Furniture, fixtures and equipment......................... 5,877 9,760
Other property............................................ 837 3,470
Construction in process................................... 7,009 7,799
------- --------
42,025 253,025
Less: accumulated depreciation.......................... 6,562 16,128
------- --------
Total property and equipment, net................... $35,463 $236,897
======= ========
Accounts Payable And Accrued Expenses Consists Of:
Accounts payable.......................................... $ 6,761 $ 25,005
Interest payable.......................................... 213 17,483
Accrued compensation...................................... 3,151 6,165
Other accrued expenses.................................... 5,086 13,331
------- --------
Total accounts payable and accrued expenses......... $15,211 $ 61,984
======= ========
</TABLE>
NOTE 5: DEBT OBLIGATIONS
Company debt consists of:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1997
------- --------
(IN THOUSANDS)
<S> <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 warrants to
purchase 7,778 common shares.............................. 59,079 72,233
Other financing agreements.................................. 26,468 18,204
------- --------
85,547 500,224
Less: debt maturing within one year....................... 21,208 12,098
------- --------
Total long-term debt.............................. $64,339 $488,126
======= ========
</TABLE>
In the third quarter of 1997, HER issued $265.0 million aggregate principal
amount 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,
94
<PAGE> 136
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2002 at specific redemption prices. HER may also redeem a portion of 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.
In July 1997, the Company issued $144.8 million aggregate principal amount
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 as defined in the Bond
Agreement. 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 feature, interest
expense is being accrued and accreted at a 15% annual rate. (Subsequent to year
end, the Company completed the Stock Offering at $20.00 per common share which
will result in the Bonds being convertible into approximately 7.2 million shares
of the Company's common stock. In addition, due to the completion of the Stock
Offering, the interest rate will remain at 8.75% until maturity (see Note 15,
"Subsequent Events").)
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 warrants to purchase 7,777,776 common
shares, valued at $20.7 million. 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. 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. As of December 31,
1997, the Debt Obligations have been classified within "Related party long-term
debt, less current portion" on the balance sheet. Subsequent to year end the
Company repaid the Debt Obligations by using a portion of the proceeds from the
Offerings (see Note 15, "Subsequent Events").
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 December 31, 1997, are as
follows: 1998 -- $12.1 million, 1999 -- $1.1 million, 2000 -- $149.4 million,
2001 -- $0.2 million and $349.5 million thereafter.
The Company paid interest of $0.7 million, $0.2 million and $2.0 million in
1995, 1996 and 1997, respectively. The Company incurred interest expense of
$39.1 million in 1997 and would have recorded $33.1 million in additional
interest expense in 1997 had the Senior Notes and Bonds been outstanding on
January 1, 1997.
95
<PAGE> 137
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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, 1995.................................. 5,090,876 $ 9.00 $42,138
December 31, 1996.................................. 8,348,532 13.33 107,744
December 31, 1997.................................. 2,502,686 15.67 36,432
</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 over the next three
years. During 1997, the 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. The Company has
accreted the value of the outstanding common stock subject to repurchase
(325,000 shares at December 31, 1996 and 797,100 shares at December 31, 1997),
to the fair value of the Company's common stock as of December 31, 1996 and 1997
($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 warrants to purchase 7,777,776 common shares 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
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 15,572,260 shares of common stock for issuance
upon conversion of the exercise of outstanding and future stock options,
warrants and similar rights.
PREFERRED STOCK
As of December 31, 1996 and 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, 1996 and 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, 1996 and 1997 would have been
approximately $40.9 million, $69.4 million and $123.4 million, respectively. The
fair value of options
96
<PAGE> 138
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
granted during 1995 and 1996 are estimated as $2.19 and $2.93 per common 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 1997 are estimated as $7.35 per common 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 the 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 December 31, 1997, the maximum number of shares of common stock
available for grant under the Option Plans was 8,836,534. All options granted
under the Option Plans are at exercise prices that were 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.
Additional information with respect to stock option activity is summarized
as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
1995 1996 1997
-------------------- -------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of
year...................... 2,431,800 $3.65 3,422,399 $ 5.56 4,869,360 $ 7.31
Options granted............. 1,210,800 9.04 1,612,962 11.10 2,215,296 14.53
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 (433,173) 7.38
--------- --------- ---------
Outstanding at end of
year...................... 3,422,399 5.56 4,869,360 7.31 6,562,171 9.75
========= ========= =========
Options exercisable at year
end....................... 995,617 $3.59 1,992,236 $ 4.65 2,962,110 $ 6.06
</TABLE>
The following table summarizes information about stock options outstanding:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------- ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF EXERCISE PRICE NUMBER CONTRACTUAL LIFE EXERCISE NUMBER EXERCISE
AT DECEMBER 31, 1997: OUTSTANDING (IN YEARS) PRICE EXERCISABLE PRICE
----------------------- ----------- ---------------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$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 7.88 986,679 7.66
$10.00 to $15.67..................... 3,845,521 8 13.03 604,431 11.13
--------- ---------
6,562,171 7 $ 9.75 2,962,110 $ 6.06
========= =========
</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, 1996 and 1997.
97
<PAGE> 139
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During 1996, the Company implemented the GTS 1996 Top Talent Retention
Program (the "Program"), which granted options to certain employees under the
1992 Stock Option Plan. The Program was offered to 28 employees, who had an
aggregate of 339,524 options, and provided for an altered vesting period based
on certain revenue levels achieved and certain stock price levels maintained. If
these performance-based achievements are not attained, the options vest in April
2001. As of December 31, 1997 no performance levels were met.
In the fourth quarter of 1997, HER implemented a stock option plan for its
key officers and employees (the "HER Plan"). The ownership dilution caused by
the HER Plan is not expected to be significant. As a result of issuing options
under the HER Plan, HER will incur a non-cash charge of approximately $3.7
million, of which $2.6 million was recorded during the fourth quarter and the
remaining $1.1 million will be recognized in 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% matching contribution on the first 5% 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 approximately
$0.1 million, $0.2 million and $0.2 million for the years ended December 31,
1995, 1996 and 1997, respectively. The Company made no discretionary
(non-matching) contributions for the years ended December 31, 1995, 1996 or
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 does not bear significant financial
risk for its pension plan. HER's expense under the pension plan was $0.05
million, $0.4 million and $0.7 million for the years ended December 31, 1995,
1996 and 1997, respectively.
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>
YEAR ENDED DECEMBER 31,
--------------------------------
1995 1996 1997
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Pretax loss:
Domestic......................................... $(22,398) $(41,554) $(64,920)
Foreign.......................................... (15,437) (25,077) (53,261)
-------- -------- --------
$(37,835) $(66,631) $(118,181)
======== ======== ========
</TABLE>
For the years ended December 31, 1995, 1996 and 1997, the Company recorded
$2.6 million, $1.4 million and $2.5 million, respectively, in income tax expense
that related exclusively to its current provision for foreign taxes.
98
<PAGE> 140
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
1995 1996 1997
------------------ ------------------ ------------------
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% $(40,181) 34.0%
Foreign operating losses
generating no tax
benefit.................... 6,550 (17.3) 8,526 (12.8) 18,108 (15.3)
Domestic operating losses
generating no tax
benefit.................... 6,315 (16.7) 14,129 (21.2) 22,073 (18.7)
Other -- net................. 2,565 (6.8) 1,360 (2.1) 2,482 (2.1)
-------- ----- -------- ----- -------- -----
$ 2,565 (6.8)% $ 1,360 (2.1)% $ 2,482 (2.1)%
======== ===== ======== ===== ======== =====
</TABLE>
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,
--------------------
1996 1997
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Deferred Tax Assets:
Net operating loss carryforwards.......................... $ 20,720 $ 38,029
Other deferred tax assets................................. 1,326 3,912
-------- --------
Total deferred tax asset.................................... 22,046 41,941
Deferred Tax Liability...................................... 1,161 2,292
-------- --------
Net deferred tax asset...................................... 20,885 39,649
Less: valuation allowance................................. (20,885) (39,649)
-------- --------
Total............................................. $ -- $ --
======== ========
</TABLE>
As of December 31, 1997, the Company had net operating loss carryforwards
for U.S. federal income tax purposes of approximately $110 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 carry-forwards 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 of the Company's foreign ventures have foreign tax loss
carryforwards in excess of $60 million. The Company's financial statements do
not reflect any provision for benefits that might be associated with such loss
carryforwards.
99
<PAGE> 141
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 11: COMMITMENTS AND CONTINGENCIES
LEASES
The Company has various lease agreements for office space, equipment and
fiber. The obligations extend through 2018. Most of the leases contain renewal
options of one to twelve years. Assets under capital leases are included in the
consolidated balance sheets as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1996 1997
----- --------
(IN THOUSANDS)
<S> <C> <C>
Telecommunications equipment................................ $ -- $150,787
Less: accumulated amortization.............................. -- 482
----- --------
$ -- $150,305
===== ========
</TABLE>
Rental expense aggregated $2.0 million, $2.2 million, and $3.1 million for
the years ended December 31, 1995, 1996 and 1997, respectively.
Future minimum payments, by year and in the aggregate, under the capital
leases and other non-cancellable operating leases with initial or remaining
terms in excess of one year as of December 31, 1997 were as follows:
<TABLE>
<CAPTION>
CAPITAL LEASES OPERATING LEASES
-------------- ----------------
(IN THOUSANDS)
<S> <C> <C>
December 31, 1998....................................... $ 26,679 $ 3,311
1999.................................... 14,217 2,982
2000.................................... 15,300 1,604
2001.................................... 16,465 1,143
2002.................................... 16,630 933
Thereafter.............................................. 152,016 1,155
-------- -------
Total minimum lease payments............................ 241,307 $11,128
=======
Less amount representing interest....................... 102,172
--------
Present value of net minimum lease payments............. 139,135
Less current portion of capital lease obligations....... 21,490
--------
Long-term portion of capital lease obligations.......... $117,645
========
</TABLE>
OTHER COMMITMENTS AND CONTINGENCIES
In September 1997, the Company purchased the remaining interest in one of
its subsidiaries, which owns interests in cellular ventures 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
when certain revenue levels are met, certain other 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's consolidated and non-consolidated ventures have future
purchase commitments amounting to $2.7 million and $1.1 million, respectively,
as of December 31, 1997.
100
<PAGE> 142
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 December 31, 1997 was
approximately $29.0 million.
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.
There were no major customers in 1997.
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, 1996 and 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,
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
the Debt Obligations during 1996 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. The Company repaid
the Debt Obligations subsequent to year end (see Note 15, "Subsequent Events").
101
<PAGE> 143
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. Subsequent to the Stock Offering,
repayment of this financing must be in exchange for the Company's common stock.
This amount has been included in "Other financing agreements" (see Note 5, "Debt
Obligations").
During 1997, the 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. As a result of the issuance of the common shares, the
seller became a shareholder of the Company (see Note 3, "Investments in and
Advances to Ventures," and Note 6, "Shareholders' Equity").
The Company has entered into certain consulting agreements with directors
of the Company and paid $0.2 million, $0.2 million and $0.4 million in 1995,
1996, and 1997, respectively, pursuant to those agreements.
The Company had notes receivable due from employees aggregating $0.1
million and less than $0.1 million as of December 31, 1996 and 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 $4.4
million in 1996 and 1997, respectively. There was no significant revenue earned
from affiliate sales in 1995.
NOTE 13: SUPPLEMENTAL CASH FLOW INFORMATION
The following table summarizes non-cash investing and financing activities
for the Company:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------------
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
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
Capitalization of leases.................................... -- 139,136
</TABLE>
No significant non-cash investing activities were incurred for the year
ended December 31, 1995.
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
102
<PAGE> 144
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
consolidated financial information by geographic area for 1995, 1996 and 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, 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
</TABLE>
<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, 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
</TABLE>
<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, 1997
Total revenue................................... $ 5,373 $ 27,045 $ 13,513 $ 1,016 $ 151 $ 47,098
Gross margin.................................... (4,599) 3,940 4,985 (99) 152 4,379
Operating loss.................................. (25,926) (7,088) (5,076) (28,066) (22,474) (88,630)
Net loss........................................ (29,064) (9,505) (6,882) (28,043) (43,492) (116,986)
Identifiable assets............................. 505,593 99,926 23,840 (6,544) 157,646 780,461
Liabilities..................................... 451,171 62,862 40,465 19,161 148,580 722,239
Net (liabilities)/assets........................ 54,422 37,064 (16,625) (25,705) 9,066 58,222
</TABLE>
NOTE 15: SUBSEQUENT EVENTS
THE OFFERINGS
In February 1998, the Company completed the Stock Offering in which the
Company raised $255.3 million in gross proceeds, including $33.3 million
attributable to the sale of shares resulting from the exercise by the
underwriters of an over-allotment option, from the sale of 12.8 million shares
of common stock at an issue price of $20.00 per share. The Stock Offering
resulted in the Company's common stock being listed in the United States on the
National Association of Securities Dealers Automated Quotation Market and
internationally on the European Association of Securities Dealers Automated
Quotation Market. Also in February 1998, the Company completed the Notes
Offering and issued $105.0 million aggregate principal amount of senior notes,
due February 15, 2005. Interest at 9.875% on the Notes will be payable in cash
semiannually on February 15 and August 15 of each year, commencing August 15,
1998. Net proceeds from the Offerings were approximately $336.7 million.
Approximately $19.6 million of the net proceeds of the Notes Offering is being
held in escrow for the first four semiannual interest payments commencing in
1998.
103
<PAGE> 145
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Approximately $85.2 million of the net proceeds of the Offerings has been used
to repay the related party Debt Obligations (see Note 5, "Debt Obligations") of
$70.0 million plus accrued interest that were due March 31, 2001. In addition,
approximately $13.2 million in unamortized discount and debt issuance costs on
the Debt Obligations was written off at the time of repayment. The remaining net
proceeds from the Offerings will primarily be used to provide working capital
for existing ventures, particularly in Russia and the CIS, to expand the
Company's operations and for general corporate purposes, including strategic
acquisitions.
As a result of the completion of the Stock Offering, the interest rate for
the Bonds will remain at 8.75% until maturity (see Note 5, "Debt Obligations")
and the 6.25% additional interest that was previously accrued, $4.2 million, has
been reflected as an increase to additional paid-in capital. The Bonds are
convertible into approximately 7.2 million common shares at a conversion price
of $20.00 per share.
The following unaudited pro forma condensed balance sheet and results of
operations of the Company give effect to the Offerings as though the
transactions had occurred on December 31, 1997. The pro forma shares and per
share data have been calculated assuming the Stock Offering occurred on January
1, 1997. The pro forma results are presented for informational purposes only and
do not purport to be indicative of the results of operations which actually
would have been obtained if the transactions had occurred in such periods, or
which may exist or be obtained in the future.
104
<PAGE> 146
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
AS ADJUSTED
FOR THE
CONDENSED BALANCE SHEET (UNAUDITED) REPORTED ADJUSTMENTS OFFERINGS
----------------------------------- --------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash and cash equivalents................................... $ 318,766 $ 232,875 $ 551,641
Other assets................................................ 461,695 23,064 484,759
--------- --------- ----------
Total Assets........................................ $ 780,461 $ 255,939 $1,036,400
========= ========= ==========
Long-term debt, less current portion........................ $ 408,330 $ 105,000 $ 513,330
Related party debt.......................................... 85,504 (72,140) 13,364
Other liabilities........................................... 228,405 (4,171) 224,234
--------- --------- ----------
Total Liabilities................................... 722,239 28,689 750,928
Minority interest........................................... 18,766 -- 18,766
Common stock subject to repurchase.......................... 12,489 (12,489) --
Common stock and additional paid-in capital................. 278,120 252,952 531,072
Cumulative translation adjustment........................... (8,269) -- (8,269)
Accumulated deficit......................................... (242,884) (13,213) (256,097)
--------- --------- ----------
Total Shareholders' Equity.......................... 26,967 239,739 266,706
--------- --------- ----------
Total Liabilities and Shareholders' Equity.......... $ 780,461 $ 255,939 $1,036,400
========= ========= ==========
</TABLE>
<TABLE>
<CAPTION>
AS ADJUSTED
FOR THE LOSS
CONDENSED STATEMENT OF OPERATIONS (UNAUDITED) REPORTED ADJUSTMENTS OFFERINGS PER SHARE
--------------------------------------------- --------- ----------- ----------- ---------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C> <C>
Loss before extraordinary item.............................. $(116,986) $ -- $(116,986) $(2.41)
Extraordinary item.......................................... -- (13,213) (13,213) (0.27)
--------- -------- --------- ------
Net loss............................................ $(116,986) $(13,213) $(130,199) $(2.68)
========= ======== ========= ======
Weighted average common shares outstanding.................. 35,833 12,765 48,598
</TABLE>
OTHER SUBSEQUENT EVENT TRANSACTIONS
Pursuant to a purchase agreement that the Company has with a venture's
partner in the CIS region (see Note 3, "Investments in and Advances to
Ventures," Note 6, "Shareholders' Equity," and Note 12, "Related Party
Transactions") the Company is obligated to pay additional consideration, via
shares of common stock, based on the subsidiary's earnings performance. Based on
the 1997 results, the Company is obligated to issue 336,630 shares of common
stock during the first quarter of 1998.
Subsequent to December 31, 1997, HER 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 $12.9
million. The commitments have expected lease terms of ten to twenty-one years
with options for renewal rights of one and one-half to five additional years.
The Company entered into a rights agreement (the "Rights Agreement") on
February 2, 1998, and accordingly, the Company authorized the distribution of
one right (a "Right") for each common share outstanding from February 2, 1998
through the distribution date (the "Distribution Date"). Each Right entitles 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 an exercise price of $75 per Unit, subject to adjustment. The
Distribution Date, as defined in further detail within the Rights Agreement, is
triggered when a person acquires 15% of the outstanding common stock of the
Company, or a tender or exchange offer is commenced for 15% of such outstanding
stock, except in the case of two related party shareholders in which case the
acquisition threshold that applies is 20% of such outstanding stock. Under
certain circumstances thereafter, certain Rightholders may have the right to
purchase common stock of the Company, or of an Acquiring Person, as defined in
the Rights Agreement, having a value equal to two times
105
<PAGE> 147
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the exercise price of the Rights. In addition, the Rights are redeemable or
exchangeable under certain circumstances.
NOTE 16: EVENTS OCCURRING SUBSEQUENT TO DATE OF AUDIT REPORT
In March 1998, the Company purchased an additional 10% interest in HER from
an existing shareholder of HER for ECU 13.5 million (approximately $14.6
million). As a result of the purchase, the Company owns approximately 89% of
HER.
106
<PAGE> 148
AUDITED FINANCIAL STATEMENTS
EDN SOVINTEL
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
WITH REPORT OF INDEPENDENT AUDITORS
107
<PAGE> 149
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
EDN Sovintel
We have audited the accompanying balance sheets of EDN Sovintel as of
December 31, 1997 and 1996, and the related statements of income and retained
earnings, and cash flows for each of the three years in the period ended
December 31, 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 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,
1997 and 1996, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 1997, 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, 1997 and 1996 and for each of the three years ended December 31, 1997, 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 1997 audited
financial statements and have reported separately for the 1996 and 1995
financial statements. The significant differences between the accounting
principles applied in preparing the statutory financial statements and
accounting principles generally accepted in the United States of America are
summarized in Note 2.
Ernst & Young (CIS) Ltd.
Moscow, Russia
February 16, 1998
108
<PAGE> 150
EDN SOVINTEL
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1997 1996
------- -------
(IN THOUSANDS OF
US DOLLARS)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 5,620 $ 3,606
Cash deposit with related party........................... 485 476
Accounts receivable, net of allowances.................... 16,223 15,329
Due from affiliates....................................... 1,586 1,879
Inventories............................................... 1,697 1,749
Prepaid expenses and other assets......................... 1,630 1,171
VAT receivable, net....................................... 3,688 1,157
Deferred income taxes..................................... 186
------- -------
Total current assets.............................. 31,115 25,367
Property and equipment, net................................. 38,709 27,709
Deferred expenses........................................... 945 1,080
------- -------
Total assets...................................... $70,769 $54,156
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Note due shareholder...................................... $ 39 $ 5,700
Trade payables............................................ 5,725 8,382
Accrued liabilities and other payables.................... 3,194 1,661
Taxes accrued or payable.................................. 1,088 555
Amounts due to shareholder and affiliates................. 10,104 5,703
Amount due to partner in commercial venture............... 1,350 1,350
------- -------
Total current liabilities......................... 21,500 23,351
Commitments and contingencies
Shareholders' equity:
Capital contributions..................................... 2,000 2,000
Retained earnings......................................... 47,269 28,805
------- -------
Total shareholders' equity........................ 49,269 30,805
------- -------
Total liabilities and shareholders' equity........ $70,769 $54,156
======= =======
</TABLE>
See accompanying notes.
109
<PAGE> 151
EDN SOVINTEL
STATEMENTS OF INCOME AND RETAINED EARNINGS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
------------------------------
1997 1996 1995
-------- ------- -------
(IN THOUSANDS OF US DOLLARS)
<S> <C> <C> <C>
Revenues, net:
Service revenues.......................................... $105,288 $63,488 $29,920
Installation revenues..................................... 5,241 9,312 12,981
Product sales............................................. 3,433 2,240 1,391
-------- ------- -------
113,962 75,040 44,292
Cost of revenues:
Service costs............................................. 67,174 37,884 18,545
Cost of installation...................................... 2,621 4,656 6,491
Cost of products.......................................... 2,834 1,370 1,211
-------- ------- -------
72,629 43,910 26,247
-------- ------- -------
Gross profit................................................ 41,333 31,130 18,045
Selling, general and administrative expenses................ 17,020 10,291 7,145
Interest expense............................................ 503 638 703
Interest income............................................. (392) (87) (59)
Other (income) loss......................................... (57) 120 (98)
Foreign exchange loss on net monetary items................. 131 252 112
-------- ------- -------
Income before taxes......................................... 24,128 19,916 10,242
Income taxes................................................ 5,664 5,154 2,594
-------- ------- -------
Net income.................................................. 18,464 14,762 7,648
Retained earnings, beginning of year........................ 28,805 14,043 6,395
-------- ------- -------
Retained earnings, end of year.............................. $ 47,269 $28,805 $14,043
======== ======= =======
</TABLE>
See accompanying notes.
110
<PAGE> 152
EDN SOVINTEL
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-------------------------------
1997 1996 1995
-------- -------- -------
(IN THOUSANDS OF US DOLLARS)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income................................................ $ 18,464 $ 14,762 $ 7,648
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation........................................... 5,312 3,638 2,448
Provision for deferred income taxes.................... (186)
Provision for doubtful accounts........................ 345 678 132
Write-off of accounts receivable....................... (602) (147) (492)
Write-down of network equipment and inventories........ 100 196
Foreign exchange loss.................................. 131 252 112
Changes in operating assets and liabilities:
Accounts receivable.................................... (637) (8,460) (2,759)
Due from affiliates.................................... 293 (683) (1,011)
Inventories............................................ 52 (911) (309)
Prepaid expenses and other assets...................... (538) (1,108) 599
VAT receivable, net.................................... (2,609) 54 (906)
Trade payables......................................... (2,491) (193) 2,983
Accrued liabilities and other payables................. 1,533 310 1,233
Taxes accrued or payable............................... 570 326 229
Amounts due to shareholder and affiliates.............. 4,401 3,039 2,165
-------- -------- -------
Net cash provided by operating activities......... 24,038 11,657 12,268
INVESTING ACTIVITIES -- purchases of and advances for
property and equipment.................................... (16,177) (9,863) (9,259)
FINANCING ACTIVITIES
Borrowings from shareholder............................... 10,760 11,300 11,888
Repayments to shareholder................................. (16,421) (11,100) (9,271)
Repayments of long-term debt.............................. (694) (3,979)
Cash deposited with related party......................... (41) (476)
-------- -------- -------
Net cash used in financing activities....................... (5,702) (970) (1,362)
Effect of exchange rate changes on cash and cash
equivalents............................................... (145) (312)
-------- -------- -------
Net increase in cash and cash equivalents................... 2,014 512 1,647
Cash and cash equivalents at beginning of year.............. 3,606 3,094 1,447
-------- -------- -------
Cash and cash equivalents at end of year.................... $ 5,620 $ 3,606 $ 3,094
======== ======== =======
</TABLE>
See accompanying notes.
111
<PAGE> 153
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 May 1, 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 Soviet-American joint venture. The
venture re-registered as a Russian limited liability partnership in November
1992. The Company is 50% owned by Open Joint Stock Company "Rostelecom", an
intercity and long-distance carrier which is 38% owned by Svyazinvest, and 50%
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 certain accrued
revenue and expenses, foreign currency translation, deferred taxation, 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.
Official exchange rates are 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
112
<PAGE> 154
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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 rates at December 31, 1997, 1996 and 1995 for one US dollar
were RUR 5,960, RUR 5,560 and RUR 4,640 respectively. At February 16, 1998, the
CBR rate had changed to RUR 6,050. The effect of this devaluation of the rouble
on monetary assets and liabilities has not been determined.
On January 1, 1998, the CBR introduced a new rouble to replace existing
roubles. The new rouble has been redenominated so that one new rouble is
equivalent to one thousand old roubles. The old rouble will continue in
circulation until December 31, 1998 and will be accepted as legal tender until
December 31, 2002.
All rouble amounts reflected in these financial statements are stated in
old roubles.
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 fair value. Accounts receivable are shown in the balance sheet net
of an allowance for uncollectible accounts of $643,000 and $900,000 at December
31, 1997 and 1996, 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
is 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
Revenues from telecommunication traffic are recognized in the period in
which the traffic occurs. Revenues from product sales, connection fees, and
other services are recognized in the period in which the products are shipped,
connections made, and services rendered. Taxes on certain revenues were charged
at rates ranging from 1.5% to 4.0% over the three years ended December 31, 1997,
1996 and 1995 and amounted to $4,458,000, $2,792,000 and $1,166,000,
respectively, and are charged to selling general and administrative expenses.
113
<PAGE> 155
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
ADVERTISING
The Company expenses the cost of advertising as incurred. Advertising
expenses for the years ended December 31, 1997, 1996 and 1995 were $671,000,
$512,000 and $395,000, 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 fund and transport fund on
behalf of all its Russian employees. Contributions were 40.5%, 40.5% and 41.0%
from base payroll for 1997, 1996 and 1995, 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.
NEW ACCOUNTING PRONOUNCEMENTS
In 1997, 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." SFAS 121 requires recognition of
impairment of long-lived assets in the event the net book value of such assets
exceeds the future undiscounted cash flows attributable to such assets. The
adoption of SFAS No. 121 had no impact on the Company's financial position or
results of operations.
In June 1997, SFAS No. 130, "Reporting Comprehensive Income", was issued.
SFAS No. 130 establishes standards for the reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements and is effective for fiscal years beginning after December
15, 1997. The Company will adopt SFAS No. 130 in fiscal 1998. SFAS No. 130
expands or modifies disclosures and, accordingly, will have no impact on the
Company's reported financial position, results of operations or cash flows.
RECLASSIFICATIONS
Certain 1996 and 1995 comparative figures have been reclassified to conform
to the presentation adopted in the current year.
114
<PAGE> 156
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
<TABLE>
<CAPTION>
1997 1996
-------- -------
<S> <C> <C>
Network equipment........................................... $ 43,876 $31,251
Other property and equipment................................ 4,527 3,108
-------- -------
48,403 34,359
Accumulated depreciation.................................... (14,557) (9,380)
Construction-in-progress.................................... 4,409 1,796
Network equipment and advances for network equipment not yet
in service................................................ 454 934
-------- -------
Net book value.............................................. $ 38,709 $27,709
======== =======
</TABLE>
Total depreciation expense on property and equipment for 1997, 1996 and
1995 was $5,177,000, $3,503,000 and $2,253,000, respectively.
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 income and retained earnings for the years ended December 31, 1997, 1996 and
1995 represents the provision for current and deferred taxes.
Significant components of the provision for income taxes for the years
ended December 31 are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Current tax expense...................................... $5,850 $5,154 $2,594
Deferred tax benefit..................................... (186)
------ ------ ------
Provision for income taxes............................... $5,664 $5,154 $2,594
====== ====== ======
</TABLE>
115
<PAGE> 157
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Taxable income reported for Russian tax purposes...... $16,184 $14,726 $ 7,411
Investment incentive deductions..................... 12,337 9,030 7,220
Tax loss carry-forwards utilized.................... 97 113
Net permanent difference related to revenues and (2,455)
expenses incurred in the ordinary course of
business which are not assessable or deductible
for Russian tax purposes......................... (1,174) (2,595)
------- ------- -------
Russian income before taxes........................... 26,163 22,695 12,036
Adjustments to present financial statements in
accordance with US GAAP:
Reversal of excess depreciation due to statutory (2,101)
revaluations..................................... (1,497) (293)
Depreciation rate differences....................... (279) (424) (236)
Allowances for uncollectible accounts............... 35 369 (132)
Inventory write-downs............................... (100) (249)
Accrual of deductible expenses...................... (3,234) (2,437) (1,339)
Accrual of revenue.................................. 2,704 1,093 19
Foreign exchange differences........................ 236 280 1,425
Other............................................... 604 (63) (989)
------- ------- -------
Income before taxes under US GAAP..................... $24,128 $19,916 $10,242
======= ======= =======
</TABLE>
A reconciliation between the statutory rate and the effective income tax
rate is as follows for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Income tax expense computed on financial income before
taxes at statutory tax rate of 35%.................. $ 8,445 $ 6,970 $ 3,585
Tax effect of permanent differences:
Investment incentive deductions..................... (4,318) (3,161) (2,594)
Tax loss carryforwards utilized..................... (34) (40)
Other permanent differences......................... 859 411 805
Adjustments made to compute income before taxes for
US GAAP financial reporting...................... 1,142 813 555
Increase (decrease) in the valuation allowance for
deferred tax assets................................. (430) 161 243
------- ------- -------
Income tax expense reported in the financial
statements.......................................... $ 5,664 $ 5,154 $ 2,594
======= ======= =======
</TABLE>
116
<PAGE> 158
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (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>
1997 1996 1995
------ ------- -----
<S> <C> <C> <C>
Deferred tax assets (liabilities):
Depreciation........................................... $ 398 $ 300 $ 151
Inventory write-downs and allowances................... 235 235 147
Accrual of expenses.................................... 1,132 898 469
Accrual of revenue..................................... (946) (383) (7)
Allowance for uncollectible accounts................... (13) 129
------ ------- -----
Deferred tax assets...................................... 806 1,050 889
Valuation allowance for deferred tax assets.............. (620) (1,050) (889)
------ ------- -----
Net deferred tax assets........................ $ 186 $ -- $ --
====== ======= =====
</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.
The Company paid Russian profits tax of $4,302,000, $5,849,000 and
$2,660,000 in 1997, 1996 and 1995, respectively.
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 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
which was then extended to December 19, 1997. The loan was repaid prior to
December 31, 1997 except for withholding taxes on interest. The loan carried
interest at a rate equal to the then current six month LIBOR rate (5.6%) plus
5.0 percent per annum. As of December 31, 1997, 1996 and 1995, the outstanding
borrowings under this agreement were $39,000, $5,700,000 and $5,500,000,
respectively.
The Company believes that the carrying value of the above loans
approximates fair values.
The Company paid interest of $697,000, $542,000 and $576,000 in 1997, 1996
and 1995, respectively.
7. SHAREHOLDERS' EQUITY
The Company's capital structure as specified in the charter capital
document is as follows as of December 31:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<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.
117
<PAGE> 159
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Retained earnings available for distribution at December 31, 1997 amounted
to 256 billion roubles or approximately $42,953,000 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 follows, as of and for the years ended
December 31:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------ ------
<S> <C> <C> <C>
Sales................................................... $ 2,310 $1,525 $ 62
Telecommunication lease and traffic costs............... 11,183 4,586 1,506
Amounts due to shareholder and affiliates............... 4,184 656 460
Cash deposit with related party......................... 485 476
</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, which
was rolled over for an additional year during 1997. 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 follows, as of and for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Sales.................................................... $4,974 $3,115 $1,041
Management service fees and reimbursements of expenses of
expatriate staff....................................... 1,318 927 2,062
Balances due under credit facility....................... 39 5,700 5,500
Interest expense......................................... 503 626 461
Amounts due from affiliates.............................. 1,586 1,879 1,196
Amounts due to shareholder and affiliates................ 5,919 5,047 2,204
</TABLE>
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 follows, as of and for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Telecommunication settlement and rent expense....... $19,003 $15,889 $10,491
Balances in trade payables.......................... 1,237 2,184
Balances in accounts receivable..................... 487
Amount due to partner in commercial venture......... 1,350 1,350 1,350
Balances in prepaid expenses and other assets....... 800
</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, net of
related amortization, as deferred expenses. In 1997 the Company prepaid $800 of
1998 rent to MTU-Inform for additional office space to be occupied during 1998.
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
118
<PAGE> 160
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
from a variety of international and Russian business customers. As of December
31, 1997, two customers accounted for 16% and 11% of revenues and 11% and 7% of
accounts receivable, respectively. As of December 31, 1996, these same two
customers accounted for 17% and 16% of revenues and 25% and 10% of accounts
receivable, respectively. As of December 31, 1995, these two customers accounted
for 1% and 14% of revenues and 10% and 11% of accounts receivable, respectively.
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 1997, 1996 and 1995 was $2,794,000, $2,137,000 and
$1,234,000, respectively.
11. CONTINGENCIES
Legislation and regulations regarding taxation, foreign currency
transactions and licensing of foreign currency loans in the Russian Federation
continues to evolve as the central government manages the transformation from a
command to a market-oriented economy. The various legislation and regulations
are not always clearly written and their interpretation is subject to the
opinions of the tax inspectors, Central Bank officials and the Ministry of
Finance. Instances of inconsistent opinions between local, regional and national
tax authorities and between the Central Bank and Ministry of Finance are not
unusual.
The Company believes that it has paid or accrued all taxes that are
applicable. Where practice concerning the provision of taxes is unclear, the
Company has accrued tax liabilities based on management's best estimate. 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.
Because of the uncertainties associated with the Russian tax and legal
systems, the ultimate amount of taxes, penalties and interest, if any, assessed
may be in excess of the amount expensed to date and accrued at December 31,
1997. It is the opinion of the Company's management that any material amounts
are either not probable, not reasonably determinable, or both.
The Company's operations and financial position will continue to be
affected by Russian political developments, including the application of
existing and future legislation and tax regulations. The Company does not
believe that these contingencies, as related to its operations, are any more
significant than those of similar enterprises in Russia.
119
<PAGE> 161
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.
Information regarding Directors appears in the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A relating to the Company's
Annual Meeting of Stockholders on May 20, 1998 and is incorporated herein by
reference.
The executive officers of the Company and their ages and business
experience since at least January 1, 1993 are as follows.
Gerald W. Thames, 51, President and Chief Executive Officers. 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, 56, 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 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, 41, 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, 54, 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, 51, 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.
120
<PAGE> 162
Kevin Power, 44, 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.
Grier C. Raclin, 45, 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.
Stewart P. Reich, 53, 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.
Eileen K. Sweeney, 46, 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.
Louis T. Toth, 55, 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.
There are no family relationships among any of the officers listed above.
Officers are elected annually to serve for the following year or until the
election and qualification of their successors.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding this item appears in the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A relating to the Company's
Annual Meeting of Stockholders on May 20, 1998 and is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding this item appears in the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A relating to the Company's
Annual Meeting of Stockholders on May 20, 1998 and is incorporated herein by
reference.
ITEM. 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding this item appears in the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A relating to the Company's
Annual Meeting of Stockholders on May 20, 1998 and is incorporated herein by
reference.
121
<PAGE> 163
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
a) The following documents are filed as part of this report:
1 Financial Statements
The following consolidated financial statements of the Company are included
in Part II, Item 8 of this report:
- Independent Auditors' Report
- Consolidated Statements of Operations for each of the Three Years Ended
December 31, 1995, 1996 and 1997
- Consolidated Balance Sheets as of December 31, 1996 and 1997
- Consolidated Statements of Cash Flows for each of the Three Years Ended
December 31, 1995, 1996 and 1997
- Consolidated Statements of Changes in Stockholders' Equity for each of
the Three Years Ended December 31, 1995, 1996 and 1997
- Notes to Consolidated Financial Statements
The following financial statements of EDN Sovintel are included in Part II,
Item 8 of this report:
- Independent Auditors' Report
- Statements of Income and Retained Earnings for each of the Three Years
Ended December 31, 1997, 1996 and 1995
- Balance Sheets as of December 31, 1997 and 1996
- Statements of Cash Flows for each of the Three Years Ended December 31,
1997, 1996 and 1995
- Notes to Financial Statements
2 Consolidated Financial Statement Schedules
The Company has furnished Schedule II -- Valuation and Qualifying Accounts
on Page
All other schedules are omitted because they are not applicable or not
required, or because the required information is either incorporated herein by
reference or included in the financial statements or notes thereto included in
this report.
b) Reports on Form 8-K
<TABLE>
<CAPTION>
DATE OF REPORT SUBJECT OF REPORT
-------------- -----------------
<S> <C>
None
</TABLE>
c) Exhibits
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
3.1** -- Certificate of Incorporation of SFMT, Inc.
3.2** -- Certificate of Correction to the Certificate of
Incorporation of SFMT, Inc., filed with the Delaware
Secretary of State on October 8, 1993
3.3** -- Certificate of Ownership and Merger Merging San
Francisco/Moscow Teleport, Inc. into SFMT, Inc., filed
with the Delaware Secretary of State on November 3, 1993
</TABLE>
122
<PAGE> 164
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
3.4** -- Certificate of Amendment to the Certificate of
Incorporation of SFMT, Inc., filed with the Delaware
Secretary of State on January 12, 1995
3.5** -- Certificate of Amendment to the Certificate of
Incorporation of SFMT, Inc., filed with the Delaware
Secretary of State on February 22, 1995
3.6** -- Certificate of Amendment to the Certificate of
Incorporation of Global TeleSystems Group, Inc., filed
with the Delaware Secretary of State on October 16, 1996
3.7** -- By-laws of SFMT, Inc.
3.8** -- Certificate of Amendment to the Certificate of
Incorporation of Global TeleSystems Group, Inc., filed
with the Delaware Secretary of State on December 1, 1997
3.9** -- Form of Amended and Restated By-laws of Global
TeleSystems Group, Inc. supersedes By-laws of SFMT, Inc.
filed as Exhibit 3.7)
3.10* -- Certificate of Amendment to the Certificate of
Incorporation of Global TeleSystems Group, Inc. filed
with the Delaware Secretary of State on January 29, 1998.
3.11* -- Certificate of Amendment to the Certificate of
Incorporation of Global TeleSystems Group, Inc. filed
with the Delaware Secretary of State on February 9, 1998.
3.12* -- Certificate of Designation, of the Series A Preferred
Stock of the Company.
4.1** -- Form of Specimen Stock Certificate for Common Stock of
the Registrant
4.2** -- Indenture dated as of July 14, 1997 between the Company
and The Bank of New York (including the form of Senior
Subordinated Convertible Bond due 2000 as an exhibit
thereto)
4.3** -- Registration Rights Agreement, dated as of July 14, 1997,
between Global TeleSystems Group, Inc. and UBS Securities
LLC.
4.4** -- Indenture dated as of August 19, 1997 between Hermes
Europe Railtel B.V. and The Bank of New York (including
the form of 11 1/2% Senior Note due 2007 as an exhibit
thereto)
4.5** -- Registration Rights Agreement dated as of August 19, 1997
between Hermes Europe Railtel B.V. and Donaldson, Lufkin
& Jenrette Securities Corporation, UBS Securities LLC,
and Lehman Brothers, Inc
4.6** -- Form of Rights Agreement between Global TeleSystems
Group, Inc. and The Bank of New York as Rights Agent.
4.7* -- Indenture dated as of February 10, 1998 between Global
TeleSystems Group, Inc. and The Bank of New York
(including the form of 9 7/8% Senior Notes due 2005 as an
exhibit thereto).
10.1** -- Senior Note Purchase Agreement, dated as of January 19,
1996, among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.
10.1(a)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated June 6, 1996
10.1(b)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated June 6, 1996
</TABLE>
123
<PAGE> 165
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
10.1(c)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated July 23, 1996
10.1(d)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated September 16, 1996
10.1(e)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated July 11, 1997
10.1(f)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated July 29, 1997
10.1(g)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
10.2** -- Registration Rights Letter Agreement, dated as of January
19, 1996, among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.
10.3** -- Warrant Agreement, dated as of January 19, 1996, among
Global TeleSystems Group, Inc., The Open Society
Institute and Chatterjee Fund Management, L.P.
10.4** -- Joint Venture Letter Agreement, dated January 19, 1996,
among Global TeleSystems Group, Inc., The Open Society
Institute and Chatterjee Fund Management, L.P.
10.5 -- Intentionally Omitted
10.6** -- Registration Rights Letter Agreement, dated June 6, 1996,
among the Company, The Open Society Institute, Winston
Partners II LDC and Winston Partners II LLC
10.7** -- Warrant Agreement, dated as of June 6, 1996, between
Global TeleSystems Group, Inc., The Open Society
Institute, Winston Partners II LDC and Winston Partners
II LLC
10.8** -- Senior Note Purchase Agreement, dated as of February 2,
1996, between Global TeleSystems Group, Inc. and Emerging
Markets Growth Fund, Inc.
10.8(a)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated June 6,
1996 (see Exhibit No. 10.1(b))
10.8(b)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated June 6,
1996
10.8(c)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated July 25,
1996
10.8(d)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated September
10, 1996
10.8(e)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated September
16, 1996
</TABLE>
124
<PAGE> 166
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
10.8(f)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated December
30, 1996
10.8(g)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated May 13,
1997
10.8(h)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated June 20,
1997
10.8(i)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated July 11,
1997
10.8(j)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated July 21,
1997
10.8(k)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated August 14,
1997
10.8(l)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated September
29, 1997
10.9** -- Registration Rights Letter Agreement, dated as February
2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc.
10.10** -- Warrant Agreement, dated as of February 2, 1996, between
Global TeleSystems Group, Inc. and Emerging Markets
Growth Fund, Inc.
10.11 -- Intentionally Omitted
10.12** -- Registration Rights Letter Agreement, dated as February
2, 1996, between Global TeleSystems Group, Inc. and
Capital International Emerging Markets Funds
10.13** -- Warrant Agreement, dated as of February 2, 1996, between
Global TeleSystems Group, Inc. and Capital International
Emerging Markets Funds
10.14* -- Restated and Amended Global TeleSystems Group, Inc.
Non-Employee Directors' Stock Option Plan
10.15** -- GTS-Hermes, Inc. 1994 Stock Option Plan
10.16** -- Restricted Stock Grant letter, dated as of January 1,
1995
10.17** -- Employment Agreement dated as of January 1995 between
SFMT, Inc. and Jan Loeber
10.18** -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Louis Toth
10.19** -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Gerald W. Thames
10.20** -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Raymond J. Marks
10.21** -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Henry Radzikowski
10.22** -- SFMT, Inc. Equity Compensation Plan
10.23** -- Form of Non-Statutory Stock Option Agreement
</TABLE>
125
<PAGE> 167
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
10.24* -- Third Amended and Restated 1992 Stock Option Plan of
Global TeleSystems Group Inc. dated September 25, 1997
10.25** -- GTS-Hermes 1994 Stock Option Grant, Non-Qualified Stock
Option Grant
10.26** -- Agreement on the Creation and Functions of the Joint
Venture of EDN Sovintel, dated June 18, 1990
10.27** -- Stock Purchase Agreement among Global TeleSystems Group,
Inc, Kompaniya "Invest-Project," Swinton Limited, GTS-Vox
Limited, and MTU-Inform, dated September 6, 1995
10.28** -- Certificate of Registration of Revised and Amended
Foundation Document in the State Registration of
Commercial Organizations, dated May 30, 1996
10.29** -- Agreement on the Creation and Functions of the Joint
Venture Sovam Teleport, dated May 26, 1992
10.30** -- Amended and Restated Joint Venture Agreement between GTS
Cellular, Tricor B.V., Gerard Essing, Ivan Laska, and
Erik Jennes, dated July 6, 1995
10.31** -- Amended and Restated Shareholders' Agreement between HIT
Rail B.V., GTS-Hermes, Inc., Nationale Maatschappu Der
Belgische Spoorwegen, Teleport B.V., AB Swed Carrier, and
Hermes Europe Railtel B.V., dated July, 1997
10.31(a)** -- Shareholders' Agreement among the Hermes Europe Railtel
B.V., GTS-Hermes Inc., HIT Rail B.V., SNCB/NMBS and AB
Swed Carrier (incorporated by reference to Exhibit 10.1
to the Hermes Europe Railtel B.V.'s Registration
Statement on Form S-4 (File No. 333-37719) filed on
December 11, 1997) (supersedes the Amended and Restated
Shareholders' Agreement filed as Exhibit 10.31 to this
Registration Statement)
10.32** -- Company Agreement between The Societe National de
Financement, GTS S.A.M. and The Principality of Monaco,
dated September 27, 1995
10.33** -- Joint Venture Agreement between SFMT-Hungaro Inc. and
Montana Holding Vagyonkezelo Kft., dated December 23,
1993
10.34** -- Joint Venture and Shareholders' Agreement among Gerard
Aircraft Sales and Leasing Company, SFMT-Hungaro Inc.,
and Microsystem Telecom Rt., dated August 5, 1994
10.35** -- Agreement on the Establishment of Limited Liability
Company between SFMT-Czech, Inc. and B&H s.r.o., dated
July 12, 1994
10.36** -- Formation of the Equity Joint Venture between GTS and
SSTIC, dated April 12, 1995
10.37** -- Contract to Establish the Sino-foreign Cooperative Joint
Venture Beijing Tianmu Satellite Communications
Technology Co., Ltd, amended, by and between China
International Travel Service Telecom Co., Ltd. and
American China Investment Corporation, dated March 27,
1996
10.38** -- Joint Venture Contract between GTS TransPacific Ventures
Limited and Shanghai Intelligence Engineering, Inc.,
dated March 28, 1996
10.39** -- Agreement between Global TeleSystems Group, Inc. and
Cesia S.A., dated June 21, 1997
10.40** -- Consulting Agreement between SFMT, Inc. and Alan B.
Slifka, dated March 1, 1994
10.41** -- Consulting Agreement between Global TeleSystems Group,
Inc. and Bernard J. McFadden, dated August 15, 1996
</TABLE>
126
<PAGE> 168
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
10.42** -- Consulting Agreement between CESIA S.A. and Hermes Europe
Railtel B.V., dated June 20, 1997
10.43* -- Key Employee Stock Option Plan of Hermes Europe Railtel
B.V.
21.1* -- List of Subsidiaries of the Registrant
23.2* -- Consent of Ernst & Young LLP
24.1* -- Powers of Attorney (included on signature page to this
report)
27.1* -- Financial Data Schedule extracted from December 31, 1997
audited financial statements
</TABLE>
- ---------------
* Filed herewith.
** Incorporated by reference to the correspondingly numbered Exhibit to
Amendment No. 6 to the Company's registration statement on Form S-1 dated
February 5, 1998 (Commission File No. 333-36555)
(d) Schedules
Schedule II -- Valuation and Qualifying Accounts. The other financial
statement schedules of the Company have been omitted because the
information required to be set forth therein is not applicable or is shown
in the Financial Statements or Notes thereto.
127
<PAGE> 169
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities
Exchange Act 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of McLean,
Commonwealth of Virginia, on this 30th day of March, 1998.
GLOBAL TELESYSTEMS GROUP, INC.
By: /s/ GERALD W. THAMES
----------------------------------
Name: Gerald W. Thames
Title: President and Chief
Executive Officer
Each person whose signature appears below constitutes and appoints Gerald
W. Thames, William H. Seippel, Grier Raclin and Richard B. Nash, Jr. and each of
them singly, as his true and lawful attorney-in-fact and agents with full power
of substitution and resubstitution, for him, and in his name, place and stead,
in any and all capacities to sign any and all amendments and supplements to this
annual report on Form 10-K and to file the same, with all exhibits thereto, and
all other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents full power and
authority to do and perform each and every act and thing requisite and necessary
to be done, as full to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents or their substitute or substitutes may lawfully do or cause to be done by
virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the 30th day of March, 1998.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ GERALD W. THAMES President, Chief Executive Officer March 30, 1998
- ----------------------------------------------------- and Director (principal
Gerald W. Thames executive officer)
/s/ WILLIAM H. SEIPPEL Executive Vice President -- March 30, 1998
- ----------------------------------------------------- Finance and Chief Financial
William H. Seippel Officer (principal financial and
accounting officer)
/s/ ALAN B. SLIFKA Chairman of the Board of Directors March 30, 1998
- -----------------------------------------------------
Alan B. Slifka
/s/ GARY GLADSTEIN Director March 30, 1998
- -----------------------------------------------------
Gary Gladstein
/s/ MICHAEL GREELEY Director March 30, 1998
- -----------------------------------------------------
Michael Greeley
/s/ BERNARD MCFADDEN Director March 30, 1998
- -----------------------------------------------------
Bernard McFadden
/s/ STEWART J. PAPERIN Director March 30, 1998
- -----------------------------------------------------
Stewart J. Paperin
</TABLE>
128
<PAGE> 170
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ W. JAMES PEET Director March 30, 1998
- -----------------------------------------------------
W. James Peet
/s/ JEAN SALMONA Director March 30, 1998
- -----------------------------------------------------
Jean Salmona
Director March 30, 1998
- -----------------------------------------------------
Morris A. Sandler
/s/ JOEL SCHATZ Director March 30, 1998
- -----------------------------------------------------
Joel Schatz
Director March 30, 1998
- -----------------------------------------------------
Adam Solomon
</TABLE>
129
<PAGE> 171
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
COL. A COL. B COL. C COL. D COL. E
------ ------ ----------------------- ------ ------
ADDITIONS
-----------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS OF PERIOD
----------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts at
12/31/95.............................. 0 30 30
Allowance for doubtful accounts at
12/31/96.............................. 30 752 782
Allowance for doubtful accounts at
12/31/97.............................. 782 3,303 4,085
</TABLE>
130
<PAGE> 172
ANNEX B
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
AMENDMENT NO. 1
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTIONS 13 OR 15(D) OF THE SECURITY
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER:
GLOBAL TELESYSTEMS GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 94-3068423
(State of incorporation) (I.R.S. Employer Identification Nos.)
</TABLE>
1751 PINNACLE DRIVE, NORTH TOWER, 12TH FLOOR
MCLEAN, VIRGINIA 22102
(Address of principal executive offices)
(703) 918-4500
(Registrant's telephone number)
Securities registered pursuant to Section 12(g) of the Act:
TITLE OF EACH CLASS
Common Stock, par value $0.10 per share and Rights associated with Common Stock,
par value $0.10 per share.
Indicate by check mark whether the registrants (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) have been subject to such
filing requirements for the past 90 days. Yes [ ] No [X]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained in this Form 10-K, and will not be
contained, to the best of the registrants' knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [X]
The aggregate market value of the voting stock of Global TeleSystems Group,
Inc. held by non-affiliates on February 27, 1998 was approximately
$1,182,668,000. On February 27, 1998, there were outstanding approximately
50,904,000 shares of Common Stock of Global TeleSystems Group, Inc.
<TABLE>
<CAPTION>
ITEM OF FORM 10-K DOCUMENT INCORPORATED BY REFERENCE
----------------- ----------------------------------
<S> <C>
Part III, Item 10, 11, 12 and 13 Proxy Statement* (excluding therefrom the
subsections entitled "Report of the
Compensation Committee of the Board of
Directors" and "Performance Graph")
Part IV, Item 14(c) Exhibits
</TABLE>
- ---------------
* Refers to the definitive Proxy Statement of Global TeleSystems Group, Inc., to
be filed pursuant to Regulation 14A, relating to the Annual Meeting of
Stockholders of Global TeleSystems Group, Inc. to be held on May 20, 1998.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 173
GLOBAL TELESYSTEMS GROUP, INC.
The registrant hereby amends the following item of its Annual Report on
Form 10-K for the fiscal year ended December 31, 1997, as set forth below:
<TABLE>
<CAPTION>
ITEM PAGE
---- ----
<S> <C>
Item 8. Financial Statements and Supplementary Data......... 81
106
108
119
</TABLE>
1
<PAGE> 174
GLOBAL TELESYSTEMS GROUP, INC.
FORM 10-K
YEAR ENDED DECEMBER 31, 1997
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I
ITEM 1. Business.................................................... 3
Introduction........................................................ 3
Business Strategy................................................... 6
Russia and the CIS.................................................. 8
Sovintel......................................................... 12
TCM.............................................................. 15
TeleRoss......................................................... 16
Sovam............................................................ 19
GTS Cellular..................................................... 21
Certain Considerations Applicable to the Company's Operations in 29
Russia and the CIS..............................................
Western Europe...................................................... 32
HER.............................................................. 34
GTS Monaco Access................................................ 47
Central Europe...................................................... 50
Asia................................................................ 52
Certain Considerations Generally Applicable to the Company's 53
Operations.......................................................
Glossary of Telecommunications Industry Terms....................... 59
ITEM 2. Properties.................................................. 63
ITEM 3. Legal Proceedings........................................... 63
ITEM 4. Submission of Matters to a Vote of Security Holders......... 63
PART II
ITEM 5. Market for the Company's Common Equity and Related
Stockholder Matters....................................... 64
ITEM 6. Selected Financial Data..................................... 67
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 69
ITEM 8. Consolidated Financial Statements and Supplementary
Information for the Company............................... 80
ITEM 9. Changes In and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 120
PART III
ITEM 10. Directors and Executive Officers of the Company............. 120
ITEM 11. Executive Compensation...................................... 121
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 121
ITEM 13. Certain Relationships and Related Transactions.............. 121
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K....................................................... 122
SIGNATURES............................................................ 128
</TABLE>
2
<PAGE> 175
PART I
ITEM 1. BUSINESS
To aid the reader, a "Glossary of Telecommunications Industry Terms," which
defines certain terms used in this "Business" section and elsewhere in this
Report, follows commencing on page 59.
INTRODUCTION
The predecessor to Global TeleSystems Group, Inc. (the "Company" or "GTS")
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.
The Company 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
below), 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 operates cellular networks in
thirteen 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 1997. 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 442 million minutes of traffic for the year ended
December 31, 1997 and had approximately 33,300 customers, including
approximately 23,400 cellular subscribers, as of December 31, 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 S.A.M. ("GTS-Monaco Access"). HER's
3
<PAGE> 176
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 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 pan-European high capacity
fiber optic network designed to interconnect a majority of the largest Western
and Central European cities. As of April 1, 1998, HER's network will link
Brussels, Antwerp, Rotterdam, Amsterdam, London, Paris, and Frankfurt. HER
expects the initial five country network and Switzerland 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 3,800 kilometers of
fiber optic cable linking, in addition to the cities discussed above, the cities
of Zurich, Geneva, Dusseldorf, Stuttgart, and Munich. 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 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."
4
<PAGE> 177
The following table sets forth certain information, as of December 31,
1997, for the principal ventures through which the Company conducts its
business:
<TABLE>
<CAPTION>
COUNTRY/REGION GTS PRINCIPAL
COMPANY NAME OF OPERATIONS OWNERSHIP PARTNERS BUSINESS
------------ -------------- --------- -------- ---------
<S> <C> <C> <C> <C>
CIS
Sovintel............ Russia 50% Rostelecom International Long
Distance; Local
Access and Local
Access Lines
TCM................. Russia 50%(1) MTU Inform and Local Access Lines
others
TeleRoss............ Russia 50%(2) Various local PTOs Domestic Long
Distance Data and
Internet
Sovam............... Russia 67%(3) Institute for
Automated Systems
GTS Cellular........ CIS 25-70%(4) Primarily various Basic Cellular
local PTOs
WESTERN EUROPE
HER................. Western Europe 79%(5) Various Carriers' Carrier
Carriers' Carrier;
GTS-Monaco Access... Monaco 50% Principality of International Gateway
Monaco
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
5
<PAGE> 178
ventures that are 50% beneficially-owned by GTS (the "TeleRoss Ventures").
See "-- Russia and the CIS -- TeleRoss."
(3) GTS purchased its minority partner's 33.3% interest 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 12 operational 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 "-- Russia and the CIS -- GTS Cellular."
(5) As a result of the sale of shares by one of the other shareholders of HER in
March 1998, GTS currently owns approximately 89% of HER. See "Western
Europe -- HER -- HER Recapitalization." 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 HER stock option plan established in the
fourth quarter of 1997. See "Executive Compensation and Other
Information -- Key Employee Stock Option Plan of Hermes Europe Railtel B.V."
in the Company's Proxy Statement for its 1998 Annual Meeting.
(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.
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
6
<PAGE> 179
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. From
1993 through 1997, the Company raised privately 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. On February 10, 1998, the Company completed an initial
public offering of its common stock. The Company sold 12,765,000 shares
in the offering, including 1,665,000 shares sold as a result of the
exercise of over-allotment options granted to the underwriters of the
offering and realized net proceeds of $238.7 million from the offering
after the payment of underwriting fees but, before payment of other
expenses associated with the offering. On the same date, the Company also
sold $105 million aggregate principal amount of 9 7/8% Senior Notes due
2005 ("the Senior Notes"), and realized net proceeds of $82.3 million,
after the payment of underwriting fees and the deposit of $19.6 million
in escrow to cover the first four scheduled payments of interest on the
Senior Notes, but before expenses associated with the sale of the Senior
Notes.
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
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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.
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
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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 Ministry of Communications (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 (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 second 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
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privatization of Svyazinvest, or the evolution of government policy regarding
Svyazinvest and Rostelecom, will not have a material adverse effect on the
Company or its ventures.
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 benefited 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 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
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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.
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. Several of the TeleRoss Ventures and
the cellular joint ventures were not operational, or had just commenced
operating, in 1995. As a result, TeleRoss and GTS Cellular did not generate
significant revenues in 1995.
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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,
--------------
1996 1997
----- -----
<S> <C> <C>
Cities In Service........................................... 33 40
Total Voice Minutes (millions)(1)
Inter-city................................................ 15.8 57.1
Local..................................................... 133.0 269.1
International Outgoing.................................... 20.5 46.0
Incoming.................................................. 33.2 69.9
Total Data Customers (thousands)............................ 6.2 9.9
Total Cellular Subscribers (thousands)...................... 9.8 23.4
</TABLE>
- ---------------
(1) Amounts include minutes between Company affiliates.
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 43,900 telephone numbers, or "ports," for
business customers and cellular providers and had over 275 employees as of
December 31, 1997.
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.
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
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with the Sovam data network. Accordingly, from a customer's perspective,
Sovintel offers a broad range of telecommunication services.
The following table sets forth certain operating data related to Sovintel's
operations:
<TABLE>
<CAPTION>
AT AND FOR THE YEAR ENDED DECEMBER 31.
---------------------------------------
1995 1996 1997
---------- ---------- -----------
<S> <C> <C> <C>
MINUTES OF USE(1)
International Minutes
Number of Minutes............................... 10,516 20,839 43,664
Average Rate Per Minute......................... $ 2.06 $ 1.55 $ 1.12
Domestic Long Distance Minutes
Number of Minutes............................... 2,047 10,098 26,606
Average Rate Per Minute......................... $ 0.86 $ 0.65 $ 0.52
Moscow (Local) Fixed Line Minutes
Number of Minutes............................... -- -- 3,501
Average Rate Per Minute......................... -- -- $ 0.05
Moscow (Local) Cellular Minutes Number of
Minutes......................................... 21,478 83,673 118,447
Average Rate Per Minute......................... $ 0.06 $ 0.08 $ 0.08
Incoming Minutes Number of Minutes................. 3,839 24,306 43,626
Average Rate Per Minutes........................ $ 0.58 $ 0.28 $ 0.30
PORTS
Number of Ports (cumulative)....................... 6,079 29,646 43,976
NUMBER OF PRIVATE LINE CHANNELS
International...................................... 26 89 201
Inter- and Intra-City.............................. 26 103 243
APPROXIMATE EQUIPMENT SALES (THOUSANDS).............. $ 1,400 $ 2,200 $ 3,400
</TABLE>
- ---------------
(1) Minutes in thousands. Amounts include minutes among affiliates.
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 each case
benefiting from Sovintel's high quality infrastructure. Private line
domestic long distance
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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 $1.12 per
minute for the year ended December 31, 1997. Sovintel expects increased pricing
pressure from competitors over time. Sovintel prices domestic long distance
services in line with those of its principal competitors, however, due to its
obligations under certain agreements with affiliated entities, Sovintel's
margins for these services are declining. 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),
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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 December 31, 1997, GTS and Rostelecom have each made equity contributions
of $1.0 million to Sovintel. The Sovintel joint venture agreement does not have
an expiration date. See "-- Certain Considerations Generally Applicable to the
Company's Operations -- Dependence on Certain Local Parties; Absence of Control"
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations Accounting Methodology Profit and Loss Accounting."
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 50,000 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. 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 for TCM-Sovintel joint customers are performed by
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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 December 31, 1997, GTS had no outstanding loans relating to
TCM. None of the operative charters and agreements relating to the holding
company or TCM have expiration dates. See "Certain Considerations Generally
Applicable to the Company's Operations -- Dependence on Certain Local Parties;
Absence of Control" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations Accounting Methodology Profit and Loss
Accounting."
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, 24 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 December 31, 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.
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 12
million. TeleRoss's licenses cover the entire oblast surrounding these cities,
with populations totaling approximately 38 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: Arkhangelsk, Ekaterinburg, Irkutsk, Khabarovsk, Krasnodar,
Nizhni Novgorod, Novosibirsk, Syktyvkar, Tyumen, Ufa, Vladivostok, Volgograd and
Voronezh. The Company has formed an additional TeleRoss Venture in the city of
Samara. As of March 1998, this venture was not operational.
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 24 customers
in 24 additional cities through VSAT technology which links the customers via
satellite to the Moscow hub.
16
<PAGE> 189
The following table sets forth certain operating data related to TeleRoss's
operations:
<TABLE>
<CAPTION>
AT AND FOR THE YEAR
ENDED DECEMBER 31,
-------------------
1996 1997
------- --------
<S> <C> <C>
MINUTES OF USE(1)
Domestic Minutes (thousands).............................. 4,035 23,233
Average Rate Per Domestic Minute.......................... $ 0.99 $ 0.63
International Minutes (thousands)......................... 272 744
Average Rate Per International Minute..................... $ 2.76 $ 2.47
NUMBER OF CITIES SERVED(2).................................. 13 14
WORLD CONNECT DIAL/RUSSIA
Number of Connect Dial Ports.............................. 472 1,112
Average Revenue Per Port Per Month........................ $ 767 $ 370
MOSCOW CONNECT
Number of Ports........................................... 49 78
Average Revenue Per Port Per Month........................ $1,165 $ 1,358
DEDICATED CIRCUITS
Number of Dedicated Channels.............................. 33 60
Average Price Per Channel................................. $4,553 $ 4,140
WORLD ACCESS SERVICE
Number of World Access Card Users......................... 3,929 4,595
Average Revenue Per Card Per Month........................ $ 52 $ 48
VSAT SERVICES
Number of VSATs........................................... 12 24
</TABLE>
- ---------------
(1) Includes minutes among affiliates.
(2) Includes connection to Moscow.
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 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.
17
<PAGE> 190
- 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 December 31, 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. During
the year ended December 31, 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 December 31, 1997, TeleRoss
employed 31 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 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
18
<PAGE> 191
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
"-- Certain Considerations Generally Applicable to the Company's
Operations -- 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 December 31, 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 $3.4 million to GTS as of December 31, 1997.
In addition, as of December 31, 1997, GTS had made equity contributions of $5.8
million to the TeleRoss Operating Company and the TeleRoss Operating Company had
outstanding loans of $37.4 million to GTS. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Accounting
Methodology -- Profit and Loss Accounting."
SOVAM
Sovam is a venture that is wholly owned by GTS. Sovam was founded in 1990
as a venture equally owned by GTS and the Institute for Automated Systems
("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 66.7%. GTS purchased IAS's interest in Sovam 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. (Russia On
Line(TM) is a trademark of the Company.) As of December 31, 1997, Sovam had
approximately 1,571 data service customers and approximately 3,960 Russia On
Line customers. Sovam employed over 110 persons in Moscow and other regions of
the CIS as of December 31, 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 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.
19
<PAGE> 192
The following table sets forth certain operating data related to Sovam's
operations:
<TABLE>
<CAPTION>
AT AND FOR THE YEAR ENDED
DECEMBER 31
--------------------------
1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
BASIC DATA SERVICE
Percentage of Total Sovam Revenue...................... 91% 79% 81%
Number of Customers.................................... 1,587 1,726 1,571
Average Revenue Per Month Per Customer................. $ 201 $ 446 $ 728
Number of Cities in Service............................ 11 25 30
EQUIPMENT AND HARDWARE SALES
Percentage of Total Sovam Revenue...................... 8% 14% 8%
RUSSIA ON LINE SERVICE
Percentage of Total Sovam Revenue...................... 1% 7% 11%
Number of Subscribers(1)............................... 407 1,854 3,159
Average Revenue Per Month Per Subscriber............... $ 49 $ 52 $ 64
</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 December 31, 1997, there were approximately 800 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 1,571 customers as of
December 31, 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 3,960 Russia On Line
subscribers (which includes approximately 800 trial subscribers) as of
December 31, 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 also entered into
agreements with equipment manufacturers, including Dell, Motorola and
Acer, to include Russia On Line software with their products.
20
<PAGE> 193
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 $728 per subscriber in 1996 and
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. At December 31, 1997, GTS owned 66.7% of Sovam and
IAS owned the remaining 33.3%. GTS purchased IAS's interest in Sovam in February
1998, thereby making Sovam a wholly owned subsidiary of GTS. As of December 31,
1997, neither GTS nor IAS were obligated to fund Sovam's operations or capital
expenditures. Losses and profits of Sovam were allocated to the partners in
accordance with their ownership percentages, in consideration of funds at risk.
As of December 31, 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 $5.7 million to GTS as of December 31, 1997. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operation -- 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 is organized in
The Netherlands), which currently operates twelve 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 1997 population of approximately 25 million
people.
21
<PAGE> 194
GTS currently offers cellular services in the following regions as of
December 31, 1997:
<TABLE>
<CAPTION>
GTS'S
OPERATING ECONOMIC NUMBER OF
COMPANY INTEREST(1)(2) CITY SUBSCRIBERS
--------- -------------- ---- -----------
<S> <C> <C> <C>
RUSSIA
Vostok Mobile(2)
Arkhangelsk Mobile................... 50.0% Arkhangelsk 602
Networks
Astrakhan Mobile..................... 50.0% Astrakhan 1,264
Barnaul Mobile(3).................... 50.0% Barnaul --
Chuvashi Mobile...................... 70.0% Cheboksary 1,201
Lipetsk Mobile....................... 70.0% Lipetsk 461
Murmanskaya Mobilnaya Set............ 50.0% Murmansk 1,457
Penza Mobile......................... 60.0% Penza 519
Saratov Mobile....................... 50.0% Saratov 1,456
Parma Mobile......................... 50.0% Syktyvkar 750
Volgograd Mobile..................... 50.0% Volgograd 2,065
Votec Mobile......................... 50.0% Voronezh 1,725
Mar Mobile........................... 50.0% Yoshkar-ola 2,061
PrimTelefone............................ 50.0% Vladivostok(4) 6,152
UKRAINE
Bancomsvyaz............................. 24.9% Kiev 3,664
------
Total........................... 23,377
------
</TABLE>
- ---------------
(1) Represents the indirect economic interest of GTS in each entity.
(2) 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 12 operational cellular joint ventures in various regions
in Russia. In the second half of 1997, the Company formed three additional
ventures in the cities of Bryansk, Kostroma and Ufa. As of March 1998, these
additional ventures were not operational. Moreover, GTS intends to enter
into the cellular markets of additional Russian regions through its Vostok
Mobile venture.
(3) Joint venture acquired in October 1997; operations commenced in February
1998.
(4) Includes Vladivostok and four other cities in the Primorsky region.
22
<PAGE> 195
The following table sets forth certain operating data related to GTS
Cellular's operations:
<TABLE>
<CAPTION>
AT AND FOR THE
YEAR ENDED
DECEMBER 31,
------------------
1996 1997
------- -------
<S> <C> <C>
Vostok Mobile
Total Subscribers......................................... 6,884 13,561
Average Revenue Per Subscriber Per Month.................. $ 128 $ 146
Minutes of Use(1)(thousands).............................. 10,561 27,771
Population Covered by Licenses (thousands)................ 18,400 18,400
Population Covered by Networks (thousands)................ 6,500 6,500
Subscriber Penetration of Population Covered by
Networks............................................... 0.11% 0.21%
PrimTelefone
Total Subscribers......................................... 2,822 6,152
Average Revenue Per Subscriber Per Month(2)............... $ 236 $ 188
Minutes of Use(1)(thousands).............................. 6,919 14,270
Population Covered by Licenses (thousands)................ 2,200 2,270
Population Covered by Networks (thousands)................ 1,175 1,175
Subscriber Penetration of Population Covered by
Networks(2)............................................ 0.24% 0.52%
Bancomsvyaz
Cellular Network Total Subscribers........................ 121 3,664
Average Revenue Per Subscriber Per Month.................. $ 62 $ 160
Minutes of Use(1)(thousands).............................. 9 5,085
Population Covered by Licenses (thousands)................ 4,500 4,536
Population Covered by Networks (thousands)................ 1,669 2,507
Subscriber Penetration of Population Covered by
Networks............................................... 0.01% 0.15%
Overlay Network Minutes of Use(1)(thousands).............. -- 4,909
Number of Ports........................................... -- 751
Average Revenue Per Minute................................ -- $ 0.34
</TABLE>
- ---------------
(1) Includes minutes among affiliates.
(2) 1997 operating data calculated using 5,212 active subscribers.
Vostok Mobile. Through Vostok Mobile, GTS currently operates twelve
cellular joint ventures in Russia. Vostok Mobile owns between 50% and 70%
interests in each of the twelve 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 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.
23
<PAGE> 196
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 330
persons as of December 31, 1997, with over 290 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 total subscriber base has grown to 6,152 (including 5,212
active subscribers) as of December 31, 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 December 31, 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 owns a 50% economic interest in an 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 approximately 100 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 December 31, 1997,
its cellular network covered an area with approximately 2.5 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 "-- Certain
Considerations Generally Applicable to the Company's Operations -- 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 December 31, 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 $25.0
million to GTS as of December 31, 1997. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- 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
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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.
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 directly 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, and has notified Bancomsvyaz that it has levied a $2.9
million frequency license fee on Bancomsvyaz's cellular license. At this time,
the Company is formulating its response to the government's action and expects
that the authorities will grant a ninety-day extension for payment of such fee.
The Company does not believe the outcome will have a material adverse effect on
the Company. There can be no assurance that additional 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
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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. 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
number of circuits leased is approximately 444 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. The Company's purchase of
IAS's 33.3% interest in Sovam requires that Sovam re-register its license.
The Company expects that the license will be re-registered.
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
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telecommunications providers. Large competitors include the "Combellga" 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 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.
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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 Combellga. However, since TCM has obtained an allocation of 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.
CERTAIN CONSIDERATIONS APPLICABLE TO THE COMPANY'S OPERATIONS IN 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. In March 1998, President Yeltsin
dismissed his entire cabinet, including Prime Minister Victor Chernomyrdin,
citing, among other things, a need for more dynamism and initiative in the
Russian government. It was unclear, however, how the change will affect
governmental policy and constitutional issues, including the identity of
President Yeltsin's successor if he were not to survive his term of office. In
addition, it was uncertain whether the resolution of these and other issues
could 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.
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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.
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 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. As of March 1998, there had not been any readings of
the draft legislation beyond the first reading. 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 "-- Russia and the CIS -- Licenses and Regulatory Issues."
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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 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.
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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.
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.
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. In addition, since November 1997,
Russian monetary authorities have pegged the ruble/U.S. dollar exchange rate to
fluctuate within a certain narrow range. It is uncertain whether the Russian
authorities will be able to maintain this exchange rate and there can be no
assurance that there will not be a significant and sudden decline in the value
of the ruble. Such a devaluation of the ruble could have a material adverse
effect on the Company and its results of operations and on the Russian economy
generally.
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, particularly in Russia and
the CIS. 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, there can be no assurance as to what effect
such personnel changes will have on the Company's operations in Russia and the
CIS.
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
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18,000 kilometer high capacity fiber optic network designed to interconnect a
majority of the largest Western and Central European cities. As of April 1,
1998, HER's network will link Brussels, Antwerp, Rotterdam, Amsterdam,
London,Paris, and Frankfurt. HER expects the initial five country network and
Switzerland 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 3,800 kilometers of fiber optic cable linking the cities of
London, Rotterdam, Amsterdam, Antwerp, Brussels, Paris, Dusseldorf, Frankfurt,
Stuttgart, Munich, Geneva and Zurich. 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 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.
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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.
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. 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 and Switzerland in the second quarter of 1998, as discussed
below, 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.
HER expects to continue to roll-out full telecommunications transport
service on the initial network in the first five countries and Switzerland
linking the additional cities of Dusseldorf, Stuttgart, Munich, Zurich and
Geneva by June 30, 1998. This initial network is expected to consist of
approximately 3,800 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. 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 coverage is planned to
be expanded to include the cities Berlin, 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 33 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. Additional contracts have
been concluded in Switzerland, Denmark, Sweden, Spain and Italy. HER continues
to negotiate rights-of-way and other infrastructure arrangements in order to
extend its network in Western Europe. 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.
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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 may need to 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 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. 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.
HER was formed on July 6, 1993 by HIT Rail B.V. ("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, Inc., a Delaware corporation
("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. In March 1998, GTS-Hermes increased
its ownership of HER to 89% by purchasing a portion of Hit Rail's ownership
interest in HER. GTS-Hermes is a wholly owned subsidiary of GTS.
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 offers 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
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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 high-bandwidth E1 equivalent
circuits on transborder European routes is artificially high and not
necessarily related to the cost of such circuits. HER offers competitive
pricing. HER also offers 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.
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
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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 provide 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 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
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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 certain of its railway shareholders and/or railway or other infrastructure
providers 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 upfront 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.
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 January 1998, twenty customers were under
contract for service on the HER network, including PTOs, a global consortium of
PTOs, Internet service providers, an international carrier, value added networks
("VANs") and resellers. HER provided capacity of approximately 446 E1 equivalent
circuits as of January 1998. 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
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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.
- 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.
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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 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.
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 regenerators 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
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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 Company
believes that the relationships between HER and local access network suppliers
can benefit both parties.
Network Routes. HER's current planning dates for operation in certain
cities and kilometers covered by the initial network in the first five countries
and Switzerland are set forth below.
Expected to be operational by:
April 30, 1998 -- Brussels, Antwerp, Rotterdam, Amsterdam, London,
Paris, Strasbourg, Frankfurt, Zurich and Geneva -- covering approximately
3,000 kilometers.
June 30, 1998 -- Above cities and Dusseldorf, Stuttgart and
Munich -- covering approximately 3,800 kilometers.
HER expects to have an aggregate of approximately 10,000 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 routes planned to be operational in the second quarter of 1998 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 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.
HER is deploying the network along the rights-of-way of a variety of
alternative sources, including railways, 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
railways, highway commissions, pipeline owners, utilities or others. 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
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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, Inc. ("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.
In addition, Exprit Telecom Group plc ("Esprit") also recently announced
plans to construct an SDH fiber optic ring network that will connect the United
Kingdom, France, the Netherlands and Belgium.
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
"-- Certain Considerations Generally Applicable to the Company's
Operations -- Competition."
HER RECAPITALIZATION
During 1997, HER 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 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. In March 1998, Hit Rail sold
all of its shares in HER to GTS-Hermes, SNCB/NMBS and AB Swed Carrier. As a
result of such sale, GTS-Hermes, SNCB/NMBS and AB Swed Carrier currently own
170,307, 13,610, and 6,551 shares of HER, repectively, or 89.4%, 7.2%, and 3.4%,
respectively of HER.
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
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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. As a result of the
March 1998 sale by Hit Rail of all its shares in HER, Hit Rail no longer has any
rights or obligations, except as set forth below, under the Shareholders
Agreement and GTS-Hermes, acting alone, can approve all the matters described
above which require an 85% HER shareholder vote.
Articles of Association and Shareholders Agreement
Under the Articles of Association and the Shareholders Agreement, HER's
shareholders 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 it. 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.
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, which is an Exhibit to this Report.
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.
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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 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 -- "Certain Considerations Generally Applicable to the Company's
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Operations -- 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 by mid -- 1998.] Given the fact that
the implementation of the EC Directives is late, 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.
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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. HER has notified the ART of the
initial public offering of the Company's common stock and intends to notify the
ART of the March 1998 increase to approximately 89% of GTS-Hermes' ownership
interest in HER.
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. HER has filed an application for a concession for the
operation of a telecommunications infrastructure and was granted a provisional
concession on March 16, 1998. The provisional concession takes retroactive
effect as of January 1, 1998 and HER expects that the Swiss regulatory authority
will grant HER a final concession by the end of the third quarter 1998. However,
no assurance can be given that such final 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 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.
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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.
In addition, to the discussion above, 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 HER's 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 and the Company.
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
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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
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 December 31, 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 $2.8 million to GTS as of
December 31, 1997. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- 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 competitive 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 "indepen-
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dent" international gateway service offerings of GTS-Monaco Access to
those of their PTO competitors.
- 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
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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 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. GTS intends to evaluate additional
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.
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As of December 31, 1997, GTS-Hungary's VSAT network consisted of
approximately 968 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 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 50% of GTS-Hungary's total revenue for the year ended December 31,
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 December 31, 1997, GTS had made equity
contributions of $12.5 million to GTS-Hungary, GTS' partner has not made any
equity contributions as of December 31, 1997. In addition, GTS-Hungary had
outstanding loans of $2.8 million to GTS as of December 31, 1997. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- 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 of Financial Condition and Results of
Operations -- 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 December 31, 1997, the Czech Companies had concluded agreements with
building owners to convert PABXs in 25 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 a shareholder of the Company owns a 25% interest. See "Certain
Related Party Transactions" in the Company's Proxy Statement for its 1998 Annual
Meeting. 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 by the end of the third quarter of 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 of Financial Condition and Results of
Operations -- 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 of Financial Condition and Results of Operations --
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 December 31, 1997, GTS and its consolidated subsidiaries employed a
total of 387 persons. On December 31, 1997, the joint ventures in which GTS
participates employed approximately 1,195 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.
CERTAIN CONSIDERATIONS GENERALLY APPLICABLE TO THE COMPANY'S OPERATIONS
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
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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 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.
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
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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, the Company or its ventures
could be exposed, among other things, to significant fines, risk of prosecution
and loss of its licenses.
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 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.
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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 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.
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 EU telecommunications market on
January 1, 1998 under existing European Community
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("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 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.
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. See
also "Western Europe -- HER -- Competition" for a discussion of the plans of
WorldCom, Viatel and Esprit to build fiber optic networks in Western Europe.
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
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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."
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.
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.
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.
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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.
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.
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).
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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.
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.
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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.
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.
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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 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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ITEM 2. PROPERTIES
The Company leases, under long-term leases, office space to serve as sales
office and/or administrative facilities, including its 15,000 square-foot
headquarters in McLean, Virginia with a five year lease expiring December, 2000.
The Company maintains regional headquarters offices in Moscow and Budapest, as
well as facilities in London. HER is headquartered just outside of Brussels,
Belgium.
HER leases, under long-term leases, portions of railroad, utility and other
rights-of-way for its fiber-optic routes. HER is creating a fiber optic network
consisting of optical fiber pairs, which are leased under long-term leases, and
technical sites leased under long-term leases. See "Business -- Western
Europe -- HER."
ITEM 3. LEGAL PROCEEDINGS
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.
On March 27, 1998, V-Tech brought a claim for approximately $1.1 million
against Gilat Satellite Networks, Ltd. ("Gilat"), the vendor of a Ku-band VSAT
hub and system which V-Tech purchased in 1996, in an arbitration proceeding
under the Rules of Arbitration of the ICC International Court of Arbitration. V-
Tech has demanded in the request for arbitration that Gilat accept return of the
equipment, which V-Tech has not accepted or commissioned because it has failed
to meet contract specifications, and refund purchase amounts already paid under
the contract, plus other sums. Gilat has previously asserted that the equipment
meets specifications and demanded that V-Tech pay the balance due under the
contract, approximately $400,000. It is not possible at this time to make an
assessment of the outcome of the arbitration proceeding.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
During the fourth quarter of 1997 and first quarter of 1998, the Company,
in lieu of calling stockholders meetings, solicited written consents from its
common stockholders with respect to the following three proposed actions:
1) The Company solicited written consents from its common stockholders
of record on November 14, 1997, regarding a proposal to amend the Company's
Certificate of Incorporation, as amended (the "Charter"), to:
a) change the par value per share of the Company's common stock
from $0.0001 to $0.10;
b) effect a 3-for-2 split of the Company's common stock; and
c) increase the authorized common stock from 60 million to 135
million shares.
As of December 1, 1997, holders representing 17,847,036 shares of the
Company's common stock, or 71% of the outstanding shares of common stock,
submitted written consents approving such proposed amendment of the
Charter. The Company did not receive any responses "against," or
abstentions with respect to, the proposed amendment.
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2) The Company solicited written consents from its common stockholders
of record on December 10, 1997 regarding a proposal to amend its Charter
to:
a) classify its Board of Directors into three classes and stagger
the election of each such class for three-year terms commencing at the
annual stockholders meetings to be held in 1998, 1999 and 2000;
b) eliminate the ability of the stockholders to act by written
consent; and
c) provide that the provisions of the charter set forth in (a) and
(b) above can be amended only by an affirmative vote of 75% of the
shares present and eligible to vote (the "Locking Provision").
As of January 29, 1998, holders representing 20,627,807 shares of the
Company's common stock, or 55% of the outstanding shares of common stock,
submitted written consents approving such proposed amendments of the
Charter. The Company received 2,014,287 votes, or 5% of the outstanding
common stock, against the proposed amendment. The Company did not receive
any abstentions with respect to the proposed amendment.
3) The Company solicited written consents from its common stockholders
of record on January 12, 1998 regarding a proposal to amend the Charter to
require an affirmative vote of 75% of the shares present and eligible to
vote to amend the Locking Provision. As of January 29, 1998 holders
representing 23,595,352 shares of the Company's common stock, or 63% of the
outstanding shares of common stock, submitted written consents approving
such proposed amendment of the Charter. The Company did not receive any
responses "against," or abstentions with respect to, the proposed
amendment.
PART II
ITEM 5.MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The listing of the Company's common stock on the NASDAQ National Market
commenced on February 5, 1997. The high and low sale prices of the Company's
common stock as reported by the NASDAQ National Market from February 5, 1998
through February 27, 1998 were:
High $38.75; Low $25
As of February 27, 1997, the Company's common stock was held by 179 holders
of record.
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 Company's 9-7/8% Senior Notes due 2005 contains restrictions on
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
such 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 such indenture).
Moreover, GTS is a holding company which has no significant business operations
or assets other than its interests in joint ventures and its subsidiaries.
Accordingly, GTS must rely entirely upon distributions from the joint ventures
and its subsidiaries and investments to generate the funds necessary to pay any
dividends. The joint ventures and the Company's subsidiaries are separate and
distinct legal entities which have no obligation, contingent or otherwise, to
pay any amount to the Company, whether by dividends, loans or other payments,
except for payments under certain intercompany indebtedness. See "Business." In
addition, should the Company receive dividends or other distributions from its
joint ventures, subsidiaries or investments, the ability of the Company to
repatriate such profits and capital is dependent upon the provisions of the
applicable foreign investment and exchange laws and availability of foreign
exchange in sufficient quantities in those countries. The amount of such
dividends and other distributions from these entities will be
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affected by the current tax systems in these jurisdictions, primarily the
provisions relating to corporate profits and withholding taxes. Furthermore,
because consent is required of the venture partners in some of the Company's
joint ventures for distributions from such joint ventures, the Company's ability
to receive dividends and other distributions is to some degree dependent on
cooperation from its joint venture partners. Thus, there can be no assurance
that the Company will be able to realize benefits from its joint ventures,
subsidiaries and investments through the receipt of dividends or other
distributions at such times and amounts it desires. In addition, the Company and
certain operating subsidiaries of the Company may enter into future financings,
the terms of which may include dividend restrictions.
The foregoing reflects a 3-for-2 common stock split and an increase in the
par value per share of common stock to $0.10 effective December 1, 1997.
During the year ended December 31, 1997 the Company issued securities which
were not registered under the Securities Act of 1933, as amended (the
"Securities Act") as follows:
On July 14, 1997 and July 31, 1997, the Company issued an aggregate
$141,295,000 of its Senior Subordinated Convertible Bonds due 2000, convertible
into the common stock, par value $0.10 per share, at a purchase price of 100%,
pursuant to a subscription agreement. UBS Securities LLC, Donaldson, Lufkin &
Jenrette Securities Corporation and Merrill Lynch & Co. acted as managers in the
offering and the aggregate discount was $5,651,800. The securities were sold to
a limited number of qualified institutional buyers as defined in Rule 144A under
the Securities Act and to non-U.S. persons outside the United States. Exemption
from registration was claimed under Rule 144A and Regulation S of the Securities
Act. On February 10, 1998, the Company completed a "Complying Public Equity
Offering," as defined in the indenture for such Bonds, and, as a result, such
Bonds became convertible into the common stock at a conversion price of $20 per
share.
On August 15, 1997, August 29, 1997 and September 5, 1997, the Company
issued an aggregate 2,502,686 shares of common stock, par value $0.10 per share,
at a purchase price of $15.67 per share, for an aggregate offering price of
$39.2 million, pursuant to a stock purchase agreement. In addition to (i)
certain investment funds and (ii) certain individual private investors, these
shares were issued to certain members of management and various entities
affiliated with certain members of management. Exemption from registration was
claimed under Section 4(2) of the Securities Act regarding transactions by an
issuer not involving any public offering.
On August 29, 1997, the Company issued $3.5 million of its Senior
Subordinated Convertible Bonds due 2000, convertible into the common stock, par
value $0.10 per share, at a purchase price of 100%. In addition to (i) certain
investment funds and (ii) certain individual private investors, these shares
were issued to certain members of management and various entities affiliated
with certain members of management. Exemption from registration was claimed
under Section 4(2) of the Securities Act regarding transactions by an issuer not
involving any public offering. See the discussion above concering the terms of
conversion of these Bonds.
On September 26, 1997, the Company filed a registration statement
(Commission file no. 333-36555) (the "Stock Registration Statement") with the
Securities and Exchange Commission (the "Commission") to offer and sell to the
public, in an underwritten offering, 11,100,000 shares of its common stock, par
value $0.10 per share (the "Stock Offering"). Merrill Lynch & Co., Donaldson,
Lufkin & Jenrette Securities Corporation, UBS Securities LLC, Lehman Brothers
Inc. and Furman Selz LLC acted as the managers of the U.S. portion (7,400,000
shares) of the Stock Offering. Merrill Lynch International, UBS Limited,
Donaldson, Lufkin and Jenrette International, Lehman Brothers International
(Europe) and Baring Brothers Limited (as agent for ING Bank N.V.) acted as the
managers of the international portion (3,700,000 shares) of the Stock Offering.
The Stock Registration Statement was declared effective by the Commission on
February 5, 1998. In connection with the Stock Offering, the managing
underwriters exercised an overallotment option of 1, 665,000 shares. The Stock
Offering has terminated. The Company realized from the sale of a total of
12,765,000 common shares at $20 per share net proceeds from the Stock Offering,
including shares issued pursuant to exercise of the overallotment option, of
$238,705,500, after payment of $16,594,500 in underwriting discounts. On
December 23, 1997, the Company also filed a registration statement (Commission
file no. 333-43155) (the "Debt Registration Statement") to offer and sell to the
public, in an underwritten offering,
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<PAGE> 238
senior notes due 2005 of the Company (the "Debt Offering"). Donaldson, Lufkin &
Jenrette Securities Corporation, Merrill Lynch & Co. and UBS Securities acted as
managers of this offering. The Debt Registration Statement was declared
effective by the Commission on February 5, 1998. The Debt Offering has
terminated and the Company issued $105 million aggregate principal amount of
9 7/8% Senior Notes due 2005 (the "Senior Notes"). The Company realized from the
sale of the Senior Notes net proceeds of $82.3 million, after payment of
underwriting discounts and commissions of $3,150,000, and the deposit of $19.6
million in escrow to cover the first four scheduled payments of interest on the
Senior Notes. In February 1998, the Company applied a portion of the net
proceeds of the Offerings, approximately $85.2 million, to repay the outstanding
principal of, and accrued interest on, certain loans from related parties. See
Note 5 Debt Obligations the Company's audited consolidated financial statements
for a description of such related party loans. The Company will disclose
additional information regarding expenses incurred in connection with, and
application of net proceeds of, the Offerings in its quarterly report on Form
10-Q for the quarter ended March 31, 1998.
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<PAGE> 239
ITEM 6. SELECTED FINANCIAL DATA
Selected financial data for the Company is presented below.
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The following selected historical consolidated financial data as of and for
the years ended December 31, 1993, 1994, 1995, 1996 and 1997 are derived from
the Company's audited 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, many 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 3 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>
YEARS ENDED DECEMBER 31,
----------------------------------------------------
1993 1994 1995 1996 1997(1) 1997
------- -------- -------- -------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
PRO FORMA
(2)
---------
<CAPTION>
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues, net....................................... $ 328 $ 2,468 $ 8,412 $ 24,117 $ 47,098 47,098
Gross margin........................................ 328 23 16 5,176 4,379 4,379
Operating expenses.................................. 3,340 12,863 41,014 52,955 78,410 78,410
Equity in earnings (losses) of ventures............. 472 (135) (7,871) (10,150) (14,599) (14,599)
Other income (expense).............................. 100 990 11,034 (8,729) (29,551) (29,551)
Loss before extraordinary loss...................... (2,440) (11,985) (40,400) (67,991) (116,986) (116,986)
Extraordinary loss.................................. -- -- -- -- -- (13,213)
Net loss............................................ (2,440) (11,985) (40,400) (67,991) (116,986) (130,199)
Loss per share before extraordinary loss............ (0.26) (0.69) (1.61) (2.22) (3.26) (3.26)
Extraordinary loss per share........................ -- -- -- -- -- (0.27)
Net loss per share.................................. (0.26) (0.69) (1.61) (2.22) (3.26) (2.68)
BALANCE SHEET DATA (AT END OF PERIOD):
Cash and cash equivalents........................... $ 3,641 $ 29,635 $ 9,044 $ 57,874 $ 318,766 551,641
Property and equipment, net......................... 829 8,393 29,523 35,463 236,897 236,897
Investments in and advances to ventures............. 794 13,841 56,153 104,459 76,730 76,730
Total assets........................................ 5,968 61,957 115,621 237,378 780,461 1,036,400
Total debt.......................................... 725 2,152 27,454 85,547 639,359 672,219
Minority interest and stock subject to repurchase... -- 8 5,273 6,248 31,255 18,766
Shareholders' equity................................ 4,685 54,684 55,322 113,668 26,967 266,706
</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.
(2) The above unaudited pro forma information gives effect to the underwritten
public offerings by the Company of common stock and debt securities
consummated in February 1998, as though the transactions had occurred on
December 31, 1997. The adjustments include the raising of $255.3 million
from the sale of 12.8 million shares of common stock at an issue price of
$20.00 per share. In addition, the Company issued $105.0 million in senior
notes. Approximately $85.2 million of the net proceeds were used to repay
the related party debt obligations. See Note 15, Audited Financial
Statements of the Company.
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<PAGE> 240
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, 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)
YEAR ENDED DECEMBER 31, 1997
Sovintel............................................. 50% $113,962 $72,629 $17,020 $18,464
TCM.................................................. 50% 29,308 7,169 3,286 12,512
TeleRoss............................................. 50% 6,794 2,138 3,612 71
Sovam................................................ 66.7% 17,808 10,684 5,653 780
GTS Cellular Companies............................... 50%(3) 44,275 21,355 17,678 (906)
Other................................................ 50%(3) 14,013 13,757 27,596 (26,591)
-------- -------- ------- -------
Total.......................................... 226,160 127,732 74,845 4,330
ADJUSTMENTS FOR INTER-AFFILIATE TRANSACTIONS(1)...... (24,927) (23,250) (8,357)
</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.
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<PAGE> 241
ITEM 7.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 December 31, 1997, 1996 and 1995 and for the
years ended December 31, 1997, 1996, 1995. The following discussion should be
read in conjunction with the Company's Consolidated Financial Statements and the
notes related thereto.
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
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.
In addition, 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 Report. 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
"Business," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and elsewhere in this Report.
The factors described in this Report 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 may 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.
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, Central Europe and Asia. In Western Europe, through HER, GTS
is developing and operating the initial segment 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
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<PAGE> 242
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. See "Business."
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.
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. See
"Business -- Certain Considerations Applicable to the Company's Operations in
Russia and the CIS" and "-- Certain Considerations Generally Applicable to the
Company's Operations."
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 minority
shareholder rights, 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 December 31, 1997, $5.3
million and $10.0 million represent the net unrecovered Excess Losses for the
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<PAGE> 243
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 issuance of $265 million aggregate
principal amount of senior notes (of which $56.6 million was placed in escrow
for the first two years' interest payments) in August 1997, the Company 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.
The following table summarizes the accounting methodology for the principal
business ventures through which the Company conducts its business.
<TABLE>
<CAPTION>
COUNTRY/REGION EFFECTIVE GTS ACCOUNTING
COMPANY NAME OF OPERATIONS OWNERSHIP METHODOLOGY
------------ -------------- ------------- ------------
<S> <C> <C> <C>
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" and "Business -- Russia and the
CIS -- TeleRoss." 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 1997, all of the TeleRoss
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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 operating 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."
(3) GTS purchased the remaining 33% interest in Sovam in February 1998.
(4) GTS conducts its cellular operations through (i) Vostok Mobile, a wholly
owned GTS venture that owns between 50% and 70% of a series of 12 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.
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, the Czech Companies
and HER (for 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 1997), GTS-Monaco Access,
EuroHivo and the Asia business ventures.
Revenue. The Company's consolidated revenue was $47.1 million, $24.1
million and $8.4 million for the years ended December 31, 1997, 1996, and 1995,
respectively. The growth in revenue was attributable to the commencement in 1995
of commercial operations by TeleRoss Operating Company, as well as the continued
expansion of services and customer base in Central Europe, and HER's initial
Amsterdam to Brussels route and further expansion to London and Paris during
1997.
The CIS region's consolidated revenue was $27.1 million, $12.7 million, and
$3.8 million for the years ended December 31, 1997, 1996 and 1995 respectively.
TeleRoss Operating Company generated revenue of $24.7 million, $9.2 million and
$3.8 million, representing 91.1%, 72.4% and 100% of the region's consolidated
revenue for the years ended December 31, 1997, 1996 and 1995, respectively.
Service revenue represented 81.8%, 64.1% and 21.1% of TeleRoss Operating
Company's revenue for the years ended December 31, 1997, 1996 and 1995,
respectively, with the balance of its revenue in such periods principally
represented by installation and equipment sales. The growth in revenue was a
result of increased traffic volume generated by the TeleRoss Ventures as they
expanded to 13 cities for the year ended December 31, 1997, added customers in
existing cities and installed several VSATs at customer locations outside of
cities in which they have a presence.
Within the Central Europe region, GTS-Hungary and the Czech Companies
accounted for 100% of the revenue earned, of which GTS-Hungary and the Czech
Companies provided $8.5 million and $5.1 million of the Company's consolidated
revenue in 1997, respectively, compared to $6.9 million and $2.3 million in
1996, respectively, and $4.2 million and $0.3 million in 1995, respectively. The
growth in revenue of GTS-Hungary from 1995 to 1997 was due to the expansion of
its customer base and the introduction of microwave technology services. The
Hungary state lottery accounted for 50.6%, 55.3% and 65.0% of GTS-Hungary's
revenue in 1997, 1996 and 1995, respectively. The growth in revenue of the Czech
Companies was generated through increases in voice traffic carried from
twenty-five buildings at December 31, 1997, as compared to sixteen buildings at
December 31, 1996.
All of Western Europe's consolidated revenue of $5.4 million for the year
ended December 31, 1997 was derived from HER.
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<PAGE> 245
Gross Margin. GTS's consolidated gross margin was $4.4 million, or 9.3% of
revenue, for the year ended December 31, 1997, $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 year ended December 31, 1995.
The CIS region had a gross margin of $4.0 million, $0.8 million and $(0.9)
million for the years ended December 31, 1997, 1996 and 1995, respectively.
TeleRoss Operating Company had a gross margin of $3.5 million, or 14.2% of
revenues, for the year ended December 31, 1997 and a negative gross margin of
$(1.0) million for each of 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 and the Czech Companies comprised 100% of the Central Europe
region's gross margin. GTS-Hungary had a gross margin of $3.5 million, $3.0
million, and $1.7 million, representing 41.2%, 43.4%, and 40.5% of GTS-Hungary's
revenue for the years ended December 31, 1997, 1996 and 1995, respectively. The
favorable gross margin trend reflected the increased utilization of
GTS-Hungary's 1,000 VSAT capacity hub located in Budapest. The Czech Companies
had a gross margin of $1.5 million, $0.3 million and $(0.1) million for the
years ended December 31, 1997, 1996 and 1995, respectively. HER incurred a
negative gross margin of $(4.6) million for the year ended December 31, 1997,
which was primarily due to the initial cost structure of the new routes and
minimal revenue generated.
Operating Expenses. Consolidated operating costs were $76.7 million, $52.9
million, and $41.0 million for the years ended December 31, 1997, 1996 and 1995,
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, the inclusion of HER's operating
expenses in 1997 and increasing corporate staff.
Equity in (Losses)/Earnings of Ventures. GTS recognized losses from its
investments in non-consolidated ventures of $14.6 million, $10.2 million and
$7.9 million for the years ended December 31, 1997, 1996 and 1995, respectively.
Included in these losses were $3.6 million, $5.7 million and $5.2 million for
the years ended December 31, 1997, 1996 and 1995, respectively, that related to
GTS's ownership share of the losses. Also included in the losses for the year
ended December 31, 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) that
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," 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," "Business -- Central Europe" and
"Business -- Asia." Additionally, included within GTS's ownership share of the
losses incurred and the Excess Losses for the year ended December 31, 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 $5.2 million for the year ended
December 31, 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 due to the recognition of Excess Losses of $5.6 million,
$4.5 million and $2.7 million for the years ended December 31, 1997, 1996 and
1995, respectively. See "-- Overview." 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 $15.5
million, $11.8 million and $3.8 million for the years ended December 31, 1997,
1996 and 1995, respectively, which partially offset losses generated by other
ventures.
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<PAGE> 246
Other Non-Operating Income. Favorably affecting the 1995 results was the
non-recurring $10.3 million gain that 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 $39.1 million, $11.1
million and $0.7 million for the years ended December 31, 1997, 1996 and 1995,
respectively. Interest expense is comprised of interest incurred from debt
maturing within one year, long-term debt obligations, capital lease obligations,
amortization of debt discount on the long-term debt obligations and various
other debt obligations. The significant increase in interest expense was due to
the $409.8 million increase in debt raised in 1997. See "-- Liquidity and
Capital Resources."
GTS earned interest income of $11.4 million, $3.6 million and $2.2 million
for the years ended December 31, 1997, 1996 and 1995, 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
$2.5 million, $1.4 million and $2.6 million for the years ended December 31,
1997, 1996 and 1995, respectively. 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 non-U.S. loss
carryforwards will be allowed, in part or in full, by local tax authorities
against future income.
RESULTS OF OPERATIONS -- NON-CONSOLIDATED VENTURES (EQUITY INVESTEES)
Russia -- CIS
Sovintel. Sovintel's revenue for the years ended December 31, 1997, 1996
and 1995 was $114.0 million, $75.0 million and $44.3 million, respectively. The
increase in revenue was primarily the result of telecommunications service
revenue, which increased to $85.4 million for the year ended December 31, 1997
from $50.8 million and $26.8 million for the years ended December 31, 1996 and
1995, respectively, 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. Revenue from incoming international
minutes also increased to $13.1 million for the year ended December 31, 1997,
from $6.8 million and $2.2 million for the years ended December 31, 1996 and
1995, respectively. Included in Sovintel's traffic revenue for 1997 and 1996 was
$12.4 million and $5.0 million, respectively, 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 international/long
distance billings from TCM-supplied phone numbers.
Sovintel's non-traffic-related revenue of $28.6 million, $24.2 million and
$17.5 million for the years ended December 31, 1997, 1996 and 1995,
respectively, was primarily attributable to port sales and monthly port fees
revenues.
Sovintel's gross margin was $41.3 million, $31.1 million and $18.0 million,
or 36.2%, 41.5% and 40.6% of revenue, for the years ended December 31, 1997,
1996 and 1995, respectively. The decrease in gross margin percentage was
attributable to a general price decrease in international and domestic revenues
due to competitive pressures and a higher percentage of domestic minutes, which
yield a lower margin.
Operating expenses were $17.0 million, $10.3 million and $7.1 million, or
14.9%, 13.7% and 16.0% of total revenue, for the years ended December 31, 1997,
1996 and 1995, respectively. The increase in operating expenses was related to
increases 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 $5.7 million, $5.2 million and $2.6 million for the
years ended December 31, 1997, 1996 and 1995, respectively. The increase in
income tax expense was attributable to Sovintel's profitable operations.
TCM. TCM's revenue was $29.3 million and $16.5 million for the years ended
December 31, 1997 and 1996, respectively. TCM had minimal activities in 1995.
TCM had a gross margin of $22.1 million and
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<PAGE> 247
$13.2 million, or 75.4% and 80.0% of total revenue. The decrease in gross margin
as a percentage of revenue was attributable to higher infrastructure and
settlement costs. TCM had operating expenses of $3.3 million and $1.9 million,
or 11.3% and 11.5% of total revenue, for the years ended December 31, 1997 and
1996, respectively.
Sovam. Sovam's revenue was $17.8 million, $11.7 million and $4.4 million
for the years ended December 31, 1997, 1996 and 1995, respectively. The increase
in revenues is primarily attributable to the expansion of Sovam's network
throughout Russia and the CIS and the wider variety of service offerings,
including the introduction of Russia On Line services.
Gross margin was $7.1 million, $3.4 million and $1.5 million, or 39.9%,
29.1% and 34.1% of total revenue for the years ended December 31 in 1997, 1996
and 1995, respectively. Operating expenses were $5.7 million, $5.7 million and
$3.3 million, or 32.0%, 48.7% and 75.0% of total revenue, for the years ended
December 31, 1997, 1996 and 1995, respectively.
TeleRoss Ventures. Revenue for the TeleRoss Ventures for the years ended
December 31, 1997, 1996 and 1995 was $6.8 million, $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, an additional seven new cities in the network in 1996 and an additional
city in 1997.
Gross margin for the years ended December 31, 1997, 1996 and 1995 was $4.7
million, $1.6 million and $0.1 million, respectively. Operating expenses of $3.6
million, $2.3 million and $0.2 million were incurred for the years ended
December 31, 1997, 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 $25.8 million, $16.5 million and $2.0 million
for the years ended December 31, 1997, 1996 and 1995, respectively. Vostok
Mobile's gross margin was $13.6 million, $9.3 million and $1.1 million, or
52.7%, 56.4% and 55.0% of total revenue, and operating expenses were $10.1
million, $9.2 million and $4.7 million for the years ended December 31, 1997,
1996 and 1995, respectively.
Revenue for PrimTelefone was $12.1 million, $8.4 million and $2.2 million
for the years ended December 31, 1997, 1996 and 1995, respectively.
PrimTelefone's gross margin was $6.6 million, $4.7 million and $0.6 million, or
54.5%, 56.0% and 27.3% of total revenue, and operating expenses were $3.6
million, $3.7 million and $0.7 million for the years ended December 31, 1997,
1996 and 1995, respectively.
Bancomsvyaz did not have significant operations until 1997. Revenue for
Bancomsvyaz was $7.2 million and gross margin was $2.8 million, or 38.9% of
total revenue, for the year ended December 31, 1997. Operating expenses were
$4.9 million for the year ended December 31, 1997.
Western Europe
HER. HER earned a small revenue stream in 1996 and no revenue in 1995.
Operating expenses were $16.0 million and $6.7 million for the years ended
December 31, 1996 and 1995, respectively. The increase in selling, general and
administrative expenses reflected HER's continued transition from the start-up
phase to the operational phase. In 1997, HER was included in the consolidated
results of the Company.
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 $13.0 million and
$3.9 million and gross margin was $0.2 million and $(0.4) million for the years
ended December 31, 1997 and 1996, respectively.
Central Europe
EuroHivo. EuroHivo's operating results were minimal for the years ended
December 31, 1997, 1996 and 1995. In September 1997, the Company recorded a $2.4
million charge to recognize the liabilities associated
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with the planned liquidation and discontinuance of EuroHivo's operations. See
Footnote 3 in the Company's audited financial statements for additional
disclosures related to EuroHivo.
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 for the year ended December 31,
1996, and had minimal revenues in 1997 and 1995. 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.
During the year ended December 31, 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 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 of 1997. See Footnote 3 in the Company's
audited financial statements for additional disclosures related to the Company's
Asia operations and "Business -- Asia."
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 $36.4 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 $248.3
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 $285.3 million and $46.9 million as of
December 31, 1997 and 1996, respectively. Approximately $190.5 million of
working capital at December 31, 1997 is intended to be used for the buildout of
the HER Network. The Company had an accumulated deficit of $242.9 million as of
December 31, 1997, including net losses of approximately $117.0 million, $68.0
million and $40.4 million for the years ended December 31, 1997, 1996 and 1995,
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
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<PAGE> 249
expenditures and investments in ventures during the next three 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 due in August 2007 by HER that may be redeemed upon the successful
completion of a complying equity offering by HER or meeting other certain
criteria, and (iii) the issuance in July and August 1997 of $144.8 million in
gross proceeds of the Convertible Bonds by GTS that are convertible into Common
Stock upon the Company's completion of a complying equity offering.
The Company effected a three-for-two split of its common stock effective
December 31, 1997, and the information presented in this "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
reflects that action.
Subsequent to December 31, 1997, the Company raised approximately $255.3
million in gross proceeds from an initial public stock offering of 12.8 million
common shares at $20.00 per share. Such initial public offering constituted a
"complying public equity offering" under the Company's Convertible Bonds. As a
result, the conversion price of the Bonds is $20 per share. In addition, the
Company issued $105.0 million in gross proceeds of 9.875% senior notes due
February 15, 2005, of which $19.6 million was placed in escrow to fund the first
two years' interest payments. The Company believes that the net proceeds from
these 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.
The actual amount and timing of the Company's future capital requirements
may differ materially from management's estimates. In particular, the accuracy
of management's estimates is 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 Convertible
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 "Business."
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.
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<PAGE> 250
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, with approximately
$35 million required for the initial five country network. See
"Business -- Western Europe -- HER." As of December 31, 1997, approximately
$34.3 million has been spent on network capital expenditure. 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 discussions 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 HER Recapitalization, in 1997, 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 HER. 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 HER 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 HER
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." In March 1998, Hit Rail sold a portion
of its ownership interest to GTS-Hermes for ECU 13.5 million (approximately
$14.6 million) and, as a result, GTS-Hermes increased its ownership of HER to
89.42%. See "Business -- Western Europe -- HER -- HER Recapitalization."
LIQUIDITY ANALYSIS
The Company had cash and cash equivalents of $318.8 million and $57.9
million as of December 31, 1997 and 1996, respectively. Approximately $190.5
million of the $319.0 million of cash and cash equivalents at December 31, 1997,
is intended to be used for the build-out of the HER network. The Company had
restricted cash of $66.9 million and $16.2 million as of December 31, 1997 and
1996, respectively. Restricted cash included $29.0 million 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 years ended December 31, 1997 and 1996, the Company used $48.6
million and $39.0 million, respectively, of cash for operating activities. Cash
used for investing activities was $103.4 million and $80.9 million for the years
ended December 31, 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. 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.
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
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consolidated operations transact their business in the following significant
currencies: Russian Ruble, Hungarian Florint, Belgium Franc and the European
Currency Equivalent. 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 is attempting 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.
See "Business -- Russia and the CIS -- Certain Considerations Applicable to the
Company's Operations in Russia and the CIS -- Exchange Controls and Risks
Relating to Russian Securities" and "Business -- Certain Considerations
Generally Applicable to the Company's Operations -- Currency and Exchange
Risks."
The Company has developed risk management policies that establish
guidelines for managing foreign exchange risk. The Company is currently
evaluating the materiality of foreign exchange exposures in different countries
and the financial instruments available to mitigate this exposure. The Company's
ability to hedge its exposure is limited since certain of its operations are
located in countries whose currencies are not easily convertible. Financial
hedge instruments for these countries are nonexistent or limited and also
pricing of these instruments is often volatile and not always efficient. The
Company is designing reporting processes to monitor the potential exposure on an
ongoing basis and expects to implement this process before the end of 1998. The
Company will use the output of this process to execute financial hedges to cover
foreign exchange exposure when practical and economically justified.
The Company is considering alternatives to hedge the foreign exchange
exposure resulting from the issuance of $265 million senior notes by HER. It
expects to have a transaction which eliminates this risk consummated by the end
of April 1998.
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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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
GLOBAL TELESYSTEMS GROUP, INC.
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
YEAR END FINANCIAL STATEMENTS
Report of Ernst & Young LLP, Independent Auditors......... 81
Consolidated Balance Sheets as of December 31, 1996 and
1997................................................... 82
Consolidated Statements of Operations for the years ended
December 31, 1995, 1996,
and 1997............................................... 83
Consolidated Statements of Cash Flows for the years ended
December 31, 1995, 1996,
and 1997............................................... 84
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1995,
1996, and 1997......................................... 85
Notes to Consolidated Financial Statements................ 86
</TABLE>
EDN SOVINTEL
YEAR END FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Ernst & Young (CIS) Limited, Independent
Auditors.................................................. 108
Balance Sheets as of December 31, 1997 and 1996............. 109
Statements of Income and Retained Earnings for the years
ended December 31, 1997, 1996,
and 1995.................................................. 110
Statements of Cash Flows for the years ended December 31,
1997, 1996, and 1995...................................... 111
Notes to Financial Statements............................... 112
</TABLE>
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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, 1996 and 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, 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, 1996 and 1997, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
Ernst & Young LLP
Vienna, Virginia
February 26, 1998, except for
Note 17, as to which the date
is November 12, 1998
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<PAGE> 254
GLOBAL TELESYSTEMS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1996 1997
--------- ---------
(IN THOUSANDS,
EXCEPT SHARE DATA)
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents................................. $ 57,874 $ 318,766
Accounts receivable, net.................................. 8,920 17,079
Restricted cash........................................... 13,627 30,486
Prepaid expenses.......................................... 2,537 14,101
Other assets.............................................. 2,396 6,707
--------- ---------
TOTAL CURRENT ASSETS.............................. 85,354 387,139
Property and equipment, net................................. 35,463 236,897
Investments in and advances to ventures..................... 104,459 76,730
Goodwill and intangible assets, net of accumulated
amortization of $3,916 and $10,184 at December 31, 1996
and 1997, respectively.................................... 9,548 43,284
Restricted cash............................................. 2,554 36,411
--------- ---------
TOTAL ASSETS...................................... $ 237,378 $ 780,461
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses..................... $ 15,211 $ 61,984
Debt maturing within one year............................. 16,261 6,390
Current portion of capital lease obligations.............. -- 21,490
Related party debt maturing within one year............... 4,947 5,708
Other current liabilities................................. 2,040 6,301
--------- ---------
TOTAL CURRENT LIABILITIES......................... 38,459 101,873
Long-term debt, less current portion........................ 5,260 408,330
Long-term portion of capital lease obligations.............. -- 117,645
Related party long-term debt, less current portion.......... 59,079 79,796
Taxes and other non-current liabilities..................... 14,664 14,595
--------- ---------
TOTAL LIABILITIES................................. 117,462 722,239
COMMITMENTS AND CONTINGENCIES
Minority interest......................................... 1,915 18,766
Common stock, subject to repurchase (325,000 shares and
797,100 shares outstanding at December 31, 1996 and 1997,
respectively)............................................. 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; 34,589,106, and 37,606,814 shares issued
and outstanding, net of 116,639 and 195,528 shares of
treasury stock at December 31, 1996 and 1997,
respectively).......................................... 3,459 3,761
Additional paid-in capital................................ 238,268 274,359
Cumulative translation adjustment......................... (2,161) (8,269)
Accumulated deficit....................................... (125,898) (242,884)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY........................ 113,668 26,967
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $ 237,378 $ 780,461
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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<PAGE> 255
GLOBAL TELESYSTEMS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1995 1996 1997
---------- ---------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
REVENUES, NET:
Telecommunication and other services.................... $ 5,979 $ 19,210 $ 41,300
Equipment sales......................................... 2,433 4,907 5,798
-------- -------- ---------
8,412 24,117 47,098
-------- -------- ---------
OPERATING COSTS AND EXPENSES
Cost of revenues:
Telecommunication and other services................. 8,150 14,741 37,206
Equipment sales...................................... 246 4,200 5,513
Selling, general and administrative..................... 37,291 47,940 68,425
Depreciation and amortization........................... 3,491 4,165 6,227
Non-income taxes........................................ 234 850 2,085
-------- -------- ---------
49,412 71,896 119,456
Write-off of venture-related assets..................... -- -- 1,673
Equity in losses of ventures............................ 7,871 10,150 14,599
-------- -------- ---------
Loss from operations...................................... (48,871) (57,929) (88,630)
OTHER INCOME/(EXPENSE):
Other non-operating income.............................. 10,270 -- --
Interest income......................................... 2,177 3,569 11,361
Interest expense........................................ (728) (11,122) (39,086)
Foreign currency losses................................. (685) (1,176) (1,826)
-------- -------- ---------
11,034 (8,729) (29,551)
-------- -------- ---------
Net loss before income taxes and minority interest........ (37,837) (66,658) (118,181)
Income taxes.............................................. 2,565 1,360 2,482
-------- -------- ---------
Net loss before minority interest......................... (40,402) (68,018) (120,663)
Minority interest......................................... 2 27 3,677
-------- -------- ---------
Net loss.................................................. $(40,400) $(67,991) $(116,986)
======== ======== =========
Net loss per share........................................ $ (1.70) $ (2.33) $ (3.26)
======== ======== =========
Weighted average common shares outstanding................ 23,707 29,157 35,833
======== ======== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
83
<PAGE> 256
GLOBAL TELESYSTEMS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1995 1996 1997
-------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss................................................ $(40,400) $(67,991) $(116,986)
ADJUSTMENTS TO RECONCILE NET LOSS TO NET CASH USED IN
OPERATING ACTIVITIES:
Depreciation and amortization........................... 3,721 7,444 14,843
Amortization of discount on note payable................ -- 3,598 5,023
Equity in losses of ventures, net of dividends
received............................................. 7,871 11,123 17,474
Deferred interest....................................... -- 6,583 12,970
Write-off of venture related assets..................... -- -- 1,673
Non-cash compensation................................... -- -- 4,571
Minority interest....................................... (2) (27) (3,677)
Other................................................... 2,577 1,342 2,985
Changes in assets and liabilities, excluding effects of
acquisitions and ventures:
Accounts receivable.................................. (1,557) (6,996) (10,900)
Prepaid expenses..................................... (438) (605) (7,522)
Accounts payable and accrued expenses................ 12,820 (1,694) 34,925
Other changes in assets and liabilities.............. 9,474 8,207 (3,984)
-------- -------- ---------
NET CASH USED IN OPERATING ACTIVITIES........... (5,934) (39,016) (48,605)
INVESTING ACTIVITIES Investments in and advances to
ventures, net of repayments............................. (45,102) (54,932) 5,943
Purchases of property and equipment..................... (24,324) (12,195) (45,148)
Restricted cash......................................... (2,543) (13,138) (62,924)
Acquisitions, net of cash acquired...................... (1,871) -- 1,050
Goodwill and other intangibles.......................... (6,181) (487) (2,196)
Other investing activities.............................. 2,069 (125) (149)
-------- -------- ---------
NET CASH USED IN INVESTING ACTIVITIES........... (77,952) (80,877) (103,424)
FINANCING ACTIVITIES
Proceeds from debt...................................... 23,325 63,599 409,817
Payment of debt issue costs............................. (779) (2,777) (24,927)
Net proceeds from issuance of common stock.............. 42,175 107,775 36,432
Other financing activities.............................. (750) -- (536)
-------- -------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES....... 63,971 168,597 420,786
Effect of exchange rate changes on cash and cash
equivalents............................................. (676) 126 (7,865)
-------- -------- ---------
Net (decrease) increase in cash and cash equivalents...... (20,591) 48,830 260,892
Cash and cash equivalents at beginning of year............ 29,635 9,044 57,874
-------- -------- ---------
CASH AND CASH EQUIVALENTS AT END OF YEAR.................. $ 9,044 $ 57,874 $ 318,766
======== ======== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
84
<PAGE> 257
GLOBAL TELESYSTEMS GROUP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996, AND 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, 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 $2,777.......................... 2,503 250 36,182 -- -- 36,432
Translation adjustment........................ -- -- -- (6,108) -- (6,108)
Net loss...................................... -- -- -- -- (116,986) (116,986)
Other......................................... 515 52 (91) -- -- (39)
------ ------ -------- ------- --------- ---------
BALANCE AT DECEMBER 31, 1997.................... 37,607 $3,761 $274,359 $(8,269) $(242,884) $ 26,967
====== ====== ======== ======= ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
85
<PAGE> 258
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.
On December 1, 1997, the Company filed an amendment to its Certificate of
Incorporation to effect 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 $0.10 on a post-split
basis. Accordingly, the Company has presented share and per share data for
issued and outstanding shares as well as options and warrants 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.
Subsequent to year end, the Company completed an initial public offering of
12.8 million shares of common stock at $20 per common share (the "Stock
Offering"). The Company also issued aggregate principal amount $105.0 million of
9.875% senior notes due 2005 (the "Notes Offering" and together with the Stock
Offering, the "Offerings"). See Note 15, "Subsequent Events."
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 minority shareholder rights, 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
86
<PAGE> 259
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
profitable, the Company recognizes 100% of the profits until such time as the
excess losses previously recognized have been recovered.
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 $16.2 million and $66.9 million of restricted cash at December 31, 1996 and
1997, respectively. The restricted cash is primarily related to cash held in
escrow for interest payments associated with the Company's debt obligations.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation, which includes the
amortization of assets recorded under capital leases, is calculated on a
straight-line basis over the lesser of the estimated lives, ranging from five to
ten years for telecommunications equipment and three to five years for
furniture, fixtures and equipment and other property, or their contractual term.
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.
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
34, "Capitalization of Interest Costs," the Company intends to capitalize
material interest costs associated with the construction of capital assets for
business operations and amortize the costs over the assets' useful lives. The
Company has not capitalized any interest costs through December 31, 1997.
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 Accounting Principles Board
("APB") Opinion No. 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
In accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," 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
87
<PAGE> 260
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 year ended December 31, 1996, the Company's analyses
indicated that there was not an impairment of its long-lived assets. During the
year ended December 31, 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 its investments 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
During 1997, the Company adopted SFAS No. 128, "Earnings Per Share," which
requires the Company to present basic and fully diluted earnings per share for
all years presented. The Company's net loss per share calculation (basic and
fully diluted) is based upon the weighted average common shares issued. There
are no reconciling items in the numerator or denominator of the Company's net
loss per share calculation. Employee stock options, warrants, and convertible
debt instruments have been excluded from the net loss per share calculation
because their effect would be anti-dilutive (see Note 5, "Debt Obligations,"
Note 6, Shareholders' Equity and Note 7, "Stock Option Plans").
88
<PAGE> 261
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company believes that the carrying amount of its financial instruments
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 currently hedge against foreign currency fluctuations,
although the Company may implement such practices in the future. Under current
practices, the Company's results of operations could be adversely affected by
fluctuations in foreign currency exchange rates.
STOCK BASED COMPENSATION
SFAS No. 123, "Accounting for Stock-Based Compensation," 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." The Company has elected
to account for its stock-based compensation in accordance with the provisions of
APB No. 25 and presents 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.
NEW ACCOUNTING STANDARDS
The Financial Accounting Standards Board has issued two new standards which
become effective for reporting periods beginning after December 15, 1997. SFAS
No. 130, "Reporting Comprehensive Income," requires additional disclosures with
respect to certain changes in assets and liabilities that previously were not
required to be reported as results of operations for the period. The Company
will begin making the additional disclosures required by SFAS No. 130 in the
first quarter of 1998. SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," requires financial and descriptive
information with respect to "operating segments" of an entity based on the way
management disaggregates the entity for making internal operating decisions. The
Company will begin making the disclosures required by SFAS No. 131 with
financial statements for the period ending December 31, 1998.
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.
89
<PAGE> 262
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of the Company's investments in and advances to ventures are
as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1997
-------- -------
(IN THOUSANDS)
<S> <C> <C>
Equity in net assets acquired............................... $ 41,105 $31,183
Excess of investment cost over equity in net assets acquired
net of amortization of $4,347 and $4,851 at December 31,
1996 and 1997, respectively............................... 11,288 7,582
Accumulated (losses) earnings recognized.................... (13,840) 14,659
Dividends................................................... (973) (3,848)
Cash advances and other..................................... 66,879 27,154
-------- -------
Total investments in and advances to ventures..... $104,459 $76,730
======== =======
</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 its 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 December 31, 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
90
<PAGE> 263
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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) earnings recognized.................... (23,253)
Dividends................................................... --
Cash advances and other..................................... 10,921
--------
Net write-off as of December 31, 1997....................... $ 5,354
========
</TABLE>
Prior to the write-off detailed above, the Company included approximately
$14.4 million in its accumulated 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 year ended December 31, 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 and are included in
the $(23.3) million accumulated (losses) detailed above. Additionally, during
the year ended December 31, 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 year ended December 31, 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 million of goodwill
in connection with the recapitalization. As a result of the Company's loss
recognition policy, the consolidation of HER would 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 December 31, 1997, the consolidation of HER resulted in reductions of
$72.9 million, $10.0 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 December 31, 1997 the
consolidation of HER had a $21.4 million favorable impact on the accumulated
(losses) earnings recognized.
91
<PAGE> 264
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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,
--------------------
1996 1997
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Balance, at beginning of period............................. $ 56,153 $104,459
Equity in net assets acquired............................... 22,441 80,054
Excess of investment cost over equity in net assets
acquired.................................................. 5,288 10,187
Dividends................................................... (973) (2,875)
Cash advances (repayments) and other........................ 31,700 (24,171)
Effect of consolidating equity method company............... -- (76,325)
-------- --------
58,456 (13,130)
Equity ownership in losses.................................. (3,122) (5,552)
Excess losses recognized over amount attributable to
ownership
interest.................................................. (4,451) (10,610)
Amortization of excess of investment cost over equity in net
assets acquired........................................... (2,577) (3,313)
Loss in value that is other than temporary.................. -- (5,354)
Effect of consolidating equity method company............... -- 10,230
-------- --------
(10,150) (14,599)
-------- --------
Balance, at end of period................................... $104,459 $ 76,730
======== ========
</TABLE>
As of December 31, 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 (holds a 95% interest in TeleCommunications
of Moscow)................................................ 52.64%
TeleRoss Ventures -- 13 joint ventures in various regions in
the CIS................................................... 50%
Vostok Ventures -- 12 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, in shares of the
Company's common stock, based on the actual earnings of the venture. 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 the first quarter of 1998, the
Company will issue additional shares based on the venture's 1997 earnings (see
Note 15, "Subsequent Events").
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 by
exchange for 713,311 shares of the Company's common stock. Subsequent to the
Stock Offering, repayment of this financing is due on demand and must be in
exchange for the Company's common stock. This amount has been included in "Other
financing agreements" (see Note 5, "Debt Obligations").
92
<PAGE> 265
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Subsequent to year end, the Company purchased the remaining interest in
Sovam Teleport, one of its equity method investments in the CIS.
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, 1996 and 1997.
YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
MAJORITY OWNED 50% OR LESS TOTAL EQUITY
EQUITY METHOD ENTITIES VENTURES OWNED VENTURES METHOD 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>
YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
MAJORITY OWNED 50% OR LESS TOTAL EQUITY
EQUITY METHOD ENTITIES VENTURES OWNED VENTURES METHOD VENTURES
---------------------- -------------- -------------- ---------------
(IN THOUSANDS)
<S> <C> <C> <C>
Revenue.......................................... $47,986 $178,174 $226,160
Gross margin..................................... 29,292 69,136 98,428
Net (loss) income................................ (10,370) 14,700 4,330
Equity in net (losses) earnings.................. (11,538) 5,131 (6,407)
Current assets................................... 20,841 59,959 80,800
Total assets..................................... 35,090 176,117 211,207
Current liabilities.............................. 18,719 68,503 87,222
Total liabilities................................ 27,653 102,758 130,411
Net assets....................................... 7,438 73,359 80,797
Ownership interest in equity in net assets....... 9,541 45,638 55,179
</TABLE>
93
<PAGE> 266
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4: SUPPLEMENTAL BALANCE SHEET INFORMATION
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1997
------- --------
(IN THOUSANDS)
<S> <C> <C>
Accounts Receivable Consists Of:
Trade accounts receivable................................. $ 6,769 $ 15,725
Value added taxes receivable.............................. 1,971 3,350
Other receivables......................................... 962 2,089
------- --------
9,702 21,164
Less: allowance for doubtful accounts................... 782 4,085
------- --------
Total accounts receivable, net...................... $ 8,920 $ 17,079
======= ========
Property And Equipment Consists Of:
Telecommunications equipment.............................. $28,302 $231,996
Furniture, fixtures and equipment......................... 5,877 9,760
Other property............................................ 837 3,470
Construction in process................................... 7,009 7,799
------- --------
42,025 253,025
Less: accumulated depreciation.......................... 6,562 16,128
------- --------
Total property and equipment, net................... $35,463 $236,897
======= ========
Accounts Payable And Accrued Expenses Consists Of:
Accounts payable.......................................... $ 6,761 $ 25,005
Interest payable.......................................... 213 17,483
Accrued compensation...................................... 3,151 6,165
Other accrued expenses.................................... 5,086 13,331
------- --------
Total accounts payable and accrued expenses......... $15,211 $ 61,984
======= ========
</TABLE>
NOTE 5: DEBT OBLIGATIONS
Company debt consists of:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1997
------- --------
(IN THOUSANDS)
<S> <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 warrants to
purchase 7,778 common shares.............................. 59,079 72,233
Other financing agreements.................................. 26,468 18,204
------- --------
85,547 500,224
Less: debt maturing within one year....................... 21,208 12,098
------- --------
Total long-term debt.............................. $64,339 $488,126
======= ========
</TABLE>
In the third quarter of 1997, HER issued $265.0 million aggregate principal
amount 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,
94
<PAGE> 267
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2002 at specific redemption prices. HER may also redeem a portion of 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.
In July 1997, the Company issued $144.8 million aggregate principal amount
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 as defined in the Bond
Agreement. 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 feature, interest
expense is being accrued and accreted at a 15% annual rate. (Subsequent to year
end, the Company completed the Stock Offering at $20.00 per common share which
will result in the Bonds being convertible into approximately 7.2 million shares
of the Company's common stock. In addition, due to the completion of the Stock
Offering, the interest rate will remain at 8.75% until maturity (see Note 15,
"Subsequent Events").)
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 warrants to purchase 7,777,776 common
shares, valued at $20.7 million. 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. 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. As of December 31,
1997, the Debt Obligations have been classified within "Related party long-term
debt, less current portion" on the balance sheet. Subsequent to year end the
Company repaid the Debt Obligations by using a portion of the proceeds from the
Offerings (see Note 15, "Subsequent Events").
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 December 31, 1997, are as
follows: 1998 -- $12.1 million, 1999 -- $1.1 million, 2000 -- $149.4 million,
2001 -- $0.2 million and $349.5 million thereafter.
The Company paid interest of $0.7 million, $0.2 million and $2.0 million in
1995, 1996 and 1997, respectively. The Company incurred interest expense of
$39.1 million in 1997 and would have recorded $33.1 million in additional
interest expense in 1997 had the Senior Notes and Bonds been outstanding on
January 1, 1997.
95
<PAGE> 268
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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, 1995.................................. 5,090,876 $ 9.00 $42,138
December 31, 1996.................................. 8,348,532 13.33 107,744
December 31, 1997.................................. 2,502,686 15.67 36,432
</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 over the next three
years. During 1997, the 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. The Company has
accreted the value of the outstanding common stock subject to repurchase
(325,000 shares at December 31, 1996 and 797,100 shares at December 31, 1997),
to the fair value of the Company's common stock as of December 31, 1996 and 1997
($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 warrants to purchase 7,777,776 common shares 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
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 15,572,260 shares of common stock for issuance
upon conversion of the exercise of outstanding and future stock options,
warrants and similar rights.
PREFERRED STOCK
As of December 31, 1996 and 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, 1996 and 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, 1996 and 1997 would have been
approximately $40.9 million, $69.4 million and $123.4 million, respectively. The
fair value of options
96
<PAGE> 269
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
granted during 1995 and 1996 are estimated as $2.19 and $2.93 per common 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 1997 are estimated as $7.35 per common 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 the 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 December 31, 1997, the maximum number of shares of common stock
available for grant under the Option Plans was 8,836,534. All options granted
under the Option Plans are at exercise prices that were 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.
Additional information with respect to stock option activity is summarized
as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
1995 1996 1997
-------------------- -------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of
year...................... 2,431,800 $3.65 3,422,399 $ 5.56 4,869,360 $ 7.31
Options granted............. 1,210,800 9.04 1,612,962 11.10 2,215,296 14.53
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 (433,173) 7.38
--------- --------- ---------
Outstanding at end of
year...................... 3,422,399 5.56 4,869,360 7.31 6,562,171 9.75
========= ========= =========
Options exercisable at year
end....................... 995,617 $3.59 1,992,236 $ 4.65 2,962,110 $ 6.06
</TABLE>
The following table summarizes information about stock options outstanding:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------- ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF EXERCISE PRICE NUMBER CONTRACTUAL LIFE EXERCISE NUMBER EXERCISE
AT DECEMBER 31, 1997: OUTSTANDING (IN YEARS) PRICE EXERCISABLE PRICE
----------------------- ----------- ---------------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$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 7.88 986,679 7.66
$10.00 to $15.67..................... 3,845,521 8 13.03 604,431 11.13
--------- ---------
6,562,171 7 $ 9.75 2,962,110 $ 6.06
========= =========
</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, 1996 and 1997.
97
<PAGE> 270
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During 1996, the Company implemented the GTS 1996 Top Talent Retention
Program (the "Program"), which granted options to certain employees under the
1992 Stock Option Plan. The Program was offered to 28 employees, who had an
aggregate of 339,524 options, and provided for an altered vesting period based
on certain revenue levels achieved and certain stock price levels maintained. If
these performance-based achievements are not attained, the options vest in April
2001. As of December 31, 1997 no performance levels were met.
In the fourth quarter of 1997, HER implemented a stock option plan for its
key officers and employees (the "HER Plan"). The ownership dilution caused by
the HER Plan is not expected to be significant. As a result of issuing options
under the HER Plan, HER will incur a non-cash charge of approximately $3.7
million, of which $2.6 million was recorded during the fourth quarter and the
remaining $1.1 million will be recognized in 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% matching contribution on the first 5% 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 approximately
$0.1 million, $0.2 million and $0.2 million for the years ended December 31,
1995, 1996 and 1997, respectively. The Company made no discretionary
(non-matching) contributions for the years ended December 31, 1995, 1996 or
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 does not bear significant financial
risk for its pension plan. HER's expense under the pension plan was $0.05
million, $0.4 million and $0.7 million for the years ended December 31, 1995,
1996 and 1997, respectively.
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>
YEAR ENDED DECEMBER 31,
--------------------------------
1995 1996 1997
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Pretax loss:
Domestic......................................... $(22,398) $(41,554) $(64,920)
Foreign.......................................... (15,437) (25,077) (53,261)
-------- -------- --------
$(37,835) $(66,631) $(118,181)
======== ======== ========
</TABLE>
For the years ended December 31, 1995, 1996 and 1997, the Company recorded
$2.6 million, $1.4 million and $2.5 million, respectively, in income tax expense
that related exclusively to its current provision for foreign taxes.
98
<PAGE> 271
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
1995 1996 1997
------------------ ------------------ ------------------
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% $(40,181) 34.0%
Foreign operating losses
generating no tax
benefit.................... 6,550 (17.3) 8,526 (12.8) 18,108 (15.3)
Domestic operating losses
generating no tax
benefit.................... 6,315 (16.7) 14,129 (21.2) 22,073 (18.7)
Other -- net................. 2,565 (6.8) 1,360 (2.1) 2,482 (2.1)
-------- ----- -------- ----- -------- -----
$ 2,565 (6.8)% $ 1,360 (2.1)% $ 2,482 (2.1)%
======== ===== ======== ===== ======== =====
</TABLE>
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,
--------------------
1996 1997
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Deferred Tax Assets:
Net operating loss carryforwards.......................... $ 20,720 $ 38,029
Other deferred tax assets................................. 1,326 3,912
-------- --------
Total deferred tax asset.................................... 22,046 41,941
Deferred Tax Liability...................................... 1,161 2,292
-------- --------
Net deferred tax asset...................................... 20,885 39,649
Less: valuation allowance................................. (20,885) (39,649)
-------- --------
Total............................................. $ -- $ --
======== ========
</TABLE>
As of December 31, 1997, the Company had net operating loss carryforwards
for U.S. federal income tax purposes of approximately $110 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 carry-forwards 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 of the Company's foreign ventures have foreign tax loss
carryforwards in excess of $60 million. The Company's financial statements do
not reflect any provision for benefits that might be associated with such loss
carryforwards.
99
<PAGE> 272
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 11: COMMITMENTS AND CONTINGENCIES
LEASES
The Company has various lease agreements for office space, equipment and
fiber. The obligations extend through 2018. Most of the leases contain renewal
options of one to twelve years. Assets under capital leases are included in the
consolidated balance sheets as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1996 1997
----- --------
(IN THOUSANDS)
<S> <C> <C>
Telecommunications equipment................................ $ -- $150,787
Less: accumulated amortization.............................. -- 482
----- --------
$ -- $150,305
===== ========
</TABLE>
Rental expense aggregated $2.0 million, $2.2 million, and $3.1 million for
the years ended December 31, 1995, 1996 and 1997, respectively.
Future minimum payments, by year and in the aggregate, under the capital
leases and other non-cancellable operating leases with initial or remaining
terms in excess of one year as of December 31, 1997 were as follows:
<TABLE>
<CAPTION>
CAPITAL LEASES OPERATING LEASES
-------------- ----------------
(IN THOUSANDS)
<S> <C> <C>
December 31, 1998....................................... $ 26,679 $ 3,311
1999.................................... 14,217 2,982
2000.................................... 15,300 1,604
2001.................................... 16,465 1,143
2002.................................... 16,630 933
Thereafter.............................................. 152,016 1,155
-------- -------
Total minimum lease payments............................ 241,307 $11,128
=======
Less amount representing interest....................... 102,172
--------
Present value of net minimum lease payments............. 139,135
Less current portion of capital lease obligations....... 21,490
--------
Long-term portion of capital lease obligations.......... $117,645
========
</TABLE>
OTHER COMMITMENTS AND CONTINGENCIES
In September 1997, the Company purchased the remaining interest in one of
its subsidiaries, which owns interests in cellular ventures 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
when certain revenue levels are met, certain other 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's consolidated and non-consolidated ventures have future
purchase commitments amounting to $2.7 million and $1.1 million, respectively,
as of December 31, 1997.
100
<PAGE> 273
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 December 31, 1997 was
approximately $29.0 million.
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.
There were no major customers in 1997.
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, 1996 and 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,
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
the Debt Obligations during 1996 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. The Company repaid
the Debt Obligations subsequent to year end (see Note 15, "Subsequent Events").
101
<PAGE> 274
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. Subsequent to the Stock Offering,
repayment of this financing must be in exchange for the Company's common stock.
This amount has been included in "Other financing agreements" (see Note 5, "Debt
Obligations").
During 1997, the 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. As a result of the issuance of the common shares, the
seller became a shareholder of the Company (see Note 3, "Investments in and
Advances to Ventures," and Note 6, "Shareholders' Equity").
The Company has entered into certain consulting agreements with directors
of the Company and paid $0.2 million, $0.2 million and $0.4 million in 1995,
1996, and 1997, respectively, pursuant to those agreements.
The Company had notes receivable due from employees aggregating $0.1
million and less than $0.1 million as of December 31, 1996 and 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 $4.4
million in 1996 and 1997, respectively. There was no significant revenue earned
from affiliate sales in 1995.
NOTE 13: SUPPLEMENTAL CASH FLOW INFORMATION
The following table summarizes non-cash investing and financing activities
for the Company:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------------
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
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
Capitalization of leases.................................... -- 139,136
</TABLE>
No significant non-cash investing activities were incurred for the year
ended December 31, 1995.
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
102
<PAGE> 275
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
consolidated financial information by geographic area for 1995, 1996 and 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, 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
</TABLE>
<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, 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
</TABLE>
<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, 1997
Total revenue................................... $ 5,373 $ 27,045 $ 13,513 $ 1,016 $ 151 $ 47,098
Gross margin.................................... (4,599) 3,940 4,985 (99) 152 4,379
Operating loss.................................. (25,926) (7,088) (5,076) (28,066) (22,474) (88,630)
Net loss........................................ (29,064) (9,505) (6,882) (28,043) (43,492) (116,986)
Identifiable assets............................. 505,593 99,926 23,840 (6,544) 157,646 780,461
Liabilities..................................... 451,171 62,862 40,465 19,161 148,580 722,239
Net (liabilities)/assets........................ 54,422 37,064 (16,625) (25,705) 9,066 58,222
</TABLE>
NOTE 15: SUBSEQUENT EVENTS
THE OFFERINGS
In February 1998, the Company completed the Stock Offering in which the
Company raised $255.3 million in gross proceeds, including $33.3 million
attributable to the sale of shares resulting from the exercise by the
underwriters of an over-allotment option, from the sale of 12.8 million shares
of common stock at an issue price of $20.00 per share. The Stock Offering
resulted in the Company's common stock being listed in the United States on the
National Association of Securities Dealers Automated Quotation Market and
internationally on the European Association of Securities Dealers Automated
Quotation Market. Also in February 1998, the Company completed the Notes
Offering and issued $105.0 million aggregate principal amount of senior notes,
due February 15, 2005. Interest at 9.875% on the Notes will be payable in cash
semiannually on February 15 and August 15 of each year, commencing August 15,
1998. Net proceeds from the Offerings were approximately $336.7 million.
Approximately $19.6 million of the net proceeds of the Notes Offering is being
held in escrow for the first four semiannual interest payments commencing in
1998.
103
<PAGE> 276
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Approximately $85.2 million of the net proceeds of the Offerings has been used
to repay the related party Debt Obligations (see Note 5, "Debt Obligations") of
$70.0 million plus accrued interest that were due March 31, 2001. In addition,
approximately $13.2 million in unamortized discount and debt issuance costs on
the Debt Obligations was written off at the time of repayment. The remaining net
proceeds from the Offerings will primarily be used to provide working capital
for existing ventures, particularly in Russia and the CIS, to expand the
Company's operations and for general corporate purposes, including strategic
acquisitions.
As a result of the completion of the Stock Offering, the interest rate for
the Bonds will remain at 8.75% until maturity (see Note 5, "Debt Obligations")
and the 6.25% additional interest that was previously accrued, $4.2 million, has
been reflected as an increase to additional paid-in capital. The Bonds are
convertible into approximately 7.2 million common shares at a conversion price
of $20.00 per share.
The following unaudited pro forma condensed balance sheet and results of
operations of the Company give effect to the Offerings as though the
transactions had occurred on December 31, 1997. The pro forma shares and per
share data have been calculated assuming the Stock Offering occurred on January
1, 1997. The pro forma results are presented for informational purposes only and
do not purport to be indicative of the results of operations which actually
would have been obtained if the transactions had occurred in such periods, or
which may exist or be obtained in the future.
104
<PAGE> 277
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
AS ADJUSTED
FOR THE
CONDENSED BALANCE SHEET (UNAUDITED) REPORTED ADJUSTMENTS OFFERINGS
----------------------------------- --------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash and cash equivalents................................... $ 318,766 $ 232,875 $ 551,641
Other assets................................................ 461,695 23,064 484,759
--------- --------- ----------
Total Assets........................................ $ 780,461 $ 255,939 $1,036,400
========= ========= ==========
Long-term debt, less current portion........................ $ 408,330 $ 105,000 $ 513,330
Related party debt.......................................... 85,504 (72,140) 13,364
Other liabilities........................................... 228,405 (4,171) 224,234
--------- --------- ----------
Total Liabilities................................... 722,239 28,689 750,928
Minority interest........................................... 18,766 -- 18,766
Common stock subject to repurchase.......................... 12,489 (12,489) --
Common stock and additional paid-in capital................. 278,120 252,952 531,072
Cumulative translation adjustment........................... (8,269) -- (8,269)
Accumulated deficit......................................... (242,884) (13,213) (256,097)
--------- --------- ----------
Total Shareholders' Equity.......................... 26,967 239,739 266,706
--------- --------- ----------
Total Liabilities and Shareholders' Equity.......... $ 780,461 $ 255,939 $1,036,400
========= ========= ==========
</TABLE>
<TABLE>
<CAPTION>
AS ADJUSTED
FOR THE LOSS
CONDENSED STATEMENT OF OPERATIONS (UNAUDITED) REPORTED ADJUSTMENTS OFFERINGS PER SHARE
--------------------------------------------- --------- ----------- ----------- ---------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C> <C>
Loss before extraordinary item.............................. $(116,986) $ -- $(116,986) $(2.41)
Extraordinary item.......................................... -- (13,213) (13,213) (0.27)
--------- -------- --------- ------
Net loss............................................ $(116,986) $(13,213) $(130,199) $(2.68)
========= ======== ========= ======
Weighted average common shares outstanding.................. 35,833 12,765 48,598
</TABLE>
OTHER SUBSEQUENT EVENT TRANSACTIONS
Pursuant to a purchase agreement that the Company has with a venture's
partner in the CIS region (see Note 3, "Investments in and Advances to
Ventures," Note 6, "Shareholders' Equity," and Note 12, "Related Party
Transactions") the Company is obligated to pay additional consideration, via
shares of common stock, based on the subsidiary's earnings performance. Based on
the 1997 results, the Company is obligated to issue 336,630 shares of common
stock during the first quarter of 1998.
Subsequent to December 31, 1997, HER 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 $12.9
million. The commitments have expected lease terms of ten to twenty-one years
with options for renewal rights of one and one-half to five additional years.
The Company entered into a rights agreement (the "Rights Agreement") on
February 2, 1998, and accordingly, the Company authorized the distribution of
one right (a "Right") for each common share outstanding from February 2, 1998
through the distribution date (the "Distribution Date"). Each Right entitles 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 an exercise price of $75 per Unit, subject to adjustment. The
Distribution Date, as defined in further detail within the Rights Agreement, is
triggered when a person acquires 15% of the outstanding common stock of the
Company, or a tender or exchange offer is commenced for 15% of such outstanding
stock, except in the case of two related party shareholders in which case the
acquisition threshold that applies is 20% of such outstanding stock. Under
certain circumstances thereafter, certain Rightholders may have the right to
purchase common stock of the Company, or of an Acquiring Person, as defined in
the Rights Agreement, having a value equal to two times
105
<PAGE> 278
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
based on the subsidiary's earnings performance. Based on the 1997 results, the
Company is obligated to issue 336,630 shares of common stock during the first
quarter of 1998.
Subsequent to December 31, 1997, HER 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 $12.9
million. The commitments have expected lease terms of ten to twenty-one years
with options for renewal rights of one and one-half to five additional years.
The Company entered into a rights agreement (the "Rights Agreement") on
February 2, 1998, and accordingly, the Company authorized the distribution of
one right (a "Right") for each common share outstanding from February 2, 1998
through the distribution date (the "Distribution Date"). Each Right entitles 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 an exercise price of $75 per Unit, subject to adjustment. The
Distribution Date, as defined in further detail within the Rights Agreement, is
triggered when a person acquires 15% of the outstanding common stock of the
Company, or a tender or exchange offer is commenced for 15% of such outstanding
stock, except in the case of two related party shareholders in which case the
acquisition threshold that applies is 20% of such outstanding stock. Under
certain circumstances thereafter, certain Rightholders may have the right to
purchase common stock of the Company, or of an Acquiring Person, as defined in
the Rights Agreement, having a value equal to two times the exercise price of
the Rights. In addition, the Rights are redeemable or exchangeable under certain
circumstances.
NOTE 16: EVENTS OCCURRING SUBSEQUENT TO DATE OF AUDIT REPORT
In March 1998, the Company purchased an additional 10% interest in HER from
an existing shareholder of HER for ECU 13.5 million (approximately $14.6
million). As a result of the purchase, the Company owns approximately 89% of
HER.
NOTE 17: RECENT DEVELOPMENTS
On August 17, 1998 the exchange rate of the Russian ruble, relative to
other currencies, declined significantly. The following measures were
implemented by the Russian government: 1) The repayment of sovereign securities
were suspended; subsequently, secondary trading therein was halted. Since many
Russian banks had substantial investments in these securities, severe liquidity
problems resulted for the banks. 2) The value of the ruble was allowed to
fluctuate below the ruble/US dollar exchange rate corridor that the government
had previously committed to support; this represented an effective devaluation
of the ruble. 3) A 90-day moratorium on offshore credit repayments was issued.
The 90-day moratorium was not extended when it expired on November 16, 1998 and
it is anticipated that the ruble will continue to be devalued. Due to the
devaluation and the end of the 90-day moratorium, there is an ongoing risk that
many Russian banks may be declared bankrupt. Deposits held at Russian banks,
other than Sberbank, are not insured. The official exchange rate as of September
30, 1998 was 16.0645 per US dollar. The last official exchange rate prior to the
suspension of trading on August 17, 1998 was 6.2725 rubles per US dollar.
As a result of the devaluation of the ruble and the consequences of the
banking and economic crisis within Russia, the Company recorded a $13.1 million
pre-tax charge within its financial statements for the third quarter 1998, that
is mainly comprised of foreign currency exchange losses for ruble-denominated
net monetary assets with the remainder associated with estimates for
uncollectible accounts receivable and unrecoverable cash deposits in Russian
banks.
106
<PAGE> 279
AUDITED FINANCIAL STATEMENTS
EDN SOVINTEL
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
WITH REPORT OF INDEPENDENT AUDITORS
107
<PAGE> 280
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
EDN Sovintel
We have audited the accompanying balance sheets of EDN Sovintel as of
December 31, 1997 and 1996, and the related statements of income and retained
earnings, and cash flows for each of the three years in the period ended
December 31, 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 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,
1997 and 1996, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 1997, 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, 1997 and 1996 and for each of the three years ended December 31, 1997, 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 1997 audited
financial statements and have reported separately for the 1996 and 1995
financial statements. The significant differences between the accounting
principles applied in preparing the statutory financial statements and
accounting principles generally accepted in the United States of America are
summarized in Note 2.
Ernst & Young (CIS) Ltd.
Moscow, Russia
February 16, 1998
except for Note 12,
as to which the date is
November 12, 1998
108
<PAGE> 281
EDN SOVINTEL
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1997 1996
------- -------
(IN THOUSANDS OF
US DOLLARS)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 5,620 $ 3,606
Cash deposit with related party........................... 485 476
Accounts receivable, net of allowances.................... 16,223 15,329
Due from affiliates....................................... 1,586 1,879
Inventories............................................... 1,697 1,749
Prepaid expenses and other assets......................... 1,630 1,171
VAT receivable, net....................................... 3,688 1,157
Deferred income taxes..................................... 186
------- -------
Total current assets.............................. 31,115 25,367
Property and equipment, net................................. 38,709 27,709
Deferred expenses........................................... 945 1,080
------- -------
Total assets...................................... $70,769 $54,156
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Note due shareholder...................................... $ 39 $ 5,700
Trade payables............................................ 5,725 8,382
Accrued liabilities and other payables.................... 3,194 1,661
Taxes accrued or payable.................................. 1,088 555
Amounts due to shareholder and affiliates................. 10,104 5,703
Amount due to partner in commercial venture............... 1,350 1,350
------- -------
Total current liabilities......................... 21,500 23,351
Commitments and contingencies
Shareholders' equity:
Capital contributions..................................... 2,000 2,000
Retained earnings......................................... 47,269 28,805
------- -------
Total shareholders' equity........................ 49,269 30,805
------- -------
Total liabilities and shareholders' equity........ $70,769 $54,156
======= =======
</TABLE>
See accompanying notes.
109
<PAGE> 282
EDN SOVINTEL
STATEMENTS OF INCOME AND RETAINED EARNINGS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
------------------------------
1997 1996 1995
-------- ------- -------
(IN THOUSANDS OF US DOLLARS)
<S> <C> <C> <C>
Revenues, net:
Service revenues.......................................... $105,288 $63,488 $29,920
Installation revenues..................................... 5,241 9,312 12,981
Product sales............................................. 3,433 2,240 1,391
-------- ------- -------
113,962 75,040 44,292
Cost of revenues:
Service costs............................................. 67,174 37,884 18,545
Cost of installation...................................... 2,621 4,656 6,491
Cost of products.......................................... 2,834 1,370 1,211
-------- ------- -------
72,629 43,910 26,247
-------- ------- -------
Gross profit................................................ 41,333 31,130 18,045
Selling, general and administrative expenses................ 17,020 10,291 7,145
Interest expense............................................ 503 638 703
Interest income............................................. (392) (87) (59)
Other (income) loss......................................... (57) 120 (98)
Foreign exchange loss on net monetary items................. 131 252 112
-------- ------- -------
Income before taxes......................................... 24,128 19,916 10,242
Income taxes................................................ 5,664 5,154 2,594
-------- ------- -------
Net income.................................................. 18,464 14,762 7,648
Retained earnings, beginning of year........................ 28,805 14,043 6,395
-------- ------- -------
Retained earnings, end of year.............................. $ 47,269 $28,805 $14,043
======== ======= =======
</TABLE>
See accompanying notes.
110
<PAGE> 283
EDN SOVINTEL
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-------------------------------
1997 1996 1995
-------- -------- -------
(IN THOUSANDS OF US DOLLARS)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income................................................ $ 18,464 $ 14,762 $ 7,648
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation........................................... 5,312 3,638 2,448
Provision for deferred income taxes.................... (186)
Provision for doubtful accounts........................ 345 678 132
Write-off of accounts receivable....................... (602) (147) (492)
Write-down of network equipment and inventories........ 100 196
Foreign exchange loss.................................. 131 252 112
Changes in operating assets and liabilities:
Accounts receivable.................................... (637) (8,460) (2,759)
Due from affiliates.................................... 293 (683) (1,011)
Inventories............................................ 52 (911) (309)
Prepaid expenses and other assets...................... (538) (1,108) 599
VAT receivable, net.................................... (2,609) 54 (906)
Trade payables......................................... (2,491) (193) 2,983
Accrued liabilities and other payables................. 1,533 310 1,233
Taxes accrued or payable............................... 570 326 229
Amounts due to shareholder and affiliates.............. 4,401 3,039 2,165
-------- -------- -------
Net cash provided by operating activities......... 24,038 11,657 12,268
INVESTING ACTIVITIES -- purchases of and advances for
property and equipment.................................... (16,177) (9,863) (9,259)
FINANCING ACTIVITIES
Borrowings from shareholder............................... 10,760 11,300 11,888
Repayments to shareholder................................. (16,421) (11,100) (9,271)
Repayments of long-term debt.............................. (694) (3,979)
Cash deposited with related party......................... (41) (476)
-------- -------- -------
Net cash used in financing activities....................... (5,702) (970) (1,362)
Effect of exchange rate changes on cash and cash
equivalents............................................... (145) (312)
-------- -------- -------
Net increase in cash and cash equivalents................... 2,014 512 1,647
Cash and cash equivalents at beginning of year.............. 3,606 3,094 1,447
-------- -------- -------
Cash and cash equivalents at end of year.................... $ 5,620 $ 3,606 $ 3,094
======== ======== =======
</TABLE>
See accompanying notes.
111
<PAGE> 284
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 May 1, 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 Soviet-American joint venture. The
venture re-registered as a Russian limited liability partnership in November
1992. The Company is 50% owned by Open Joint Stock Company "Rostelecom", an
intercity and long-distance carrier which is 38% owned by Svyazinvest, and 50%
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 certain accrued
revenue and expenses, foreign currency translation, deferred taxation, 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.
Official exchange rates are 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
112
<PAGE> 285
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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 rates at December 31, 1997, 1996 and 1995 for one US dollar
were RUR 5,960, RUR 5,560 and RUR 4,640 respectively. At February 16, 1998, the
CBR rate had changed to RUR 6,050. The effect of this devaluation of the rouble
on monetary assets and liabilities has not been determined.
On January 1, 1998, the CBR introduced a new rouble to replace existing
roubles. The new rouble has been redenominated so that one new rouble is
equivalent to one thousand old roubles. The old rouble will continue in
circulation until December 31, 1998 and will be accepted as legal tender until
December 31, 2002.
All rouble amounts reflected in these financial statements are stated in
old roubles.
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 fair value. Accounts receivable are shown in the balance sheet net
of an allowance for uncollectible accounts of $643,000 and $900,000 at December
31, 1997 and 1996, 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
is 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
Revenues from telecommunication traffic are recognized in the period in
which the traffic occurs. Revenues from product sales, connection fees, and
other services are recognized in the period in which the products are shipped,
connections made, and services rendered. Taxes on certain revenues were charged
at rates ranging from 1.5% to 4.0% over the three years ended December 31, 1997,
1996 and 1995 and amounted to $4,458,000, $2,792,000 and $1,166,000,
respectively, and are charged to selling general and administrative expenses.
113
<PAGE> 286
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
ADVERTISING
The Company expenses the cost of advertising as incurred. Advertising
expenses for the years ended December 31, 1997, 1996 and 1995 were $671,000,
$512,000 and $395,000, 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 fund and transport fund on
behalf of all its Russian employees. Contributions were 40.5%, 40.5% and 41.0%
from base payroll for 1997, 1996 and 1995, 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.
NEW ACCOUNTING PRONOUNCEMENTS
In 1997, 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." SFAS 121 requires recognition of
impairment of long-lived assets in the event the net book value of such assets
exceeds the future undiscounted cash flows attributable to such assets. The
adoption of SFAS No. 121 had no impact on the Company's financial position or
results of operations.
In June 1997, SFAS No. 130, "Reporting Comprehensive Income", was issued.
SFAS No. 130 establishes standards for the reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements and is effective for fiscal years beginning after December
15, 1997. The Company will adopt SFAS No. 130 in fiscal 1998. SFAS No. 130
expands or modifies disclosures and, accordingly, will have no impact on the
Company's reported financial position, results of operations or cash flows.
RECLASSIFICATIONS
Certain 1996 and 1995 comparative figures have been reclassified to conform
to the presentation adopted in the current year.
114
<PAGE> 287
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
<TABLE>
<CAPTION>
1997 1996
-------- -------
<S> <C> <C>
Network equipment........................................... $ 43,876 $31,251
Other property and equipment................................ 4,527 3,108
-------- -------
48,403 34,359
Accumulated depreciation.................................... (14,557) (9,380)
Construction-in-progress.................................... 4,409 1,796
Network equipment and advances for network equipment not yet
in service................................................ 454 934
-------- -------
Net book value.............................................. $ 38,709 $27,709
======== =======
</TABLE>
Total depreciation expense on property and equipment for 1997, 1996 and
1995 was $5,177,000, $3,503,000 and $2,253,000, respectively.
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 income and retained earnings for the years ended December 31, 1997, 1996 and
1995 represents the provision for current and deferred taxes.
Significant components of the provision for income taxes for the years
ended December 31 are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Current tax expense...................................... $5,850 $5,154 $2,594
Deferred tax benefit..................................... (186)
------ ------ ------
Provision for income taxes............................... $5,664 $5,154 $2,594
====== ====== ======
</TABLE>
115
<PAGE> 288
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Taxable income reported for Russian tax purposes...... $16,184 $14,726 $ 7,411
Investment incentive deductions..................... 12,337 9,030 7,220
Tax loss carry-forwards utilized.................... 97 113
Net permanent difference related to revenues and (2,455)
expenses incurred in the ordinary course of
business which are not assessable or deductible
for Russian tax purposes......................... (1,174) (2,595)
------- ------- -------
Russian income before taxes........................... 26,163 22,695 12,036
Adjustments to present financial statements in
accordance with US GAAP:
Reversal of excess depreciation due to statutory (2,101)
revaluations..................................... (1,497) (293)
Depreciation rate differences....................... (279) (424) (236)
Allowances for uncollectible accounts............... 35 369 (132)
Inventory write-downs............................... (100) (249)
Accrual of deductible expenses...................... (3,234) (2,437) (1,339)
Accrual of revenue.................................. 2,704 1,093 19
Foreign exchange differences........................ 236 280 1,425
Other............................................... 604 (63) (989)
------- ------- -------
Income before taxes under US GAAP..................... $24,128 $19,916 $10,242
======= ======= =======
</TABLE>
A reconciliation between the statutory rate and the effective income tax
rate is as follows for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Income tax expense computed on financial income before
taxes at statutory tax rate of 35%.................. $ 8,445 $ 6,970 $ 3,585
Tax effect of permanent differences:
Investment incentive deductions..................... (4,318) (3,161) (2,594)
Tax loss carryforwards utilized..................... (34) (40)
Other permanent differences......................... 859 411 805
Adjustments made to compute income before taxes for
US GAAP financial reporting...................... 1,142 813 555
Increase (decrease) in the valuation allowance for
deferred tax assets................................. (430) 161 243
------- ------- -------
Income tax expense reported in the financial
statements.......................................... $ 5,664 $ 5,154 $ 2,594
======= ======= =======
</TABLE>
116
<PAGE> 289
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (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>
1997 1996 1995
------ ------- -----
<S> <C> <C> <C>
Deferred tax assets (liabilities):
Depreciation........................................... $ 398 $ 300 $ 151
Inventory write-downs and allowances................... 235 235 147
Accrual of expenses.................................... 1,132 898 469
Accrual of revenue..................................... (946) (383) (7)
Allowance for uncollectible accounts................... (13) 129
------ ------- -----
Deferred tax assets...................................... 806 1,050 889
Valuation allowance for deferred tax assets.............. (620) (1,050) (889)
------ ------- -----
Net deferred tax assets........................ $ 186 $ -- $ --
====== ======= =====
</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.
The Company paid Russian profits tax of $4,302,000, $5,849,000 and
$2,660,000 in 1997, 1996 and 1995, respectively.
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 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
which was then extended to December 19, 1997. The loan was repaid prior to
December 31, 1997 except for withholding taxes on interest. The loan carried
interest at a rate equal to the then current six month LIBOR rate (5.6%) plus
5.0 percent per annum. As of December 31, 1997, 1996 and 1995, the outstanding
borrowings under this agreement were $39,000, $5,700,000 and $5,500,000,
respectively.
The Company believes that the carrying value of the above loans
approximates fair values.
The Company paid interest of $697,000, $542,000 and $576,000 in 1997, 1996
and 1995, respectively.
7. SHAREHOLDERS' EQUITY
The Company's capital structure as specified in the charter capital
document is as follows as of December 31:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<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.
117
<PAGE> 290
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Retained earnings available for distribution at December 31, 1997 amounted
to 256 billion roubles or approximately $42,953,000 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 follows, as of and for the years ended
December 31:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------ ------
<S> <C> <C> <C>
Sales................................................... $ 2,310 $1,525 $ 62
Telecommunication lease and traffic costs............... 11,183 4,586 1,506
Amounts due to shareholder and affiliates............... 4,184 656 460
Cash deposit with related party......................... 485 476
</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, which
was rolled over for an additional year during 1997. 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 follows, as of and for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Sales.................................................... $4,974 $3,115 $1,041
Management service fees and reimbursements of expenses of
expatriate staff....................................... 1,318 927 2,062
Balances due under credit facility....................... 39 5,700 5,500
Interest expense......................................... 503 626 461
Amounts due from affiliates.............................. 1,586 1,879 1,196
Amounts due to shareholder and affiliates................ 5,919 5,047 2,204
</TABLE>
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 follows, as of and for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Telecommunication settlement and rent expense....... $19,003 $15,889 $10,491
Balances in trade payables.......................... 1,237 2,184
Balances in accounts receivable..................... 487
Amount due to partner in commercial venture......... 1,350 1,350 1,350
Balances in prepaid expenses and other assets....... 800
</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, net of
related amortization, as deferred expenses. In 1997 the Company prepaid $800 of
1998 rent to MTU-Inform for additional office space to be occupied during 1998.
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
118
<PAGE> 291
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
from a variety of international and Russian business customers. As of December
31, 1997, two customers accounted for 16% and 11% of revenues and 11% and 7% of
accounts receivable, respectively. As of December 31, 1996, these same two
customers accounted for 17% and 16% of revenues and 25% and 10% of accounts
receivable, respectively. As of December 31, 1995, these two customers accounted
for 1% and 14% of revenues and 10% and 11% of accounts receivable, respectively.
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 1997, 1996 and 1995 was $2,794,000, $2,137,000 and
$1,234,000, respectively.
11. CONTINGENCIES
Legislation and regulations regarding taxation, foreign currency
transactions and licensing of foreign currency loans in the Russian Federation
continues to evolve as the central government manages the transformation from a
command to a market-oriented economy. The various legislation and regulations
are not always clearly written and their interpretation is subject to the
opinions of the tax inspectors, Central Bank officials and the Ministry of
Finance. Instances of inconsistent opinions between local, regional and national
tax authorities and between the Central Bank and Ministry of Finance are not
unusual.
The Company believes that it has paid or accrued all taxes that are
applicable. Where practice concerning the provision of taxes is unclear, the
Company has accrued tax liabilities based on management's best estimate. 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.
Because of the uncertainties associated with the Russian tax and legal
systems, the ultimate amount of taxes, penalties and interest, if any, assessed
may be in excess of the amount expensed to date and accrued at December 31,
1997. It is the opinion of the Company's management that any material amounts
are either not probable, not reasonably determinable, or both.
The Company's operations and financial position will continue to be
affected by Russian political developments, including the application of
existing and future legislation and tax regulations. The Company does not
believe that these contingencies, as related to its operations, are any more
significant than those of similar enterprises in Russia.
12. SUBSEQUENT EVENTS
On August 17, 1998 the exchange rate of the Russian ruble, relative to
other currencies, declined significantly. The following measures were
implemented by the Russian government: 1) The repayment of sovereign securities
were suspended; subsequently, secondary trading therein was halted. Since many
Russian banks had substantial investments in these securities, severe liquidity
problems resulted for the banks. 2) The value of the ruble was allowed to
fluctuate below the ruble/US dollar exchange rate corridor that the government
had previously committed to support; this represented an effective devaluation
of the ruble. 3) A 90-day moratorium on offshore credit repayments was issued.
The 90-day moratorium was not extended when it expired on November 16, 1998 and
it is anticipated that the ruble will continue to be devalued. Due to the
devaluation and the end of the 90-day moratorium, there is an ongoing risk that
many Russian banks may be declared bankrupt. Deposits held at Russian banks,
other than Sberbank, are not insured. The official exchange rate as of September
30, 1998 was 16.0645 per US dollar. The last official exchange rate prior to the
suspension of trading on August 17, 1998 was 6.2725 rubles per US dollar.
119
<PAGE> 292
EDN SOVINTEL
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
As a result of the devaluation of the ruble and the consequences of the
banking and economic crisis within Russia, the Company recorded a $7.4 million
pre-tax charge within its financial statements for the third quarter 1998, that
is mainly comprised of foreign currency exchange losses for ruble-denominated
net monetary assets with the remainder associated with estimates for
uncollectible accounts receivable and unrecoverable cash deposits in Russian
banks.
120
<PAGE> 293
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.
Information regarding Directors appears in the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A relating to the Company's
Annual Meeting of Stockholders on May 20, 1998 and is incorporated herein by
reference.
The executive officers of the Company and their ages and business
experience since at least January 1, 1993 are as follows.
Gerald W. Thames, 51, President and Chief Executive Officers. 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, 56, 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 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, 41, 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, 54, 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, 51, 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.
121
<PAGE> 294
Kevin Power, 44, 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.
Grier C. Raclin, 45, 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.
Stewart P. Reich, 53, 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.
Eileen K. Sweeney, 46, 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.
Louis T. Toth, 55, 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.
There are no family relationships among any of the officers listed above.
Officers are elected annually to serve for the following year or until the
election and qualification of their successors.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding this item appears in the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A relating to the Company's
Annual Meeting of Stockholders on May 20, 1998 and is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding this item appears in the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A relating to the Company's
Annual Meeting of Stockholders on May 20, 1998 and is incorporated herein by
reference.
ITEM. 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding this item appears in the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A relating to the Company's
Annual Meeting of Stockholders on May 20, 1998 and is incorporated herein by
reference.
122
<PAGE> 295
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
a) The following documents are filed as part of this report:
1 Financial Statements
The following consolidated financial statements of the Company are included
in Part II, Item 8 of this report:
- Independent Auditors' Report
- Consolidated Statements of Operations for each of the Three Years Ended
December 31, 1995, 1996 and 1997
- Consolidated Balance Sheets as of December 31, 1996 and 1997
- Consolidated Statements of Cash Flows for each of the Three Years Ended
December 31, 1995, 1996 and 1997
- Consolidated Statements of Changes in Stockholders' Equity for each of
the Three Years Ended December 31, 1995, 1996 and 1997
- Notes to Consolidated Financial Statements
The following financial statements of EDN Sovintel are included in Part II,
Item 8 of this report:
- Independent Auditors' Report
- Statements of Income and Retained Earnings for each of the Three Years
Ended December 31, 1997, 1996 and 1995
- Balance Sheets as of December 31, 1997 and 1996
- Statements of Cash Flows for each of the Three Years Ended December 31,
1997, 1996 and 1995
- Notes to Financial Statements
2 Consolidated Financial Statement Schedules
The Company has furnished Schedule II -- Valuation and Qualifying Accounts
on Page
All other schedules are omitted because they are not applicable or not
required, or because the required information is either incorporated herein by
reference or included in the financial statements or notes thereto included in
this report.
b) Reports on Form 8-K
<TABLE>
<CAPTION>
DATE OF REPORT SUBJECT OF REPORT
-------------- -----------------
<S> <C>
None
</TABLE>
c) Exhibits
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
3.1** -- Certificate of Incorporation of SFMT, Inc.
3.2** -- Certificate of Correction to the Certificate of
Incorporation of SFMT, Inc., filed with the Delaware
Secretary of State on October 8, 1993
3.3** -- Certificate of Ownership and Merger Merging San
Francisco/Moscow Teleport, Inc. into SFMT, Inc., filed
with the Delaware Secretary of State on November 3, 1993
</TABLE>
123
<PAGE> 296
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
3.4** -- Certificate of Amendment to the Certificate of
Incorporation of SFMT, Inc., filed with the Delaware
Secretary of State on January 12, 1995
3.5** -- Certificate of Amendment to the Certificate of
Incorporation of SFMT, Inc., filed with the Delaware
Secretary of State on February 22, 1995
3.6** -- Certificate of Amendment to the Certificate of
Incorporation of Global TeleSystems Group, Inc., filed
with the Delaware Secretary of State on October 16, 1996
3.7** -- By-laws of SFMT, Inc.
3.8** -- Certificate of Amendment to the Certificate of
Incorporation of Global TeleSystems Group, Inc., filed
with the Delaware Secretary of State on December 1, 1997
3.9** -- Form of Amended and Restated By-laws of Global
TeleSystems Group, Inc. supersedes By-laws of SFMT, Inc.
filed as Exhibit 3.7)
3.10+ -- Certificate of Amendment to the Certificate of
Incorporation of Global TeleSystems Group, Inc. filed
with the Delaware Secretary of State on January 29, 1998.
3.11+ -- Certificate of Amendment to the Certificate of
Incorporation of Global TeleSystems Group, Inc. filed
with the Delaware Secretary of State on February 9, 1998.
3.12+ -- Certificate of Designation, of the Series A Preferred
Stock of the Company.
4.1** -- Form of Specimen Stock Certificate for Common Stock of
the Registrant
4.2** -- Indenture dated as of July 14, 1997 between the Company
and The Bank of New York (including the form of Senior
Subordinated Convertible Bond due 2000 as an exhibit
thereto)
4.3** -- Registration Rights Agreement, dated as of July 14, 1997,
between Global TeleSystems Group, Inc. and UBS Securities
LLC.
4.4** -- Indenture dated as of August 19, 1997 between Hermes
Europe Railtel B.V. and The Bank of New York (including
the form of 11 1/2% Senior Note due 2007 as an exhibit
thereto)
4.5** -- Registration Rights Agreement dated as of August 19, 1997
between Hermes Europe Railtel B.V. and Donaldson, Lufkin
& Jenrette Securities Corporation, UBS Securities LLC,
and Lehman Brothers, Inc
4.6** -- Form of Rights Agreement between Global TeleSystems
Group, Inc. and The Bank of New York as Rights Agent.
4.7+ -- Indenture dated as of February 10, 1998 between Global
TeleSystems Group, Inc. and The Bank of New York
(including the form of 9 7/8% Senior Notes due 2005 as an
exhibit thereto).
10.1** -- Senior Note Purchase Agreement, dated as of January 19,
1996, among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.
10.1(a)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated June 6, 1996
10.1(b)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated June 6, 1996
</TABLE>
124
<PAGE> 297
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
10.1(c)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated July 23, 1996
10.1(d)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated September 16, 1996
10.1(e)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated July 11, 1997
10.1(f)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated July 29, 1997
10.1(g)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
10.2** -- Registration Rights Letter Agreement, dated as of January
19, 1996, among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.
10.3** -- Warrant Agreement, dated as of January 19, 1996, among
Global TeleSystems Group, Inc., The Open Society
Institute and Chatterjee Fund Management, L.P.
10.4** -- Joint Venture Letter Agreement, dated January 19, 1996,
among Global TeleSystems Group, Inc., The Open Society
Institute and Chatterjee Fund Management, L.P.
10.5 -- Intentionally Omitted
10.6** -- Registration Rights Letter Agreement, dated June 6, 1996,
among the Company, The Open Society Institute, Winston
Partners II LDC and Winston Partners II LLC
10.7** -- Warrant Agreement, dated as of June 6, 1996, between
Global TeleSystems Group, Inc., The Open Society
Institute, Winston Partners II LDC and Winston Partners
II LLC
10.8** -- Senior Note Purchase Agreement, dated as of February 2,
1996, between Global TeleSystems Group, Inc. and Emerging
Markets Growth Fund, Inc.
10.8(a)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated June 6,
1996 (see Exhibit No. 10.1(b))
10.8(b)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated June 6,
1996
10.8(c)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated July 25,
1996
10.8(d)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated September
10, 1996
10.8(e)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated September
16, 1996
</TABLE>
125
<PAGE> 298
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
10.8(f)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated December
30, 1996
10.8(g)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated May 13,
1997
10.8(h)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated June 20,
1997
10.8(i)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated July 11,
1997
10.8(j)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated July 21,
1997
10.8(k)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated August 14,
1997
10.8(l)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc.
and Emerging Markets Growth Fund, Inc., dated September
29, 1997
10.9** -- Registration Rights Letter Agreement, dated as February
2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc.
10.10** -- Warrant Agreement, dated as of February 2, 1996, between
Global TeleSystems Group, Inc. and Emerging Markets
Growth Fund, Inc.
10.11 -- Intentionally Omitted
10.12** -- Registration Rights Letter Agreement, dated as February
2, 1996, between Global TeleSystems Group, Inc. and
Capital International Emerging Markets Funds
10.13** -- Warrant Agreement, dated as of February 2, 1996, between
Global TeleSystems Group, Inc. and Capital International
Emerging Markets Funds
10.14+ -- Restated and Amended Global TeleSystems Group, Inc.
Non-Employee Directors' Stock Option Plan
10.15** -- GTS-Hermes, Inc. 1994 Stock Option Plan
10.16** -- Restricted Stock Grant letter, dated as of January 1,
1995
10.17** -- Employment Agreement dated as of January 1995 between
SFMT, Inc. and Jan Loeber
10.18** -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Louis Toth
10.19** -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Gerald W. Thames
10.20** -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Raymond J. Marks
10.21** -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Henry Radzikowski
10.22** -- SFMT, Inc. Equity Compensation Plan
10.23** -- Form of Non-Statutory Stock Option Agreement
</TABLE>
126
<PAGE> 299
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
10.24+ -- Third Amended and Restated 1992 Stock Option Plan of
Global TeleSystems Group Inc. dated September 25, 1997
10.25** -- GTS-Hermes 1994 Stock Option Grant, Non-Qualified Stock
Option Grant
10.26** -- Agreement on the Creation and Functions of the Joint
Venture of EDN Sovintel, dated June 18, 1990
10.27** -- Stock Purchase Agreement among Global TeleSystems Group,
Inc, Kompaniya "Invest-Project," Swinton Limited, GTS-Vox
Limited, and MTU-Inform, dated September 6, 1995
10.28** -- Certificate of Registration of Revised and Amended
Foundation Document in the State Registration of
Commercial Organizations, dated May 30, 1996
10.29** -- Agreement on the Creation and Functions of the Joint
Venture Sovam Teleport, dated May 26, 1992
10.30** -- Amended and Restated Joint Venture Agreement between GTS
Cellular, Tricor B.V., Gerard Essing, Ivan Laska, and
Erik Jennes, dated July 6, 1995
10.31** -- Amended and Restated Shareholders' Agreement between HIT
Rail B.V., GTS-Hermes, Inc., Nationale Maatschappu Der
Belgische Spoorwegen, Teleport B.V., AB Swed Carrier, and
Hermes Europe Railtel B.V., dated July, 1997
10.31(a)** -- Shareholders' Agreement among the Hermes Europe Railtel
B.V., GTS-Hermes Inc., HIT Rail B.V., SNCB/NMBS and AB
Swed Carrier (incorporated by reference to Exhibit 10.1
to the Hermes Europe Railtel B.V.'s Registration
Statement on Form S-4 (File No. 333-37719) filed on
December 11, 1997) (supersedes the Amended and Restated
Shareholders' Agreement filed as Exhibit 10.31 to this
Registration Statement)
10.32** -- Company Agreement between The Societe National de
Financement, GTS S.A.M. and The Principality of Monaco,
dated September 27, 1995
10.33** -- Joint Venture Agreement between SFMT-Hungaro Inc. and
Montana Holding Vagyonkezelo Kft., dated December 23,
1993
10.34** -- Joint Venture and Shareholders' Agreement among Gerard
Aircraft Sales and Leasing Company, SFMT-Hungaro Inc.,
and Microsystem Telecom Rt., dated August 5, 1994
10.35** -- Agreement on the Establishment of Limited Liability
Company between SFMT-Czech, Inc. and B&H s.r.o., dated
July 12, 1994
10.36** -- Formation of the Equity Joint Venture between GTS and
SSTIC, dated April 12, 1995
10.37** -- Contract to Establish the Sino-foreign Cooperative Joint
Venture Beijing Tianmu Satellite Communications
Technology Co., Ltd, amended, by and between China
International Travel Service Telecom Co., Ltd. and
American China Investment Corporation, dated March 27,
1996
10.38** -- Joint Venture Contract between GTS TransPacific Ventures
Limited and Shanghai Intelligence Engineering, Inc.,
dated March 28, 1996
10.39** -- Agreement between Global TeleSystems Group, Inc. and
Cesia S.A., dated June 21, 1997
10.40** -- Consulting Agreement between SFMT, Inc. and Alan B.
Slifka, dated March 1, 1994
10.41** -- Consulting Agreement between Global TeleSystems Group,
Inc. and Bernard J. McFadden, dated August 15, 1996
</TABLE>
127
<PAGE> 300
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
10.42** -- Consulting Agreement between CESIA S.A. and Hermes Europe
Railtel B.V., dated June 20, 1997
10.43+ -- Key Employee Stock Option Plan of Hermes Europe Railtel
B.V.
21.1+ -- List of Subsidiaries of the Registrant
23.2* -- Consent of Ernst & Young LLP
23.3* -- Consent of Ernst & Young (CIS) LTD.
24.1+ -- Powers of Attorney (included on signature page to this
report)
27.1+ -- Financial Data Schedule extracted from December 31, 1997
audited financial statements
</TABLE>
- ---------------
* Filed herewith.
** Incorporated by reference to the correspondingly numbered Exhibit to
Amendment No. 6 to the Company's registration statement on Form S-1 dated
February 5, 1998 (Commission File No. 333-36555)
+ Previously filed.
(d) Schedules
Schedule II -- Valuation and Qualifying Accounts. The other financial
statement schedules of the Company have been omitted because the
information required to be set forth therein is not applicable or is shown
in the Financial Statements or Notes thereto.
128
<PAGE> 301
SIGNATURES
Pursuant to the requirements of this Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized in the City of McLean, Commonwealth of
Virginia, on this 7th day of December, 1998.
GLOBAL TELESYSTEMS GROUP, INC.
Date: December 7, 1998 By: /s/ GRIER C. RACLIN
------------------------------------
Name: Grier C. Raclin
Title: Senior Vice President and
General Counsel
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the 7th day of December, 1998.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
* President, Chief Executive Officer December 7, 1998
- ----------------------------------------------------- and Director (principal
Gerald W. Thames executive officer)
* Executive Vice President -- December 7, 1998
- ----------------------------------------------------- Finance and Chief Financial
William H. Seippel Officer (principal financial and
accounting officer)
* Chairman of the Board of Directors December 7, 1998
- -----------------------------------------------------
Alan B. Slifka
Director December 7, 1998
- -----------------------------------------------------
Robert J. Amman
* Director December 7, 1998
- -----------------------------------------------------
Michael Greeley
* Director December 7, 1998
- -----------------------------------------------------
Bernard McFadden
* Director December 7, 1998
- -----------------------------------------------------
Stewart J. Paperin
* Director December 7, 1998
- -----------------------------------------------------
W. James Peet
* Director December 7, 1998
- -----------------------------------------------------
Jean Salmona
Director December 7, 1998
- -----------------------------------------------------
David Dey
</TABLE>
129
<PAGE> 302
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
* Director December 7, 1998
- -----------------------------------------------------
Joel Schatz
Director December 7, 1998
- -----------------------------------------------------
Adam Solomon
Director December 7, 1998
- -----------------------------------------------------
Roger W. Hale
*By: /s/ GRIER C. RACLIN
-------------------------------------------------
Grier C. Raclin
Attorney-in-Fact
for the Directors
</TABLE>
130
<PAGE> 303
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
COL. A COL. B COL. C COL. D COL. E
------ ------ ----------------------- ------ ------
ADDITIONS
-----------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS OF PERIOD
----------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts at
12/31/95.............................. 0 30 30
Allowance for doubtful accounts at
12/31/96.............................. 30 752 782
Allowance for doubtful accounts at
12/31/97.............................. 782 3,303 4,085
</TABLE>
131
<PAGE> 304
ANNEX C
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1998
(COMMISSION FILE NUMBER: )
GLOBAL TELESYSTEMS GROUP, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 94-3068423
(State of incorporation) (I.R.S. Employer Identification No.)
</TABLE>
1751 PINNACLE DRIVE, NORTH TOWER, 12TH FLOOR
MCLEAN, VIRGINIA 22102
(Address of principal executive office)
(703) 918-4500
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
At April 30, 1998, there were outstanding approximately 53,245,706 shares
of common stock of the registrant.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 305
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I. Financial Information
Item 1A Financial Statements of Global TeleSystems Group, Inc....... 3
Condensed Consolidated Balance Sheets as of December 31,
1997 and
March 31, 1998............................................ 4
Condensed Consolidated Statements of Operations for the
Three Months Ended March 31, 1997 and 1998................ 5
Condensed Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 1997 and 1998................ 6
Notes to Condensed Consolidated Financial Statements........ 7
Item 1B Financial Statements of EDN Sovintel........................ 10
Condensed Balance Sheets as of December 31, 1997 and March
31, 1998.................................................. 11
Condensed Statements of Operations for the Three Months
Ended March 31, 1997 and 1998............................. 12
Condensed Statements of Cash Flows for the Three Months
Ended March 31, 1997 and 1998............................. 13
Notes to Condensed Financial Statements..................... 14
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 16
PART II. Other Information
Item 2 Changes in Securities and Use of Proceeds................... 27
Item 5 Other Information........................................... 27
Item 6 Exhibits and Reports on Form 8-K............................ 27
Signatures............................................................ 28
</TABLE>
2
<PAGE> 306
PART I. FINANCIAL INFORMATION
ITEM 1A. FINANCIAL STATEMENTS OF GLOBAL TELESYSTEMS GROUP, INC.
Condensed Consolidated Balance Sheets as of December 31, 1997 and March 31,
1998
Condensed Consolidated Statements of Operations for the Three Months Ended
March 31, 1997 and 1998
Condensed Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 1997 and 1998
Notes to Condensed Consolidated Financial Statements
3
<PAGE> 307
GLOBAL TELESYSTEMS GROUP, INC.
CONDENSED, CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1997 1998
--------------- -------------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents................................. $ 318,766 $ 507,895
Accounts receivable, net.................................. 17,079 23,078
Restricted cash........................................... 30,486 41,344
Prepaid expenses.......................................... 14,101 15,492
Other assets.............................................. 6,707 8,113
--------- ----------
TOTAL CURRENT ASSETS.............................. 387,139 595,922
Property and equipment, net................................. 236,897 270,641
Investments in and advances to ventures..................... 76,730 88,083
Goodwill and intangible assets, net......................... 43,284 58,055
Restricted cash............................................. 36,411 35,849
--------- ----------
TOTAL ASSETS...................................... $ 780,461 $1,048,550
========= ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses..................... $ 61,984 $ 62,750
Debt maturing within one year............................. 6,390 8,882
Current portion of capital lease obligations.............. 21,490 19,250
Related party debt maturing within one year............... 5,708 10,023
Other current liabilities................................. 6,301 20,510
--------- ----------
TOTAL CURRENT LIABILITIES......................... 101,873 121,415
Long-term debt, less current portion........................ 408,330 506,336
Long-term portion of capital lease obligations.............. 117,645 136,988
Related party long-term debt, less current portion.......... 79,796 3,530
Taxes and other non-current liabilities..................... 14,595 12,970
--------- ----------
TOTAL LIABILITIES................................. 722,239 781,239
COMMITMENTS AND CONTINGENCIES
Minority interest........................................... 18,766 12,470
Common stock, subject to repurchase (797,100 outstanding at
December 31, 1997)........................................ 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; 37,606,814 and 52,040,140 shares issued and
outstanding, net of 195,528 and 195,528 shares of treasury
stock at December 31, 1997 and March 31, 1998,
respectively)............................................. 3,761 5,204
Additional paid-in capital.................................. 274,359 539,911
Accumulated other comprehensive loss........................ (8,269) (10,213)
Accumulated deficit......................................... (242,884) (280,061)
--------- ----------
TOTAL SHAREHOLDERS' EQUITY........................ 26,967 254,841
--------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $ 780,461 $1,048,550
========= ==========
</TABLE>
4
<PAGE> 308
GLOBAL TELESYSTEMS GROUP, INC.
CONDENSED, CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS
ENDED MARCH 31, ENDED MARCH 31,
1997 1998
----------------- -----------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C>
REVENUES, NET:
Telecommunication and other services...................... $ 7,957 $ 20,792
Equipment sales........................................... 430 2,025
-------- --------
8,387 22,817
-------- --------
OPERATING COSTS AND EXPENSES:
Cost of revenues:
Telecommunication and other services................... 5,550 17,467
Equipment sales........................................ 874 1,556
Selling, general and administrative....................... 11,488 19,749
Depreciation and amortization............................. 1,246 2,195
Non-income taxes.......................................... 287 742
-------- --------
19,445 41,709
Equity in losses (earnings) of ventures................... 3,420 (3,412)
-------- --------
LOSS FROM OPERATIONS........................................ (14,478) (15,480)
OTHER INCOME (EXPENSE):
Interest income........................................... 1,296 7,066
Interest expense.......................................... (3,668) (16,466)
Foreign currency losses................................... (494) (1,394)
-------- --------
(2,866) (10,794)
-------- --------
Net loss before income taxes, minority interest and
extraordinary loss........................................ (17,344) (26,274)
Income taxes................................................ 365 552
-------- --------
Net loss before minority interest and extraordinary loss.... (17,709) (26,826)
Minority interest........................................... (24) 2,353
-------- --------
Net loss before extraordinary loss.......................... (17,733) (24,473)
Extraordinary loss -- extinguishment of debt................ -- (12,704)
-------- --------
NET LOSS.................................................... $(17,733) $(37,177)
======== ========
Loss per share before extraordinary loss.................... $ (0.51) $ (0.54)
Extraordinary loss per share................................ -- (0.28)
-------- --------
Net loss per share.......................................... $ (0.51) $ (0.82)
======== ========
Weighted average common shares outstanding.................. 34,758 45,549
======== ========
</TABLE>
5
<PAGE> 309
GLOBAL TELESYSTEMS GROUP, INC.
CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS
ENDED MARCH 31, ENDED MARCH 31,
1997 1998
--------------- ---------------
(IN THOUSANDS)
<S> <C> <C>
OPERATING ACTIVITIES
Net loss.................................................... $(17,733) $(37,177)
ADJUSTMENTS TO RECONCILE NET LOSS TO NET CASH USED IN
OPERATING ACTIVITIES:
Extraordinary loss........................................ -- 12,704
Depreciation and amortization............................. 2,124 7,150
Amortization of discount on note payable.................. 1,157 477
Equity in losses (earnings) of ventures, net of dividends
received............................................... 3,420 (3,412)
Deferred interest......................................... 1,806 1,636
Minority interest......................................... 24 (6,561)
Other..................................................... 255 (237)
Changes in assets and liabilities, excluding effects of
acquisitions and ventures:
Accounts receivable.................................... (2,259) (2,162)
Prepaid expenses....................................... (803) (1,161)
Accounts payable and accrued expenses.................. (1,848) (774)
Other changes in assets and liabilities................ 500 2,130
-------- --------
NET CASH USED IN OPERATING ACTIVITIES............. (13,357) (27,387)
INVESTING ACTIVITIES
Investments in and advances to ventures, net of
repayments............................................. (10,420) 2,370
Purchases of property and equipment....................... (1,589) (14,389)
Restricted cash........................................... 238 (10,357)
Goodwill and other intangibles............................ 208 (14,634)
-------- --------
NET CASH USED IN INVESTING ACTIVITIES............. (11,563) (37,010)
FINANCING ACTIVITIES
Proceeds from debt........................................ -- 105,300
Repayments of debt........................................ (175) (91,355)
Payment of debt issue costs............................... -- (3,957)
Net proceeds from issuance of common stock................ -- 235,620
Other financing activities................................ (394) 7,199
-------- --------
NET CASH (USED IN) PROVIDED BY FINANCING
ACTIVITIES...................................... (569) 252,807
Effect of exchange rate changes on cash and cash
equivalents............................................... (1,692) 719
-------- --------
Net (decrease) increase in cash and cash equivalents........ (27,181) 189,129
Cash and cash equivalents at beginning of period............ 57,874 318,766
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $ 30,693 $507,895
======== ========
</TABLE>
6
<PAGE> 310
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. FINANCIAL PRESENTATION AND DISCLOSURES
The financial statements of Global TeleSystems Group, Inc. (the "Company")
included herein are unaudited and have been prepared in accordance with
generally accepted accounting principles for interim financial reporting and
Securities and Exchange Commission regulations. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. Material intercompany affiliate account
transactions have been eliminated; however, other adjustments may have been
required had an audit been performed. In the opinion of management, the
financial statements reflect all adjustments of a normal and recurring nature
necessary to present fairly the Company's financial position, results of
operations and cash flows for the interim periods. These financial statements
should be read in conjunction with the Company's 1997 audited consolidated
financial statements and the notes related thereto. The results of operations
for the three months ended March 31, 1998 may not be indicative of the operating
results for the full year.
The Company's operations are carried out through alliances with strategic
local partners in the form of venture arrangements. Wholly-owned subsidiaries
and majority-owned ventures where the Company has unilateral operating and
financial control are consolidated within the Company's financial results and
operations. 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 investments
that are accounted for by the equity method as a result of minority shareholder
rights, 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 the ventures, those ventures are 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 recorded have been recovered.
2. POLICIES AND PROCEDURES
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income," which establishes
standards for reporting and display of comprehensive income and its components
in a full set of general purpose financial statements. Comprehensive income is
defined as the change in equity of a business enterprise during a period from
nonowner sources. Comprehensive loss was $19.4 million and $39.1 million for the
three months ended March 31, 1997 and 1998, respectively, and was comprised of
net loss of $17.7 million and $37.2 million and foreign currency translation
adjustments of $1.7 million and $1.9 million for the three months ended March
31, 1997 and 1998, respectively.
During 1997, the Company adopted SFAS No. 128, "Earnings Per Share," which
requires the Company to present basic and diluted earnings per share for all
periods presented. The Company's net loss per share calculation (basic and
diluted) is based upon the weighted average common shares issued. There are no
reconciling items in the numerator or denominator of the Company's net loss per
share calculation. Employee stock options, warrants, and convertible debt
instruments have been excluded from the net loss per share calculation because
their effect would be anti-dilutive.
7
<PAGE> 311
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Certain reclassifications have been made to the March 1997 condensed,
consolidated financial statements in order to conform to the 1998 presentation.
3. SHAREHOLDERS' EQUITY
In February 1998, the Company completed an initial public offering of 12.8
million shares of common stock at $20.00 per common share (the "Stock
Offering"). The Stock Offering resulted in the Company's common stock being
listed in the United States on the National Association of Securities Dealers
Automated Quotation Market and internationally on the European Association of
Securities Dealers Automated Quotation Market. Net proceeds from the Stock
Offering were approximately $235.6 million.
As a result of the Stock Offering, the Company no longer has a significant
obligation to repurchase or assist the seller in locating a purchaser for the
797,100 shares of common stock subject to repurchase that were outstanding at
December 31, 1997. Therefore, all amounts outstanding have been reclassified as
additional paid-in capital as of March 31, 1998.
4. DEBT OBLIGATIONS
In February 1998, the Company issued aggregate principal amount $105.0
million of 9.875% senior notes due in 2005 (the "Notes Offering" and together
with the Stock Offering, the "Offerings"). Net proceeds from the Notes Offering
were approximately $100.5 million. Approximately $19.6 million of the net
proceeds was placed in escrow for the first four semiannual interest payments,
commencing August 15, 1998.
As a result of the completion of the Stock Offering, the interest rate on
the $144.8 million aggregate principal amount of senior subordinated convertible
bonds issued in July 1997 (the "Bonds") will remain at 8.75% until maturity and
the approximately $5.1 million of the 6.25% additional interest that was
previously accrued through the date of the Stock Offering has been reflected as
an increase to additional paid-in capital. Upon completion of the Stock
Offering, the Bonds became convertible into 7.2 million common shares at a
conversion price of $20.00 per share. In March 1998, $6.4 million of the
outstanding Bonds was converted into 0.3 million shares of the Company's
common stock.
In 1996, the Company entered into long-term obligations ("Debt
Obligations") totaling $70.0 million with lenders that are affiliated with and
are considered related parties to the Company as a result of their ownership of
the Company's common stock. In February 1998, approximately $85.2 million of the
net proceeds of the Offerings was used to repay the Debt Obligations of $70.0
million plus accrued interest that were due March 31, 2001. In addition, the
unamortized discount costs and debt issuance costs on the Debt Obligations were
written off at the time of repayment, resulting in the Company recording an
extraordinary loss of $12.7 million.
5. OTHER TRANSACTIONS
In March 1998, the Company purchased an additional 10.3% interest in Hermes
Europe Railtel B.V. ("HER") from an existing shareholder of HER for ECU 13.5
million (approximately $14.6 million). As a result of the purchase, the Company
owns approximately 89.4% of HER. The purchase price has been allocated to the
net assets based on the fair value at the date of acquisition. The excess
purchase price over the fair value of the net assets acquired was $10.2 million,
which has been recorded as goodwill and is being amortized on a straight-line
basis over five years.
Pursuant to a purchase agreement that the Company has with a venture's
partner, the Company was obligated to issue 336,630 shares of common stock to
the partner, based on the venture's 1997 earnings performance. These shares were
issued to the partner in April 1998 and the obligation of $13.5 million, based
on the share price of the common stock on the date of issuance, has been
reflected in "Other current liabilities" on the balance sheet as of March 31,
1998.
8
<PAGE> 312
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In February 1998, the Company acquired the remaining 33% interest in Sovam
Teleport from its minority partner and as a result in 1998 Sovam is accounted
for by the consolidation as opposed to the equity method of accounting. The
Company paid a nominal amount for the additional interest.
6. SUPPLEMENTAL CASH FLOW INFORMATION
The following table summarizes non-cash investing and financing activities
for the Company:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1998
------------------
(IN THOUSANDS)
<S> <C>
Capitalization of leases.................................... $26,864
Accrual for additional consideration in relation to purchase
of a venture.............................................. 13,549
Reclassification of common stock subject to repurchase...... 12,489
Conversion of the Bonds into common stock................... 6,350
Reclassification of accrued interest on the Bonds........... 5,052
</TABLE>
No significant non-cash activities were incurred for the three months ended
March 31, 1997.
7. SUBSEQUENT EVENTS
In April 1998, $16.3 million of the Bonds were converted into 0.8 million
common shares of the Company's common stock.
Subsequent to March 31, 1998, HER entered into contractual commitments to
lease fiber pairs, including facilities and maintenance and utilize the partial
routes for laying fiber optic cable. Based on the contract provisions, these
commitments are currently estimated to aggregate approximately $22.5 million.
The commitments have expected lease terms of ten to twenty-one years with
options for renewal rights of one and one-half to five additional years.
9
<PAGE> 313
ITEM 1B. FINANCIAL STATEMENTS OF EDN SOVINTEL
Condensed Balance Sheets As of December 31, 1997 and March 31, 1998
Condensed Statements of Operations For the Three Months Ended March 31,
1997 and 1998
Condensed Statements of Cash Flows For the Three Months Ended March 31,
1997 and 1998
Notes to Condensed Financial Statements
10
<PAGE> 314
EDN SOVINTEL
CONDENSED BALANCE SHEETS
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1997 1998
------------ ---------
(IN THOUSANDS)
<S> <C> <C>
Current assets
Cash and cash equivalents................................. $ 5,620 $ 6,956
Accounts receivable, less allowance for doubtful accounts
of $643 and $800 at December 31, 1997 and March 31,
1998................................................... 16,223 19,766
Restricted cash........................................... 485 474
Due from affiliated companies............................. 1,586 2,267
Inventory................................................. 1,697 1,697
Deferred tax asset........................................ 186 186
Prepaid expenses and other assets......................... 5,318 7,303
------- -------
Total current assets.............................. 31,115 38,649
Property and equipment, net of accumulated depreciation of
$14,557 and $16,026 at December 31, 1997 and March 31,
1998...................................................... 38,709 40,741
Deferred expenses........................................... 945 912
------- -------
TOTAL ASSETS...................................... $70,769 $80,302
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable.......................................... $ 5,725 $ 6,543
Accrued expenses.......................................... 3,194 2,969
Due to affiliated companies............................... 10,104 12,478
Note payable to shareholder............................... 39 --
Taxes and other liabilities............................... 2,438 4,698
------- -------
TOTAL LIABILITIES................................. 21,500 26,688
Commitments and contingencies
SHAREHOLDERS' EQUITY
Contributed capital......................................... 2,000 2,000
Retained earnings........................................... 47,269 51,614
------- -------
TOTAL SHAREHOLDERS' EQUITY........................ 49,269 53,614
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $70,769 $80,302
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
11
<PAGE> 315
EDN SOVINTEL
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------
1997 1998
------- -------
(IN THOUSANDS)
<S> <C> <C>
REVENUES, NET:.............................................. $25,162 $32,404
COST OF REVENUES:........................................... 14,763 21,957
------- -------
Gross margin................................................ 10,399 10,447
OPERATING EXPENSES:
Selling, general and administrative....................... 2,696 3,027
Depreciation and amortization............................. 160 177
Non-income taxes.......................................... 999 1,442
------- -------
Total operating expenses.......................... 3,855 4,646
Income from operations...................................... 6,544 5,801
OTHER (EXPENSE) INCOME:
Interest income........................................... 55 37
Interest expense.......................................... (159) --
Foreign currency losses................................... (38) (220)
------- -------
(142) (183)
Net income before taxes..................................... 6,402 5,618
Income taxes................................................ 1,708 1,273
------- -------
Net income........................................ $ 4,694 $ 4,345
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
12
<PAGE> 316
EDN SOVINTEL
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------
1997 1998
------- -------
(IN THOUSANDS)
<S> <C> <C>
OPERATING ACTIVITIES
Net income.................................................. $ 4,694 $ 4,345
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................. 1,113 1,501
Provision for doubtful accounts........................... 152 157
Changes in assets and liabilities:
Accounts receivable.................................... (4,616) (3,700)
Inventory.............................................. 293 --
Prepaid expenses and other assets...................... (600) (1,985)
Accounts payable and accrued expenses.................. 1,686 2,853
------- -------
Net cash provided by operating activities......... 2,722 3,171
INVESTING ACTIVITIES
Purchases of property and equipment....................... (3,541) (3,500)
Restricted cash........................................... (31) 11
------- -------
Net cash used in investing activities............. (3,572) (3,489)
FINANCING ACTIVITIES
Borrowing on (repayment of) shareholder note, net......... 204 (39)
Due to affiliated companies, net.......................... (961) 1,693
------- -------
Net cash (used in) provided by financing activities......... (757) 1,654
------- -------
Net (decrease) increase in cash and cash equivalents........ (1,607) 1,336
Cash and cash equivalents at beginning of period............ 3,606 5,620
------- -------
Cash and cash equivalents at end of period.................. $ 1,999 $ 6,956
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
13
<PAGE> 317
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, 1997 and March 31, 1998, and the
results of operations and cash flows for the periods indicated.
The Company was established as a competitive local exchange carrier (CLEC)
in August 1990. Through the design, construction, and operation of a
telecommunications network in Moscow, the Company provides its customers,
principally major hotels, business offices and mobile communications companies,
with an alternative to the local telephone company for worldwide communications
services. 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 May 1, 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 Soviet-American joint venture. The
venture re-registered as a Russian limited liability partnership in November
1992. The Company is 50% owned by Open Joint Stock Company "Rostelecom," an
intercity and long-distance carrier which is 38% owned by Svyazinvest, and 50%
owned by Sovinet, a US general partnership, owned by two wholly-owned Global
TeleSystems Group, Inc. ("GTS") subsidiaries.
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 1997 audited financial statements and the notes related thereto. The
results of operations for the three months ended March 31, 1998 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 statutory 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 certain
accrued revenue and expenses, foreign currency translation, deferred taxation,
and depreciation and valuation of property and equipment. 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.
2. POLICIES AND PROCEDURES
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 130, "Reporting Comprehensive Income," which establishes
standards for reporting and display of comprehensive income and its components
in a full set of general purpose financial statements. Comprehensive income is
defined as the change in equity of a business enterprise during a period from
nonowner sources. For the three months ended March 31, 1997 and 1998,
comprehensive income for the Company is equal to net income.
14
<PAGE> 318
EDN SOVINTEL
NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
3. CONTINGENCIES
Legislation and regulations regarding taxation, foreign currency
transactions and licensing of foreign currency loans in the Russian Federation
continues to evolve as the central government manages the transformation from a
command to a market-oriented economy. The various legislation and regulations
are not always clearly written and their interpretation is subject to the
opinions of the tax inspectors, Central Bank officials and the Ministry of
Finance. Instances of inconsistent opinions between local, regional and national
tax authorities and between the Central Bank and Ministry of Finance are not
unusual.
The Company believes that it has paid or accrued all taxes that are
applicable. Where practice concerning the provision of taxes is unclear, the
Company has accrued tax liabilities based on management's best estimate. 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.
Because of the uncertainties associated with the Russian tax and legal
systems, the ultimate amount of taxes, penalties and interest, if any, assessed
may be in excess of the amount expensed to date and accrued at December 31, 1997
and March 31, 1998.
The Company's operations and financial position will continue to be
affected by Russian political developments, including the application of
existing and future legislation and tax regulations. The Company does not
believe that these contingencies, as related to its operations, are any more
significant than those of similar enterprises in Russia.
15
<PAGE> 319
ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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, Central Europe and Asia. In Western 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.
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
16
<PAGE> 320
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 minority
shareholder rights, 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 March 31, 1998, $5.3
million and $8.9 million represent 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 issuance of $265 million aggregate
principal amount of senior notes (of which $56.6 million was placed in escrow
for the first two years' interest payments) in August 1997, the Company 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.
17
<PAGE> 321
The following table summarizes the accounting methodology for the principal
business ventures through which the Company conducts its business.
<TABLE>
<CAPTION>
COUNTRY/REGION EFFECTIVE GTS ACCOUNTING
COMPANY NAME OF OPERATIONS OWNERSHIP METHODOLOGY
- ------------ -------------- ------------- -----------
<S> <C> <C> <C>
CIS
Sovintel................................ Russia 50% Equity
TCM..................................... Russia 50%(1) Equity
TeleRoss Operating Company.............. Russia 100%(2) Consolidated
TeleRoss Ventures....................... Russia 50%(3) Equity
Sovam................................... Russia 100%(4) Consolidated(4)
GTS Cellular............................ CIS 25%-70%(5) Equity
Western Europe
HER..................................... Western Europe 89%(6) Consolidated(6)
GTS-Monaco Access....................... Monaco 50% Equity
Central Europe
GTS-Hungary............................. Hungary 99% Consolidated
EuroHivo................................ Hungary 70%(7) 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 Company is currently engaged in negotiations to purchase the remaining
minority ownership interest in GTS-Vox Limited. If such purchase is
consummated the Company would have a 95% interest in TCM.
(2) The TeleRoss Operating Company is comprised of a wholly-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. To date, 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.
(3) TeleRoss Ventures is comprised of fourteen 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."
(4) GTS purchased the remaining 33% interest in Sovam in February 1998 and as a
result Sovam is now accounted for by the consolidation as opposed to the
equity method of accounting.
(5) GTS conducts its cellular operations through (i) Vostok Mobile, a wholly
owned GTS venture that owns between 50% and 70% of a series of twelve
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. The Company
is currently engaged in negotiations to restructure the capital and
ownership of Bancomsvyaz.
(6) As of July 16, 1997, HER is accounted for by the consolidation as opposed to
the equity method of accounting. In addition, in March 1998, GTS acquired an
additional 10% interest in HER.
(7) The Company has reached a definitive agreement to sell its ownership
interest in EuroHivo. The closing of this transaction is conditioned upon
the regulatory approval of the share transfer and customary conditions
precedent. The Company does not anticipate that the closing of this
transaction will have a material effect on the Company's results from
operations and financial condition.
18
<PAGE> 322
RESULTS OF OPERATIONS -- CONSOLIDATED VENTURES
Management's discussion included within "-- Results of
Operations -- Consolidated Ventures" reflects the following significant
operating ventures: TeleRoss Operating Company, Sovam, GTS-Hungary, the Czech
Companies and HER. Although the Company was not able to follow consolidation
method of accounting for Sovam and HER in the three months ended March 31, 1997,
the Company has included, for comparative purposes, a discussion of their
financial performance for the three months ended March 31, 1997 in our
discussion of "Results of Operations -- Consolidated Ventures." See "Results of
Operations -- Non-Consolidated Ventures(Equity Investees)" for a discussion of
the operating results of Sovintel, TCM, TeleRoss Ventures, GTS Cellular and
GTS-Monaco Access.
Revenue. The Company's consolidated revenue was $22.8 million and $8.4
million for the three months ended March 31, 1998 and 1997, respectively. The
$14.4 million growth in revenue was primarily attributable to the inclusion of
Sovam and HER in the Company's consolidated financial results, with Sovam and
HER contributing $5.9 million and $4.7 million in revenue, respectively. The
remaining revenue growth was attributable to the TeleRoss Operating Company, as
its revenue increased $2.7 million year over year.
The CIS region's consolidated revenue was $13.8 million and $5.2 million
for the three months ended March 31, 1998 and 1997, respectively. TeleRoss
Operating Company generated revenue of $7.1 million and $4.4 million,
representing 51.4% and 84.6% of the region's consolidated revenue for the three
months ended March 31, 1998 and 1997, respectively. The growth in the TeleRoss
Operating Company revenue from March 1997 to March 1998 was the result of the
increase in traffic volume generated by the TeleRoss Ventures due the increase
in the number of cities and number of VSAT's installed at customer locations
outside of cities in which they have a presence. Sovam generated revenue of $5.9
million and $3.7 million for the three months ended March 31, 1998 and 1997
(Sovam was an equity method company in 1997), respectively. The growth in Sovam
revenue is primarily attributable to the expansion of Sovam's network throughout
Russia and the CIS and the wider variety of service offerings.
HER generated $4.7 million of revenue in the three months ended March 31,
1998, compared to $0.2 million in the same period in 1997 (HER was an equity
method company prior to July 1997). The growth in revenue is attributable to the
deployment of the network; i.e. the Brussels-Amsterdam route generated revenue
in 1997 whereas the Brussels-Amsterdam-London-Paris route generated revenue in
1998.
The Central Europe region's consolidated revenue was $3.9 million in the
three months ended March 31, 1998, compared to $2.8 million in the same period
of 1997. The Company's operations in both Hungary and the Czech Republic
experienced year over year revenue growth of 39.3%. This growth is attributable
the expansion of the customer base and product offerings of these businesses.
Gross Margin. GTS's consolidated gross margin was $3.8 million, or 16.7% of
revenue, for the three months ended March 31, 1998 and $2.0 million, or 23.8% of
revenue, for the three months ended March 31, 1997.
Sovam contributed $2.8 million to consolidated gross margin for the three
months ended March 31, 1998. For comparative purposes, Sovam had a gross margin
of $1.3 million for three months ended March 31, 1997 (Sovam was an equity
method company in 1997). Sovam had gross margin as a percentage of revenues of
47.5% and 35.1%, for the three months ended March 31, 1998 and 1997,
respectively. The increase in gross margin, both amount and as a percentage of
revenue, reflects the higher margin service offerings that Sovam is currently
providing and also management's focus to improve its cost structure; i.e. the
negotiation of improved channel costs from suppliers and controlled growth in
both personnel and capital expenditures. The TeleRoss Operating Company
contributed gross margin of $1.0 million and $1.5 million for the three months
ended March 31, 1998 and 1997, respectively, or 14.1% and 34.1% of TeleRoss
Operating Company revenue for the respective periods. The decrease in margin,
both amount and as a percentage of revenue, reflects the high fixed cost
component of its network hub in Moscow. The Central European region contributed
$1.3 million to gross margin in both the three months ended March 31, 1998 and
March 31, 1997, respectively, or 33.3% and 44.8% of Central European revenue for
the respective periods. The decrease in gross margin as a percentage of revenue
primarily reflects the startup activities of the GTS Net product offering in
Hungary. HER had an
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<PAGE> 323
unfavorable effect on consolidated gross margins of $(1.4) million for the three
months ended March 31, 1998. For comparative purposes, HER had an unfavorable
gross margin of $(1.2) million for three months ended March 31, 1997 (HER was an
equity method company prior to July 1997.)
Operating Expenses. Consolidated operating costs were $22.7 million and
$13.0 million for the three months ended March 31, 1998 and 1997, respectively.
The increase in operating costs is attributable to the inclusion of HER and
Sovam in the Company's consolidated financial results, the growth in
expenditures associated with building business infrastructure for primarily the
TeleRoss Operating Company and costs attributable to increasing the corporate
staff.
Equity in (Losses)/Earnings of Ventures. GTS recognized earnings of $3.4
million for its investments in non-consolidated ventures in the three months
ended March 31, 1998 as compared to recognizing losses of $3.4 million in the
same period a year ago. This improvement was primarily the result of HER no
longer being an equity method investee and TCM's year over year net income
improvement. Included in the March 31, 1998 results were $0.1 million of
additional earnings associated with our recovery of prior period excess losses
recognized. Included in the March 31, 1997 results were $2.7 million of
additional losses as a result of the application of the Company's previously
discussed profit and loss accounting. Sovintel and TCM generated combined
earnings of $4.1 million and $3.9 million for the three months ended March 31,
1998 and 1997, respectively, which offset the losses generated by other ventures
that are in the early stages of operations. See "Results of
Operations -- Non-Consolidated Ventures (Equity Investees) for a discussion of
the results of operations of the Company's significant equity investees.
Interest, Net. GTS incurred interest expense of $16.5 million and $3.7
million for the three months ended March 31, 1998 and 1997, respectively. The
significant increase in interest expense was due to the $409.8 million increase
in debt raised in 1997. See " -- Liquidity and Capital Resources."
GTS earned interest income of $7.1 million and $1.3 million for the three
months ended March 31, 1998 and 1997, respectively, primarily as a result of
investing the proceeds from the Company's 1997 and 1998 capital raising efforts.
See "-- Liquidity and Capital Resources."
Provision for Income Taxes. The Company's consolidated tax provision was
$0.6 million and $0.4 million for the three months ended March 31, 1998 and
1997, respectively. 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 non-U.S. loss carryforwards
will be allowed, in part or in full, by local tax authorities against future
income.
Extraordinary Loss. The Company recognized a $12.7 million extraordinary
charge to earnings in the three months ended March 31, 1998, as a result of the
Company's early extinguishment of certain related party debt obligations. The
nature of the charge is comprised of the write-off of $11.6 million of
unamortized debt discount and $1.1 million of unamortized debt issuance costs
that were deferred as financing costs and were being amortized over the original
maturity of the debt.
RESULTS OF OPERATIONS -- NON-CONSOLIDATED VENTURES (EQUITY INVESTEES)
Russia -- CIS
Sovintel. Sovintel's revenue for the three months ended March 31, 1998 and
1997 was $32.4 million and $25.2 million, respectively. The increase in revenue
was primarily the result of telecommunications service revenue, which increased
to $23.8 million for the three months ended March 31, 1998 from $19.1 million
for the three months ended March 31, 1997, 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. Sovintel
realized a 91% increase in outgoing international and domestic minutes in the
three months ended March 31, 1998, as compared with the same period a year-ago.
Revenue from incoming international minutes decreased slightly to $2.5 million
for the three months ended March 31, 1998, from $2.7 million for the three
months ended March 31, 1997.
20
<PAGE> 324
Sovintel's non-traffic-related revenue of $8.6 million and $6.1 million for
the three months ended March 31, 1998 and 1997, respectively, was primarily
attributable to port sales and monthly port fees revenue.
Sovintel's gross margin was $10.4 million in both the three months ended
March 31, 1998 and 1997, respectively, or 32.1% and 41.3% of revenue for the
respective periods. The decrease in gross margin as a percentage of revenue was
attributable to a general price decrease in international and domestic revenue
due to competitive pressures and a higher percentage of domestic minutes, which
yield a lower margin.
Operating expenses were $4.6 million and $3.9 million, or 14.2% and 15.5%
of total revenue, for the three months ended March 31, 1998 and 1997,
respectively. The increase in operating expenses was related to increases 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 $1.3 million and $1.7 million for the three months
ended March 31, 1998 and 1997, respectively. The increase in income tax expense
was attributable to Sovintel's profitable operations.
TCM. TCM's revenue was $9.5 million and $6.3 million for the three months
ended March 31, 1998 and 1997, respectively. TCM had a gross margin of $6.9
million and $4.8 million, or 72.6% and 76.2% of total revenue. The decrease in
gross margin as a percentage of revenue was attributable to higher
infrastructure and settlement costs. TCM had operating expenses of $0.9 million
and $0.6 million, or 9.5% and 9.5% of total revenue, for the three months ended
March 31, 1998 and 1997, respectively.
TeleRoss Ventures. Revenue for the TeleRoss Ventures for the three months
ended March 31, 1998 and 1997 was $2.4 million and $1.5 million, respectively.
Revenues resulted from settlement fees charged to TeleRoss Operating Company.
The growth in revenue reflects the growth of the customer base.
Gross margin for the three months ended March 31, 1998 and 1997 was $1.7
million and $1.2 million, respectively. Operating expenses of $1.0 million and
$0.6 million were incurred for the three months ended March 31, 1998 and 1997,
respectively.
GTS Cellular. The Company operates three cellular networks through
differing ownership structures: Vostok Mobile, PrimTelefone and Bancomsvyaz.
Revenue for Vostok Mobile was $7.3 million and $5.0 million for the three
months ended March 31, 1998 and 1997, respectively. Vostok Mobile's gross margin
was $3.7 million and $2.8 million, or 50.7% and 56.0% of total revenue, and
operating expenses were $2.6 million and $2.1 million for the three months ended
March 31, 1998 and 1997, respectively.
Revenue for PrimTelefone was $3.7 million and $2.5 million for the three
months ended March 31, 1998 and 1997, respectively. PrimTelefone's gross margin
was $2.1 million and $1.7 million, or 56.8% and 68.0% of total revenue, and
operating expenses were $1.1 million and $0.6 million for the three months ended
March 31, 1998 and 1997, respectively.
Revenue for Bancomsvyaz was $4.2 million and $0.6 million for the three
months ended March 31, 1998 and 1997, respectively. Bancomsvyaz's gross margin
was $2.4 million and $(0.04) million, or 57.1% and (6.7)% of total revenue, and
operating expenses were $1.8 million and $1.0 million for the three months ended
March 31, 1998 and 1997, respectively.
Western Europe
GTS-Monaco Access: Total revenue was $4.5 million and $1.9 million and
gross margin was $0.2 million and $0.02 million for the three months ended March
31, 1998 and 1997, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Company
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,
21
<PAGE> 325
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 $238.7 million, $36.4 million, $107.7 million, $42.1 million and $62.1
million in 1998, 1997, 1996, 1995 and 1994, respectively, net of placement fees,
for a total of $487.0 million. In addition, the Company and HER received $105.0
million, $409.8 million, $60.0 million and $23.3 million in 1998, 1997, 1996 and
1995, respectively, for a total of $598.1 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 $474.5 million and $23.0 million as of
March 31, 1998 and 1997, respectively. The Company had an accumulated deficit of
$280.1 million as of March 31, 1998, including net losses of approximately $37.2
million and $17.7 million for the three months ended March 31, 1998 and 1997,
respectively. During 1998, 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 $510.0 million of capital expenditures and investments
in ventures during the next three years, of which approximately $171.0 million
is expected to be incurred in the remaining three quarters of 1998. The Company
obtained funds in 1998 through a variety of financing arrangements, including
(i) the Company raised approximately $255.3 million in gross proceeds from an
initial public stock offering of 12.8 million common shares at $20.00 per share,
and (ii) the Company issued $105.0 million in gross proceeds of 9 7/8% senior
notes due February 15, 2005, of which $19.6 million was placed in escrow to fund
the first two years' interest payments ("9 7/8% Notes"). The initial public
offering constituted a "complying public equity offering" under the Company's
Convertible Bonds. As a result, the conversion price of the Convertible Bonds is
$20 per share. The Company believes that its existing cash balances will be
sufficient to fund its expected capital needs under its current business plan,
excluding any funds expended in connection with the potential implementation of
the Company's business plan with regard to its European Services Strategy. See
"European Services Strategy." The amount and timing of the Company's future
capital requirements, however, may differ materially from management's estimates
and, therefore, GTS may require additional capital to operate 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.
The actual amount and timing of the Company's future capital requirements
may differ materially from management's estimates. In particular, the accuracy
of management's estimates is 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
22
<PAGE> 326
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 Convertible
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 will need to raise
additional capital.
There can be no assurance 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. Through March 31,
1998, approximately $64.7 million has been spent on network capital expenditure.
In August 1997, HER completed the issuance of $265.0 million in gross proceeds
of 11 1/2% Senior Notes due in August 2007 ("11 1/2% Senior Notes). The 11 1/2%
Senior Notes are general unsecured obligations of HER. The Company believes that
the net proceeds of the 11 1/2% Senior Notes, combined with HER's projected
internally generated funds, should be sufficient to fund HER's expected capital
expenditures. However, the actual amount and timing of HER's future requirements
may differ materially from management's estimates. 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.
European Services Strategy
In order to capitalize on the increasing liberalization of
telecommunications regulation in Europe, GTS intends to offer, through one or
more subsidiaries, facilities-based telecommunications products and services
primarily to business and other high-usage customers in certain metropolitan
markets throughout Europe (the "European Services Strategy"). GTS presently
provides end user services in Russia, the CIS and Central Europe and carriers'
carrier services in Western Europe and has experience in developing cross-border
networks in Western Europe through HER. Management has developed a business plan
for the Company's European Services Strategy that calls for the Company to
leverage its experience in developing and operating local, national and
international telecommunications networks by building or acquiring networks and
establishing competitive local exchange carrier service capabilities in up to 12
metropolitan markets throughout Europe, as regulatory conditions permit.
Currently the regulatory regimes in Europe vary from country to country and some
countries do not permit competitive local exchange carriers to operate.
The aforementioned discussion of capital requirements does not include any
capital spending that will be required for the implementation of the Company's
European Services Strategy. Due to the preliminary nature of the Company's
business plan for such strategy, the Company cannot estimate with any degree of
certainty the amount and timing of the Company's future capital requirements for
such implementation, which will be dependent on many factors, including the
success of the Company's European services business, the rate at which the
Company expands its networks and develops new networks, the types of services
the Company offers, staffing levels, acquisitions and customer growth, as well
as other factors that are not within the Company's control, including
competitive conditions, regulatory developments and capital costs. Management
believes, however, that if the European Services Strategy is implemented it is
likely that the Company will need to raise additional capital above that being
raised in the offerings of $300.0 million of Common Stock and
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<PAGE> 327
$400.0 million aggregate principal amount of senior convertible debentures,
which offerings the Company registered with the Securities and Exchange
Commission on May 15, 1998.
Many of GTS's planned service offerings under its European Services
Strategy will compete with the services offered by customers that HER targets as
an independent carrier's carrier. To the extent that GTS's other subsidiaries
offering the new services discussed above contract with HER for capacity, GTS
expects that such arrangements will be entered into on an arms' length basis.
However, GTS's European Services Strategy could affect the perception of HER as
an independent operator and could negatively impact HER's ability to attract and
retain customers which could, in turn, have an adverse effect on the Company's
financial condition and results of operations.
LIQUIDITY ANALYSIS
The Company had cash and cash equivalents of $507.9 million and $30.7
million as of March 31, 1998 and 1997, respectively. The Company had restricted
cash of $77.2 million and $1.5 million as of March 31, 1998 and 1997,
respectively. The restricted cash at March 31, 1998 primarily represents amounts
held in escrow to pay the first two years interest payments on the $105.0
million of the 9 7/8% Notes and $265.0 million of the 11 1/2% Senior Notes.
During the three months ended March 31, 1998 and 1997, the Company used
$27.4 million and $13.4 million, respectively, of cash for operating activities.
Cash used for investing activities was $37.0 million and $11.6 million for the
three months ended March 31, 1998 and 1997, respectively. Included in the cash
used for investing activities for the three months ended March 31, 1998 is $10.2
million to acquire an additional 10.3% interest in HER. 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. 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.
In February 1998, as contemplated by the Company, as contemplated by
approximately $85.2 million of the net proceeds from the initial public offering
and the 9 7/8% Notes were applied by the Company to repay $70.0 million plus
accrued interest of debt 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.
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 Florint, Belgium Franc and the European Currency Equivalent. 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 is attempting 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 has developed risk management policies that establish
guidelines for managing foreign exchange risk. The Company is currently
evaluating the materiality of foreign exchange exposures in different countries
and the financial instruments available to mitigate this exposure. The Company's
ability to hedge its exposure is limited since certain of its operations are
located in countries whose currencies are not easily convertible. Financial
hedge instruments for these countries are nonexistent or limited and also
pricing of these instruments is often volatile and not always efficient. The
Company is designing reporting processes to
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<PAGE> 328
monitor the potential exposure on an ongoing basis and expects to implement this
process before the end of 1998. The Company will use the output of this process
to execute financial hedges to cover foreign exchange exposure when practical
and economically justified.
In April 1998, the Company consummated a transaction to hedge the foreign
exchange exposure resulting from the issuance of the 11 1/2% Senior Notes by
HER.
YEAR 2000 COMPLIANCE
The Company is currently in the process of assessing its year 2000
compliance costs and of converting, where necessary, 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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<PAGE> 329
SUPPLEMENTAL INFORMATION -- SELECTED HISTORICAL
FINANCIAL DATA -- COMBINED EQUITY INVESTMENTS
The following unaudited selected historical financial data -- equity
investments for the three months ended March 31, 1997 and March 31, 1998, are
derived from the Company's financial records. It is intended to supplement the
unaudited condensed consolidated financial statements. 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 of
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>
NET
OWNERSHIP COST OF OPERATING INCOME/
INTEREST(1) REVENUES REVENUES EXPENSES (LOSS)
----------- -------- -------- --------- -------
<S> <C> <C> <C> <C> <C>
THREE MONTHS ENDED MARCH 31, 1997
Sovintel................................ 50% $25,162 $14,763 $ 3,855 $ 4,695
TCM..................................... 50% 6,326 1,535 600 2,910
TeleRoss................................ 50% 1,529 284 674 515
Sovam................................... 66.7% 3,703 2,388 1,359 (118)
GTS Cellular Companies.................. 50%(2) 8,045 3,665 3,590 (877)
Other................................... 50%(2) 3,261 4,186 4,067 (5,159)
------- ------- ------- -------
Total........................... $48,026 $26,821 $14,145 $ 1,966
Adjustments for Inter-Affiliate
Transactions(3)......................... (5,933) (4,760) (2,875)
THREE MONTHS ENDED MARCH 31, 1998(4)
Sovintel................................ 50% $32,404 $21,957 4,646 $ 4,345
TCM..................................... 50% 9,456 2,578 852 3,847
TeleRoss................................ 50% 2,392 717 978 325
GTS Cellular Companies.................. 50%(2) 14,905 6,775 5,192 1,415
Other................................... 50%(2) 4,526 4,360 1,124 (947)
------- ------- ------- -------
Total........................... $63,683 $36,387 $12,792 $ 8,985
Adjustments for Inter-Affiliate
Transactions(3)......................... (8,890) (8,105) 4,158
</TABLE>
- ---------------
(1) 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.
(2) The Company generally maintains a 50% ownership interest in these equity
investments.
(3) 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."
(4) As a result of the Company's purchase of the minority partner's 33.3%
interest in Sovam during the first quarter of 1998, the Company accounts for
its ownership interest in Sovam under the consolidation method of
accounting. Prior to this date, the Company accounted for Sovam under the
equity method of accounting.
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<PAGE> 330
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(d) In February 1998, the Company completed the sale of 12.8 million shares
of Common Stock at a per share price of $20.00 in an initial public offering
("Offering") pursuant to a Registration Statement on Form S-1 (Registration No.
333-36555), which was declared effective on February 5, 1998. The shares of
Common Stock were sold by several U.S. and international underwriters and the
Global Coordinator was Merrill Lynch & Co. with UBS Securities in a Co-Global
Coordinator role. Of the $255.3 million in gross proceeds, including $33.3
million attributable to the sale of shares resulting from the exercise by the
underwriters of an over-allotment option, the Company paid $16.6 million to the
underwriters in connection with underwriting discounts and $3.1 million was paid
by the Company in connection with expenses, including legal, printing and filing
fees, in connection with the offering.
The remaining net proceeds of $235.6 million have been invested by the
Company for future use as additional working capital. Concurrent with the
Offering, the Company issued $105.0 million of senior notes, net proceeds of
$100.5 million, that was principally used to extinguish shareholder debt of
approximately $85.2 million. Accordingly, there were no direct or indirect
payments to directors or officers of the Company or to any person or entity and
none of the proceeds from the Offering have been used for the repayment of
indebtedness.
ITEM 5. OTHER INFORMATION
As described in "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources -- The
Company -- European Services Strategy," in May 1998, the Company filed
registration statements with the Securities and Exchange Commission to offer to
sell concurrently $300 million of its common stock (with an overallotment option
of up to $75 million in additional shares) and $400 aggregate principal amount
of its convertible senior debentures (with an overallotment option of up to $60
million in additional debentures). The common stock offering may include a
secondary offering of $200 million of common shares owned by existing
shareholders.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<S> <C>
27 -- Financial Data Schedule
</TABLE>
B. Reports on Form 8-K
<TABLE>
<CAPTION>
DATE OF REPORT SUBJECT OF REPORT
-------------- -----------------
<S> <C>
None
</TABLE>
27
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrants have duly caused this report to be signed on their behalf by the
undersigned thereunto duly authorized.
GLOBAL TELESYSTEMS GROUP, INC.
(Registrant)
By: /s/ WILLIAM H. SEIPPEL
----------------------------------
Name: William H. Seippel
Title: Executive Vice President
and
Chief Financial Officer
(Principal
Financial and Accounting
Officer)
Date: May 15, 1998
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<PAGE> 332
ANNEX D
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
(COMMISSION FILE NUMBER: )
GLOBAL TELESYSTEMS GROUP, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 94-3068423
(State of incorporation) (I.R.S. Employer Identification No.)
</TABLE>
1751 PINNACLE DRIVE, NORTH TOWER, 12TH FLOOR
MCLEAN, VIRGINIA 22102
(Address of principal executive office)
(703) 918-4500
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
At July 31, 1998, there were outstanding 60,297,763 shares of common stock
of the registrant.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 333
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I. Financial Information
Item 1A Financial Statements of Global TeleSystems Group, Inc....... 3
Condensed Consolidated Balance Sheets as of December 31,
1997 and June 30, 1998.................................... 4
Condensed Consolidated Statements of Operations for the
Three and Six Months Ended June 30, 1997 and 1998......... 5
Condensed Consolidated Statements of Cash Flows for the
Three and Six Months Ended June 30, 1997 and 1998......... 6
Notes to Condensed Consolidated Financial Statements........ 7
Item 1B Financial Statements of EDN Sovintel........................ 11
Condensed Balance Sheets as of December 31, 1997 and June
30, 1998.................................................. 12
Condensed Statements of Operations for the Three and Six
Months Ended June 30, 1997 and 1998....................... 13
Condensed Statements of Cash Flows for the Three and Six
Months Ended June 30, 1997 and 1998....................... 14
Notes to Condensed Financial Statements..................... 15
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 17
PART II. Other Information
Item 2 Changes in Securities and Use of Proceeds................... 30
Item 4 Submission of Matters to a Vote of Security Holders......... 30
Item 5 Other Information........................................... 30
Item 6 Exhibits and Reports on Form 8-K............................ 30
Signatures............................................................ 31
</TABLE>
2
<PAGE> 334
PART I. FINANCIAL INFORMATION
ITEM 1A. FINANCIAL STATEMENTS OF GLOBAL TELESYSTEMS GROUP, INC.
Condensed Consolidated Balance Sheets as of December 31, 1997 and June 30,
1998
Condensed Consolidated Statements of Operations for the Three and Six Months
Ended June 30, 1997 and 1998
Condensed Consolidated Statements of Cash Flows for the Three and Six Months
Ended June 30, 1997 and 1998
Notes to Condensed Consolidated Financial Statements
3
<PAGE> 335
GLOBAL TELESYSTEMS GROUP, INC.
CONDENSED, CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1997 1998
--------------- -------------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents................................. $ 318,766 $ 477,996
Accounts receivable, net.................................. 17,079 50,228
Restricted cash........................................... 30,486 44,783
Prepaid expenses.......................................... 14,101 19,293
Other assets.............................................. 6,707 13,291
--------- ----------
TOTAL CURRENT ASSETS.............................. 387,139 605,591
Property and equipment, net................................. 236,897 330,847
Investments in and advances to ventures..................... 76,730 76,885
Goodwill and intangible assets, net......................... 43,284 82,693
Restricted cash............................................. 36,411 38,094
--------- ----------
TOTAL ASSETS...................................... $ 780,461 $1,134,110
========= ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses..................... $ 61,984 $ 101,835
Debt maturing within one year............................. 6,390 9,028
Current portion of capital lease obligations.............. 21,490 17,380
Related party debt maturing within one year............... 5,708 --
Other current liabilities................................. 6,301 21,466
--------- ----------
TOTAL CURRENT LIABILITIES......................... 101,873 149,709
Long-term debt, less current portion........................ 408,330 495,042
Long-term portion of capital lease obligations.............. 117,645 158,700
Related party long-term debt, less current portion.......... 79,796 3,530
Taxes and other non-current liabilities..................... 14,595 13,679
--------- ----------
TOTAL LIABILITIES................................. 722,239 820,660
COMMITMENTS AND CONTINGENCIES
Minority interest........................................... 18,766 39,466
Common stock, subject to repurchase (797,100 and 336,630
shares outstanding at December 31, 1997 and June 30, 1998,
respectively)............................................. 12,489 16,411
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; 37,606,814 and 57,241,716 shares issued and
outstanding, net of 195,528 and 603,929 shares of treasury
stock at December 31, 1997 and June 30, 1998,
respectively)............................................. 3,761 5,724
Additional paid-in capital.................................. 274,359 567,573
Accumulated other comprehensive loss........................ (8,269) (9,483)
Accumulated deficit......................................... (242,884) (306,241)
--------- ----------
TOTAL SHAREHOLDERS' EQUITY........................ 26,967 257,573
--------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $ 780,461 $1,134,110
========= ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE> 336
GLOBAL TELESYSTEMS GROUP, INC.
CONDENSED, CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
1997 1998 1997 1998
-------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
REVENUES, NET:
Telecommunication and other services............. $ 7,899 $ 28,998 $ 15,856 $ 49,790
Equipment sales.................................. 1,009 1,650 1,439 3,675
-------- -------- -------- --------
8,908 30,648 17,295 53,465
-------- -------- -------- --------
OPERATING COSTS AND EXPENSES:
Cost of revenues:
Telecommunication and other services.......... 6,258 23,013 11,808 40,480
Equipment sales............................... 281 1,182 1,155 2,738
Selling, general and administrative.............. 12,274 24,756 23,762 44,505
Depreciation and amortization.................... 1,080 3,390 2,326 5,585
Non-income taxes................................. 713 578 1,000 1,320
-------- -------- -------- --------
20,606 52,919 40,051 94,628
Equity in losses/(earnings) of ventures.......... 6,747 (4,215) 10,167 (7,627)
-------- -------- -------- --------
LOSS FROM OPERATIONS............................... (18,445) (18,056) (32,923) (33,536)
OTHER INCOME (EXPENSE):
Interest income.................................. 866 7,186 2,162 14,252
Interest expense................................. (3,495) (14,128) (7,163) (30,594)
Foreign currency losses.......................... (465) (1,637) (959) (3,031)
-------- -------- -------- --------
(3,094) (8,579) (5,960) (19,373)
-------- -------- -------- --------
Net loss before income taxes, minority interest and
extraordinary loss............................... (21,539) (26,635) (38,883) (52,909)
Income taxes....................................... 452 829 817 1,381
-------- -------- -------- --------
Net loss before minority interest and extraordinary
loss............................................. (21,991) (27,464) (39,700) (54,290)
Minority interest.................................. 37 1,284 13 3,637
-------- -------- -------- --------
Net loss before extraordinary loss................. (21,954) (26,180) (39,687) (50,653)
Extraordinary loss -- extinguishment of debt....... -- -- -- (12,704)
-------- -------- -------- --------
NET LOSS........................................... $(21,954) $(26,180) $(39,687) $(63,357)
======== ======== ======== ========
Loss per share before extraordinary loss........... $ (0.63) $ (0.48) $ (1.14) $ (1.02)
Extraordinary loss per share....................... -- -- -- (0.25)
-------- -------- -------- --------
Net loss per share................................. $ (0.63) $ (0.48) $ (1.14) $ (1.27)
======== ======== ======== ========
Weighted average common shares outstanding......... 35,093 54,028 34,899 49,789
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE> 337
GLOBAL TELESYSTEMS GROUP, INC.
CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
1997 1998 1997 1998
-------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss........................................... $(21,954) $(26,180) $(39,687) $(63,357)
ADJUSTMENTS TO RECONCILE NET LOSS TO NET CASH USED
IN OPERATING ACTIVITIES:
Extraordinary loss............................... -- -- -- 12,704
Depreciation and amortization.................... 2,354 9,334 4,478 16,484
Amortization of discount on note payable......... 1,220 -- 2,377 477
Equity in losses (earnings) of ventures, net of
dividends received............................ 6,747 (4,215) 10,167 (7,627)
Deferred interest................................ 2,063 190 3,869 1,826
Minority interest................................ (45) (1,284) (21) (7,845)
Other............................................ 329 3,141 584 2,905
Changes in assets and liabilities, excluding
effects of acquisitions and ventures:
Accounts receivable........................... (621) (18,971) (2,880) (21,133)
Prepaid expenses.............................. 185 (5,577) (618) (6,738)
Accounts payable and accrued expenses......... (1,476) 19,895 (3,324) 19,121
Other changes in assets and liabilities....... 1,303 16,381 1,803 18,510
-------- -------- -------- --------
NET CASH USED IN OPERATING ACTIVITIES.... (9,895) (7,286) (23,252) (34,673)
INVESTING ACTIVITIES
Investments in and advances to ventures, net of
repayments.................................... (2,453) 4,565 (12,873) 6,935
Purchases of property and equipment.............. (1,538) (25,454) (3,127) (39,842)
Restricted cash.................................. 77 (5,626) 315 (15,983)
Goodwill and other intangibles................... (1,636) (2,985) (1,428) (17,619)
Acquisitions -- cash acquired.................... -- 13,352 -- 13,352
-------- -------- -------- --------
NET CASH USED IN INVESTING ACTIVITIES.... (5,550) (16,148) (17,113) (53,157)
FINANCING ACTIVITIES
Proceeds from debt............................... 483 -- 483 105,300
Repayments of debt............................... -- (6,660) (175) (98,015)
Payment of debt issue costs...................... -- (1,286) -- (5,243)
Common stock repurchased for treasury............ (433) -- (433) --
Net proceeds from issuance of common stock....... -- -- -- 235,620
Other financing activities....................... 295 2,272 (99) 9,471
-------- -------- -------- --------
NET CASH (USED IN) PROVIDED BY FINANCING
ACTIVITIES............................. 345 (5,674) (224) 247,133
Effect of exchange rate changes on cash and cash
equivalents...................................... (1,006) (791) (2,698) (73)
-------- -------- -------- --------
Net (decrease) increase in cash and cash
equivalents...................................... (16,106) (29,899) (43,287) 159,230
Cash and cash equivalents at beginning of period... 30,693 507,895 57,874 318,766
-------- -------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD......... $ 14,587 $477,996 $ 14,587 $477,996
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE> 338
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. FINANCIAL PRESENTATION AND DISCLOSURES
The financial statements of Global TeleSystems Group, Inc. (the "Company"
or "GTS") included herein are unaudited and have been prepared in accordance
with generally accepted accounting principles for interim financial reporting
and in accordance with Securities and Exchange Commission regulations. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. Material
intercompany affiliate account transactions have been eliminated; however, other
adjustments may have been required had an audit been performed. In the opinion
of management, the financial statements reflect all adjustments of a normal and
recurring nature necessary to present fairly the Company's financial position,
results of operations and cash flows for the interim periods. These financial
statements should be read in conjunction with the Company's 1997 audited
consolidated financial statements and the notes related thereto. The results of
operations for the three and six months ended June 30, 1998 may not be
indicative of the operating results for the full year.
The Company's operations are carried out through alliances with strategic
local partners in the form of venture arrangements. Wholly-owned subsidiaries
and majority-owned ventures where the Company has unilateral operating and
financial control are consolidated within the Company's financial results and
operations. 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 investments
that are accounted for by the equity method as a result of minority shareholder
rights, 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 the ventures, those ventures are 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 recorded have been recovered.
2. POLICIES AND PROCEDURES
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income," which establishes
standards for reporting and display of comprehensive income and its components
in a full set of general purpose financial statements. Comprehensive income
(loss) is defined as the change in equity of a business enterprise during a
period from nonowner sources. Comprehensive loss was $23.0 million and $42.4
million for the three and six months ended June 30, 1997, respectively, and was
comprised of net losses of $22.0 million and $39.7 million and foreign currency
translation adjustments of $1.0 million and $2.7 million for the three and six
months ended June 30, 1997, respectively. Comprehensive loss was $25.5 million
and $64.6 million for the three and six months ended June 30, 1998,
respectively, and was comprised of net losses of $26.2 million and $63.4 million
and foreign currency translation income of $0.7 million for the three months
ended June 30, 1998 and foreign currency loss of $1.2 million for the six months
ended June 30, 1998.
During 1997, the Company adopted SFAS No. 128, "Earnings Per Share," which
requires the Company to present basic and fully diluted earnings per share for
all periods presented. The Company's net loss per share calculation (basic and
diluted) is based upon the weighted average common shares issued. There are no
reconciling items in the numerator or denominator of the Company's net loss per
share calculation. Employee
7
<PAGE> 339
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
stock options, warrants, and convertible debt instruments have been excluded
from the net loss per share calculation because their effect would be
anti-dilutive.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", which will be
required to be adopted by January 1, 2000. This statement establishes accounting
and reporting standards requiring that every derivative instrument be recorded
in the balance sheet as either an asset or liability measured at its fair value.
The statement also requires that changes in the derivatives fair value be
recognized in earnings unless specific hedge accounting criteria are met. The
Company is currently assessing the impact of this new statement on its
consolidated financial position and results of operations.
Certain reclassifications have been made to the June 1997 condensed,
consolidated financial statements in order to conform to the 1998 presentation.
3. SHAREHOLDERS' EQUITY
In February 1998, the Company completed an initial public offering of 12.8
million shares of common stock at $20.00 per common share (the "Stock
Offering"). The Stock Offering resulted in the Company's common stock being
listed in the United States on the National Association of Securities Dealers
Automated Quotation Market and internationally on the European Association of
Securities Dealers Automated Quotation Market. Net proceeds from the Stock
Offering were approximately $235.6 million. As a result of the Stock Offering,
the Company no longer has an obligation to repurchase the 797,100 shares of
common stock that were subject to repurchase at December 31, 1997.
Pursuant to a purchase agreement that the Company has with a venture
partner, the Company issued 336,630 shares of common stock to the partner in
April 1998. In accordance with 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. The shares issued are
restricted and therefore, have been classified as common stock subject to
repurchase as of June 30, 1998.
In June 1998, pursuant to the Debt Obligation described below, 3,333,333
warrants were exercised at an exercise price of $9.33 per common share. An
additional 4,444,444 warrants to purchase the Company's common stock expire in
the first and second quarters of 2002.
4. DEBT OBLIGATIONS
In February 1998, the Company issued aggregate principal amount $105.0
million of 9.875% senior notes due 2005 (the "Notes Offering" and together with
the Stock Offering, the "Offerings"). Net proceeds from the Notes Offering were
approximately $100.5 million. Approximately $19.6 million of the net proceeds
was placed in escrow for the first four semiannual interest payments, commencing
August 15, 1998.
As a result of the completion of the Stock Offering, the interest rate on
the $144.8 million aggregate principal amount of 8.75% senior subordinated
convertible bonds due 2000, which were issued in July 1997 (the "Bonds") will
remain at 8.75% until maturity and the approximately $5.1 million of the 6.25%
additional interest that was previously accrued through the date of the Stock
Offering has been reflected as an increase to additional paid-in capital. Upon
completion of the Stock Offering, the Bonds became convertible into 7.2 million
common shares at a conversion price of $20.00 per share. During the second
quarter of 1998, $19.0 million of the Bonds were converted into approximately
1.0 million common shares of the Company's common stock for a total of $25.4
million converted into 1.3 million common shares for the six months ended June
30, 1998.
In 1996, the Company entered into long-term obligations ("Debt
Obligations") totaling $70.0 million with lenders that are affiliated with and
are considered related parties to the Company as a result of their
8
<PAGE> 340
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ownership of the Company's common stock. In February 1998, approximately $85.2
million of the net proceeds of the Offerings was used to repay the Debt
Obligations plus accrued interest. In addition, the unamortized discount costs
and debt issuance costs on the Debt Obligations were written off at the time of
repayment, resulting in the Company recording an extraordinary loss of $12.7
million.
5. OTHER TRANSACTIONS
In June 1998, the Company completed the restructuring of the capital and
ownership of Bancomsvyaz, one of its equity method investees, which resulted in
the Company's beneficial ownership increasing from approximately 25% to
approximately 57%. Prior to the restructuring, Bancomsvyaz was 49% owned by GTS
Ukrainian TeleSystems LLC ("UTS"), another equity method investee which was 60%
owned by the Company and 40% owned by a shareholder of the Company (the
"Shareholder"). The total consideration paid for the additional interest in
Bancomsvyaz was $11.4 million. In conjunction with this restructuring, the
Shareholder exercised its right to receive 0.7 million shares of the Company's
common stock in lieu of their ownership interest in UTS, and as a result, the
Company reclassified an $8.6 million short-term obligation as additional paid-in
capital. Further, the Shareholder contributed an additional $5.8 million for a
25% interest in UTS. As a result of the restructuring, as of June 30, 1998, UTS
and Bancomsvyaz are accounted for by the consolidation as opposed to the equity
method of accounting. The purchase price has been allocated to the net assets
based on the fair value at the date of acquisition. The excess purchase price
over the fair value of the net assets acquired was $1.2 million, which has been
recorded as goodwill and is being amortized, on a straight-line basis over five
years.
In June 1998, Hermes Europe Railtel B.V. ("HER") completed the acquisition
for ECU 90 million (approximately $99.5 million) from Ebone Holding Association
(the "Association") of a 75% interest in Ebone A/S ("Ebone"), a Tier 1 Internet
backbone provider, principally serving as a carriers' carrier for European
internet service providers. As part of the transaction, Ebone will purchase,
under a transmission capacity agreement, long-term rights on HER's network
valued at ECU 90 million. The purchase price has been allocated to the net
assets based on the fair value at the date of acquisition. The excess purchase
price over the fair value of the net assets acquired was $17.2 million, which
has been recorded as goodwill and is being amortized, on a straight-line basis
over five years. The members of the Association have the right to buy shares of
Ebone in a future issuance to occur by the end of 1998, which could reduce HER's
ownership in Ebone from 75% to not less than 54%.
In March 1998, the Company purchased an additional 10.3% interest in Hermes
Europe Railtel B.V. ("HER") from an existing shareholder of HER for ECU 13.5
million (approximately $14.6 million). As a result of the purchase, the Company
owns approximately 89.4% of HER. The purchase price has been allocated to the
net assets based on the fair value at the date of acquisition. The excess
purchase prices over the fair value of the net assets acquired was $10.2
million, which has been recorded as goodwill and is being amortized, on a
straight-line basis over five years.
In February 1998, the Company acquired the remaining 33% interest in Sovam
Teleport from its minority partner and as a result Sovam became a wholly-owned
subsidiary of the Company and in 1998 is accounted for by the consolidation as
opposed to the equity method of accounting. The Company paid a nominal amount
for the 33% interest.
9
<PAGE> 341
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. SUPPLEMENTAL CASH FLOW INFORMATION
The following table summarizes non-cash investing and financing activities
for the Company:
<TABLE>
<CAPTION>
THREE
MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 1998 JUNE 30, 1998
------------- -------------
(IN THOUSANDS)
<S> <C> <C>
Capitalization of leases.................................... $23,374 $50,238
Exercise of warrants........................................ 31,110 31,110
Conversion of the Bonds into common stock................... 19,035 25,385
Additional consideration in relation to purchase of interest
in a CIS region subsidiary................................ 13,549 --
Reclassification of common stock subject to repurchase...... -- 12,489
Conversion of note payable into common stock................ 8,625 8,635
Note receivable from shareholder for additional
consideration in relation to purchase of a venture........ 5,750 5,750
Reclassification of accrued interest on the Bonds........... -- 5,052
</TABLE>
No significant non-cash activities were incurred for the three and six
months ended June 30, 1997.
7. SUBSEQUENT EVENTS
In July 1998, a wholly-owned subsidiary of the Company purchased the
remaining 47.36% interest in GTS Vox Limited for $40.0 million, which will be
paid in installments. In connection with this buy-out, a modification was made
to the original stock purchase agreement with the Company's partner in GTS Vox,
in which the Company's obligation to issue 224,190 shares of common stock to
such partner will be accelerated to 1998. Under the stock purchase agreement,
the Company is also obligated to assist the former partner in locating a buyer
for these shares of common stock and if unable to do so, the Company will
repurchase the shares of common stock. In addition to the above payments, the
purchase agreement includes guarantees of certain cash flow assumption for GTS
Vox Limited's consolidated subsidiary.
Subsequent to June 30, 1998, the Company completed a secondary public
offering of 2.8 million shares of common stock at $45.50 per common share. Net
proceeds from the offering were approximately $119.9 million. In addition, in
conjunction with such offering, shareholders of the Company sold 11.7 million
shares of the Company's common stock. The Company did not realize any of the
proceeds of such sale. In addition, the Company issued aggregate principal
amount of $466.9 million of 5.75% convertible senior subordinated debentures
(the "Debentures") that mature July 1, 2010 and will be redeemable from July 1,
2001 at the option of the Company, at redemption prices as set forth in the
Debentures agreement. Net proceeds from the Debentures offering were
approximately $452.1 million. The Debentures are convertible into shares of
common stock at any time prior to maturity or redemption at a conversion price
of $55.05 per common share. Interest on the Debentures will be payable
semi-annually on January 1 and July 1, commencing January 1, 1999. The
Debentures are subordinated to all existing and future indebtedness of the
Company, except for the Bonds, with which they rank pari passu in right of
payment.
10
<PAGE> 342
ITEM 1B. FINANCIAL STATEMENTS OF EDN SOVINTEL
Condensed Balance Sheets As of December 31, 1997 and June 30, 1998
Condensed Statements of Operations For the Three and Six Months Ended June
30, 1997 and 1998
Condensed Statements of Cash Flows For the Three and Six Months Ended June
30, 1997 and 1998
Notes to Condensed Financial Statements
11
<PAGE> 343
EDN SOVINTEL
CONDENSED BALANCE SHEETS
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1997 1998
------------ --------
(IN THOUSANDS)
<S> <C> <C>
Current assets
Cash and cash equivalents................................. $ 5,620 $ 3,265
Accounts receivable, less allowance for doubtful accounts
of $643 and $870 at December 31, 1997 and June 30,
1998................................................... 16,223 20,980
Restricted cash........................................... 485 468
Due from affiliated companies............................. 1,586 2,066
Inventory................................................. 1,697 1,343
Deferred tax asset........................................ 186 186
Prepaid expenses and other assets......................... 5,318 12,033
------- -------
Total current assets.............................. 31,115 40,341
Property and equipment, net of accumulated depreciation of
$14,557 and $17,467 at December 31, 1997 and June 30,
1998...................................................... 38,709 42,920
Deferred expenses........................................... 945 878
------- -------
TOTAL ASSETS...................................... $70,769 $84,139
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable.......................................... $ 5,725 $ 9,163
Accrued expenses.......................................... 3,194 4,502
Due to affiliated companies............................... 10,104 9,702
Note payable to shareholder............................... 39 --
Taxes and other liabilities............................... 2,438 1,864
------- -------
TOTAL LIABILITIES................................. 21,500 25,231
Commitments and contingencies
SHAREHOLDERS' EQUITY
Contributed capital......................................... 2,000 2,000
Retained earnings........................................... 47,269 56,908
------- -------
TOTAL SHAREHOLDERS' EQUITY........................ 49,269 58,908
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $70,769 $84,139
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
12
<PAGE> 344
EDN SOVINTEL
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -----------------
1997 1998 1997 1998
-------- -------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
REVENUES, net:........................................ $28,977 $34,703 $54,139 $67,107
COST OF REVENUES:..................................... 18,073 22,646 32,836 44,603
------- ------- ------- -------
Gross margin.......................................... 10,904 12,057 21,303 22,504
OPERATING EXPENSES:
Selling, general and administrative................. 2,739 3,335 5,435 6,362
Depreciation and amortization....................... 53 214 213 391
Non-income taxes.................................... 1,468 1,593 2,467 3,035
------- ------- ------- -------
Total operating expenses.................... 4,260 5,142 8,115 9,788
Income from operations................................ 6,644 6,915 13,188 12,716
OTHER (EXPENSE) INCOME:
Interest income..................................... 49 61 104 98
Interest expense.................................... (115) -- (274) --
Foreign currency losses............................. (31) (73) (69) (293)
------- ------- ------- -------
(97) (12) (239) (195)
Net income before taxes............................... 6,547 6,903 12,949 12,521
Income taxes.......................................... 1,512 1,609 3,220 2,882
------- ------- ------- -------
Net income.................................. $ 5,035 $ 5,294 $ 9,729 $ 9,639
======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
13
<PAGE> 345
EDN SOVINTEL
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -----------------
1997 1998 1997 1998
-------- -------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income............................................. $ 5,035 $ 5,294 $ 9,729 $ 9,639
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization........................ 1,114 1,409 2,227 2,910
Provision for doubtful accounts...................... (504) (384) (352) (227)
Changes in assets and liabilities:
Accounts receivable............................... (2,103) (1,284) (6,719) (4,984)
Inventory......................................... (415) 354 (122) 354
Prepaid expenses and other assets................. (929) (5,210) (1,529) (7,195)
Accounts payable and accrued expenses............. 2,437 1,319 4,123 4,172
------- ------- ------- -------
Net cash provided by operating activities.... 4,635 1,498 7,357 4,669
INVESTING ACTIVITIES
Purchases of property and equipment.................. (5,015) (3,621) (8,556) (7,121)
Restricted cash...................................... 9 6 (22) 17
------- ------- ------- -------
Net cash used in investing activities........ (5,006) (3,615) (8,578) (7,104)
FINANCING ACTIVITIES
Repayment of shareholder note, net................... (932) -- (728) (39)
Due to affiliated companies, net..................... 2,464 (1,574) 1,503 119
------- ------- ------- -------
Net cash (used in) provided by financing activities.... 1,532 (1,574) 775 80
------- ------- ------- -------
Net increase (decrease) in cash and cash equivalents... 1,161 (3,691) (446) (2,355)
Cash and cash equivalents at beginning of period....... 1,999 6,956 3,606 5,620
------- ------- ------- -------
Cash and cash equivalents at end of period............. $ 3,160 $ 3,265 $ 3,160 $ 3,265
======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
14
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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, 1997 and June 30, 1998, and the
results of operations and cash flows for the periods indicated.
The Company was established as a competitive local exchange carrier (CLEC)
in August 1990. Through the design, construction, and operation of a
telecommunications network in Moscow, the Company provides its customers,
principally major hotels, business offices and mobile communications companies,
with an alternative to the local telephone company for worldwide communications
services. 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 May 1, 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. Currently, customers have the option of being billed in
roubles or dollars. All payments from Russian companies are made in roubles.
The venture is a Russian limited liability partnership. The Company is 50%
owned by Open Joint Stock Company "Rostelecom," an intercity and long-distance
carrier which is 38% owned by Svyazinvest, and 50% owned by Sovinet, a US
general partnership, which is owned by two wholly-owned Global TeleSystems
Group, Inc. ("GTS") subsidiaries.
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 1997 audited financial statements and the notes related thereto. The
results of operations for the three and six months ended June 30, 1998 may not
be indicative of the operating results for the full year.
The Company also 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 Russian statutory
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 certain accrued revenue and expenses, foreign
currency translation, deferred taxation, and depreciation and valuation of
property and equipment. 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.
2. POLICIES AND PROCEDURES
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 130, "Reporting Comprehensive Income," which establishes
standards for reporting and display of comprehensive income and its components
in a full set of general purpose financial statements. Comprehensive income is
defined as the change in equity of a business enterprise during a period from
nonowner sources. For the three and six months ended June 30, 1997 and 1998,
comprehensive income for the Company is equal to net income.
15
<PAGE> 347
EDN SOVINTEL
NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
3. CONTINGENCIES
Legislation and regulations regarding taxation, foreign currency
transactions and licensing of foreign currency loans in the Russian Federation
continues to evolve as the central government manages the transformation from a
command to a market-oriented economy. The various legislation and regulations
are not always clearly written and their interpretation is subject to the
opinions of the tax inspectors, Central Bank officials and the Ministry of
Finance. Instances of inconsistent opinions between local, regional and national
tax authorities and between the Central Bank and Ministry of Finance are not
unusual.
The Company believes that it has paid or accrued all taxes that are
applicable. Where practice concerning the provision of taxes is unclear, the
Company has accrued tax liabilities based on management's best estimate. 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.
Because of the uncertainties associated with the Russian tax and legal
systems, the ultimate amount of taxes, penalties and interest, if any, assessed
may be in excess of the amount expensed to date and accrued at December 31, 1997
and June 30, 1998.
The Company's operations and financial position will continue to be
affected by Russian political developments, including the application of
existing and future legislation and tax regulations. The Company does not
believe that these contingencies, as related to its operations, are any more
significant than those of similar enterprises in Russia.
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ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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, Central Europe and Asia. In Western 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.
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
17
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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 minority
shareholder rights, 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 June 30, 1998, $5.3 million
and $9.0 million represent 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 issuance in August 1997, of $265
million aggregate principal amount of 11.5% senior notes due 2007 (of which
$56.6 million was placed in escrow for the first two years' interest payments)
the Company 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.
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The following table summarizes the accounting methodology for the principal
business ventures through which the Company conducts its business.
<TABLE>
<CAPTION>
COUNTRY/REGION EFFECTIVE GTS ACCOUNTING
COMPANY NAME OF OPERATIONS OWNERSHIP METHODOLOGY
------------ -------------- ------------- -----------
<S> <C> <C> <C>
CIS
Sovintel.............................. Russia 50% Equity
TCM................................... Russia 50%(1) Equity
TeleRoss Operating Company............ Russia 100%(2) Consolidated
TeleRoss Ventures..................... Russia 50%(3) Equity
Sovam................................. Russia 100%(4) Consolidated(4)
GTS Cellular.......................... CIS 50%-75%(5) Equity/Consolidated
Western Europe
HER................................... Western Europe 89%(6) Consolidated(6)
GTS-Monaco Access..................... Monaco 50% Equity
Central Europe
GTS-Hungary........................... Hungary 99% Consolidated
EuroHivo.............................. Hungary 70%(7) 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) Subsequent to June 30, 1998, the Company purchased the remaining minority
ownership interest in GTS-Vox Limited. As a result, effective July 1998, the
Company will have a 95% indirect interest in TCM and TCM will be accounted
for by the consolidation as opposed to the equity method of accounting.
(2) The TeleRoss Operating Company is comprised of a wholly-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" and "Business -- Russia
and the CIS -- TeleRoss." A significant portion of TeleRoss Operating
Company's costs of revenue consists of settlement fees paid to the TeleRoss
Ventures [as defined in (4) below], with such fees being recorded as revenue
by the TeleRoss Ventures. To date, 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.
(3) TeleRoss Ventures is comprised of fourteen 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."
(4) GTS purchased the remaining 33% interest in Sovam in February 1998 and as a
result, effective February 1998, Sovam is accounted for by the consolidation
as opposed to the equity method of accounting.
(5) GTS conducts its cellular operations through (i) Vostok Mobile, a wholly
owned GTS venture that owns between 50% and 70% of a series of thirteen
cellular joint ventures in various regions in Russia, (ii) PrimTelefone, a
50% owned venture in Vladivostok, Russia and (iii) Bancomsvyaz, an
approximately 57% beneficially owned venture in Kiev, Ukraine. The Company
completed a restructuring of the capital and ownership of Bancomsvyaz on
June 30, 1998, which results in GTS beneficially owning approxi-
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<PAGE> 351
mately 57% of Bancomsvyaz. As a result, effective June 30, 1998, Bancomsvyaz
is accounted for by the consolidation as opposed to equity method of
accounting.
(6) As of July 16, 1997, HER is accounted for by the consolidation as opposed to
the equity method of accounting. In addition, in March 1998, GTS acquired an
additional 10% interest in HER.
(7) The Company has reached a definitive agreement to sell its ownership
interest in EuroHivo. The closing of this transaction is anticipated to
occur by the end of August 1998, but is conditioned upon the Ministry's
approval of the share transfer. The Company does not anticipate that the
closing of this transaction will have a material effect on the Company's
results from operations and financial condition.
RESULTS OF OPERATIONS -- CONSOLIDATED VENTURES
Management's discussion included within "-- Results of
Operations -- Consolidated Ventures" reflects the following significant
operating ventures: TeleRoss Operating Company, Sovam, GTS-Hungary, the Czech
Companies and HER. Although the Company was not able to follow consolidation
method of accounting for Sovam and HER in the three and six months ended June
30, 1997, the Company has included, for comparative purposes, a discussion of
their financial performance for the three and six months ended June 30, 1997 in
our discussion of "Results of Operations -- Consolidated Ventures". See "Results
of Operations -- Non-Consolidated Ventures (Equity Investees)" for a discussion
of the operating results of Sovintel, TCM, TeleRoss Ventures, GTS Cellular and
GTS-Monaco Access.
Revenue. The Company's consolidated revenue was $30.6 million and $53.5
million for the second quarter and year to date ended June 30, 1998,
respectively, which was $21.8 million and $36.2 million above the same periods
in 1997. The growth in revenue was primarily attributable to the inclusion of
Sovam and HER in the Company's consolidated financial results, who contributed
$12.4 million and $15.9 million in revenue, respectively, for the six months
ended June 30, 1998. The remaining revenue growth was attributable to the
TeleRoss Operating Company, as its revenue increased $5.5 million year over
year.
The CIS region's consolidated revenue increased 165.5% and 165.4% to $14.6
million and $28.4 million for the three and six months ended June 30, 1998,
respectively, from the comparable periods in 1997. TeleRoss Operating Company
generated revenue of $8.3 million and $15.4 million, representing 56.8% and
54.2% of the region's consolidated revenue for the three and six months ended
June 30, 1998, respectively. The growth in TeleRoss Operating Company revenue of
50.9% and 55.6% for the second quarter and year to date, respectively, from the
same periods last year was the result of the increase in traffic volume
generated by the TeleRoss Ventures due to the increase in the number of cities
and number of VSAT's installed at customer locations outside of cities in which
they have a presence. Sovam generated revenue of $6.5 million and $12.4 million
for the three and six months ended June 30, 1998, respectively. The 51.2% and
55.0% increase from prior year periods in Sovam revenue is primarily
attributable to the expansion of Sovam's network throughout Russia and the CIS
and the wider variety of service offerings. (Sovam was an equity method company
in 1997.)
HER generated $11.2 million and $15.9 million of revenue in the three and
six months ended June 30, 1998, respectively, compared to $0.4 million and $0.6
million, respectively, in the same periods in 1997 (HER was an equity method
company prior to July 1997). The growth in revenue is attributable to the
continued deployment of the HER network. HER commenced commercial service over
the Brussels-Amsterdam route in late 1996, the London-Paris portion in November
1997 and Frankfurt, Zurich, Geneva, Stuttgart, Dusseldorf and Munich were added
in the second quarter of 1998.
The Central Europe region's consolidated revenue increased 30.3% and 34.4%
to $4.3 million and $8.2 million for the three and six months ended June 30,
1998, respectively, from the comparable periods in 1997. This growth is
attributable to the expansion of the customer base and product offerings of
these businesses.
Gross Margin. GTS's consolidated gross margin was $6.5 million and $10.2
million, or 21.2% and 19.1% of revenue, for the three and six months ended June
30, 1998, respectively, and $2.3 million and $4.3 million, or 25.8% and 24.9% of
revenue, for the three and six months ended June 30, 1997, respectively.
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<PAGE> 352
Sovam represented 49.2% and 58.8% of the consolidated gross margin for the
three and six months ended June 30, 1998, respectively. (Sovam was an equity
method company in 1997). Sovam had gross margin as a percentage of revenues of
49.2% and 48.4% for the three and six months ended June 30, 1998, respectively.
The increase of 12.0% and 12.1% in gross margin as a percentage of revenue in
comparison to the same periods in 1997 reflects the higher margin service
offerings that Sovam is currently providing and also management's focus to
improve its cost structure; i.e., the negotiation of improved channel costs from
suppliers and controlled growth in both personnel and capital expenditures. The
TeleRoss Operating Company represented 12.3% and 17.5% of the consolidated gross
margin for the three and six months ended June 30, 1998, respectively, and 0.0%
and 34.9% for the three and six months ended June 30, 1997, respectively.
TeleRoss had gross margin as a percentage of revenue of 9.6% and 11.7% for the
three and six months ended June 30, 1998, respectively. The decrease of 3.5% in
margin as a percentage of revenue for the six months ended June 30,1998 in
comparison to the comparable period in 1997 reflects the high fixed cost
component of its network hub in Moscow. The Central European region had gross
margin as a percentage of revenue of 34.9% and 34.1% for the three and six
months ended June 30, 1998, respectively. The decrease of 1.5% and 6.8% in gross
margin as a percentage of revenue in comparison to the comparable periods in
1997 primarily reflects the startup activities of the GTS Net product offering
in Hungary. HER had a favorable effect on consolidated gross margins of $0.4
million for the three months ended June 30, 1998, and an unfavorable effect on
consolidated gross margins of $(1.0) million for the six months ended June 30,
1998. For comparative purposes, HER had an unfavorable gross margin of $(1.1)
million and $(2.7) million for the three and six months ended June 30, 1997 (HER
was an equity method company prior to July 1997.)
Operating Expenses. Consolidated operating costs were $28.7 million and
$51.4 million for the three and six months ended June 30, 1998, respectively, a
104.2% and 89.8% increase above the comparable periods in 1997. The increase in
operating costs is attributable to the inclusion of HER and Sovam in the
Company's consolidated financial results, the growth in expenditures associated
with building business infrastructure for primarily the TeleRoss Operating
Company and costs attributable to increasing the corporate staff.
Equity in (Losses)/Earnings of Ventures. GTS recognized earnings of $4.2
million and $7.6 million for its investments in non-consolidated ventures in the
three and six months ended June 30, 1998, respectively, as compared to
recognizing losses of $6.7 million and $10.2 million in the comparable periods,
respectively, in 1997. This improvement was primarily the result of HER no
longer being an equity method investee, the Company's exclusion of the
unfavorable financial results of several of its businesses as a result of its
write-off of certain investments in and advances to ventures in Asia and Central
Europe in the third quarter of 1997 and TCM's year over year net income
improvement. Included in the quarter ended June 30, 1998 was $0.1 million of
additional losses as a result of excess losses recognized. For the six months
ended June 30, 1998, excess losses recognized were minimal. Included in the
quarter and year to date results for June 30, 1997 were $5.1 million and $7.8
million of additional losses as a result of the application of the Company's
previously discussed profit and loss accounting. Sovintel and TCM generated
combined earnings of $5.3 million and $9.4 million for the three and six months
ended June 30, 1998, respectively, and $4.2 million and $8.1 million for the
three and six months ended June 30, 1997, respectively, which offset the losses
generated by other ventures that are in the early stages of operations. See
"Results of Operations -- Non-Consolidated Ventures (Equity Investees) for a
discussion of the results of operations of the Company's significant equity
investees.
Interest, Net. GTS incurred interest expense of $14.1 million and $30.6
million for the three and six months ended June 30, 1998, respectively, which
was 304.2% and 327.1% above the comparable periods in 1997. The significant
increase in interest expense was due to the $409.8 million increase in debt
raised in 1997 and $105.0 million raised in 1998. See "-- Liquidity and Capital
Resources."
GTS earned interest income of $7.2 million and $14.3 million for the three
and six months ended June 30, 1998, respectively, a 729.8% and 559.2% increase
over the same periods in 1997, primarily as a result of investing the proceeds
from the Company's 1997 and 1998 capital raise efforts. See "-- Liquidity and
Capital Resources."
Provision for Income Taxes. The Company's consolidated tax provision was
$0.8 million and $1.4 million for the three and six months ended June 30, 1998
and $0.5 million and $0.8 million for the three and six
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<PAGE> 353
months ended June 30, 1997, respectively. 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 non-U.S.
loss carryforwards will be allowed, in part or in full, by local tax authorities
against future income.
Extraordinary Loss. The Company recognized a $12.7 million extraordinary
charge to earnings in the first quarter of 1998, as a result of the Company's
early extinguishment of certain related party debt obligations. The nature of
the charge is comprised of the write-off of $11.6 million of unamortized debt
discount and $1.1 million of unamortized debt issuance costs that were deferred
as financing costs and were being amortized over the original maturity of the
debt.
RESULTS OF OPERATIONS -- NON-CONSOLIDATED VENTURES (EQUITY INVESTEES)
Russia -- CIS
Sovintel. Sovintel's revenue was $34.7 million and $67.1 million for the
second quarter and year to date ended June 30, 1998, which increased $5.7
million and $13.0 million over revenues for the comparable periods in 1997. The
growth in revenue was primarily the result of telecommunications service
revenue, which increased 10.4% and 17.2% to $24.6 million and $48.4 million for
the three and six months ended June 30, 1998, respectively, from comparable
periods in 1997, 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. Sovintel realized a 69.3% and 80.4%
increase in outgoing international and domestic minutes for the three and six
months ended June 30, 1998, as compared with the same periods a year ago.
Revenue from incoming international minutes decreased by 45.8% and 29.9% to $2.1
million and $4.6 million for the three and six months ended June 30, 1998,
respectively, from the same periods in 1997.
Sovintel's non-traffic-related revenue increased 51.3% and 45.9% to $10.1
million and $18.7 million for three and six months ended June 30, 1998,
respectively, over the comparable periods in 1997, which was primarily
attributable to port sales and monthly port fees revenue.
Sovintel's gross margin as a percentage of revenues was 34.7% and 33.5%,
for the three and six months ended June 30, 1998, and was 37.6% and 39.4% for
comparable periods in 1997. The decrease in gross margin as a percentage of
revenue for the respective periods in 1998 and 1997, was attributable to a
general price decrease in international and domestic revenue due to competitive
pressures and a higher percentage of domestic minutes, which yield a lower
margin.
Operating expenses were $5.2 million and $9.8 million, or 15.0% and 14.6%
of total revenue, for the three and six months ended June 30, 1998. The increase
of 21.3% and 20.9% in operating expenses in comparison to the same periods in
1997 was related to increases in turnover taxes associated with revenues and
also increased personnel, advertising and sales force costs required to support
Sovintel's growth.
TCM. TCM's revenue for the three and six months ended June 30, 1998
increased 83.5% and 66.9% to $12.1 million and $21.6 million, respectively, from
the comparable periods in 1997. These increases were primarily due to increases
in local and international/long-distance traffic revenue. TCM had gross margin
as a percentage of revenues of 74.4% and 73.6% for the three and six months
ended June 30, 1998, respectively. Gross margin as a percentage of revenue
decreased 7.8% and 5.5% in comparison to the same periods in 1997 as a result of
higher infrastructure and settlement costs. TCM had operating expenses of $1.0
million and $1.9 million, or 8.3% and 8.8% of total revenue, for the three and
six months ended June 30, 1998, respectively, which represents decreases of 1.5%
and 0.9% in operating expenses as a percentage of revenue in comparison to the
same periods in 1997.
TeleRoss Ventures. Revenue for the TeleRoss Ventures increased 97.6% and
77.4% to $2.6 million and $5.0 million for the three and six months ended June
30, 1998, respectively, from the comparable periods in 1997. Revenues were
primarily resulted from settlement fees charged to TeleRoss Operating Company.
The growth in revenue reflects the growth of the customer base.
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Gross margin as a percentage of revenue was 69.2% and 70.0% for the three
and six months ended June 30, 1998, respectively, compared to 84.6% and 82.1%
for the three and six months ended June 30, 1997, respectively due to the
increase in settlement costs. Operating expenses were $1.2 million and $2.2
million, or 46.2% and 44.0% of revenue, for the three and six months ended June
30, 1998, respectively, compared to 92.3% and 64.3% of revenue, for the
comparable periods in 1997.
GTS Cellular. The Company operates three cellular networks through
differing ownership structures: Vostok Mobile, PrimTelefone and Bancomsvyaz.
Revenue for Vostok Mobile was $7.4 million and $14.7 million for the three
and six months ended June 30, 1998, respectively, which represented a 28.0% and
36.4% increase from the comparable periods in 1997. The growth in revenue was
primarily attributable to subscriber growth.
Vostok Mobile's gross margin was 48.3% and 49.4% of revenue, for the three
and six months ended June 30, 1998, respectively, compared to 50.7% and 53.3% of
revenue, for the comparable periods in 1997. Operating expenses were $3.6
million and $6.2 million, or 48.6% and 42.2% of revenue, for the three and six
months ended June 30, 1998, respectively, compared to $3.0 million and $5.0
million, or 51.3% and 46.7% of revenue, for the comparable periods in 1997.
Revenue for PrimTelefone was $3.6 million and $7.3 million for the three
and six months ended June 30, 1998, respectively, which represented a 44.0% and
46.0% increase from the comparable periods in 1997. The growth in revenue was
primarily attributable to the subscriber growth.
PrimTelefone's gross margin was 58.3% and 57.5% of total revenue, and
operating expenses were $1.2 million and $2.3 million for the three and six
months ended June 30, 1998, respectively, compared to gross margin of 64.0% and
66.0% of total revenue, and operating expenses of $0.9 million and $1.5 million,
respectively, for the comparable periods in 1997.
Revenue for Bancomsvyaz was $5.7 million and $9.9 million for the three and
six months ended June 30, 1998, respectively, which represented a 376.5% and
443.9% increase from the comparable periods in 1997. The growth in revenue was
primarily attributable to the increase in cellular subscribers.
Bancomsvyaz's gross margin was 53.6% and 55.7% of total revenue, and
operating expenses were $2.3 million and $4.1 million for the three and six
months ended June 30, 1998, respectively, compared to gross margin of 28.3% and
18.5% of total revenue, and operating expenses of $2.1 million and $2.2 million,
respectively, for the comparable periods in 1997.
Western Europe
GTS-Monaco Access: Total revenue was $7.4 million and $11.9 million for the
three and six months ended June 30, 1998, respectively, which represented a
179.6% and 164.7% increase from the comparable periods in 1997. Gross margin was
$0.8 million and $1.0 million, or 10.8% and 8.4% of revenue, for the three and
six months ended June 30, 1998, respectively, compared to $0.1 million and $0.1
million, or 4.4% and 3.1% of revenue, for the comparable periods in 1997.
LIQUIDITY AND CAPITAL RESOURCES
Corporate
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 $238.7 million, $36.4 million, $107.7 million, $42.1 million and $62.1
million in the first six months of 1998, and in the full years of 1997, 1996,
1995 and
23
<PAGE> 355
1994, respectively, net of placement fees, for a total of $487.0 million. In
addition, the Company and HER received $105.0 million, $409.8 million, $60.0
million and $23.3 million in gross proceeds in the first six months of 1998, and
in the full years of 1997, 1996 and 1995, respectively, for a total of $598.1
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, of which $70.0
million was repaid in 1998.
The Company had working capital of $455.9 million and $0.6 million as of
June 30, 1998 and 1997, respectively. The Company had an accumulated deficit of
$306.2 million as of June 30, 1998, including net losses of approximately $63.4
million and $26.2 million for the three and six months ended June 30, 1998 and
$22.0 million and $39.7 million for the three and six months ended June 30,
1997, respectively. During 1998, 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 $500.0 million of capital expenditures and investments
in ventures during the next three years, of which approximately $100.0 million
will be incurred in the last two quarters of 1998. The Company obtained funds in
1998 through a variety of financing arrangements, including (i) the Company
raised approximately $255.3 million in gross proceeds from an initial public
stock offering of 12.8 million common shares at $20.00 per share, and (ii) the
Company issued $105.0 million in gross proceeds of 9.875% senior notes due
February 15, 2005, of which $19.6 million was placed in escrow to fund the first
two years' interest payments. The initial public offering constituted a
"complying public equity offering" under the Company's 8.75% Senior Subordinated
Convertible Bonds due 2000 (the "Bonds"). As a result, the conversion price of
the Bonds is $20 per share.
Subsequent to June 30, 1998, the Company completed a secondary public
offering of 2.8 million shares of common stock at $45.50 per common share. Net
proceeds from the offering were approximately $119.9 million. In addition, the
Company issued aggregate principal amount $466.9 million of 5.75% convertible
senior subordinated debentures (the "Debentures") that mature July 1, 2010 and
will be redeemable from July 1, 2001 at the option of the Company, at redemption
prices set forth in the Debentures agreement. The Debentures are convertible
into shares of common stock at any time prior to maturity or redemption at a
conversion price of $55.05 per common share. Interest on the Debentures will be
payable semi-annually on January 1 and July 1, commencing January 1, 1999. The
Debentures are subordinated to all existing and future indebtedness of the
Company, except for the Bonds, with which they rank pari passu in right of
payment. Net proceeds from the Debentures offering were approximately $452.1
million.
The Company believes its existing cash balances and cash flow from
operations will be sufficient to fund its expected capital needs under its
current business plan, excluding any funds expended in connection with the
implementation of the Company's European Services Strategy. See "Liquidity and
Capital Resources -- European Services Strategy." The Company contemplates that
it will raise additional debt financing through a newly formed subsidiary of the
Company, the proceeds of which will be applied toward the implementation of the
Company's European Services Strategy. The actual amount and timing of such
financing have not yet been determined by the Company.
The actual amount and timing of the Company's future capital requirements
may differ materially from management's estimates. In particular, the accuracy
of management's estimates is 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
24
<PAGE> 356
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 ventures in
excess of forecast amounts. In addition, certain of the Company's 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 the Bonds upon maturity on June 30, 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 will need to
raise 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. Through June 30,
1998, approximately $81.9 million has been spent on network capital expenditure.
An additional $194.6 million has been capitalized in connection with long-term
fiber lease arrangements. In August 1997, HER completed the issuance of $265.0
million in gross proceeds of 11.5% Senior Notes (the "Senior Notes") due in
August 2007. The Senior Notes are general unsecured obligations of HER. The
Company believes that the net proceeds of such issuance, combined with HER's
projected internally generated funds, should be enough to fund HER's expected
capital expenditures. However the actual amount and timing of HER's future
capital requirements may differ materially from management's estimates. If the
actual amount and timing of HER's future capital requirements differ materially
from management's estimates, 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.
EUROPEAN SERVICES STRATEGY
The aforementioned discussion of capital requirements does not include any
capital spending that will be required for the implementation of the Company's
European Services Strategy. Due to the preliminary nature of the Company's
business plan for such strategy, the Company cannot estimate with any degree of
certainty the amount and timing of the Company's future capital requirements for
such implementation, which will be dependent on many factors, including the
success of the Company's European services business, the rate at which the
Company expands its networks and develops new networks, the types of services
the Company offers, staffing levels, acquisitions and customer growth, as well
as other factors that are not within the Company's control, including
competitive conditions, regulatory developments and capital costs. Management
believes, however, that if the European Services Strategy is implemented it is
likely that the Company will need to raise additional capital above that raised
through July 31, 1998. The Company expects that it will have
25
<PAGE> 357
significant operating and net losses and will record significant net cash
outflow, before financing, in coming years including in connection with its
European services business. There can be no assurance that the Company's
operations, including the Company's European services business, will achieve or
sustain profitability or positive cash flow in the future.
Liquidity Analysis
The Company had cash and cash equivalents of $478.0 million and $14.6
million as of June 30, 1998 and 1997, respectively. The Company had restricted
cash of $82.9 million and $4.3 million as of June 30, 1998 and 1997,
respectively. The restricted cash at June 30, 1998 primarily represents amounts
held in escrow to pay the first two years interest payments on the $105 million
of the 9.875% Senior Notes due 2005 of the Company and $265 million of the
Senior Notes of HER.
During the three and six months ended June 30, 1998, the Company used $7.3
million and $34.7 million, respectively, of cash for operating activities,
compared to $9.9 million and $23.3 million, respectively, used in the comparable
periods of 1997. Cash used for investing activities was $16.1 million and $53.2
million for the three months and six months ended June 30, 1998 and $5.6 million
and $17.1 million for the three and six months ended June 30, 1997,
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. 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.
In February 1998, the Company used approximately $85.2 million of the net
proceeds from the initial public offering and the $105.0 million Senior Notes to
repay $70.0 million plus accrued interest of debt 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.
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 Florint, Belgium Franc and the European Currency Equivalent. 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 is attempting 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 has developed risk management policies that establish
guidelines for managing foreign exchange risk. The Company is currently
evaluating the materiality of foreign exchange exposures in different countries
and the financial instruments available to mitigate this exposure. The Company's
ability to hedge its exposure is limited since certain of its operations are
located in countries whose currencies are not easily convertible. Financial
hedge instruments for these countries are nonexistent or limited and also
pricing of these instruments is often volatile and not always efficient. The
Company is designing reporting processes to monitor the potential exposure on an
ongoing basis and expects to implement this process before the end of 1998. The
Company will use the output of this process to execute financial hedges to cover
foreign exchange exposure when practical and economically justified.
In April 1998, the Company consummated an economic transaction to hedge the
foreign exchange exposure resulting from the issuance of $265 million senior
notes by HER.
26
<PAGE> 358
YEAR 2000 COMPLIANCE
The Company is currently in the process of assessing its year 2000
compliance costs and of converting, where necessary, its internal hardware and
software as well as customer facing telecommunications infrastructure to year
2000 compliance. 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.
27
<PAGE> 359
SUPPLEMENTAL INFORMATION -- SELECTED HISTORICAL
FINANCIAL DATA -- COMBINED EQUITY INVESTMENTS
The following unaudited selected historical financial data -- equity
investments for the three and six months ended June 30, 1997 and June 30, 1998,
are derived from the Company's financial records. It is intended to supplement
the unaudited condensed consolidated financial statements. 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 of
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>
NET
OWNERSHIP COST OF OPERATING INCOME/
INTEREST(1) REVENUES REVENUES EXPENSES (LOSS)
----------- -------- -------- --------- --------
<S> <C> <C> <C> <C> <C>
THREE MONTHS ENDED JUNE 30, 1997
Sovintel................................. 50% 28,977 18,073 4,260 5,035
TCM...................................... 50% 6,609 1,173 754 3,224
TeleRoss................................. 50% 1,302 266 1,122 (192)
Sovam.................................... 66.7%(4) 4,329 2,724 1,715 (263)
GTS Cellular Companies................... 50%(2) 9,292 4,560 4,815 (1,872)
Other.................................... 50%(2) 3,205 4,753 6,144 (8,719)
-------- -------- -------- ------- --------
Total............................ 53,714 31,549 18,810 (2,787)
Adjustments for Inter-Affiliate
Transactions(3).......................... (3,924) (4,898) (5,707)
THREE MONTHS ENDED JUNE 30, 1998(4)
Sovintel................................. 50% 34,703 22,646 5,169 5,294
TCM...................................... 50% 12,130 3,111 1,005 4,996
TeleRoss................................. 50% 2,648 775 1,254 295
GTS Cellular Companies................... 50%(2) 16,391 7,519 5,928 1,140
Other.................................... 50%(2) 7,512 6,620 1,916 (530)
-------- -------- -------- ------- --------
Total............................ 73,384 40,671 15,272 11,195
Adjustments for Inter-Affiliate
Transactions(3).......................... (8,753) (7,897) 5,529
SIX MONTHS ENDED JUNE 30, 1997
Sovintel................................. 50% 54,139 32,836 8,115 9,730
TCM...................................... 50% 12,935 2,708 1,354 6,134
TeleRoss................................. 50% 2,831 550 1,796 323
Sovam.................................... 66.7%(4) 8,032 5,112 3,074 (381)
GST Cellular Companies................... 50%(2) 17,337 8,225 8,405 (2,749)
Other.................................... 50%(2) 6,466 8,939 10,211 (13,878)
-------- -------- -------- ------- --------
Total............................ 101,740 58,370 32,955 (821)
Adjustments for Inter-Affiliate
Transactions(3).......................... (9,857) (9,658) (8,582)
SIX MONTHS ENDED JUNE 30, 1998(4)
Sovintel................................. 50% 67,107 44,603 9,815 9,639
TCM...................................... 50% 21,586 5,689 1,857 8,843
TeleRoss................................. 50% 5,040 1,492 2,232 620
GTS Cellular Companies................... 50%(2) 31,296 14,294 11,120 2,555
Other.................................... 50%(2) 12,038 10,980 3,040 (1,477)
-------- -------- -------- ------- --------
Total............................ 137,067 77,058 28,064 20,180
Adjustments for Inter-Affiliate
Transactions(3).......................... (17,643) (16,002) 9,687
</TABLE>
28
<PAGE> 360
- ---------------
(1) 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.
(2) The Company generally maintains a 50% ownership interest in these equity
investments.
(3) 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."
(4) As a result of the Company's purchase of the minority partner's 33.3%
interest in Sovam during the first quarter of 1998, the Company accounts for
its ownership interest in Sovam under the consolidation method of
accounting. Prior to this date, the Company accounted for Sovam under the
equity method of accounting.
29
<PAGE> 361
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) In conjunction with the restructuring of Bancomsvyaz, one of the
Company's subsidiaries, on June 30, 1998, the Company issued to an existing
shareholder, in a private placement, 713,311 shares of common stock. This stock
was issued pursuant to a contractual put right held by such shareholder, which
permitted the shareholder to put to the Company its $8.6 million of investment
in GTS Ukrainian TeleSystems LLC in exchange for such stock. See Note 5 to the
Company's unaudited Condensed, Consolidated Financial Statements included in
this report.
Pursuant to a purchase agreement that the Company has with a venture
partner in GTS Vox Limited, the intermediate holding company of TCM, the Company
issued 336,630 shares of common stock to the Partner in April 1998. See Note 3
to the Company's Unaudited Condensed, Consolidated Financial Statements included
in this report.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 20, 1998, the Company held its annual meeting of shareholders. In
connection with the meeting, the Company solicited proxies pursuant to
Regulation 14 under the Securities Exchange Act of 1934 from holders of record
of its common stock as of March 31, 1998. Each of the Company's four nominees
for election to its Board of Directors was elected to a term ending at the
Company's annual meeting of shareholders to be held in 2001. Three additional
proposals were submitted to shareholders for approval and the votes cast on each
such proposal was as follows:
Approval of the Company's Fourth Amended and Restated Stock Option Plan
For 24,925,951 shares Against 6,229,912 shares Abstain 36,095 shares
Approval of certain stock option grants to certain members of the Company's
Board of Directors
For 24,357,024 shares Against 6,796,169 shares Abstain 38,765 shares
Ratification of selection of Ernst & Young LLP as the Company's independent
auditors for 1998
For 30,619,182 shares Against 568,586 shares Abstain 4,190 shares
ITEM 5. OTHER INFORMATION
See Notes 5 and 7 to the Company's unaudited Condensed, Consolidated
Financial Statements included in this report.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<S> <C>
27 -- Financial Data Schedule
</TABLE>
B. Reports on Form 8-K
<TABLE>
<CAPTION>
DATE OF REPORT SUBJECT OF REPORT
-------------- -----------------
<S> <C>
None
</TABLE>
30
<PAGE> 362
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrants have duly caused this report to be signed on their behalf by the
undersigned thereunto duly authorized.
GLOBAL TELESYSTEMS GROUP, INC.
(Registrant)
By: /s/ WILLIAM H. SEIPPEL
----------------------------------
Name: William H. Seippel
Title: Executive Vice President
and
Chief Financial Officer
(Principal
Financial and Accounting
Officer)
Date: August 14, 1998
31
<PAGE> 363
ANNEX E
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
---------------------
(COMMISSION FILE NUMBER: 0-23717)
---------------------
GLOBAL TELESYSTEMS GROUP, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 94-3068423
(State of incorporation) (I.R.S. Employer Identification No.)
</TABLE>
1751 PINNACLE DRIVE, NORTH TOWER, 12TH FLOOR
MCLEAN, VIRGINIA 22102
(Address of principal executive office)
(703) 918-4500
(Registrant's telephone number, including area code)
---------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
At October 31, 1998, there were outstanding 60,502,708 shares of common
stock of the registrant.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 364
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I Financial Information.......................................
Item 1A Financial Statements of Global TeleSystems Group, Inc....... 3
Condensed Consolidated Balance Sheets as of December 31,
1997 and September 30, 1998............................... 4
Condensed Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 1997 and 1998... 5
Condensed Consolidated Statements of Cash Flows for the
Three and Nine Months Ended September 30, 1997 and 1998... 6
Notes to Condensed Consolidated Financial Statements........ 7
Item 1B Financial Statements of EDN Sovintel........................ 13
Condensed Balance Sheets as of December 31, 1997 and
September 30, 1998........................................ 14
Condensed Statements of Operations for the Three and Nine
Months Ended September 30, 1997 and 1998.................. 15
Condensed Statements of Cash Flows for the Three and Nine
Months Ended September 30, 1997 and 1998.................. 16
Notes to Condensed Financial Statements..................... 17
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 19
PART II Other Information...........................................
Item 2 Changes in Securities and Use of Proceeds................... 34
Item 5 Other Information........................................... 34
Item 6 Exhibits and Reports on Form 8-K............................ 34
Signatures............................................................. 35
</TABLE>
2
<PAGE> 365
PART I
FINANCIAL INFORMATION
ITEM 1A. FINANCIAL STATEMENTS OF GLOBAL TELESYSTEMS GROUP, INC.
Condensed Consolidated Balance Sheets as of December 31, 1997 and September
30, 1998
Condensed Consolidated Statements of Operations for the Three and Nine Months
Ended September 30, 1997 and 1998
Condensed Consolidated Statements of Cash Flows for the Three and Nine Months
Ended September 30, 1997 and 1998
Notes to Condensed Consolidated Financial Statements
3
<PAGE> 366
GLOBAL TELESYSTEMS GROUP, INC.
CONDENSED, CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
--------------- ----------------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents................................. $ 318,766 $ 993,928
Accounts receivable, net.................................. 17,079 59,822
Restricted cash........................................... 30,486 42,047
Prepaid expenses.......................................... 14,101 22,122
Other assets.............................................. 6,707 12,539
--------- ----------
TOTAL CURRENT ASSETS.............................. 387,139 1,130,458
Property and equipment, net................................. 236,897 436,019
Investments in and advances to ventures..................... 76,730 61,705
Goodwill and intangible assets, net......................... 43,284 161,893
Restricted cash and other noncurrent assets................. 36,411 24,818
--------- ----------
TOTAL ASSETS...................................... $ 780,461 $1,814,893
========= ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses..................... $ 61,984 $ 135,565
Debt maturing within one year............................. 6,390 23,741
Current portion of capital lease obligations.............. 21,490 31,130
Related party debt maturing within one year............... 5,708 --
Other current liabilities................................. 6,301 32,408
--------- ----------
TOTAL CURRENT LIABILITIES......................... 101,873 222,844
Long-term debt, less current portion........................ 408,330 962,232
Long-term portion of capital lease obligations.............. 117,645 187,900
Related party long-term debt, less current portion.......... 79,796 3,530
Taxes and other non-current liabilities..................... 14,595 27,378
--------- ----------
TOTAL LIABILITIES................................. 722,239 1,403,884
COMMITMENTS AND CONTINGENCIES
Minority interest......................................... 18,766 43,957
Common stock, subject to repurchase (797,100 and 463,489
shares outstanding at December 31, 1997 and September
30, 1998, respectively)................................ 12,489 15,643
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; 37,606,814 and 60,495,446 shares issued and
outstanding, net of 195,528 and 96,375 shares of
treasury stock at December 31, 1997 and September 30,
1998, respectively).................................... 3,761 6,050
Additional paid-in capital................................ 274,359 696,574
Accumulated other comprehensive loss...................... (8,269) (7,496)
Accumulated deficit....................................... (242,884) (343,719)
--------- ----------
TOTAL SHAREHOLDERS' EQUITY........................ 26,967 351,409
--------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $ 780,461 $1,814,893
========= ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE> 367
GLOBAL TELESYSTEMS GROUP, INC.
CONDENSED, CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- --------------------
1997 1998 1997 1998
-------- -------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
REVENUES, NET:
Telecommunication and other services............ $ 10,691 $ 61,405 $ 26,547 $ 111,195
Equipment sales................................. 2,230 2,429 3,669 6,104
-------- -------- -------- ---------
12,921 63,834 30,216 117,299
-------- -------- -------- ---------
OPERATING COSTS AND EXPENSES:
Cost of revenues:
Telecommunication and other services......... 13,361 37,045 25,169 77,525
Equipment sales.............................. 2,028 1,804 3,183 4,542
Selling, general and administrative............. 22,441 30,645 46,203 75,150
Depreciation and amortization................... 2,078 8,368 4,404 13,953
Non-income taxes................................ 452 3,820 1,452 5,140
-------- -------- -------- ---------
40,360 81,682 80,411 176,310
Write-off of venture-related assets............... 1,673 -- 1,673 --
Equity in losses/(earnings) of ventures........... 8,067 3,485 18,234 (4,142)
-------- -------- -------- ---------
LOSS FROM OPERATIONS.............................. (37,179) (21,333) (70,102) (54,869)
OTHER INCOME (EXPENSE):
Interest income................................. 3,116 13,858 5,278 28,110
Interest expense................................ (13,923) (22,009) (21,086) (52,603)
Foreign currency losses......................... (135) (7,333) (1,094) (10,364)
-------- -------- -------- ---------
(10,942) (15,484) (16,902) (34,857)
-------- -------- -------- ---------
Net loss before income taxes, minority interest
and extraordinary loss.......................... (48,121) (36,817) (87,004) (89,726)
Income taxes...................................... 1,021 770 1,838 2,151
-------- -------- -------- ---------
Net loss before minority interest and
extraordinary loss.............................. (49,142) (37,587) (88,842) (91,877)
Minority interest................................. 957 109 970 3,746
-------- -------- -------- ---------
Net loss before extraordinary loss................ (48,185) (37,478) (87,872) (88,131)
Extraordinary loss -- extinguishment of debt...... -- -- -- (12,704)
-------- -------- -------- ---------
NET LOSS.......................................... $(48,185) $(37,478) $(87,872) $(100,835)
======== ======== ======== =========
Loss per share before extraordinary loss.......... $ (1.34) $ (0.62) $ (2.49) $ (1.65)
Extraordinary loss per share...................... -- -- -- (0.24)
-------- -------- -------- ---------
Net loss per share................................ $ (1.34) $ (0.62) $ (2.49) $ (1.89)
======== ======== ======== =========
Weighted average common shares outstanding........ 35,928 60,182 35,242 53,253
======== ======== ======== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE> 368
GLOBAL TELESYSTEMS GROUP, INC.
CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- --------------------
1997 1998 1997 1998
-------- -------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss.............................................. $(48,185) $(37,478) $(87,872) $(100,835)
ADJUSTMENTS TO RECONCILE NET LOSS TO NET CASH (USED
IN) PROVIDED BY OPERATING ACTIVITIES:
Extraordinary loss.................................. -- -- -- 12,704
Depreciation and amortization....................... 4,695 17,060 9,173 33,544
Amortization of discount on note payable............ 1,288 -- 3,665 477
Equity in losses (earnings) of ventures, net of
dividends received............................... 8,067 3,485 18,234 (4,142)
Deferred interest................................... 4,273 -- 8,142 1,826
Fair value adjustment for foreign currency
instruments...................................... -- 18,016 -- 21,240
Write-off of venture-related assets................. 1,673 -- 1,673 --
Non-cash compensation............................... 3,390 493 3,390 493
Minority interest................................... (949) (79) (970) (7,924)
Other............................................... 1,741 6,779 2,325 9,684
Changes in assets and liabilities, excluding effects
of acquisitions and ventures:
Accounts receivable.............................. (2,843) (6,826) (5,723) (27,959)
Prepaid expenses................................. 5,005 (2,417) 4,387 (9,155)
Accounts payable and accrued expenses............ 10,710 16,473 7,386 35,594
Other changes in assets and liabilities.......... (4,546) 13,743 (2,743) 29,029
-------- -------- -------- ---------
NET CASH (USED IN) PROVIDED BY OPERATING
ACTIVITIES................................ (15,681) 29,249 (38,933) (5,424)
INVESTING ACTIVITIES
Investments in and advances to ventures, net of
repayments....................................... 10,716 8,120 (2,157) 15,055
Purchases of property and equipment................. (10,734) (71,892) (13,861) (111,734)
Restricted cash..................................... (56,128) 16,815 (55,813) 832
Goodwill and other intangibles...................... (798) (42,743) (2,226) (60,362)
Acquisitions -- cash acquired....................... 1,050 -- 1,050 13,352
-------- -------- -------- ---------
NET CASH USED IN INVESTING ACTIVITIES....... (55,894) (89,700) (73,007) (142,857)
FINANCING ACTIVITIES
Proceeds from debt.................................. 415,678 470,134 416,161 575,434
Repayments of debt.................................. (6,013) (175) (104,028)
Payment of debt issue costs......................... (24,178) (16,014) (24,178) (21,257)
Common stock repurchased for treasury............... -- -- (433) --
Net proceeds from issuance of common stock.......... 36,527 127,109 36,527 362,729
Other financing activities.......................... (25) -- (124) 9,471
-------- -------- -------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES... 428,002 575,216 427,778 822,349
Effect of exchange rate changes on cash and cash
equivalents......................................... (4,173) 1,167 (6,871) 1,094
-------- -------- -------- ---------
Net increase in cash and cash equivalents............. 352,254 515,932 308,967 675,162
Cash and cash equivalents at beginning of period...... 14,587 477,996 57,874 318,766
-------- -------- -------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD............ $366,841 $993,928 $366,841 $ 993,928
======== ======== ======== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE> 369
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. FINANCIAL PRESENTATION AND DISCLOSURES
The financial statements of Global TeleSystems Group, Inc. (the "Company"
or "GTS") included herein are unaudited and have been prepared in accordance
with generally accepted accounting principles for interim financial reporting
and in accordance with Securities and Exchange Commission regulations. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. Material
intercompany affiliate account transactions have been eliminated; however, other
adjustments may have been required had an audit been performed. In the opinion
of management, the financial statements reflect all adjustments of a normal and
recurring nature necessary to present fairly the Company's financial position,
results of operations and cash flows for the interim periods. These financial
statements should be read in conjunction with the Company's 1997 audited
consolidated financial statements and the notes related thereto. The results of
operations for the three and nine months ended September 30, 1998 may not be
indicative of the operating results for the full year.
The Company's operations are carried out through alliances with strategic
local partners in the form of venture arrangements. Wholly-owned subsidiaries
and majority-owned ventures where the Company has unilateral operating and
financial control are consolidated within the Company's financial results and
operations. 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 investments
that are accounted for by the equity method as a result of minority shareholder
rights, super-majority voting conditions or other governmentally imposed
uncertainties so severe that they prevent the Company from exercising unilateral
control of the venture. If the Company has little ability to exercise
significant influence over the ventures, those ventures are 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 recorded have been recovered.
2. RUSSIAN ECONOMIC CRISIS
On August 17, 1998 the exchange rate of the Russian ruble, relative to
other currencies, declined significantly. The following measures were
implemented by the Russian government: 1) The repayment of sovereign securities
were suspended; subsequently, secondary trading therein was halted. Since many
Russian banks had substantial investments in these securities, severe liquidity
problems resulted for the banks. 2) The value of the ruble was allowed to
fluctuate below the ruble/US dollar exchange rate corridor that the government
had previously committed to support; this represented an effective devaluation
of the ruble. 3) A 90-day moratorium on offshore credit repayments was issued.
The 90-day moratorium was not extended when it expired on November 16, 1998 and
it is anticipated that the ruble will continue to be devalued. Due to the
devaluation and the end of the 90-day moratorium, there is an ongoing risk that
many Russian banks may be declared bankrupt. Deposits held at Russian banks,
other than Sberbank, are not insured. The official exchange rate as of September
30, 1998 was 16.0645 per US dollar. The last official exchange rate prior to the
suspension of trading on August 17, 1998 was 6.2725 rubles per US dollar.
As a result of the devaluation of the ruble and the consequences of the
banking and economic crisis within Russia, the Company recorded a $13.1 million
pre-tax charge within its financial statements for the third quarter 1998, that
is mainly comprised of foreign currency exchange losses for ruble-denominated
net
7
<PAGE> 370
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
monetary assets with the remainder associated with estimates for uncollectible
accounts receivable and unrecoverable cash deposits in Russian banks.
3. POLICIES AND PROCEDURES
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income," which establishes
standards for reporting and display of comprehensive income and its components
in a full set of general purpose financial statements. Comprehensive income
(loss) is defined as the change in equity of a business enterprise during a
period from nonowner sources. Comprehensive loss was $50.3 million and $92.7
million for the three and nine months ended September 30, 1997, respectively,
and was comprised of net losses of $48.2 million and $87.9 million and foreign
currency translation adjustments of $2.2 million and $4.9 million for the three
and nine months ended September 30, 1997, respectively. Comprehensive loss was
$35.5 million and $100.1 million for the three and nine months ended September
30, 1998, respectively, and was comprised of net losses of $37.5 million and
$100.8 million and foreign currency translation income of $2.0 million for the
three months ended September 30, 1998 and foreign currency transaction income of
$0.8 million for the nine months ended September 30, 1998.
During 1997, the Company adopted SFAS No. 128, "Earnings Per Share," which
requires the Company to present basic and diluted earnings per share for all
periods presented. The Company's net loss per share calculation (basic and
diluted) is based upon the weighted average common shares issued. There are no
reconciling items in the numerator or denominator of the Company's net loss per
share calculation. Employee stock options, warrants, and convertible debt
instruments have been excluded from the net loss per share calculation because
their effect would be anti-dilutive.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", which will be
required to be adopted by January 1, 2000. This statement establishes accounting
and reporting standards requiring that every derivative instrument be recorded
in the balance sheet as either an asset or liability measured at its fair value.
The statement also requires that changes in the derivatives fair value be
recognized in earnings unless specific hedge accounting criteria are met. The
Company is currently assessing the impact of this new statement on its
consolidated financial position and results of operations.
Certain reclassifications have been made to the September 1997 condensed,
consolidated financial statements in order to conform to the 1998 presentation.
4. SHAREHOLDERS' EQUITY
In February 1998, the Company completed an initial public offering of 12.8
million shares of common stock at $20.00 per common share (the "Stock
Offering"). The Stock Offering resulted in the Company's common stock being
listed, under the symbol "GTSG", in the United States on the National
Association of Securities Dealers Automated Quotation Market and internationally
on the European Association of Securities Dealers Automated Quotation Market.
Net proceeds from the Stock Offering were approximately $235.6 million. As a
result of the Stock Offering, the Company no longer has an obligation to
repurchase the 797,100 shares of common stock that were subject to repurchase at
December 31, 1997.
In July 1998, the Company completed a secondary public offering of 2.8
million shares of common stock at $45.50 per common share. Net proceeds from the
offering were approximately $119.9 million. In addition, in conjunction with
such offering, shareholders of the Company sold 11.7 million shares of the
Company's common stock. The Company did not realize any of the proceeds of such
sale.
Pursuant to a purchase agreement that the Company has with a venture
partner, the Company issued 336,630 and 126,859 shares of common stock to the
partner in April 1998 and July 1998, respectively. In
8
<PAGE> 371
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
accordance with the purchase agreement, if such entity is unable to sell these
shares, the Company is obligated to assist the seller in locating a purchaser
for the Common Stock, and if the Company is unable to do so, to repurchase the
issued common stock. The shares issued are restricted and therefore, have been
classified as common stock subject to repurchase as of September 30, 1998.
In June 1998, pursuant to the Debt Obligation described below, 3,333,333
warrants were exercised at an exercise price of $9.33 per common share. An
additional 4,444,444 warrants to purchase the Company's common stock expire in
the first and second quarters of 2002.
5. DEBT OBLIGATIONS
In February 1998, the Company issued aggregate principal amount of $105.0
million of 9.875% senior notes due 2005 (the "Notes Offering" and together with
the Stock Offering, the "Offerings"). Net proceeds from the Notes Offering were
approximately $100.5 million. Approximately $19.6 million of the net proceeds
were placed in escrow for the first four semi-annual interest payments,
commencing August 15, 1998.
As a result of the completion of the Stock Offering, the interest rate on
the $144.8 million aggregate principal amount of 8.75% senior subordinated
convertible bonds due 2000, which were issued in July 1997 (the "Bonds") will
remain at 8.75% until maturity and the approximately $5.1 million of the 6.25%
additional interest that was previously accrued through the date of the Stock
Offering has been reflected as an increase to additional paid-in capital. Upon
completion of the Stock Offering, the Bonds became convertible into 7.2 million
common shares at a conversion price of $20.00 per share. During the nine-month
period ended September 30, 1998, a total of $25.4 million of the Bonds were
converted into approximately 1.3 million common shares of the Company's common
stock.
In July 1998, the Company issued aggregate principal amount of $466.9
million of 5.75% convertible senior subordinated debentures (the "Debentures")
that mature July 1, 2010 and will be redeemable from July 1, 2001 at the option
of the Company, at redemption prices as set forth in the Debentures agreement.
Net proceeds from the Debentures offering were approximately $452.1 million. The
Debentures are convertible into 8.5 million common shares at any time prior to
maturity or redemption at a conversion price of $55.05 per common share.
Interest on the Debentures will be payable semi-annually on January 1 and July
1, commencing January 1, 1999. The Debentures are subordinated to all existing
and future indebtedness of the Company, except for the Bonds, with which they
rank pari passu in right of payment.
In 1996, the Company entered into long-term obligations ("Debt
Obligations") totaling $70.0 million with lenders that are affiliated with and
are considered related parties to the Company as a result of their ownership of
the Company's common stock. In February 1998, approximately $85.2 million of the
net proceeds of the Offerings were used to repay the Debt Obligations plus
accrued interest. In addition, the unamortized discount costs and debt issuance
costs on the Debt Obligations were written off at the time of repayment,
resulting in the Company recording an extraordinary loss of $12.7 million.
6. OTHER TRANSACTIONS
In July 1998, a wholly-owned subsidiary of the Company purchased the
remaining 47.36% interest in GTS Vox Limited, which resulted in the Company's
beneficial ownership in TCM increasing from 50% to 95%. The total consideration
paid for the additional interest in GTS Vox Limited was $40.5 million. In
connection with this buy-out, a modification was made to the original stock
purchase agreement with the Company's partner in GTS Vox, in which the Company's
obligation to issue 126,859 shares of common stock to such partner was
accelerated to July 1998. Under the stock purchase agreement, the Company is
also obligated to assist the former partner in locating a buyer for these shares
of common stock and if unable to do so, the Company will repurchase the shares
of common stock. In addition to the above payments, the purchase agreement
includes guarantees of certain cash flow assumptions for GTS Vox Limited's
consolidated subsidiary. As a result of the purchase of the remaining 47.36% of
GTS Vox Limited, the Company accounts
9
<PAGE> 372
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
for GTS Vox Limited and TCM by the consolidation as opposed to the equity method
of accounting. The purchase price has been allocated to the net assets based on
the fair value at the date of acquisition. The excess purchase price over the
fair value of the net assets acquired was approximately $33.4 million, which has
been recorded as goodwill and is being amortized, on a straight-line basis, over
ten years.
In June 1998, the Company completed the restructuring of the capital and
ownership of Bancomsvyaz, one of its equity method investees, which resulted in
the Company's beneficial ownership increasing from approximately 25% to
approximately 57%. Prior to the restructuring, Bancomsvyaz was 49% owned by GTS
Ukrainian TeleSystems LLC ("UTS"), another equity method investee which was 60%
owned by the Company and 40% owned by a shareholder of the Company (the
"Shareholder"). The total consideration paid for the additional interest in
Bancomsvyaz was $11.4 million. In conjunction with this restructuring, the
Shareholder exercised its right to receive 0.7 million shares of the Company's
common stock in lieu of their ownership interest in UTS, and as a result, the
Company reclassified an $8.6 million short-term obligation as additional paid-in
capital. Further, the Shareholder contributed an additional $5.8 million for a
25% interest in UTS. As a result of the restructuring, as of June 30, 1998, UTS
and Bancomsvyaz are accounted for by the consolidation as opposed to the equity
method of accounting. The purchase price has been allocated to the net assets
based on the fair value at the date of acquisition. The excess purchase price
over the fair value of the net assets acquired was $1.2 million, which has been
recorded as goodwill and is being amortized, on a straight-line basis over five
years.
In June 1998, Hermes Europe Railtel B.V. ("HER") completed the acquisition
for ECU 90 million (approximately $99.5 million) from Ebone Holding Association
(the "Association") of a 75% interest in Ebone A/S ("Ebone"), a Tier 1 Internet
backbone provider, principally serving as a carriers' carrier for European
internet service providers. As part of the transaction, Ebone will purchase,
under a transmission capacity agreement, long-term rights on HER's network
valued at ECU 90 million. The purchase price has been allocated to the net
assets based on the fair value at the date of acquisition. The excess purchase
price over the fair value of the net assets acquired was $17.2 million, which
has been recorded as goodwill and is being amortized, on a straight-line basis
over five years. The members of the Association were offered the right to buy
shares of Ebone in the third quarter of 1998; however, HER's ownership interest
in Ebone was not reduced as a result of the offer.
In March 1998, the Company purchased an additional 10.3% interest in HER
from an existing shareholder of HER for ECU 13.5 million (approximately $14.6
million). As a result of the purchase, the Company owns approximately 89.4% of
HER. The purchase price has been allocated to the net assets based on the fair
value at the date of acquisition. The excess purchase price over the fair value
of the net assets acquired was $10.2 million, which has been recorded as
goodwill and is being amortized, on a straight-line basis over five years.
In February 1998, the Company acquired the remaining 33% interest in Sovam
Teleport from its minority partner and as a result Sovam became a wholly-owned
subsidiary of the Company and in 1998 is accounted for by the consolidation as
opposed to the equity method of accounting. The Company paid a nominal amount
for the 33% interest.
10
<PAGE> 373
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. FOREIGN CURRENCY TRANSACTIONS
On April 19, 1998, HER entered into a foreign currency swap transaction
agreement (the "Swap") with Rabobank International ("Rabo") in order to minimize
the foreign currency exposure resulting from the issuance in August 1997 of $265
million aggregate principal amount 11.5% Senior Notes due 2007 (the "Notes").
HER has marked the Swap to its fair value as of September 30, 1998 and the
resulting adverse change in the fair value of $20.4 million has been recorded as
a Noncurrent Liability on the balance sheet and recognized as a foreign currency
loss in the statement of operations. In addition, in July 1998, HER entered into
several forward exchange contracts, with terms ranging from thirty to ninety
days, to limit HER's exposure to foreign currency transactions. HER has marked
the outstanding contracts to their fair value as of September 30, 1998 and the
resulting adverse change in the fair value of $2.1 million has been recorded as
an Other Current Liability on the balance sheet and recognized as a foreign
currency loss in the statement of operations.
8. SUPPLEMENTAL CASH FLOW INFORMATION
The following table summarizes non-cash investing and financing activities
for the Company:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1998
------------- -------------
(IN THOUSANDS)
<S> <C> <C>
Capitalization of leases.................................. $42,950 $93,188
Exercise of warrants...................................... -- 31,110
Conversion of the Bonds into common stock................. -- 25,385
Additional consideration in relation to purchase of
interest in a CIS region subsidiary..................... 5,973 19,522
Reclassification of common stock subject to repurchase.... -- 12,489
Conversion of note payable into common stock.............. -- 8,635
Reclassification of accrued interest on the Bonds......... -- 5,052
</TABLE>
No significant non-cash activities were incurred for the three and nine
months ended September 30, 1997.
9. SUBSEQUENT EVENTS
On October 16, 1998, the Company initiated an offer (the "Offer") to
acquire the outstanding shares of NetSource Europe ASA ("NetSource Europe"), a
limited liability company organized under the laws of Norway for aggregate
consideration consisting of (i) 4,037,500 shares of Company common stock and
(ii) cash consisting of (A) $15 million and (B) the value in cash of 712,500
shares of Company common stock on the closing date of the Offer. An additional
$35 million (in cash or Company common stock, at the Company's election) may be
paid to the NetSource Europe shareholders and certain NetSource Europe managers
if NetSource Europe meets or exceeds certain quarterly and annual revenue,
operating margin and cashflow targets in calendar year 1999.
The boards of directors of both the Company and NetSource Europe have
approved the transaction and the NetSource Europe board of directors has
recommended to its shareholders that they accept the Offer. The Company's
consummation of the Offer is subject to acceptance of the Offer by holders of
not less than 67 percent of NetSource Europe's shares on a fully diluted basis,
completion of due diligence by the Company and NetSource Europe, receipt of
applicable regulatory approvals, and satisfaction of certain other conditions.
As of the end of the acceptance period, October 31, 1998, 90.2% (on a fully
diluted basis) of the shareholders of NetSource Europe had accepted the offer.
The Offer may be terminated by the Company or the above-
11
<PAGE> 374
GLOBAL TELESYSTEMS GROUP, INC.
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
referenced holders of NetSource Europe stock if the Offer has not been
consummated by November 30, 1998. During the course of the Company's due
diligence investigation, which is ongoing, the Company has identified certain
issues which are being discussed with NetSource Europe and certain of its
shareholders and which must be resolved to the parties satisfaction prior to the
consummation of the transaction. NetSource Europe is a European
telecommunications services company engaged primarily in the business of
reselling voice communications services with executive offices in Birmingham,
England and sales and operating offices in seven European countries.
The shares of Company common stock offered to NetSource Europe's
shareholders will not be registered under the Securities Act; however, GTS has
agreed to register, as soon as reasonably practicable, the shares of Company
common stock that will be issued as consideration to the NetSource Europe
shareholders.
12
<PAGE> 375
ITEM 1B. FINANCIAL STATEMENTS OF EDN SOVINTEL
Condensed Balance Sheets As of December 31, 1997 and September 30, 1998
Condensed Statements of Operations For the Three and Nine Months Ended
September 30, 1997 and 1998
Condensed Statements of Cash Flows For the Three and Nine Months Ended
September 30, 1997 and 1998
Notes to Condensed Financial Statements
13
<PAGE> 376
EDN SOVINTEL
CONDENSED BALANCE SHEETS
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
(IN THOUSANDS)
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents................................. $ 5,620 $ 2,012
Accounts receivable, less allowance for doubtful accounts
of $643 and $1,927 at December 31, 1997 and September
30, 1998............................................... 16,223 23,108
Restricted cash........................................... 485 205
Due from affiliated companies............................. 1,586 2,210
Inventory................................................. 1,697 1,906
Deferred tax asset........................................ 186 186
Prepaid expenses and other assets......................... 5,318 10,149
------- -------
TOTAL CURRENT ASSETS.............................. 31,115 39,776
Property and equipment, net of accumulated depreciation of
$14,557 and $19,361 at December 31, 1997 and September 30,
1998...................................................... 38,709 48,919
Deferred expenses........................................... 945 844
------- -------
TOTAL ASSETS...................................... $70,769 $89,539
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable.......................................... $ 5,725 $ 9,770
Accrued expenses.......................................... 3,194 4,318
Due to affiliated companies............................... 10,104 17,312
Note payable to shareholder............................... 39
Taxes and other liabilities............................... 2,438 1,979
------- -------
TOTAL LIABILITIES................................. 21,500 33,379
------- -------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Contributed capital....................................... 2,000 2,000
Retained earnings......................................... 47,269 54,160
------- -------
TOTAL SHAREHOLDERS' EQUITY........................ 49,269 56,160
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $70,769 $89,539
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
14
<PAGE> 377
EDN SOVINTEL
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------
1997 1998 1997 1998
-------- -------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
REVENUES, NET:......................................... $27,890 $32,391 $82,029 $99,498
COST OF REVENUES:...................................... 18,212 21,176 51,048 65,779
------- ------- ------- -------
Gross margin........................................... 9,678 11,215 30,981 33,719
OPERATING EXPENSES:
Selling, general and administrative.................. 2,740 5,731 8,175 12,093
Depreciation and amortization........................ 239 467 452 858
Non-income taxes..................................... 1,230 1,667 3,697 4,702
------- ------- ------- -------
TOTAL OPERATING EXPENSES..................... 4,209 7,865 12,324 17,653
Income from operations................................. 5,469 3,350 18,657 16,066
OTHER (EXPENSE) INCOME:
Interest income...................................... 72 59 176 157
Interest expense..................................... (173) -- (447) --
Foreign currency losses.............................. (18) (5,197) (87) (5,490)
------- ------- ------- -------
(119) (5,138) (358) (5,333)
------- ------- ------- -------
Net income (loss) before taxes......................... 5,350 (1,788) 18,299 10,733
Income taxes........................................... 864 960 4,084 3,842
------- ------- ------- -------
NET INCOME (LOSS)............................ $ 4,486 $(2,748) $14,215 $ 6,891
======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
15
<PAGE> 378
EDN SOVINTEL
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
1997 1998 1997 1998
-------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss).................................... $ 4,486 $(2,748) $ 14,215 $ 6,891
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO NET
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
Depreciation and amortization...................... 1,590 1,995 3,817 4,905
Provision for doubtful accounts.................... (225) 1,511 (577) 1,284
Income tax benefit................................. (665) -- (665) --
Changes in assets and liabilities:
Accounts receivable............................. 7,845 (3,185) 1,126 (8,169)
Inventory....................................... (965) (563) (1,087) (209)
Prepaid expenses and other assets.................. (687) 1,740 (2,216) (5,455)
Accounts payable and accrued expenses.............. (2,186) 538 1,937 4,710
------- ------- -------- --------
NET CASH PROVIDED BY (USED IN) OPERATING
ACTIVITIES............................... 9,193 (712) 16,550 3,957
INVESTING ACTIVITIES
Purchases of property and equipment................ (2,773) (7,893) (11,329) (15,014)
Restricted cash.................................... 6 263 (16) 280
------- ------- -------- --------
NET CASH USED IN INVESTING ACTIVITIES...... (2,767) (7,630) (11,345) (14,734)
FINANCING ACTIVITIES
Repayment of shareholder note...................... (1,523) -- (2,251) (39)
Due to affiliated companies........................ (2,022) 7,089 (519) 7,208
------- ------- -------- --------
Net cash (used in) provided by financing
activities......................................... (3,545) 7,089 (2,770) 7,169
------- ------- -------- --------
Net increase (decrease) in cash and cash
equivalents........................................ 2,881 (1,253) 2,435 (3,608)
Cash and cash equivalents at beginning of period..... 3,160 3,265 3,606 5,620
------- ------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD........... $ 6,041 $ 2,012 $ 6,041 $ 2,012
======= ======= ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
16
<PAGE> 379
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, 1997 and September 30, 1998, and
the results of operations and cash flows for the periods indicated.
The Company was established as a competitive local exchange carrier (CLEC)
in August 1990. Through the design, construction, and operation of a
telecommunications network in Moscow, the Company provides its customers,
principally major hotels, business offices and mobile communications companies,
with an alternative to the local telephone company for worldwide communications
services. 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 May 1, 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. Currently, customers have the option of being billed in
rubles or dollars. All payments from Russian companies are made in rubles.
The venture is a Russian limited liability partnership. The Company is 50%
owned by Open Joint Stock Company "Rostelecom," an intercity and long distance
carrier which is 38% owned by Svyazinvest, and 50% owned by Sovinet, a US
general partnership, which is owned by two wholly-owned Global TeleSystems
Group, Inc. ("GTS") subsidiaries.
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 1997 audited financial statements and the notes related thereto. The
results of operations for the three and nine months ended September 30, 1998 may
not be indicative of the operating results for the full year.
The Company also maintains its records and prepares its financial
statements in Russian rubles 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 Russian statutory
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 certain accrued revenue and expenses, foreign
currency translation, deferred taxation, and depreciation and valuation of
property and equipment. 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.
2. RUSSIAN ECONOMIC CRISIS
On August 17, 1998 the exchange rate of the Russian ruble, relative to
other currencies, declined significantly. The following measures were
implemented by the Russian government: 1) The repayment of sovereign securities
were suspended; subsequently, secondary trading therein was halted. Since many
Russian banks had substantial investments in these securities, severe liquidity
problems resulted for the banks. 2) The value of the ruble was allowed to
fluctuate below the ruble/US dollar exchange rate corridor that the government
had previously committed to support; this represented an effective devaluation
of the ruble. 3) A 90-day moratorium on offshore credit repayments was issued.
The 90-day moratorium was not extended when it expired on November 16, 1998 and
it is anticipated that the ruble will continue to be devalued. Due to the
devaluation and the end of the 90-day moratorium, there is an ongoing risk that
many Russian banks may be
17
<PAGE> 380
EDN SOVINTEL
NOTES TO CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
declared bankrupt. Deposits held at Russian banks, other than Sberbank, are not
insured. The official exchange rate as of September 30, 1998 was 16.0645 per US
dollar. The last official exchange rate prior to the suspension of trading on
August 17, 1998 was 6.2725 rubles per US dollar.
As a result of the devaluation of the ruble and the consequences of the
banking and economic crisis within Russia, the Company recorded a $7.4 million
pre-tax charge within its financial statements for the third quarter 1998, that
is mainly comprised of foreign currency exchange losses for ruble-denominated
net monetary assets with the remainder associated with estimates for
uncollectible accounts receivable and unrecoverable cash deposits in Russian
banks.
3. POLICIES AND PROCEDURES
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 130, "Reporting Comprehensive Income," which establishes
standards for reporting and display of comprehensive income and its components
in a full set of general purpose financial statements. Comprehensive income is
defined as the change in equity of a business enterprise during a period from
nonowner sources. For the three and nine months ended September 30, 1997 and
1998, comprehensive income for the Company is equal to net income (loss).
4. CONTINGENCIES
Legislation and regulations regarding taxation, foreign currency
transactions and licensing of foreign currency loans in the Russian Federation
continues to evolve as the central government manages the transformation from a
command to a market-oriented economy. The various legislation and regulations
are not always clearly written and their interpretation is subject to the
opinions of the tax inspectors, Central Bank officials and the Ministry of
Finance. Instances of inconsistent opinions between local, regional and national
tax authorities and between the Central Bank and Ministry of Finance are not
unusual.
The Company believes that it has paid or accrued all taxes that are
applicable. Where practice concerning the provision of taxes is unclear, the
Company has accrued tax liabilities based on management's best estimate. 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.
Because of the uncertainties associated with the Russian tax and legal
systems, the ultimate amount of taxes, penalties and interest, if any, assessed
may be in excess of the amount expensed to date and accrued at December 31, 1997
and September 30, 1998.
The Company's operations and financial position will continue to be
affected by Russian political developments, including the application of
existing and future legislation and tax regulations. The Company does not
believe that these contingencies, as related to its operations, are any more
significant than those of similar enterprises in Russia.
18
<PAGE> 381
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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, Central Europe and Asia. In Western Europe, through HER, GTS
is continuing to develop and operate 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.
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
19
<PAGE> 382
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 minority
shareholder rights, super-majority voting conditions or other governmentally
imposed uncertainties so severe that they prevent the Company from exercising
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, 1998, $8.3
million and $7.6 million represent 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 issuance in August 1997, of $265
million aggregate principal amount of 11.5% senior notes due 2007, the Company
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.
20
<PAGE> 383
The following table, as of September 30, 1998, 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> <C>
CIS
Sovintel................................ Russia 50 % Equity
TCM..................................... Russia 95 %(1) Consolidated(1)
TeleRoss Operating Company.............. Russia 100 %(2) Consolidated
TeleRoss Ventures....................... Russia 50 %(3) Equity
Sovam................................... Russia 100 %(4) Consolidated(4)
GTS Cellular............................ CIS 50%-75 %(5) Equity/Consolidated
Western Europe
HER..................................... Western Europe 89 %(6) Consolidated(6)
GTS-Monaco Access....................... Monaco 50 % Equity
Central Europe
GTS-Hungary............................. Hungary 99 % Consolidated
EuroHivo................................ Hungary 70 %(7) 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) During the quarter ended September 30, 1998, the Company purchased the
remaining 47.36% interest in GTS Vox Limited, the intermediate holding
company of TCM. As a result, effective July 1998, the Company will have a
95% indirect interest in TCM and will also account for its interest in TCM
using the consolidation as opposed to the equity method of accounting.
(2) The TeleRoss Operating Company is comprised of a wholly-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" and "Business -- Russia
and the CIS -- TeleRoss." A significant portion of TeleRoss Operating
Company's costs of revenue consists of settlement fees paid to the TeleRoss
Ventures [as defined in (3) below], with such fees being recorded as revenue
by the TeleRoss Ventures. To date, 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.
(3) TeleRoss Ventures is comprised of fourteen 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 accounted for under the equity method of
accounting. TeleRoss Ventures' operations are further discussed in
"-- Results of Operations -- Non-Consolidated Ventures."
(4) GTS purchased the remaining 33% interest in Sovam in February 1998 and as a
result, effective February 1998, Sovam is accounted for by the consolidation
as opposed to the equity method of accounting.
(5) GTS conducts its cellular operations through (i) Vostok Mobile, a wholly
owned GTS venture that owns between 50% and 100% of a series of thirteen
cellular joint ventures in various regions in Russia, (ii) PrimTelefone, a
50% owned venture in Vladivostok, Russia and (iii) Bancomsvyaz, an
approximately 57% beneficially owned venture in Kiev, Ukraine. The Company
completed a restructuring of the capital and ownership of Bancomsvyaz on
June 30, 1998, which results in GTS beneficially owning approxi-
21
<PAGE> 384
mately 57% of Bancomsvyaz. As a result, effective June 30, 1998, Bancomsvyaz
is accounted for by the consolidation as opposed to equity method of
accounting.
(6) As of July 16, 1997, HER is accounted for by the consolidation as opposed to
the equity method of accounting. In addition, in March 1998, GTS acquired an
additional 10% interest in HER.
(7) The Company sold its interest in EuroHivo in August 1998. The closing of
this transaction did not have a material effect on the Company's results
from operations and financial condition.
Russian Economic Crisis. The Company recorded a $13.1 million pre-tax
charge to earnings in its third quarter 1998 financial results that resulted
from the devaluation of the ruble and the consequences of the banking and
economic crisis within Russia. See "Liquidity and Capital Resources".
Further, as identified in the preceding table that summarizes the
accounting methodology for the Company's principal business ventures, several of
the Company's business ventures within Russia are accounted for under the equity
method of accounting. Accordingly, the $13.1 million pre-tax charge; that is
mainly comprised of foreign currency exchange losses for ruble-denominated net
monetary assets with the remainder associated with estimates for uncollectible
accounts receivable and unrecoverable cash deposits in Russian banks, is
primarily reflected in the "equity in losses/(earnings) of ventures" line item
with the remainder in the "foreign currency losses" and "selling, general and
administrative" line items within the Company's Condensed, Consolidated
Statements of Operations.
RESULTS OF OPERATIONS -- CONSOLIDATED VENTURES
Management's discussion included within "-- Results of
Operations -- Consolidated Ventures" reflects the following significant
operating ventures: TeleRoss Operating Company, Sovam, TCM, Bancomsvyaz, HER,
GTS-Hungary and the Czech Companies. Although the Company was not able to follow
the consolidation method of accounting for Sovam, TCM and Bancomsvyaz in the
three and nine months ended September 30, 1997, and TCM and Bancomsvyaz for the
first six months of 1998, the Company has included, for comparative purposes, a
discussion of their financial performance for the three and nine months ended
September 30, 1997, and nine months ended September 30, 1998, respectively, in
our discussion of "Results of Operations -- Consolidated Ventures." See "Results
of Operations -- Non-Consolidated Ventures (Equity Investees)" for a discussion
of the operating results of Sovintel, TeleRoss Ventures, GTS Cellular and GTS-
Monaco Access.
Revenue. The Company's consolidated revenue was $63.8 million and $117.3
million for the third quarter and year to date ended September 30, 1998,
respectively, which was $50.9 million and $87.1 million above the same periods
in 1997. The growth in revenue was primarily attributable to the inclusion of
HER, TeleRoss, Sovam, TCM and Bancomsvyaz in the Company's consolidated
financial results, who contributed $42.9 million, $22.2 million, $18.8 million,
$12.3, and $7.0 million, respectively, for the nine months ended September 30,
1998. TCM and Bancomsvyaz third quarter revenues are included in the Company's
consolidated revenues for the third quarter and year to date ended September 30,
1998.
The CIS region's consolidated revenue increased 345.1% and 237.1% to $31.6
million and $60.0 million for the three and nine months ended September 30,
1998, respectively, from the comparable periods in 1997. TeleRoss Operating
Company generated revenue of $6.8 million and $22.2 million, representing 21.5%
and 37.0% of the CIS region's consolidated revenue for the three and nine months
ended September 30, 1998, respectively. The growth in TeleRoss Operating Company
revenue of 35.4% for the year to date from the same periods last year was the
result of the increase in traffic volume generated by the TeleRoss Ventures due
to the increase in the number of cities and number of VSAT's installed at
customer locations outside of cities in which they have a presence.
Sovam generated revenue of $6.4 million and $18.8 million for the three and
nine months ended September 30, 1998, respectively. The 30.6% and 45.7% increase
from prior year periods in Sovam revenue is primarily attributable to the
expansion of Sovam's network throughout Russia and the CIS and the wider variety
of service offerings. (Sovam was an equity method company in 1997.)
22
<PAGE> 385
TCM's revenue for the three and nine months ended September 30, 1998
increased 57.7% and 63.8% to $12.3 million and $33.9 million, respectively, from
the comparable periods in 1997. This increase was primarily due to increases in
local and international/long distance traffic revenue and increases in monthly
port charges and the sale of additional local access lines. (TCM was an equity
method company prior to July 1, 1998.)
Revenue for Bancomsvyaz was $7.0 million and $16.9 million for the three
and nine months ended September 30, 1998, respectively, which represents a
218.2% and 322.5% increase from the comparable periods in 1997. The growth in
revenue was primarily attributable to the increase in cellular subscribers.
(Bancomsvyaz was an equity method company prior to July 1, 1998.)
HER generated $27.0 million and $42.9 million of revenue in the three and
nine months ended September 30, 1998, respectively, compared to $1.7 million and
$2.3 million, respectively, in the same periods in 1997 (HER was an equity
method company prior to July 1997). The growth in revenue is attributable to the
continued deployment of the HER network as well as the inclusion of Ebone, whose
revenue was $7.4 million for the three months ended September 30, 1998. HER
commenced commercial service over the Brussels-Amsterdam route in late 1996, the
London-Paris portion in November 1997, Frankfurt, Zurich, Geneva, Stuttgart,
Dusseldorf and Munich were added in the second quarter of 1998, and Milan was
added during the third quarter of 1998.
The Central Europe region's consolidated revenue increased 29.4% and 32.6%
to $4.4 million and $12.6 million for the three and nine months ended September
30, 1998, respectively, from the comparable periods in 1997. This growth is
attributable to the expansion of the customer base and product offerings of
these businesses.
Gross Margin. GTS's consolidated gross margin was $25.0 million and $35.2
million, or 39.2% and 30.0% of revenue, for the three and nine months ended
September 30, 1998, respectively, and ($2.4) million and $1.9 million, or
(18.6%) and 6.3% of revenue, for the three and nine months ended September 30,
1997, respectively.
Sovam represented 11.2% and 25.0% of the consolidated gross margin for the
three and nine months ended September 30, 1998, respectively. (Sovam was an
equity method company in 1997.) Sovam had gross margin as a percentage of
revenues of 43.8% and 46.8% for the three and nine months ended September 30,
1998, respectively. The increase of 0.9% and 8.0% in gross margin as a
percentage of revenue in comparison to the same periods in 1997 reflects the
higher margin service offerings that Sovam is currently providing and also
management's focus to improve its cost structure; i.e., the negotiation of
improved channel costs from suppliers and controlled growth in both personnel
and capital expenditures.
The TeleRoss Operating Company represented 1.2% and 6.0% of the
consolidated gross margin for the three and nine months ended September 30,
1998, respectively, and 20.8% and 52.6% for the three and nine months ended
September 30, 1997, respectively. TeleRoss had gross margin as a percentage of
revenue of 4.4% and 9.5% for the three and nine months ended September 30, 1998,
respectively. The increase of 12.1% and 3.4% in margin as a percentage of
revenue in comparison to the comparable periods in 1997 reflects the overall
increase in revenue as discussed above.
TCM represented 36.0% of the consolidated gross margin for the third
quarter 1998 (TCM was an equity method company prior to July 1, 1998). TCM had
gross margin as a percentage of revenues of 73.2% and 73.5% for the three and
nine months ended September 30, 1998, respectively. Gross margin as a percentage
of revenue decreased 1.2% and 3.8% in comparison to the same period in 1997 as a
result of higher infrastructure and settlement costs.
Bancomsvyaz represented 17.6% of the consolidated gross margin for the
third quarter 1998 (Bancomsvyaz was an equity method company prior to July 1,
1998). Bancomsvyaz's gross margin was 62.9% and 58.6% of revenue for the three
months ended September 30, 1998 compared to gross margin of 54.5% and 37.5% of
total revenue for the comparable periods during 1997.
23
<PAGE> 386
HER had a favorable effect on consolidated gross margins of $7.3 million
and $6.3 million for the three months and nine months ended September 30, 1998.
For comparative purposes, HER had an unfavorable gross margin of ($1.0) million
and ($3.7) million for the three and nine months ended September 30, 1997 (HER
was an equity method company prior to July 1997). HER represented 29.2% and
17.9% of the consolidated gross margin for the three and nine months ended
September 30, 1998. The improvement in gross margins in 1998 as compared to 1997
is reflective of the increased utilization of the network as well as the
inclusion of Ebone, whose gross margin was $3.9 million for the three months
ended September 30, 1998.
The Central European region had gross margin as a percentage of revenue of
31.8% and 33.3% for the three and nine months ended September 30, 1998,
respectively. The decrease of 3.5% and 5.6% in gross margin as a percentage of
revenue in comparison to the comparable periods in 1997 primarily reflects the
startup activities of the GTS Net product offering in Hungary.
Operating Expenses. Consolidated operating costs were $42.8 million and
$94.2 million for the three and nine months ended September 30, 1998,
respectively, a 71.5% and 81.0% increase above the comparable periods in 1997.
The increase in operating costs is attributable to the inclusion of HER, Sovam,
TCM and Bancomsvyaz in the Company's consolidated financial results, the growth
in expenditures associated with building business infrastructure for primarily
the TeleRoss Operating Company and costs attributable to increasing the
corporate staff.
Equity in (Losses)/Earnings of Ventures. GTS recognized (losses)/earnings
of ($3.5) million and $4.1 million for its investments in non-consolidated
ventures in the three and nine months ended September 30, 1998, respectively, as
compared to recognizing losses of $8.1 million and $18.2 million in the
comparable periods, respectively, in 1997. This improvement was primarily the
result of HER and Bancomsvyaz no longer being equity method investees offset by
a $7.7 million charge to earnings associated with the Company's business
operations in Russia as a result of the deterioration of the economic conditions
in Russia during the quarter. The $7.7 million charge is principally comprised
of foreign exchange losses with the remainder associated with estimates for
uncollectible accounts receivable and unrecoverable cash deposits in Russian
banks. In addition, the Company's third quarter 1997 financial results were
unfavorably affected by management's decision to write-off certain investments
in and advances to ventures in Asia and Central Europe. As a result of the
application of the Company's previously discussed profit and loss accounting,
additional losses of $1.6 million were recognized for the three and nine months
ended September 30, 1998. Included in the quarter and year to date results for
September 30, 1997 were $3.1 million and $10.9 million of additional losses. See
"Results of Operations -- Non-Consolidated Ventures (Equity Investees)" for a
discussion of the results of operations of the Company's significant equity
investees.
Interest, Net. GTS earned interest income of $13.9 million and $28.1
million for the three and nine months ended September 30, 1998, respectively, a
344.7% and 432.6% increase over the same periods in 1997, primarily as a result
of investing the proceeds from the Company's 1997 and 1998 capital raise
efforts. See "-- Liquidity and Capital Resources."
GTS incurred interest expense of $22.0 million and $52.6 million for the
three and nine months ended September 30, 1998, respectively, which was 58.1%
and 149.5% above the comparable periods in 1997. The significant increase in
interest expense was due to the $571.9 million increase in debt raised in 1998
and the $409.8 million debt raised in 1997. See "-- Liquidity and Capital
Resources."
Foreign Currency Losses. GTS recognized foreign currency losses of $7.3
million and $10.4 million for the three and nine months ended September 30,
1998. These losses are primarily attributable to the devaluation of the Russian
ruble and foreign currency exposure at HER. HER has recorded foreign exchange
losses due to its foreign exchange exposure associated with its issuance in
August 1997 of aggregate principal $265 million U.S. dollar denominated debt,
other U.S. dollar denominated cash and payable balances, losses on several
forward exchange contracts and the weakening of the U.S. dollar versus European
currencies in the third quarter of 1998. See "-- Liquidity and Capital
Resources -- Liquidity Analysis" for further discussion.
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Provision for Income Taxes. The Company's consolidated tax provision was
$0.8 million and $2.2 million for the three and nine months ended September 30,
1998 and $1.0 million and $1.8 million for the three and nine months ended
September 30, 1997, respectively. 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 non-U.S. loss
carryforwards will be allowed, in part or in full, by local tax authorities
against future income.
Extraordinary Loss. The Company recognized a $12.7 million extraordinary
charge to earnings in the first quarter of 1998, as a result of the Company's
early extinguishment of certain related party debt obligations. The nature of
the charge is comprised of the write-off of $11.6 million of unamortized debt
discount and $1.1 million of unamortized debt issuance costs that were deferred
as financing costs and were being amortized over the original maturity of the
debt.
RESULTS OF OPERATIONS -- NON-CONSOLIDATED VENTURES (EQUITY INVESTEES)
Russia -- CIS
Sovintel. Sovintel's revenue was $32.4 million and $99.5 million for the
third quarter and year to date ended September 30, 1998, which increased $4.5
million and $17.5 million over revenues for the comparable periods in 1997. The
growth in revenue was primarily the result of telecommunications service
revenue, which increased 8.3% and 14.3% to $21.8 million and $70.2 million for
the three and nine months ended September 30, 1998, respectively, from
comparable periods in 1997, 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. Sovintel realized a
35.4% and 28.7% increase in outgoing international and domestic revenues for the
three and nine months ended September 30, 1998, as compared with the same
periods a year ago. Revenue from incoming international minutes decreased by
55.1% and 38.5% to $1.5 million and $6.1 million for the three and nine months
ended September 30, 1998, respectively, from the same periods in 1997.
Sovintel's non-traffic-related revenue increased 36.6% and 42.4% to $10.6
million and $29.3 million for three and nine months ended September 30, 1998,
respectively, over the comparable periods in 1997, which was primarily
attributable to port sales and monthly port fees revenue.
Sovintel's gross margin as a percentage of revenues was 34.6% and 33.9%,
for the three and nine months ended September 30, 1998, and was 34.8% and 37.8%
for comparable periods in 1997. The decrease in gross margin as a percentage of
revenue for the respective periods in 1998 and 1997 was attributable to a
general price decrease in international and domestic revenue due to competitive
pressures and a higher percentage of domestic minutes, which yield a lower
margin.
Operating expenses were $7.9 million and $17.7 million, or 24.4% and 17.8%
of total revenue, for the three and nine months ended September 30, 1998. The
increase of 9.3% and 2.8% in operating expenses in comparison to the same
periods in 1997 was primarily due to charges related to the Russian financial
crisis, specifically, $1.9 million of uncollectible accounts receivable and $0.4
million in unrecoverable cash.
Sovintel recorded a foreign exchange loss of $5.2 million during the
quarter, of which $5.1 million was attributable to the devaluation of the ruble
in mid-August 1998.
TeleRoss Ventures. Revenue for the TeleRoss Ventures increased 4.3% and
45.1% to $2.4 million and $7.4 million for the three and nine months ended
September 30, 1998, respectively, from the comparable periods in 1997. Revenues
were primarily resulted from settlement fees charged to TeleRoss Operating
Company. The growth in revenue reflects the growth of the customer base.
Gross margin as a percentage of revenue was 75.0% and 71.6% for the three
and nine months ended September 30, 1998, respectively, compared to 60.9% and
72.5% for the three and nine months ended September 30, 1997, respectively.
Operating expenses were $1.0 million and $3.2 million, or 41.7% and 43.2% of
revenue, for the three and nine months ended September 30, 1998, respectively,
compared to 30.4% and 49.0% of revenue, for the comparable periods in 1997.
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GTS Cellular. The Company operates three cellular networks through
differing ownership structures: Vostok Mobile, PrimTelefone and Bancomsvyaz
(consolidated for the three months ended September 30, 1998).
Revenue for Vostok Mobile was $6.2 million and $20.9 million for the three
and nine months ended September 30, 1998, respectively, which represented a
47.6% and 39.3% increase from the comparable periods in 1997. The growth in
revenue was primarily attributable to subscriber growth.
Vostok Mobile's gross margin was 40.9% and 46.9% of revenue, for the three
and nine months ended September 30, 1998, respectively, compared to 45.2% and
50.7% of revenue, for the comparable periods in 1997. Operating expenses were
$5.5 million and $11.7 million, or 88.7% and 56.0% of revenue, for the three and
nine months ended September 30, 1998, respectively, compared to ($0.2) million
and $4.8 million, or (4.8%) and 32% of revenue, for the comparable periods in
1997.
Vostok Mobile recorded a foreign exchange loss of $2.4 million during the
third quarter 1998, that resulted primarily from the devaluation of the ruble in
mid-August 1998.
Revenue for PrimTelefone was $2.9 million and $10.2 million for the three
and nine months ended September 30, 1998, respectively, which represented a 9.4%
decrease and a 24.4% increase from the comparable periods in 1997. The decrease
in current period revenue is due to decreases in airtime, subscriber fees and
handset sales during the third quarter of 1998. The growth in year to date
revenue was primarily attributable to the subscriber growth in the first and
second quarters of 1998.
PrimTelefone's gross margin was 58.6% and 57.8% of total revenue, and
operating expenses were $0.9 million and $3.2 million for the three and nine
months ended September 30, 1998, respectively, compared to gross margin of 43.8%
and 57.3% of total revenue, and operating expenses of $1.2 million and $2.7
million, respectively, for the comparable periods in 1997.
Western Europe
GTS-Monaco Access: Total revenue was $6.8 million and $18.7 million for the
three and nine months ended September 30, 1998, respectively, which represented
a 100.0% and 136.7% increase from the comparable periods in 1997. Gross margin
was ($0.3) million and $0.7 million, or (4.4%) and 3.7% of revenue, for the
three and nine months ended September 30, 1998, respectively, compared to $0.3
million and $0.4 million, or 7.7% and 5.1% of revenue, for the comparable
periods in 1997. The decrease in gross margin for the third quarter of 1998 is
primarily the result of service credit recorded in September.
LIQUIDITY AND CAPITAL RESOURCES
Corporate
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 $358.6 million, $36.4 million, $107.7 million, $42.1 million and $62.1
million in the first nine months of 1998, and in the full years of 1997, 1996,
1995 and 1994, respectively, net of placement fees, for a total of $606.9
million. In addition, the Company and HER received $571.9 million, $409.8
million, $60.0 million and $23.3 million in gross proceeds in the first nine
months of 1998, and in the full years of 1997, 1996 and 1995, respectively, for
a total of $1,065.0 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, of which
$70.0 million was repaid in 1998.
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The Company had working capital of $907.6 million and $353.4 million as of
September 30, 1998 and 1997, respectively. The Company had an accumulated
deficit of $343.7 million as of September 30, 1998, including net losses of
approximately $37.5 million and $100.8 million for the three and nine months
ended September 30, 1998 and $48.2 million and $87.9 million for the three and
nine months ended September 30, 1997, respectively. During 1998, 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 spend over $800 million in cash related to capital expenditures
and investments in ventures during the next three years. The Company obtained
funds in 1998 through a variety of financing arrangements, including (i)
approximately $255.3 million in gross proceeds from an initial public stock
offering of 12.8 million common shares at $20.00 per common share, (ii) $105.0
million in gross proceeds from the sale of 9.875% senior notes due February 15,
2005, of which $19.6 million was placed in escrow to fund the first two years'
interest payments. The initial public stocking offering constituted a "complying
public equity offering" under the Company's 8.75% Senior Subordinated
Convertible Bonds due 2000 (the "Bonds"), and as a result, the conversion price
of the Bonds is $20 per share, (iii) approximately $127.4 million in gross
proceeds from a secondary public stock offering of 2.8 million shares of common
stock at $45.50 per common share, and (iv) approximately $466.9 million in gross
proceeds from the sale of 5.75% convertible senior subordinated debentures (the
"Debentures") that mature July 1, 2010. The debentures are redeemable from July
1, 2001 at the option of the Company, at redemption prices set forth in the
Debentures agreement and are convertible into shares of common stock at any time
prior to maturity or redemption at a conversion price of $55.05 per common
share. The Debentures are subordinated to all existing and future indebtedness
of the Company, except for the Bonds, with which they rank pari passu in right
of payment.
The Company believes that its existing cash balances and cash flow from
operations will be sufficient to fund its expected capital needs under its
current business plan, excluding any funds expended in connection with the
implementation of the Company's European Services Strategy. See "Liquidity and
Capital Resources -- European Services Strategy." The Company contemplates that
it will raise additional debt financing through a newly formed subsidiary of the
Company, the proceeds of which will be applied toward the implementation of the
Company's European Services Strategy. The Company has not yet determined the
actual amount and timing of such financing.
The actual amount and timing of the Company's future capital requirements
may differ materially from management's estimates. In particular, the accuracy
of management's estimates is 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 political, economic and 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 ventures in excess of forecast
amounts. In addition, certain of the Company's 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 the Bonds upon maturity on June 30, 2000 to the
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extent the 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 will need to raise 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. HER has spent approximately $136 million on
network capital expenditures through September 30, 1998 and expects to incur an
additional $318 million through 2000 in order to complete the buildout of the
core network. The total capital expenditures required to complete the buildout
of the core 33 city, 15 country network has increased approximately $164 million
as a result of additional routes currently being planned, excluding
transatlantic routes, and increased spending on network equipment in order to
increase the capacity of the network based on current forecasted requirements.
Additionally, as of September 30, 1998, the Company has capitalized $242.2
million in connection with long-term fiber lease arrangements and expects to
capitalize an additional $93 million through 2000 in order to complete the
buildout of the core network. Moreover, subsequent to September 30, 1998, HER
entered into an additional contractual commitment for $36.8 million, payable
within twelve months, to lease an indefeasible right of use to transatlantic
capacity for a term of twenty-five years. In August 1997, HER completed the
issuance of $265.0 million in gross proceeds of 11.5% Senior Notes (the "Senior
Notes") due in August 2007. The Senior Notes are general unsecured obligations
of HER. The Company believes that the net proceeds from the Senior Notes,
combined with HER's projected internally generated funds, should be sufficient
to fund HER's expected capital expenditures as well as payments on the long-term
fiber lease arrangements. However the actual amount and timing of HER's future
capital requirements may differ materially from management's estimates. If the
actual amount and timing of HER's future capital requirements differ materially
from management's estimates, 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.
European Services Strategy
Due to the preliminary nature of the Company's business plan for its
European Services Strategy, the Company cannot estimate with any degree of
certainty the amount and timing of the Company's future capital requirements for
its implementation, which will be dependent on many factors, including the
success of the Company's European services business, the rate at which the
Company expands its networks and develops new networks, the types of services
the Company offers, staffing levels, acquisitions and customer growth, as well
as other factors that are not within the Company's control, including
competitive conditions, regulatory developments and capital costs. Management
believes that it is likely that the Company will need to raise additional
capital above that raised through July 31, 1998. The Company expects that it
will have significant operating and net losses and will record significant net
cash outflow, before financing, in coming years in connection with its European
services business. There can be no assurance that the Company's operations,
including the Company's European services business, will achieve or sustain
profitability or positive cash flow in the future.
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Liquidity Analysis
The Company had cash and cash equivalents of $993.9 million and $366.8
million as of September 30, 1998 and 1997, respectively. The Company had
restricted cash of $66.9 million and $59.8 million as of September 30, 1998 and
1997, respectively. The restricted cash at September 30, 1998 primarily
represents amounts held in escrow to pay the first two years interest payments
on the $105 million of the 9.875% Senior Notes due 2005 of the Company and $265
million of the Senior Notes of HER.
During the three and nine months ended September 30, 1998, the Company's
operations provided cash of $29.2 million and used $5.4 million, respectively,
compared to a cash use of $15.7 million and $38.9 million, respectively, in the
comparable periods of 1997. Cash used for investing activities was $89.7 million
and $142.9 million for the three months and nine months ended September 30, 1998
and $55.9 million and $73.0 million for the three and nine months ended
September 30, 1997, 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. 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.
In February 1998, the Company used approximately $85.2 million of the net
proceeds from the initial public offering and the $105.0 million Senior Notes to
repay $70.0 million plus accrued interest of debt 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.
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 Florint, Belgium Franc and the European Currency Equivalent. 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 is attempting to
match revenues, costs, borrowing and repayments in terms of their respective
currencies, the Company has experienced, and may continue to experience, losses
and a resulting 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 has developed risk management policies that establish
guidelines for managing foreign exchange risk. The Company is currently
evaluating the materiality of foreign exchange exposures in different countries
and the financial instruments available to mitigate this exposure. The Company's
ability to hedge its exposure is limited since certain of its operations are
located in countries whose currencies are not easily convertible. Financial
hedge instruments for these countries are nonexistent or limited and also
pricing of these instruments is often volatile and not always efficient. The
Company is designing reporting processes to monitor the potential exposure on an
ongoing basis and expects to implement this process before the end of 1998. The
Company will use the output of this process to execute financial hedges to cover
foreign exchange exposure when practical and economically justified.
In April 1998, the Company consummated an economic transaction to hedge the
foreign exchange exposure resulting from the issuance of $265 million Senior
Notes by HER.
On August 17, 1998 the exchange rate of the Russian ruble, relative to
other currencies, declined significantly. The following measures were
implemented by the Russian government (collectively, the "August 17th
Decision"): 1) The repayment of state securities were suspended; subsequently,
secondary trading therein was halted. Since many Russian banks had substantial
investments in these securities, severe
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liquidity problems resulted for the banks. 2) The value of the ruble was allowed
to fluctuate below the ruble/US dollar exchange rate corridor that the
government had committed to support; this represented an effective devaluation
of the ruble. 3) A 90-day moratorium on offshore credit repayments was issued.
The 90-day moratorium was not extended when it expired on November 16, 1998 and
it is anticipated that the ruble will continue to be devalued. Due to the
devaluation and the end of the 90-day moratorium, there is an ongoing risk that
many Russian banks may be declared bankrupt. Deposits held at Russian banks,
other than Sberbank, are not insured. The official exchange rate as of September
30, 1998 was 16.0645 per US dollar. The last official exchange rate prior to the
suspension of trading on August 17, 1998 was 6.2725 rubles per US dollar.
As a result of the devaluation of the ruble and the consequences of the
banking and economic crisis within Russia, the Company recorded a $13.1 million
pre-tax charge within its financial statements for the third quarter 1998, that
is mainly comprised of foreign currency exchange losses for ruble-denominated
net monetary assets with the remainder associated with estimates for
uncollectible accounts receivable and unrecoverable cash deposits in Russian
banks. See "Results of Operations -- Consolidated Ventures" and "Results of
Operations -- Non-Consolidated Ventures (Equity Investees)".
Moreover, the Russian government has defaulted on payments, and proposed a
restructuring, of certain sovereign debt obligations which has been criticized
by Western holders of such obligations. As a result, it is likely that the
Russian government and Russian businesses will have difficulty accessing Western
financial markets for the foreseeable future. The consequences of the August 17
Decision and its aftermath remain unclear, but no assurance can be given that
these emergency measures, coupled with the policies of Russia's new government,
will be sufficient to stabilize the currency, enhance liquidity or prevent
further economic dislocation. In particular, there can be no assurance that
there will not be a further significant and sudden decline in the value of the
ruble and consequent increased Company exchange-related losses and increased
loss of investor confidence in the Russian economy. Such consequences coupled
with an overall downturn in the Russian economy and resulting reduced demand for
telecommunication services could have a material adverse effect on the Company
and its financial condition and results of operations and the Russian economy
generally.
YEAR 2000 COMPLIANCE
The Company expects to complete the assessment phase of its year 2000
readiness plans in the fourth quarter of 1998. The assessment phase includes
internal and third party review of potential risks associated with the
availability, integrity and reliability of operational systems necessary to
conduct business after the year 2000. The Company's preliminary observations
from the assessment phase are that most of the Company's telecommunications
equipment and software that has been purchased within the past three years bears
a lower risk of year 2000 non-compliance than equipment and software acquired
prior to that period. In addition, the Company is obtaining confirmations from
the Company's primary telecommunication facility providers, vendors, business
partners, customers and equipment and software vendors as to what plans, if any,
are being developed by them or are already in place to address their ability to
process transactions in the year 2000. Upon the completion of this assessment
phase, the Company intends to commence a detailed planning phase that will be
followed by a remediation and testing phase in early 1999.
The Company expects that it will incur between $2.0 million to $3.5 million
in expenses to complete the assessment, detailed planning and remediation and
testing phases, exclusive of replacement costs for telecommunications equipment
and software, of which approximately $0.6 million has been incurred for the nine
months ended September 30, 1998. It is estimated that between $1.0 million to
$2.0 million of the total expenditure will be required to complete the
remediation and testing phase, excluding the replacement of telecommunications
equipment and software. The Company is currently unable to quantify the costs
that it may incur during the remediation and testing phase, associated with the
replacement of any telecommunications equipment and software due to its early
stage in the year 2000 readiness review. Funding of these costs will be absorbed
from operating cash flows and expensed as incurred. The preceding cost estimates
do not include amounts associated with the accelerated acquisition of
replacement systems, as none are included in the initial assessment during the
third quarter 1998. The Company does not expect that the costs of addressing
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its year 2000 readiness will have a material effect on the Company's financial
condition or results of operations. However, there can be no assurance that year
2000 non-compliance by the Company's systems or the systems of vendors,
customers, partners or others will not result in a material adverse effect.
The worst case scenario for the Company would be the failing of its
telecommunications equipment, power providers and/or interfaces with other
telecommunication vendors. These cases would create business interruption at
some of the Company's operations and would adversely affect the Company's
revenues. For example, the Moscow power authorities have publicly stated that
they do not intend to address year 2000 issues until problems arise. However,
the Company has operations that are diversified geographically as well as by
line of business; therefore, it is not anticipated that the worst case scenario
would affect worldwide operations concurrently. Additionally, if power failures
occur, the Company has diesel generators at certain of its major sites. Based on
its assessment during the third quarter 1998, the Company does not foresee a
material loss due to these conditions. However, there can be no assurance that
year 2000 non-compliance by the Company's systems or the systems of vendors,
customers, partners or others will not result in a material adverse effect.
The Company is considering a contingency plan to address its worst case
scenario; however, certain of the initiatives are subject to execution risk.
This risk would include the inability to have access to diesel fuel or large
generators should power failures occur, the inability to quickly replace
telecommunications equipment and the inability to contract with alternative
telecommunication providers at reasonable terms. Moreover, the Company is
further limited in resources in certain geographical regions due to the market
volatility and weak economies in which the Company has business operations. See
"Risk Factors -- Risks Relating to Russia and the CIS."
INTRODUCTION OF THE EURO
On January 1, 1999, certain countries of the European Union are scheduled
to establish fixed conversion rates between their existing sovereign currencies
and a new currency to be called the "Euro." The Euro will then trade on currency
exchanges and be available for non-cash transactions. Thereafter and until
January 1, 2002, the existing sovereign currencies will remain legal tender in
these countries. On January 1, 2002, the Euro is scheduled to replace the
sovereign legal currencies of these countries. Through certain of its
subsidiaries, the Company has significant operations within the European Union,
including many of the countries that are scheduled to adopt the Euro. The
Company is currently evaluating the systems and business issues raised by the
adoption of the Euro, including the need to adapt information systems and the
competitive impact of cross-border pricing transparency. The Company has not yet
completed its evaluation of the potential impact likely to be caused by the Euro
adoption.
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SUPPLEMENTAL INFORMATION -- SELECTED HISTORICAL
FINANCIAL DATA -- COMBINED EQUITY INVESTMENTS
The following unaudited selected historical financial data -- equity
investments for the three and nine months ended September 30, 1997 and September
30, 1998, are derived from the Company's financial records. It is intended to
supplement the unaudited condensed consolidated financial statements. 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 of
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>
NET
OWNERSHIP COST OF OPERATING INCOME/
INTEREST(1) REVENUES REVENUES EXPENSES (LOSS)
----------- -------- -------- --------- -------
<S> <C> <C> <C> <C> <C>
THREE MONTHS ENDED SEPTEMBER 30, 1997
Sovintel........................................... 50% 27,890 18,212 4,209 4,486
TCM................................................ 50%(2) 7,780 2,025 916 3,519
TeleRoss........................................... 50% 2,282 869 664 189
Sovam.............................................. 66.7%(3) 4,845 2,755 1,561 213
GTS Cellular Companies............................. 50%(4)(5) 12,075 6,002 4,617 3
Other.............................................. 50%(4) 2,394 (539) 15,525 (11,269)
----- ------- ------- ------- -------
Total....................................... 57,266 29,324 27,492 (2,859)
Adjustments for Inter-Affiliate Transactions(6)...... (7,192) (6,195) (2,523)
THREE MONTHS ENDED SEPTEMBER 30, 1998(2)(3)(5)
Sovintel........................................... 50% 32,391 21,176 7,865 (2,748)
TeleRoss........................................... 50% 2,396 671 1,009 (741)
GTS Cellular Companies............................. 50%(4)(5) 8,890 4,443 3,038 (2,097)
Other.............................................. 50%(4) 6,800 7,127 894 (1,114)
----- ------- ------- ------- -------
Total....................................... 50,477 33,417 12,806 (6,700)
Adjustments for Inter-Affiliate Transactions(6)...... (7,358) (7,958) (8,194)
NINE MONTHS ENDED SEPTEMBER 30, 1997
Sovintel........................................... 50% 82,029 51,048 12,324 14,215
TCM................................................ 50%(2) 20,715 4,733 2,270 9,653
TeleRoss........................................... 50% 5,113 1,419 2,460 512
Sovam.............................................. 66.7%(3) 12,877 7,867 4,635 (168)
GST Cellular Companies............................. 50%(4)(5) 29,412 14,227 13,022 (2,746)
Other.............................................. 50%(4) 8,860 8,400 25,736 (25,146)
----- ------- ------- ------- -------
Total....................................... 159,006 87,694 60,447 (3,680)
Adjustments for Inter-Affiliate Transactions(6)...... (17,049) (15,853) (11,105)
NINE MONTHS ENDED SEPTEMBER 30, 1998 (2)(3)(5)
Sovintel........................................... 50% 99,498 65,779 17,653 6,891
TCM................................................ 50%(2) 21,586 5,689 1,857 8,843
TeleRoss........................................... 50% 7,436 2,163 3,241 (121)
GTS Cellular Companies............................. 50%(4)(5) 40,186 18,737 14,158 458
Other.............................................. 50%(4) 18,838 18,107 3,961 (2,591)
----- ------- ------- ------- -------
Total....................................... 187,544 110,475 40,870 13,480
Adjustments for Inter-Affiliate Transactions(6)...... (25,001) (23,960) 1,493
</TABLE>
32
<PAGE> 395
SUPPLEMENTAL INFORMATION -- SELECTED HISTORICAL
FINANCIAL DATA -- COMBINED EQUITY INVESTMENTS -- (CONTINUED)
- ---------------
(1) 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.
(2) During the quarter ended September 30, 1998, the Company purchased the
remaining 47.36% interest in GTS Vox Limited, the intermediate holding
company of TCM. As a result, effective July 1998, the Company will have a
95% indirect interest in TCM and will also account for its interest in TCM
using the consolidation as opposed to the equity method of accounting. The
results of TCM for the six months ended June 30, 1998 have been included
within the nine months ended September 30, 1998 presented above.
(3) GTS purchased the remaining 33% interest in Sovam in February 1998 and as a
result, effective February 1998, Sovam is accounted for by the consolidation
as opposed to the equity method of accounting.
(4) The Company generally maintains a 50% ownership interest in these equity
investments.
(5) Prior to July 1, 1998, the Company beneficially owned approximately 25% of
Bancomsvyaz and included its results within the GTS Cellular companies
accounted for under the equity method. During the second quarter of 1998,
the Company completed a restructuring of the capital and ownership of
Bancomsvyaz, which results in GTS beneficially owning approximately 57% of
Bancomsvyaz. As a result, effective June 30, 1998, Bancomsvyaz is accounted
for under the consolidation as opposed to equity method of accounting. The
results of Bancomsvyaz for the three months ended March 31, 1998 have been
included within the nine months ended September 30, 1998 presented above.
(6) 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."
33
<PAGE> 396
PART II
OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) In conjunction with the restructuring of Bancomsvyaz, one of the
Company's subsidiaries, on June 30, 1998, the Company issued to an existing
shareholder, in a private placement, 713,311 shares of common stock. This stock
was issued pursuant to a contractual put right held by such shareholder, which
permitted the shareholder to put to the Company its $8.6 million of investment
in GTS Ukrainian TeleSystems LLC in exchange for such stock. See Note 5 to the
Company's unaudited Condensed, Consolidated Financial Statements included in
this report.
Pursuant to a purchase agreement that the Company has with a venture
partner in GTS Vox Limited, the intermediate holding company of TCM, the Company
issued 336,630 shares of common stock to the Partner in April 1998. See Note 3
to the Company's Unaudited Condensed, Consolidated Financial Statements included
in this report.
ITEM 5. OTHER INFORMATION
See Notes 5 and 7 to the Company's unaudited Condensed, Consolidated
Financial Statements included in this report.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
<TABLE>
<CAPTION>
DESIGNATION DESCRIPTION
----------- -----------
<C> <S>
27 -- Financial Data Schedule
</TABLE>
B. Reports on Form 8-K
None.
34
<PAGE> 397
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrants have duly caused this report to be signed on their behalf by the
undersigned thereunto duly authorized.
GLOBAL TELESYSTEMS GROUP, INC.
(Registrant)
By: /s/ WILLIAM H. SEIPPEL
----------------------------------
William H. Seippel
Executive Vice President and Chief
Financial Officer (Principal
Financial and Accounting
Officer)
Date: November 16, 1998
35
<PAGE> 398
ANNEX F
GLOBAL TELESYSTEMS GROUP, INC.
1751 PINNACLE DRIVE
NORTH TOWER, 12TH FLOOR
MCLEAN, VA 22102
------------------------
NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
MAY 20, 1998
MCLEAN, VIRGINIA
------------------------
April 15, 1998
To the Stockholders of
Global TeleSystems Group, Inc.
The 1998 annual meeting of stockholders of Global TeleSystems Group, Inc.
(the "Company" or "GTS") will be held at the Holiday Inn Tysons Corner, 1960
Chain Bridge Road, McLean, Virginia on May 20, 1998 at 10:00 a.m. local time, to
consider and act on the following matters:
1. The election of 4 directors to hold office for a term of three years or
until their successors are elected and qualified (Item No. 1).
2. Approval of the Fourth Amended and Restated 1992 Stock Option Plan of
the Company (Item No. 2).
3. Approval of certain grants of stock options to certain members of the
Board of Directors of the Company (Item No. 3).
4. Ratification of the selection of auditors of the Company for fiscal year
1998 (Item No. 4).
5. The transaction of such other business as may properly come before the
meeting.
Eligible stockholders of record at the close of business on March 31, 1998
will be entitled to vote at the meeting. A list of stockholders entitled to vote
at the meeting may be examined at the executive offices of the Company at 1751
Pinnacle Drive, North Tower, 12th Floor, McLean, Virginia 22102.
By Order of the Board of Directors
GRIER C. RACLIN
Corporate Secretary
IF YOU DO NOT EXPECT TO ATTEND THE MEETING IN PERSON, PLEASE SIGN AND DATE
THE ACCOMPANYING PROXY AND RETURN IT PROMPTLY IN THE ENCLOSED ENVELOPE, WHICH
REQUIRES NO POSTAGE IF MAILED IN THE UNITED STATES.
<PAGE> 399
GLOBAL TELESYSTEMS GROUP, INC.
1751 PINNACLE DRIVE
NORTH TOWER, 12TH FLOOR
MCLEAN, VA 22102
------------------------
PROXY STATEMENT
ANNUAL MEETING OF STOCKHOLDERS
MAY 20, 1998
------------------------
INTRODUCTION
This Proxy Statement is furnished in connection with the solicitation by
the Board of Directors (the "Board of Directors") of Global TeleSystems Group,
Inc. (the "Company" or "GTS") of proxies to be voted at the annual meeting of
stockholders in McLean, Virginia on May 20, 1998. Enclosed with this Proxy
Statement is notice of the meeting, together with a proxy for your signature if
you are unable to attend. Stockholders who execute proxies may revoke them at
any time before they are voted. Any proxy may be revoked by the person giving it
any time before it is voted by delivering to the Corporate Secretary of the
Company at 1751 Pinnacle Drive, North Tower, 12th Floor, McLean, Virginia 22102,
on or before the business day prior to the meeting or at the meeting itself, a
subsequent written notice of revocation or a subsequent proxy relating to the
same shares or by attending the meeting and voting in person. The approximate
date on which this Proxy Statement and the accompanying form of proxy will first
be sent to the Company's stockholders is April 15, 1998.
Shares of the Company's common stock, par value $0.10 per share ("Common
Stock"), represented by properly executed proxies received prior to or at the
meeting, unless such proxies have been revoked, will be voted in accordance with
the instructions indicated in the proxies. If no instructions are indicated on a
properly executed proxy of the Company, the shares will be voted in accordance
with the recommendations of the Board of Directors.
Common stockholders of record at the close of business on March 31, 1998
(the "Record Date") are entitled to vote at the meeting. On March 31, 1998, the
Company had outstanding 51,722,640 shares of Common Stock (excluding treasury
stock). The number of outstanding shares and all other data in this Proxy
Statement regarding shares of Common Stock, including without limitation stock
ownership, stock option, and per share pricing information, reflect a
three-for-two split of the Common Stock effective on December 1, 1997.
REQUIRED VOTES
The vote of the holders of a plurality of the votes cast by holders of
shares of Common Stock will elect candidates for director (Item No. 1 on your
proxy). Abstentions or broker non-votes as to the election of directors will not
affect the election of the candidates receiving the plurality of votes. The vote
of the holders of at least a majority of the shares of Common Stock present in
person or represented by proxy at the meeting and entitled to vote, voting
together as a single class, is required to approve the Fourth Amended and
Restated 1992 Stock Option Plan of the Company (Item No. 2 on your proxy),
approve certain grants of stock options to certain members of the Board of
Directors of the Company (Item No. 3 on your proxy), and ratify the Board of
Directors' appointment of Ernst & Young LLP as the Company's independent public
accountants for 1998 (Item No. 4 on your proxy). Therefore, abstentions as to
these particular proposals will have the same effect as votes against such
proposals. Broker non-votes as to these particular proposals, however, will be
deemed shares of stock not entitled to vote on such proposals, will not be
counted as votes for or against such proposals, and will not be included in
calculating the number of votes necessary for approval of such proposals.
1
<PAGE> 400
BENEFICIAL SECURITY OWNERSHIP
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 and nominees
for director, (iii) each of the named officers and (iv) all directors, nominees
for director and executive officers of the Company as a group as of March 31,
1998. 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>
NUMBER OF
SHARES PERCENTAGE
BENEFICIALLY BENEFICIALLY
NAME OF BENEFICIAL OWNER OWNED(1)(2) OWNED(1)
------------------------ ----------- --------
<S> <C> <C>
George Soros affiliates.................................... 10,837,791(3) 19.3%
c/o Soros Fund Management 888 Seventh Avenue, 31st Floor
New York, NY 10106
Alan B. Slifka and affiliates.............................. 5,492,981(4) 10.6%
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) 9.7%
c/o Capital Research International 25 Bedford Street
London WC2E England
Emerging Markets Management................................ 2,767,046(6) 5.3%
1001 19th Street North, 16th Floor Arlington, VA 22209
David Dey.................................................. -- *
Gary Gladstein............................................. 30,000(7) *
Roger W. Hale.............................................. -- *
Bernard McFadden........................................... 37,500 *
Michael A. Greeley......................................... 13,500(8) *
Stewart J. Paperin......................................... 9,000(7) *
W. James Peet.............................................. 13,500(7) *
Jean Salmona............................................... 13,500 *
Morris A. Sandler.......................................... 351,000 *
Joel Schatz................................................ 500,250 *
Adam Solomon............................................... 57,414 *
Gerald W. Thames........................................... 740,924 1.4%
Bruno d'Avanzo............................................. 44,419 *
Jan Loeber................................................. 30,000(9) *
Raymond I. Marks........................................... 299,687 *
Louis T. Toth.............................................. 293,023 *
Other officers............................................. 169,376 *
All Directors, nominees for Director, and Executive
Officers as a group (22 persons)......................... 2,586,179 4.8%
Total of above............................................. 29,274,933
Total shares on a fully diluted basis:..................... 59,500,416
</TABLE>
2
<PAGE> 401
- ---------------
* Less than 1%
(1) The percentage of ownership is based upon 59,500,416 shares, comprised of
51,722,640 shares of Common Stock issued and outstanding, and warrants to
purchase 7,777,776 shares of Common Stock. Excluded from the calculation
are: 5,152,452 shares of Common Stock issued to employees under the Third
Amended and Restated 1992 Stock Option Plan of the Company (the "Stock
Option Plan"), of which 2,010,260 are vested at March 31, 1998; 759,000
options to purchase shares of Common Stock issued to employees prior to the
adoption of the Stock Option Plan and options issued pursuant to the Global
TeleSystems Group, Inc. Non-Employee Directors' Stock Option Plan (the
"Directors' Plan") and the SFMT, Inc. Equity Compensation Plan (the "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 March 31, 1998.
(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
30,000 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) 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.
(8) 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.
(9) Includes 10,000 restricted shares of Common Stock.
ELECTION OF DIRECTORS (ITEM NO. 1)
The Company's Certificate of Incorporation, as amended, classifies the
Board of Directors into three classes, as nearly equal in number as possible,
all of the members of which will ultimately serve for terms of three years. The
provision classifying the Board of Directors was implemented in 1998, and,
accordingly, the Board of Directors has classified its members into three
classes. The members of Class I have terms expiring at this Annual Meeting; the
members of Class II have terms expiring at the 1999 annual stockholders meeting
and the members of Class III have terms expiring at the 2000 annual stockholders
meeting. Thereafter, the terms of office of the members of one class of
directors expire each year in rotation so that the members of one class are
elected at each annual stockholders meeting for full three-year terms.
3
<PAGE> 402
The terms of office of four of the present directors will expire at this
Annual Meeting. Two of these directors, Messrs. Gladstein and Sandler, have
decided not to stand for re-election. Two new nominees, Messrs. Dey and Hale,
and two incumbent directors, Messrs. Salmona and Solomon have been nominated for
election for three-year terms expiring at the Annual Meeting in 2001, or until
their successors are elected and qualified. The terms of the other seven
directors will continue as indicated below.
The ages and business experience of directors set forth below are as of
March 31, 1998.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE
"FOR" EACH OF THE NOMINEES LISTED BELOW.
NOMINEES FOR TERMS EXPIRING IN 2001
David Dey, 60. Since 1995, Mr. Dey has served as an independent consultant,
particularly to high technology start-up companies in Europe. In that capacity,
he has served as Chairman of The Connections Group, a provider of branded
Internet services and Web-based electronic mail, and as Chairman of STARTECH
Scotland, a high technology incubator that focuses on telecommunications and
software start-up companies. From 1992 to 1995, Mr. Dey served as Chief
Executive Officer of Energis Communications, which grew from a start-up company
to become the United Kingdom's third national telecommunications operation
during his tenure. Mr. Dey was employed by British Telecom plc from 1987 to
1991, most recently as Managing Director of its Business Communications
Division, and he held various management positions at IBM Corporation where he
was employed from 1961 to 1985.
Roger W. Hale, 54. Mr. Hale is Chairman, President and Chief Executive
Officer of LG&E Energy Corp., a diversified energy services and marketing
company with businesses in retail gas and electric utility services, energy
marketing and trading, and power generation and project development. Mr. Hale
has served in that capacity since August 1990. Previously, Mr. Hale served as
Executive Vice President of Bell South Enterprises, Inc. from 1986 to 1989 and
with AT&T Corporation from 1966 to 1986, serving in various management positions
including Vice President of Marketing, Southern Region. Mr. Hale is a Director
of H&R Block, Inc. and PNC Bank, Kentucky, Inc.
Jean Salmona, 62. 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. Mr. Salmona is a
graduate of Ecole Polytechnique, Paris, Institut d'Etudes Politiques, Paris and
Ecole Naqtionale de la Statistique et de l'Administration Economique, Paris. Mr.
Salmona is a member of the Audit and Budget Committee of the Board of Directors.
Adam Solomon, 45. 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. Mr.
Solomon is a member of the Compensation and Executive Committees of the Board of
Directors.
DIRECTORS WHOSE TERMS EXPIRE IN 1999
Michael A. Greeley, 35. 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.
4
<PAGE> 403
Mr. Greeley is also a director of Teletrac, Inc., Crescent Communications,
American Capital Access Holdings, LLC and Fuelman, Inc. 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. Mr. Greeley is a member of the Audit and Budget and
Compensation Committees of the Board of Directors.
W. James Peet, 43. 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: Viatel Global Communications, a
public company, 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, which right expires in 2001.
Mr. Peet is the designee of The Chatterjee Group to the Board of Directors. Mr.
Peet is a member of the Executive Committee of the Board of Directors.
Joel Schatz, 61. 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. Mr. Schatz is a member of the Audit and Budget
Committee of the Board of Directors.
Gerald W. Thames, 51. 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. Mr. Thames is a member of the Executive
Committee of the Board of Directors.
DIRECTORS WHOSE TERMS EXPIRE IN 2000
Bernard McFadden, 64. 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 Hermes Europe
Railtel B.V., a subsidiary of the Company. 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. Mr. McFadden is
Chairman of the Compensation Committee and is a member of the Governance and
Executive Committees of the Board of Directors.
Stewart J. Paperin, 50. Mr. Paperin has served as a director of GTS since
March 1997. Mr. Paperin serves as Executive Vice President of the Soros
Foundations (Open Society Institute). 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.
Mr. Paperin is Chairman of the Audit and Budget Committee and is a member of the
Compensation and Governance Committees of the Board of Directors.
Alan B. Slifka, 68, 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 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
5
<PAGE> 404
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. Mr. Slifka is Chairman of the
Executive and Governance Committees of the Board of Directors.
COMMITTEES AND MEETINGS OF THE BOARD OF DIRECTORS
The Board of Directors of the Company held nineteen meetings in 1997.
During 1997, the Board of Directors had established the following standing
committees: Audit Committee, Executive Committee, Finance Committee and
Compensation Committee. During 1997, the Audit Committee held six meetings, the
Executive Committee held two meetings, the Finance Committee held seventeen
meetings, and the Compensation Committee held nine meetings.
During 1997, the Audit Committee, in consultation with financial officers
of the Company and the independent public accountants, assisted in establishing
the scope of the annual audit. The Audit Committee (1) reviewed annual and
quarterly financial statements, (2) recommended to the Board of Directors the
appointment of independent public accountants, (3) reviewed the annual programs
of the internal audit staff and (4) reviewed programs designed to protect and
maintain the assets of the Company, including insurance and internal security
programs.
The Compensation Committee reviewed the salaries, incentive compensation,
stock option and restricted stock grants, retirement and other benefits which
accrued to officers of the Company and its subsidiaries, including the Chief
Executive Officer, administered the Stock Option Plan and the Equity
Compensation Plan, and set compensation guidelines for the Company and its
subsidiaries.
During 1997, each of the incumbent directors, except Mr. Solomon, attended
75 percent or more of the meetings of the Board of Directors and of the
committees on which the directors served.
In March 1998, the Company's Board of Directors reconstituted its
committees and established the Executive, Audit and Budget, Compensation and
Governance Committees. The Audit and Budget Committee reviews and recommends to
the Boards of Directors corporate budget and capital expenditure requests,
reviews the financial integrity of the corporate books and records, conducts
special audits as may be recommended by the Board of Directors, the Chief
Executive Officer and the Chief Financial Officer of the Company and reviews the
policies of the Company regarding compliance with applicable laws. The
Compensation Committee performs the same functions it carried out in 1997 as
described above.
EXECUTIVE COMPENSATION AND OTHER INFORMATION
COMPENSATION OF DIRECTORS
Each Director of GTS, except Mr. Thames, receives an annual directors' fee
of $15,000. In addition, the fee paid to each Director, except for Mr. Thames,
for attending any meeting of the Board of Directors is $1,500 per meeting,
except for telephonic Board of Directors meetings of two hours or less, where
the fee is $750 for each such meeting. Each Director, except Mr. Thames, who
attends a committee meeting is 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 $500 is paid. See "Approval of Stock Options Granted to
Certain Members of the Board of Directors (Item 3)"
EXECUTIVE COMPENSATION
The following table sets forth each component of compensation paid or
awarded to, or earned by, the Chief Executive Officer and the four other most
highly compensated executive officers serving as of December 31, 1997
(collectively, the "Named Executive Officers") for the years indicated.
6
<PAGE> 405
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
------------------------
ANNUAL COMPENSATION AWARDS
----------------------------------------- ------------------------
RESTRICTED SECURITIES
PAID OTHER ANNUAL STOCK UNDERLYING ALL OTHER
SALARY BONUS COMPENSATION AWARD(S) OPTIONS COMPENSATION
NAME AND PRINCIPAL POSITION YEAR ($) ($) ($) ($) (#) ($)(9)
--------------------------- ---- -------- -------- ------------ ---------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Gerald W. Thames............... 1997 $375,417 $140,000 (1) -0- 141,195(5) $ 19,850
President and Chief Executive 1996 $325,000 $113,750 (1) -0- 112,500(5) $ 9,954
Officer
Bruno d'Avanzo................. 1997 $340,000 $ 83,313(2) -0- -0- 104,475(5) $ 21,675
Executive Vice President and 1996 $141,667 $ 33,333(2) -0- -0- 83,025(5) $ 5,650
Chief Operating Officer
Jan Loeber..................... 1997 $235,000 $ 78,608 46,598(3) -0- 4,812(6) $179,450
Senior Vice President -- HER 1996 $235,000 $ 78,608 42,806(3) 30,000(4) 3.5(7) $ 12,986
Raymond I. Marks............... 1997 $231,008 $ 49,826 (1) -0- 27,750(5) $ 12,250
Senior Vice President -- Asia 1996 $230,091 $ 46,200 (1) -0- 55,500(5) $ 13,788
Louis T. Toth.................. 1997 $204,750 $ 50,307 60,106(8) -0- 45,000(5) $ 14,550
Senior Vice 1996 $203,937 $ 40,950 33,602(8) -0- 43,500(5) $ 13,004
President -- Central Europe
</TABLE>
- ---------------
(1) Perquisites and other personal benefits paid to the Named Executive Officer
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. D'Avanzo's bonuses in 1997 and 1996 include the first two installments
of a $100,000 sign-on bonus that the Company agreed to pay in three equal
annual installments when he was hired in 1996.
(3) For 1997, the amount listed represents the sum of a cost of living
allowance of $16,450, a tax equalization payment of $13,953 that
compensates Mr. Loeber for the higher taxes he pays because he resides in
Belgium instead of the United States, use of a car, which was valued at
$4,547, and a gross-up payment of $11,648 for certain tax liabilities. For
1996, the amount listed represents the sum of a cost of living allowance of
$16,450, paid home leave of 9,031, use of a car valued at $4,547 and a
gross-up payment of $12,778 for certain tax liabilities.
(4) Shares of restricted stock that vest in an amount of one-third each year on
the three anniversary dates of grant, beginning on January 2, 1997.
(5) Stock options awarded under the Stock Option Plan.
(6) Stock options awarded under The Key Employee Stock Option Plan of Hermes
Europe Railtel B.V.(the "HER Stock Option Plan").
(7) Stock options awarded under the GTS-Hermes, Inc. Stock Option Plan (the
"GTS-Hermes Stock Option Plan"), which will be terminated. The stock
options granted to Mr. Loeber in 1997 and described in footnote (6) are in
substitution for the 3.5 stock options granted to Mr. Loeber in 1996, which
have been cancelled.
(8) For 1997, the amount listed represents the sum of a cost of living
allowance of $30,000, use of a car valued at $10,800, paid home leave of
$12,501, and a gross-up payment for certain tax liabilities in the amount
of $6,805. For 1996, the amount listed represents the sum of a cost of
living allowance of $27,500 and paid home leave of $6,102 paid to Mr. Toth.
(9) Amounts hereunder represent the sum of 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, as defined below, to each Named Executive
Officer's account, except for Mr. D'Avanzo who does not participate in the
401(k) plan because of his foreign citizenship. In the case of Mr. Loeber,
the amount also includes $156,700 which represents the value, as of
December 31, 1997 of 10,000 shares of restricted stock which vested in
1997.
RETIREMENT BENEFITS
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 Internal Revenue Code (the "Code"). All employees of GTS,
subject to certain regulatory qualifications, including the Named Executive
Officers, who
7
<PAGE> 406
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.
OPTION GRANTS IN THE LAST FISCAL YEAR
The following table provides information on stock option grants to the
Named Executive Officers in 1997 under the 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($)(2)
---- ---------- ------------ ------------ ---------- -----------
<S> <C> <C> <C> <C> <C>
Gerald W. Thames...................... 88,695(1) 4.11 $13.33 02-03-07 $597,000
52,500(1) 2.43 15.67 10-10-07 415,300
Bruno d'Avanzo........................ 66,975(1) 3.11 13.33 02-03-07 450,700
37,500(1) 1.74 15.67 10-10-07 296,600
Jan Loeber............................ -- -- -- -- --
Raymond I. Marks...................... 27,750(1) 1.29 13.33 02-03-07 186,800
Louis T. Toth......................... 22,500(1) 1.04 13.33 02-03-07 151,400
22,500(1) 1.04 15.67 10-10-07 178,000
</TABLE>
- ---------------
(1) Each option vests one-fourth on each of the first four anniversaries of the
date of grant.
(2) The present value of each grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions: dividend yield 0%, expected volatility of 0.50, risk-free
interest rate of 5.79% and expected life of five years.
8
<PAGE> 407
AGGREGATED OPTION EXERCISES IN THE LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION VALUES
The following table provides information on the number of options under the
Stock Option Plan held by the Named Executive Officers at December 31, 1997, and
the value of all unexercised options held by such persons as of that date.
<TABLE>
<CAPTION>
NUMBER OF
SECURITIES
UNDERLYING
UNEXERCISED
OPTIONS AT
FY-END(#)(1) VALUE OF UNEXERCISED
EXERCISABLE/ IN-THE-MONEY OPTIONS
NAME UNEXERCISABLE AT FY-END($)(2)
---- --------------- ---------------------
<S> <C> <C>
Gerald W. Thames..................................... 676,562/327,133 $7,539,655/$1,321,913
Bruno d'Avanzo....................................... 27,675/159,825 64,676/285,874
Jan Loeber........................................... -- --
Raymond I. Marks..................................... 246,937/121,313 2,671,519/675,211
Louis T. Toth........................................ 256,537/97,613 3,090,927/355,013
</TABLE>
- ---------------
(1) No options were exercised during the year ended December 31, 1997.
(2) Based on $15.67 per share value of Common Stock as of December 31, 1997 less
the exercise price.
OPTION GRANTS IN THE LAST FISCAL YEAR -- HER STOCK OPTION PLAN (1)
The following table provides information on stock option grants to one of
the Named Executive Officers, Jan Loeber, in 1997 under the HER Stock Option
Plan. As of December 31, 1997, Mr. Loeber was not granted in 1997, and does not
hold, any options to purchase Common Stock.
<TABLE>
<CAPTION>
% OF
TOTAL
OPTIONS
NUMBER OF GRANTED
SECURITIES TO
UNDERLYING EMPLOYEES EXERCISE OR GRANT DATE
OPTIONS IN FISCAL BASE EXPIRATION PRESENT
NAME GRANTED(#) YEAR PRICE($/SH.) DATE VALUE($)(2)
---- ---------- --------- ------------ ---------- -----------
<S> <C> <C> <C> <C> <C>
Jan Loeber............................. 4812 47.3 $83.12 2006 $2,234,019
</TABLE>
- ---------------
(1) Each stock option vests one-third on each of the first three anniversaries
of the date of grant. During the fourth quarter of 1997, HER established the
HER Stock Option Plan to replace the GTS-Hermes Stock Option Plan. The
options outstanding under the GTS-Hermes Plan were cancelled and replaced by
options under the HER Stock Option Plan.
(2) The present value of each grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions: dividend yield 0%, expected volatility of 0.50, risk-free
interest rate of 5.79% and expected life of five years.
9
<PAGE> 408
AGGREGATED OPTION EXERCISES IN THE LAST FISCAL YEAR AND
FISCAL YEAR-ENDED OPTION VALUES -- HER STOCK OPTION PLAN
The following table provides information on the number of options held by
Mr. Loeber under the HER Stock Option Plan at December 31, 1997, and the value
of all unexercised options held by Mr. Loeber as of that date.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FY-END(#) AT FY-END($)(1)
NAME EXERCISABLE/UNEXERCISABLE(1) EXERCISABLE/UNEXERCISABLE(2)
---- ---------------------------- ----------------------------
<S> <C> <C>
Jan Loeber.................................... 3,208/1,604 1,417,551/708,775
</TABLE>
- ---------------
(1) No options were exercised during the year ended December 31, 1997.
(2) Based on $525.00 per share value of common stock as of December 31, 1997
less the exercise price.
EMPLOYMENT AGREEMENTS
GTS has executed employment agreements (together, the "Employment
Agreements") with all the Named Executive Officers. The agreements with Messrs.
Thames, and Marks include a three-year term of employment commencing on February
1, 1997 and April 1, 1996, respectively. Mr. D'Avanzo's employment agreement has
a three-year term commencing on March 1, 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, except for Mr.
Thames' and Mr. D'Avanzo's 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. Mr. Thames
agreement provides for an automatic renewal each year for a new three-year
period. Mr. D'Avanzo's agreement terminates on March 1, 2000, unless either GTS
or Mr. D'Avanzo requests an extension 180 days prior to such termination and the
parties agree upon an extension. 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 Stock Option Plan (with
the exception of Mr. Loeber whose employment agreement provides him with an
option grant under the HER Stock Option 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 Employment Agreements provide for severance payments in the event of
(a) termination without cause, as defined, or (b) resignation for good reason,
as defined, following a change of control event, as defined. Mr. Thames would be
eligible for severance payments of base salary for the greater of 24 months or
the remaining term of his agreement. Severance arrangements with other named
officers are for a period of six to eighteen months of base salary. If the Named
Executive Officer is terminated for cause or if he voluntarily terminates his
employment other than for good reason after a change of control event, he shall
not be entitled to any salary, bonus or severance payments (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.
10
<PAGE> 409
REPORT OF THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS
The Compensation Committee of the Board of Directors has responsibility for
setting the compensation of the Chief Executive Officer, reviews compensation
proposals for other key executives, approves stock option grants for all
executive officers, and establishes broad compensation practices for the
Company.
The Company operates in a highly competitive and rapidly evolving
international technology marketplace. The Compensation Committee believes that
the remuneration programs for the executive officers of the Company should
reflect the following objectives:
- To offer total compensation packages that allow the Company to attract,
retain, and motivate executives in consideration of compensation
practices at selected companies with whom the Company competes for
executive talent.
- To provide performance-based compensation that reflects the overall
financial performance of the Company and individual executive achievement
against pre-established goals.
- To include significant ownership of the Company's Common Stock in order
to align the executive officers' objectives with the interest of
maximizing shareholder value.
Compensation for the Company's executive officers is comprised of three
major components: (i) base salary, (ii) incentive bonus awards, and (iii)
long-term stock option awards. Each year, the Compensation Committee reviews
comparative compensation information as analyzed by an external consulting firm.
Peer companies are identified within the telecommunications and technology
industries and are analyzed for similarity of product lines, size, and
complexity of structure.
Based upon competitive information and individual performance, Mr. Thames'
base salary for 1997 was established at the fiftieth percentile level relative
to peer companies. The amount of Mr. Thames' bonus paid in 1997 took into
consideration the growth in Company revenues, the improvement in overall
financial measurements, strategic planning, and individual leadership
contribution. Stock option awards in 1997 were granted at a level to reflect Mr.
Thames' individual contribution and long term commitment to growth of the
Company, and are considered a critical component in retention of key executives.
Each year, the Compensation Committee reviews the other executive officers'
base salaries considering relevant competitive data and each executive's
individual performance level. Executive bonus awards are based upon overall
company financial performance and achievement of individual goals and
objectives. The level of stock option award reflects individual past performance
and potential for future contribution to the Company.
The Company is subject to Internal Revenue Code Section 162 (m), which
could limit the deductibility of certain compensation payments to its senior
executive officers. The Company generally intends to comply with the
requirements of Section 162 (m) in connection with the incentive bonus program
and stock option plan.
Bernard McFadden, Chairman
Stewart J. Paperin
Jean Salmona
Alan B. Slifka
(Members of the Compensation
Committee during 1997)
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Alan B. Slifka, 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. Until April 1,
1998, GTS retained a small office space in New York City that was leased from
Mr. Slifka on a monthly basis, and the annual expense for 1997 was $30,690. Mr.
Slifka also has a consulting agreement with GTS pursuant to which he is paid
consulting fees of $100,000 per year.
11
<PAGE> 410
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 August and September 1997, affiliates of Mr. Slifka purchased 57,015
shares of Common Stock, at a price of $15.67 per share in the Company's private
stock offering. In addition, in September 1997, affiliates of Mr. Slifka
purchased $2.9 million of the Company's Senior Subordinated Convertible Bonds
(the "Convertible Bonds") due 2000. 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 conversion price of $20.
Bernard McFadden, a Director and Chairman of the Compensation Committee,
has a consulting agreement with GTS pursuant to which he is paid $100,000 in
consulting fees each year.
Jean Salmona, a director of GTS, is the Chairman and Chief Executive
Officer of CESIA. CESIA also provides consultancy services for C-Datacomm
International, Inc. ("CDI"), a wholly owned subsidiary of the Company, which
provides digital international private line communication to and from India for
multiple applications, including data and voice and for Hermes Europe Railtel
B.V. ("HER"), another subsidiary of the Company, which is constructing a
pan-European fiber optic network. The Company paid $37,500 in 1997 to CESIA for
consulting services related to CDI. In addition, HER paid $405,893 in 1997 to
CESIA for consulting services. Further, the Company paid $5,843 to CESIA in
1997, pursuant to the purchase agreement with CESIA related to the CDI business.
APPROVAL OF FOURTH AMENDED AND RESTATED 1992 STOCK OPTION PLAN
OF THE COMPANY (ITEM NO. 2)
The Stock Option Plan was adopted by the Board of Directors of GTS and
approved by stockholders in 1992 and has been subsequently amended, among other
things, to increase the number of shares available for grant. The Board of
Directors of GTS adopted the Fourth Amended and Restated Plan on April 9, 1998,
subject to stockholder approval at the Annual Meeting: (i) to modify the
provisions relating to the number of shares with respect to which options to
purchase shares of Common Stock may be granted under the Stock Option Plan; (ii)
to extend eligibility under the Stock Option Plan to nonemployee directors and
independent contractors of the Company (as defined in the Stock Option Plan, as
it is proposed to be amended), its subsidiaries and affiliates; (iii) to provide
the Stock Option Committee (as defined in the Stock Option Plan, as it is
proposed to be amended) with more flexibility to specify the terms of options
granted under the Stock Option Plan; (iv) to specify that the options covering
not more than 1.5 million shares of Common Stock may be granted to any employee
during any calendar year; (v) to extend the term of the Stock Option Plan, as
amended, to April 9, 2008 and (vi) to eliminate certain provisions that are not
necessary or desirable in an option plan of a public company. As of March 31,
1998, there were approximately 1,800 employees, non-employee directors and
independent contractors of GTS and its subsidiaries and affiliates who were
eligible to participate in the Stock Option Plan, as it is proposed to be
amended.
The principal provisions of the Stock Option Plan, as it is proposed to be
amended, are summarized below. Such summary does not, however, purport to be
complete and is qualified in its entirety by the terms of the Stock Option Plan.
A copy of the Stock Option Plan, as amended, is attached hereto as Exhibit A and
is incorporated herein by reference.
The Board of Directors of GTS believes that stock options are important to
attract and to encourage the continued employment and service of officers, other
selected employees, non-employee directors and selected independent contractors
by facilitating their acquisition of a stock interest in GTS. The acquisition
and holding of an equity interest in GTS by such individuals is in the best
interest of GTS because equity
12
<PAGE> 411
ownership will even more closely align their interests with the interests of
GTS's stockholders. As of March 31, 1998, 446,464 shares remain available for
the grant of options under the Stock Option Plan, before the amendments
contemplated hereunder.
The Board has determined that it is desirable to amend the Stock Option
Plan so that increases in the number of outstanding shares will be taken into
account immediately for purposes of determining the number of shares available
under the Stock Option Plan for the grant of options. The Board also has
determined to specify a fixed number of shares that will be available for the
grant of options qualifying as incentive stock options for tax purposes
("incentive options"). The Fourth Amended and Restated Plan incorporates a
provision establishing a limit on annual grants to employees to enable grants
under the plan to satisfy the requirements applicable to "qualified
performance-based compensation" under the Code. The Board believes that it is
desirable and in the best interests of GTS to be able to grant options to key
independent contractors and to nonemployee directors of the Company (as defined)
and the Fourth Amended and Restated Plan extends eligibility to those
individuals. The Board also believes that the terms of the Stock Option Plan
should be extended to provide a full ten-year period in which grants can be
made. Finally, with the advice of counsel, the Board has amended the Stock
Option Plan to provide greater flexibility and to eliminate certain provisions
that are not necessary or desirable now that GTS is a public company.
The amendment of the Stock Option Plan is subject to stockholder approval
at the Annual Meeting. GTS is submitting the Fourth Amended and Restated Stock
Option Plan for stockholder approval at the Annual Meeting to allow GTS to
obtain a tax deduction for the full amount allowable with respect to the
exercise of options granted under the Stock Option Plan and to provide
flexibility to grant incentive options, although GTS intends that most or all of
the options granted under the Stock Option Plan will be nonqualified options.
See "--Federal Income Tax Consequences of the Stock Option Plan."
DESCRIPTION OF THE STOCK OPTION PLAN
The Stock Option Plan, as proposed to be amended, provides for the grant of
options to employees, non-employee directors, and independent contractors of GTS
and any subsidiary or affiliate of GTS. A total of 9,568,688 shares of Common
Stock will be reserved for issuance to employees, non-employee directors and
independent contractors under the Stock Option Plan, as it is proposed to be
amended, representing 18.5% of the outstanding shares of Common Stock on March
31, 1998. Based on the closing price of a share of Common Stock on the NASDAQ
Stock Market on March 31, 1998, the aggregate value of the 9,568,688 shares
reserved for issuance under the Stock Option Plan, as it is proposed to be
amended, is $447,336,182. Prior to the proposed amendment of the Stock Option
Plan, a total of 6,957,260 shares of Common Stock, representing 18.5% of
outstanding shares of Common Stock on January 1, 1998, would have been available
for the grant of options. On March 31, 1998, 5,152,453 shares of Common Stock
were subject to outstanding options granted under the Stock Option Plan and
1,358,343 options had been exercised, leaving 446,464 shares of Common Stock
with respect to which Options could be granted under the Stock Option Plan,
before the proposed amendment. As amended, the Stock Option Plan provides that
the number of shares available for issuance under options granted pursuant to
the Stock Option Plan is the greater of 9,568,688 shares or 18.5% of the
outstanding shares of Common Stock at the time of grant. A total of 1 million
shares of Common Stock may be issued pursuant to options qualifying as incentive
options under the Stock Option Plan.
The Stock Option Plan is administered by the Stock Option Committee, which
consists of not less than two directors appointed by the Board of Directors. The
Stock Option Committee selects the employees, independent contractors and
directors of GTS and its subsidiaries and affiliates to whom options will be
granted. Options covering not more than 1.5 million shares of Common Stock may
be granted to any employee during any calendar year.
The option exercise price under the Stock Option Plan may not be less than
the exercise price determined by the Stock Option Committee (or 110% of the fair
market value of the Common Stock on the date of grant of the option in the case
of an incentive option granted to an optionee beneficially owing more than 10%
of the outstanding Common Stock). The maximum option term is 10 years and one
day (or five years in the case of an incentive option granted to an optionee
beneficially owning more than 10% of the outstanding Common
13
<PAGE> 412
Stock). Options become vested and exercisable at the time and to the extent
provided in the option agreement related to such Option. The Stock Option
Committee has the discretion to accelerate the vesting and exercisability of
options.
There is a $100,000 limit on the value of stock (determined at the time of
grant) covered by incentive options that first become exercisable by an optionee
in any calendar year. No option may be granted more than 10 years after the
effective date of the Stock Option Plan. Generally, during an optionee's
lifetime, only the optionee (or a guardian or committee if the optionee is
incapacitated) may exercise an option except that, upon approval by the Stock
Option Committee, nonqualified options may be transferred to the spouse of the
optionee and certain nonqualified options may be granted or transferred to the
GTS Employee Stock Option Plan Trust for the benefit of one or more designated
foreign employees, independent contractors or directors. Incentive stock options
are non-transferable except at death.
Payment for shares purchased under options granted pursuant to the Stock
Option Plan may be made either in cash or by exchanging shares of Common Stock
of GTS (which shares have been held by the optionee for at least six months)
with a fair market value of up to the total option exercise price and cash for
any difference. Options may be exercised by directing that certificates for the
shares purchased be delivered to a licensed broker-dealer as agent for the
optionee, provided that the broker-dealer tenders to GTS cash or cash
equivalents equal to the option exercise price plus the amount of any taxes that
GTS may be required to withhold in connection with the exercise of the option.
If an optionee's employment or service with GTS or a subsidiary or
affiliate terminates by reason of death, retirement or permanent and total
disability, his or her vested options may be exercised within one year after
such death, retirement or disability, unless otherwise provided with respect to
a particular option (but not later than the date the option would otherwise
expire). If the optionee's employment or service with GTS or a subsidiary or
affiliate terminates for any reason other than death, retirement or disability,
options held by such optionee terminate 90 days after such termination, unless
otherwise provided with respect to a particular option (but not later than the
date the options would otherwise expire), except that options terminate
immediately upon termination of an employee or independent contractor for
"cause" (as defined), unless the Stock Option Committee determines otherwise.
Each option would be exercisable to the extent it had become vested before the
termination of employment or service (unless otherwise provided in the option
agreement).
If the outstanding shares of Common Stock are increased or decreased or
changed into or exchanged for a different number or kind of shares or securities
of GTS, by reason of merger, consolidation, reorganization, recapitalization,
reclassification, stock split-up, combination of shares, exchange of shares,
stock dividend, spin-off or other distribution payable in capital stock, or
other increase or decrease in such shares without receipt of consideration by
GTS, an appropriate and proportionate adjustment will be made in the number and
kinds of shares subject to the Stock Option Plan, and in the number, kinds and
per share exercise price of shares subject to the unexercised portion of options
granted prior to any such change, in order to preserve the value of any granted
options. Any such adjustment in an outstanding option, however, will be made
without a change in the total price applicable to the unexercised portion of the
option, but with a corresponding adjustment in the per share option price.
Upon any dissolution or liquidation of GTS, or upon a reorganization,
merger or consolidation in which GTS is not the surviving corporation, or upon
the sale of substantially all of the assets of GTS to another corporation, or
upon any transaction (including, without limitation, a merger or reorganization
in which GTS is the surviving corporation) approved by the Board of Directors
which results in any person or entity owning 80% or more of the total combined
voting power of all classes of stock of GTS, the Stock Option Plan and the
options issued thereunder will terminate, unless provision is made in connection
with such transaction for the continuation of the Stock Option Plan, the
assumption of such options or for the substitution for such options of new
options covering the stock of a successor corporation or a parent or subsidiary
thereof, with appropriate adjustments as to the number and kinds of shares and
the per share exercise price. In the event of such termination, all outstanding
options shall be exercisable in full during such period immediately prior to the
occurrence of such termination as the Board of Directors in its discretion shall
determine.
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The Board of Directors may further amend the Stock Option Plan with respect
to shares of the Common Stock as to which options have not been granted.
However, GTS's stockholders must approve any amendment that would (i) change the
requirements as to eligibility to receive incentive options; or (ii) increase
the maximum number of shares in the aggregate for which incentive options may be
granted (except for adjustments upon changes in capitalization); or (iii)
otherwise to the extent required by applicable law, rule or regulation.
The Board of Directors at any time may terminate or suspend the Stock
Option Plan. Unless previously terminated, the Stock Option Plan will terminate
automatically on April 9, 2008. No termination, suspension or amendment of the
Stock Option Plan may, without the consent of the person to whom an option has
been granted, adversely affect the rights of the holder of the option.
No grants of options have been made under the Stock Option Plan, as it is
proposed to be amended, that are subject to shareholder approval.
FEDERAL INCOME TAX CONSEQUENCES OF THE STOCK OPTION PLAN
The grant of an option under the Stock Option Plan is not a taxable event
for the optionee or GTS.
Upon exercising a non-qualifying option, an optionee will recognize
ordinary income in an amount equal to the difference between the exercise price
and the fair market value of the Common Stock on the date of exercise (except
that, if the optionee is subject to certain restrictions on transfer of shares
of Common Stock, the measurement date may be delayed, unless the optionee makes
a special tax election within 30 days after exercise to have income determined
without regard to the restrictions). If the Company complies with applicable
reporting requirements, it will be entitled to a business expense deduction in
the same amount. Non-qualifying options under the Stock Option Plan are intended
to satisfy the requirements applicable to "qualified performance-related
compensation" under the Code, so that the Company should be entitled to deduct
the full amount of such compensation income without regard to the $1,000,000
limitation imposed on the deduction of annual compensation paid to each of the
chief executive officer and the four other most highly compensated officers of a
publicly held corporation. Upon a taxable disposition of shares acquired
pursuant to the exercise of a non-incentive option, the optionee will have
taxable gain or loss, measured by the difference between the amount realized on
the disposition and the tax basis of the shares (generally, the amount paid for
the shares plus the amount treated as ordinary income at the time the option was
exercised).
If the optionee surrenders shares of Common Stock in payment of part or all
of the exercise price for nonqualifying options, no gain or loss will be
recognized with respect to the shares surrendered and the optionee will be
treated as receiving an equivalent number of shares pursuant to the exercise of
the option in a non-taxable exchange. The basis of the shares surrendered will
be treated as the substituted tax basis for an equivalent number of option
shares received. However, the fair market value of any shares received in excess
of the number of shares surrendered will be taxed as ordinary income.
With respect to "incentive options," an optionee will not recognize taxable
income upon exercise of an incentive option, and any gain realized upon a
disposition of shares received pursuant to the exercise of an incentive option
will be taxed as long-term capital gain if the optionee holds the shares for at
least two years after the date of grant and for one year after the date of
exercise of the option. However, the excess of the fair market value of the
shares subject to an incentive option on the exercise date over the option
exercise price will be included in the optionee's alternative minimum taxable
income in the year of exercise (except that, if the optionee is subject to
certain restrictions on transfer, the determination of the amount included in
alternative minimum taxable income may be delayed, unless the optionee elects
within 30 days following exercise to have income determined without regard to
such restrictions) for purposes of the alternative minimum tax. An optionee may
be entitled to a credit against regular tax liability in future years for
minimum taxes paid with respect to the exercise of incentive options. the
Company and its subsidiaries and affiliates will not be entitled to any business
expense deduction with respect to the grant or exercise of an incentive option,
except as discussed below.
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For the exercise of an incentive option to qualify for the foregoing tax
treatment, the optionee generally must be an employee of the Company or its
subsidiaries from the date the option is granted through a date within three
months before the date of exercise. In the case of an optionee who is disabled,
this three-month period is extended to one year. In the case of an employee who
dies, the three-month period and the holding period for shares received pursuant
to the exercise of the option are waived.
If all of the foregoing requirements for incentive option treatment are met
except for the special holding period rules set forth above, the optionee will
recognize ordinary income upon the disposition of the shares in an amount equal
to the excess of the fair market value of the shares at the time the option was
exercised (or at the time of the disposition, if less) over the option exercise
price. However, if the optionee was subject to certain restrictions on transfer
of Common Stock at the time the option was exercised, the measurement date may
be delayed, unless the optionee has made a special tax election within 30 days
after the date of exercise to have taxable income determined without regard to
such restrictions. The balance of the realized gain, if any, will be short- or
long-term capital gain, and the tax rate will depend upon how long the shares
were held after the option was exercised. If the optionee sells the shares prior
to the satisfaction of the holding period rules but at a price below the fair
market value of the shares at the time the option was exercised (or other
applicable measurement date), the amount of ordinary income (and the amount
included in alternative minimum taxable income, if the sale occurs during the
same year as the option was exercised) will be limited to the excess of the
amount realized on the sale over the option exercise price. If the Company
complies with applicable (if any) reporting requirements, it will be allowed a
business expense deduction to the extent the optionee recognizes ordinary
income.
If an optionee exercises an incentive option by tendering shares of Common
Stock with a fair market value equal to part or all of the option exercise
price, the exchange of shares generally will be treated as a nontaxable exchange
(except that this treatment would not apply if the optionee had acquired the
shares being transferred pursuant to the exercise of an incentive option and had
not satisfied the special holding period requirements summarized above). If the
exercise is treated as a tax free exchange, the optionee would have no taxable
income from the exchange and exercise (other than minimum taxable income as
discussed above) and the tax basis of the shares exchanged would be treated as
the substituted basis for the shares received. If the optionee used shares
received pursuant to the exercise of an incentive option (or another statutory
option) as to which the optionee had not satisfied the applicable holding period
requirement, the exchange would be treated as a taxable disqualifying
disposition of the exchanged shares.
The foregoing is a brief summary of some of the principal federal income
tax consequences of stock option grants under the Stock Option Plan and
recipients of grants under the Stock Option Plan, as amended, should consult
with their personal tax advisors with respect to such grants and transactions in
stock acquired pursuant to the Stock Option Plan, as amended.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" APPROVAL OF THE
FOURTH AMENDED AND RESTATED STOCK OPTION PLAN (ITEM NO. 2)
APPROVAL OF STOCK OPTIONS GRANTED TO CERTAIN MEMBERS OF THE
BOARD OF DIRECTORS (ITEM NO. 3)
On February 27, 1998, the Board of Directors granted to each of its then
incumbent members, except Mr. Thames, options to purchase 15,000 shares of
Common Stock, or a total of 150,000 shares. Messrs. Dey and Hale were not
granted such stock options. These options were awarded, on a one-time basis, by
the Board of Directors to such persons in recognition of the extraordinary
efforts of each then non-employee Director in successfully accomplishing the
initial public offering ("IPO") of the Company's Common Stock; and to reflect
the increased responsibilities of directors of publicly-held reporting
companies. In connection with its IPO, the Company issued 12,765,000 shares
(including exercise of an underwriters' overallotment option) of Common Stock at
$20 per share and realized net proceeds of $238.7 million, after the payment of
underwriting discounts and commissions. Accordingly, the awarded stock options
have an exercise price of $20 per share. The grant of these options is subject
to stockholder approval at the Annual Meeting.
The stock options are not subject to any stock option plan and will be
covered by an agreement between the Company and each optionee. The options will
vest over the following schedule: 5,000 options will vest on
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<PAGE> 415
August 27, 1998; 5,000 options will vest on August 27, 1999; and 5,000 options
will vest on August 27, 2000. The stock options will expire on February 28,
2008, ten years and one day after grant. As discussed below, the stock options
are nonqualified options which are not qualified for special tax treatment. The
full purchase price of the shares of Common Stock covered by the stock options
must be paid, either in cash, by delivery of shares owned at least six months
prior thereto, or by delivering a written direction to the Company that the
option be exercised pursuant to a "cashless" exercise/sale procedure through a
licensed broker-dealer whereby a stock certificate or certificates will be
delivered to the broker-dealer as the agent for the Director exercising the
option and the broker-dealer will deliver to the Company cash or cash
equivalents equal to the exercise price for the shares of Common Stock purchased
pursuant to the exercise of the options, plus the amount of any federal and
other taxes that the Company may be required to withhold with respect to the
exercise of the Option.
If an optionee's service with the Company terminates by reason of death or
disability, his vested options may be exercised within one year after death or
declared disability (but not later than the date the options would otherwise
expire). If the optionee's service with GTS terminates as a result of any other
event other than to take an employment position with the Company, vested options
held by such optionee will be exercisable for 90 days following such
termination. (but not later than the date the options would otherwise expire).
Unvested stock options will terminate if and when the optionee terminates his
position on the Company's Board of Directors for any reason, subject to
acceleration of vesting by the Board of Directors at its discretion.
If the outstanding shares of Common Stock are increased or decreased or
changed into or exchanged for a different number or kind of shares or securities
of the Company, by reason of merger, consolidation, reorganization,
recapitalization, reclassification, stock split-up, combination of shares,
exchange of shares, stock dividend, spin-off or other distribution payable in
capital stock, or other increase or decrease in such shares without receipt of
consideration by the Company, an appropriate and proportionate adjustment will
be made in the number and kinds of shares subject to the options, and in the
number, kinds and per share exercise price of shares subject to the unexercised
portion of options granted prior to any such change, in order to preserve the
value of any granted options. Any such adjustment in an outstanding option,
however, will be made without a change in the total price applicable to the
unexercised portion of the option, but with a corresponding adjustment in the
per share option price.
Any unvested options will vest and become exercisable upon any dissolution
or liquidation of the Company in connection with a "change of control" over the
Company, which is defined to include the purchase by any person or entity of a
majority of the voting stock of the Company; a reorganization, merger or
consolidation (a "Transaction") in which the Company is not the surviving
corporation or after which the shareholders of the Company prior to the
Transaction do not control the majority of the voting securities of the
surviving entity; and the sale of all or substantially all of the assets of the
Company to another corporation; in each case unless provision is made in
connection with such transaction for the continuation of the options, the
assumption of the options or both the continuation of the options and the
assumption of such options, or for the substitution for such options of new
options covering the stock of a successor corporation or a parent or subsidiary
thereof, with appropriate adjustments as to the number and kinds of shares and
the per share exercise price.
NEW PLAN BENEFITS
The table below provides certain information as of the date of this Proxy
Statement regarding the stock options granted to non-executive directors of the
Company on the date of grant, February 27, 1998. All such grants are subject to
stockholder approval.
NEW PLAN BENEFITS(1)
<TABLE>
<CAPTION>
NUMBER OF
NAME AND POSITION(S) DOLLAR VALUE(2) OPTIONS GRANTED
-------------------- --------------- ---------------
<S> <C> <C>
Non-Executive Director Group (10 persons)................... $3,000,000 150,000
</TABLE>
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- ---------------
(1) The option grants were made pursuant to a "plan," as defined under the
applicable rules of the Securities and Exchange Commission (the "SEC"). In
addition, such rules require the inclusion of this table in this Proxy
Statement.
(2) Represents the aggregate exercise price of the options granted.
Depending on the fair market value of the Common Stock on the date that the
grants of such stock options are approved by the Company's stockholders, the
Company will record a compensation charge equal to the difference, if any,
between the fair market value per share of the Common Stock on such date and the
$20 exercise price per share, multiplied by 150,000. Such compensation charge,
if any, will be expensed over the vesting schedule of the options. The Company
has entered into a hedging transaction to cap its exposure to such compensation
charge with respect to any appreciation in the per share value of the Common
Stock in excess of $40.
FEDERAL INCOME TAX CONSEQUENCES OF THE OPTIONS
The grant of an option is not a taxable event for the optionee or the
Company.
Upon exercising a non-qualifying option, an optionee will recognize
ordinary income in an amount equal to the difference between the exercise price
and the fair market value of the Common Stock on the date of exercise (except
that, if the optionee is subject to certain restrictions on transfer of shares
of Common Stock, the measurement date may be delayed, unless the optionee makes
a special tax election within 30 days after exercise to have income determined
without regard to the restrictions). If the Company complies with applicable
reporting requirements, it will be entitled to a business expense deduction in
the same amount. Upon a taxable disposition of shares acquired pursuant to the
exercise of a nonqualifying option, the optionee will have taxable gain or loss,
measured by the difference between the amount realized on the disposition and
the tax basis of the shares (generally, the amount paid for the shares plus the
amount treated as ordinary income at the time the option was exercised).
If the optionee surrenders shares of Common Stock in payment of part or all
of the exercise price for nonqualifying options, no gain or loss will be
recognized with respect to the shares surrendered and the optionee will be
treated as receiving an equivalent number of shares pursuant to the exercise of
the option in a non-taxable exchange. The basis of the shares surrendered will
be treated as the substituted tax basis for an equivalent number of option
shares received. However, the fair market value of any shares received in excess
of the number of shares surrendered will be taxed as ordinary income.
The foregoing is a brief summary of some of the principal federal income
tax consequences of the stock option grants to the Directors described below.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" ITEM NO. 3
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RATIFICATION OF APPOINTMENT OF AUDITORS
(ITEM NO. 4)
The Board of Directors has selected Ernst & Young LLP ("Ernst & Young"),
independent public accountants, to audit the consolidated financial statements
of the Company for the fiscal year ending December 31, 1998 and recommends that
the stockholders ratify such selection. This appointment will be submitted to
the stockholders for ratification at the Annual Meeting.
The submission of the appointment of Ernst & Young is not required by law
or by the By-laws of the Company. The Board of Directors is nevertheless
submitting it to the stockholders to ascertain their views. If the stockholders
do not ratify the appointment, the selection of other independent public
accountants will be considered by the Board of Directors. If Ernst & Young shall
decline to accept or become incapable of accepting its appointment, or if its
appointment is otherwise discontinued, the Board of Directors will appoint other
independent public accountants.
A representative of Ernst & Young is expected to be present at the Annual
Meeting, will have the opportunity to make a statement, and will be available to
respond to appropriate questions.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" ITEM NO. 4.
PERFORMANCE GRAPH
At the end of 1997, the Company was not subject to the reporting
requirements of the Securities Exchange Act of 1934 (the "Exchange Act"). The
Company's Common Stock has only been subject to such requirements since February
5, 1998. Accordingly, the inclusion of a performance graph in this Proxy
Statement is not required.
RELATED PARTY TRANSACTIONS
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.
In August and September, 1997 affiliates of George Soros purchased 319,149
shares of Common Stock at a price of $15.67 per share in the Company's private
stock offering. In addition, 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 19% 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. On February 10, 1998, the Company repaid
the $40 million in notes, plus accrued interest, using, in part, the proceeds of
a sale of senior notes by the Company. In addition, these affiliates collect a
monitoring fee of $40,000 per month. Under certain agreements, these affiliates
have the right to co-invest with GTS in all of its new ventures throughout Asia,
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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, an
affiliate of the Company.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires the Company's directors and
executive officers, and persons or entities who own more than 10% of the
Company's Common Shares, to file with the SEC and the Nasdaq Stock Market
initial reports of beneficial ownership and changes in beneficial ownership of
the Company's Common Shares. Such persons are also required by SEC regulations
to furnish the Company with copies of all Section 16(a) forms they file. To the
Company's knowledge, based solely on a review of the copies of such reports
furnished to the Company as to transactions for which reports are required, all
Section 16(a) filing requirements applicable to such individuals or entities
have been complied since the Company become subject on February 5, 1998 to the
reporting requirements of the Exchange Act.
OTHER BUSINESS WHICH MAY PROPERLY COME BEFORE THE MEETING
The Board of Directors knows of no business which may come before the
meeting except that indicated above. However, if other business is brought
before the meeting, the persons acting under the enclosed form of proxy may vote
thereunder in accordance with their best judgment.
COST AND METHOD OF PROXY SOLICITATION
Proxies will be solicited by mail. The expense of such solicitation will be
borne by the Company. Directors, officers, or regular employees of the Company
may solicit proxies by telephone or in person. The cost of such solicitation
will be nominal. In addition, Corporate Investor Communications, Inc. has been
retained by the Company to assist in soliciting proxies from brokerage firms,
bank nominees and other institutional holders to assure a timely vote by the
beneficial owners of stock held of records by such firms, banks and
institutions. This firm will receive a fee not to exceed $4,000 for its
services.
DATE FOR SUBMISSION OF STOCKHOLDER
PROPOSALS FOR 1998 ANNUAL MEETING
Stockholder proposals, in order to be timely submitted for inclusion in the
Company's proxy materials for the 1999 annual meeting of stockholders, must be
received at the Company's principal executive offices by January 30, 1999.
* * *
The Company will provide, without charge, to each person to whom this Proxy
Statement is delivered, upon written request of such person, a copy of the
Company's annual report on From 10-K for the year ended December 31, 1997.
Requests should be addressed to the Vice President-Investor Relations and
Corporate Communications, Global TeleSystems Group, Inc. 1751 Pinnacle Drive,
North Tower, 12th Floor, McLean, VA 22102.
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EXHIBIT A
FOURTH AMENDED AND RESTATED
1992 STOCK OPTION PLAN OF
GLOBAL TELESYSTEMS GROUP, INC.
(AS OF APRIL 9, 1998)
1. PURPOSES OF THE PLAN. The purposes of the Fourth Amended and Restated
1992 Stock Option Plan of Global TeleSystems Group, Inc. are to attract and
retain the best available personnel for positions of substantial responsibility,
to provide additional incentives to Employees of the Company and its Parent or
Subsidiaries, and to promote the success of the business of the Company and its
Parent or Subsidiaries. At the discretion of the Committee, Options granted
hereunder may be either Incentive Stock Options or Nonstatutory Stock Options.
Each Option shall be a Nonstatutory Stock Option unless such Option is granted
to an Employee and is specifically designated at the time of grant as being an
Incentive Stock Option.
2. DEFINITIONS. As used herein, and in any Option granted hereunder, the
following definitions shall apply:
(a) "Board" shall mean the Board of Directors of GTS.
(b) "Code" shall mean the Internal Revenue Code of 1986, as amended.
(c) "Common Stock" shall mean the Common Stock of GTS, par value $.10
per share.
(d) "Company" shall mean GTS, any Parent, Subsidiary or affiliate of
GTS, and except as provided in Section 11 below, any successors in interest
to GTS or such Parent, Subsidiary or affiliate.
(e) "Committee" shall mean the Stock Option Committee appointed by the
Board in accordance with Section 4 of the Plan. If the Board does not
appoint or ceases to maintain a Committee, the term "Committee" shall refer
to the Board.
(f) "Continuous Employment" shall mean the absence of any interruption
or termination of service as an Employee, independent contractor or
director with the Company. For purposes of the preceding sentence, service
shall not be considered interrupted during any period of vacation, sick
leave, military leave or any other absence approved by the Board and shall
not be considered terminated as a result of a transfer between locations
within the Company.
(g) "Director" shall mean any person serving on the Board of Directors
of the Company or analogous governing body in the case of entities
organized in jurisdictions outside the United States.
(H) "Employee" shall mean any person, including any officer (whether
or not he or she is a director of the Company), employed by the Company.
(i) "Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended.
(j) "GTS" shall mean Global TeleSystems Group, Inc., a Delaware
corporation, and except as provided in Section 11 below, its successors in
interest.
(k) "Incentive Stock Option" shall mean any option granted under this
Plan and any other option granted to an Employee in accordance with the
provisions of Section 422 of the Code and the regulations promulgated
thereunder.
(l) "Non-Employee Director" shall mean a "non-employee director" of
GTS within the meaning of Rule 16b-3 promulgated under the Exchange Act who
is an "outside director" for purposes of Section 162(m) of the Code.
(m) "Nonstatutory Stock Option" shall mean any Option granted under
the Plan that is not an Incentive Stock Option.
(n) "Option" shall mean a stock option granted pursuant to the Plan.
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(o) "Option Agreement" shall mean a written agreement between the
Company and the Optionee or the Trust regarding the grant and exercise of
Options to purchase Shares and the terms and conditions thereof as
determined by the Committee pursuant to the Plan.
(p) "Optioned Shares" shall mean the Common Stock subject to an
Option.
(q) "Optionee" shall mean an Employee, independent contractor or
director who receives an Option under the Plan, either directly or as a
beneficiary of the Trust.
(r) "Parent" shall mean a "parent corporation," whether now or
hereafter existing, as defined in Section 424(e) of the Code.
(s) "Plan" shall mean this Fourth Amended and Restated 1992 Stock
Option Plan of GTS
(t) "Registration Date" shall mean February 5, 1998, the effective
date of the first registration statement filed by GTS, pursuant to Section
12(g) of the Exchange Act, with respect to any class of equity securities.
(u) "Securities Act" shall mean the Securities Act of 1933, as
amended.
(v) "Share" shall mean a share of the Common Stock, as adjusted in
accordance with Section 11 of the Plan.
(w) "Subsidiary" shall mean a "subsidiary corporation," whether now or
hereafter existing, as defined in Section 424(f) of the Code.
(x) "Trust" shall mean the GTS Employee Stock Option Plan Trust, as
may be amended from time to time.
(y) "Trustee" shall mean the trustee of the Trust, as may be
designated from time to time in accordance with the terms and provisions of
the Trust.
3. STOCK SUBJECT TO THE PLAN. Without limiting the application of Section
11 of the Plan, the maximum aggregate number of Shares which may be subject to
Options and sold under the Plan is the greater of 9,568,688 or 18.5% of the
total number of Shares outstanding at the time of the grant of such Options or
on any other relevant date. The number of Shares that may be issued pursuant to
Incentive Stock Options granted under the Plan shall not exceed in the aggregate
1 million Shares, subject to adjustment as provided in Section 11 below (the
"Incentive Option Pool"). Incentive Stock Options shall be granted under the
Plan only to the extent that Shares remain available in the Incentive Option
Pool. Unless otherwise specified by the Committee at the time of the grant of a
Nonstatutory Stock Option, Nonstatutory Stock Options shall be granted only with
respect to Shares available under this Section 3 in excess of the number of
Shares in the Incentive Option Pool. If any Incentive Stock Option or any
Nonstatutory Stock Option that was designated at the time of grant as having
been granted from the Incentive Option Pool expires, terminates, or is
terminated or becomes unexercisable for any reason (other than settlement in
cash) prior to exercise in full, the Shares that were subject to the unexercised
portion of such Option shall be restored to the Incentive Option Pool and shall
be available for future Incentive Stock Option grants under the Plan, unless the
Plan shall have been terminated. If an Option is surrendered to the Company for
cash or other consideration (including Shares withheld in payment of taxes
relating to awards or in payment of the exercise price of Options), if Shares
are surrendered to the Company in payment of the exercise price of Options or
taxes relating to awards, or if a Nonstatutory Stock Option that was not
designated as having been granted from the Incentive Option Pool expires,
terminates, or is terminated or becomes unexercisable for any reason without
having been exercised in full, the Shares that were subject to the unexercised
portion of such Option and the Shares surrendered to the Company shall become
available for future Nonstatutory Stock Option grants under the Plan, unless the
Plan shall have been terminated, but such Shares shall not be included in the
Incentive Option Pool. The Shares may include authorized but unissued or
reacquired Common Stock.
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The Committee may adopt reasonable counting procedures to ensure
appropriate counting, avoid double counting and make adjustments if the number
of Shares actually delivered differs from the number of Shares previously
counted in connection with an award.
4. ADMINISTRATION OF THE PLAN.
(a) Procedure. The Plan shall be administered by the Board. The Board may
appoint a Stock Option Committee consisting of not less than two members of the
Board to administer the Plan, subject to the direction of the Board and such
terms and conditions as the Board may prescribe. Once appointed, the Committee
shall continue to serve until otherwise directed by the Board. In the discretion
of the Board, the Committee may be comprised of members each of whom qualifies
as a Non-Employee Director.
From time to time, the Board may increase the size of the Committee and
appoint additional members thereof, remove members (with or without cause) and
appoint new members in substitution therefor, fill vacancies, however caused,
and remove all members of the Committee and, thereafter, directly administer the
Plan. Members of the Board or Committee who are either eligible for Options or
have been granted Options (either directly or as a beneficiary of the Trust) may
vote on any matters affecting the administration of the Plan or the grant of
Options pursuant to the Plan, except that no such member shall act upon the
granting of an Option to such member (either directly or as a beneficiary of the
Trust) but any such member may be counted in determining the existence of a
quorum at any meeting of the Board or the Committee during which action is taken
with respect to the granting of an Option to such member (either directly or as
a beneficiary of the Trust).
The Committee shall meet at such times and places and upon such notice as
the Chairperson determines. A majority of the Committee shall constitute a
quorum. Any acts by the Committee may be taken at any meeting at which a quorum
is present and shall be by majority vote of those members entitled to vote.
Additionally, any acts reduced to writing or approved in writing by all of the
members of the Committee shall be valid acts of the Committee.
(b) Procedure After Registration Date. After the Registration Date, the
Board shall take all action necessary to administer the Plan in accordance with
the then effective provisions of Rule 16b-3 promulgated under the Exchange Act,
provided that any amendment to the Plan required for compliance with such
provisions shall be made in accordance with Section 13 of the Plan.
(c) Powers of the Committee. Subject to the provisions of the Plan, the
Committee shall have discretionary authority: (i) to determine, upon review of
relevant information, the fair market value of the Common Stock; (ii) to
determine the exercise price of Options to be granted, the persons (including
the Trust) to whom and the time or times at which Options shall be granted, and
the number of Shares to be represented by each Option; (iii) to interpret the
Plan; (iv) to prescribe, amend and rescind rules and regulations relating to the
Plan; (v) to establish the terms and conditions of each Option granted under the
Plan (which terms and conditions need not be identical in any two Options) and,
with the consent of the holder thereof, to modify or amend any Option; (vi) to
authorize any person to execute on behalf of the Company any instruments
required to effect the grant of an Option awarded by the Committee; (vii) to
accelerate or (with the consent of an Optionee) to defer an exercise date of any
Option subject to the provisions of Section 9(a) of the Plan; (viii) to
determine whether Options granted under the Plan will be Incentive Stock Options
or Nonstatutory Stock Options; and (ix) to make all other determinations deemed
necessary or advisable for the administration of the Plan.
(d) Effect of Committee's Decision. All decisions, determinations and
interpretations of the Committee shall be final and binding on all potential or
actual Optionees, any other holder of an Option or other equity security of the
Company and all other persons. In any controversy regarding the administration
of the Plan, any arbitrator or court reviewing any decision, determination or
interpretation by the Committee shall not set aside or modify such decision,
determination or interpretation unless it is arbitrary, capricious or clearly
contrary to the terms of the Plan.
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5. ELIGIBILITY.
(a) Persons Eligible to Participate. Options under the Plan may be granted
only to (i) Employees, (ii) the Trust for the benefit of Employees; (iii)
independent contractors performing services for the Company, whom the Committee
may designate from time to time and (iv) Directors of the Company who are not
Employees. Each Employee in certain jurisdictions, as designated by the
Committee from time to time, must be a beneficiary of the Trust in order to be a
participant under this Plan. Incentive Stock Options may be granted only to
Employees. An Optionee who has been granted an Option may receive an additional
Option or Options, if he or she is otherwise eligible for such grant. Such
additional Option or Options may be granted to the Trust for the benefit of such
eligible Optionee. However, an Option intended to constitute an Incentive Stock
Option (and so designated at the time of grant) shall qualify as an Incentive
Stock Option only to the extent that the aggregate fair market value (determined
at the time the Option is granted) of the Shares with respect to which Incentive
Stock Options are exercisable for the first time by the Optionee during any
calendar year (under the Plan and all other plans of the Optionee's employer
corporation and its parent and subsidiary corporations within the meaning of
Section 422(d) of the Code) does not exceed $100,000. This limitation shall be
applied by taking Options into account in the order in which they were granted.
(b) No Right to Continuing Employment or Service. Neither the
establishment nor operation of the Plan or the Trust shall confer upon any
Optionee or any other person any right with respect to continuation of
employment or other service with the Company, nor shall the Plan or the Trust
interfere in any way with the right of the Optionee or other person or the right
of the Company to terminate such employment or service at any time.
6. TERM OF PLAN. This Fourth Amended and Restated Plan shall become
effective upon its adoption by the Board. The Plan shall continue until April 9,
2008 unless sooner terminated under Section 11 or 13 of the Plan.
7. TERM OF OPTION. Unless the Committee determines otherwise, at the time
of the grant of an Option, the term of each Nonstatutory Stock Option granted
under the Plan shall be 10 years and one day from the date of grant; and the
term of each Incentive Stock Option shall be 10 years from the date of grant. No
Option shall be exercisable after the expiration of its term. In all cases the
terms of an Option shall be set forth in the Option Agreement.
8. OPTION PRICE, CONSIDERATION AND RESTRICTIONS.
(a) Option Price. Except as provided in subsection 8(b), the option price
for the Shares to be issued pursuant to any Option shall be such price as is
determined by the Committee which, in the case of Incentive Stock Options, shall
in no event be less than the fair market value of such Shares on the date the
Option is granted. Fair market value of the Common Stock shall be determined by
the Committee using such criteria as it deems relevant; provided, however, that
where there is a public market for the Common Stock, the fair market value per
Share shall be the average of the last reported bid and asked prices of the
Common Stock on the date of grant, as reported in The Wall Street Journal (or,
if not so reported, as otherwise reported by the National Association of
Securities Dealers Automated Quotation ("NASDAQ") System; or, in the event the
Common Stock is listed on a national securities exchange, within the meaning of
Section 6 of the Exchange Act, the fair market value per Share shall be the
closing price on such exchange on the date of grant of the Option, as reported
in The Wall Street Journal.
(b) Ten Percent Shareholders. No Incentive Stock Option shall be granted
to any Employee who, at the date such Option is granted, owns (within the
meaning of Section 424(d) of the Code) more than 10% of the total combined
voting power of all classes of stock of the Company, unless the option price for
the Shares to be issued pursuant to such Incentive Stock Option is equal to at
least 110% of the fair market value of such Shares on the grant date as
determined by the Committee in the manner set forth in subsection (a) above.
(c) Consideration. The consideration to be paid for the Shares to be issued
upon exercise of an Option shall be payment in cash or by check or with Shares
of the Company's Common Stock. The Committee may also, in its discretion,
authorize at the time of the grant of the Option payment in some other
consideration or method (such as by promissory note) for the issuance of Shares
as may be permitted under Section 157 of the
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General Corporation Law of the State of Delaware. Any cash or other property
received by the Company from the sale of Common Stock pursuant to the Plan shall
constitute part of the general assets of the Company.
(d) Code Section 162(m). The maximum number of Shares subject to Options
that may be granted during any calendar year under the Plan to any executive
officer or other Employee whose compensation is or may be subject to Code
Section 162(m) is 1,500,000 shares (subject to adjustment as provided in Section
11 hereof).
9. EXERCISE OF OPTION.
(a) Vesting Period. Any Option granted hereunder shall be exercisable at
such times and under such conditions as determined by the Committee and as shall
be permissible under the terms of the Plan, which times and conditions shall be
specified in the Option Agreement evidencing the grant of the Option. Unless the
Committee specifically determines otherwise in the Option Agreement, each Option
shall vest and become exercisable, cumulatively, by an Optionee or by the Trust
on behalf of an Optionee, to the extent of (i) one-fourth of the Optioned Shares
as of the first anniversary of the date on which the Option is granted, (ii)
one-half of the Optioned Shares as of the second anniversary of the date on
which the Option is granted, (iii) three-fourths of the Optional Shares as of
the third anniversary of the date on which the Option is granted, and (iv) all
of the Optioned Shares as of the fourth anniversary of the date on which the
Option is granted, subject to the Optionee's Continuous Employment; provided,
however, that the Optionee must complete 12 months of employment to exercise an
Incentive Stock Option. An Option may not be exercised for fractional Shares or
for less than 10 Shares.
(b) Exercise Procedures. An Option shall be deemed to be exercised when
written notice of such exercise has been given to the Company in accordance with
the terms of the Option Agreement by an Optionee or by the Trust on behalf of an
Optionee and full payment for the Shares with respect to which the Option is
exercised has been received by the Company. As soon as administratively
practicable following the exercise of an Option in the manner set forth above,
the Company shall issue or cause its transfer agent to issue stock certificates
representing the Shares purchased. Until the issuance of such stock certificates
(as evidenced by the appropriate entry on the books of the Company or of a duly
authorized transfer agent of the Company), no right to vote or receive dividends
or any other rights as a stockholder shall exist with respect to the Optioned
Shares notwithstanding the exercise of the Option. Except as provided in Section
11 below, no adjustment will be made for a dividend or other rights for which
the record date occurs prior to the date the stock certificates are issued.
(c) Exercise of Option with Stock, by Cashless Exercise or Net of Exercise
Price. The consideration to be paid for the Shares to be issued upon exercise
of an Option shall be made (i) in cash or in cash equivalents; (ii) through the
tender to the Company of Shares, which Shares shall be valued, for purposes of
determining the extent to which the Option price has been paid thereby, as
provided below, and which Shares have been held by the Optionee for at least six
months; (iii) by delivering a written direction to the Company that the Option
be exercised pursuant to a "cashless" exercise/sale procedure (pursuant to which
funds to pay for exercise of the Option are delivered to the Company by a broker
upon receipt of stock certificates from the Company) or a cashless exercise/loan
procedure (pursuant to which the Optionee would obtain a margin loan from a
broker to fund the exercise) through a licensed broker acceptable to the Company
whereby the stock certificate or certificates for the Shares for which the
Option is exercised will be delivered to such broker as the agent for the person
exercising the Option and the broker will deliver to the Company cash (or cash
equivalents acceptable to the Company) equal to the option price for the Shares
purchased pursuant to the exercise of the Option, plus the amount (if any) of
federal and other taxes that the Company, may, in its judgment, be required to
withhold with respect to the exercise of the Option; or (iv) by a combination of
the methods described in (i), (ii) and (iii). The Committee, in its discretion,
may permit an Optionee or the Trust on behalf of an Optionee to exercise an
Option in whole or in part by delivering that number of whole Shares, that have
been held by the Optionee for at least six months, having a fair market value
equal to the Option price. Shares of the Company's Common Stock so delivered
shall be valued at their fair market value at the close of the last business day
immediately preceding the date of exercise of the Option, as determined by the
Committee. Any balance of the Option price shall be paid in cash. Any Shares
delivered in accordance
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with this provision shall again become available for purposes of the Plan and
for Nonstatutory Stock Options subsequently granted thereunder.
(d) Termination of Status as Employee, Contractor or Director. If an
Optionee shall cease to be an Employee, independent contractor or director of
the Company for any reason other than permanent and total disability (within the
meaning of Section 22(e)(3) of the Code as determined in the sole discretion of
the Committee), retirement, death or, in the case of an Employee or independent
contractor, involuntary termination for "cause," such individual's Option
(irrespective of whether such Option has been transferred to the Trust) shall
automatically terminate 90 days following the date he or she ceases to be an
Employee, independent contractor or director of the Company, unless the
Committee, in its discretion, determines to provide a different post-termination
exercise period under the Option Agreement with respect to such Option or any
amendment thereto (which period shall in no event extend beyond the term of the
relevant Option).
(1) If an Optionee's employment or service as an independent
contractor of the Company is terminated involuntarily by the Company for
"cause," such individual's Option (irrespective of whether such Option has
been transferred to the Trust) shall automatically terminate on the date he
or she ceases to be an Employee or independent contractor of the Company,
unless the Committee, in its discretion, determines to determines to
provide a different post-termination exercise period under the Option
Agreement with respect to such Option or any amendment thereto (which shall
in no event extend beyond the term of the relevant Option). Prior to such
termination of the Option, the Optionee or the Trust on behalf of an
Optionee may exercise such Option to the extent that the Optionee or the
Trust on behalf of an Optionee was entitled to exercise on the exercise
date, subject to the condition that no Option shall be exercised after the
expiration of the term of the Option. For this purpose, "cause" shall have
the meaning set out in the Option Agreement relating to a particular
Option, or, in the absence of such a definition, shall mean:
(i) fraud, embezzlement, or any other illegal act in connection
with the Optionee's duties as an Employee of the Company which causes or
may reasonably be expected to cause substantial economic injury to or
substantial injury to the reputation of the Company,
(ii) conviction of any crime which causes or may reasonably be
expected to cause substantial economic injury to or substantial injury
to the reputation of the Company,
(iii) material breach of any fiduciary duty owed to the Company,
(iv) willful misconduct in connection with the Optionee's duties to
the Company which causes or may reasonably be expected to cause
substantial economic injury to or substantial injury to the reputation
of the Company,
(v) willful failure to perform assigned duties as an Employee of
the Company,
(vi) misrepresentation of qualifications for position,
(vii) the commission of any other act which causes or may
reasonably be expected to cause substantial economic injury to or
substantial injury to the reputation of the Company, including, without
limitation, any material violation of the Foreign Corrupt Practices Act,
as described herein below;
(viii) a continuing conflict of interest or continuing failure to
perform duties or to follow reasonable directions or instructions of the
Optionee's superiors. For purposes of this provision, a conflict of
interest or failure to perform or follow directions shall be deemed to
be "continuing" if the Optionee does not correction the conflict or
failure within ten (10) days of receipt of written notice of such
conflict or failure; or
(ix) an extended period of absence or repeated absences by the
Optionee from the performance of Optionee's duties, which absence shall
be for a reason other than vacation, illness or disability, or which has
not been approved by the Optionee's immediate supervisor; or
(x) material breach of a material provision of any employment
agreement by the Optionee.
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(e) Disability of Optionee. In the event of the permanent and total
disability (within the meaning of Section 22(e)(3) of the Code as determined in
the sole discretion of the Committee) during the term of the Option of an
Optionee who is at the time of such disability, or was within the 90-day period
prior thereto, an Employee, independent contractor or Director of the Company
and who was in Continuous Employment as such from the date of the grant of the
Option until the date of disability or termination, the Option may be exercised
at any time within one year following the date of disability, unless the
Committee, in its discretion, determines to provide a different post-termination
exercise period under the Option Agreement with respect to such Option or any
amendment thereto, but only to the extent that the Optionee or the Trust was
entitled to exercise the Option at the time of the termination or disability,
whichever comes first, unless otherwise determined by the Committee in its
discretion, and subject to the condition that no Option shall be exercised after
the expiration of the term of the Option.
(f) Retirement of Optionee. In the event of the retirement during the
Option period of an Optionee who is at the time of such retirement, or was
within the 90-day period prior thereto, an Employee and who was in Continuous
Employment as such from the date of the grant of the Option until the date of
the retirement, the Option may be exercised by the Optionee or the Trust on
behalf of an Optionee at any time within one year following the retirement date,
unless the Committee, in its discretion, determines to provide a different post-
termination exercise period under the Option Agreement with respect to such
Option or any amendment thereto, but only to the extent that the Optionee or the
Trust was entitled to exercise the Option at the time of the Optionee's
retirement, unless otherwise determined by the Committee in its discretion, and
subject to the condition that no Option shall be exercised after the expiration
of the Option period. For purposes of this Section 9, the term "retirement"
shall mean voluntary termination of employment by an Employee who is at least
age 55 and who has completed five years of employment with the Company.
(g) Death of Optionee. In the event of the death during the term of the
Option of an Optionee who is at the time of his or her death, or was within the
90-day period immediately prior thereto, an Employee, independent contractor or
Director of the Company and who was in Continuous Employment as such from the
date of the grant of the Option until the date of death, the Option may be
exercised for a period up to one year following the date of death, unless the
Committee, in its discretion, determines to provide a different post-
termination exercise period under the Option Agreement with respect to such
Option or any amendment thereto, at any time prior to the expiration of the term
of the Option, by the Optionee's estate or by a person who acquired the right to
exercise the Option by bequest, inheritance or otherwise as a result of the
Optionee's death, or by the Trust for the benefit of such estate or person, but
only to the extent that the Optionee or Trust was entitled to exercise the
Option at the time of the death, unless otherwise determined by the Committee in
its discretion, and subject to the condition that no Option shall be exercised
after the expiration of the Option period.
(h) Tax Withholding. When an Optionee or the Trust on behalf of an Optionee
is required to pay to the Company an amount with respect to income or employment
tax withholding obligations in connection with the exercise of an Option granted
under the Plan, the Optionee or the Trust on behalf of an Optionee may elect,
prior to the date the amount of such withholding is determined (the "Tax Date")
to make such payment, or such increased payment as the Optionee or the Trust on
behalf of an Optionee elects to make up to the maximum federal, state and local
marginal tax rates (including any related obligation under the Federal Insurance
Contribution Act) applicable to the Optionee and the particular transaction, by
(i) delivering cash; (ii) delivering part or all of the payment in previously
owned stock (whether or not acquired through the prior exercise of a stock
option); or (iii) subject to the consent of the Committee, irrevocably directing
the Company to withhold from the Shares that would otherwise be issued upon
exercise of the Option that number of whole Shares having a fair market value
equal to the amount of tax required or elected to be withheld (a "Withholding
Election"). If an Optionee's Tax Date is deferred beyond the date of exercise
and the Optionee or the Trust on behalf of an Optionee makes a Withholding
Election, the Optionee or the Trust on behalf of an Optionee will receive the
full amount of Shares otherwise issuable upon exercise of the Option minus the
number of Shares necessary to satisfy the minimum withholding requirements
measured on the date the Option is exercised (or such higher payment as the
Optionee or the Trust may have elected to make) with adjustments to be made in
cash after the Tax Date. Any adverse consequences incurred by an Optionee
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with respect to his or her participation in the Plan or the Trust, the use of
Shares to pay any part of the Option price or income or employment tax arising
in connection with the exercise of an Option (including without limitation any
adverse tax consequences arising as result of a disqualifying disposition within
the meaning of Section 422 of the Code) shall be the sole responsibility of the
Optionee or Trust. The Company does not warrant or represent to the Optionee any
tax consequence of any transaction under this Plan or the Trust, including the
initial and continuing satisfaction of the conditions for an Incentive Stock
Option under Section 422 of the Code.
10. NON-TRANSFERABILITY OF OPTIONS AND SHARES OF COMMON STOCK.
(a) Options. An Option may not be sold, pledged, assigned, hypothecated,
transferred or disposed of in any manner other than by will or by the laws of
descent and distribution and may be exercised, during the lifetime of the
Optionee, only by the Optionee. Notwithstanding the preceding sentence, (i) an
Optionee who is eligible to participate in the Trust may transfer or direct the
Company to transfer Nonstatutory Stock Options or Optioned Shares to the Trust,
subject to the terms and conditions of this Plan and the Trust, and (ii) a
Nonstatutory Stock Option may be transferred to a spouse of the Optionee only
upon approval of the Committee, providing all the conditions of exercisability
and vesting have been met. If the Option Agreement permits, the Optionee may
designate a beneficiary who may (i) exercise an Option under Section 9(g) above,
or (ii) receive Shares issued pursuant to the exercise of an Option where the
death of an Optionee occurs between the date on which the Optionee exercises the
Option and the date the Company issues the Shares.
(b) Shares of Common Stock. The Committee may impose such other
restrictions on Shares issued under this Plan as it deems advisable. The
certificates representing the Optioned Shares shall bear a legend which shall
give notice of such restrictions.
11. ADJUSTMENTS UPON CHANGES IN CAPITALIZATION. Subject to any required
action by the shareholders of the Company, the number of Shares of Common Stock
covered by each outstanding Option and the per share price thereof in each such
Option, shall be proportionately adjusted for any increase or decrease in the
number of issued Shares of Common Stock resulting from a stock split, reverse
stock split, combination, reclassification, the payment of a stock dividend on
the Common Stock or any other increase or decrease in the number of such Shares
of Common Stock effected without receipt of consideration by the Company;
provided, however, that conversion of any convertible securities of the Company
shall not be deemed to have been "effected without receipt of consideration."
Such adjustment shall be made by the Committee, whose determination in that
respect shall be final, binding and conclusive. Except as expressly provided
herein, no issue by the Company of shares of stock of any class, or securities
convertible into shares of stock of any class, shall affect (and no adjustment
by reason thereof shall be made with respect to) the number or price of Shares
subject to an Option.
The Committee may, if it so determines in the exercise of its sole
discretion, also make provision for adjusting the number or class of securities
covered by any Option, as well as the price to be paid therefor, in the event of
the Company's effecting one or more reorganizations, recapitalizations, rights
offerings, spin-offs, or other increases or reductions of the number of Shares
of its outstanding Common Stock, or in the event of the Company's being
consolidated with or merged into any other corporation.
Unless otherwise determined by the Committee, upon the dissolution or
liquidation of the Company, or upon a merger, consolidation or reorganization of
the Company with one or more other corporations in which the Company is not the
surviving corporation, or upon a sale of all or substantially all of the assets
of the Company to another corporation, or upon any transaction (including,
without limitation, a merger or reorganization in which the Company is the
surviving corporation) approved by the Board which results in any person or
entity owning 80% or more of the combined voting power of all classes of stock
of the Company, the Plan and all Options outstanding hereunder shall terminate,
except to the extent provision is made in writing in connection with such
transaction for the continuation of the Plan and/or the assumption of the
Options theretofore granted, or for the substitution for such Options of new
options covering the stock of a successor corporation, or a parent or subsidiary
thereof, with appropriate adjustments as to the number and kinds of shares and
exercise prices, in which event the Plan and Options theretofore granted shall
continue in the manner and under the terms so provided. Except as otherwise
provided in the Option Agreement with respect
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to such Option, in the event of any such termination of the Plan, each person
holding an Option shall have the right (subject to the general limitations on
exercise set forth herein), immediately prior to the occurrence of such
termination and during such period occurring prior to such termination as the
Committee in its sole discretion shall determine and designate, to exercise such
Option in whole or in part, and the exercisability of each outstanding Option
shall be accelerated so that the Optionee and the Trust may within such period
exercise up to the entire unexercised portion of their respective Options. The
Committee shall send written notice of an event that will result in such a
termination to the Trust and all persons who hold Options not later than the
time at which the Company gives notice thereof to its stockholders and, in any
event, not less than 10 days before such event. Upon the occurrence of any such
event, any Option not exercised prior thereto shall terminate.
12. TIME OF GRANTING OPTIONS. Unless otherwise specified by the Committee
or as may be required by applicable law, regulation or rule (including rules of
stock exchanges or other self-regulatory organizations), the date of grant of an
Option under the Plan shall be the date on which the Committee makes the
determination to grant such Option or, if later, the date on which are satisfied
any conditions precedent to such grant. As soon as feasible after the Committee
makes its determination regarding the grant of an Option, the Committee shall
notify the person or class of persons who are the recipients of the grant.
13. AMENDMENT AND TERMINATION OF THE PLAN. The Board may amend or terminate
the Plan from time to time in such respects as the Board may deem advisable,
except that amendments or modifications to the Plan shall be subject to
shareholder approval (a) if such amendment or modification increases the Shares
available for issuance under Incentive Stock Options granted under the Plan or
changes the requirements as to eligibility to receive Incentive Stock Options or
(b) to the extent required by applicable law, regulation or rule (including
rules of stock exchanges or other self-regulatory organizations). Any amendment
or termination of the Plan shall not adversely affect any Option already granted
without the relevant Optionee's consent; and if no such consent is secured such
Option shall remain in full force and effect as if the Plan had not been amended
or terminated.
14. CONDITIONS UPON ISSUANCE OF SHARES. Shares shall not be issued with
respect to an Option granted under the Plan unless the exercise of such Option
and the issuance and delivery of such Shares pursuant thereto shall comply with
all relevant provisions of law, including, without limitation, the Securities
Act, the Exchange Act, the rules and regulations promulgated thereunder, and the
requirements of any stock exchange upon which the Shares may then be listed, and
shall be further subject to the approval of counsel for the Company with respect
to such compliance. As a condition to the exercise of an Option, the Company may
require the Optionee to represent and warrant, at the time of any such exercise,
that the Shares are being purchased only for investment and without any present
intention to sell or distribute such Shares if, in the opinion of counsel for
the Company, such a representation is required by any of the aforementioned
relevant provisions of law.
15. RESERVATION OF SHARES. During the term of this Plan, the Company will
at all times reserve and keep available the number of Shares as shall be
sufficient to satisfy the requirements of the Plan. Inability of the Company to
obtain from any regulatory body having jurisdiction and authority deemed by the
Company's counsel to be necessary to the lawful issuance and sale of any Shares
hereunder shall relieve the Company of any liability in respect to the
nonissuance or sale of such Shares as to which such requisite authority shall
not have been obtained.
16. INFORMATION TO OPTIONEE. During the term of any Option granted under
the Plan, the Company shall provide or otherwise make available to each Optionee
and the Trust a copy of its annual report to shareholders and financial
information which is provided to its shareholders in accordance with the
provisions of the Company's Bylaws and applicable law.
17. OPTION AGREEMENT. All Options granted under the Plan shall be evidenced
by Option Agreements.
18. BEST PAYMENTS. If the gross amount of any payment or benefit under the
Plan, either separately or in combination with any other payment or benefit
payable by the Company or pursuant to a plan of the Company would constitute a
parachute payment within the meaning of Code Section 280G, then the total
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payments and benefits accrued and payable under this Plan shall not exceed the
amount necessary to maximize the amount received by the Optionee after payment
of all employment, income and excise taxes imposed on the Optionee with respect
to such payments and benefits. The Optionee may elect, by written notice to the
Committee, which items of compensation, if any, shall be reduced so as to meet
the requirements of the preceding sentence. If there is a dispute between the
Company and the Optionee regarding (i) the extent, if any, to which any payments
or benefits to the Optionee are parachute payments or excess parachute payments,
under Code Section 280G, (ii) the base amount of such Optionee's compensation,
under Code Section 280G, or (iii) the status of such Optionee as a disqualified
individual, under Code Section 280G, such dispute shall be resolved as provided
in Section 19 below. Within 30 days of the Optionee's receiving notice of (a) a
change of control of the Company within the meaning of Code Section 280G or (b)
the Optionee's termination of service with the Company or the Company's
receiving notice of such termination, either the Optionee or the Company may
request, in accordance with Section 19 below, (a) a determination of the amount
of any parachute payment, excess parachute payment, or base amount of
compensation, or (b) a determination of the reduction necessary to maximize the
amount receivable by the Optionee as described above. Any fees, costs or
expenses incurred by the Optionee or the Trust in connection with such
determinations shall be paid by the Optionee.
19. MANDATORY ARBITRATION. Any dispute arising out of or relating to this
Plan or any Option Agreement shall be resolved solely by arbitration before one
arbitrator in accordance with the Employee Benefit Plan Claim Rules of the
American Arbitration Association. The location of the arbitration proceeding
shall be in McLean, Virginia. Judgment on the award rendered by the arbitrator
may be entered in any court having jurisdiction. Each party to any dispute
regarding the Plan or an Option Agreement shall pay the costs and fees
(including attorneys' fees) of presenting his, her or its case in arbitration.
All other costs of arbitration, including the costs of any transcript of the
proceedings, administrative fees and the arbitrator's fees, shall be borne
equally by the parties. All statutes of limitation which would otherwise be
applicable shall apply to any arbitration proceeding. The provisions of this
Section 19 are exclusive for all purposes and applicable to any and all disputes
arising out of or relating to the Plan or any Option Agreement. The arbitrator
who hears and decides any dispute shall have jurisdiction and authority to award
only compensatory damages to make whole a person or entity sustaining
foreseeable economic loss, and shall not have jurisdiction or authority to make
any other award of any type, including, without limitation, punitive damages,
unforeseeable economic damages, adverse tax consequences, damages for pain,
suffering or emotional distress, or any other kind or form of damages. The
remedy, if any, awarded by the arbitrator shall be the sole and exclusive remedy
for any dispute which is subject to arbitration under this Plan.
20. GOVERNING LAW. The validity, construction and effect of the Plan and
any agreement hereunder shall be determined in accordance with the laws of the
State of Delaware and applicable federal law.
* * *
This Plan was duly adopted and approved by the Board of Directors of the
Company by resolution at a meeting held on the 9th day of April, 1998.
/s/ GRIER C. RACLIN
--------------------------------------
Secretary of the Company
This Plan was duly approved by the stockholders of the Company at a meeting
held on the day of , 1998.
--------------------------------------
Secretary of the Company
10
<PAGE> 429
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
1.1+++ -- Form of Dealer Manager Agreement between the Registrant and
Bear, Stearns & Co. Inc. ...................................
2.1* -- Offer Agreement dated as of December 8, 1998 between the
Registrant and Esprit Telecom Group plc.....................
2.2* -- Irrevocable Undertaking by Walter Anderson dated as of
December 8, 1998............................................
2.3* -- Irrevocable Undertaking by Apax Funds Nominees Limited dated
as of December 8, 1998......................................
2.4* -- Irrevocable Undertaking by Gold & Appel Transfer S.A. dated
as of December 8, 1998......................................
2.5* -- Irrevocable Undertaking by Warburg, Pincus Ventures, L.P.
dated as of December 8, 1998................................
2.6* -- Irrevocable Undertaking by Sir Robin Biggam dated as of
December 8, 1998............................................
2.7* -- Irrevocable Undertaking by John McMonigall dated as of
December 8, 1998............................................
2.8* -- Irrevocable Undertaking by Roy Merritt dated as of December
8, 1998.....................................................
2.9* -- Irrevocable Undertaking by David Oertle dated as of December
8, 1998.....................................................
2.10* -- Irrevocable Undertaking by Michael Potter dated as of
December 8, 1998............................................
2.11* -- Irrevocable Undertaking by Dominic Shorthouse dated as of
December 8, 1998............................................
3.1** -- Certificate of Incorporation of SFMT, Inc. .................
3.2** -- Certificate of Correction to the Certificate of
Incorporation of SFMT, Inc., filed with the Delaware
Secretary of State on October 8, 1993.......................
3.3** -- Certificate of Ownership and Merger Merging San
Francisco/Moscow Teleport, Inc. into SFMT, Inc., filed with
the Delaware Secretary of State on November 3, 1993.........
3.4** -- Certificate of Amendment to the Certificate of Incorporation
of SFMT, Inc., filed with the Delaware Secretary of State on
January 12, 1995 ...........................................
3.5** -- Certificate of Amendment to the Certificate of Incorporation
of SFMT, Inc., filed with the Delaware Secretary of State on
February 22, 1995 ..........................................
3.6** -- Certificate of Amendment to the Certificate of Incorporation
of Global TeleSystems Group, Inc., filed with the Delaware
Secretary of State on October 16, 1996......................
3.7** -- By-laws of SFMT, Inc. ......................................
3.8** -- Certificate of Amendment to the Certificate of Incorporation
of Global TeleSystems Group, Inc., filed with the Delaware
Secretary of State on December 1, 1997......................
3.9** -- Form of Amended and Restated By-laws of Global TeleSystems
Group, Inc. (supersedes By-laws of SFMT, Inc. filed as
Exhibit 3.7)................................................
3.10+ -- Certificate of Amendment to the Certificate of Incorporation
of Global TeleSystems Group, Inc. filed with the Delaware
Secretary of State on January 29, 1998......................
3.11+ -- Certificate of Amendment to the Certificate of Incorporation
of Global TeleSystems Group, Inc. filed with the Delaware
Secretary of State on February 9, 1998......................
3.12+ -- Certificate of Designation of the Series A Preferred Stock
of the Company..............................................
</TABLE>
<PAGE> 430
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
4.1** -- Form of Specimen Stock Certificate for Common Stock of the
Registrant .................................................
4.2** -- Indenture dated as of July 14, 1997 between the Company and
The Bank of New York (including the form of Senior
Subordinated Convertible Bond due 2000 as an exhibit
thereto) ...................................................
4.3** -- Registration Rights Agreement, dated as of July 14, 1997,
between Global TeleSystems Group, Inc. and UBS Securities
LLC. .......................................................
4.4** -- Indenture dated as of August 19, 1997 between Hermes Europe
Railtel B.V. and The Bank of New York (including the form of
11 1/2% Senior Note due 2007 as an exhibit thereto) ........
4.5** -- Registration Rights Agreement dated as of August 19, 1997
between Hermes Europe Railtel B.V. and Donaldson, Lufkin &
Jenrette Securities Corporation, UBS Securities LLC, and
Lehman Brothers, Inc. ......................................
4.6** -- Form of Rights Agreement between Global TeleSystems Group,
Inc. and The Bank of New York, as Rights Agent..............
4.7+ -- Indenture dated as of February 10, 1998 between Global
TeleSystems Group, Inc. and The Bank of New York (including
the form of 9 7/8% Senior Notes due 2005 as an exhibit
thereto)....................................................
4.8++ -- Indenture dated as of July 8, 1998 between Global
TeleSystems Group, Inc. and The Bank of New York relating to
the Company's 5 3/4% Convertible Senior Debentures due
2010........................................................
4.9* -- Registration Rights Agreement dated as of December 8, 1998
by and among the Registrant, Apax Funds Nominees Limited and
Warburg, Pincus Ventures, L.P...............................
5.1+++ -- Opinion of Shearman & Sterling respecting the Securities
registered hereby...........................................
10.1** -- Senior Note Purchase Agreement, dated as of January 19,
1996, among Global TeleSystems Group, Inc., The Open Society
Institute and Chatterjee Fund Management, L.P. .............
10.1(a)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated June 6, 1996..........................................
10.1(b)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated June 6, 1996..........................................
10.1(c)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated July 23, 1996.........................................
10.1(d)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated September 16, 1996 ...................................
10.1(e)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated July 11, 1997.........................................
10.1(f)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated July 29, 1997.........................................
</TABLE>
<PAGE> 431
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
10.1(g)** -- Amendment to Senior Note Purchase Agreement dated January
19, 1996 among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P.,
dated September 29, 1997....................................
10.2** -- Registration Rights Letter Agreement, dated as of January
19, 1996, among Global TeleSystems Group, Inc., The Open
Society Institute and Chatterjee Fund Management, L.P. .....
10.3** -- Warrant Agreement, dated as of January 19, 1996, among
Global TeleSystems Group, Inc., The Open Society Institute
and Chatterjee Fund Management, L.P. .......................
10.4** -- Joint Venture Letter Agreement, dated January 19, 1996,
among Global TeleSystems Group, Inc., The Open Society
Institute and Chatterjee Fund Management, L.P. .............
10.5 -- Intentionally Omitted
10.6** -- Registration Rights Letter Agreement, dated June 6, 1996,
among the Company, The Open Society Institute, Winston
Partners II LDC and Winston Partners II LLC.................
10.7** -- Warrant Agreement, dated as of June 6, 1996, between Global
TeleSystems Group, Inc., The Open Society Institute, Winston
Partners II LDC and Winston Partners II LLC.................
10.8** -- Senior Note Purchase Agreement, dated as of February 2,
1996, between Global TeleSystems Group, Inc. and Emerging
Markets Growth Fund, Inc. ..................................
10.8(a)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated June 6, 1996 (see
Exhibit No. 10.1(b))........................................
10.8(b)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated June 6, 1996......
10.8(c)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated July 25, 1996.....
10.8(d)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated September 10,
1996........................................................
10.8(e)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated September 16,
1996........................................................
10.8(f)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated December 30,
1996........................................................
10.8(g)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated May 13, 1997......
10.8(h)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated June 20, 1997.....
</TABLE>
<PAGE> 432
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
10.8(i)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated July 11, 1997.....
10.8(j)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated July 21, 1997.....
10.8(k)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated August 14, 1997...
10.8(l)** -- Amendment to Senior Note Purchase Agreement, dated as of
February 2, 1996, between Global TeleSystems Group, Inc. and
Emerging Markets Growth Fund, Inc., dated September 29,
1997........................................................
10.9** -- Registration Rights Letter Agreement, dated as February 2,
1996, between Global TeleSystems Group, Inc. and Emerging
Markets Growth Fund, Inc. ..................................
10.10** -- Warrant Agreement, dated as of February 2, 1996, between
Global TeleSystems Group, Inc. and Emerging Markets Growth
Fund, Inc. .................................................
10.11 -- Intentionally Omitted
10.12** -- Registration Rights Letter Agreement, dated as February 2,
1996, between Global TeleSystems Group, Inc. and Capital
International Emerging Markets Funds........................
10.13** -- Warrant Agreement, dated as of February 2, 1996, between
Global TeleSystems Group, Inc. and Capital International
Emerging Markets Funds......................................
10.14+ -- Restated and Amended Global TeleSystems Group, Inc.
Non-Employee Directors' Stock Option Plan...................
10.15+ -- Restated and Amended GTS-Hermes, Inc. 1994 Stock Option
Plan........................................................
10.16** -- Restricted Stock Grant letter, dated as of January 1,
1995........................................................
10.17** -- Employment Agreement dated as of January 1995 between SFMT,
Inc. and Jan Loeber.........................................
10.18** -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Louis Toth..................................
10.19** -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Gerald W. Thames............................
10.20** -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Raymond J. Marks............................
10.21** -- Employment Agreement dated as of April 1996 between GTS
Group, Inc. and Henry Radzikowski...........................
10.22** -- SFMT, Inc. Equity Compensation Plan.........................
10.23** -- Form of Non-Statutory Stock Option Agreement................
10.24+ -- Third Amended and Restated 1992 Stock Option Plan of Global
TeleSystems Group Inc. dated as of September 25, 1997.......
10.25** -- GTS-Hermes 1994 Stock Option Grant, Non-Qualified Stock
Option Grant................................................
10.26** -- Agreement on the Creation and Functions of the Joint Venture
of EDN Sovintel, dated June 18, 1990........................
10.27** -- Stock Purchase Agreement among Global Telesystems Group,
Inc, Kompaniya "Invest-Project," Swinton Limited, GTS-Vox
Limited, and MTU-Inform, dated September 6, 1995............
</TABLE>
<PAGE> 433
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
10.28** -- Certificate of Registration of Revised and Amended
Foundation Document in the State Registration of Commercial
Organizations, dated May 30, 1996...........................
10.29** -- Agreement on the Creation and Functions of the Joint Venture
Sovam Teleport, dated May 26, 1992..........................
10.30** -- Amended and Restated Joint Venture Agreement between GTS
Cellular, Tricor B.V., Gerard Essing, Ivan Laska, and Erik
Jennes, dated July 6, 1995..................................
10.31** -- Amended and Restated Shareholders' Agreement between HIT
Rail B.V., GTS-Hermes, Inc., Nationale Maatschappij Der
Belgische Spoorwegen, Teleport B.V., AB Swed Carrier, and
Hermes Europe Railtel B.V., dated July, 1997................
10.31(a)** -- Shareholders' Agreement among the Hermes Europe Railtel,
B.V., GTS-Hermes Inc., HIT Rail B.V., SNCB/NMBS and AB Swed
Carrier (incorporated by reference to Exhibit 10.1 to the
Hermes Europe Railtel B.V.'s Registration Statement on Form
S-4 (File No. 333-37719) filed on December 11, 1997)
(supersedes the Amended and Restated Shareholders' Agreement
incorporated by reference as Exhibit 10.31 to this
Registration Statement).....................................
10.32** -- Company Agreement between The Societe National de
Financement, GTS S.A.M. and The Principality of Monaco,
dated September 27, 1995....................................
10.33** -- Joint Venture Agreement between SFMT-Hungaro Inc. and
Montana Holding Vagyonkezelo Kft., dated December 23,
1993........................................................
10.34** -- Joint Venture and Shareholders' Agreement among Gerard
Aircraft Sales and Leasing Company, SFMT-Hungaro Inc., and
Microsystem Telecom Rt., dated August 5, 1994...............
10.35** -- Agreement on the Establishment of Limited Liability Company
between SFMT-Czech, Inc. and B&H s.r.o., dated July 12,
1994........................................................
10.36** -- Formation of the Equity Joint Venture between GTS and SSTIC,
dated April 12, 1995........................................
10.37** -- Contract to Establish the Sino-foreign Cooperative Joint
Venture Beijing Tianmu Satellite Communications Technology
Co., Ltd, amended, by and between China International Travel
Service Telecom Co., Ltd. and American China Investment
Corporation, dated March 27, 1996...........................
10.38** -- Joint Venture Contract between GTS TransPacific Ventures
Limited and Shanghai Intelligence Engineering, Inc., dated
March 28, 1996..............................................
10.39** -- Agreement between Global TeleSystems Group, Inc. and Cesia
S.A., dated June 21, 1997...................................
10.40** -- Consulting Agreement between SFMT, Inc. and Alan B. Slifka,
dated March 1, 1994.........................................
10.41** -- Consulting Agreement between Global TeleSystems Group, Inc.
and Bernard J. McFadden, dated August 15, 1996..............
10.42** -- Consulting Agreement between CESIA S.A. and Hermes Europe
Railtel B.V., dated June 20, 1997...........................
10.43++ -- Master Agreement, dated June , 1998 between Ebone Holding
Association, Ebone A/S, Hermes Europe Railtel Holdings B.V.
and Hermes Europe Railtel (Ireland) Limited.................
21.1+ -- List of Subsidiaries of the Registrant .....................
23.1+++ -- Consent of Shearman & Sterling (included in its opinion
delivered under Exhibit No. 5.1) ...........................
</TABLE>
<PAGE> 434
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C> <C>
23.2* -- Consent of Ernst & Young LLP ...............................
23.3* -- Consent of Ernst & Young (CIS) Ltd. ........................
24.1* -- Powers of Attorney (included on signature page to this
registration statement).....................................
27.1+ -- Financial Data Schedule extracted from 12/31/97 audited
financial statements........................................
27.2* -- Financial Data Schedule extracted from 9/30/98 unaudited
financial statements........................................
</TABLE>
- ---------------
* Filed herewith.
** Incorporated by reference to the corresponding exhibit to the Company's
Registration Statement on Form S-1 (File No. 333-36555) filed on September
26, 1997.
+ Incorporated by reference to the corresponding exhibit to the Company's
Annual Report on Form 10-K for the year ended December 31, 1997.
++ Incorporated by reference to the corresponding exhibit to the Company's
Registration Statement on Form S-1 (File No. 333-52733) filed on May 14,
1998.
+++ To be filed by amendment.
<PAGE> 1
EXHIBIT 2.1
OFFER AGREEMENT
between
Esprit Telecom Group plc
and
Global TeleSystems Group Inc.
Strictly Private & Confidential
[SIMMONS & SIMMONS LETTERHEAD]
<PAGE> 2
THIS AGREEMENT is made 8 December 1998
BETWEEN
(1) GLOBAL TELESYSTEMS GROUP INC. ("GTS") of 1751 Pinnacle Drive, North Tower,
12th Floor, McLean VA 22102, USA; and
(2) ESPRIT TELECOM GROUP PLC ("Esprit") of Minerva House, Valpy Street,
Reading, Berkshire RG1 1AR.
IT IS AGREED AS FOLLOWS:
1. THE OFFER
Reference is made to the press announcement in the form of the draft attached
hereto (the "Press Announcement") setting out the terms and conditions upon
which Bear Stearns will, on behalf of GTS, make an offer (the "Offer") to
acquire the whole of the issued and to be issued share capital of Esprit Telecom
Group plc excluding any such share capital owned by GTS or any subsidiary of GTS
on the date that the Offer is made.
2. DEFINITIONS
In this Agreement, unless the context otherwise requires:
(A) "Offer":
(1) means any offer or offers that may be made by or on behalf
of GTS to acquire:
(a) the whole of the share capital of Esprit in issue at
the date on which the Offer is made (including any
securities in Esprit attributable to or derived from
such share capital, but excluding any such share
capital owned on such date by GTS or any subsidiary of
GTS); and
(b) any share capital of Esprit allotted while the Offer
remains open for acceptance, or before such earlier
date as GTS may, subject to the City Code, determine,
whether pursuant to the exercise of conversion or
subscription rights or otherwise; and
1
<PAGE> 3
(2) extends to any new, increased, extended or revised
offer or offers by or on behalf of GTS, provided that
in any such case the terms of such offer or offers are,
in the opinion of Bear Stearns, with the agreement of
Esprit's financial advisers appointed for the purposes
of Rule 3 of the City Code provided such agreement is
not unreasonably withheld or delayed (but without
hereby creating any duty of care owed by Bear Stearns,
except to GTS or by Esprit's financial advisers, except
to Esprit) no less favourable to shareholders of Esprit
than the terms set out in the Press Announcement or the
Offer Document;
(B) save as referred to above words defined in the Press
Announcement have the same meaning herein.
3. RELEASE OF PRESS ANNOUNCEMENT
GTS and Esprit each irrevocably consent to the issue of the Press Announcement
incorporating references to them and to this Agreement subject to any amendments
which may be agreed between them or their financial advisers. They also each
consent to the issue of the Offer Document, incorporating references to them,
and to this Agreement, substantially similar to those references contained in
the Press Announcement. Each understands that this Agreement will be made
available for public inspection.
4. COVENANTS
4.1 Esprit hereby agrees with GTS that:
(A) at all times after the date hereof and until the Offer shall have
lapsed or been withdrawn, Esprit shall refrain from:
(1) soliciting, procuring or initiating; or
(2) (subject to the fiduciary duties of the directors of Esprit)
engaging in,
directly or indirectly any discussions or negotiations with any third
party, involving any other offer by any third party for all or any
part of the issued share capital of Esprit or involving the
acquisition outside the ordinary course of business (as carried on to
the date hereof) of, or any business combination involving, Esprit or
any of its subsidiaries or any shares of Esprit or any material part
of the shares or assets of Esprit or any of its subsidiaries or in
each case any interest therein (each an "Esprit Transaction");
(B) at all times from the date hereof until the Offer shall have
lapsed or been withdrawn, Esprit shall, so far as is consistent
with the fiduciary duties of its directors, refrain from:
2
<PAGE> 4
(1) (save as required by Rule 20.2 of the City Code in which
case only that information strictly required to be provided
shall be disclosed and only on the basis of an undertaking
as to confidentiality substantially similar to that given by
GTS) providing any information in relation to, or
facilitating or cooperating with in any way, any Esprit
Transaction; or
(2) communicating with any person in relation to or discussing
with any person the terms of the Offer or any matter
relating thereto without the prior consent of GTS provided
that this shall not apply to any communications or
discussions with Esprit's professional advisers who
appreciate the need for and requirements as to
confidentiality in relation to the Offer or to
communications or discussions limited to information set out
in the Press Announcement or any other document or
announcement published with the consent of GTS in connection
with the Offer or otherwise in the public domain;
(C) Esprit confirms that it is not in discussions with any third
party in relation to any Esprit Transaction;
(D) subject to the satisfaction of the pre-conditions to the posting
of the Offer Document and subject to the fiduciary duties of the
directors of Esprit, so far as Esprit is reasonably able to do
so, it will procure that such information (other than information
of a commercially sensitive nature the disclosure of which may
prejudice Esprit) as GTS or its advisers reasonably request in
relation to Esprit and its subsidiaries and their respective
businesses will be supplied to GTS as soon as practicable
following any such request and Esprit will procure that to the
extent it is able to procure the same, Esprit and its
subsidiaries will provide GTS and its advisers with access to
such of the books and financial and other records of Esprit and
its subsidiaries as GTS may reasonably require in order to
satisfy itself as to the business, finances and affairs of Esprit
and its subsidiaries;
(E) from the date hereof and until the date on which the offer lapses
or is withdrawn, Esprit will not take any action which would
require shareholder approval under Rule 21 of the City Code
without the prior consent of GTS such consent not to be
unreasonably withheld or delayed. For the purposes of this
paragraph 4.1(E) GTS hereby consents to the issue of shares by
Esprit upon the exercise of options under the Esprit Share Option
Schemes; the grant of options, in the normal course of business,
pursuant to such Esprit Share Option Schemes; the issue of shares
by Esprit in connection with pre-existing contractual
obligations and in connection with any proposed acquisition by
Esprit of which GTS is currently aware;
3
<PAGE> 5
(F) if GTS believes on reasonable grounds that circumstances exist
which would lead to any of the conditions of the Offer not being
satisfied, Esprit shall use all reasonable endeavours to ensure
that (at all reasonable times following the release of the Press
Announcement and before the Offer becomes unconditional in all
respects or lapses) GTS and its advisers are provided with such
information regarding the Wider Esprit Group as GTS reasonably
requires to enable GTS to establish whether or not the relevant
condition is satisfied provided that any information so provided
shall be provided without liability on the part of any director
or officer of Esprit to GTS or Esprit or otherwise;
(G) as soon as practicable after the date hereof, Esprit shall
deliver to GTS a letter identifying all persons it believes are
"affiliates" of Esprit for the purposes of the US Securities Act
of 1933, as amended or for the purposes of qualifying the Offer
and the transactions contemplated thereby for pooling of
interests accounting treatment under Opinion 16 of the Accounting
Principles Board and applicable SEC rules and regulations. Esprit
shall use its best efforts to cause each such person, save for
those "affiliates" of Esprit that have entered into certain
Registration Rights Agreements concurrently herewith, to deliver
to GTS by the close of the Offer a written undertaking in
customary form.
4.2 GTS agrees with Esprit as follows:
(A) subject to their fiduciary duties under applicable law, the board of
directors of GTS will recommend to the stockholders of GTS that they
vote in favour of the issuance of GTS shares necessary to complete the
Offer and the acquisition by GTS of Esprit at any meeting of
stockholders convened for such purpose, or any adjournment thereof;
(B) the level of directors' and officers' liability cover currently
provided to the directors and officers of Esprit will be maintained,
provided that GTS may substitute therefor policies of at least the
same coverage and amounts containing terms and conditions which afford
substantially the same coverage to the insured as the insurance
currently maintained by Esprit for a period of six years after the
Offer becomes wholly unconditional, and such level of cover for the
directors and officers of Esprit shall be maintained (in the form of
liability insurance or otherwise) notwithstanding any of the directors
or officers of Esprit ceasing to be a director or officer;
(C) GTS shall use its best efforts to cause all persons who may be
"affiliates" of GTS for the purposes of qualifying the Offer and the
transactions contemplated thereby for pooling of interests accounting
treatment under Opinion 16 of the Accounting Principles Board and
applicable SEC rules and regulations to comply with applicable holding
periods;
4
<PAGE> 6
(D) that it will not amend the memorandum or articles of association of
Esprit in a manner that would be adverse to the directors and officers
of Esprit. In the event that the employment of such directors or
officers is transferred by GTS to any member of the Wider GTS Group,
or substantially all of Esprit's assets are transferred, GTS shall
ensure that any director or officer of Esprit (current or former)
affected by such action is afforded no lower level of indemnity by GTS
in respect of his or her office than he or she currently enjoys;
(E) GTS undertakes that it will not, directly or indirectly, commence or
solicit indications of interest or make any proposals with respect to
(in each case, written or otherwise), any exchange or similar offer
or, except as contemplated by (F) below, propose any amendments with
respect to the Esprit Telecom Bonds or the related indentures until
pre-condition (A) to the Offer set out in paragraph 1 to Appendix 1 of
the Press Announcement (the "Consent Pre-Condition") has been waived
or satisfied;
(F) GTS undertakes to solicit, on behalf of Esprit and in good faith,
amendments to the indentures governing the Esprit Telecom Bonds
necessary to satisfy the Consent Pre-Condition (and no other
amendments) on terms and conditions and pursuant to documents
reasonably satisfactory to Esprit and its advisers and after
consulting with Esprit as to the terms and conditions of such
solicitation (after having provided Esprit and its advisers with a
reasonable opportunity to review and discuss the same); provided that
in no event shall Esprit be obliged to pay any amounts in respect
thereof prior to the time that the Offer is declared wholly
unconditional (and then only if the same would not violate any
applicable law); and
(G) that GTS will use all reasonable efforts to file a registration
statement with the SEC, EASDAQ and any other relevant authority in
connection with the GTS Shares to be issued pursuant to the Offer and
have such registration statement declared effective or otherwise
approved as promptly as is reasonably practicable and that the Offer
Document will be posted promptly thereafter.
4.3 Esprit and GTS undertake with each other as follows:
(A) each of Esprit and GTS shall use all reasonable efforts to take, or
cause to be taken, all action and to do, or cause to be done, all
things necessary, proper or advisable under applicable laws and
regulations to consummate and make effective the transactions
contemplated by the Offer and the satisfaction of the conditions set
out in Appendix 1 to the Press Announcement, including using its
reasonable efforts to obtain all necessary or advisable waivers,
consents or approvals of third parties required in order to preserve
material contractual relationships of GTS,
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Esprit and their respective subsidiaries, all necessary or appropriate
waivers, consents and approvals from the SEC and the Panel to effect
all necessary registrations, filings and submissions and to lift any
injunction or other legal bar to the Offer (and, in such case, to
proceed with the Offer as expeditiously as possible);
(B) without limitation to the foregoing, each of GTS and Esprit
undertakes:
(1) to make members of management available to the extent reasonably
necessary to facilitate the successful completion of the Offer
and (to the extent agreed) the refinancing or amendment of the
existing financing facilities of Esprit, including participation
in meetings with investors and shareholders;
(2) to provide all reasonable assistance as may be required to
satisfy the pre-conditions to the posting of the Offer Document
and the conditions of the Offer;
(C) GTS and Esprit will each provide such information and do such acts as
may be reasonably necessary to prepare and expedite the posting of the
Offer Document and, in particular, but without prejudice to the
generality of the foregoing will each provide all necessary
information regarding their respective companies and their
subsidiaries and the interests of their respective directors in the
share capital of each company and options over such share capital
which is required to be contained therein in order to comply with the
requirements of the City Code, US Securities Law or any other
applicable law or regulation;
(D) all costs and expenses incurred in connection with this Agreement and
the transactions contemplated hereby shall be paid by the party
incurring such expenses, except that those expenses incurred in
connection with printing and filing the Offering Circular/Proxy
Statement/Prospectus, and all expenses incurred in connection with
satisfying the Consent Pre-Condition shall be borne by GTS;
(E) to comply with GTS's obligations to participants in the Esprit Share
Option Schemes under Rule 15 of the City Code, GTS will offer
participants the opportunity to roll over their options to acquire
Esprit Shares into options to acquire GTS shares substantially on (and
in accordance with) the terms of the existing Esprit Share Option
Schemes ("the Rollover Offer") and on the same exchange ratio as the
Offer. Subject to the taxation effects of the Rollover Offer for
participants in the Esprit Share Option Schemes being no less
favourable than the taxation effects of exercising options and
accepting the Offer, Esprit agrees that no amendments will be made to
the Esprit Share Option Schemes and no consents given which would have
the effect of allowing participants to
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exercise options in circumstances where they are currently not
entitled to do so. Where Esprit believes that such taxation effects
would be materially adverse to participants, it will consult with GTS
with a view to agreeing (at GTS's option) either that participants
will be able to exercise options in circumstances where they are
currently not able to do so in order that they can accept the Offer or
GTS providing an appropriate indemnity against such adverse taxation
effects;
(F) each of GTS and Esprit agree to use their reasonable best efforts to
avoid taking any action that would prevent the transactions
contemplated by the Offer receiving "pooling of interests" treatment
for financial accounting purposes (including, in the case of GTS,
approving any transfer or disposition of shares by any shareholders of
Esprit unless Esprit's independent auditors have advised Esprit that
such transfer or disposition would not prevent the transactions
contemplated by the offer from receiving "pooling of interests"
treatment for financial accounting purposes). Each of GTS and Esprit
further agrees that in the event they become aware of any event or
circumstance that would reasonably be expected to prevent the
transactions contemplated by the Offer receiving "pooling of
interests" treatment, they shall each use their reasonable best
efforts to remedy such event or circumstance so as to permit such
"pooling of interests" treatment.
5. LAW AND JURISDICTION
5.1 This Agreement is governed by, and construed in accordance with,
English law.
5.2 In relation to any legal action or proceedings to enforce this
Agreement or arising out of or in connection with this Agreement
("Proceedings") the parties irrevocably submit to the jurisdiction of
the English courts and waive any objection to Proceedings in such
courts on the grounds of venue or on the grounds that the Proceedings
have been brought in an inconvenient forum.
6. CONDITIONS
6.1 Notwithstanding any other provision hereof, this Agreement and GTS's
obligation to make the Offer, are conditional upon:
(A) the release of the Press Announcement at or before 9.00 a.m. on
08 December 1998; and
(B) irrevocable undertakings, in a form acceptable to GTS, being
received in respect of not less than 50.1% of the issued ordinary
shares of Esprit prior to the release of the Press Announcement.
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6.2 If these conditions shall not have been satisfied by such time and
date this Agreement shall automatically lapse and be of no further
force or effect and no party hereto shall have any claim against the
other save in respect of any antecedent breach of its terms.
7. MISCELLANEOUS
7.1 No failure or delay by either party in exercising any right, power or
privilege hereunder shall operate as a waiver thereof, nor shall any
single or partial exercise thereof preclude any other or further
exercise of any right, power or privilege hereunder. The parties agree
that any breach of this Agreement is likely to cause substantial harm
to the other and that money damages might not be a sufficient remedy
for any breach of this Agreement and that the other will be entitled
to specific performance and injunctive relief as remedies for any such
breach. Such remedies shall not be deemed to be the exclusive remedies
for a breach of this Agreement but shall be in addition to all other
remedies available at law or equity.
7.2 The covenants of Esprit set forth herein shall supersede any
obligation that Esprit may have to GTS under the second paragraph on
page 4 of the Confidentiality Agreement dated October 15, 1998 between
GTS and Esprit (the "Confidentiality Agreement") relating to a
Takeover Proposal (as such term is defined in the Confidentiality
Agreement).
8. LAPSING
This Agreement shall automatically lapse and be of no further force or effect
and no party hereto shall have any claim against the other save in respect of
any antecedent breach of its terms, in the event that:
(A) precondition (A) to the Offer set out in Paragraph 1 of Appendix
1 of the Press Announcement (relating to the Esprit Telecom
Bonds) shall not have been satisfied or waived on or before 29
January 1999;
(B) the Offer Document is not despatched on or before 15 April 1999;
(C) GTS announces that any of the pre-conditions to the Offer set out
in paragraph 1 of Appendix 1 to the Press Announcement has not
been satisfied and that it has not been and will not be waived;
or
(D) the Offer is not declared wholly unconditional on or before the
60th day after the Offer Document is despatched or, if later, the
date to which the Initial Offer Period is extended pursuant to
paragraph 7(G) of the Shareholders' Irrevocable.
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9. EXECUTION
This Agreement may be executed in more than one part.
IN WITNESS whereof this Agreement has been signed on behalf of the parties the
day and year first above written.
GERALD THAMES
for
Global TeleSystems Group, Inc.
ROY MERRITT
for
Esprit Telecom Group plc
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<PAGE> 1
EXHIBIT 2.2
IRREVOCABLE
UNDERTAKING
by
Walter Anderson
Strictly Private & Confidential
SIMMONS & SIMMONS
21 Wilson Street London EC2M 2TX
Tel: 0171-628 2020 / 528 9292 Fax: 0171-628 2070 DX Box No 12
<PAGE> 2
To: Global TeleSystems Group, Inc.
("GTS")
1751 Pinnacle Drive
North Tower 12th Floor
McLean VA 22102
United States of America
From: Walter Anderson
8 December 1998
Dear Sirs,
1. THE OFFER
We refer to the press announcement in the form of the draft attached hereto (the
"Press Announcement") setting out the terms and conditions upon which Bear
Stearns will, on behalf of GTS, make an offer (the "Offer") to acquire the whole
of the issued and to be issued share capital of Esprit Telecom Group plc
("Esprit") excluding any such share capital owned by GTS or any subsidiary of
GTS on the date that the Offer is made.
2. DEFINITIONS
In this letter, unless the context otherwise requires:
(A) "the Acceptance Date" means 3.00 pm on the 17th US
Business Day following the posting of the Offer Document
or, if a MAC Notice has been served before such day, 1.00
pm on the US Business Day following the determination in
accordance with paragraph 7(B) or 7(C) below that no GTS
MAC has occurred;
(B) "GTS MAC" means a material adverse change in the value of
the GTS Group by virtue of:
(i) a specific event which causes an adverse
change in the business, assets, financial or
trading position or profits or prospects of
any member of the Wider GTS Group; or
(ii) there having been a material misrepresentation
of fact or omission to state a fact necessary
to make the information contained therein not
materially misleading in any financial,
business or other information publicly
disclosed by GTS in relation to the business,
assets, financial or trading position or
prospects of any member of the Wider GTS
Group;
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which in either case is material in the context of the
GTS Group taken as a whole. For the purposes of this
definition:
(1) a GTS MAC shall exclude (without limitation)
general factors affecting the global
telecommunications industry or other
industries as a whole;
(2) a decline in the market price of any
securities of GTS or any change in interest
rates will not, of themselves, amount to a GTS
MAC; and
(3) GTS shall be considered on a stand alone basis
excluding Esprit;
(C) "Esprit Shares" means the ordinary shares and American
Depositary Shares ("ADSs") in Esprit shown in columns 3
and 4 of Schedule 1 and, except in sub-paragraph (A) of
Paragraph 5 shall include any shares in Esprit
attributable to or deriving from such shares and shall
include any other ordinary shares in Esprit which we
acquire and beneficially own after signing this
undertaking but excluding any shares in Esprit
transferred with the prior written consent of GTS;
(D) "the Majority Shareholders" means each of Apax Funds
Nominees Limited, Warburg, Pincus Ventures, L.P. and Gold
& Appel Transfer S.A;
(E) "Offer":
(1) means any offer or offers that may be made by
or on behalf of GTS to acquire:
(a) the whole of the share capital of
Esprit in issue at the date on
which the Offer is made (including
any securities in Esprit
attributable to or derived from
such share capital, but excluding
any such share capital owned on
such date by GTS or any subsidiary
of GTS); and
(b) any share capital of Esprit
allotted while the Offer remains
open for acceptance or before such
earlier date as GTS may determine
whether pursuant to the exercise of
conversion or subscription rights
or otherwise; and
(2) extends to any new, increased, extended or
revised offer or offers by or on behalf of
GTS, provided that in any such case the terms
of such offer or offers are, in the opinion of
Bear Stearns, with the agreement of Esprit's
financial advisers, appointed for the purposes
of Rule 3 of the City Code provided such
agreement is not unreasonably withheld or
delayed (but without hereby
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creating any duty of care owed by Bear
Stearns, except to GTS or by Esprit's
financial advisers, except to Esprit) no less
favourable to shareholders of Esprit than the
terms set out in the Press Announcement or the
Offer Document;
(F) references to the share capital of Esprit include that
represented by ADSs; and
(G) save as referred to above words defined in the Press
Announcement have the same meanings herein.
3. RELEASE OF PRESS ANNOUNCEMENT
We irrevocably consent to the issue of the Press Announcement incorporating
references to us and to this undertaking subject to any amendments which may be
agreed with us or Esprit's financial advisers. We also consent to the issue of
the Offer Document, incorporating references to us, and to this undertaking,
substantially similar to those references contained in the Press Announcement.
We understand that this irrevocable undertaking will be made available for
public inspection.
4. UNDERTAKINGS
In consideration of GTS agreeing to make the Offer in all material respects on
the terms and subject to the conditions referred to in the Press Announcement,
we hereby irrevocably undertake to GTS as follows:-
(A) we shall accept or procure acceptance of the Offer in
accordance with its terms in respect of all the Esprit
Shares by not later than the Acceptance Date and shall
forward or procure that there is forwarded, with such
acceptance, the share certificates or other documents of
title in respect of the Esprit Shares in accordance with
the terms of the Offer;
(B) the Esprit Shares will be acquired by GTS fully paid and
free from all liens, equities, charges, encumbrances and
other interests and together with all rights now or
hereafter attaching thereto, including the right to
receive and retain all dividends and other distributions
declared, made or paid hereafter;
(C) notwithstanding that we may be or become entitled to
withdraw our acceptance(s) of the Offer by virtue of any
term of the Offer or the rules of the City Code or any
provision of the securities laws or regulations of the US
or otherwise, we shall not withdraw our acceptance(s) and
shall procure that our acceptance(s) is not withdrawn in
respect of all or any of the Esprit Shares;
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(D) save as required by paragraph 4(A) or in this paragraph
4(D), we shall not prior to the lapsing or withdrawal of
the Offer, conditionally or unconditionally, sell,
transfer, charge, pledge or grant any option over or
otherwise dispose of or permit the sale or other
disposition of all or any of the Esprit Shares or any
interest held by us in any of the Esprit Shares save that
we may transfer or otherwise dispose of all or some of
our Esprit Shares provided that:
(1) prior to such transfer or disposition Esprit
shall have received the advice of its
independent auditors and GTS shall have
received the advice of its independent
auditors that such transfer or disposition
would not prevent the transactions
contemplated by the Offer from receiving
"pooling of interests" treatment for financial
accounting purposes;
(2) such transfer or disposition would not delay
the Offer becoming wholly unconditional by
more than 10 days or beyond the 60th day after
posting of the Offer Document, or if earlier,
the last date by which the Offer can become
wholly unconditional;
(3) before such transfer or disposition the
transferee of such Esprit Shares shall have
executed an irrevocable undertaking for no
consideration and under seal in a form
substantially similar to this Irrevocable
Undertaking together with a legal opinion in
respect thereof as to due execution and
enforceability in a form reasonably
satisfactory to GTS;
(4) such transferee has been advised by Esprit's
financial advisers that the transfer or
disposition would not violate the provisions
of the Code;
(5) such transferee is (i) not listed on Schedule
2 hereto; and (ii) immediately prior to such
transfer does not own more than one per cent
of the outstanding GTS Shares; and
(6) we have consulted with GTS (in a way which
does not oblige GTS to make a public
announcement) with respect to the timing of
such sale or disposition to mitigate any
adverse effect such sale or disposition would
have on the market price of GTS Shares;
(E) we shall not prior to the lapsing or withdrawal of the
Offer without the prior written consent of GTS purchase
or otherwise acquire any shares in Esprit or any interest
therein or agree to do so whether conditionally or
unconditionally;
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(F) we shall procure that, save pursuant to this undertaking,
unless and until the Offer shall have lapsed or shall
have been withdrawn, no other agreement or arrangement
(including any undertaking) shall be entered into (other
than with GTS) which could result in the disposal of, or
the creation or existence of any encumbrance on, all or
any of the Esprit Shares or any interest therein or which
might in any way restrict the disposal of the Esprit
Shares or any of them and no other offer shall be
accepted in respect of the Esprit Shares or any of them
(whether it is conditional or unconditional and
irrespective of the means by which it is to be
implemented);
(G) we shall not, prior to the issue of the Press
Announcement without the prior written consent of GTS,
disclose or announce to any person the fact that
discussions or negotiations are taking or have taken
place concerning the Offer save as (and then only to the
extent) required by any law, the rules of NASDAQ or
EASDAQ or the City Code or the Panel or pursuant to any
enquiry by a governmental, official or regulatory body
having jurisdiction provided that, in such circumstances,
we shall advise GTS prior to any such disclosure or
announcement so that GTS has an opportunity to seek to
control the timing and manner of such disclosure;
(H) at all times after the date hereof and until the Offer
shall have lapsed or been withdrawn, we shall refrain
from knowingly taking any action or making any statement
which is or may be prejudicial to the success of the
Offer, including, without limitation:
(1) soliciting procuring, initiating or engaging
in, directly or indirectly, any discussions or
negotiations with any third party, involving
any other offer by any third party for all or
any part of the issued share capital of Esprit
or involving the acquisition outside the
ordinary course of business (as carried on to
the date hereof) of or any business
combination involving Esprit or any of its
subsidiaries or any material part of the
shares or assets of Esprit or any of its
subsidiaries or in each case any interest
therein ("each a Esprit Transaction");
(2) entering into discussions or negotiations
with, or (save as required by Rule 20.2 of the
City Code in which case only that information
strictly required to be provided shall be
disclosed and on the basis of an undertaking
as to confidentiality substantially similar to
that given by GTS) providing any information
to any person in relation to, or facilitating
or cooperating with in any way, any Esprit
Transaction; or
(3) communicating with any person in relation to
or discussing with any person the terms of the
Offer or any matter relating thereto
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without the prior written consent of GTS
provided that this shall not apply to any
communications or discussions with our or
Esprit's professional advisers who appreciate
the need for requirements as to
confidentiality in relation to the Offer or to
communications or discussions limited to
information set out in the Press Announcement
or any other document or announcement
published with the consent of GTS in
connection with the Offer;
(I) we shall inform GTS immediately:
(1) if we receive an approach from any person in
relation to a Esprit Transaction;
(2) if we are asked to, or do, provide any
information to any person with a view to any
person investigating or entering into a Esprit
Transaction; or
(3) if we become aware of any material breach of
the provisions of this undertaking;
and in the case of (1) and (2) above, we shall provide
reasonable details as to the identity of any relevant
person and the terms and conditions of any proposal or
details of any information requested or provided, and in
the case of (3) above, shall provide reasonable details
of the relevant breach;
(J) we are not in discussions with any third party in
relation to any Esprit Transaction;
(K) we will procure for GTS all necessary information
regarding us and our interests, in the share capital of
Esprit which is required to be contained in the Offer
Document in order to comply with the requirements of the
City Code, US securities law or any other applicable law
or regulation;
(L) we shall not prior to the date the Offer becomes wholly
unconditional or lapses or is withdrawn, transfer,
dispose of, grant rights over or in any way charge, or
otherwise deal in or enter into any agreement,
arrangement or undertaking (conditional or unconditional)
to transfer, dispose of grant rights over or in any way
charge, or otherwise deal in any GTS Shares or any
interest therein or any derivative referenced thereto or
any security convertible into GTS Shares.
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5. WARRANTIES
5.1 We hereby further undertake warrant and represent to GTS as follows:
(A) we are the registered holder and beneficial owner of the
Esprit Shares (other than those represented by ADSs) and
the beneficial owner of the Esprit Shares represented by
ADSs and the Esprit Shares are free from all liens,
equities charges or encumbrances. There are no other
ordinary shares in Esprit registered in our name or
beneficially owned, or managed and controlled by us, or
in which we have an interest and we have no rights,
warrants or options to acquire or subscribe for ordinary
shares in Esprit or any interest therein save as
specified in columns 3 and 4 of Schedule 1;
(B) save pursuant to this undertaking we have not agreed,
conditionally or otherwise, to dispose of all or any of
the Esprit Shares or any interest therein and have (and,
upon the Offer being made, will continue to have) all
necessary authority to enter into this undertaking and
accept or procure acceptance of the Offer in respect of
the Esprit Shares;
(C) we have the right to transfer the Esprit Shares with all
rights attaching to them as envisaged by the terms of the
Offer;
(D) otherwise than in the ordinary course of Esprit's
telecommunications business there is not outstanding any
indebtedness or other liability (actual or contingent)
owing by any member of the Wider Esprit Group to us or
any person connected with us, nor is there any
indebtedness owing to any member of the Wider Esprit
Group by any such person;
(E) neither we nor any person connected with us has entered
into any agreement, undertaking, instrument or
arrangement with any member of the Wider Esprit Group.
5.2 We shall procure that (save as may be necessary to give effect to
this undertaking) we shall not allow nor shall we do or procure any
act or omission before the date the Offer becomes wholly
unconditional which would constitute a breach of any of the above
warranties if they were given at any and all times from the date
hereof down to the date the Offer becomes wholly unconditional, or
which would make any of the above warranties inaccurate or
misleading if they were so given.
5.3 We further undertake to forthwith disclose in writing to GTS any
matter or thing which may arise or become known to me after the date
hereof and before the date the Offer becomes wholly unconditional
which is inconsistent with any of the above warranties or which
might make any of them inaccurate or misleading if they were given
at any and all times from the date hereof down to the date the Offer
becomes wholly unconditional or which is a breach of sub-paragraph
5.2 above.
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6. VOTING RIGHTS
We hereby further irrevocably undertake, represent, warrant and agree to and
with GTS that, until the Offer shall have closed, lapsed or been withdrawn we
shall exercise or procure the exercise of the voting rights attached to the
Esprit Shares as instructed by GTS on any resolution to enable the Offer to
become unconditional if it were passed or rejected at a general or separate
class meeting of GTS.
7. GTS MAC
(A) If at any time before the 17th US Business Day after the
posting of the Offer Document we become aware of an event
which could or might reasonably be expected to give rise
to a GTS MAC we shall immediately serve notice on GTS
providing full details of the event alleged to be
expected to give rise to the GTS MAC and of its effect on
the value of GTS ("the MAC Notice"). We shall also serve
a copy of the MAC Notice on the other Majority
Shareholders and Esprit. Not more than one MAC Notice may
be served in respect of any individual event, and in the
event that more than one Majority Shareholder serves a
MAC Notice in respect of the same event, only the first
to be received by GTS will be valid. In no event shall a
Majority Shareholder have the right to serve a MAC Notice
more than 10 US Business Days after it becomes aware of
an event which could or might reasonably be expected to
give rise to the GTS MAC to which such MAC Notice relates
or after the Acceptance Date. For the purposes of this
paragraph we shall be deemed to be aware of the contents
of all public filings made by GTS. GTS shall provide
copies to us immediately following filing of any such
filings made by GTS from the date hereof until the
Acceptance Date.
(B) As soon as practicable after the service of the MAC
Notice, and in any event within two US Business Days,
each of ourselves and GTS will appoint an investment
banking firm of international repute to act as an
appraiser ("the Appraiser"). Each of ourselves and GTS
will use their best endeavours to ensure that the
Appraisers shall make an appraisal as to whether a GTS
MAC has occurred and shall notify ourselves and GTS of
their decision within three US Business Days of their
appointment. If the Appraisers agree with each other they
shall immediately notify the Majority Shareholders and
GTS.
(C) If the Appraisers are unable to agree between themselves
whether a GTS MAC has occurred, we and GTS will use our
best endeavours to procure that the two Appraisers select
a third bank with similar qualifications ("the Referee")
which shall make its determination as to whether a GTS
MAC has occurred and shall notify ourselves and GTS of
their decision within three US Business Days after its
selection. If our respective Appraisers fail to agree
upon the appointment of the Referee either we or
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GTS may refer the matter to the President for the time
being of the Law Society of England and Wales who shall
promptly appoint the Referee.
(D) Each of ourselves and GTS will have all reasonable
opportunity of making oral and written representations to
each Appraiser and to the Referee in enabling them to
reach their determinations. The Appraisers and the
Referee shall act as experts and not as arbitrators and,
absent fraud or manifest error, the determination of the
Appraisers and the Referee hereunder will be binding upon
ourselves and GTS.
(E) If it is determined under sub-paragraph (B) or (C) that a
GTS MAC has occurred then the provisions of paragraph 12
will apply. The determination of whether a GTS MAC has or
has not occurred can be relied upon by GTS and all the
Shareholders.
(F) Each of ourselves and GTS recognise that the provisions
of this paragraph involve the co-operation of third
parties. Each of ourselves and GTS agree to use our
respective best endeavours to ensure that such third
parties co-operate in order to determine, within the
time frame described in this paragraph, whether a GTS MAC
has occurred. If it is not practicable to determine
whether a GTS MAC has occurred within that time frame,
the parties shall nevertheless use their best endeavours
to ensure that the question is determined as soon as
possible thereafter, and in any event before the day
("the Last Acceptance Date") which is two US Business
Days and UK Business Days before the last date the Offer
is capable of becoming wholly unconditional.
(G) If it is not determined by the Last Acceptance Date that
a GTS MAC has occurred we and GTS agree that we will
jointly request the Panel (and request the directors of
Esprit to assist us in this respect) to extend the last
date that the Offer may become wholly unconditional to a
date not later than 81 days after the posting of the
Offer Document. If the determination that no GTS MAC has
occurred does not take place until such date, then the
Acceptance Date shall be extended to 1.00 p.m. on such
date.
8. LAW AND JURISDICTION
(A) This undertaking is governed by, and construed in
accordance with, English law.
(B) In relation to any legal action or proceedings to enforce
this undertaking or arising out of or in connection with
this undertaking ("Proceedings") we irrevocably submit to
the jurisdiction of the English courts and waive any
objection to Proceedings in such courts on the grounds of
venue or on
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the grounds that the Proceedings have been brought in an
inconvenient forum.
(C) We hereby appoint Herbert Smith (for the attention of Ben
Ward) of Exchange House, Primrose Street, London EC2A 2HS
as my process agent to receive on our behalf service of
process in any proceedings in England. Service upon the
process agent shall be good service upon us whether or
not it is forwarded to and received by us. If for any
reason the process agent ceases to be able to act as
process agent, or no longer has an address in England, we
irrevocably agree to appoint a substitute process agent
with an address in England acceptable to GTS and to
deliver to GTS a copy of the substitute process agent's
acceptance of that appointment within seven days. In the
event that we fail to appoint a substitute process agent,
it shall be effective service for GTS to serve the
process upon the last known address in England of our
last known process agent notified to GTS, notwithstanding
that such process agent is no longer found at such
address or has ceased to act.
9. NOMINEES
In the case where the Esprit Shares are registered in the name of a nominee, we
shall direct the nominee to act as if the nominee were bound by the terms of
this irrevocable undertaking and we shall procure that such nominee does all
acts and things necessary to carry the terms hereof into effect as if we had
been the registered holder of the Esprit Shares registered in the name of such
nominee.
10. CONDITIONS
Notwithstanding any other provision hereof, this irrevocable undertaking and
GTS's obligation to make the Offer, are conditional upon:
(A) the release of the Press Announcement at or before 9 a.m.
on 8 December 1998; and
(B) irrevocable undertakings, in a form acceptable to GTS,
being received in respect of not less than 50.1 per cent.
of the issued ordinary shares of Esprit prior to the
release of the Press Announcement.
If these conditions shall not have been satisfied by such time and date this
irrevocable undertaking shall automatically lapse and be of no further force or
effect and no party hereto shall have any claim against the other save in
respect of any antecedent breach of its terms.
10
<PAGE> 12
11. MISCELLANEOUS
(A) We acknowledge that we are not entering into this
undertaking in reliance upon any representation, warranty
or undertaking save as expressly set out herein and, in
the absence of fraud, we shall have no claim or remedy
against GTS or Esprit in respect of any
misrepresentation, untrue statement, omission or
non-disclosure. In particular, our undertakings pursuant
to paragraph 4 shall be irrevocable and, in the absence
of fraud, shall not be capable of rescission or
termination on the basis of any information subsequently
disclosed by GTS or Esprit in any offer document, listing
particulars or registration statement or for any other
reason whatsoever including (without limitation) any
failure by all or any of the directors of Esprit to
recommend the Offer or to continue to recommend the Offer
after the date of this undertaking.
(B) No failure or delay by GTS in exercising any right, power
or privilege hereunder shall operate as a waiver thereof,
nor shall any single or partial exercise thereof preclude
any other or further exercise of any right, power or
privilege hereunder. We agree that any breach of this
Undertaking is likely to cause substantial harm to GTS
and that money damages would not be a sufficient remedy
for any breach of this Undertaking and that GTS will be
entitled to specific performance and injunctive relief as
remedies for any such breach. Such remedies shall not be
deemed to be the exclusive remedies for a breach of this
Undertaking but shall be in addition to all other
remedies available at law or equity.
12. LAPSING
This irrevocable undertaking shall automatically lapse and be of no further
force or effect and no party hereto shall have any claim against the other save
in respect of any antecedent breach of its terms in the event that:
(A) precondition (A) to the Offer set out in Paragraph 1 of
Appendix 1 of the Press Announcement (relating to the
Esprit Bonds) shall not have been satisfied or waived on
or before 29 January 1999;
(B) the Offer Document is not despatched on or before 15
April 1999; or in the event that a MAC Notice is served
before the despatch of the Offer Document, the date
falling 10 US Business Days after determination that a
GTS MAC has not occurred (if later);
(C) GTS announces that any of the pre-conditions of the Offer
set out in Paragraph 1 of Appendix 1 to the Press
Announcement has not been satisfied and that it has not
been and will not be waived;
(D) it is determined that a GTS MAC has occurred; or
11
<PAGE> 13
(E) the Offer is not declared wholly unconditional on or
before the 60th day after the Offer document is
despatched (or, if later, the date to which the Initial
Offer Period is extended pursuant to paragraph 7(G)).
13. EXECUTION
This undertaking may be executed in more than one part.
Yours faithfully,
EXECUTED AS A DEED )
by WALTER ANDERSON )WALTER ANDERSON
acting through its attorney in fact )
Witness' signature GRIER RACLIN
Witness' name GRIER RACLIN
Witness' address 104 Summerfield Road, Chevy Chase MD 20815
...................................
Witness' occupation Attorney at law
We agree and accept the terms of this undertaking.
GRIER RACLIN
For and on behalf of
GLOBAL TELESYSTEMS GROUP, INC.
12
<PAGE> 14
SCHEDULE 1
The following represents our shareholding and shares subject to options,
warrants or rights to acquire or subscribe in Esprit:
<TABLE>
<CAPTION>
Column 1 Column 2 Column 3 Column 4 Column 5
- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C>
Registered Beneficial Number of Number of Number of
- ---------- ---------- --------- --------- ---------
Holder Owner Ordinary ADSs Ordinary
- ------ ----- -------- ---- --------
Shares Shares subject
------ --------------
to options,
-----------
warrants or
-----------
rights to
---------
acquire or
----------
subscribe
---------
Walter Walter 9 nil nil
Anderson Anderson
BNY Walter 47,230 nil
(Nominees) Anderson
Limited as
Esprit register
of members
</TABLE>
13
<PAGE> 15
SCHEDULE 2
The Shareholder agrees not to transfer or dispose of any of its Shares to any of
the following persons or any of their respective affiliates:
Viatel Inc.
RSL Communications, Ltd.
Colt Telecom Group plc
Rupert Murdoch
PLD Telekom Inc.
Belgacom S.A.
Com Belga
Systema
WorldPort Communications, Inc.
Deutsche Telekom A.G.
France Telecom
British Telecommunications plc
Telecom Italia SpA
Telia AB
Koninklijke KPN NV
Telefonica de Spana, S.A.
ATT Corp.
MCI Worldcom Inc
Sprint Corp.
Global One
Qwest Communications International Inc.
Cable & Wireless Communications plc.
Energis plc
Equant NV
Global Crossing Ltd.
Metromedia Fiber Network Inc.
Teleglobe Inc.
14
<PAGE> 1
EXHIBIT 2.3
IRREVOCABLE
UNDERTAKING
by
Apax Funds Nominees Limited
Strictly Private & Confidential
SIMMONS & SIMMONS
21 Wilson Street London EC2M 2TX
Tel: 0171-628 2020 / 528 9292 Fax: 0171-628 2070 DX Box No 12
<PAGE> 2
To: Global TeleSystems Group, Inc.
("GTS")
1751 Pinnacle Drive
North Tower 12th Floor
McLean VA 22102
United States of America
From: Apax Funds Nominees Limited
62 Green Street
London W1Y 4BA
8 December 1998
Dear Sirs,
1. THE OFFER
We refer to the press announcement in the form of the draft attached hereto (the
"Press Announcement") setting out the terms and conditions upon which Bear
Stearns will, on behalf of GTS, make an offer (the "Offer") to acquire the whole
of the issued and to be issued share capital of Esprit Telecom Group plc
("Esprit") excluding any such share capital owned by GTS or any subsidiary of
GTS on the date that the Offer is made.
2. DEFINITIONS
In this letter, unless the context otherwise requires:
(A) "the Acceptance Date" means 3.00 pm on the 17th US
Business Day following the posting of the Offer Document
or, if a MAC Notice has been served before such day, 1.00
pm on the US Business Day following the determination in
accordance with paragraph 7(B) or 7(C) below that no GTS
MAC has occurred;
(B) "GTS MAC" means a material adverse change in the value of
the GTS Group by virtue of:
(i) a specific event which causes an adverse
change in the business, assets, financial or
trading position or profits or prospects of
any member of the Wider GTS Group; or
(ii) there having been anything misleading or a
misrepresentation of fact or omission to state
a fact necessary to make the information
contained therein not misleading in any
financial, business or other information
publicly disclosed by GTS in relation to the
1
<PAGE> 3
business, assets, financial or trading
position or prospects of any member of the
Wider GTS Group;
which in either case is material in the context of the
GTS Group taken as a whole. For the purposes of this
definition:
(1) a GTS MAC shall exclude (without limitation)
general factors affecting the global
telecommunications industry or other
industries as a whole;
(2) a decline in the market price of any
securities of GTS or any change in interest
rates will not, of themselves, amount to a GTS
MAC; and
(3) GTS shall be considered on a stand alone basis
excluding Esprit;
(C) "Esprit Shares" means the ordinary shares and American
Depositary Shares ("ADSs") in Esprit shown in columns 3
and 4 of Schedule 1 and, except in sub-paragraph (A) of
Paragraph 5 shall include any shares in Esprit
attributable to or deriving from such shares and shall
include any other ordinary shares in Esprit which we
acquire and beneficially own after signing this
undertaking but excluding any shares in Esprit
transferred in accordance with paragraph 4(D);
(D) "the Majority Shareholders" means each of Apax Funds
Nominees Limited, Warburg, Pincus Ventures, L.P., Gold &
Appel Transfer S.A and Walter Anderson;
(E) "Offer":
(1) means any offer or offers that may be made by
or on behalf of GTS to acquire:
(a) the whole of the share capital of
Esprit in issue at the date on
which the Offer is made (including
any securities in Esprit
attributable to or derived from
such share capital, but excluding
any such share capital owned on
such date by GTS or any subsidiary
of GTS); and
(b) any share capital of Esprit
allotted while the Offer remains
open for acceptance or before such
earlier date as GTS may determine
whether pursuant to the exercise of
conversion or subscription rights
or otherwise; and
(2) extends to any new, increased, extended or
revised offer or offers by or on behalf of
GTS, provided that in any such case the terms
2
<PAGE> 4
of such offer or offers are, in the opinion of
Bear Stearns, with the agreement of Esprit's
financial advisers, appointed for the purposes
of Rule 3 of the City Code provided such
agreement is not unreasonably withheld or
delayed (but without hereby creating any duty
of care owed by Bear Stearns, except to GTS or
by Esprit's financial advisers, except to
Esprit) no less favourable to shareholders of
Esprit than the terms set out in the Press
Announcement or the Offer Document;
(F) references to the share capital of Esprit include that
represented by ADSs; and
(G) save as referred to above words defined in the Press
Announcement have the same meanings herein.
3. RELEASE OF PRESS ANNOUNCEMENT
We irrevocably consent to the issue of the Press Announcement incorporating
references to us and to this undertaking subject to any amendments which may be
agreed with us or Esprit's financial advisers. We also consent to the issue of
the Offer Document, incorporating references to us, and to this undertaking,
substantially similar to those references contained in the Press Announcement.
We understand that this irrevocable undertaking will be made available for
public inspection.
4. UNDERTAKINGS
In consideration of GTS agreeing to make the Offer in all material respects on
the terms and subject to the conditions referred to in the Press Announcement,
we hereby irrevocably undertake to GTS as follows:-
(A) we shall accept or procure acceptance of the Offer in
accordance with its terms in respect of all the Esprit
Shares by not later than the Acceptance Date and shall
forward or procure that there is forwarded, with such
acceptance, the share certificates or other documents of
title in respect of the Esprit Shares in accordance with
the terms of the Offer;
(B) the Esprit Shares will be acquired by GTS fully paid and
free from all liens, equities, charges, encumbrances and
other interests and together with all rights now or
hereafter attaching thereto, including the right to
receive and retain all dividends and other distributions
declared, made or paid hereafter;
(C) notwithstanding that we may be or become entitled to
withdraw our acceptance(s) of the Offer by virtue of any
term of the Offer or the rules of the City Code or any
provision of the securities laws or regulations of the US
or otherwise, we shall not withdraw our acceptance(s) and
shall
3
<PAGE> 5
procure that our acceptance(s) is not withdrawn in
respect of all or any of the Esprit Shares;
(D) save as required by paragraph 4(A) or in this paragraph
4(D), we shall not prior to the lapsing or withdrawal of
the Offer, conditionally or unconditionally, sell,
transfer, charge, pledge or grant any option over or
otherwise dispose of or permit the sale or other
disposition of all or any of the Esprit Shares or any
interest held by us in any of the Esprit Shares save that
we may transfer or otherwise dispose of all or some of
our Esprit Shares provided that:
(1) prior to such transfer or disposition Esprit
shall have received the advice of its
independent auditors and GTS shall have
received the advice of its independent
auditors that such transfer or disposition
would not prevent the transactions
contemplated by the Offer from receiving
"pooling of interests" treatment for financial
accounting purposes;
(2) such transfer or disposition would not delay
the Offer becoming wholly unconditional by
more than 10 days or beyond the 60th day after
posting of the Offer Document, or if earlier,
the last date by which the Offer can become
wholly unconditional;
(3) before such transfer or disposition the
transferee of such Esprit Shares shall have
executed an irrevocable undertaking for no
consideration and under seal in a form
substantially similar to this Irrevocable
Undertaking together with a legal opinion in
respect thereof as to due execution and
enforceability in a form reasonably
satisfactory to GTS;
(4) such transferee has been advised by Esprit's
financial advisers that the transfer or
disposition would not violate the provisions
of the Code;
(5) such transferee is (i) not listed on Schedule
1 hereto; and (ii) immediately prior to such
transfer does not own more than one per cent
of the outstanding GTS Shares; and
(6) we have consulted with GTS (in a way which
does not oblige GTS to make a public
announcement - provided that if GTS is obliged
to disclose as a result of such disclosure
this shall not be a breach of this provision
by us) with respect to the timing of such sale
or disposition to mitigate any adverse effect
such sale or disposition would have on the
market price of GTS Shares;
4
<PAGE> 6
(E) we shall not prior to the lapsing or withdrawal of the
Offer without the prior written consent of GTS purchase
or otherwise acquire any shares in Esprit or any interest
therein or agree to do so whether conditionally or
unconditionally;
(F) we shall procure that, save pursuant to this undertaking,
unless and until the Offer shall have lapsed or shall
have been withdrawn, no other agreement or arrangement
(including any undertaking) shall be entered into (other
than with GTS) which could result in the disposal of, or
the creation or existence of any encumbrance on, all or
any of the Esprit Shares or any interest therein or which
might in any way restrict the disposal of the Esprit
Shares or any of them and no other offer shall be
accepted in respect of the Esprit Shares or any of them
(whether it is conditional or unconditional and
irrespective of the means by which it is to be
implemented);
(G) we shall not, prior to the issue of the Press
Announcement without the prior written consent of GTS,
disclose or announce to any person the fact that
discussions or negotiations are taking or have taken
place concerning the Offer save as (and then only to the
extent) required by any law, the rules of NASDAQ or
EASDAQ or the City Code or the Panel or pursuant to any
enquiry by a governmental, official or regulatory body
having jurisdiction provided that, in such circumstances,
we shall advise GTS prior to any such disclosure or
announcement so that GTS has an opportunity to seek to
control the timing and manner of such disclosure;
(H) subject to paragraph 4(D), at all times after the date
hereof and until the Offer shall have lapsed or been
withdrawn, we shall refrain from knowingly taking any
action or making any statement which is or may be
prejudicial to the success of the Offer, including,
without limitation:
(1) soliciting procuring, initiating or engaging
in, directly or indirectly, any discussions or
negotiations with any third party, involving
any other offer by any third party for all or
any part of the issued share capital of Esprit
or involving the acquisition outside the
ordinary course of business (as carried on to
the date hereof) of or any business
combination involving Esprit or any of its
subsidiaries or any material part of the
shares or assets of Esprit or any of its
subsidiaries or in each case any interest
therein ("each an Esprit Transaction");
(2) entering into discussions or negotiations
with, or (save as required by Rule 20.2 of the
City Code in which case only that information
strictly required to be provided shall be
disclosed and on the basis of an undertaking
as to confidentiality substantially similar to
that given by GTS) providing any information
to any
5
<PAGE> 7
person in relation to, or facilitating or
cooperating with in any way, any Esprit
Transaction; or
(3) communicating with any person in relation to
or discussing with any person the terms of the
Offer or any matter relating thereto without
the prior written consent of GTS provided that
this shall not apply to any communications or
discussions with our or Esprit's professional
advisers who appreciate the need for
requirements as to confidentiality in relation
to the Offer or to communications or
discussions limited to information set out in
the Press Announcement or any other document
or announcement published with the consent of
GTS in connection with the Offer;
(I) we shall inform GTS immediately:
(1) if we receive an approach from any person in
relation to a Esprit Transaction save to the
extent bound by any existing duty of
confidentiality;
(2) if we are asked to, or do, provide any
information to any person with a view to any
person investigating or entering into a Esprit
Transaction save to the extent bound by any
existing duty of confidentiality; or
(3) if we become aware of any material breach of
the provisions of this undertaking;
and in the case of (1) and (2) above, we shall provide
reasonable details as to the identity of any relevant
person and the terms and conditions of any proposal or
details of any information requested or provided, and in
the case of (3) above, shall provide reasonable details
of the relevant breach;
(J) we are not in discussions with any third party in
relation to any Esprit Transaction;
(K) we will procure for GTS all necessary information
regarding us and our interests and those of the funds on
whose behalf we hold the Esprit Shares as nominee, in the
share capital of Esprit which is required to be contained
in the Offer Document in order to comply with the
requirements of the City Code, US securities law or any
other applicable law or regulation;
(L) we shall not prior to the date the Offer becomes wholly
unconditional or lapses or is withdrawn, transfer,
dispose of, grant rights over or in any way charge, or
otherwise deal in or enter into any agreement,
arrangement or undertaking (conditional or unconditional)
to transfer, dispose of grant
6
<PAGE> 8
rights over or in any way charge, or otherwise deal in
any GTS Shares or any interest therein or any derivative
referenced thereto or any security convertible into GTS
Shares (subject to paragraph 4(D)).
5. WARRANTIES
5.1 We hereby further undertake warrant and represent to GTS as follows:
(A) we are the registered holder of the Esprit Shares (other
than those represented by ADSs) and the owner of the
Esprit Shares represented by ADSs and the Esprit Shares
are free from all liens, charges or encumbrances. There
are no other ordinary shares in Esprit registered in our
name or beneficially owned, or managed and controlled by
us, or in which we have an interest and we have no
rights, warrants or options to acquire or subscribe for
ordinary shares in Esprit or any interest therein save as
specified in columns 3 and 4 of Schedule 1;
(B) save pursuant to this undertaking we have not agreed,
conditionally or otherwise, to dispose of all or any of
the Esprit Shares or any interest therein and have (and,
upon the Offer being made, will continue to have) all
necessary authority to enter into this undertaking and
accept or procure acceptance of the Offer in respect of
the Esprit Shares;
(C) at the time we are obliged to accept the Offer pursuant
to paragraph 4 (A) we will have the right to transfer the
Esprit Shares with all rights attaching to them as
envisaged by the terms of the Offer.
6. VOTING RIGHTS
We hereby further irrevocably undertake, represent, warrant and agree to and
with GTS that, until the Offer shall have closed, lapsed or been withdrawn we
shall exercise or procure the exercise of the voting rights attached to the
Esprit Shares as instructed by GTS on any resolution to enable the Offer to
become unconditional if it were passed or rejected at a general or separate
class meeting of Esprit.
7. GTS MAC
(A) If at any time before the Acceptance Date we become aware
of an event which could or might reasonably be expected
to give rise to a GTS MAC we shall immediately serve
notice on GTS providing full details of the event,
misleading statement, misrepresentation or omission
alleged to be expected to give rise to the GTS MAC ("the
MAC Notice"). We shall also serve a copy of the MAC
Notice on the other Majority Shareholders and Esprit. Not
more than one MAC Notice may be served in respect of any
individual event, and in the event that more than one
Majority Shareholder serves a MAC Notice in respect of
the same event, only the
7
<PAGE> 9
first to be received by GTS will be valid. In no event
shall a Majority Shareholder have the right to serve a
MAC Notice more than 10 US Business Days after it becomes
aware of an event which could or might reasonably be
expected to give rise to the GTS MAC to which such MAC
Notice relates or after the Acceptance Date. For the
purposes of this paragraph we shall be deemed to be aware
of the contents of all public filings made by GTS. GTS
shall provide copies to us immediately following filing
of any such filings made by GTS from the date hereof
until the Acceptance Date. No MAC Notice may in any event
be served later than 8 US Business Days before the date
referred to in paragraph 12(E).
(B) As soon as practicable after the service of the MAC
Notice, and in any event within two US Business Days,
each of ourselves and GTS will appoint an investment
banking firm of international repute to act as an
appraiser ("the Appraiser"). Each of ourselves and GTS
will use their best endeavours to ensure that the
Appraisers shall make an appraisal as to whether a GTS
MAC has occurred and shall notify ourselves and GTS of
their decision within three US Business Days of their
appointment. If the Appraisers agree with each other they
shall immediately notify the Majority Shareholders and
GTS.
(C) If the Appraisers are unable to agree between themselves
whether a GTS MAC has occurred, we and GTS will use our
best endeavours to procure that the two Appraisers select
a third bank with similar qualifications ("the Referee")
which shall make its determination as to whether a GTS
MAC has occurred and shall notify ourselves and GTS of
their decision within three US Business Days after its
selection. If our respective Appraisers fail to agree
upon the appointment of the Referee either we or GTS may
refer the matter to the President for the time being of
the Law Society of England and Wales who shall promptly
appoint the Referee.
(D) Each of ourselves and GTS will have all reasonable
opportunity of making oral and written representations to
each Appraiser and to the Referee in enabling them to
reach their determinations. The Appraisers and the
Referee shall act as experts and not as arbitrators and,
absent fraud or manifest error, the determination of the
Appraisers and the Referee hereunder will be binding upon
ourselves and GTS.
(E) If it is determined under sub-paragraph (B) or (C) that a
GTS MAC has occurred then the provisions of paragraph 12
will apply. The determination of whether a GTS MAC has or
has not occurred can be relied upon by GTS and all the
Majority Shareholders.
(F) Each of ourselves and GTS recognise that the provisions
of this paragraph involve the co-operation of third
parties. Each of ourselves and GTS agree to use our
respective best endeavours to ensure that such third
parties co-
8
<PAGE> 10
operate in order to determine, within the time frame
described in this paragraph, whether a GTS MAC has
occurred. If it is not practicable to determine whether a
GTS MAC has occurred within that time frame, the parties
shall nevertheless use their best endeavours to ensure
that the question is determined as soon as possible
thereafter, and in any event before the day ("the Last
Acceptance Date") which is two US Business Days and UK
Business Days before the last date the Offer is capable
of becoming wholly unconditional.
(G) If it is not determined by the Last Acceptance Date that
a GTS MAC has occurred we and GTS agree that we will
jointly request the Panel (and request the directors of
Esprit to assist us in this respect) to extend the last
date that the Offer may become wholly unconditional to a
date not later than 81 days after the posting of the
Offer Document. If the determination that no GTS MAC has
occurred does not take place until such date, then the
Acceptance Date shall be extended to 1.00 p.m. on such
date.
8. LAW AND JURISDICTION
(A) This undertaking is governed by, and construed in
accordance with, English law.
(B) In relation to any legal action or proceedings to enforce
this undertaking or arising out of or in connection with
this undertaking ("Proceedings") we irrevocably submit to
the jurisdiction of the English courts and waive any
objection to Proceedings in such courts on the grounds of
venue or on the grounds that the Proceedings have been
brought in an inconvenient forum.
9. NOMINEES
In the case where the Esprit Shares are registered in the name of a nominee, we
shall direct the nominee to act as if the nominee were bound by the terms of
this irrevocable undertaking and we shall procure that such nominee does all
acts and things necessary to carry the terms hereof into effect as if we had
been the registered holder of the Esprit Shares registered in the name of such
nominee.
10. CONDITIONS
Notwithstanding any other provision hereof, this irrevocable undertaking and
GTS's obligation to make the Offer, are conditional upon:
(A) the release of the Press Announcement at or before 9 a.m.
on 8 December 1998; and
9
<PAGE> 11
(B) irrevocable undertakings, in a form acceptable to GTS,
being received in respect of not less than 50.1 per cent.
of the issued ordinary shares of Esprit prior to the
release of the Press Announcement.
If these conditions shall not have been satisfied by such time and date this
irrevocable undertaking shall automatically lapse and be of no further force or
effect and no party hereto shall have any claim against the other save in
respect of any antecedent breach of its terms.
11. MISCELLANEOUS
(A) We acknowledge that we are not entering into this
undertaking in reliance upon any representation, warranty
or undertaking save as expressly set out herein and, in
the absence of fraud, we shall have no claim or remedy
against GTS or Esprit in respect of any
misrepresentation, untrue statement, omission or
non-disclosure. In particular, our undertakings pursuant
to paragraph 4 shall be irrevocable and, in the absence
of fraud, shall not be capable of rescission or
termination on the basis of any information subsequently
disclosed by GTS or Esprit in any offer document, listing
particulars or registration statement or for any other
reason whatsoever including (without limitation) any
failure by all or any of the directors of Esprit to
recommend the Offer or to continue to recommend the Offer
after the date of this undertaking.
(B) No failure or delay by GTS in exercising any right, power
or privilege hereunder shall operate as a waiver thereof,
nor shall any single or partial exercise thereof preclude
any other or further exercise of any right, power or
privilege hereunder. We agree that any breach of this
Undertaking is likely to cause substantial harm to GTS
and that money damages would not be a sufficient remedy
for any breach of this Undertaking and that GTS will be
entitled to specific performance and injunctive relief as
remedies for any such breach. Such remedies shall not be
deemed to be the exclusive remedies for a breach of this
Undertaking but shall be in addition to all other
remedies available at law or equity.
12. LAPSING
This irrevocable undertaking shall automatically lapse and be of no further
force or effect and no party hereto shall have any claim against the other save
in respect of any antecedent breach of its terms in the event that:
(A) precondition (A) to the Offer set out in Paragraph 1 of
Appendix 1 of the Press Announcement (relating to the
Esprit Bonds) shall not have been satisfied or waived on
or before 29 January 1999;
10
<PAGE> 12
(B) the Offer Document is not despatched on or before 15
April 1999; or in the event that a MAC Notice is served
before the despatch of the Offer Document, the date
falling 10 US Business Days after determination that a
GTS MAC has not occurred (if later);
(C) GTS announces that any of the pre-conditions of the Offer
set out in Paragraph 1 of Appendix 1 to the Press
Announcement has not been satisfied and that it has not
been and will not be waived;
(D) it is determined that a GTS MAC has occurred; or
(E) the Offer is not declared wholly unconditional on or
before the 60th day after the Offer document is
despatched (or, if later, the date to which the Initial
Offer Period is extended pursuant to paragraph 7(G)).
13. EXECUTION
This undertaking may be executed in more than one part.
Yours faithfully,
EXECUTED AS A DEED )
by APAX FUNDS NOMINEES LIMITED ) ANDREW BARRETT
by its attorney )
)
)
Witness' signature TIMOTHY DRAKE
Witness' name Timothy Drake
Witness' address 222 Grays Inn Road London WC1X 8HB
----------------------------------------------
Witness' occupation Solicitor
We agree and accept the terms of this undertaking.
11
<PAGE> 13
GERALD THAMES
For Global TeleSystems Group, Inc.
12
<PAGE> 14
SCHEDULE 1
The following represents our shareholding in Esprit:
<TABLE>
<CAPTION>
Column 1 Column 2 Column 3 Column 4 Column 5
- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C>
Registered Beneficial Number of Number of Number of
Holder Owner Ordinary ADSs Ordinary
Shares Shares subject
to options,
warrants or
rights to
acquire or
subscribe
Apax Funds Investors in 32,294,100 nil nil
Nominees funds IV and V
Limited
BNY Investors in nil 1,263,500 nil
Nominees funds IV and V
Limited on
Esprit register
</TABLE>
13
<PAGE> 15
SCHEDULE 2
The Shareholder agrees not to transfer or dispose of any of its Shares to any of
the following persons or any of their respective affiliates:
Viatel Inc.
RSL Communications, Ltd.
Colt Telecom Group plc
Rupert Murdoch
PLD Telekom Inc.
Belgacom S.A.
Com Belga
Systema
WorldPort Communications, Inc.
Deutsche Telekom A.G.
France Telecom
British Telecommunications plc
Telecom Italia SpA
Telia AB
Koninklijke KPN NV
Telefonica de Spana, S.A.
ATT Corp.
MCI Worldcom Inc
Sprint Corp.
Global One
Qwest Communications International Inc.
Cable & Wireless Communications plc.
Energis plc
Equant NV
Global Crossing Ltd.
Metromedia Fiber Network Inc.
Teleglobe Inc.
14
<PAGE> 1
EXHIBIT 2.4
IRREVOCABLE
UNDERTAKING
by
Gold & Appel Transfer S.A.
Strictly Private & Confidential
SIMMONS & SIMMONS
21 Wilson Street London EC2M 2TX
Tel: 0171-628 2020 / 528 9292 Fax: 0171-628 2070 DX Box No 12
<PAGE> 2
To: Global TeleSystems Group, Inc.
("GTS")
1751 Pinnacle Drive
North Tower 12th Floor
McLean VA 22102
United States of America
From: Gold & Appel Transfer S.A.
Omar Hodge Building
Wickams's Cay
Road Town
Tortola
British Virgin Islands
8 December 1998
Dear Sirs,
1. THE OFFER
We refer to the press announcement in the form of the draft attached hereto (the
"Press Announcement") setting out the terms and conditions upon which Bear
Stearns will, on behalf of GTS, make an offer (the "Offer") to acquire the whole
of the issued and to be issued share capital of Esprit Telecom Group plc
("Esprit") excluding any such share capital owned by GTS or any subsidiary of
GTS on the date that the Offer is made.
2. DEFINITIONS
In this letter, unless the context otherwise requires:
(A) "the Acceptance Date" means 3.00 pm on the 17th US
Business Day following the posting of the Offer Document
or, if a MAC Notice has been served before such day, 1.00
pm on the US Business Day following the determination in
accordance with paragraph 7(B) or 7(C) below that no GTS
MAC has occurred;
(B) "GTS MAC" means a material adverse change in the value of
the GTS Group by virtue of:
(i) a specific event which causes an adverse
change in the business, assets, financial or
trading position or profits or prospects of
any member of the Wider GTS Group; or
(ii) there having been a material misrepresentation
of fact or omission to state a fact necessary
to make the information contained
1
<PAGE> 3
therein not materially misleading in any
financial, business or other information
publicly disclosed by GTS in relation to the
business, assets, financial or trading
position or prospects of any member of the
Wider GTS Group;
which in either case is material in the context of the
GTS Group taken as a whole. For the purposes of this
definition:
(1) a GTS MAC shall exclude (without limitation)
general factors affecting the global
telecommunications industry or other
industries as a whole;
(2) a decline in the market price of any
securities of GTS or any change in interest
rates will not, of themselves, amount to a GTS
MAC; and
(3) GTS shall be considered on a stand alone basis
excluding Esprit;
(C) "Esprit Shares" means the ordinary shares and American
Depositary Shares ("ADSs") in Esprit shown in columns 3
and 4 of Schedule 1 and, except in sub-paragraph (A) of
Paragraph 5 shall include any shares in Esprit
attributable to or deriving from such shares and shall
include any other ordinary shares in Esprit which we
acquire and beneficially own after signing this
undertaking but excluding any shares in Esprit
transferred with the prior written consent of GTS;
(D) "the Majority Shareholders" means each of Apax Funds
Nominees Limited, Warburg, Pincus Ventures, L.P. and Gold
& Appel Transfer S.A;
(E) "Offer":
(1) means any offer or offers that may be made by
or on behalf of GTS to acquire:
(a) the whole of the share capital of
Esprit in issue at the date on
which the Offer is made (including
any securities in Esprit
attributable to or derived from
such share capital, but excluding
any such share capital owned on
such date by GTS or any subsidiary
of GTS); and
(b) any share capital of Esprit
allotted while the Offer remains
open for acceptance or before such
earlier date as GTS may determine
whether pursuant to the exercise of
conversion or subscription rights
or otherwise; and
2
<PAGE> 4
(2) extends to any new, increased, extended or
revised offer or offers by or on behalf of
GTS, provided that in any such case the terms
of such offer or offers are, in the opinion of
Bear Stearns, with the agreement of Esprit's
financial advisers, appointed for the purposes
of Rule 3 of the City Code provided such
agreement is not unreasonably withheld or
delayed (but without hereby creating any duty
of care owed by Bear Stearns, except to GTS or
by Esprit's financial advisers, except to
Esprit) no less favourable to shareholders of
Esprit than the terms set out in the Press
Announcement or the Offer Document;
(F) references to the share capital of Esprit include that
represented by ADSs; and
(G) save as referred to above words defined in the Press
Announcement have the same meanings herein.
3. RELEASE OF PRESS ANNOUNCEMENT
We irrevocably consent to the issue of the Press Announcement incorporating
references to us and to this undertaking subject to any amendments which may be
agreed with us or Esprit's financial advisers. We also consent to the issue of
the Offer Document, incorporating references to us, and to this undertaking,
substantially similar to those references contained in the Press Announcement.
We understand that this irrevocable undertaking will be made available for
public inspection.
4. UNDERTAKINGS
In consideration of GTS agreeing to make the Offer in all material respects on
the terms and subject to the conditions referred to in the Press Announcement,
we hereby irrevocably undertake to GTS as follows:-
(A) we shall accept or procure acceptance of the Offer in
accordance with its terms in respect of all the Esprit
Shares by not later than the Acceptance Date and shall
forward or procure that there is forwarded, with such
acceptance, the share certificates or other documents of
title in respect of the Esprit Shares in accordance with
the terms of the Offer;
(B) the Esprit Shares will be acquired by GTS fully paid and
free from all liens, equities, charges, encumbrances and
other interests and together with all rights now or
hereafter attaching thereto, including the right to
receive and retain all dividends and other distributions
declared, made or paid hereafter;
(C) notwithstanding that we may be or become entitled to
withdraw our acceptance(s) of the Offer by virtue of any
term of the Offer or the rules of
3
<PAGE> 5
the City Code or any provision of the securities laws or
regulations of the US or otherwise, we shall not withdraw
our acceptance(s) and shall procure that our
acceptance(s) is not withdrawn in respect of all or any
of the Esprit Shares;
(D) save as required by paragraph 4(A) or in this paragraph
4(D), we shall not prior to the lapsing or withdrawal of
the Offer, conditionally or unconditionally, sell,
transfer, charge, pledge or grant any option over or
otherwise dispose of or permit the sale or other
disposition of all or any of the Esprit Shares or any
interest held by us in any of the Esprit Shares save that
we may transfer or otherwise dispose of all or some of
our Esprit Shares provided that:
(1) prior to such transfer or disposition Esprit
shall have received the advice of its
independent auditors and GTS shall have
received the advice of its independent
auditors that such transfer or disposition
would not prevent the transactions
contemplated by the Offer from receiving
"pooling of interests" treatment for financial
accounting purposes;
(2) such transfer or disposition would not delay
the Offer becoming wholly unconditional by
more than 10 days or beyond the 60th day after
posting of the Offer Document, or if earlier,
the last date by which the Offer can become
wholly unconditional;
(3) before such transfer or disposition the
transferee of such Esprit Shares shall have
executed an irrevocable undertaking for no
consideration and under seal in a form
substantially similar to this Irrevocable
Undertaking together with a legal opinion in
respect thereof as to due execution and
enforceability in a form reasonably
satisfactory to GTS;
(4) such transferee has been advised by Esprit's
financial advisers that the transfer or
disposition would not violate the provisions
of the Code;
(5) such transferee is (i) not listed on Schedule
2 hereto; and (ii) immediately prior to such
transfer does not own more than one per cent
of the outstanding GTS Shares; and
(6) we have consulted with GTS (in a way which
does not oblige GTS to make a public
announcement) with respect to the timing of
such sale or disposition to mitigate any
adverse effect such sale or disposition would
have on the market price of GTS Shares;
4
<PAGE> 6
(E) we shall not prior to the lapsing or withdrawal of the
Offer without the prior written consent of GTS purchase
or otherwise acquire any shares in Esprit or any interest
therein or agree to do so whether conditionally or
unconditionally;
(F) we shall procure that, save pursuant to this undertaking,
unless and until the Offer shall have lapsed or shall
have been withdrawn, no other agreement or arrangement
(including any undertaking) shall be entered into (other
than with GTS) which could result in the disposal of, or
the creation or existence of any encumbrance on, all or
any of the Esprit Shares or any interest therein or which
might in any way restrict the disposal of the Esprit
Shares or any of them and no other offer shall be
accepted in respect of the Esprit Shares or any of them
(whether it is conditional or unconditional and
irrespective of the means by which it is to be
implemented);
(G) we shall not, prior to the issue of the Press
Announcement without the prior written consent of GTS,
disclose or announce to any person the fact that
discussions or negotiations are taking or have taken
place concerning the Offer save as (and then only to the
extent) required by any law, the rules of NASDAQ or
EASDAQ or the City Code or the Panel or pursuant to any
enquiry by a governmental, official or regulatory body
having jurisdiction provided that, in such circumstances,
we shall advise GTS prior to any such disclosure or
announcement so that GTS has an opportunity to seek to
control the timing and manner of such disclosure;
(H) at all times after the date hereof and until the Offer
shall have lapsed or been withdrawn, we shall refrain
from knowingly taking any action or making any statement
which is or may be prejudicial to the success of the
Offer, including, without limitation:
(1) soliciting procuring, initiating or engaging
in, directly or indirectly, any discussions or
negotiations with any third party, involving
any other offer by any third party for all or
any part of the issued share capital of Esprit
or involving the acquisition outside the
ordinary course of business (as carried on to
the date hereof) of or any business
combination involving Esprit or any of its
subsidiaries or any material part of the
shares or assets of Esprit or any of its
subsidiaries or in each case any interest
therein ("each a Esprit Transaction");
(2) entering into discussions or negotiations
with, or (save as required by Rule 20.2 of the
City Code in which case only that information
strictly required to be provided shall be
disclosed and on the basis of an undertaking
as to confidentiality substantially similar to
that given by GTS) providing any information
to any
5
<PAGE> 7
person in relation to, or facilitating or
cooperating with in any way, any Esprit
Transaction; or
(3) communicating with any person in relation to
or discussing with any person the terms of the
Offer or any matter relating thereto without
the prior written consent of GTS provided that
this shall not apply to any communications or
discussions with our or Esprit's professional
advisers who appreciate the need for
requirements as to confidentiality in relation
to the Offer or to communications or
discussions limited to information set out in
the Press Announcement or any other document
or announcement published with the consent of
GTS in connection with the Offer;
(I) we shall inform GTS immediately:
(1) if we receive an approach from any person in
relation to a Esprit Transaction;
(2) if we are asked to, or do, provide any
information to any person with a view to any
person investigating or entering into a Esprit
Transaction; or
(3) if we become aware of any material breach of
the provisions of this undertaking;
and in the case of (1) and (2) above, we shall provide
reasonable details as to the identity of any relevant
person and the terms and conditions of any proposal or
details of any information requested or provided, and in
the case of (3) above, shall provide reasonable details
of the relevant breach;
(J) we are not in discussions with any third party in
relation to any Esprit Transaction;
(K) we will procure for GTS all necessary information
regarding us and our interests, in the share capital of
Esprit which is required to be contained in the Offer
Document in order to comply with the requirements of the
City Code, US securities law or any other applicable law
or regulation;
(L) we shall not prior to the date the Offer becomes wholly
unconditional or lapses or is withdrawn, transfer,
dispose of, grant rights over or in any way charge, or
otherwise deal in or enter into any agreement,
arrangement or undertaking (conditional or unconditional)
to transfer, dispose of grant rights over or in any way
charge, or otherwise deal in any GTS Shares or any
interest therein or any derivative referenced thereto or
any security convertible into GTS Shares.
6
<PAGE> 8
5. WARRANTIES
5.1 We hereby further undertake warrant and represent to GTS as follows:
(A) we are the registered holder and beneficial owner of the
Esprit Shares (other than those represented by ADSs) and
the beneficial owner of the Esprit Shares represented by
ADSs and the Esprit Shares are free from all liens,
equities charges or encumbrances. There are no other
ordinary shares in Esprit registered in our name or
beneficially owned, or managed and controlled by us, or
in which we have an interest and we have no rights,
warrants or options to acquire or subscribe for ordinary
shares in Esprit or any interest therein save as
specified in columns 3 and 4 of Schedule 1;
(B) save pursuant to this undertaking we have not agreed,
conditionally or otherwise, to dispose of all or any of
the Esprit Shares or any interest therein and have (and,
upon the Offer being made, will continue to have) all
necessary authority to enter into this undertaking and
accept or procure acceptance of the Offer in respect of
the Esprit Shares;
(C) we have the right to transfer the Esprit Shares with all
rights attaching to them as envisaged by the terms of the
Offer;
(D) otherwise than in the ordinary course of Esprit's
telecommunications business there is not outstanding any
indebtedness or other liability (actual or contingent)
owing by any member of the Wider Esprit Group to us or
any person connected with us, nor is there any
indebtedness owing to any member of the Wider Esprit
Group by any such person;
(E) neither we nor any person connected with us has entered
into any agreement, undertaking, instrument or
arrangement with any member of the Wider Esprit Group.
5.2 We shall procure that (save as may be necessary to give effect to
this undertaking) we shall not allow nor shall we do or procure any
act or omission before the date the Offer becomes wholly
unconditional which would constitute a breach of any of the above
warranties if they were given at any and all times from the date
hereof down to the date the Offer becomes wholly unconditional, or
which would make any of the above warranties inaccurate or
misleading if they were so given.
5.3 We further undertake to forthwith disclose in writing to GTS any
matter or thing which may arise or become known to me after the date
hereof and before the date the Offer becomes wholly unconditional
which is inconsistent with any of the above warranties or which
might make any of them inaccurate or misleading if they were given
at any and all times from the date hereof down to the date the Offer
becomes wholly unconditional or which is a breach of sub-paragraph
5.2 above.
7
<PAGE> 9
6. VOTING RIGHTS
We hereby further irrevocably undertake, represent, warrant and agree to and
with GTS that, until the Offer shall have closed, lapsed or been withdrawn we
shall exercise or procure the exercise of the voting rights attached to the
Esprit Shares as instructed by GTS on any resolution to enable the Offer to
become unconditional if it were passed or rejected at a general or separate
class meeting of GTS.
7. GTS MAC
(A) If at any time before the 17th US Business Day after the
posting of the Offer Document we become aware of an event
which could or might reasonably be expected to give rise
to a GTS MAC we shall immediately serve notice on GTS
providing full details of the event alleged to be
expected to give rise to the GTS MAC and of its effect on
the value of GTS ("the MAC Notice"). We shall also serve
a copy of the MAC Notice on the other Majority
Shareholders and Esprit. Not more than one MAC Notice may
be served in respect of any individual event, and in the
event that more than one Majority Shareholder serves a
MAC Notice in respect of the same event, only the first
to be received by GTS will be valid. In no event shall a
Majority Shareholder have the right to serve a MAC Notice
more than 10 US Business Days after it becomes aware of
an event which could or might reasonably be expected to
give rise to the GTS MAC to which such MAC Notice relates
or after the Acceptance Date. For the purposes of this
paragraph we shall be deemed to be aware of the contents
of all public filings made by GTS. GTS shall provide
copies to us immediately following filing of any such
filings made by GTS from the date hereof until the
Acceptance Date.
(B) As soon as practicable after the service of the MAC
Notice, and in any event within two US Business Days,
each of ourselves and GTS will appoint an investment
banking firm of international repute to act as an
appraiser ("the Appraiser"). Each of ourselves and GTS
will use their best endeavours to ensure that the
Appraisers shall make an appraisal as to whether a GTS
MAC has occurred and shall notify ourselves and GTS of
their decision within three US Business Days of their
appointment. If the Appraisers agree with each other they
shall immediately notify the Majority Shareholders and
GTS.
(C) If the Appraisers are unable to agree between themselves
whether a GTS MAC has occurred, we and GTS will use our
best endeavours to procure that the two Appraisers select
a third bank with similar qualifications ("the Referee")
which shall make its determination as to whether a GTS
MAC has occurred and shall notify ourselves and GTS of
their decision within three US Business Days after its
selection. If our respective Appraisers fail to agree
upon the appointment of the Referee either we or
8
<PAGE> 10
GTS may refer the matter to the President for the time
being of the Law Society of England and Wales who shall
promptly appoint the Referee.
(D) Each of ourselves and GTS will have all reasonable
opportunity of making oral and written representations to
each Appraiser and to the Referee in enabling them to
reach their determinations. The Appraisers and the
Referee shall act as experts and not as arbitrators and,
absent fraud or manifest error, the determination of the
Appraisers and the Referee hereunder will be binding upon
ourselves and GTS.
(E) If it is determined under sub-paragraph (B) or (C) that a
GTS MAC has occurred then the provisions of paragraph 12
will apply. The determination of whether a GTS MAC has or
has not occurred can be relied upon by GTS and all the
Shareholders.
(F) Each of ourselves and GTS recognise that the provisions
of this paragraph involve the co-operation of third
parties. Each of ourselves and GTS agree to use our
respective best endeavours to ensure that such third
parties co- operate in order to determine, within the
time frame described in this paragraph, whether a GTS MAC
has occurred. If it is not practicable to determine
whether a GTS MAC has occurred within that time frame,
the parties shall nevertheless use their best endeavours
to ensure that the question is determined as soon as
possible thereafter, and in any event before the day
("the Last Acceptance Date") which is two US Business
Days and UK Business Days before the last date the Offer
is capable of becoming wholly unconditional.
(G) If it is not determined by the Last Acceptance Date that
a GTS MAC has occurred we and GTS agree that we will
jointly request the Panel (and request the directors of
Esprit to assist us in this respect) to extend the last
date that the Offer may become wholly unconditional to a
date not later than 81 days after the posting of the
Offer Document. If the determination that no GTS MAC has
occurred does not take place until such date, then the
Acceptance Date shall be extended to 1.00 p.m. on such
date.
8. LAW AND JURISDICTION
(A) This undertaking is governed by, and construed in
accordance with, English law.
(B) In relation to any legal action or proceedings to enforce
this undertaking or arising out of or in connection with
this undertaking ("Proceedings") we irrevocably submit to
the jurisdiction of the English courts and waive any
objection to Proceedings in such courts on the grounds of
venue or on
9
<PAGE> 11
the grounds that the Proceedings have been brought in an
inconvenient forum.
(C) We hereby appoint Herbert Smith (for the attention of Ben
Ward) of Exchange House, Primrose Street, London EC2A 2HS
as my process agent to receive on our behalf service of
process in any proceedings in England. Service upon the
process agent shall be good service upon us whether or
not it is forwarded to and received by us. If for any
reason the process agent ceases to be able to act as
process agent, or no longer has an address in England, we
irrevocably agree to appoint a substitute process agent
with an address in England acceptable to GTS and to
deliver to GTS a copy of the substitute process agent's
acceptance of that appointment within seven days. In the
event that we fail to appoint a substitute process agent,
it shall be effective service for GTS to serve the
process upon the last known address in England of our
last known process agent notified to GTS, notwithstanding
that such process agent is no longer found at such
address or has ceased to act.
9. NOMINEES
In the case where the Esprit Shares are registered in the name of a nominee, we
shall direct the nominee to act as if the nominee were bound by the terms of
this irrevocable undertaking and we shall procure that such nominee does all
acts and things necessary to carry the terms hereof into effect as if we had
been the registered holder of the Esprit Shares registered in the name of such
nominee.
10. CONDITIONS
Notwithstanding any other provision hereof, this irrevocable undertaking and
GTS's obligation to make the Offer, are conditional upon:
(A) the release of the Press Announcement at or before 9 a.m.
on 8 December 1998; and
(B) irrevocable undertakings, in a form acceptable to GTS,
being received in respect of not less than 50.1 per cent.
of the issued ordinary shares of Esprit prior to the
release of the Press Announcement.
If these conditions shall not have been satisfied by such time and date this
irrevocable undertaking shall automatically lapse and be of no further force or
effect and no party hereto shall have any claim against the other save in
respect of any antecedent breach of its terms.
10
<PAGE> 12
11. MISCELLANEOUS
(A) We acknowledge that we are not entering into this
undertaking in reliance upon any representation, warranty
or undertaking save as expressly set out herein and, in
the absence of fraud, we shall have no claim or remedy
against GTS or Esprit in respect of any
misrepresentation, untrue statement, omission or
non-disclosure. In particular, our undertakings pursuant
to paragraph 4 shall be irrevocable and, in the absence
of fraud, shall not be capable of rescission or
termination on the basis of any information subsequently
disclosed by GTS or Esprit in any offer document, listing
particulars or registration statement or for any other
reason whatsoever including (without limitation) any
failure by all or any of the directors of Esprit to
recommend the Offer or to continue to recommend the Offer
after the date of this undertaking.
(B) No failure or delay by GTS in exercising any right, power
or privilege hereunder shall operate as a waiver thereof,
nor shall any single or partial exercise thereof preclude
any other or further exercise of any right, power or
privilege hereunder. We agree that any breach of this
Undertaking is likely to cause substantial harm to GTS
and that money damages would not be a sufficient remedy
for any breach of this Undertaking and that GTS will be
entitled to specific performance and injunctive relief as
remedies for any such breach. Such remedies shall not be
deemed to be the exclusive remedies for a breach of this
Undertaking but shall be in addition to all other
remedies available at law or equity.
12. LAPSING
This irrevocable undertaking shall automatically lapse and be of no further
force or effect and no party hereto shall have any claim against the other save
in respect of any antecedent breach of its terms in the event that:
(A) precondition (A) to the Offer set out in Paragraph 1 of
Appendix 1 of the Press Announcement (relating to the
Esprit Bonds) shall not have been satisfied or waived on
or before 29 January 1999;
(B) the Offer Document is not despatched on or before 15
April 1999; or in the event that a MAC Notice is served
before the despatch of the Offer Document, the date
falling 10 US Business Days after determination that a
GTS MAC has not occurred (if later);
(C) GTS announces that any of the pre-conditions of the Offer
set out in Paragraph 1 of Appendix 1 to the Press
Announcement has not been satisfied and that it has not
been and will not be waived;
(D) it is determined that a GTS MAC has occurred; or
11
<PAGE> 13
(E) the Offer is not declared wholly unconditional on or
before the 60th day after the Offer document is
despatched (or, if later, the date to which the Initial
Offer Period is extended pursuant to paragraph 7(G)).
13. EXECUTION
This undertaking may be executed in more than one part.
Yours faithfully,
EXECUTED AS A DEED )
by GOLD & APPEL TRANSFER S.A. ) WALTER ANDERSON
acting through its attorney in fact )
Witness' signature GRIER RACLIN
Witness' name GRIER RACLIN
Witness' address 104 Summerfield Road, Chevy Chase MD USA
Witness' occupation Attorney at law
We agree and accept the terms of this undertaking.
GRIER RACLIN
For and on behalf of
GLOBAL TELESYSTEMS GROUP, INC.
12
<PAGE> 14
SCHEDULE 1
The following represents our shareholding and shares subject to options,
warrants or rights to acquire or subscribe in Esprit:
<TABLE>
<CAPTION>
Column 1 Column 2 Column 3 Column 4 Column 5
- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C>
Registered Beneficial Number of Number of Number of
Holder Owner Ordinary ADSs Ordinary
Shares Shares subject
to options,
warrants or
rights to
acquire or
subscribe
Gold & Appel Gold & Appel 16
Transfer S.A. Transfer S.A.
BNY Gold & Appel 4,662,555 nil
(Nominees) Transfer S.A.
Limited as
Esprit register
of members;
Bear Stearns as
registered
holder of ADS
</TABLE>
13
<PAGE> 15
SCHEDULE 2
The Shareholder agrees not to transfer or dispose of any of its Shares to any of
the following persons or any of their respective affiliates:
Viatel Inc.
RSL Communications, Ltd.
Colt Telecom Group plc
Rupert Murdoch
PLD Telekom Inc.
Belgacom S.A.
Com Belga
Systema
WorldPort Communications, Inc.
Deutsche Telekom A.G.
France Telecom
British Telecommunications plc
Telecom Italia SpA
Telia AB
Koninklijke KPN NV
Telefonica de Spana, S.A.
ATT Corp.
MCI Worldcom Inc
Sprint Corp.
Global One
Qwest Communications International Inc.
Cable & Wireless Communications plc.
Energis plc
Equant NV
Global Crossing Ltd.
Metromedia Fiber Network Inc.
Teleglobe Inc.
14
<PAGE> 1
EXHIBIT 2.5
IRREVOCABLE
UNDERTAKING
by
Warburg, Pincus Ventures, L.P.
Strictly Private & Confidential
SIMMONS & SIMMONS
21 Wilson Street London EC2M 2TX
Tel: 0171-628 2020 / 528 9292 Fax: 0171-628 2070 DX Box No 12
<PAGE> 2
To: Global TeleSystems Group, Inc.
("GTS")
1751 Pinnacle Drive
North Tower 12th Floor
McLean VA 22102
United States of America
From: Warburg, Pincus Ventures, L.P.
466 Lexington Avenue
10017 New York
United States of America
8 December 1998
Dear Sirs,
1. THE OFFER
We refer to the press announcement in the form of the draft attached hereto (the
"Press Announcement") setting out the terms and conditions upon which Bear
Stearns will, on behalf of GTS, make an offer (the "Offer") to acquire the whole
of the issued and to be issued share capital of Esprit Telecom Group plc
("Esprit") excluding any such share capital owned by GTS or any subsidiary of
GTS on the date that the Offer is made.
2. DEFINITIONS
In this letter, unless the context otherwise requires:
(A) "the Acceptance Date" means 3.00 pm on the 17th US
Business Day following the posting of the Offer Document
or, if a MAC Notice has been served before such day, 1.00
pm on the US Business Day following the determination in
accordance with paragraph 7(B) or 7(C) below that no GTS
MAC has occurred;
(B) "GTS MAC" means a material adverse change in the value of
the GTS Group by virtue of:
(i) a specific event which causes an adverse
change in the business, assets, financial or
trading position or profits or prospects of
any member of the Wider GTS Group; or
(ii) there having been anything misleading or a
misrepresentation of fact or omission to state
a fact necessary to make the information
contained therein not misleading in any
financial, business or other information
publicly disclosed by GTS in relation to the
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<PAGE> 3
business, assets, financial or trading
position or prospects of any member of the
Wider GTS Group;
which in either case is material in the context of the
GTS Group taken as a whole. For the purposes of this
definition:
(1) a GTS MAC shall exclude (without limitation)
general factors affecting the global
telecommunications industry or other
industries as a whole;
(2) a decline in the market price of any
securities of GTS or any change in interest
rates will not, of themselves, amount to a GTS
MAC; and
(3) GTS shall be considered on a stand alone basis
excluding Esprit;
(C) "Esprit Shares" means the ordinary shares and American
Depositary Shares ("ADSs") in Esprit shown in columns 3
and 4 of Schedule 1 and, except in sub-paragraph (A) of
Paragraph 5 shall include any shares in Esprit
attributable to or deriving from such shares and shall
include any other ordinary shares in Esprit which we
acquire and beneficially own after signing this
undertaking but excluding any shares in Esprit
transferred in accordance with paragraph 4(D);
(D) "the Majority Shareholders" means each of Apax Funds
Nominees Limited, Warburg, Pincus Ventures, L.P. and Gold
& Appel Transfer S.A. and Walter Anderson;
(E) "Offer":
(1) means any offer or offers that may be made by
or on behalf of GTS to acquire:
(a) the whole of the share capital of
Esprit in issue at the date on
which the Offer is made (including
any securities in Esprit
attributable to or derived from
such share capital, but excluding
any such share capital owned on
such date by GTS or any subsidiary
of GTS); and
(b) any share capital of Esprit
allotted while the Offer remains
open for acceptance or before such
earlier date as GTS may determine
whether pursuant to the exercise of
conversion or subscription rights
or otherwise; and
(2) extends to any new, increased, extended or
revised offer or offers by or on behalf of
GTS, provided that in any such case the terms
2
<PAGE> 4
of such offer or offers are, in the opinion of
Bear Stearns, with the agreement of Esprit's
financial advisers, appointed for the purposes
of Rule 3 of the City Code provided such
agreement is not unreasonably withheld or
delayed (but without hereby creating any duty
of care owed by Bear Stearns, except to GTS or
by Esprit's financial advisers, except to
Esprit) no less favourable to shareholders of
Esprit than the terms set out in the Press
Announcement or the Offer Document;
(F) references to the share capital of Esprit include that
represented by ADSs; and
(G) save as referred to above words defined in the Press
Announcement have the same meanings herein.
3. RELEASE OF PRESS ANNOUNCEMENT
We irrevocably consent to the issue of the Press Announcement incorporating
references to us and to this undertaking subject to any amendments which may be
agreed with us or Esprit's financial advisers. We also consent to the issue of
the Offer Document, incorporating references to us, and to this undertaking,
substantially similar to those references contained in the Press Announcement.
We understand that this irrevocable undertaking will be made available for
public inspection.
4. UNDERTAKINGS
In consideration of GTS agreeing to make the Offer in all material respects on
the terms and subject to the conditions referred to in the Press Announcement,
we hereby irrevocably undertake to GTS as follows:-
(A) we shall accept or procure acceptance of the Offer in
accordance with its terms in respect of all the Esprit
Shares by not later than the Acceptance Date and shall
forward or procure that there is forwarded, with such
acceptance, the share certificates or other documents of
title in respect of the Esprit Shares in accordance with
the terms of the Offer;
(B) the Esprit Shares will be acquired by GTS fully paid and
free from all liens, equities, charges, encumbrances and
other interests and together with all rights now or
hereafter attaching thereto, including the right to
receive and retain all dividends and other distributions
declared, made or paid hereafter;
(C) notwithstanding that we may be or become entitled to
withdraw our acceptance(s) of the Offer by virtue of any
term of the Offer or the rules of the City Code or any
provision of the securities laws or regulations of the US
or otherwise, we shall not withdraw our acceptance(s) and
shall
3
<PAGE> 5
procure that our acceptance(s) is not withdrawn in
respect of all or any of the Esprit Shares;
(D) save as required by paragraph 4(A) or in this paragraph
4(D), we shall not prior to the lapsing or withdrawal of
the Offer, conditionally or unconditionally, sell,
transfer, charge, pledge or grant any option over or
otherwise dispose of or permit the sale or other
disposition of all or any of the Esprit Shares or any
interest held by us in any of the Esprit Shares save that
we may transfer or otherwise dispose of all or some of
our Esprit Shares provided that:
(1) prior to such transfer or disposition Esprit
shall have received the advice of its
independent auditors and GTS shall have
received the advice of its independent
auditors that such transfer or disposition
would not prevent the transactions
contemplated by the Offer from receiving
"pooling of interests" treatment for financial
accounting purposes;
(2) such transfer or disposition would not delay
the Offer becoming wholly unconditional by
more than 10 days or beyond the 60th day after
posting of the Offer Document, or if earlier,
the last date by which the Offer can become
wholly unconditional;
(3) before such transfer or disposition the
transferee of such Esprit Shares shall have
executed an irrevocable undertaking for no
consideration and under seal in a form
substantially similar to this Irrevocable
Undertaking together with a legal opinion in
respect thereof as to due execution and
enforceability in a form reasonably
satisfactory to GTS;
(4) such transferee has been advised by Esprit's
financial advisers that the transfer or
disposition would not violate the provisions
of the Code;
(5) such transferee is (i) not listed on Schedule
1 hereto; and (ii) immediately prior to such
transfer does not own more than one per cent
of the outstanding GTS Shares; and
(6) we have consulted with GTS (in a way which
does not oblige GTS to make a public
announcement - provided that if GTS is obliged
to disclose as a result of such disclosure
this shall not be a breach of this provision
by us) with respect to the timing of such sale
or disposition to mitigate any adverse effect
such sale or disposition would have on the
market price of GTS Shares;
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<PAGE> 6
(E) we shall not prior to the lapsing or withdrawal of the
Offer without the prior written consent of GTS purchase
or otherwise acquire any shares in Esprit or any interest
therein or agree to do so whether conditionally or
unconditionally;
(F) we shall procure that, save pursuant to this undertaking,
unless and until the Offer shall have lapsed or shall
have been withdrawn, no other agreement or arrangement
(including any undertaking) shall be entered into (other
than with GTS) which could result in the disposal of, or
the creation or existence of any encumbrance on, all or
any of the Esprit Shares or any interest therein or which
might in any way restrict the disposal of the Esprit
Shares or any of them and no other offer shall be
accepted in respect of the Esprit Shares or any of them
(whether it is conditional or unconditional and
irrespective of the means by which it is to be
implemented);
(G) we shall not, prior to the issue of the Press
Announcement without the prior written consent of GTS,
disclose or announce to any person the fact that
discussions or negotiations are taking or have taken
place concerning the Offer save as (and then only to the
extent) required by any law, the rules of NASDAQ or
EASDAQ or the City Code or the Panel or pursuant to any
enquiry by a governmental, official or regulatory body
having jurisdiction provided that, in such circumstances,
we shall advise GTS prior to any such disclosure or
announcement so that GTS has an opportunity to seek to
control the timing and manner of such disclosure;
(H) subject to paragraph 4(D), at all times after the date
hereof and until the Offer shall have lapsed or been
withdrawn, we shall refrain from knowingly taking any
action or making any statement which is or may be
prejudicial to the success of the Offer, including,
without limitation:
(1) soliciting procuring, initiating or engaging
in, directly or indirectly, any discussions or
negotiations with any third party, involving
any other offer by any third party for all or
any part of the issued share capital of Esprit
or involving the acquisition outside the
ordinary course of business (as carried on to
the date hereof) of or any business
combination involving Esprit or any of its
subsidiaries or any material part of the
shares or assets of Esprit or any of its
subsidiaries or in each case any interest
therein ("each a Esprit Transaction");
(2) entering into discussions or negotiations
with, or (save as required by Rule 20.2 of the
City Code in which case only that information
strictly required to be provided shall be
disclosed and on the basis of an undertaking
as to confidentiality substantially similar to
that given by GTS) providing any information
to any
5
<PAGE> 7
person in relation to, or facilitating or
cooperating with in any way, any Esprit
Transaction; or
(3) communicating with any person in relation to
or discussing with any person the terms of the
Offer or any matter relating thereto without
the prior written consent of GTS provided that
this shall not apply to any communications or
discussions with our or Esprit's professional
advisers who appreciate the need for
requirements as to confidentiality in relation
to the Offer or to communications or
discussions limited to information set out in
the Press Announcement or any other document
or announcement published with the consent of
GTS in connection with the Offer;
(I) we shall inform GTS immediately:
(1) if we receive an approach from any person in
relation to a Esprit Transaction save to the
extent bound by any existing duty of
confidentiality;
(2) if we are asked to, or do, provide any
information to any person with a view to any
person investigating or entering into a Esprit
Transaction save to the extent bound by any
existing duty of confidentiality; or
(3) if we become aware of any material breach of
the provisions of this undertaking;
and in the case of (1) and (2) above, we shall provide
reasonable details as to the identity of any relevant
person and the terms and conditions of any proposal or
details of any information requested or provided, and in
the case of (3) above, shall provide reasonable details
of the relevant breach;
(J) we are not in discussions with any third party in
relation to any Esprit Transaction;
(K) we will procure for GTS all necessary information
regarding us and our interests and those of the funds on
whose behalf we hold the Esprit Shares as nominee, in the
share capital of Esprit which is required to be contained
in the Offer Document in order to comply with the
requirements of the City Code, US securities law or any
other applicable law or regulation;
(L) we shall not prior to the date the Offer becomes wholly
unconditional or lapses or is withdrawn, transfer,
dispose of, grant rights over or in any way charge, or
otherwise deal in or enter into any agreement,
arrangement or undertaking (conditional or unconditional)
to transfer, dispose of grant
6
<PAGE> 8
rights over or in any way charge, or otherwise deal in
any GTS Shares or any interest therein or any derivative
referenced thereto or any security convertible into GTS
Shares (subject to paragraph 4(D)).
5. WARRANTIES
5.1 We hereby further undertake warrant and represent to GTS as follows:
(A) we are the registered holder of the Esprit Shares (other
than those represented by ADSs) and the owner of the
Esprit Shares represented by ADSs and the Esprit Shares
are free from all liens, charges or encumbrances. There
are no other ordinary shares in Esprit registered in our
name or beneficially owned, or managed and controlled by
us, or in which we have an interest and we have no
rights, warrants or options to acquire or subscribe for
ordinary shares in Esprit or any interest therein save as
specified in columns 3 and 4 of Schedule 1;
(B) save pursuant to this undertaking we have not agreed,
conditionally or otherwise, to dispose of all or any of
the Esprit Shares or any interest therein and have (and,
upon the Offer being made, will continue to have) all
necessary authority to enter into this undertaking and
accept or procure acceptance of the Offer in respect of
the Esprit Shares;
(C) at the time we are obliged to accept the Offer pursuant
to paragraph 4 (A) we will have the right to transfer the
Esprit Shares with all rights attaching to them as
envisaged by the terms of the Offer.
6. VOTING RIGHTS
We hereby further irrevocably undertake, represent, warrant and agree to and
with GTS that, until the Offer shall have closed, lapsed or been withdrawn we
shall exercise or procure the exercise of the voting rights attached to the
Esprit Shares as instructed by GTS on any resolution to enable the Offer to
become unconditional if it were passed or rejected at a general or separate
class meeting of Esprit.
7. GTS MAC
(A) If at any time before the Acceptance Date we become aware
of an event which could or might reasonably be expected
to give rise to a GTS MAC we shall immediately serve
notice on GTS providing full details of the event,
misleading statement, misrepresentation or omission
alleged to be expected to give rise to the GTS MAC ("the
MAC Notice"). We shall also serve a copy of the MAC
Notice on the other Majority Shareholders and Esprit. Not
more than one MAC Notice may be served in respect of any
individual event, and in the event that more than one
Majority Shareholder serves a MAC Notice in respect of
the same event, only the
7
<PAGE> 9
first to be received by GTS will be valid. In no event
shall a Majority Shareholder have the right to serve a
MAC Notice more than 10 US Business Days after it becomes
aware of an event which could or might reasonably be
expected to give rise to the GTS MAC to which such MAC
Notice relates or after the Acceptance Date. For the
purposes of this paragraph we shall be deemed to be aware
of the contents of all public filings made by GTS. GTS
shall provide copies to us immediately following filing
of any such filings made by GTS from the date hereof
until the Acceptance Date. No MAC Notice may in any event
be served later than 8 US Business Days before the date
referred to in paragraph 12(E).
(B) As soon as practicable after the service of the MAC
Notice, and in any event within two US Business Days,
each of ourselves and GTS will appoint an investment
banking firm of international repute to act as an
appraiser ("the Appraiser"). Each of ourselves and GTS
will use their best endeavours to ensure that the
Appraisers shall make an appraisal as to whether a GTS
MAC has occurred and shall notify ourselves and GTS of
their decision within three US Business Days of their
appointment. If the Appraisers agree with each other they
shall immediately notify the Majority Shareholders and
GTS.
(C) If the Appraisers are unable to agree between themselves
whether a GTS MAC has occurred, we and GTS will use our
best endeavours to procure that the two Appraisers select
a third bank with similar qualifications ("the Referee")
which shall make its determination as to whether a GTS
MAC has occurred and shall notify ourselves and GTS of
their decision within three US Business Days after its
selection. If our respective Appraisers fail to agree
upon the appointment of the Referee either we or GTS may
refer the matter to the President for the time being of
the Law Society of England and Wales who shall promptly
appoint the Referee.
(D) Each of ourselves and GTS will have all reasonable
opportunity of making oral and written representations to
each Appraiser and to the Referee in enabling them to
reach their determinations. The Appraisers and the
Referee shall act as experts and not as arbitrators and,
absent fraud or manifest error, the determination of the
Appraisers and the Referee hereunder will be binding upon
ourselves and GTS.
(E) If it is determined under sub-paragraph (B) or (C) that a
GTS MAC has occurred then the provisions of paragraph 12
will apply. The determination of whether a GTS MAC has or
has not occurred can be relied upon by GTS and all the
Majority Shareholders.
(F) Each of ourselves and GTS recognise that the provisions
of this paragraph involve the co-operation of third
parties. Each of ourselves and GTS agree to use our
respective best endeavours to ensure that such third
parties co-
8
<PAGE> 10
operate in order to determine, within the time frame
described in this paragraph, whether a GTS MAC has
occurred. If it is not practicable to determine whether a
GTS MAC has occurred within that time frame, the parties
shall nevertheless use their best endeavours to ensure
that the question is determined as soon as possible
thereafter, and in any event before the day ("the Last
Acceptance Date") which is two US Business Days and UK
Business Days before the last date the Offer is capable
of becoming wholly unconditional.
(G) If it is not determined by the Last Acceptance Date that
a GTS MAC has occurred we and GTS agree that we will
jointly request the Panel (and request the directors of
Esprit to assist us in this respect) to extend the last
date that the Offer may become wholly unconditional to a
date not later than 81 days after the posting of the
Offer Document. If the determination that no GTS MAC has
occurred does not take place until such date, then the
Acceptance Date shall be extended to 1.00 p.m. on such
date.
8. LAW AND JURISDICTION
(A) This undertaking is governed by, and construed in
accordance with, English law.
(B) In relation to any legal action or proceedings to enforce
this undertaking or arising out of or in connection with
this undertaking ("Proceedings") we irrevocably submit to
the jurisdiction of the English courts and waive any
objection to Proceedings in such courts on the grounds of
venue or on the grounds that the Proceedings have been
brought in an inconvenient forum.
(C) We hereby appoint E. M. Warburg, Pincus & Co.
International Ltd. of 28 King Street, St. James, London
SW1Y 6QW as my process agent to receive on our behalf
service of process in any proceedings in England. Service
upon the process agent shall be good service upon us
whether or not it is forwarded to and received by us. If
for any reason the process agent ceases to be able to act
as process agent, or no longer has an address in England,
we irrevocably agree to appoint a substitute process
agent with an address in England acceptable to GTS and to
deliver to GTS a copy of the substitute process agent's
acceptance of that appointment within seven days. In the
event that we fail to appoint a substitute process agent,
it shall be effective service for GTS to serve the
process upon the last known address in England of our
last known process agent notified to GTS, notwithstanding
that such process agent is no longer found at such
address or has ceased to act.
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<PAGE> 11
9. NOMINEES
In the case where the Esprit Shares are registered in the name of a nominee, we
shall direct the nominee to act as if the nominee were bound by the terms of
this irrevocable undertaking and we shall procure that such nominee does all
acts and things necessary to carry the terms hereof into effect as if we had
been the registered holder of the Esprit Shares registered in the name of such
nominee.
10. CONDITIONS
Notwithstanding any other provision hereof, this irrevocable undertaking and
GTS's obligation to make the Offer, are conditional upon:
(A) the release of the Press Announcement at or before 9a.m.
on 8 December 1998; and
(B) irrevocable undertakings, in a form acceptable to GTS,
being received in respect of not less than 50.1 per cent.
of the issued ordinary shares of Esprit prior to the
release of the Press Announcement.
If these conditions shall not have been satisfied by such time and date this
irrevocable undertaking shall automatically lapse and be of no further force or
effect and no party hereto shall have any claim against the other save in
respect of any antecedent breach of its terms.
11. MISCELLANEOUS
(A) We acknowledge that we are not entering into this
undertaking in reliance upon any representation, warranty
or undertaking save as expressly set out herein and, in
the absence of fraud, we shall have no claim or remedy
against GTS or Esprit in respect of any
misrepresentation, untrue statement, omission or
non-disclosure. In particular, our undertakings pursuant
to paragraph 4 shall be irrevocable and, in the absence
of fraud, shall not be capable of rescission or
termination on the basis of any information subsequently
disclosed by GTS or Esprit in any offer document, listing
particulars or registration statement or for any other
reason whatsoever including (without limitation) any
failure by all or any of the directors of Esprit to
recommend the Offer or to continue to recommend the Offer
after the date of this undertaking.
(B) No failure or delay by GTS in exercising any right, power
or privilege hereunder shall operate as a waiver thereof,
nor shall any single or partial exercise thereof preclude
any other or further exercise of any right, power or
privilege hereunder. We agree that any breach of this
Undertaking is likely to cause substantial harm to GTS
and that money damages would not be a sufficient remedy
for any breach of this Undertaking and that
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<PAGE> 12
GTS will be entitled to specific performance and
injunctive relief as remedies for any such breach. Such
remedies shall not be deemed to be the exclusive remedies
for a breach of this Undertaking but shall be in addition
to all other remedies available at law or equity.
12. LAPSING
This irrevocable undertaking shall automatically lapse and be of no further
force or effect and no party hereto shall have any claim against the other save
in respect of any antecedent breach of its terms in the event that:
(A) precondition (A) to the Offer set out in Paragraph 1 of
Appendix 1 of the Press Announcement (relating to the
Esprit Bonds) shall not have been satisfied or waived on
or before 29 January 1999;
(B) the Offer Document is not despatched on or before 15
April 1999; or in the event that a MAC Notice is served
before the despatch of the Offer Document, the date
falling 10 US Business Days after determination that a
GTS MAC has not occurred (if later);
(C) GTS announces that any of the pre-conditions of the Offer
set out in Paragraph 1 of Appendix 1 to the Press
Announcement has not been satisfied and that it has not
been and will not be waived;
(D) it is determined that a GTS MAC has occurred; or
(E) the Offer is not declared wholly unconditional on or
before the 60th day after the Offer document is
despatched (or, if later, the date to which the Initial
Offer Period is extended pursuant to paragraph 7(G)).
13. EXECUTION
This undertaking may be executed in more than one part.
Yours faithfully,
EXECUTED AS A DEED ) ROBERTO ITALIA for and on behalf of
by WARBURG, PINCUS ) Dominic Shorthouse
VENTURES, L.P. ) Member
by )
)
11
<PAGE> 13
Witness' signature MATHEW F. HERMAN
Witness' name Mathew F. Herman
Witness' address 64 Holland Park London W11
--------------------------
Witness' occupation Attorney
We agree and accept the terms of this undertaking.
GERALD THAMES
For Global TeleSystems Group, Inc.
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<PAGE> 14
SCHEDULE 1
The following represents our shareholding in Esprit:
<TABLE>
<CAPTION>
Column 1 Column 2 Column 3 Column 4 Column 5
- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C>
Registered Beneficial Number of Number of Number of
Holder Owner Ordinary ADSs Ordinary
Shares Shares subject
to options,
warrants or
rights to
acquire or
subscribe
Warburg, Investors in the 15,442,150 nil nil
Pincus relevant
Ventures, L.P. Warburg
Pincus funds
</TABLE>
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<PAGE> 15
SCHEDULE 2
The Shareholder agrees not to transfer or dispose of any of its Shares to any of
the following persons or any of their respective affiliates:
Viatel Inc.
RSL Communications, Ltd.
Colt Telecom Group plc
Rupert Murdoch
PLD Telekom Inc.
Belgacom S.A.
Com Belga
Systema
WorldPort Communications, Inc.
Deutsche Telekom A.G.
France Telecom
British Telecommunications plc
Telecom Italia SpA
Telia AB
Koninklijke KPN NV
Telefonica de Spana, S.A.
ATT Corp.
MCI Worldcom Inc
Sprint Corp.
Global One
Qwest Communications International Inc.
Cable & Wireless Communications plc.
Energis plc
Equant NV
Global Crossing Ltd.
Metromedia Fiber Network Inc.
Teleglobe Inc.
14
<PAGE> 1
EXHIBIT 2.6
IRREVOCABLE
UNDERTAKING
by
Sir Robin Biggam
Strictly Private & Confidential
SIMMONS & SIMMONS
21 Wilson Street London EC2M 2TX
Tel: 0171-628 2020 / 528 9292 Fax: 0171-628 2070 DX Box No 12
<PAGE> 2
To: Global TeleSystems Group, Inc.
("GTS")
1751 Pinnacle Drive
North Tower 12th Floor
McLean VA 22102
United States of America
From: Sir Robin Biggam
Streatley House
Streatley
Bedfordshire LU3 3PS
United Kingdom
8 December 1998
Dear Sirs,
1. THE OFFER
I refer to the press announcement in the form of the draft attached hereto (the
"Press Announcement") setting out the terms and conditions upon which Bear
Stearns will, on behalf of GTS, make an offer (the "Offer") to acquire the whole
of the issued and to be issued share capital of Esprit Telecom Group plc
("Esprit") excluding any such share capital owned by GTS or any subsidiary of
GTS on the date that the Offer is made.
2. DEFINITIONS
In this letter, unless the context otherwise requires:
(A) "Offer":
(1) means any offer or offers that may be made by
or on behalf of GTS to acquire:
(a) the whole of the share capital of
Esprit in issue at the date on
which the Offer is made (including
any securities in Esprit
attributable to or derived from
such share capital, but excluding
any such share capital owned on
such date by GTS or any subsidiary
of GTS); and
(b) any share capital of Esprit
allotted while the Offer remains
open for acceptance or before such
earlier date as GTS may determine
whether pursuant to the exercise of
conversion or subscription rights
or otherwise; and
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<PAGE> 3
(2) extends to any new, increased, extended or
revised offer or offers by or on behalf of
GTS, provided that in any such case the terms
of such offer or offers are, in the opinion of
Bear Stearns, with the agreement of Esprit's
financial advisers appointed for the purposes
of Rule 3 of the City Code provided such
agreement is not unreasonably withheld or
delayed (but without hereby creating any duty
of care owed by Bear Stearns, except to GTS or
by Esprit's financial advisers, except to
Esprit) no less favourable to shareholders of
Esprit than the terms set out in the Press
Announcement or the Offer Document;
(B) "Options" means the options to subscribe ordinary shares
of 1p each in Esprit held by me shown in Schedule 1; and
(C) save as referred to above words defined in the Press
Announcement have the same meanings herein.
3. RELEASE OF PRESS ANNOUNCEMENT
I irrevocably consent to the issue of the Press Announcement incorporating
references to me and to this undertaking subject to any amendments which may be
agreed between GTS and Esprit or Esprit's financial advisers. I also consent to
the issue of the Offer Document, incorporating references to me, and to this
undertaking, substantially similar to those references contained in the Press
Announcement. I understand that this irrevocable undertaking will be made
available for public inspection.
4. DIRECTOR'S UNDERTAKINGS
In consideration of GTS agreeing to make the Offer in all material respects on
the terms and subject to the conditions referred to in the Press Announcement, I
hereby irrevocably undertake to GTS as follows:
(A) to the extent that my Options may be exercisable and I
exercise my Options, I shall accept the Offer in
accordance with its terms in respect of all my resulting
Esprit Shares and shall forward or procure that there is
forwarded, with such acceptance, the certificates or
other documents of title in respect of my Esprit Shares
in accordance with the terms of the Offer;
(B) save as required by paragraph 4(A), and save with the
prior written consent of GTS (not to be unreasonably
withheld or delayed) I shall not prior to the lapsing or
withdrawal of the Offer, conditionally or
unconditionally, sell, transfer, charge, pledge or grant
any option over or otherwise dispose of or permit the
sale or other disposition of all or any of my Options or
any interest in any of my Options;
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<PAGE> 4
(C) otherwise than pursuant to the exercise of my Options I
shall not prior to the lapsing or withdrawal of the Offer
without the prior written consent of GTS purchase or
otherwise acquire any shares in Esprit or any interest
therein or agree to do so whether conditionally or
unconditionally;
(D) I shall procure that, save pursuant to this undertaking,
unless and until the date the Offer shall have lapsed or
shall have been withdrawn, no other agreement or
arrangement (including any undertaking) shall be entered
into (other than with GTS) which could result in the
disposal of, or the creation or existence of any
encumbrance on, all or any of my Options or any interest
therein or which might in any way restrict the disposal
of my Options or any of them and no other offer shall be
accepted in respect of my Options or any of them (whether
it is conditional or unconditional and irrespective of
the means by which it is to be implemented);
(E) I shall not, prior to the issue of the Press
Announcement, without the prior written consent of GTS,
disclose or announce to any person the fact that
discussions or negotiations are taking or have taken
place concerning the Offer save as (and then only to the
extent) required by any law, the rules of NASDAQ or
EASDAQ or the City Code or the Panel or pursuant to any
enquiry by a governmental, official or regulatory body
having jurisdiction provided that, in such circumstances,
I shall where practicable advise GTS prior to any such
disclosure or announcement so that GTS has an opportunity
to seek to control the timing and manner of such
disclosure;
(F) at all times after the date hereof and until the Offer
shall have lapsed or been withdrawn, I shall refrain
from:
(1) soliciting, procuring or initiating; or
(2) (subject to my fiduciary duties as a director
of Esprit), engaging in
directly or indirectly, any discussions or negotiations
with any third party, involving any other offer by any
third party for all or any part of the issued share
capital of Esprit or involving the acquisition outside
the ordinary course of business (as carried on to the
date hereof) of, or any business combination involving,
Esprit or any of its subsidiaries or any material part of
the shares or business undertaking or assets of Esprit or
any of its subsidiaries or in each case any interest
therein (each "an Esprit Transaction");
(G) at all times from the date hereof until the Offer shall
have lapsed or been withdrawn, I shall, so far as is
consistent with my fiduciary duties as a director of
Esprit and my duties under the City Code, refrain from:
3
<PAGE> 5
(1) (save as required by Rule 20.2 of the City
Code in which case only that information
strictly required to be provided shall be
disclosed and only on the basis of an
undertaking as to confidentiality
substantially similar to that given by GTS)
providing any information to any person in
relation to, or facilitating or cooperating
with in any way, any Esprit Transaction; or
(2) communicating with any person in relation to
or discussing with any person the terms of the
Offer or any matter relating thereto without
the prior consent of GTS provided that this
shall not apply to any communications or
discussions with my or Esprit's professional
advisers who appreciate the need for
requirements as to confidentiality in relation
to the Offer or to communications or
discussions limited to information set out in
the Press Announcement or any other document
or announcement published with the consent of
GTS in connection with the Offer or otherwise
in the public domain;
(H) I am not currently in discussion with any person (other
than GTS) in relation to any Esprit Transaction;
(I) I will provide such information and do such acts as may
be reasonably necessary to prepare and expedite the
posting of the Offer Document and, in particular, but
without prejudice to the generality of the foregoing:
(1) will provide all reasonable assistance to GTS
as may be required to satisfy the
pre-conditions to the posting of the Offer
Document and the conditions of the Offer;
(2) will cooperate with GTS in seeking any
extension of the Initial Offer Period pursuant
to paragraph 7(G) of the Shareholders'
Undertakings and otherwise will agree to any
extension of time limits in the City Code
which GTS requests (unless it is acting
unreasonably) and which the Panel approves;
and
(3) will use all my reasonable efforts to provide
for GTS all necessary information regarding
Esprit and its subsidiaries and my interests
in the share capital of Esprit and options
over such share capital which is required to
be contained therein in order to comply with
the requirements of the City Code, US
Securities Law or any other applicable law or
regulation;
(4) in so far as I am involved in the management
of Esprit, I will make myself available to the
extent reasonably necessary to facilitate the
successful completion of the Offer and (to the
extent
4
<PAGE> 6
agreed) the refinancing or amendment of the
existing financing facilities of Esprit
including participation in meetings with
investors and shareholders;
(J) I will join with the other directors of Esprit in making
in the Offer Document a statement of responsibility in
the terms or to the effect required by the City Code
(subject to any variation agreed by the Panel) or by any
applicable law or regulation;
(K) so far as is consistent with my duties or obligations
under the City Code and with my fiduciary duties as a
director of Esprit I will (together with the other
directors of Esprit) recommend to all the shareholders in
Esprit that they should accept the Offer and will agree
to a statement substantially in the terms set out in the
paragraph headed "Recommendation" in the Press
Announcement being included in the Offer Document;
(L) I will, on the Offer becoming unconditional (so far as is
consistent with my fiduciary duties as a director of
Esprit) join with the other members of the board of
Esprit in appointing any persons nominated by GTS to the
board of Esprit and its subsidiaries and in approving
alternate directors nominated by such newly appointed
directors;
(M) I shall not prior to the date the Offer becomes wholly
unconditional or lapses or is withdrawn or transfer,
dispose of grant rights over or in any way charge, or
otherwise deal in or enter into any agreement,
arrangement or undertaking (conditional or unconditional)
to transfer, dispose of grant rights over or in any way
charge, or otherwise deal in any GTS Shares or any
interest therein or any derivative referenced thereto or
any security convertible into GTS Shares; and
(N) in so far as I hold Options, I confirm that it is my
current intention, subject to my receiving satisfactory
tax advice (and to the extent that I have not then
exercised my Options), to accept the Rollover Offer in
respect of my remaining Options.
5. DIRECTOR'S FURTHER UNDERTAKINGS
5.1 I hereby further undertake to GTS as follows:
(A) there are no ordinary shares in Esprit registered in my
name or beneficially owned, or managed and controlled by
me, or in which I have an interest and I have no rights,
warrants or options to acquire or subscribe for ordinary
shares in Esprit or any interest therein save as
specified in Schedule 1;
5
<PAGE> 7
(B) save pursuant to this undertaking I have not agreed,
conditionally or otherwise, to dispose of all or any of
my Options or any interest therein and have (and, upon
the Rollover Offer being made, will continue to have) all
necessary authority to enter into this undertaking and
accept or procure acceptance of the Rollover Offer in
respect of my Options;
(C) save for any regular emoluments and expenses payable
pursuant to my engagement as a director or employee of
Esprit there is not outstanding any indebtedness or other
liability (actual or contingent) (other than any claim
for indemnity I may have under the articles of
association of Esprit) owing by any member of the Esprit
Group to me, nor is there any indebtedness owing to any
member of the Esprit Group by me; and
(D) save for the terms of my engagement as a director or
employee of Esprit which have been disclosed in writing
to GTS I have not entered into any agreement,
undertaking, instrument or arrangement with any member of
the Esprit Group.
5.2 Save, in respect of paragraph 5.1(A), for any exercise of Options
following which the resulting shares are assented to the Offer in
accordance with paragraph 4(A) and further, in respect of paragraph
5.1(B) any regular emoluments and expenses referred to therein, I
shall procure that (save as may be necessary to give effect to this
undertaking) I shall not allow nor shall I do or procure any act or
omission before the date the Offer becomes wholly unconditional
which would constitute a breach of any of the above undertakings if
they were given at any and all times from the date hereof down to
the date the Offer becomes wholly unconditional, or which would make
any of the above undertakings inaccurate or misleading if they were
so given.
6. LAW AND JURISDICTION
(A) This undertaking is governed by, and construed in
accordance with, English law.
(B) In relation to any legal action or proceedings to enforce
this undertaking or arising out of or in connection with
this undertaking ("Proceedings") I irrevocably submit to
the jurisdiction of the English courts and waive any
objection to Proceedings in such courts on the grounds of
venue or on the grounds that the Proceedings have been
brought in an inconvenient forum.
7. CONDITIONS
Notwithstanding any other provision hereof, this irrevocable undertaking and
GTS's obligation to make the Offer, are conditional upon:
6
<PAGE> 8
(A) the release of the Press Announcement at or before 9 a.m
on 8 December 1998; and
(B) irrevocable undertakings, in a form acceptable to GTS,
being received in respect of not less than 50.1 per cent.
of the issued ordinary shares of Esprit prior to the
release of the Press Announcement.
If these conditions shall not have been satisfied by such time and date this
irrevocable undertaking shall automatically lapse and be of no further force or
effect and no party hereto shall have any claim against the other save in
respect of any antecedent breach of its terms.
8. MISCELLANEOUS
(A) My undertakings pursuant to paragraph 4 shall be
irrevocable and, in the absence of fraud, shall not be
capable of rescission or termination on the basis of any
information subsequently disclosed by GTS or Esprit in
any offer document, listing particulars or registration
statement or for any other reason whatsoever including
(without limitation) any failure by all or any of the
directors of Esprit to recommend the Offer or to continue
to recommend the Offer after the date of this
Undertaking.
(B) No failure or delay by GTS in exercising any right, power
or privilege hereunder shall operate as a waiver thereof,
nor shall any single or partial exercise thereof preclude
any other or further exercise of any right, power or
privilege hereunder. I agree that any breach of this
Undertaking is likely to cause substantial harm to GTS
and that money damages would not be a sufficient remedy
for any breach of this Undertaking and that GTS will be
entitled to specific performance and injunctive relief as
remedies for any such breach. Such remedies shall not be
deemed to be the exclusive remedies for a breach of this
Undertaking but shall be in addition to all other
remedies available at law or equity.
9. LAPSING
This irrevocable undertaking shall automatically lapse and be of no further
force or effect and no party hereto shall have any claim against the other save
in respect of any antecedent breach of its terms, in the event that:
(A) precondition (A) to the Offer set out in Paragraph 1 of
Appendix 1 of the Press Announcement (relating to the
Esprit Bonds) shall not have been satisfied or waived on
or before 29 January 1999;
(B) the Offer Document is not despatched on or before 15
April 1999; or
7
<PAGE> 9
(C) GTS announces that any of the pre-conditions of the Offer
set out in Paragraph 1 of Appendix 1 to the Press
Announcement has not been satisfied and that it has not
been and will not be waived; or
(D) the Offer is not declared wholly unconditional on or
before the 60th day after the Offer Document is
despatched or, if later, the date to which the Initial
Offer Period is extended pursuant to paragraph 7(G) of
the Shareholders' Undertakings; or
(E) I cease to be a director of Esprit.
10. EXECUTION
This undertaking may be executed in more than one part.
Yours faithfully,
SIGNED and DELIVERED
as a Deed by SIR ROBIN BIGGAM DAVID OERTLE
(as attorney for Sir Robin Biggam)
in the presence of:
Witness' signature:J CHAMBERS
Witness' name:J. Chambers
Witness' address: 20 Blackfriars Lane, London EC4V 6HB
Witness' occupation: Solicitor
We agree and accept the terms of this undertaking.
GERALD THAMES
For and on behalf of
GLOBAL TELESYSTEMS GROUP, INC.
8
<PAGE> 10
SCHEDULE 1
The following represents my shares subject to options, warrants or rights to
acquire or subscribe in Esprit:
Number of Ordinary Shares subject to options, warrants or rights to acquire or
subscribe
nil
9
<PAGE> 1
EXHIBIT 2.7
IRREVOCABLE
UNDERTAKING
by
John McMonigall
Strictly Private & Confidential
SIMMONS & SIMMONS
21 Wilson Street London EC2M 2TX
Tel: 0171-628 2020 / 528 9292 Fax: 0171-628 2070 DX Box No 12
<PAGE> 2
To: Global TeleSystems Group, Inc.
("GTS")
1751 Pinnacle Drive
North Tower 12th Floor
McLean VA 22102
United States of America
From: John McMonigall
"Murrell"
Totters Lane
Murrell Green
Hook
Hampshire RG27 8HX
8 December 1998
Dear Sirs,
1. THE OFFER
I refer to the press announcement in the form of the draft attached hereto (the
"Press Announcement") setting out the terms and conditions upon which Bear
Stearns will, on behalf of GTS, make an offer (the "Offer") to acquire the whole
of the issued and to be issued share capital of Esprit Telecom Group plc
("Esprit") excluding any such share capital owned by GTS or any subsidiary of
GTS on the date that the Offer is made.
2. DEFINITIONS
In this letter, unless the context otherwise requires:
(A) "Offer":
(1) means any offer or offers that may be made by
or on behalf of GTS to acquire:
(a) the whole of the share capital of
Esprit in issue at the date on
which the Offer is made (including
any securities in Esprit
attributable to or derived from
such share capital, but excluding
any such share capital owned on
such date by GTS or any subsidiary
of GTS); and
(b) any share capital of Esprit
allotted while the Offer remains
open for acceptance or before such
earlier date as GTS may determine
whether pursuant to the exercise of
conversion or subscription rights
or otherwise; and
1
<PAGE> 3
(2) extends to any new, increased, extended or
revised offer or offers by or on behalf of
GTS, provided that in any such case the terms
of such offer or offers are, in the opinion of
Bear Stearns, with the agreement of Esprit's
financial advisers appointed for the purposes
of Rule 3 of the City Code provided such
agreement is not unreasonably withheld or
delayed (but without hereby creating any duty
of care owed by Bear Stearns, except to GTS or
by Esprit's financial advisers, except to
Esprit) no less favourable to shareholders of
Esprit than the terms set out in the Press
Announcement or the Offer Document;
(B) "Options" means the options to subscribe ordinary shares
of 1p each in Esprit held by me shown in Schedule 1; and
(C) save as referred to above words defined in the Press
Announcement have the same meanings herein.
3. RELEASE OF PRESS ANNOUNCEMENT
I irrevocably consent to the issue of the Press Announcement incorporating
references to me and to this undertaking subject to any amendments which may be
agreed between GTS and Esprit or Esprit's financial advisers. I also consent to
the issue of the Offer Document, incorporating references to me, and to this
undertaking, substantially similar to those references contained in the Press
Announcement. I understand that this irrevocable undertaking will be made
available for public inspection.
4. DIRECTOR'S UNDERTAKINGS
In consideration of GTS agreeing to make the Offer in all material respects on
the terms and subject to the conditions referred to in the Press Announcement, I
hereby irrevocably undertake to GTS as follows:
(A) to the extent that my Options may be exercisable and I
exercise my Options, I shall accept the Offer in
accordance with its terms in respect of all my resulting
Esprit Shares and shall forward or procure that there is
forwarded, with such acceptance, the certificates or
other documents of title in respect of my Esprit Shares
in accordance with the terms of the Offer;
(B) save as required by paragraph 4(A), and save with the
prior written consent of GTS (not to be unreasonably
withheld or delayed) I shall not prior to the lapsing or
withdrawal of the Offer, conditionally or
unconditionally, sell, transfer, charge, pledge or grant
any option over or otherwise dispose of or permit the
sale or other disposition of all or any of my Options or
any interest in any of my Options;
2
<PAGE> 4
(C) otherwise than pursuant to the exercise of my Options I
shall not prior to the lapsing or withdrawal of the Offer
without the prior written consent of GTS purchase or
otherwise acquire any shares in Esprit or any interest
therein or agree to do so whether conditionally or
unconditionally;
(D) I shall procure that, save pursuant to this undertaking,
unless and until the date the Offer shall have lapsed or
shall have been withdrawn, no other agreement or
arrangement (including any undertaking) shall be entered
into (other than with GTS) which could result in the
disposal of, or the creation or existence of any
encumbrance on, all or any of my Options or any interest
therein or which might in any way restrict the disposal
of my Options or any of them and no other offer shall be
accepted in respect of my Options or any of them (whether
it is conditional or unconditional and irrespective of
the means by which it is to be implemented);
(E) I shall not, prior to the issue of the Press
Announcement, without the prior written consent of GTS,
disclose or announce to any person the fact that
discussions or negotiations are taking or have taken
place concerning the Offer save as (and then only to the
extent) required by any law, the rules of NASDAQ or
EASDAQ or the City Code or the Panel or pursuant to any
enquiry by a governmental, official or regulatory body
having jurisdiction provided that, in such circumstances,
I shall where practicable advise GTS prior to any such
disclosure or announcement so that GTS has an opportunity
to seek to control the timing and manner of such
disclosure;
(F) at all times after the date hereof and until the Offer
shall have lapsed or been withdrawn, I shall refrain
from:
(1) soliciting, procuring or initiating; or
(2) (subject to my fiduciary duties as a director
of Esprit), engaging in
directly or indirectly, any discussions or negotiations
with any third party, involving any other offer by any
third party for all or any part of the issued share
capital of Esprit or involving the acquisition outside
the ordinary course of business (as carried on to the
date hereof) of, or any business combination involving,
Esprit or any of its subsidiaries or any material part of
the shares or business undertaking or assets of Esprit or
any of its subsidiaries or in each case any interest
therein save for any transaction specifically permitted
by paragraph 4(D) of the Shareholders Undertaking given
by Apax Funds Nominees Limited (each "an Esprit
Transaction");
3
<PAGE> 5
(G) at all times from the date hereof until the Offer shall
have lapsed or been withdrawn, I shall, so far as is
consistent with my fiduciary duties as a director of
Esprit and my duties under the City Code, refrain from:
(1) (save as required by Rule 20.2 of the City
Code in which case only that information
strictly required to be provided shall be
disclosed and only on the basis of an
undertaking as to confidentiality
substantially similar to that given by GTS)
providing any information to any person in
relation to, or facilitating or cooperating
with in any way, any Esprit Transaction; or
(2) communicating with any person in relation to
or discussing with any person the terms of the
Offer or any matter relating thereto without
the prior consent of GTS provided that this
shall not apply to any communications or
discussions with my or Esprit's professional
advisers who appreciate the need for
requirements as to confidentiality in relation
to the Offer or to communications or
discussions limited to information set out in
the Press Announcement or any other document
or announcement published with the consent of
GTS in connection with the Offer or otherwise
in the public domain;
(H) I am not currently in discussion with any person (other
than GTS) in relation to any Esprit Transaction;
(I) I will provide such information and do such acts as may
be reasonably necessary to prepare and expedite the
posting of the Offer Document and, in particular, but
without prejudice to the generality of the foregoing:
(1) will provide all reasonable assistance to GTS
as may be required to satisfy the
pre-conditions to the posting of the Offer
Document and the conditions of the Offer;
(2) will cooperate with GTS in seeking any
extension of the Initial Offer Period pursuant
to paragraph 7(G) of the Shareholders'
Undertakings and otherwise will agree to any
extension of time limits in the City Code
which GTS requests (unless it is acting
unreasonably) and which the Panel approves;
and
(3) will use all my reasonable efforts to provide
for GTS all necessary information regarding
Esprit and its subsidiaries and my interests
in the share capital of Esprit and options
over such share capital which is required to
be contained therein in order to comply with
the requirements of the City Code, US
Securities Law or any other applicable law or
regulation;
4
<PAGE> 6
(4) in so far as I am involved in the management
of Esprit, I will make myself available to the
extent reasonably necessary to facilitate the
successful completion of the Offer and (to the
extent agreed) the refinancing or amendment of
the existing financing facilities of Esprit
including participation in meetings with
investors and shareholders;
(J) I will join with the other directors of Esprit in making
in the Offer Document a statement of responsibility in
the terms or to the effect required by the City Code
(subject to any variation agreed by the Panel) or by any
applicable law or regulation;
(K) so far as is consistent with my duties or obligations
under the City Code and with my fiduciary duties as a
director of Esprit I will (together with the other
directors of Esprit) recommend to all the shareholders in
Esprit that they should accept the Offer and will agree
to a statement substantially in the terms set out in the
paragraph headed "Recommendation" in the Press
Announcement being included in the Offer Document;
(L) I will, on the Offer becoming unconditional (so far as is
consistent with my fiduciary duties as a director of
Esprit) join with the other members of the board of
Esprit in appointing any persons nominated by GTS to the
board of Esprit and its subsidiaries and in approving
alternate directors nominated by such newly appointed
directors;
(M) I shall not prior to the date the Offer becomes wholly
unconditional or lapses or is withdrawn or transfer,
dispose of grant rights over or in any way charge, or
otherwise deal in or enter into any agreement,
arrangement or undertaking (conditional or unconditional)
to transfer, dispose of grant rights over or in any way
charge, or otherwise deal in any GTS Shares or any
interest therein or any derivative referenced thereto or
any security convertible into GTS Shares; and
(N) in so far as I hold Options, I confirm that it is my
current intention, subject to my receiving satisfactory
tax advice (and to the extent that I have not then
exercised my Options), to accept the Rollover Offer in
respect of my remaining Options.
5. DIRECTOR'S FURTHER UNDERTAKINGS
5.1 I hereby further undertake to GTS as follows:
(A) there are no ordinary shares in Esprit registered in my
name or beneficially owned, or managed and controlled by
me, or in which I have an interest and I have no rights,
warrants or options to acquire or subscribe for
5
<PAGE> 7
ordinary shares in Esprit or any interest therein save as
specified in Schedule 1;
(B) save pursuant to this undertaking I have not agreed,
conditionally or otherwise, to dispose of all or any of
my Options or any interest therein and have (and, upon
the Rollover Offer being made, will continue to have) all
necessary authority to enter into this undertaking and
accept or procure acceptance of the Rollover Offer in
respect of my Options;
(C) save for any regular emoluments and expenses payable
pursuant to my engagement as a director or employee of
Esprit there is not outstanding any indebtedness or other
liability (actual or contingent) (other than any claim
for indemnity I may have under the articles of
association of Esprit) owing by any member of the Esprit
Group to me, nor is there any indebtedness owing to any
member of the Esprit Group by me; and
(D) save for the terms of my engagement as a director or
employee of Esprit which have been disclosed in writing
to GTS I have not entered into any agreement,
undertaking, instrument or arrangement with any member of
the Esprit Group.
5.2 Save, in respect of paragraph 5.1(A), for any exercise of Options
following which the resulting shares are assented to the Offer in
accordance with paragraph 4(A) and further, in respect of paragraph
5.1(B) any regular emoluments and expenses referred to therein, I
shall procure that (save as may be necessary to give effect to this
undertaking) I shall not allow nor shall I do or procure any act or
omission before the date the Offer becomes wholly unconditional
which would constitute a breach of any of the above undertakings if
they were given at any and all times from the date hereof down to
the date the Offer becomes wholly unconditional, or which would make
any of the above undertakings inaccurate or misleading if they were
so given.
6. LAW AND JURISDICTION
(A) This undertaking is governed by, and construed in
accordance with, English law.
(B) In relation to any legal action or proceedings to enforce
this undertaking or arising out of or in connection with
this undertaking ("Proceedings") I irrevocably submit to
the jurisdiction of the English courts and waive any
objection to Proceedings in such courts on the grounds of
venue or on the grounds that the Proceedings have been
brought in an inconvenient forum.
6
<PAGE> 8
7. CONDITIONS
Notwithstanding any other provision hereof, this irrevocable undertaking and
GTS's obligation to make the Offer, are conditional upon:
(A) the release of the Press Announcement at or before 9 a.m.
on 8 December 1998; and
(B) irrevocable undertakings, in a form acceptable to GTS,
being received in respect of not less than 50.1 per cent.
of the issued ordinary shares of Esprit prior to the
release of the Press Announcement.
If these conditions shall not have been satisfied by such time and date this
irrevocable undertaking shall automatically lapse and be of no further force or
effect and no party hereto shall have any claim against the other save in
respect of any antecedent breach of its terms.
8. MISCELLANEOUS
(A) My undertakings pursuant to paragraph 4 shall be
irrevocable and, in the absence of fraud, shall not be
capable of rescission or termination on the basis of any
information subsequently disclosed by GTS or Esprit in
any offer document, listing particulars or registration
statement or for any other reason whatsoever including
(without limitation) any failure by all or any of the
directors of Esprit to recommend the Offer or to continue
to recommend the Offer after the date of this
Undertaking.
(B) No failure or delay by GTS in exercising any right, power
or privilege hereunder shall operate as a waiver thereof,
nor shall any single or partial exercise thereof preclude
any other or further exercise of any right, power or
privilege hereunder. I agree that any breach of this
Undertaking is likely to cause substantial harm to GTS
and that money damages would not be a sufficient remedy
for any breach of this Undertaking and that GTS will be
entitled to specific performance and injunctive relief as
remedies for any such breach. Such remedies shall not be
deemed to be the exclusive remedies for a breach of this
Undertaking but shall be in addition to all other
remedies available at law or equity.
9. LAPSING
This irrevocable undertaking shall automatically lapse and be of no further
force or effect and no party hereto shall have any claim against the other save
in respect of any antecedent breach of its terms, in the event that:
7
<PAGE> 9
(A) precondition (A) to the Offer set out in Paragraph 1 of
Appendix 1 of the Press Announcement (relating to the
Esprit Bonds) shall not has been satisfied or waived on
or before 29 January 1999;
(B) the Offer Document is not despatched on or before 15
April 1999; or
(C) GTS announces that any of the pre-conditions of the Offer
set out in Paragraph 1 of Appendix 1 to the Press
Announcement has not been satisfied and that it has not
been and will not be waived; or
(D) the Offer is not declared wholly unconditional on or
before the 60th day after the Offer Document is
despatched or, if later, the date to which the Initial
Offer Period is extended pursuant to paragraph 7(G) of
the Shareholders' Undertakings; or
(E) I cease to be a director of Esprit.
10. EXECUTION
This undertaking may be executed in more than one part.
Yours faithfully,
SIGNED and DELIVERED
as a Deed by JOHN MCMONIGALL acting through his attorney, ANDREW BARRETT
in the presence of:
Witness' signature: TIMOTHY DRAKE
Witness' name: Timothy Drake
Witness' address: 222 Grays Inn Road, London WC1X 8HJ
Witness' occupation: Solicitor
We agree and accept the terms of this undertaking.
GERALD THAMES
For and on behalf of
GLOBAL TELESYSTEMS GROUP, INC.
8
<PAGE> 10
SCHEDULE 1
The following represents my shares subject to options, warrants or rights to
acquire or subscribe in Esprit:
Number of Ordinary Shares subject to options, warrants or rights to acquire or
subscribe
nil
9
<PAGE> 1
EXHIBIT 2.8
IRREVOCABLE
UNDERTAKING
by
Roy Merritt
Strictly Private & Confidential
SIMMONS & SIMMONS
21 Wilson Street London EC2M 2TX
Tel: 0171-628 2020 / 528 9292 Fax: 0171-628 2070 DX Box No 12
<PAGE> 2
To: Global TeleSystems Group, Inc.
("GTS")
1751 Pinnacle Drive
North Tower 12th Floor
McLean VA 22102
United States of America
From: Roy Merritt
8a Moorhouse Road
Notting Hill Gate
London W2 5DJ
United Kingdom
8 December 1998
Dear Sirs,
1. THE OFFER
I refer to the press announcement in the form of the draft attached hereto (the
"Press Announcement") setting out the terms and conditions upon which Bear
Stearns will, on behalf of GTS, make an offer (the "Offer") to acquire the whole
of the issued and to be issued share capital of Esprit Telecom Group plc
("Esprit") excluding any such share capital owned by GTS or any subsidiary of
GTS on the date that the Offer is made.
2. DEFINITIONS
In this letter, unless the context otherwise requires:
(A) "Offer":
(1) means any offer or offers that may be made by
or on behalf of GTS to acquire:
(a) the whole of the share capital of
Esprit in issue at the date on
which the Offer is made (including
any securities in Esprit
attributable to or derived from
such share capital, but excluding
any such share capital owned on
such date by GTS or any subsidiary
of GTS); and
(b) any share capital of Esprit
allotted while the Offer remains
open for acceptance or before such
earlier date as GTS may determine
whether pursuant to the exercise of
conversion or subscription rights
or otherwise; and
1
<PAGE> 3
(2) extends to any new, increased, extended or
revised offer or offers by or on behalf of
GTS, provided that in any such case the terms
of such offer or offers are, in the opinion of
Bear Stearns, with the agreement of Esprit's
financial advisers appointed for the purposes
of Rule 3 of the City Code provided such
agreement is not unreasonably withheld or
delayed (but without hereby creating any duty
of care owed by Bear Stearns, except to GTS or
by Esprit's financial advisers, except to
Esprit) no less favourable to shareholders of
Esprit than the terms set out in the Press
Announcement or the Offer Document;
(B) "Options" means the options to subscribe ordinary shares
of 1p each in Esprit held by me shown in Schedule 1; and
(C) save as referred to above words defined in the Press
Announcement have the same meanings herein.
3. RELEASE OF PRESS ANNOUNCEMENT
I irrevocably consent to the issue of the Press Announcement incorporating
references to me and to this undertaking subject to any amendments which may be
agreed between GTS and Esprit or Esprit's financial advisers. I also consent to
the issue of the Offer Document, incorporating references to me, and to this
undertaking, substantially similar to those references contained in the Press
Announcement. I understand that this irrevocable undertaking will be made
available for public inspection.
4. DIRECTOR'S UNDERTAKINGS
In consideration of GTS agreeing to make the Offer in all material respects on
the terms and subject to the conditions referred to in the Press Announcement, I
hereby irrevocably undertake to GTS as follows:
(A) to the extent that my Options may be exercisable and I
exercise my Options, I shall accept the Offer in
accordance with its terms in respect of all my resulting
Esprit Shares and shall forward or procure that there is
forwarded, with such acceptance, the certificates or
other documents of title in respect of my Esprit Shares
in accordance with the terms of the Offer;
(B) save as required by paragraph 4(A), and save with the
prior written consent of GTS (not to be unreasonably
withheld or delayed) I shall not prior to the lapsing or
withdrawal of the Offer, conditionally or
unconditionally, sell, transfer, charge, pledge or grant
any option over or otherwise dispose of or permit the
sale or other disposition of all or any of my Options or
any interest in any of my Options;
2
<PAGE> 4
(C) otherwise than pursuant to the exercise of my Options I
shall not prior to the lapsing or withdrawal of the Offer
without the prior written consent of GTS purchase or
otherwise acquire any shares in Esprit or any interest
therein or agree to do so whether conditionally or
unconditionally;
(D) I shall procure that, save pursuant to this undertaking,
unless and until the date the Offer shall have lapsed or
shall have been withdrawn, no other agreement or
arrangement (including any undertaking) shall be entered
into (other than with GTS) which could result in the
disposal of, or the creation or existence of any
encumbrance on, all or any of my Options or any interest
therein or which might in any way restrict the disposal
of my Options or any of them and no other offer shall be
accepted in respect of my Options or any of them (whether
it is conditional or unconditional and irrespective of
the means by which it is to be implemented);
(E) I shall not, prior to the issue of the Press
Announcement, without the prior written consent of GTS,
disclose or announce to any person the fact that
discussions or negotiations are taking or have taken
place concerning the Offer save as (and then only to the
extent) required by any law, the rules of NASDAQ or
EASDAQ or the City Code or the Panel or pursuant to any
enquiry by a governmental, official or regulatory body
having jurisdiction provided that, in such circumstances,
I shall where practicable advise GTS prior to any such
disclosure or announcement so that GTS has an opportunity
to seek to control the timing and manner of such
disclosure;
(F) at all times after the date hereof and until the Offer
shall have lapsed or been withdrawn, I shall refrain
from:
(1) soliciting, procuring or initiating; or
(2) (subject to my fiduciary duties as a director
of Esprit), engaging in
directly or indirectly, any discussions or negotiations
with any third party, involving any other offer by any
third party for all or any part of the issued share
capital of Esprit or involving the acquisition outside
the ordinary course of business (as carried on to the
date hereof) of, or any business combination involving,
Esprit or any of its subsidiaries or any material part of
the shares or business undertaking or assets of Esprit or
any of its subsidiaries or in each case any interest
therein (each "an Esprit Transaction");
(G) at all times from the date hereof until the Offer shall
have lapsed or been withdrawn, I shall, so far as is
consistent with my fiduciary duties as a director of
Esprit and my duties under the City Code, refrain from:
3
<PAGE> 5
(1) (save as required by Rule 20.2 of the City
Code in which case only that information
strictly required to be provided shall be
disclosed and only on the basis of an
undertaking as to confidentiality
substantially similar to that given by GTS)
providing any information to any person in
relation to, or facilitating or cooperating
with in any way, any Esprit Transaction; or
(2) communicating with any person in relation to
or discussing with any person the terms of the
Offer or any matter relating thereto without
the prior consent of GTS provided that this
shall not apply to any communications or
discussions with my or Esprit's professional
advisers who appreciate the need for
requirements as to confidentiality in relation
to the Offer or to communications or
discussions limited to information set out in
the Press Announcement or any other document
or announcement published with the consent of
GTS in connection with the Offer or otherwise
in the public domain;
(H) I am not currently in discussion with any person (other
than GTS) in relation to any Esprit Transaction;
(I) I will provide such information and do such acts as may
be reasonably necessary to prepare and expedite the
posting of the Offer Document and, in particular, but
without prejudice to the generality of the foregoing:
(1) will provide all reasonable assistance to GTS
as may be required to satisfy the
pre-conditions to the posting of the Offer
Document and the conditions of the Offer;
(2) will cooperate with GTS in seeking any
extension of the Initial Offer Period pursuant
to paragraph 7(G) of the Shareholders'
Undertakings and otherwise will agree to any
extension of time limits in the City Code
which GTS requests (unless it is acting
unreasonably) and which the Panel approves;
and
(3) will use all my reasonable efforts to provide
for GTS all necessary information regarding
Esprit and its subsidiaries and my interests
in the share capital of Esprit and options
over such share capital which is required to
be contained therein in order to comply with
the requirements of the City Code, US
Securities Law or any other applicable law or
regulation;
(4) in so far as I am involved in the management
of Esprit, I will make myself available to the
extent reasonably necessary to facilitate the
successful completion of the Offer and (to the
extent
4
<PAGE> 6
agreed) the refinancing or amendment of the
existing financing facilities of Esprit
including participation in meetings with
investors and shareholders;
(J) I will join with the other directors of Esprit in making
in the Offer Document a statement of responsibility in
the terms or to the effect required by the City Code
(subject to any variation agreed by the Panel) or by any
applicable law or regulation;
(K) so far as is consistent with my duties or obligations
under the City Code and with my fiduciary duties as a
director of Esprit I will (together with the other
directors of Esprit) recommend to all the shareholders in
Esprit that they should accept the Offer and will agree
to a statement substantially in the terms set out in the
paragraph headed "Recommendation" in the Press
Announcement being included in the Offer Document;
(L) I will, on the Offer becoming unconditional (so far as is
consistent with my fiduciary duties as a director of
Esprit) join with the other members of the board of
Esprit in appointing any persons nominated by GTS to the
board of Esprit and its subsidiaries and in approving
alternate directors nominated by such newly appointed
directors;
(M) I shall not prior to the date the Offer becomes wholly
unconditional or lapses or is withdrawn or transfer,
dispose of grant rights over or in any way charge, or
otherwise deal in or enter into any agreement,
arrangement or undertaking (conditional or unconditional)
to transfer, dispose of grant rights over or in any way
charge, or otherwise deal in any GTS Shares or any
interest therein or any derivative referenced thereto or
any security convertible into GTS Shares; and
(N) in so far as I hold Options, I confirm that it is my
current intention, subject to my receiving satisfactory
tax advice (and to the extent that I have not then
exercised my Options), to accept the Rollover Offer in
respect of my remaining Options.
5. DIRECTOR'S FURTHER UNDERTAKINGS
5.1 I hereby further undertake to GTS as follows:
(A) there are no ordinary shares in Esprit registered in my
name or beneficially owned, or managed and controlled by
me, or in which I have an interest and I have no rights,
warrants or options to acquire or subscribe for ordinary
shares in Esprit or any interest therein save as
specified in Schedule 1;
5
<PAGE> 7
(B) save pursuant to this undertaking I have not agreed,
conditionally or otherwise, to dispose of all or any of
my Options or any interest therein and have (and, upon
the Rollover Offer being made, will continue to have) all
necessary authority to enter into this undertaking and
accept or procure acceptance of the Rollover Offer in
respect of my Options;
(C) save for any regular emoluments and expenses payable
pursuant to my engagement as a director or employee of
Esprit there is not outstanding any indebtedness or other
liability (actual or contingent) (other than any claim
for indemnity I may have under the articles of
association of Esprit) owing by any member of the Esprit
Group to me, nor is there any indebtedness owing to any
member of the Esprit Group by me; and
(D) save for the terms of my engagement as a director or
employee of Esprit which have been disclosed in writing
to GTS I have not entered into any agreement,
undertaking, instrument or arrangement with any member of
the Esprit Group.
5.2 Save, in respect of paragraph 5.1(A), for any exercise of Options
following which the resulting shares are assented to the Offer in
accordance with paragraph 4(A) and further, in respect of paragraph
5.1(B) any regular emoluments and expenses referred to therein, I
shall procure that (save as may be necessary to give effect to this
undertaking) I shall not allow nor shall I do or procure any act or
omission before the date the Offer becomes wholly unconditional
which would constitute a breach of any of the above undertakings if
they were given at any and all times from the date hereof down to
the date the Offer becomes wholly unconditional, or which would make
any of the above undertakings inaccurate or misleading if they were
so given.
6. LAW AND JURISDICTION
(A) This undertaking is governed by, and construed in
accordance with, English law.
(B) In relation to any legal action or proceedings to enforce
this undertaking or arising out of or in connection with
this undertaking ("Proceedings") I irrevocably submit to
the jurisdiction of the English courts and waive any
objection to Proceedings in such courts on the grounds of
venue or on the grounds that the Proceedings have been
brought in an inconvenient forum.
7. CONDITIONS
Notwithstanding any other provision hereof, this irrevocable undertaking and
GTS's obligation to make the Offer, are conditional upon:
6
<PAGE> 8
(A) the release of the Press Announcement at or before 9 a.m.
on 8 December 1998; and
(B) irrevocable undertakings, in a form acceptable to GTS,
being received in respect of not less than 50.1 per cent.
of the issued ordinary shares of Esprit prior to the
release of the Press Announcement.
If these conditions shall not have been satisfied by such time and date this
irrevocable undertaking shall automatically lapse and be of no further force or
effect and no party hereto shall have any claim against the other save in
respect of any antecedent breach of its terms.
8. MISCELLANEOUS
(A) My undertakings pursuant to paragraph 4 shall be
irrevocable and, in the absence of fraud, shall not be
capable of rescission or termination on the basis of any
information subsequently disclosed by GTS or Esprit in
any offer document, listing particulars or registration
statement or for any other reason whatsoever including
(without limitation) any failure by all or any of the
directors of Esprit to recommend the Offer or to continue
to recommend the Offer after the date of this
Undertaking.
(B) No failure or delay by GTS in exercising any right, power
or privilege hereunder shall operate as a waiver thereof,
nor shall any single or partial exercise thereof preclude
any other or further exercise of any right, power or
privilege hereunder. I agree that any breach of this
Undertaking is likely to cause substantial harm to GTS
and that money damages would not be a sufficient remedy
for any breach of this Undertaking and that GTS will be
entitled to specific performance and injunctive relief as
remedies for any such breach. Such remedies shall not be
deemed to be the exclusive remedies for a breach of this
Undertaking but shall be in addition to all other
remedies available at law or equity.
9. LAPSING
This irrevocable undertaking shall automatically lapse and be of no further
force or effect and no party hereto shall have any claim against the other save
in respect of any antecedent breach of its terms, in the event that:
(A) precondition (A) to the Offer set out in Paragraph 1 of
Appendix 1 of the Press Announcement (relating to the
Esprit Bonds) shall not have been satisfied or waived on
or before 29 January 1999;
(B) the Offer Document is not despatched on or before 15
April 1999; or
7
<PAGE> 9
(C) GTS announces that any of the pre-conditions of the Offer
set out in Paragraph 1 of Appendix 1 to the Press
Announcement has not been satisfied and that it has not
been and will not be waived; or
(D) the Offer is not declared wholly unconditional on or
before the 60th day after the Offer Document is
despatched or, if later, the date to which the Initial
Offer Period is extended pursuant to paragraph 7(G) of
the Shareholders' Undertakings; or
(E) I cease to be a director of Esprit.
10. EXECUTION
This undertaking may be executed in more than one part.
Yours faithfully,
SIGNED and DELIVERED
as a Deed by ROY MERRITT ROY MERRITT
in the presence of:
Witness' signature: MICHAEL POTTER
Witness' name: Michael Potter
Witness' address: 14 Connaught Square Flat 2 W2
Witness' occupation: Executive
We agree and accept the terms of this undertaking.
GERALD THAMES
For and on behalf of
GLOBAL TELESYSTEMS GROUP, INC.
8
<PAGE> 10
SCHEDULE 1
The following represents my shares subject to options, warrants or rights to
acquire or subscribe in Esprit:
Number of Ordinary Shares subject to options, warrants or rights to acquire or
subscribe
1,459,758 options
9
<PAGE> 1
EXHIBIT 2.9
IRREVOCABLE
UNDERTAKING
by
David Oertle
Strictly Private & Confidential
SIMMONS & SIMMONS
21 Wilson Street London EC2M 2TX
Tel: 0171-628 2020 / 528 9292 Fax: 0171-628 2070 DX Box No 12
<PAGE> 2
To: Global TeleSystems Group, Inc.
("GTS")
1751 Pinnacle Drive
North Tower 12th Floor
McLean VA 22102
United States of America
From: David Oertle
Pavillion Cottage
Eastfield Lane
Whitchurch-on-Thames
Oxon RG8 8EJ
United Kingdom
8 December 1998
Dear Sirs,
1. THE OFFER
I refer to the press announcement in the form of the draft attached hereto (the
"Press Announcement") setting out the terms and conditions upon which Bear
Stearns will, on behalf of GTS, make an offer (the "Offer") to acquire the whole
of the issued and to be issued share capital of Esprit Telecom Group plc
("Esprit") excluding any such share capital owned by GTS or any subsidiary of
GTS on the date that the Offer is made.
2. DEFINITIONS
In this letter, unless the context otherwise requires:
(A) "Offer":
(1) means any offer or offers that may be made by
or on behalf of GTS to acquire:
(a) the whole of the share capital of
Esprit in issue at the date on
which the Offer is made (including
any securities in Esprit
attributable to or derived from
such share capital, but excluding
any such share capital owned on
such date by GTS or any subsidiary
of GTS); and
(b) any share capital of Esprit
allotted while the Offer remains
open for acceptance or before such
earlier date as GTS may determine
whether pursuant to the exercise of
conversion or subscription rights
or otherwise; and
1
<PAGE> 3
(2) extends to any new, increased, extended or
revised offer or offers by or on behalf of
GTS, provided that in any such case the terms
of such offer or offers are, in the opinion of
Bear Stearns, with the agreement of Esprit's
financial advisers appointed for the purposes
of Rule 3 of the City Code provided such
agreement is not unreasonably withheld or
delayed (but without hereby creating any duty
of care owed by Bear Stearns, except to GTS or
by Esprit's financial advisers, except to
Esprit) no less favourable to shareholders of
Esprit than the terms set out in the Press
Announcement or the Offer Document;
(B) "Options" means the options to subscribe ordinary shares
of 1p each in Esprit held by me shown in Schedule 1; and
(C) save as referred to above words defined in the Press
Announcement have the same meanings herein.
3. RELEASE OF PRESS ANNOUNCEMENT
I irrevocably consent to the issue of the Press Announcement incorporating
references to me and to this undertaking subject to any amendments which may be
agreed between GTS and Esprit or Esprit's financial advisers. I also consent to
the issue of the Offer Document, incorporating references to me, and to this
undertaking, substantially similar to those references contained in the Press
Announcement. I understand that this irrevocable undertaking will be made
available for public inspection.
4. DIRECTOR'S UNDERTAKINGS
In consideration of GTS agreeing to make the Offer in all material respects on
the terms and subject to the conditions referred to in the Press Announcement, I
hereby irrevocably undertake to GTS as follows:
(A) to the extent that my Options may be exercisable and I
exercise my Options, I shall accept the Offer in
accordance with its terms in respect of all my resulting
Esprit Shares and shall forward or procure that there is
forwarded, with such acceptance, the certificates or
other documents of title in respect of my Esprit Shares
in accordance with the terms of the Offer;
(B) save as required by paragraph 4(A), and save with the
prior written consent of GTS (not to be unreasonably
withheld or delayed) I shall not prior to the lapsing or
withdrawal of the Offer, conditionally or
unconditionally, sell, transfer, charge, pledge or grant
any option over or otherwise dispose of or permit the
sale or other disposition of all or any of my Options or
any interest in any of my Options;
2
<PAGE> 4
(C) otherwise than pursuant to the exercise of my Options I
shall not prior to the lapsing or withdrawal of the Offer
without the prior written consent of GTS purchase or
otherwise acquire any shares in Esprit or any interest
therein or agree to do so whether conditionally or
unconditionally;
(D) I shall procure that, save pursuant to this undertaking,
unless and until the date the Offer shall have lapsed or
shall have been withdrawn, no other agreement or
arrangement (including any undertaking) shall be entered
into (other than with GTS) which could result in the
disposal of, or the creation or existence of any
encumbrance on, all or any of my Options or any interest
therein or which might in any way restrict the disposal
of my Options or any of them and no other offer shall be
accepted in respect of my Options or any of them (whether
it is conditional or unconditional and irrespective of
the means by which it is to be implemented);
(E) I shall not, prior to the issue of the Press
Announcement, without the prior written consent of GTS,
disclose or announce to any person the fact that
discussions or negotiations are taking or have taken
place concerning the Offer save as (and then only to the
extent) required by any law, the rules of NASDAQ or
EASDAQ or the City Code or the Panel or pursuant to any
enquiry by a governmental, official or regulatory body
having jurisdiction provided that, in such circumstances,
I shall where practicable advise GTS prior to any such
disclosure or announcement so that GTS has an opportunity
to seek to control the timing and manner of such
disclosure;
(F) at all times after the date hereof and until the Offer
shall have lapsed or been withdrawn, I shall refrain
from:
(1) soliciting, procuring or initiating; or
(2) (subject to my fiduciary duties as a director
of Esprit), engaging in
directly or indirectly, any discussions or negotiations
with any third party, involving any other offer by any
third party for all or any part of the issued share
capital of Esprit or involving the acquisition outside
the ordinary course of business (as carried on to the
date hereof) of, or any business combination involving,
Esprit or any of its subsidiaries or any material part of
the shares or business undertaking or assets of Esprit or
any of its subsidiaries or in each case any interest
therein (each "an Esprit Transaction");
(G) at all times from the date hereof until the Offer shall
have lapsed or been withdrawn, I shall, so far as is
consistent with my fiduciary duties as a director of
Esprit and my duties under the City Code, refrain from:
3
<PAGE> 5
(1) (save as required by Rule 20.2 of the City
Code in which case only that information
strictly required to be provided shall be
disclosed and only on the basis of an
undertaking as to confidentiality
substantially similar to that given by GTS)
providing any information to any person in
relation to, or facilitating or cooperating
with in any way, any Esprit Transaction; or
(2) communicating with any person in relation to
or discussing with any person the terms of the
Offer or any matter relating thereto without
the prior consent of GTS provided that this
shall not apply to any communications or
discussions with my or Esprit's professional
advisers who appreciate the need for
requirements as to confidentiality in relation
to the Offer or to communications or
discussions limited to information set out in
the Press Announcement or any other document
or announcement published with the consent of
GTS in connection with the Offer or otherwise
in the public domain;
(H) I am not currently in discussion with any person (other
than GTS) in relation to any Esprit Transaction;
(I) I will provide such information and do such acts as may
be reasonably necessary to prepare and expedite the
posting of the Offer Document and, in particular, but
without prejudice to the generality of the foregoing:
(1) will provide all reasonable assistance to GTS
as may be required to satisfy the
pre-conditions to the posting of the Offer
Document and the conditions of the Offer;
(2) will cooperate with GTS in seeking any
extension of the Initial Offer Period pursuant
to paragraph 7(G) of the Shareholders'
Undertakings and otherwise will agree to any
extension of time limits in the City Code
which GTS requests (unless it is acting
unreasonably) and which the Panel approves;
and
(3) will use all my reasonable efforts to provide
for GTS all necessary information regarding
Esprit and its subsidiaries and my interests
in the share capital of Esprit and options
over such share capital which is required to
be contained therein in order to comply with
the requirements of the City Code, US
Securities Law or any other applicable law or
regulation;
(4) in so far as I am involved in the management
of Esprit, I will make myself available to the
extent reasonably necessary to facilitate the
successful completion of the Offer and (to the
extent
4
<PAGE> 6
agreed) the refinancing or amendment of the
existing financing facilities of Esprit
including participation in meetings with
investors and shareholders;
(J) I will join with the other directors of Esprit in making
in the Offer Document a statement of responsibility in
the terms or to the effect required by the City Code
(subject to any variation agreed by the Panel) or by any
applicable law or regulation;
(K) so far as is consistent with my duties or obligations
under the City Code and with my fiduciary duties as a
director of Esprit I will (together with the other
directors of Esprit) recommend to all the shareholders in
Esprit that they should accept the Offer and will agree
to a statement substantially in the terms set out in the
paragraph headed "Recommendation" in the Press
Announcement being included in the Offer Document;
(L) I will, on the Offer becoming unconditional (so far as is
consistent with my fiduciary duties as a director of
Esprit) join with the other members of the board of
Esprit in appointing any persons nominated by GTS to the
board of Esprit and its subsidiaries and in approving
alternate directors nominated by such newly appointed
directors;
(M) I shall not prior to the date the Offer becomes wholly
unconditional or lapses or is withdrawn or transfer,
dispose of grant rights over or in any way charge, or
otherwise deal in or enter into any agreement,
arrangement or undertaking (conditional or unconditional)
to transfer, dispose of grant rights over or in any way
charge, or otherwise deal in any GTS Shares or any
interest therein or any derivative referenced thereto or
any security convertible into GTS Shares; and
(N) in so far as I hold Options, I confirm that it is my
current intention, subject to my receiving satisfactory
tax advice (and to the extent that I have not then
exercised my Options), to accept the Rollover Offer in
respect of my remaining Options.
5. DIRECTOR'S FURTHER UNDERTAKINGS
5.1 I hereby further undertake to GTS as follows:
(A) there are no ordinary shares in Esprit registered in my
name or beneficially owned, or managed and controlled by
me, or in which I have an interest and I have no rights,
warrants or options to acquire or subscribe for ordinary
shares in Esprit or any interest therein save as
specified in Schedule 1;
5
<PAGE> 7
(B) save pursuant to this undertaking I have not agreed,
conditionally or otherwise, to dispose of all or any of
my Options or any interest therein and have (and, upon
the Rollover Offer being made, will continue to have) all
necessary authority to enter into this undertaking and
accept or procure acceptance of the Rollover Offer in
respect of my Options;
(C) save for any regular emoluments and expenses payable
pursuant to my engagement as a director or employee of
Esprit there is not outstanding any indebtedness or other
liability (actual or contingent) (other than any claim
for indemnity I may have under the articles of
association of Esprit) owing by any member of the Esprit
Group to me, nor is there any indebtedness owing to any
member of the Esprit Group by me; and
(D) save for the terms of my engagement as a director or
employee of Esprit which have been disclosed in writing
to GTS I have not entered into any agreement,
undertaking, instrument or arrangement with any member of
the Esprit Group.
5.2 Save, in respect of paragraph 5.1(A), for any exercise of Options
following which the resulting shares are assented to the Offer in
accordance with paragraph 4(A) and further, in respect of paragraph
5.1(B) any regular emoluments and expenses referred to therein, I
shall procure that (save as may be necessary to give effect to this
undertaking) I shall not allow nor shall I do or procure any act or
omission before the date the Offer becomes wholly unconditional
which would constitute a breach of any of the above undertakings if
they were given at any and all times from the date hereof down to
the date the Offer becomes wholly unconditional, or which would make
any of the above undertakings inaccurate or misleading if they were
so given.
6. LAW AND JURISDICTION
(A) This undertaking is governed by, and construed in
accordance with, English law.
(B) In relation to any legal action or proceedings to enforce
this undertaking or arising out of or in connection with
this undertaking ("Proceedings") I irrevocably submit to
the jurisdiction of the English courts and waive any
objection to Proceedings in such courts on the grounds of
venue or on the grounds that the Proceedings have been
brought in an inconvenient forum.
7. CONDITIONS
Notwithstanding any other provision hereof, this irrevocable undertaking and
GTS's obligation to make the Offer, are conditional upon:
6
<PAGE> 8
(A) the release of the Press Announcement at or before 9 a.m
on 8 December 1998; and
(B) irrevocable undertakings, in a form acceptable to GTS,
being received in respect of not less than 50.1 per cent.
of the issued ordinary shares of Esprit prior to the
release of the Press Announcement.
If these conditions shall not have been satisfied by such time and date this
irrevocable undertaking shall automatically lapse and be of no further force or
effect and no party hereto shall have any claim against the other save in
respect of any antecedent breach of its terms.
8. MISCELLANEOUS
(A) My undertakings pursuant to paragraph 4 shall be
irrevocable and, in the absence of fraud, shall not be
capable of rescission or termination on the basis of any
information subsequently disclosed by GTS or Esprit in
any offer document, listing particulars or registration
statement or for any other reason whatsoever including
(without limitation) any failure by all or any of the
directors of Esprit to recommend the Offer or to continue
to recommend the Offer after the date of this
Undertaking.
(B) No failure or delay by GTS in exercising any right, power
or privilege hereunder shall operate as a waiver thereof,
nor shall any single or partial exercise thereof preclude
any other or further exercise of any right, power or
privilege hereunder. I agree that any breach of this
Undertaking is likely to cause substantial harm to GTS
and that money damages would not be a sufficient remedy
for any breach of this Undertaking and that GTS will be
entitled to specific performance and injunctive relief as
remedies for any such breach. Such remedies shall not be
deemed to be the exclusive remedies for a breach of this
Undertaking but shall be in addition to all other
remedies available at law or equity.
9. LAPSING
This irrevocable undertaking shall automatically lapse and be of no further
force or effect and no party hereto shall have any claim against the other save
in respect of any antecedent breach of its terms, in the event that:
(A) precondition (A) to the Offer set out in Paragraph 1 of
Appendix 1 of the Press Announcement (relating to the
Esprit Bonds) shall not have been satisfied or waived on
or before 29 January 1999;
(B) the Offer Document is not despatched on or before 15
April 1999; or
7
<PAGE> 9
(C) GTS announces that any of the pre-conditions of the Offer
set out in Paragraph 1 of Appendix 1 to the Press
Announcement has not been satisfied and that it has not
been and will not be waived; or
(D) the Offer is not declared wholly unconditional on or
before the 60th day after the Offer Document is
despatched or, if later, the date to which the Initial
Offer Period is extended pursuant to paragraph 7(G) of
the Shareholders' Undertakings; or
(E) I cease to be a director of Esprit.
10. EXECUTION
This undertaking may be executed in more than one part.
Yours faithfully,
SIGNED and DELIVERED
as a Deed by DAVID OERTLE DAVID OERTLE
in the presence of:
Witness' signature: J. CHAMBERS
Witness' name: J. Chambers
Witness' address: 20 Blackfriars Lane, London EC4V 6HD
Witness' occupation: Solicitor
We agree and accept the terms of this undertaking.
GERALD THAMES
For and on behalf of
GLOBAL TELESYSTEMS GROUP, INC.
8
<PAGE> 10
SCHEDULE 1
The following represents my shares subject to options, warrants or rights to
acquire or subscribe in Esprit:
Number of Ordinary Shares subject to options, warrants or rights to acquire or
subscribe
3,172,762 options
9
<PAGE> 1
EXHIBIT 2.10
IRREVOCABLE
UNDERTAKING
by
Michael Potter
Strictly Private & Confidential
SIMMONS & SIMMONS
21 Wilson Street London EC2M 2TX
Tel: 0171-628 2020 / 528 9292 Fax: 0171-628 2070 DX Box No 12
<PAGE> 2
To: Global TeleSystems Group, Inc.
("GTS")
1751 Pinnacle Drive
North Tower 12th Floor
McLean VA 22102
United States of America
From: Michael Potter
14 Connaught Square
London W2
United Kingdom
8 December 1998
Dear Sirs,
1. THE OFFER
I refer to the press announcement in the form of the draft attached hereto (the
"Press Announcement") setting out the terms and conditions upon which Bear
Stearns will, on behalf of GTS, make an offer (the "Offer") to acquire the whole
of the issued and to be issued share capital of Esprit Telecom Group plc
("Esprit") excluding any such share capital owned by GTS or any subsidiary of
GTS on the date that the Offer is made.
2. DEFINITIONS
In this letter, unless the context otherwise requires:
(A) "Offer":
(1) means any offer or offers that may be made by
or on behalf of GTS to acquire:
(a) the whole of the share capital of
Esprit in issue at the date on
which the Offer is made (including
any securities in Esprit
attributable to or derived from
such share capital, but excluding
any such share capital owned on
such date by GTS or any subsidiary
of GTS); and
(b) any share capital of Esprit
allotted while the Offer remains
open for acceptance or before such
earlier date as GTS may determine
whether pursuant to the exercise of
conversion or subscription rights
or otherwise; and
1
<PAGE> 3
(2) extends to any new, increased, extended or
revised offer or offers by or on behalf of
GTS, provided that in any such case the terms
of such offer or offers are, in the opinion of
Bear Stearns, with the agreement of Esprit's
financial advisers appointed for the purposes
of Rule 3 of the City Code provided such
agreement is not unreasonably withheld or
delayed (but without hereby creating any duty
of care owed by Bear Stearns, except to GTS or
by Esprit's financial advisers, except to
Esprit) no less favourable to shareholders of
Esprit than the terms set out in the Press
Announcement or the Offer Document;
(B) "Options" means the options to subscribe ordinary shares
of 1p each in Esprit held by me shown in Schedule 1; and
(C) save as referred to above words defined in the Press
Announcement have the same meanings herein.
3. RELEASE OF PRESS ANNOUNCEMENT
I irrevocably consent to the issue of the Press Announcement incorporating
references to me and to this undertaking subject to any amendments which may be
agreed between GTS and Esprit or Esprit's financial advisers. I also consent to
the issue of the Offer Document, incorporating references to me, and to this
undertaking, substantially similar to those references contained in the Press
Announcement. I understand that this irrevocable undertaking will be made
available for public inspection.
4. DIRECTOR'S UNDERTAKINGS
In consideration of GTS agreeing to make the Offer in all material respects on
the terms and subject to the conditions referred to in the Press Announcement, I
hereby irrevocably undertake to GTS as follows:
(A) to the extent that my Options may be exercisable and I
exercise my Options, I shall accept the Offer in
accordance with its terms in respect of all my resulting
Esprit Shares and shall forward or procure that there is
forwarded, with such acceptance, the certificates or
other documents of title in respect of my Esprit Shares
in accordance with the terms of the Offer;
(B) save as required by paragraph 4(A), and save with the
prior written consent of GTS (not to be unreasonably
withheld or delayed) I shall not prior to the lapsing or
withdrawal of the Offer, conditionally or
unconditionally, sell, transfer, charge, pledge or grant
any option over or otherwise dispose of or permit the
sale or other disposition of all or any of my Options or
any interest in any of my Options;
2
<PAGE> 4
(C) otherwise than pursuant to the exercise of my Options I
shall not prior to the lapsing or withdrawal of the Offer
without the prior written consent of GTS purchase or
otherwise acquire any shares in Esprit or any interest
therein or agree to do so whether conditionally or
unconditionally;
(D) I shall procure that, save pursuant to this undertaking,
unless and until the date the Offer shall have lapsed or
shall have been withdrawn, no other agreement or
arrangement (including any undertaking) shall be entered
into (other than with GTS) which could result in the
disposal of, or the creation or existence of any
encumbrance on, all or any of my Options or any interest
therein or which might in any way restrict the disposal
of my Options or any of them and no other offer shall be
accepted in respect of my Options or any of them (whether
it is conditional or unconditional and irrespective of
the means by which it is to be implemented);
(E) I shall not, prior to the issue of the Press
Announcement, without the prior written consent of GTS,
disclose or announce to any person the fact that
discussions or negotiations are taking or have taken
place concerning the Offer save as (and then only to the
extent) required by any law, the rules of NASDAQ or
EASDAQ or the City Code or the Panel or pursuant to any
enquiry by a governmental, official or regulatory body
having jurisdiction provided that, in such circumstances,
I shall where practicable advise GTS prior to any such
disclosure or announcement so that GTS has an opportunity
to seek to control the timing and manner of such
disclosure;
(F) at all times after the date hereof and until the Offer
shall have lapsed or been withdrawn, I shall refrain
from:
(1) soliciting, procuring or initiating; or
(2) (subject to my fiduciary duties as a director
of Esprit), engaging in
directly or indirectly, any discussions or negotiations
with any third party, involving any other offer by any
third party for all or any part of the issued share
capital of Esprit or involving the acquisition outside
the ordinary course of business (as carried on to the
date hereof) of, or any business combination involving,
Esprit or any of its subsidiaries or any material part of
the shares or business undertaking or assets of Esprit or
any of its subsidiaries or in each case any interest
therein (each "an Esprit Transaction";
(G) at all times from the date hereof until the Offer shall
have lapsed or been withdrawn, I shall, so far as is
consistent with my fiduciary duties as a director of
Esprit and my duties under the City Code, refrain from:
3
<PAGE> 5
(1) (save as required by Rule 20.2 of the City
Code in which case only that information
strictly required to be provided shall be
disclosed and only on the basis of an
undertaking as to confidentiality
substantially similar to that given by GTS)
providing any information to any person in
relation to, or facilitating or cooperating
with in any way, any Esprit Transaction; or
(2) communicating with any person in relation to
or discussing with any person the terms of the
Offer or any matter relating thereto without
the prior consent of GTS provided that this
shall not apply to any communications or
discussions with my or Esprit's professional
advisers who appreciate the need for
requirements as to confidentiality in relation
to the Offer or to communications or
discussions limited to information set out in
the Press Announcement or any other document
or announcement published with the consent of
GTS in connection with the Offer or otherwise
in the public domain;
(H) I am not currently in discussion with any person (other
than GTS) in relation to any Esprit Transaction;
(I) I will provide such information and do such acts as may
be reasonably necessary to prepare and expedite the
posting of the Offer Document and, in particular, but
without prejudice to the generality of the foregoing:
(1) will provide all reasonable assistance to GTS
as may be required to satisfy the
pre-conditions to the posting of the Offer
Document and the conditions of the Offer;
(2) will cooperate with GTS in seeking any
extension of the Initial Offer Period pursuant
to paragraph 7(G) of the Shareholders'
Undertakings and otherwise will agree to any
extension of time limits in the City Code
which GTS requests (unless it is acting
unreasonably) and which the Panel approves;
and
(3) will use all my reasonable efforts to provide
for GTS all necessary information regarding
Esprit and its subsidiaries and my interests
in the share capital of Esprit and options
over such share capital which is required to
be contained therein in order to comply with
the requirements of the City Code, US
Securities Law or any other applicable law or
regulation;
(4) in so far as I am involved in the management
of Esprit, I will make myself available to the
extent reasonably necessary to facilitate the
successful completion of the Offer and (to the
extent
4
<PAGE> 6
agreed) the refinancing or amendment of the
existing financing facilities of Esprit
including participation in meetings with
investors and shareholders;
(J) I will join with the other directors of Esprit in making
in the Offer Document a statement of responsibility in
the terms or to the effect required by the City Code
(subject to any variation agreed by the Panel) or by any
applicable law or regulation;
(K) so far as is consistent with my duties or obligations
under the City Code and with my fiduciary duties as a
director of Esprit I will (together with the other
directors of Esprit) recommend to all the shareholders in
Esprit that they should accept the Offer and will agree
to a statement substantially in the terms set out in the
paragraph headed "Recommendation" in the Press
Announcement being included in the Offer Document;
(L) I will, on the Offer becoming unconditional (so far as is
consistent with my fiduciary duties as a director of
Esprit) join with the other members of the board of
Esprit in appointing any persons nominated by GTS to the
board of Esprit and its subsidiaries and in approving
alternate directors nominated by such newly appointed
directors;
(M) I shall not prior to the date the Offer becomes wholly
unconditional or lapses or is withdrawn or transfer,
dispose of grant rights over or in any way charge, or
otherwise deal in or enter into any agreement,
arrangement or undertaking (conditional or unconditional)
to transfer, dispose of grant rights over or in any way
charge, or otherwise deal in any GTS Shares or any
interest therein or any derivative referenced thereto or
any security convertible into GTS Shares; and
(N) in so far as I hold Options, I confirm that it is my
current intention, subject to my receiving satisfactory
tax advice (and to the extent that I have not then
exercised my Options), to accept the Rollover Offer in
respect of my remaining Options.
5. DIRECTOR'S FURTHER UNDERTAKINGS
5.1 I hereby further undertake to GTS as follows:
(A) there are no ordinary shares in Esprit registered in my
name or beneficially owned, or managed and controlled by
me, or in which I have an interest and I have no rights,
warrants or options to acquire or subscribe for ordinary
shares in Esprit or any interest therein save as
specified in Schedule 1;
5
<PAGE> 7
(B) save pursuant to this undertaking I have not agreed,
conditionally or otherwise, to dispose of all or any of
my Options or any interest therein and have (and, upon
the Rollover Offer being made, will continue to have) all
necessary authority to enter into this undertaking and
accept or procure acceptance of the Rollover Offer in
respect of my Options;
(C) save for any regular emoluments and expenses payable
pursuant to my engagement as a director or employee of
Esprit there is not outstanding any indebtedness or other
liability (actual or contingent) (other than any claim
for indemnity I may have under the articles of
association of Esprit) owing by any member of the Esprit
Group to me, nor is there any indebtedness owing to any
member of the Esprit Group by me; and
(D) save for the terms of my engagement as a director or
employee of Esprit which have been disclosed in writing
to GTS I have not entered into any agreement,
undertaking, instrument or arrangement with any member of
the Esprit Group.
5.2 Save, in respect of paragraph 5.1(A), for any exercise of Options
following which the resulting shares are assented to the Offer in
accordance with paragraph 4(A) and further, in respect of paragraph
5.1(B) any regular emoluments and expenses referred to therein, I
shall procure that (save as may be necessary to give effect to this
undertaking) I shall not allow nor shall I do or procure any act or
omission before the date the Offer becomes wholly unconditional
which would constitute a breach of any of the above undertakings if
they were given at any and all times from the date hereof down to
the date the Offer becomes wholly unconditional, or which would make
any of the above undertakings inaccurate or misleading if they were
so given.
6. LAW AND JURISDICTION
(A) This undertaking is governed by, and construed in
accordance with, English law.
(B) In relation to any legal action or proceedings to enforce
this undertaking or arising out of or in connection with
this undertaking ("Proceedings") I irrevocably submit to
the jurisdiction of the English courts and waive any
objection to Proceedings in such courts on the grounds of
venue or on the grounds that the Proceedings have been
brought in an inconvenient forum.
7. CONDITIONS
Notwithstanding any other provision hereof, this irrevocable undertaking and
GTS's obligation to make the Offer, are conditional upon:
6
<PAGE> 8
(A) the release of the Press Announcement at or before 9 a.m.
on 8 December 1998; and
(B) irrevocable undertakings, in a form acceptable to GTS,
being received in respect of not less than 50.1 per cent.
of the issued ordinary shares of Esprit prior to the
release of the Press Announcement.
If these conditions shall not have been satisfied by such time and date this
irrevocable undertaking shall automatically lapse and be of no further force or
effect and no party hereto shall have any claim against the other save in
respect of any antecedent breach of its terms.
8. MISCELLANEOUS
(A) My undertakings pursuant to paragraph 4 shall be
irrevocable and, in the absence of fraud, shall not be
capable of rescission or termination on the basis of any
information subsequently disclosed by GTS or Esprit in
any offer document, listing particulars or registration
statement or for any other reason whatsoever including
(without limitation) any failure by all or any of the
directors of Esprit to recommend the Offer or to continue
to recommend the Offer after the date of this
Undertaking.
(B) No failure or delay by GTS in exercising any right, power
or privilege hereunder shall operate as a waiver thereof,
nor shall any single or partial exercise thereof preclude
any other or further exercise of any right, power or
privilege hereunder. I agree that any breach of this
Undertaking is likely to cause substantial harm to GTS
and that money damages would not be a sufficient remedy
for any breach of this Undertaking and that GTS will be
entitled to specific performance and injunctive relief as
remedies for any such breach. Such remedies shall not be
deemed to be the exclusive remedies for a breach of this
Undertaking but shall be in addition to all other
remedies available at law or equity.
9. LAPSING
This irrevocable undertaking shall automatically lapse and be of no further
force or effect and no party hereto shall have any claim against the other save
in respect of any antecedent breach of its terms, in the event that:
(A) precondition (A) to the Offer set out in Paragraph 1 of
Appendix 1 of the Press Announcement (relating to the
Esprit Bonds) shall not have been satisfied or waived on
or before 29 January 1999;
(B) the Offer Document is not despatched on or before 15
April 1999; or
7
<PAGE> 9
(C) GTS announces that any of the pre-conditions of the Offer
set out in Paragraph 1 of Appendix 1 to the Press
Announcement has not been satisfied and that it has not
been and will not be waived; or
(D) the Offer is not declared wholly unconditional on or
before the 60th day after the Offer Document is
despatched or, if later, the date to which the Initial
Offer Period is extended pursuant to paragraph 7(G) of
the Shareholders' Undertakings; or
(E) I cease to be a director of Esprit.
10. EXECUTION
This undertaking may be executed in more than one part.
Yours faithfully,
SIGNED and DELIVERED
as a Deed by MICHAEL POTTER MICHAEL POTTER
in the presence of:
Witness' signature: ROY MERRITT
Witness' name: Roy Merritt
Witness' address: 8a Moorhouse Road, London W2 SDJ
Witness' occupation: Company Director
We agree and accept the terms of this undertaking.
GERALD THAMES
For and on behalf of
GLOBAL TELESYSTEMS GROUP, INC.
8
<PAGE> 10
SCHEDULE 1
The following represents my shares subject to options, warrants or rights to
acquire or subscribe in Esprit:
Number of Ordinary Shares subject to options, warrants or rights to acquire or
subscribe
653,312 options
9
<PAGE> 1
EXHIBIT 2.11
IRREVOCABLE
UNDERTAKING
by
Dominic Shorthouse
Strictly Private & Confidential
SIMMONS & SIMMONS
21 Wilson Street London EC2M 2TX
Tel: 0171-628 2020 / 528 9292 Fax: 0171-628 2070 DX Box No 12
<PAGE> 2
To: Global TeleSystems Group, Inc.
("GTS")
1751 Pinnacle Drive
North Tower 12th Floor
McLean VA 22102
United States of America
From: Dominic Shorthouse
Lake House
Lake Road
Virginia Water
Surrey GU25 4QW
United Kingdom
8 December 1998
Dear Sirs,
1. THE OFFER
I refer to the press announcement in the form of the draft attached hereto (the
"Press Announcement") setting out the terms and conditions upon which Bear
Stearns will, on behalf of GTS, make an offer (the "Offer") to acquire the
whole of the issued and to be issued share capital of Esprit Telecom Group plc
("Esprit") excluding any such share capital owned by GTS or any subsidiary of
GTS on the date that the Offer is made.
2. DEFINITIONS
In this letter, unless the context otherwise requires:
(A) "Offer":
(1) means any offer or offers that may be made by or on
behalf of GTS to acquire:
(a) the whole of the share capital of Esprit in issue at
the date on which the Offer is made (including any
securities in Esprit attributable to or derived from
such share capital, but excluding any such share
capital owned on such date by GTS or any subsidiary
of GTS); and
(b) any share capital of Esprit allotted while the Offer
remains open for acceptance or before such earlier
date as GTS may determine whether pursuant to the
exercise of conversion or subscription rights or
otherwise; and
1
<PAGE> 3
(2) extends to any new, increased, extended or revised offer
or offers by or on behalf of GTS, provided that in any
such case the terms of such offer or offers are, in the
opinion of Bear Stearns, with the agreement of Esprit's
financial advisers appointed for the purposes of Rule 3
of the City Code provided such agreement is not
unreasonably withheld or delayed (but without hereby
creating any duty of care owed by Bear Stearns, except
to GTS or by Esprit's financial advisers, except to
Esprit) no less favourable to shareholders of Esprit
than the terms set out in the Press Announcement or the
Offer Document;
(B) "Options" means the options to subscribe ordinary shares of
1p each in Esprit held by me shown in Schedule 1; and
(C) save as referred to above words defined in the Press
Announcement have the same meanings herein.
3. RELEASE OF PRESS ANNOUNCEMENT
I irrevocably consent to the issue of the Press Announcement incorporating
references to me and to this undertaking subject to any amendments which may be
agreed between GTS and Esprit or Esprit's financial advisers. I also consent to
the issue of the Offer Document, incorporating references to me, and to this
undertaking, substantially similar to those references contained in the Press
Announcement. I understand that this irrevocable undertaking will be made
available for public inspection.
4. DIRECTOR'S UNDERTAKINGS
In consideration of GTS agreeing to make the Offer in all material respects on
the terms and subject to the conditions referred to in the Press Announcement,
I hereby irrevocably undertake to GTS as follows:
(A) to the extent that my Options may be exercisable and I
exercise my Options, I shall accept the Offer in accordance
with its terms in respect of all my resulting Esprit Shares
and shall forward or procure that there is forwarded, with
such acceptance, the certificates or other documents of title
in respect of my Esprit Shares in accordance with the terms
of the Offer;
(B) save as required by paragraph 4(A), and save with the prior
written consent of GTS (not to be unreasonably withheld or
delayed) I shall not prior to the lapsing or withdrawal of
the Offer, conditionally or unconditionally, sell, transfer,
charge, pledge or grant any option over or otherwise dispose
of or permit the sale or other disposition of all or any of
my Options or any interest in any of my Options;
2
<PAGE> 4
(C) otherwise than pursuant to the exercise of my Options I shall
not prior to the lapsing or withdrawal of the Offer without
the prior written consent of GTS purchase or otherwise
acquire any shares in Esprit or any interest therein or agree
to do so whether conditionally or unconditionally;
(D) I shall procure that, save pursuant to this undertaking,
unless and until the date the Offer shall have lapsed or
shall have been withdrawn, no other agreement or arrangement
(including any undertaking) shall be entered into (other than
with GTS) which could result in the disposal of, or the
creation or existence of any encumbrance on, all or any of my
Options or any interest therein or which might in any way
restrict the disposal of my Options or any of them and no
other offer shall be accepted in respect of my Options or any
of them (whether it is conditional or unconditional and
irrespective of the means by which it is to be implemented);
(E) I shall not, prior to the issue of the Press Announcement,
without the prior written consent of GTS, disclose or
announce to any person the fact that discussions or
negotiations are taking or have taken place concerning the
Offer save as (and then only to the extent) required by any
law, the rules of NASDAQ or EASDAQ or the City Code or the
Panel or pursuant to any enquiry by a governmental, official
or regulatory body having jurisdiction provided that, in such
circumstances, I shall where practicable advise GTS prior to
any such disclosure or announcement so that GTS has an
opportunity to seek to control the timing and manner of such
disclosure;
(F) at all times after the date hereof and until the Offer shall
have lapsed or been withdrawn, I shall refrain from:
(1) soliciting, procuring or initiating; or
(2) (subject to my fiduciary duties as a director of
Esprit), engaging in
directly or indirectly, any discussions or negotiations with
any third party, involving any other offer by any third party
for all or any part of the issued share capital of Esprit or
involving the acquisition outside the ordinary course of
business (as carried on to the date hereof) of, or any
business combination involving, Esprit or any of its
subsidiaries or any material part of the shares or business
undertaking or assets of Esprit or any of its subsidiaries or
in each case any interest therein save for any transaction
specifically permitted by paragraph 4(D) of the Shareholders
Undertaking given by Warburg, Pincus Ventures, L.P. (each "an
Esprit Transaction");
3
<PAGE> 5
(G) at all times from the date hereof until the Offer shall have
lapsed or been withdrawn, I shall, so far as is consistent
with my fiduciary duties as a director of Esprit and my
duties under the City Code, refrain from:
(1) (save as required by Rule 20.2 of the City Code in which
case only that information strictly required to be
provided shall be disclosed and only on the basis of an
undertaking as to confidentiality substantially similar
to that given by GTS) providing any information to any
person in relation to, or facilitating or cooperating
with in any way, any Esprit Transaction; or
(2) communicating with any person in relation to or
discussing with any person the terms of the Offer or any
matter relating thereto without the prior consent of GTS
provided that this shall not apply to any communications
or discussions with my or Esprit's professional advisers
who appreciate the need for requirements as to
confidentiality in relation to the Offer or to
communications or discussions limited to information set
out in the Press Announcement or any other document or
announcement published with the consent of GTS in
connection with the Offer or otherwise in the public
domain;
(H) I am not currently in discussion with any person (other than
GTS) in relation to any Esprit Transaction;
(I) I will provide such information and do such acts as may be
reasonably necessary to prepare and expedite the posting of
the Offer Document and, in particular, but without prejudice
to the generality of the foregoing:
(1) will provide all reasonable assistance to GTS as may be
required to satisfy the pre-conditions to the posting of
the Offer Document and the conditions of the Offer;
(2) will cooperate with GTS in seeking any extension of the
Initial Offer Period pursuant to paragraph 7(G) of the
Shareholders' Undertakings and otherwise will agree to
any extension of time limits in the City Code which GTS
requests (unless it is acting unreasonably) and which
the Panel approves; and
(3) will use all my reasonable efforts to provide for GTS
all necessary information regarding Esprit and its
subsidiaries and my interests in the share capital of
Esprit and options over such share capital which is
required to be contained therein in order to comply with
the requirements of the City Code, US Securities Law or
any other applicable law or regulation;
4
<PAGE> 6
(4) in so far as I am involved in the management of Esprit,
I will make myself available to the extent reasonably
necessary to facilitate the successful completion of the
Offer and (to the extent agreed) the refinancing or
amendment of the existing financing facilities of Esprit
including participation in meetings with investors and
shareholders;
(J) I will join with the other directors of Esprit in making in
the Offer Document a statement of responsibility in the terms
or to the effect required by the City Code (subject to any
variation agreed by the Panel) or by any applicable law or
regulation;
(K) so far as is consistent with my duties or obligations under
the City Code and with my fiduciary duties as a director of
Esprit I will (together with the other directors of Esprit)
recommend to all the shareholders in Esprit that they should
accept the Offer and will agree to a statement substantially
in the terms set out in the paragraph headed "Recommendation"
in the Press Announcement being included in the Offer
Document;
(L) I will, on the Offer becoming unconditional (so far as is
consistent with my fiduciary duties as a director of Esprit)
join with the other members of the board of Esprit in
appointing any persons nominated by GTS to the board of
Esprit and its subsidiaries and in approving alternate
directors nominated by such newly appointed directors;
(M) I shall not prior to the date the Offer becomes wholly
unconditional or lapses or is withdrawn or transfer, dispose
of grant rights over or in any way charge, or otherwise deal
in or enter into any agreement, arrangement or undertaking
(conditional or unconditional) to transfer, dispose of grant
rights over or in any way charge, or otherwise deal in any
GTS Shares or any interest therein or any derivative
referenced thereto or any security convertible into GTS
Shares; and
(N) in so far as I hold Options, I confirm that it is my current
intention, subject to my receiving satisfactory tax advice
(and to the extent that I have not then exercised my
Options), to accept the Rollover Offer in respect of my
remaining Options.
5. DIRECTOR'S FURTHER UNDERTAKINGS
5.1 I hereby further undertake to GTS as follows:
(A) there are no ordinary shares in Esprit registered in my name
or beneficially owned, or managed and controlled by me, or in
which I have an interest and I have no rights, warrants or
options to acquire or subscribe for
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ordinary shares in Esprit or any interest therein save as
specified in Schedule 1;
(B) save pursuant to this undertaking I have not agreed,
conditionally or otherwise, to dispose of all or any of my
Options or any interest therein and have (and, upon the
Rollover Offer being made, will continue to have) all
necessary authority to enter into this undertaking and accept
or procure acceptance of the Rollover Offer in respect of my
Options;
(C) save for any regular emoluments and expenses payable pursuant
to my engagement as a director or employee of Esprit there is
not outstanding any indebtedness or other liability (actual
or contingent) (other than any claim for indemnity I may have
under the articles of association of Esprit) owing by any
member of the Esprit Group to me, nor is there any
indebtedness owing to any member of the Esprit Group by me;
and
(D) save for the terms of my engagement as a director or employee
of Esprit which have been disclosed in writing to GTS I have
not entered into any agreement, undertaking, instrument or
arrangement with any member of the Esprit Group.
5.2 Save, in respect of paragraph 5.1(A), for any exercise of Options
following which the resulting shares are assented to the Offer in
accordance with paragraph 4(A) and further, in respect of paragraph
5.1(B) any regular emoluments and expenses referred to therein, I
shall procure that (save as may be necessary to give effect to this
undertaking) I shall not allow nor shall I do or procure any act or
omission before the date the Offer becomes wholly unconditional
which would constitute a breach of any of the above undertakings if
they were given at any and all times from the date hereof down to
the date the Offer becomes wholly unconditional, or which would
make any of the above undertakings inaccurate or misleading if they
were so given.
6. LAW AND JURISDICTION
(A) This undertaking is governed by, and construed in accordance
with, English law.
(B) In relation to any legal action or proceedings to enforce
this undertaking or arising out of or in connection with this
undertaking ("Proceedings") I irrevocably submit to the
jurisdiction of the English courts and waive any objection to
Proceedings in such courts on the grounds of venue or on the
grounds that the Proceedings have been brought in an
inconvenient forum.
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7. CONDITIONS
Notwithstanding any other provision hereof, this irrevocable undertaking and
GTS's obligation to make the Offer, are conditional upon:
(A) the release of the Press Announcement at or before 9a.m. on 8
December 1998; and
(B) irrevocable undertakings, in a form acceptable to GTS, being
received in respect of not less than 50.1 per cent. of the
issued ordinary shares of Esprit prior to the release of the
Press Announcement.
If these conditions shall not have been satisfied by such time and date this
irrevocable undertaking shall automatically lapse and be of no further force or
effect and no party hereto shall have any claim against the other save in
respect of any antecedent breach of its terms.
8. MISCELLANEOUS
(A) My undertakings pursuant to paragraph 4 shall be irrevocable
and, in the absence of fraud, shall not be capable of
rescission or termination on the basis of any information
subsequently disclosed by GTS or Esprit in any offer
document, listing particulars or registration statement or
for any other reason whatsoever including (without
limitation) any failure by all or any of the directors of
Esprit to recommend the Offer or to continue to recommend the
Offer after the date of this Undertaking.
(B) No failure or delay by GTS in exercising any right, power or
privilege hereunder shall operate as a waiver thereof, nor
shall any single or partial exercise thereof preclude any
other or further exercise of any right, power or privilege
hereunder. I agree that any breach of this Undertaking is
likely to cause substantial harm to GTS and that money
damages would not be a sufficient remedy for any breach of
this Undertaking and that GTS will be entitled to specific
performance and injunctive relief as remedies for any such
breach. Such remedies shall not be deemed to be the exclusive
remedies for a breach of this Undertaking but shall be in
addition to all other remedies available at law or equity.
9. LAPSING
This irrevocable undertaking shall automatically lapse and be of no further
force or effect and no party hereto shall have any claim against the other save
in respect of any antecedent breach of its terms, in the event that:
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<PAGE> 9
(A) precondition (A) to the Offer set out in Paragraph 1 of
Appendix 1 of the Press Announcement (relating to the Esprit
Bonds) shall not have been satisfied or waived on or before
29 January 1999;
(B) the Offer Document is not despatched on or before 15 April
1999; or
(C) GTS announces that any of the pre-conditions of the Offer set
out in Paragraph 1 of Appendix 1 to the Press Announcement
has not been satisfied and that it has not been and will not
be waived; or
(D) the Offer is not declared wholly unconditional on or before
the 60th day after the Offer Document is despatched or, if
later, the date to which the Initial Offer Period is extended
pursuant to paragraph 7(G) of the Shareholders' Undertakings;
or
(E) I cease to be a director of Esprit.
10. EXECUTION
This undertaking may be executed in more than one part.
Yours faithfully,
SIGNED and DELIVERED
as a Deed by DOMINIC SHORTHOUSE ROBERTO ITALIA for and on behalf of
in the presence of: DOMINIC SHORTHOUSE
Witness' signature:MATHEW F. HERMAN
Witness' name:Mathew F. Herman
Witness' address: 64 Holland Park London W11
Witness' occupation: Attorney
We agree and accept the terms of this undertaking.
GERALD THAMES
For and on behalf of
GLOBAL TELESYSTEMS GROUP, INC.
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SCHEDULE 1
The following represents my shares subject to options, warrants or rights to
acquire or subscribe in Esprit:
Number of Ordinary Shares subject to options, warrants or rights to acquire or
subscribe
nil
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<PAGE> 1
EXHIBIT 4.9
This REGISTRATION RIGHTS AGREEMENT as modified, supplemented or amended from
time to time; (this "Agreement") is made and entered into as of 8 December,
1998 by and among Global TeleSystems Group, Inc., a Delaware corporation (the
"Company" or the "Registrant"), and certain persons listed on the signature
page hereto (the "Shareholders") that hold equity interests ("Equity
Interests") in Esprit Telecom Group plc ("Esprit") in the form of ordinary
shares, nominal value 1p each (the "Ordinary Shares") or American Depositary
Shares, which represent the right to receive seven Ordinary Shares.
Whereas the Company has proposed to make, subject to certain pre-conditions
(the "Pre-Conditions"), as set out in the joint press announcement dated 8
December, 1998 (the "Press Announcement"), an exchange offer (the "Offer") for
all of the outstanding share capital of Esprit;
Whereas as part of the Offer, the Company will offer the Shareholders as
consideration, shares (the "Shares") of common stock of the Company, par value
$0.10 per share ("Common Stock"), pursuant to a registration statement on Form
S-4 (the "S-4 Registration Statement");
Whereas in order to induce the Company to make the Offer, each Shareholder has
severally agreed to execute an irrevocable undertaking (an "Irrevocable") to
tender the Equity Interests held by such Shareholder if certain conditions are
satisfied and the Company makes the Offer;
Now, therefore in order to induce each Shareholder to enter into an
Irrevocable, the Company has agreed to provide the registration rights set
forth in this Agreement for the benefit of the Shareholders, and their direct
and indirect transferees and assigns. This Agreement has been entered into
simultaneously with the Irrevocable by each Shareholder.
The parties hereby agree as follows:
1. INTERPRETATION AND DEFINITIONS
"Business Day" means any day, other than a Saturday or Sunday, that is not a
day on which banking institutions in the Borough of Manhattan, the City of New
York, Wilmington, Delaware or London, United Kingdom are authorized or required
by law, regulation or executive order to close.
"Closing Date" means the date determined by the Registrant's independent
auditors as the date that the acquisition of Esprit is deemed consummated in
connection with determining whether such acquisition will receive "pooling of
interests" accounting treatment (for the avoidance of doubt, the first day of
the 30 day period of combined operations of the Company and Esprit contemplated
by Clause 2.1(A));
"Commission" means the U.S. Securities and Exchange Commission;
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"Deadline" as defined in Clause 2.1(A);
"Effectiveness End Date" means the earliest to occur of the date that is (i)
the date upon which Holders of Shares are able to sell all such Shares
immediately without restriction pursuant to Rule 144(k) or Rule 145(d) (if
applicable) under the Securities Act or otherwise or, if Rule 144(k) or Rule
145(d) (if applicable) is amended to provide a shorter restricted period, such
shorter period, (ii) the date on which the Company obtains written confirmation
from the Division of Corporate Finance of the Commission recommending that no
action be taken by the Commission in connection with the resale of Shares by
Shareholders without regard to volume or other restrictions under the
Securities Act upon resale (provided that on the Closing Date such Shareholders
receive an opinion of counsel to the effect that the Shares may be so sold); or
(iii) the date as of which all of the Shares are resold pursuant to the
Registration Statement;
"Exchange Act" means the Securities Exchange Act of 1934, as amended, and the
rules and regulations of the Commission promulgated thereunder;
"Holders" means the Shareholders and any direct or indirect transferee of a
Shareholder who agrees in writing to be bound by the provisions of this
Agreement;
"NASD" means the National Association of Securities Dealers, Inc.;
"Participant" as defined in Clause 5.1;
"Person" means an individual, partnership, corporation, trust or unincorporated
organization, or a government or agency or political subdivision thereof;
"Prospectus" means the resale prospectus included in the Registration Statement
pursuant to which the Holders will be permitted to resell Shares, including any
preliminary prospectus, in each case as the same may be amended or supplemented
by any prospectus supplement and by all other amendments thereto, including
post-effective amendments, and all material incorporated by reference into such
prospectus;
"Registrant" as defined in the preamble hereto;
"Registration Statement" means whichever of the S-4 Registration Statement or
the other registration statement referred to in Clause 2.1(B) that includes the
Prospectus, together with all amendments and supplements thereto (including
post-effective amendments) and all exhibits and material incorporated by
reference therein;
"Securities Act" means the Securities Act of 1933, as amended, and the rules
and regulations of the Commission promulgated thereunder; and
"Underwritten Offering" means a sale or other transfer of Shares by a Holder to
an underwriter for re-offering to the public.
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<PAGE> 3
2. PUBLICATION, REGISTRATION AND TRANSFER RESTRICTIONS
2.1 PUBLICATION AND REGISTRATION
The Registrant shall:
(A) as soon as practicable after the Closing Date, prepare, publish
and otherwise publicly disclose financials ("Financials") of the
Company which shall include a period of at least 30 days of
combined operations of the Company and Esprit in the form of a
quarterly earnings report, an effective registration statement
filed with the Commission, a report to the Commission on Form
10-K, 10-Q or 8-K, or any other public filing or announcement
which includes such combined results of operations (as required
by APB No. 16), provided that the date of publication of the
financials (the "Publication Date") shall in no event be later
than 20 days after the end of the calendar month that commences
immediately after the Closing Date (the "Deadline") and provided
further that the Registrant will immediately notify each Holder
in writing of such publication;
(B) before the Publication Date, either cause the S-4 Registration
Statement to include, or promptly file a new registration
statement with the Commission which will include, a Prospectus
which shall provide for resales of the Shares by Holders thereof
which have provided the information required pursuant to Clause
2.3 hereof; and
(C) use its reasonable best efforts to cause such Registration
Statement to be declared effective by the Commission as soon as
practicable, but in no event later than the Publication Date; and
use its reasonable best efforts to register or qualify the Shares
covered by such Registration Statement under such other
securities or blue sky laws of such jurisdiction within the
United States as shall be reasonably appropriate for the
distribution of the Shares covered by the Registration Statement;
provided, however, that the Company shall not be required in
connection therewith or as a condition thereto to qualify to do
business in or to file a general consent to service of process in
any jurisdiction wherein it would not but for the requirements of
this Clause 2.1(C) be obligated to do so; and provided, further,
that the Company shall not be required to qualify such Shares in
any jurisdiction in which the securities regulatory authority of
such jurisdiction requires that a Holder participating in such
registration submit any of its Shares to the terms, provisions
and restrictions of any escrow, lockup or similar agreement(s)
for consent to sell Shares in such jurisdiction unless such
Holder agrees to do so;
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<PAGE> 4
(D) ensure that all of the Shares received by Shareholders in the
Offer will be fully registered, will include no legend thereon
restricting the transfer thereof, will be subject to no stop
order or other restriction on transfer except as provided in this
Agreement and will be approved for listing on the NASDAQ - NMS
and EASDAQ; and
(E) use its reasonable best efforts to keep such Registration
Statement continuously effective, supplemented and amended as
necessary to ensure that it is continuously available for resales
of Shares by the Holders entitled to the benefit of this
Agreement, to ensure that it conforms with the requirements of
this Agreement, the Securities Act and the policies of the
Commission as announced from time to time, through the period
ending on the Effectiveness End Date; provided, however, that for
30 days or less (whether or not consecutive) in any 12-month
period, the Company shall be permitted to suspend resales of the
Shares pursuant to the Registration Statement if the Registration
Statement is no longer effective or the Prospectus included
therein is no longer useable for resales due to certain
circumstances relating to pending corporate developments, public
filings with the Commission and similar events, or because such
Prospectus contains an untrue statement of a material fact or
omits to state a material fact required to be stated therein or
necessary in order to make the statements therein not misleading;
provided, further, that in no event shall the Company be required
to keep the Registration Statement effective beyond the
Effectiveness End Date.
2.2 FAILURE TO KEEP REGISTRATION STATEMENT EFFECTIVE
If the Company shall fail to keep the Registration Statement
continuously effective or the Prospectus included therein useable for
resales in accordance with the proviso in Clause 2.1(E) or upon the
occurrence of an event contemplated by Clause 3.1(A) or 3.1(C)(iv), it
shall give Holders notice to suspend the resale of Shares pursuant to
the Registration Statement and will deduct from the 30-day period
referred to in Clause 2.1(E) the number of days during the period from
and including the date of the giving of notice to Holders of such
occurrence to and including the date when such Holders have received
copies of the supplemented or amended Prospectus necessary to permit
resales of Shares or to and including the date on which the Company has
given notice to Holders that the resale of the Shares pursuant to the
Registration Statement may be resumed, as the case may be.
2.3 PROVISION BY HOLDERS OF CERTAIN INFORMATION IN CONNECTION WITH THE
REGISTRATION STATEMENT
A Holder that proposes to sell Shares pursuant to the Prospectus and the
related Registration Statement shall be named as a selling security
holder in the Prospectus. Each Holder agrees to furnish promptly to the
Registrant such information as the Registrant may reasonably request for
use in connection with the Registration
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<PAGE> 5
Statement or Prospectus included therein, as well as all information
required to be disclosed in order to make the information previously
furnished to the Company by such Holder not materially misleading.
2.4 TRANSFER RESTRICTIONS
Each Shareholder agrees not to (i) sell, transfer or otherwise dispose
of, or execute any cashless exercise of stock options or warrants for
any nor (ii) enter into any arrangement to reduce such Shareholder's
risk relating to (x) any Equity Interests or (y) any Shares to be
received by such Shareholder in connection with the Offer for a period
commencing 30 days before the Closing Date and ending on the earliest of
(i) the Publication Date, (ii) the Deadline; and (iii) the date on which
the Offer ceases to qualify for "pooling of interests" accounting
treatment other than as a result of any action by such Shareholder;
provided that nothing in this Clause 2.4 shall prohibit the transfer of
Equity Interests contemplated by the Offer or the Irrevocable.
3. REGISTRATION PROCEDURES
3.1 GENERAL PROVISIONS
In connection with the Registration Statement and the Prospectus
required to be prepared by this Agreement, pursuant to the requirements
of Clause 2.1, the Registrant shall, subject to the provisions of Clause
2.3:
(A) upon the occurrence of any event that would cause any such
Registration Statement or the Prospectus contained therein (i) to
contain a material misstatement or omission, or (ii) not to be
effective and usable for resale of Shares during the period
required by this Agreement, the Registrant shall file promptly an
appropriate amendment to such Registration Statement, in the case
of Clause (i), correcting any such misstatement or omission, and,
in the case of either Clause (i) or (ii), use its reasonable best
efforts to cause such amendment to be declared effective and such
Registration Statement and the related Prospectus to become
usable for their intended purpose(s) as soon as practicable
thereafter;
(B) cause the Prospectus to be supplemented by any required
Prospectus supplement, and as so supplemented to be filed
pursuant to Rule 424 under the Securities Act, and to comply
fully with the applicable provisions of Rules 424 and 430A under
the Securities Act in a timely manner;
(C) advise each Holder promptly and, if requested by any Holder, to
confirm such advice in writing, (i) when the Prospectus or any
Prospectus supplement or post-effective amendment has been filed,
and, with respect to the Registration Statement or any post-
effective amendment thereto,
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<PAGE> 6
when the same has become effective, (ii) of any request by the
Commission for amendments to the Registration Statement or
amendments or supplements to the Prospectus or for additional
information relating thereto, (iii) of the issuance by the
Commission of any stop order suspending the effectiveness of the
Registration Statement under the Securities Act or of the
suspension by any state securities commission of the
qualification of the Shares for offering or resale in any
jurisdiction, or the initiation of any proceeding for any of the
preceding purposes, or (iv) of the existence of any fact or the
happening of any event (without requiring the Company to disclose
the nature of such fact or happening) that makes any statement of
a material fact made in the Registration Statement, the
Prospectus, any amendment or supplement thereto, or any document
incorporated by reference therein untrue in any material respect,
or that requires the making of any additions to or changes in the
Registration Statement or the Prospectus in order to make the
statements therein not misleading in any material respect. If at
any time the Commission shall issue any stop order suspending the
effectiveness of the Registration Statement, or any state
securities commission or other regulatory authority shall issue
an order suspending the qualification or exemption from
qualification of the Shares under state securities or Blue Sky
laws, the Registrant shall use its reasonable best efforts to
obtain the withdrawal or lifting of such order at the earliest
possible time;
(D) make available at reasonable times for inspection by the selling
Holders, any underwriter participating in any Underwritten
Offering pursuant to such Registration Statement, and any
attorney or accountant retained by such Holders or any of the
underwriter(s), all financial and other records, pertinent
corporate documents and properties of the Registrant and cause
the Registrant's officers, trustees, directors, managers and
employees to supply all information reasonably requested by any
such Holder, underwriter, attorney or accountant in connection
with such Registration Statement subsequent to the filing thereof
and prior to its effectiveness or in connection with any
amendment or supplement thereto (including the filing of any
document that is to be incorporated by reference into the
Registration Statement) provided, however, that any information
that is reasonably and in good faith designated by the Company in
writing as confidential at the time of delivery of such
information shall be kept confidential by such Persons (and such
Persons shall so agree in writing), unless (i) disclosure of such
information is required by court or administrative order or is
necessary to respond to inquiries of regulatory authorities, (ii)
disclosure of such information is required by law (including any
disclosure requirements pursuant to federal securities laws in
connection with the filing of the Registration Statement or the
use of the Prospectus), (iii) such information becomes generally
available to the public other than as a result of a disclosure or
failure to safeguard by any such Person or (iv) such information
becomes available to any such Person
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<PAGE> 7
from a source other than the Company and to the knowledge of such
Person, such source is not bound by a confidentiality agreement;
(E) if requested by any Holders or the underwriter(s) in any
Underwritten Offering promptly incorporate in the Registration
Statement or Prospectus, pursuant to a supplement or post-
effective amendment if necessary, such information as such
Holders and underwriter(s), if any, may reasonably request to
have included therein, including, without limitation, information
relating to the "Plan of Distribution" of the Shares being sold
to such underwriter(s), the purchase price being paid therefor
and any other terms of the offering of the Shares to be sold in
such offering; and make all required filings of such Prospectus
supplement or post-effective amendment as soon as practicable
after the Registrant is notified of the matters to be
incorporated in such Prospectus supplement or post-effective
amendment;
(F) upon request of any Holder, furnish to such Holder and each of
the underwriter(s) in any Underwritten Offering acting on behalf
of any such Holder without charge, copies of the Registration
Statement, as first filed with the Commission, and of each
amendment thereto, including all documents incorporated by
reference therein, if any, and all exhibits (including exhibits
incorporated therein by reference, if any), the Prospectus and
all other documents each such Holder may reasonably require in
order to facilitate its distribution of Shares;
(G) consent to the use of the Prospectus and any amendment or
supplement thereto by each of the Holders and each of the
underwriter(s) in any Underwritten Offering, if any, in
connection with the resale of the Shares covered by the
Prospectus or any amendment or supplement thereto;
(H) enter into such agreements (including an underwriting agreement),
and make such representations and warranties, and take all such
other actions in connection therewith in order to expedite or
facilitate the disposition of the Shares pursuant to the
Registration Statement contemplated by this Agreement, all to
such extent as may be requested by any Holder of Shares or any
underwriter in connection with any resale pursuant to the
Registration Statement contemplated by this Agreement; and in
connection with an Underwritten Offering, the Registrant shall
cause opinions and certificates to be prepared and delivered as
are customarily delivered by issuers to underwriters in primary
offerings; provided that the related underwriting agreement shall
set forth in full or incorporate by reference the
indemnification provisions and procedures of Clause 5 hereof with
respect to all parties to be indemnified pursuant to said Clause;
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<PAGE> 8
(I) cooperate with the Holders, the underwriter(s) in any
Underwritten Offering, and their respective counsel in connection
with the registration and qualification of the Shares under the
securities or Blue Sky laws of such jurisdictions as the selling
Holders or underwriter(s) may reasonably request and do any and
all other acts or things necessary or advisable to enable the
disposition in such jurisdictions of such Shares covered by the
Registration Statement;
(J) in connection with any Underwritten Offering, the Company will
agree to make available members of its senior management from
time to time upon reasonable notice at such place and times as
shall be reasonably requested for the purpose of conducting
"roadshow" type presentations for or one on one meetings with
potential purchasers of the Shares; provided, however, that such
roadshow shall be no more than five business days in duration;
(K) issue, upon the request of any Holder of Shares covered by the
Registration Statement, a number of shares of Common Stock equal
to the number of shares of Common Stock surrendered to the
Registrant by such Holder in exchange therefor or being resold by
such Holder; such Common Stock to be registered in the name of
such Holder or in the name of the purchaser(s) of such Common
Stock, as the case may be; in return, the Common Stock held by
such Holder shall be surrendered to the Registrant for
cancellation;
(L) cooperate with the Holders and the underwriter(s) in any
Underwritten Offering to facilitate the timely preparation and
delivery of certificates representing Common Stock to be sold;
and enable such Shares to be in such denominations and registered
in such names as the Holders or the underwriter(s), if any, may
request at least two Business Days prior to any resale of Shares
made by such underwriter(s); and
(M) cooperate and assist in any filings required to be made with the
NASD and in the performance of any due diligence investigation by
any underwriter (including any "qualified independent
underwriter") that is required to be retained in accordance with
the rules and regulations of the NASD.
3.2 Each Holder agrees that, upon receipt of any notice from the Registrant
of the existence of any fact of the kind described in Clause 3.1(A) or
3.1(C)(iv), such Holder will forthwith discontinue disposition of the
Shares pursuant to the Registration Statement until such Holder's
receipt of the copies of the supplemented or amended Prospectus
contemplated by Clauses 3.1(A) and 3.1(C)(i), or until it is advised in
writing (the "Advice") by the Registrant that the use of the Prospectus
may be resumed, and has received copies of any additional or
supplemental filings that are incorporated by reference in the
Prospectus; provided that nothing herein
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<PAGE> 9
shall limit the right of any Holder to sell or otherwise dispose of the
Shares pursuant to any available exemption under the Securities Act.
4. REGISTRATION EXPENSES
All expenses incident to the Registrant's performance of or compliance with
this Agreement in connection with Underwritten Offerings will be borne by the
Participants, regardless of whether the Registration Statement becomes
effective, including without limitation: (i) all registration and filing fees
and expenses; (ii) all fees and expenses of compliance with federal securities
and state Blue Sky or securities laws; (iii) all expenses of printing,
messenger and delivery services and telephone; (iv) all fees and disbursements
of counsel for the Registrant; (v) all application and filing fees in
connection with listing the Shares on a national securities exchange or
automated quotation system or making them eligible for trading within any other
system pursuant to the requirements hereof; and (vi) all fees and disbursements
of independent certified public accountants of the Company (including the
expenses of any special audit and comfort letters required by or incident to
such performance). Notwithstanding the foregoing, in the event that other
securities of the Registrant are included in with Shares of a Holder in an
Underwritten Offering, a Holder shall only be obligated to pay its pro rata
share of such expenses.
The Registrant will, in any event, bear its internal expenses (including,
without limitation, all salaries and expenses of its officers and employees
performing legal or accounting duties), the expenses of any annual audit and
the fees and expenses of any Person, including special experts and legal
counsel, retained by the Registrant.
5. INDEMNIFICATION AND CONTRIBUTIONS
5.1 In connection with the Registration Statement, the Registrant shall
indemnify and hold harmless each Holder of Common Stock included within
the Registration Statement, and each person, if any, who controls any
such person within the meaning of the Securities Act and any underwriter
involved in any Underwritten Offering by such Holder (each, a
"Participant"), from and against any loss, claim, damage or liability,
joint or several, or any action in respect thereof (including, but not
limited to, any loss, claim, damage, liability or action relating to
purchases and sales of Common Stock) to which such Participant or
controlling person may become subject, under the Securities Act or
otherwise, insofar as such loss, claim, damage, liability or action
arises out of, or is based upon, (i) any untrue statement or alleged
untrue statement of a material fact contained in the Registration
Statement or any Prospectus or in any amendment or supplement thereto or
document incorporated by reference therein, (ii) the omission or alleged
omission to state therein a material fact required to be stated therein
or necessary to make the statements therein not misleading or (iii) a
violation or alleged violation by the Company of the Securities Act or
the Exchange Act in connection with the Registration of the Shares, and
shall reimburse each Participant promptly upon demand for any legal or
other expenses reasonably incurred by such Participant in connection
with investigating or defending or preparing to defend against any such
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<PAGE> 10
loss, claim, damage, liability or action as such expenses are incurred;
provided, however, that (i) the Registrant shall not be liable in any
such case to the extent that any such loss, claim, damage, liability or
action arises out of, or is based upon, any untrue statement or alleged
untrue statement or omission or alleged omission made in the
Registration Statement or the Prospectus forming part thereof or in any
such amendment or supplement thereto in reliance upon and in conformity
with written information furnished to the Registrant by or on behalf of
any Participant specifically for inclusion therein. The foregoing
indemnity agreement is in addition to any liability which the
Registrant may otherwise have to any Participant or to any controlling
person of that Participant.
5.2 Each Participant, severally and not jointly, shall indemnify and hold
harmless the Registrant, each of its trustees, directors, officers,
employees or agents and each person, if any, who controls the Registrant
within the meaning of the Securities Act, from and against any loss,
claim, damage or liability, joint or several, or any action in respect
thereof, to which the Registrant or any such director, officer,
employees or agents or controlling person may become subject, under the
Securities Act or otherwise, insofar as such loss, claim, damage,
liability or action arises out of, or is based upon, (i) any untrue
statement or alleged untrue statement of a material fact contained in
the Registration Statement or any Prospectus or in any amendment or
supplement thereto or (ii) the omission or alleged omission to state
therein a material fact required to be stated therein or necessary to
make the statements therein not misleading, but in each case only to the
extent that the untrue statement or alleged untrue statement or omission
or alleged omission was made in reliance upon and in conformity with
written information furnished to the Registrant by or on behalf of that
Participant specifically for inclusion therein, and shall reimburse the
Registrant and any such trustee, director, officer, employees or agents
or controlling person for any legal or other expenses reasonably
incurred by the Registrant or any such trustee, director, officer,
employees or agents or controlling person in connection with
investigating or defending or preparing to defend against any such loss,
claim, damage, liability or action as such expenses are incurred;
provided, however, that (i) the obligations of each of the Participants
hereunder shall be limited to an amount equal to the net proceeds to
such Participant of the Shares sold in connection with such Registration
and (ii) no Participant shall be liable to any such person in any such
case to the extent of any such loss, claim, damage or liability (or
action or proceeding in respect thereof), if such Participant shall
sustain the burden of proving that such Registrant, agent or underwriter
or controlling person of such underwriter, or any other Participant, as
the case may be, sold Shares to the person alleging such loss, claim,
damage or liability (or action or proceeding in respect thereof),
without sending or giving, at or prior to the written confirmation of
such sale, a copy of the applicable Prospectus (excluding any documents
incorporated by reference therein) or the applicable Prospectus, as then
amended or supplemented (excluding any documents incorporated therein),
if such Prospectus corrected such untrue statement or alleged untrue
statement or omission or alleged omission. The foregoing indemnity
10
<PAGE> 11
agreement is in addition to any liability which any Participant may
otherwise have to the Registrant or any such trustee, director, officer
or controlling person.
5.3 Promptly after receipt by an indemnified party under this Clause 5 of
notice of any claim or the commencement of any action, the indemnified
party shall, if a claim in respect thereof is to be made against the
indemnifying party under this Clause 5, notify the indemnifying party in
writing of the claim or the commencement of that action; provided,
however, that the failure to notify the indemnifying party shall not
relieve it from any liability which it may have under this Clause 5
except to the extent it has been materially prejudiced by such failure;
and provided further that the failure to notify the indemnifying party
shall not relieve it from any liability which it may have to an
indemnified party otherwise than under this Clause 5. If any such claim
or action shall be brought against an indemnified party, and it shall
have notified the indemnifying party thereof, the indemnifying party
shall be entitled to participate therein and, to the extent that it
wishes, jointly with any other similarly notified indemnifying party, to
assume the defence thereof with counsel satisfactory to the indemnified
party. After notice from the indemnifying party to the indemnified
party of its election to assume the defence of such claim or action, the
indemnifying party shall not be liable to the indemnified party under
this Clause 5 for any legal or other expenses subsequently incurred by
the indemnified party in connection with the defence thereof other than
reasonable costs of investigation; provided, however, that any
indemnified party shall have the right to employ separate counsel in any
such action and to participate in the defence thereof but the fees and
expenses of such counsel shall be at the expense of such indemnified
party unless (i) the employment thereof has been specifically authorized
by the indemnifying party in writing, (ii) such indemnified party shall
have been advised by such counsel that there may be one or more legal
defences available to it which are different from or additional to those
available to the indemnifying party and in the reasonable judgment of
such counsel it is advisable for such indemnified party to employ
separate counsel or (iii) the indemnifying party has failed to assume
the defence of such action and employ counsel reasonably satisfactory to
the indemnified party, in which case, if such indemnified party notifies
the indemnifying party in writing that it elects to employ separate
counsel at the expense of the indemnifying party, the indemnifying party
shall not have the right to assume the defence of such action on behalf
of such indemnified party, it being understood, however, that the
indemnifying party shall not, in connection with any one such action or
separate but substantially similar or related actions in the same
jurisdiction arising out of the same general allegations or
circumstances, be liable for the reasonable fees and expenses of more
than one separate firm of attorneys at any time for all such indemnified
parties, which firm shall be designated in writing by the indemnifying
party. No indemnifying party shall (i) without the prior written
consent of the indemnified parties (which consent shall not be
unreasonably withheld), settle or compromise or consent to the entry of
any judgment with respect to any pending or threatened claim, action,
suit or proceeding in respect of which indemnification or contribution
may be sought hereunder (whether or not the indemnified parties are
actual or potential parties to
11
<PAGE> 12
such claim or action) unless such settlement, compromise or consent
includes an unconditional release of each indemnified party from all
liability arising out of such claim, action, suit or proceeding, or (ii)
be liable for any settlement of any such action effected without its
written consent (which consent shall not be unreasonably withheld), but
if settled with its written consent or if there be a final judgment of
the plaintiff in any such action, the indemnifying party agrees to
indemnify and hold harmless any indemnified party from and against any
loss of liability by reason of such settlement or judgment.
5.4 If the indemnification provided for in this Clause 5 shall for any
reason be unavailable to or insufficient to hold harmless an indemnified
party under Clause 5.1 or 5.2 in respect of any loss, claim, damage or
liability, or any action in respect thereof, referred to therein, then
each indemnifying party shall, in lieu of indemnifying such indemnified
party, contribute to the amount paid or payable by such indemnified
party as a result of such loss, claim, damage or liability, or action in
respect thereof, in such proportion as shall be appropriate to reflect
the relative fault of the Registrant on the one hand and the
Participants on the other with respect to the statements or omissions
which resulted in such loss, claim, damage or liability, or action in
respect thereof, as well as any other relevant equitable considerations.
The relative fault shall be determined by reference to whether the
untrue or alleged untrue statement of a material fact or omission or
alleged omission to state a material fact relates to information
supplied by the Registrant or the Participants, the intent of the
parties and their relative knowledge, access to information and
opportunity to correct or prevent such statement or omission. The
Registrant and the Participants agree that it would not be just and
equitable if contributions pursuant to this Clause 5.4 were to be
determined by pro rata allocation (even if the Participants were treated
as one entity for such purpose) or by any other method of allocation
which does not take into account the equitable considerations referred
to herein. The amount paid or payable by an indemnified party as a
result of the loss, claim, damage or liability, or action in respect
thereof, referred to above in this Clause 5.4 shall be deemed to
include, for purposes of this Clause 5.4, any legal or other expenses
reasonably incurred by such indemnified party in connection with
investigating or defending any such action or claim. Notwithstanding
the provisions of this Clause 5.4, no Participant shall be required to
contribute any amount in excess of the amount by which the total
proceeds received by such Participant with respect to the sale of its
Shares exceeds the amount of any damages which such Participant has
otherwise paid or become liable to pay by reason of any untrue or
alleged untrue statement or omission or alleged omission. No person
guilty of fraudulent misrepresentation (within the meaning of Section
11(f) of the Securities Act) shall be entitled to contribution from any
person who was not guilty of such fraudulent misrepresentation. The
Participants' obligations to contribute as provided in this Clause 5.4
are several and not joint.
12
<PAGE> 13
6. SELECTION OF UNDERWRITERS
Each Holder may sell Shares in an Underwritten Offering administered by an
investment banker or investment bankers or manager or managers to be selected
by the Registrant with the consent of a majority-in-interest of such Holders
participating in such Underwritten Offering (not to be unreasonably withheld,
it being understood that, among other factors, the fees to be paid to such
investment bank shall be a reasonable factor in determining whether such
Holder's consent is reasonable); provided, however, that the Registrant shall
have the right to delay any such Underwritten Offering by a period not to
exceed 45 days in the event such Underwritten Offering would, in the reasonable
judgment of the Registrant prevent or delay any other transaction being
considered by the Registrant or in the event such delay is necessary to comply
with any "quiet periods" under applicable securities regulations or the
requirements of any applicable securities exchange.
7. MISCELLANEOUS
7.1 REMEDIES
The Company agrees that monetary damages would not be adequate
compensation for any loss incurred by reason of a breach by it of the
provisions of this Agreement and hereby agree to waive the defence in
any action for specific performance that a remedy at law would be
adequate.
7.2 NO INCONSISTENT AGREEMENTS
The Company has not previously entered into any agreement granting any
registration rights with respect to its securities to any Person that
has not already been publicly filed with the Commission. The Company
represents and warrants that rights granted to the Holders hereunder do
not in any way conflict with and are not inconsistent with the rights
granted to the holders of the Company's securities under any agreement
in effect on the date hereof.
7.3 AMENDMENTS AND WAIVERS
The provisions of this Agreement may not be amended, modified or
supplemented, and waivers or consents to or departures from the
provisions hereof may not be given unless the Company has obtained the
written consent of Holders of a majority of the outstanding principal
amount of Shares.
7.4 NOTICES
All notices and other communications provided for or permitted hereunder
shall be made in writing by hand-delivery, first-class mail (registered
or certified, return receipt requested), telex, telecopier, or air
courier guaranteeing overnight, or, in the case of international
deliveries, two business days, delivery:
13
<PAGE> 14
(A) if to a Holder, at the address set forth on the records of
Esprit; and
(B) if to the Company: Global TeleSystems, Inc., 1751 Pinnacle Drive,
North Tower, McLean, Virginia 22102, Attn: General Counsel.
All such notices and communications shall be deemed to have been duly
given: at the time delivered by hand, if personally delivered, five
Business Days after being deposited in the mail, postage prepaid, if
mailed; when answered back, if telexed; when receipt acknowledged, if
telecopied; and on the next Business Day, if timely delivered to an
internationally recognized air courier guaranteeing overnight, or, in
the case of international deliveries, two business days, delivery.
7.5 SUCCESSORS AND ASSIGNS
This Agreement shall inure to the benefit of and be binding upon the
successors and assigns of each of the parties, including without
limitation and without the need for an express assignment, subsequent
Holders of Shares; provided, however, that this Agreement shall not
inure to the benefit of or be binding upon a successor or assign of a
Holder unless and to the extent such successor or assign acquired Common
Stock from such Holder.
7.6 COUNTERPARTS
This Agreement may be executed in any number of counterparts and by the
parties hereto in separate counterparts, each of which when so executed
shall be deemed to be an original and all of which taken together shall
constitute one and the same agreement.
7.7 HEADINGS
The headings in this Agreement are for convenience of reference only and
shall not limit or otherwise affect the meaning hereof.
7.8 GOVERNING LAW
This agreement and the rights and duties of the parties hereunder shall
be governed by and construed in accordance with the laws of the State of
New York.
7.9 CONSENT TO JURISDICTION
To the fullest extent permitted by applicable law, the Company and each
Holder irrevocably submits to the non-exclusive jurisdiction of any
federal or state court in the Borough of Manhattan in the City of New
York, County and State of New York or the City of McLean, the
Commonwealth of Virginia, United States of America, in any suit or
proceeding based on or arising under this Agreement, and irrevocably
agrees that all claims in respect of such suit or proceeding may be
14
<PAGE> 15
determined in any such court. The Company and each Holder, to the
fullest extent permitted by applicable law, irrevocably and fully waives
the defence of an inconvenient forum to the maintenance of such suit or
proceeding and hereby irrevocably designates and appoints Shearman &
Sterling (the "Authorized Agent"), as its authorized agent upon whom
process may be served in any such suit or proceeding. The Company
represents that it has notified the Authorized Agent of such designation
and appointment and that the Authorized Agent has accepted the same in
writing. The Company hereby irrevocably authorizes and directs its
Authorized Agent to accept such service. The Company further agrees
that service of process upon its Authorized Agent and written notice of
said service to the Company mailed by first class mail or delivered to
its Authorized Agent shall be deemed in every respect effective service
of process upon the Company in any such suit or proceeding. Nothing
herein shall affect the right of any person to serve process in any
other manner permitted by law. The Company agrees that a final action
in any such suit or proceeding shall be conclusive and may be enforced
in other jurisdictions by suit on the judgment or in any other lawful
manner.
The Company and each Holder hereby irrevocably waives, to the extent
permitted by law, any immunity to jurisdiction to which it may otherwise
be entitled (including, without limitation, immunity to pre-judgment
attachment, post-judgment attachment and execution) in any legal suit,
action or proceeding against it arising out of or based on this
Agreement or the transactions contemplated hereby.
The provisions of this Clause 7.9 are intended to be effective upon the
execution of this Agreement without any further action by the Company
and the introduction of a true copy of this Agreement into evidence
shall be conclusive and final evidence as to such matters.
7.10 SEVERABILITY
In the event that any one or more of the provisions contained herein, or
the application thereof in any circumstance, is held invalid, illegal or
unenforceable, the validity, legality and enforceability of any such
provision in every other respect and of the remaining provisions
contained herein shall not be affected or impaired thereby.
7.11 ENTIRE AGREEMENT
This Agreement is intended by the parties as a final expression of their
agreement and intended to be a complete and exclusive statement of the
agreement and understanding of the parties hereto in respect of the
subject matter contained herein. There are no restrictions, promises,
warranties or undertakings, other than those set forth or referred to
herein with respect to the registration rights granted by the Registrant
with respect to the Shares. This Agreement supersedes all prior
15
<PAGE> 16
agreements and understandings between the parties with respect to such
subject matter.
16
<PAGE> 17
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date
first written above.
GLOBAL TELESYSTEMS GROUP INC.
By: GERALD THAMES
----------------------------
APAX FUNDS NOMINEES LIMITED
By: ANDREW BARRETT
----------------------------
WARBURG, PINCUS VENTURES, L.P.
BY: E.M. WARBURG, PINCUS & CO., LLC
MANAGER
By: ROBERTO ITALIA
----------------------------
For and on behalf of Dominic
Shorthouse Member
17
<PAGE> 1
EXHIBIT 23.2
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the use of our report dated February 26, 1998, except for Note 17,
as to which the date is November 12, 1998 (Global TeleSystems Group, Inc.), in
the Registration Statement (Form S-4 No. 333- ) and related Prospectus of
Global TeleSystems Group, Inc. dated on or about December 8, 1998.
Ernst & Young LLP
Vienna, Virginia
December 4, 1998
<PAGE> 1
EXHIBIT 23.3
CONSENT OF ERNST & YOUNG(CIS) LTD., INDEPENDENT AUDITORS
We consent to the use of our reports dated February 16, 1998, except for Note
12, as to which the date is November 12, 1998 (EDN Sovintel), in the
Registration Statement (Form S-4 No. 333- ) and related Prospectus of Global
TeleSystems Group, Inc. dated on or about December 8, 1998.
Ernst & Young(CIS) Ltd.
Moscow, Russia
December 4, 1998
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